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, 2000
Commission File Number 0-4690
FINANCIAL INDUSTRIES CORPORATION
(Exact Name of Registrant as specified in its charter)
Texas 74-2126975
(State of Incorporation) (I.R.S. Employer Identification Number)
6500 River Place Boulevard, Building I
Austin, Texas 78730
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (512) 404-5000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Number of common shares outstanding ($.20 par value) at end of period:5,054,661.
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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, 2000 and December 31, 1999....................................3
Consolidated Statements of Income
For the three and six month periods ended
June 30, 2000 and June 30, 1999.......................................5
Consolidated Statements of Cash Flows
For the three and six month periods ended
June 30, 2000 and June 30, 1999.......................................9
Notes to Consolidated Financial Statements....................................13
Item 2. Management's Discussion and Analysis of
Financial Conditions and Results of Operations.......................15
Item 3. Quantitative and Qualitative Disclosures
About Market Risk ...... .......................................20
Part II
Other Information............................................................23
Signature Page...............................................................24
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<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION> June 30, December 31,
2000 1999
----------- ---------
(unaudited)
<S> <C> <C>
ASSETS
Investments other than investments
in affiliate:
Fixed maturities available for sale
at market value (amortized cost of
$81,571 and $78,252 at June 30,
2000 and December 31, 1999, respectively) $ 80,851 $ 77,515
Equity securities at market (cost
approximates $11
at June 30, 2000 and December 31, 1999) 4 4
Policy loans 3,603 3,595
Short-term investments 16,290 24,839
----------------- ----------------
Total investments 100,748 105,953
Cash 1,181 692
Investment in affiliate 73,503 70,013
Accrued investment income 1,244 1,180
Agency advances and other receivables 6,873 6,885
Reinsurance receivables 16,369 14,848
Due and deferred premiums 12,515 12,392
Property and equipment, net 1,318 1,355
Deferred policy acquisition costs 54,240 52,490
Present value of future profits
of acquired businesses 21,237 23,109
Other assets 4,791 4,758
Separate account assets 0 379
-------------------- ------------------
Total Assets $ 294,019 $ 294,054
============== ==============
</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, December31,
2000 1999
------------ ----------
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
Liabilities:
Policy liabilities and contract holder
deposit funds:
Future policy benefits $ 61,394 $ 59,783
Contract holder deposit funds 43,527 44,681
Unearned premiums 14 14
Other policy claims and benefits payable 3,734 4,282
------------------ -----------------
108,669 108,760
Subordinated notes payable to affiliate 38,423 41,497
Deferred federal income taxes 23,098 23,222
Other liabilities 3,750 4,079
Separate account liabilities 0 379
------------------- ------------------
Total Liabilities 173,940 177,937
-------------- ---------------
Commitments and Contingencies
Shareholders' equity:
Common stock, $.20 par value, 10,000,000
shares authorized; 5,845,300 shares
issued, 5,054,661 outstanding
in 2000 and 1999 1,169 1,169
Additional paid-in capital 7,225 7,225
Accumulated other comprehensive income (2,006) (2,454)
Retained earnings 121,066 117,552
--------------- ---------------
127,454 123,492
Common treasury stock, at cost, 790,639
at 2000 and 1999. (7,375) (7,375)
----------------- ----------------
Total Shareholders' Equity 120,079 116,117
--------------- --------------
Total Liabilities and Shareholders' Equity $ 294,019 $ 294,054
============== ==============
</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,
2000 1999
------------ --------
(unaudited)
<S> <C> <C>
Revenues:
Premiums $ 8,443 $ 9,101
Net investment income 1,700 1,701
Earned insurance charges 1,225 1,209
Other 3 297
----------------- -----------------
11,371 12,308
Benefits and expenses:
Policyholder benefits and expenses 3,870 4,192
Interest expense on contract holders
deposit funds 469 467
Amortization of present value of future
profits of acquired businesses 856 1,402
Amortization of deferred policy
acquisition costs 1,094 1,180
Operating expenses 2,991 2,806
Interest expense 484 552
----------------- ------------------
9,764 10,599
---------------- ----------------
Income before federal income tax and
equity in net earnings of affiliates 1,607 1,709
Provision for federal income taxes 319 434
