-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, R6w6CoJ+Blx8Wbf5GzZocT364Dcz6oDZNDtjiLFdLjX/s9+q3yTpc/UQi6MAzMZq TzNoOo23h9wz8+iouU+iDQ== 0000035733-97-000002.txt : 19970329 0000035733-97-000002.hdr.sgml : 19970329 ACCESSION NUMBER: 0000035733-97-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970328 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FINANCIAL INDUSTRIES CORP CENTRAL INDEX KEY: 0000035733 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 742126975 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-04690 FILM NUMBER: 97566806 BUSINESS ADDRESS: STREET 1: THE AUSTIN CENTER STREET 2: 701 BRAZOS 12TH FL CITY: AUSTIN STATE: TX ZIP: 78701 BUSINESS PHONE: 5124045050 MAIL ADDRESS: STREET 1: 701 BRAZOS 12TH FL CITY: AUSTIN STATE: TX ZIP: 78701 FORMER COMPANY: FORMER CONFORMED NAME: GOLDEN UNITED INVESTMENT CO STOCK PLAN DATE OF NAME CHANGE: 19731128 FORMER COMPANY: FORMER CONFORMED NAME: ILEX CORP DATE OF NAME CHANGE: 19730801 FORMER COMPANY: FORMER CONFORMED NAME: GOLDEN UNITED INVESTMENT CO DATE OF NAME CHANGE: 19730801 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended December 31, 1996 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from to Commission File Number 0-4690 FINANCIAL INDUSTRIES CORPORATION (Exact name of registrant as specified in its charter) TEXAS 74-2126975 State of Incorporation (I.R.S. Employer Identification number) 701 Brazos, Suite 1400, Austin, Texas 78701 (Address of Principal Executive Offices) (Zip Code) (512) 404-5050 (Registrant's Telephone Number) Securities Registered pursuant to Section 12(b) of the Act: None Securities Registered pursuant to Section 12(g) of the Act: Common Stock, $.20 par value (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. YES X NO The aggregate market value of the voting stock held by non- affiliates of the Registrant on March 25, 1997, based on the closing sales price in The Nasdaq Small-Cap Market ($12.25 per share), was $41,001,608. The number of shares outstanding of Registrant's common stock on March 25, 1997 was 5,427,965. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] DOCUMENTS INCORPORATED BY REFERENCE: A. Reports on Form 10-K of InterContinental Life Corporation for the fiscal years ended December 31, 1996, 1995 and 1994 are hereby incorporated by reference. PART I Item 1. Business General Financial Industries Corporation ("FIC", the "Company" or the "Registrant") is a holding company primarily engaged in the life insurance business through its ownership of 100% of Family Life Insurance Company ("Family Life") and its approximately 46% interest in InterContinental Life Corporation ("ILCO"). FIC also holds options to acquire additional shares, which, if exercised, would result in FIC owning approximately 61.5% of ILCO's outstanding shares. The Registrant was organized as an Ohio corporation in 1968 and was reincorporated in Texas in 1980. Its executive offices are located at 701 Brazos, Suite 1400, Austin, Texas 78701. Through 1984, FIC's principal business was the sale and underwriting of life and health insurance, mainly in the midwestern and southwestern United States. In 1985, FIC acquired control of ILCO. FIC, ILCO and their insurance subsidiaries have substantially identical managements, and a majority of the directors of FIC are also directors of ILCO and FIC's and ILCO's insurance subsidiaries. Officers allocate their time between FIC and ILCO in accordance with the comparative requirements of both companies and their subsidiaries. Roy F. Mitte, Chairman, President and Chief Executive Officer of FIC, ILCO and their insurance subsidiaries, owns 34% of the outstanding shares of FIC's common stock. Acquisitions Strategy. The Company's strategy has been and continues to be to grow internally and through acquisitions, while maintaining an emphasis on cost controls. Management believes that, under appropriate circumstances, it is more advantageous to acquire companies with large books of in-force life insurance than to produce new business, because initial underwriting costs have already been incurred and mature business is generally less likely to terminate, making possible more predictable profit analysis. However, Family Life does continue to market those products that are profitable, as well as develop new products and streamline distribution channels. See "Agency Operations". It is also management's belief that the continuing consolidation in the life insurance industry presents attractive opportunities for the Company to acquire life insurance companies that complement or fit within the Company's existing marketing structure and product lines. The Company's objective is to improve the profitability of acquired businesses by consolidating and streamlining the administrative functions of these businesses, eliminating unprofitable products and distribution channels, applying its marketing expertise to the acquired company's markets and agents, and benefitting from economies of scale. FIC's ability to make future acquisitions will be dependent on its being able to obtain the necessary financing. In addition, since ILCO has the same acquisition strategy as FIC, a conflict of interest could arise in the future between FIC and ILCO with respect to acquisition opportunities. Acquisition of ILCO. In January 1985, FIC acquired 26.53% of ILCO's Common Stock. FIC and Family Life subsequently acquired additional shares of ILCO's Common Stock and as of March 