---------------- --------------
Income before equity in net earnings
of affiliates 1,288 1,275
Equity in net earnings of affiliate,
net of tax 917 526
--------------- ------------------
Net Income $ 2,205 $ 1,801
============= ================
</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,
2000 1999
---------- ---------
(unaudited)
<S> <C> <C>
Net Income Per Share
Basic:
Average weighted shares
outstanding 5,055 5,055
=================== ==================
Basic earnings per share $ 0.44 $ 0.36
=================== ==================
Diluted:
Common stock and common stock equivalents 5,168 5,194
=================== ==================
Diluted earnings per share $ 0.43 $ 0.35
=================== ==================
</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>
Six Months Ended June 30,
2000 1999
------------ --------
(unaudited)
<S> <C> <C>
Revenues:
Premiums $ 16,844 $ 17,682
Net investment income 3,440 3,454
Earned insurance charges 2,372 2,585
Other 3 702
---------------------- --------------------
22,659 24,423
Benefits and expenses:
Policyholder benefits and
expenses 7,221 7,933
Interest expense on contract
holders deposit funds 1,059 972
Amortization of present value of
future profits of acquired
businesses 1,872 2,612
Amortization of deferred policy
acquisition costs 2,443 2,383
Operating expenses 5,938 5,722
Interest expense 1,012 1,250
----------------- ------------------
Total 19,545 20,872
---------------- -----------------
Income before federal income tax
and equity in net earnings
of affiliates 3,114 3,551
Provision for federal income taxes 578 773
------------------ -------------------
Income before equity in net
earnings of affiliates 2,536 2,778
Equity in net earnings of affiliate,
net of tax 1,883 1,291
------------------ ------------------
Net Income $ 4,419 $ 4,069
================= =================
</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,
2000 1999
------------ ---------
<S> <C> <C>
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding 5,055 5,055
================== =================
Basic earnings per share $ 0.87 $ 0.81
================== =================
Diluted:
Common stock and common
stock equivalents 5,167 5,201
================== =================
Diluted earnings per share $ 0.86 $ 0.78
================== =================
</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,
2000 1999
------------- ---------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income 2,205 $ 1,801
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of present value of future
profits of acquired business 856 1,402
Amortization of deferred policy
acquisition costs 1,094 1,180
Equity in undistributed earnings of
affiliate (1,505) (1,164)
Changes in assets and liabilities:
Increase in accrued investment income (113) (186)
(Increase) Decrease in agent advances
and other receivables (1 ,252) 142
Increase in due and deferred premiums (260) (458)
Increase in deferred policy
acquisition costs (2,222) (2,451)
(Increase)Decrease in other assets (133) 180
(Increase)Decrease in policy liabilities
and accruals 129 (927)
Increase (Decrease) in other liabilities 136 (761)
(Decrease) in deferred federal
income taxes (77) (298)
Other, net 445 (2)
---------------- ---------------------
Net cash used in operating activities $ (697) $ (1,542)
--------------- ----------------
</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,
2000 1999
------------ --------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (8,826) $ (2,996)
Proceeds from sales and maturities of
fixed maturities 6,406 3,486
Increase in policy loans (5) (44)
Net change in short-term investments 5,837 1,877
Purchase & retirement of property
and equipment 37 0
---------------- ----------------
Net cash provided by
investing activities 3,449 2,323
-------------- -------------
CASH FLOW FROM FINANCING
ACTIVITIES
Dividends Paid (907) 0
Repayment of subordinated notes payable (1,537) (1,537)
-------------- --------------
Net cash used in financing activities (2,444) (1,537)
-------------- --------------
Net Increase (Decrease) in cash 308 (756)
Cash, beginning of period 873 1,758
------------- --------------
Cash, end of period $ 1,181 $ 1,002
============= =============
</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,
2000 1999
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES
Net Income $ 4,419 $ 4,069
Adjustments to reconcile net income to
net cash provided
by operating activities:
Amortization of present value of future
profits of acquired business 1,872 2,612
Amortization of deferred policy
acquisition costs 2,443 2,383
Equity in undistributed earnings of
affiliate (3,031) (2,478)
Changes in assets and liabilities:
(Increase) Decrease in accrued
investment income (64) 42
Increase in agent advances and