17, 1997, FIC owned, directly and indirectly through Family Life, approximately 46% of the outstanding shares of ILCO's Common Stock. FIC holds options to acquire up to 1,702,155 additional shares of ILCO's Common Stock. Giving effect to the exercise of those options, FIC would own, directly and indirectly through Family Life, approximately 61.54% of the outstanding shares of ILCO's Common Stock. The exercise price of the options is equal to the average quoted market price of ILCO's common stock over the six-month period immediately prior to exercise. In addition, in the event that any other party should seek to acquire, without the prior approval of ILCO's Board of Directors, securities aggregating five percent or more of the outstanding shares of ILCO, FIC would then have the right to acquire, under the same price formula, that number of shares of common stock which together with the shares then owned by FIC, would amount to 51% of the outstanding shares of ILCO. The consideration for the options was FIC's granting to ILCO a loan in the principal amount of $1.2 million, FIC's agreement to guarantee additional ILCO obligations totaling $4.0 million and FIC's agreement to guarantee ILCO's lease obligation on its headquarters building upon demand. In addition, FIC guaranteed a $15.0 million term loan of ILCO. Acquisition of Family Life. FIC acquired Family Life from Merrill Lynch Insurance Group, Inc. on June 12, 1991. The consideration for the purchase was $114 million consisting of a cash payment of $70 million and $44 million of subordinated promissory notes issued by subsidiaries of FIC to the seller and its affiliates. Family Life underwrites and sells mortgage protection life insurance to customers who are mortgage borrowers from financial institutions where Family Life has marketing relationships. Family Life distributes its insurance products primarily through a national career agency sales force. See "Acquisition of Family Life". ILCO's Acquisitions In November 1986, ILCO acquired Standard Life Insurance Company ("Standard Life"), headquartered in Jackson, Mississippi, for a gross purchase price of $54.5 million. A portion of the funds used by the new life insurance company formed by ILCO to make the acquisition ("New Standard") was the proceeds of a loan extended to the Company by a national bank in the principal amount of $15.0 million (the "Standard Term Loan"). This sum was, in turn, loaned by ILCO to New Standard, and the loan was evidenced by a surplus debenture. New Standard was merged into Standard Life in June 1988. In December 1988, ILCO, through Standard Life, purchased Investors Life Insurance Company of California ("Investors-CA") and Investors Life Insurance Company of North America ("Investors-NA") from CIGNA Corporation for a purchase price of $140 million. ILCO obtained the funds used for the acquisition from: (a) a senior loan in the amount of $125.0 million provided by six financial institutions, (b) a $10.0 million subordinated loan provided by two insurance and financial service organizations and (c) the sale of $5.0 million of Class A Preferred Stock to CIGNA and $15.0 million of Class B Preferred Stock to the subordinated lenders. Approximately $15.0 million of these funds were used to discharge the Standard Term Loan. The balance of these funds were loaned by ILCO to Standard Life. To evidence this indebtedness, Standard Life issued a $140.0 million surplus debenture to ILCO. In connection with the subordinated debt and preferred stock financing, ILCO issued detachable warrants entitling the holders to purchase 1,107,480 shares of ILCO's Common Stock at $3.33 per share. In May 1990, ILCO effected an exchange agreement with the holders of its Class A Preferred Stock and its Class B Preferred Stock. Under the provisions of the exchange agreement, the holders of the Class A Preferred Stock received $5 million principal amount of a 13.25% 1998 Series Subordinate Notes, due November 1, 1998, together with a make whole amount equal to 13.25% of the then outstanding balance of the Note. The holders of the Class B Preferred Stock received $15 million principal amount of a 13.25% 1999 Series Subordinated Notes, due November 1, 1999. ILCO prepaid the subordinated debt and purchased the warrants in early 1993. See "The ILCO Senior Loan". In February, 1995, ILCO, through Investors-NA, purchased from Meridian Mutual Insurance Company the stock of Meridian Life Insurance Company, an Indianapolis-based life insurer, for a cash purchase price of $17.1 million. After the acquisition, Meridian Life changed its name to Investors Life Insurance Company of Indiana ("Investors-IN"). Investors-IN is licensed in ten states and markets a variety of individual life and annuity products through independent agents. On March 25, 1997, ILCO and Investors-IN entered into an agreement to acquire State Auto Life Insurance Company, an Ohio domiciled life insurer, from State Automobile Mutual Insurance Company, for a cash purchase price of $11.8 million, subject to certain post-closing adjustments. In connection with this transaction, the bank group participating in the Senior Loan have agreed to defer payment of $4.5 million otherwise payable on April 1, 1997 under the terms of the Senior Loan, and to reduce the amount of the payment otherwise due on July 1, 1997 by $2.5 million. This deferral would result in extending the maturity date of the Senior Loan to October 1, 1998. Under the terms of the transaction, State Auto Life would be merged into Investors- IN. The closing of the transaction, which is expected to occur during the second quarter of 1997, is subject to regulatory approvals. Business of Family Life Insurance Company Family Life, which was organized in the State of Washington in 1949, specializes in providing mortgage protection life, disability and accidental death insurance and annuity products to mortgage borrowers of financial institutions. Family Life has policies in force with customers of approximately 335 financial institutions, of which approximately 35 actively provide Family Life with regular updating of their lists of borrowers. Family Life's mortgage protection business consists of term and universal life insurance and disability insurance sold to borrowers of mortgage debt, designed to repay the mortgages of policyholders in the event of their death or disability. This business is sold to customers of client financial institutions, usually through a list of borrowers provided by the financial institution. These policies often list the lending financial institution as the primary beneficiary of the life insurance policy. An important feature of the Family Life product is the ability to bill and collect premiums through the policyholder's monthly mortgage payments. Family Life has annuity products and a variety of life insurance products, including decreasing term life insurance, universal life insurance, ten-year level term products, and a whole life insurance product. During 1996, 1995 and 1994, Family Life received premium income from sales of its annuity products and various lines of insurance as follows: $0.2 million, $3.8 million and $1.5, respectively, from annuity products; $48.3 million, $51.5 million and $52.4 million, respectively, from individual life; $1.0 million, $1.2 million and $1.4 million, respectively, from individual accident and health; $469,327, $483,373 and $609,132, respectively, from direct mail (group) life and $238,128, $289,749 and $424,429, respectively, from direct mail (group) accident and health. Family Life is licensed to sell mortgage life insurance products in 49 states and the District of Columbia. In 1996, premium income from these products was derived from all states in which Family Life is licensed, with significant amounts derived from Texas (24%), California (23%), and Illinois (5%). Family Life's primary distribution channel is its agency force of approximately 514 career agents (at December 31, 1996), who are organized into ten regions. Most of the career agents sell mortgage life insurance products exclusively for Family Life. Family Life's other distribution channel had been direct mail marketing. However, in 1992, Family Life discontinued solicitations of new direct mail business in order to concentrate more cost effectively on proven agent sold operations. The mortgage life insurance business is very fragmented. Family Life believes that it is among the larger writers of agent sold mortgage life insurance in the United States and the only nation- wide agent-sold life insurance company operating through leads from financial institutions. Many of Family Life's competitors are life insurance companies with more resources than Family Life and whose mortgage life insurance business represents only a small portion of their total business. Consolidation and Administration Following the 1991 acquisition of Family Life by FIC, management integrated the sales, marketing, underwriting, accounting, contract and licensing, investments, personnel, data processing, home office support and other departments of Family Life and the life insurance subsidiaries of ILCO. Management believes this integration has resulted in cost savings for Family Life and ILCO's insurance subsidiaries. During 1992, ILCO's and FIC's insurance operations were centralized at their headquarters in Austin, Texas, with the exception of certain services performed in Seattle, Washington. Management believes that relocating administrative functions to Austin has reduced costs and improved the efficiency of the insurance companies' operations. At December 31, 1996, the number of employees within FIC and its subsidiaries, together with the employees of ILCO's insurance subsidiaries, was approximately 332. Business of InterContinental Life Corporation ILCO was incorporated in 1969 under the laws of New Jersey. Its executive office is located at 701 Brazos, Suite 1400, Austin, Texas 78701. Operations. ILCO has developed management techniques to reduce operating expenses by centralizing, standardizing and more efficiently performing many functions common to most life insurance companies, such as underwriting and policy administration, accounting and financial reporting, marketing, regulatory compliance, actuarial services and asset management. ILCO has selectively recruited personnel in sales, marketing and various administrative departments. ILCO's centralized management techniques resulted in significant employee reductions and expense savings in the three life insurance companies acquired by ILCO in 1986 and 1988. During 1996, the general insurance expenses of ILCO's insurance subsidiaries were $12,008,160, as compared to $13,737,883 in 1995 and $12,865,000 in 1994. The attainment of this level of cost reduction has contributed significantly to the achievement of the current level of profitability. Management