other receivables (1,509) (827)
Increase in due and deferred premiums (123) (261)
Increase in deferred policy
acquisition costs (4,193) (4,508)
(Increase)Decrease in other assets (33) 521
Decrease in policy liabilities
and accruals (91) (845)
(Decrease) in other
liabilities (329) (1,413)
(Decrease) in deferred
federal income taxes (124) (160)
Other, net 305 (71)
---------------- --------------------
Net cash used in operating activities $ (458) $ (936)
-------------- -----------------
</TABLE>
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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,
2000 1999
-------------- --------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (10,288) $ (9,996)
Proceeds from sales and maturities
of fixed maturities 6,638 13,255
Increase in policy loans (8) (122)
Net change in short-term investments 8,549 (726)
Purchase & retirement of property
and equipment 37 0
---------------- ----------------
Net cash provided by
investing activities 4,928 2,411
-------------- -------------
CASH FLOW FROM FINANCING
ACTIVITIES
Dividends Paid (907) 0
Repayment of subordinated
notes payable (3,074) (3,074)
--------------- -------------
Net cash used in
financing activities (3,981) (3,074)
------------- -------------
Net Increase (Decrease) in cash 489 (1,599)
Cash, beginning of year 692 2,601
-------------- --------------
Cash, end of period $ 1,181 $ 1,002
============= =============
</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, 1999, previously filed with the Commission for
financial statements prepared in accordance with GAAP. Certain prior year
amounts have been reclassified to conform with current year presentation.
The consolidated financial statements include the accounts of Financial
Industries Corporation ("FIC") and its wholly-owned subsidiaries. The investment
of FIC in InterContinental Life Corporation ("ILCO") is presented using the
equity method. All significant intercompany items and transactions have been
eliminated.
Other Comprehensive Income (Loss)
The following is a reconciliation of accumulated other comprehensive income
(loss)from December 31, 1999 to June 30, 2000 (in thousands):
<TABLE>
<CAPTION>
Net Total
Net unrealized appreciation accumulated
gain on investments (depreciation) other
in fixed maturities of equity comprehensive
available for sale securities income (loss)
------------------ ----------- ------
<S> <C> <C> <C>
Balance at December 31, 1999 $ (2,454) $ (0) $ (2,454)
Current Period Change 451 (3) 448
----------- ---------- -----------
Balance at June 30, 2000 $ (2,003) $ (3) $ (2,006)
========= ========= =========
</TABLE>
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<PAGE>
New Accounting Pronouncements
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. FAS 133 is applicable to financial statements for all fiscal
quarters of fiscal years beginning after June 15, 2000, as amended by FAS No.
137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of FAS No.133." As the Company does not have significant
investments in derivative financial instruments, the adoption of FAS No. 133 is
not anticipated to have a material impact on the Company's results of
operations, liquidity or financial position.
Dividends Declared
On January 17, 2000, FIC's Board of Directors approved an annual cash dividend
in the amount of $.18 per common share. The dividend was paid on April 12, 2000
to shareholders of record on April 5, 2000.
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<PAGE>
Item 2. Management's Discussion and Analysis of Financial Conditions and
Results of Operation
-----------------------------------------------------------------------
The following discussion addresses the results of operations of Financial
Industries Corporation ("FIC") for the six months ended June 30, 2000 compared
with the same six-month period last year, and the financial condition as of
June 30, 2000, compared with December 31, 1999.
For the six-month period ended June 30, 2000, FIC's net income was $4,419,000
(basic earnings of $0.87 per common share, or diluted earnings of $0.86 per
common share) as compared to $4,069,000 (basic earnings of $0.81 per common
share, or diluted earnings of $0.78 per common share) in the first six months of
1999. Earnings per share are stated in accordance with the requirements of FAS
No. 128, which establishes two measures of earnings per share: basic earnings
per share and diluted earnings per share. Basic earnings per share is computed
by dividing income available to common shareholders by the weighted average
number of common shares outstanding during the period. Diluted earnings per
share reflect the potential dilution that would occur if securities or other
contracts to issue common stock were converted or exercised.