is committed to maintaining the general insurance expenses of ILCO's insurance subsidiaries at a level which will generate an acceptable level of profitability while maintaining the competitive pricing of their insurance products. Principal Products. ILCO's insurance subsidiaries are engaged primarily in administering existing portfolios of individual and group life insurance and accident and health insurance policies and annuity products. Approximately 74.5% of the total collected premiums for 1996 were derived primarily from renewal premiums on insurance policies and annuity products sold by ILCO's insurance subsidiaries prior to their acquisition by ILCO. ILCO's insurance subsidiaries are also engaged in marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. These products are marketed through independent, non-exclusive general agents. The products currently being distributed include several versions of universal life insurance and interest-sensitive whole life insurance. Under a whole life insurance policy, the policyholder pays a level premium over his or her expected lifetime. The policy combines life insurance protection with a savings plan that gradually increases in amount over a period of several years. The universal and interest-sensitive whole life insurance policies of ILCO's insurance subsidiaries provide permanent life insurance which credit company-declared current interest rates. The universal life insurance portfolio of ILCO's insurance subsidiaries consists primarily of flexible premium universal life insurance policies. Under the flexible premium policies, policyholders may vary the amounts of their coverage (subject to minimum and maximum limits) as well as the date of payment and frequency of payments. Direct premiums received from all types of universal life products were $40.6 million in 1996, as compared to $42.3 million in 1995 and $42.1 million in 1994. Investors-NA received reinsurance premiums from Family Life of $1.6 million in 1996, pursuant to the reinsurance agreement for universal life products written by Family Life. In 1996, premium income from all life insurance products was derived from all states in which ILCO's insurance subsidiaries are licensed, with significant amounts derived from Pennsylvania (14%), California (9.0%) New Jersey (9.0%). Until they discontinued sales of credit life and disability insurance in the fourth quarter of 1994, two of ILCO's insurance subsidiaries generally sold that insurance to consumers through lending and credit organizations. Such insurance was generally written on an individual or group basis to (i) persons financing the purchase of new automobiles in the State of New Jersey and (ii) persons obtaining loans from banks and finance companies in southeastern states. Most policies of this type were issued for a term of 48 months or less. Direct premiums received from credit life and accident insurance, prior to reinsurance, were $4.2 million in 1994 and $6.5 million in 1993. Two of ILCO's insurance subsidiaries receive premium income from health insurance policies. In 1996, premium income from all health insurance policies was $0.9 million, as compared to $1.1 million in 1995 and $1.4 million in 1994. Premium income from health insurance in 1996 was derived from all of the states in which those two insurance subsidiaries are licensed, with significant amounts derived from Pennsylvania (23%), New Jersey (23%), and California (10%). Investors-NA sponsors a variable annuity separate account, which offers single premium and flexible premium policies. The policies provide for the contract owner to allocate premium payments among four different portfolios of Putnam Capital Manager Trust ("PCM Fund"), a series fund which is managed by Putnam Investment Management, Inc. As of January 1, 1997, the PCM Fund changed its name to Putnam Variable Trust. Prior to April, 1995, the underlying investment vehicle for the variable annuity contracts was the CIGNA Annuity Funds Group. A substitution of the PCM Fund for the CIGNA Funds was completed in April, 1995. The plan of substitution was approved by the Securities and Exchange Commission. Following such approval, the plan was submitted to policyholders for approval, which approval was obtained. During 1996, the premium income realized in connection with these variable annuity policies was $256,294, which was received from existing contract owners. Direct deposits from the sale of fixed annuity products by ILCO's subsidiaries were $948,000 in 1996, as compared to $1,359,000 in 1995 and $1,296,000 in 1994. Investors-NA received reinsurance premiums from Family Life of $3.8 million in 1996, pursuant to the reinsurance agreement for annuity products written by Family Life. The following table sets forth, for the three years ended December 31, 1996, the combined premium income and other considerations received by ILCO's insurance subsidiaries from sales of their various lines of insurance. Year Ended December 31, Type of Insurance 1996 1995 1994 (in thousands) Individual: Life $15,031 $16,426 $15,721 Accident & Health 1,035 1,218 1,435 Total Individual Lines 16,066 17,644 17,156 Group: Life 2,018 2,594 2,226 Accident & Health 6 105 Total Group Lines 2,018 2,600 2,331 Credit: Life (85) (222) 3,282 Accident & Health (57) 240 2,296 Total Credit Lines (142) 18 5,578 Total Premiums 17,942 20,262 25,065 Reinsurance premiums ceded (7,962) (8,568) (10,748) Total Net Premium 