On January 17, 2000, FIC's Board of Directors approved an annual cash dividend
in the amount of $.18 per common share. The dividend was paid on April 12, 2000,
to record holders as of the close of business on April 5, 2000. The dividend was
paid with respect to each share of common stock which is issued on the record
date, except for shares owned directly by FIC.
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, 2000, was $3,114,000 (on revenues of
$22,659,000), as compared to $3,551,000 (on revenues of $24,423,000) in the
first six months of 1999.
Premiums for the first six months of 2000, net of reinsurance ceded, were $16.8
million, as compared to $17.7 million in the first six months of 1999.
Policyholder benefits and expenses were $7.2 million in the second quarter of
2000, as compared to $7.9 million in the first six months of 1999.
As of June 30, 2000, the market value of the fixed maturities available for sale
segment was $80.9 million as compared to an amortized cost of $81.6 million, or
an unrealized loss of $0.7 million. The decrease reflects unrealized losses on
such investments related to changes in interest rates subsequent to the purchase
of such investments. The net of tax effect of this decrease ($0.46 million at
June 30, 2000) has been recorded as an decrease in shareholders' equity. As
required under the provisions of FAS No. 130, the determination of "Accumulated
other comprehensive loss" includes separate identification of the change in
values which occurred during the current period.
The operating strategy of the Company's management emphasizes several key
objectives: expense management; marketing of competitively priced insurance
products which are designed to generate an acceptable level of profitability;
maintenance of a high quality portfolio of investment grade securities; and the
provision of quality customer service.
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<PAGE>
Equity in Net Income of InterContinental Life Corporation
General
For the six-month period ended June 30, 2000, the Company's equity in the net
earnings of InterContinental Life Corporation ("ILCO"), net of federal income
tax, was $1,883,000, as compared to $1,291,000 for the first six months of 1999.
As of June 30, 2000, FIC owned 3,590,292 shares of ILCO's common stock. In
addition, FIC's wholly- owned life insurance subsidiary, Family Life Insurance
Company ("Family Life"), owned 342,400 shares of ILCO common stock. As a result,
as of June 30, 2000, FIC owned, directly and indirectly through Family Life,
3,932,692 shares (approximately 47.9 %) of ILCO's common stock.
As of June 30, 2000, the market value of ILCO's fixed maturities available for
sale segment was $443.4 million as compared to an amortized cost of $451.7
million, or an unrealized loss of $8.3 million. The decrease reflects unrealized
losses on such investments related to changes in interest rates subsequent to
the purchase of such investments. Since FIC owns approximately 47.9 % of the
common stock of ILCO, the net of tax effect of this decrease ($2.6 million at
June 30, 2000) is included in "Accumulated other comprehensive loss" on the
Consolidated Balance Sheets and has been recorded as a decrease in
shareholders' equity.
Liquidity and Capital Resources of ILCO
ILCO is a holding company whose principal assets consist of the common stock of
Investors Life Insurance Company of North America ("Investors-NA") and its
subsidiary, Investors Life Insurance Company of Indiana ("Investors-IN"). Prior
to June 30, 2000, ILCO's primary source of funds consisted of payments under the
surplus debentures from Investors-NA.
Prior to June 30, 2000, ILCO's principal source of liquidity consisted of the
periodic payment of principal and interest to it by Investors-NA, pursuant to
the terms of two surplus debentures (the "Surplus Debentures"). The Surplus
Debentures were originally issued by Standard Life Insurance Company and their
terms were previously approved by the Mississippi Insurance Commissioner. In
connection with the 1993 merger of Standard Life into Investors-NA, the
obligations of the Surplus Debentures were assumed by Investors-NA. As of June
30, 2000, the outstanding principal balance of the Surplus Debentures was
completely paid off.
For periods subsequent to June 30, 2000, ILCO's available source of liquidity
would be from dividends paid to it from its subsidiaries, Investors-NA and
Investors-IN. Applicable state insurance laws may limit the ability of such
subsidiaries to pay dividends to ILCO. Investors-NA is domiciled in the State of
Washington. The Washington insurance law includes the "greater of" standard for
payment of dividends to shareholders, but has a requirement that prior
notification of a proposed dividend be given to the Washington Insurance
Commissioner and that cash dividends may be paid only from earned surplus. Under
the "greater of" standard, an insurer may pay a dividend in an amount equal to
the greater of (i) 10% of the policyholder surplus or (ii) the insurer's net
gain from operations for the previous year. As of June 30,
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<PAGE>
2000, Investors-NA had earned surplus of $ 55.3 million.
Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance
law, a domestic insurer may make dividend distributions upon proper notice to
the Department of Insurance, as long as the distribution is reasonable in
relation to adequate levels of policyholder surplus and quality of earnings.
Under Indiana law the dividend must be paid from earned surplus. Extraordinary
dividend approval would be required where a dividend exceeds the greater of 10%
of surplus or the net gain from operations for the prior fiscal year.
Investors-IN had earned surplus of $19.0 million at June 30, 2000. In June,
1999, Investors-IN paid a dividend in the amount of $3 million to its sole
shareholder, Investors-NA. The amount of the dividend was less than the net gain
from operations for the prior fiscal year; accordingly, no prior approval was
required for the payment of the dividend. Advance notice of the payment was
provided to the Indiana Department of Insurance, in accordance with the
provisions of the Indiana Insurance Code.
The Form 10-Qs of ILCO for the six-month periods ended June 30, 2000 and June
30,1999, set forth the business operations and financial results of ILCO and its
life insurance subsidiaries. Such 10-Q reports of ILCO, including the discussion
by ILCO's management under the caption "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" are incorporated herein by
reference.
Liquidity and Capital Resources
FIC is a holding company whose principal assets consist of the common stock of
Family Life and its equity ownership in ILCO. FIC's primary sources of capital
consists of cash flow from operations of its subsidiaries.
The cash requirements of FIC and its subsidiaries consist primarily of its
service of the indebtedness created in connection with its ownership of Family
Life. As of June 30, 2000, the outstanding balance of such indebtedness was
$38.4 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, 2000,
the statutory capital and surplus of Family Life was $24.2 million, an amount
substantially in excess of the surplus floor. As of June 30, 2000, the principal
balance of the Surplus Debenture was $9.88 million. The funds required by Family
Life to meet its obligations under the terms of the Surplus Debenture are
generated primarily from premium payments from policyholders, investment income
and the proceeds from the sale and redemption of portfolio investments.
Washington's insurance code includes the "greater of" standard for dividends but
has requirements that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and that cash
- 17 -
<PAGE>
dividends may be paid only from earned surplus. Family Life does not presently
have earned surplus as defined by the regulations adopted by the Washington
Insurance Commissioner and, therefore, is not permitted to pay cash dividends.
However, since the new law applies only to dividend payments, the ability of
Family Life to make principal and interest payments under the Surplus Debenture
is not affected. The Company does not anticipate that Family Life will have any
difficulty in making principal and interest payments on the Surplus Debenture in
the amounts necessary to enable Family Life Corporation to service its
indebtedness for the foreseeable future.
The sources of funds for Family Life consist of premium payments from
policyholders, investment income and the proceeds from the sale and redemption
of portfolio investments. These funds are applied primarily to provide for the
payment of claims under insurance and annuity policies, operating expenses,
taxes, investments in portfolio securities, shareholder dividends and payments
under the provisions of the Surplus Debenture.
FIC's net cash flow provided by operating activities was $(0.5) million in the
first six months of 2000, as compared to $(0.9) million in the first six months
of 1999. Net cash flow used in financing activities was $(4.0) million in the
first six months of 2000, as compared to $(3.1) million in the first six months
of 1999.
The guaranty commitments of FIC under the loans incurred in connection with the
acquisition of Family Life (after taking into account the repayments and new
loans which occurred in July, 1993) relate to: (i) the $22.5 million note issued
by Family Life Corporation to Investors Life Insurance Company of North America
and (ii) the $34.5 million loaned by Investors-NA to two subsidiaries of FIC.
Management believes that its cash, cash equivalents and short term investments
are sufficient to meet the needs of its business and to satisfy debt service.
There are no trends, commitments or capital asset requirements that are expected
to have an adverse effect on the liquidity of FIC.
Investments
As of June 30, 2000, the Company's investment assets totaled $100.75 million, as
compared to $105.95 million as of December 31, 1999.
The level of short-term investments at June 30, 2000 was $16.3 million, as
compared to $24.8 million as of December 31, 1999. The fixed maturities
available for sale portion represents $80.9 million of investment assets as of
June 30, 2000, as compared to $77.5 million at December 31, 1999. The amortized
cost of fixed maturities available for sale as of June 30, 2000 was $81.6
million representing a net unrealized loss of $0.7 million. This unrealized loss
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.
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<PAGE>
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, 2000, consisted
solely of fixed maturities investments which, in the annual statements of the
companies, as filed with state insurance departments, were designated under the
National Association of Insurance Commissioners ("NAIC") rating system as a "1"
(highest quality).
The investments of Family Life and ILCO's insurance subsidiaries in
mortgage-backed securities included collateralized mortgage obligations ("CMOs")
of $22.10 million and $179.1 million, respectively, and mortgage-backed
pass-through securities of $9.3 million and $46.7 million, respectively, at June
30, 2000. Mortgage-backed pass-through securities, sequential CMO's and support
bonds, which comprised approximately 50.8 % of the book value of FIC's
mortgage-backed securities and 55.9 % of the book value of ILCO's
mortgage-backed securities at June 30, 2000, are sensitive to prepayment and
extension risks. ILCO and FIC have reduced the risk of prepayment associated
with mortgage-backed securities by investing in planned amortization class
("PAC"), target amortization class ("TAC") instruments and scheduled bonds.
These investments are designed to amortize in a predictable manner by shifting
the risk of prepayment of the underlying collateral to other investors in other
tranches ("support classes") of the CMO. At June 30, 2000, PAC and TAC
instruments and scheduled bonds represented approximately 49.2 % of the book
value of FIC's mortgage-backed securities and approximately 44.1 % of the book
value of ILCO's mortgage-backed securities. Sequential and support classes
represented approximately 21.2 % of the book value of FIC's mortgage-backed
securities and approximately 35.2 % of the book value of ILCO's mortgage-backed
securities at June 30, 2000. In addition, FIC and ILCO limit the risk of
prepayment of CMOs by not paying a premium for any CMOs. ILCO and FIC do not
invest in mortgage-backed securities with increased prepayment risk, such as
interest-only stripped pass-through securities and inverse floater bonds.
Neither FIC nor ILCO had any z-accrual bonds as of June 30, 2000.
The prepayment risk that certain mortgage-backed securities are subject to is
prevalent in periods of declining interest rates, when mortgages may be repaid
more rapidly than scheduled as individuals refinance higher rate mortgages to
take advantage of the lower current rates. As a result, holders of mortgage-
backed securities may receive large prepayments on their investments which
cannot be reinvested at an interest rate comparable to the rate on the prepaying
mortgages. Neither FIC nor ILCO made additional investments in CMOs during 1999.
For the year 2000, the investment objectives of FIC and ILCO include the making
of selected investments in CMOs.
Management believes that the absence of "high-yield" or "non-investment grade"
investments (as defined above) in the portfolios of its life insurance
subsidiary enhances the ability of the Company to service its debt, provide
security to its policyholders and to credit relatively consistent rates of
return to its policyholders.
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Cautionary Statements for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform Act of 1995
Except for historical factual information set forth in this Management's
Discussion and Analysis, certain statements made in this report are forward
looking and contain information about financial results, economic conditions and
other risks and known uncertainties. The Company cautions the reader that actual
results could differ materially from those anticipated by the Company, depending
upon the eventual outcome of certain factors, including: (1) heightened
competition for new business, (2) significant changes in interest rates and (3)
adverse regulatory changes affecting the business of insurance.
Accounting Developments
In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. FAS No. 133 is applicable to financial statements for all
fiscal quarters of fiscal years beginning after June 15, 2000, as amended by FAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FAS No. 133". As the Company does not have
significant investments in derivative financial instruments, the adoption of FAS
No. 133 is not anticipated to have a material impact on the Company's results of
operations, liquidity or financial position.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
General
FIC's principal assets are financial instruments, which are subject to market
risks. Market risk is the risk of loss arising from adverse changes in market
rates, principally interest rates on fixed rate investments.
For a discussion of the Company's investment portfolio and the management of
that portfolio to reflect the nature of the underlying insurance obligations of
the Company's insurance subsidiaries, please refer to the information set forth
in Item 2, "Management's Discussion and Analysis of Financial Conditions and
Results of Operation - Investments" of this report.
The following is a discussion of the Company's primary market risk sensitive
instruments. It should be noted that this discussion has been developed using
estimates and assumptions. Actual results may differ materially from those
described below. Further, the following discussion does not take into account
actions which could be taken by management in response to the assumed changes in
market rates. In addition, the discussion does not take into account other types
of risks which may be involved in the business operations of the Company, such
as the reinsurance recoveries on reinsurance treaties with third party insurers.
The primary market risk to the Company's investment portfolio is interest rate
risk. Since the Company own approximately 47.9 % 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.
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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 $
3.7 million at June 30, 2000 and $9.7 million at December 31, 1999. For
purposes of the foregoing estimate, the following categories of the
Company's fixed income investments were taken into account: (i) fixed
maturities, including fixed maturities available for sale and (ii)
short-term investments. The market value of such assets was $ 94.9
million at June 30, 2000 and $102.4 million at December 31, 1999.
The fixed income investments of the Company include certain
mortgage-backed securities. The market value of such securities was $
31.0 million at June 30, 2000 and $ 27.3 million at December 31, 1999.
Assuming an immediate increase of 100 basis points in interest rates,
the net hypothetical loss in the fair market value related to such
mortgage-backed securities is estimated to be $ 1.5 million at June 30,
2000 and $ 1.9 million at December 31, 1999.
(b) FIC's Investment in Affiliate
The value of FIC's investment in affiliate is affected by the amount of
unrealized gains and losses, net of tax, in the investment portfolio of
its affiliate, ILCO. Assuming an immediate increase of 100 basis points
in interest rates, the net hypothetical loss in value, net of tax,
related to the Company's investment in affiliate is estimated to be
$7.0 million at June 30, 2000 and $6.3 million at December 31, 1999.
The hypothetical effect of the interest rate risk on fair values was estimated
by applying a commonly used model. The model projects the impact of interest
rate changes on a range of factors, including duration and potential prepayment.
Part II. Other Information
Item 1. Legal Proceedings
The Company and its subsidiaries are defendants in certain legal actions related
to the normal business operations of the Company. Management believes that the
resolution of such legal actions will not have a material impact upon the
financial statements.
ILCO and Investors-NA are defendants in a lawsuit which was filed in October,
1996, in Travis County, Texas. CIGNA Corporation, an unrelated Company, is also
a named defendant in the lawsuit. The named plaintiffs in the suit (a husband
and wife), allege that the universal life insurance policies sold to them by INA
Life Insurance Company (a company which was merged into Investors-NA in 1992)
utilized unfair sales practices. The named plaintiffs seek reformation of the
life insurance contracts and an unspecified amount of damages. The named
plaintiffs also seek a class action as to similarly situated individuals. No
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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 23,
2000. The only matter submitted at the meeting to a vote of
the Shareholders was the election of directors. All of the
nominees were elected as directors. The nominees included one
individual, Charles K. Chacosky, who had not previously served
as a director of the Company.
The voting tabulation as to each nominee was as follows:
Name In Favor Withheld
Barnett, John D. 2,863,282 473,054
Chacosky, Charles K. 2,862,832 473,504
Crowe, Joseph F. 2,863,682 472,654
Demgen, Jeffrey H. 2,863,622 472,714
Fleron, Theodore A. 2,863,582 472,754
Grace, James M. 2,861,672 474,664
Mitte, Dale E. 2,859,322 477,014
Mitte, Roy F. 2,857,387 478,949
Parker, Frank 2,860,152 476,184
Richmond, Thomas C. 2,862,872 473,464
Supple, Dr. Jerome H. 2,863,232 473,104
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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, 1999 heretofore filed by Registrant with the
Securities and Exchange Commission, which is hereby
incorporated by reference.
(b) Reports on Form 8-K
None.
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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, 14, 2000
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