9,980 11,694 14,317 Amount Received on Investment Type Contracts 47,135 44,130 43,372 Total Premiums and Deposits Received $57,115 $55,824 $57,689 Merger of Insurance Subsidiaries. Investors-NA redomesticated from Pennsylvania to Washington in December of 1992. Investors- CA merged into Investors-NA on December 31, 1992. Standard Life merged into Investors-NA on June 29, 1993. The mergers have achieved cost savings, such as reduced auditing expenses involved in auditing one combined company; the savings of expenses and time resulting from the combined company being examined by one state insurance department (Washington), rather than three (California, Pennsylvania and Mississippi); the reduction in the number of tax returns and other annual filings with 45 states; and smaller annual fees to do business and reduced retaliatory premium taxes in most states. Management believes that these reductions in expenses have further strengthened the financial condition of the combined company. Investment of Assets The assets held by Family Life and ILCO's life insurance subsidiaries must comply with applicable state insurance laws and regulations pertaining to life insurance companies. The investment portfolios of Family Life and ILCO's life insurance subsidiaries are tailored by their managements to reflect the nature of the insurance obligations, business needs, regulatory requirements and tax considerations relating to the underlying insurance business with respect to such assets. This is particularly the case with respect to interest-sensitive life insurance products, where the investment emphasis is to obtain a targeted margin of profit over the rate of interest credited to policyholders, while endeavoring to minimize the portfolio's exposure to changing interest rates. To reduce the exposure to such rate changes, portfolio investments are selected so that diversity, maturity and liquidity factors approximate the duration of associated policyholder liabilities. The investment objective of Family Life and ILCO's insurance subsidiaries emphasizes the selection of short to medium term, high quality fixed income securities, rated Baa-3 (investment grade) or better by Moody's Investors Service, Inc. At December 31, 1996, only 3.9% of ILCO's total assets were invested in mortgage loans or real estate. Non-affiliated corporate debt securities that were non-investment grade represented 1.1% of ILCO's total assets at December 31, 1996. ILCO had investments in debt securities of affiliated companies aggregating approximately $59.9 million as of December 31, 1996. Family Life does not have investments in mortgage loans, real estate, non- investment grade debt securities or affiliates' debt securities. The investments of Family Life and ILCO's insurance subsidiaries in mortgage-backed securities included collateralized mortgage obligations ("CMOs") of $40.4 million and $260.1 million, respectively, and mortgage-backed pass-through securities of $7.3 million and $53.7 million, respectively, at December 31, 1996. Mortgage-backed pass-through securities, sequential CMO's, support bonds and z-accrual bonds, which comprised approximately 39.8% of the book value of FIC's mortgage-backed securities and 52.3% of the book value of ILCO's mortgage-backed securities at December 31, 1996, are sensitive to prepayment and extension risks. ILCO and FIC have reduced the risk of prepayment associated with mortgage-backed securities by investing in planned amortization class ("PAC"), target amortization class ("TAC") instruments, accretion directed bonds and scheduled bonds. These investments are designed to amortize in a predictable manner by shifting the risk of prepayment of the underlying collateral to other investors in other tranches ("support classes") of the CMO. At December 31, 1996, PAC and TAC instruments and accretion directed and scheduled bonds represented approximately 60.8% of the book value of FIC's mortgage-backed securities and approximately 47.7% of the book value of ILCO's mortgage-backed securities. Sequential and support classes represented approximately 21.1% 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 December 31, 1996. 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. FIC does not have any z- accrual bonds, and those bonds constituted only 3.4% of the book value of ILCO's mortgage-backed securities at December 31, 1996. 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 1996, and the current investment objectives of both FIC and ILCO do not contemplate additions to the portfolio of CMO investments during 1997. FIC and ILCO do not invest in non-agency mortgage-backed securities, which have a greater credit risk than that of agency mortgage-backed securities. ILCO and FIC do not make new mortgage loans on commercial properties. Substantially all of ILCO's mortgage loans were made by its subsidiaries prior to their acquisition by ILCO. At December 31, 1996, 0.6% of the total book value of mortgage loans held by ILCO had defaulted as to principal or interest for more than 90 days, and none of ILCO's mortgage loans were in foreclosure. During 1996, none of ILCO's mortgage loans were converted to foreclosed real estate or were restructured while ILCO owned them. Family Life does not have any mortgage loans. Another key element of FIC's and ILCO's investment strategy is to avoid large exposure in other investment categories which management believes carry higher credit or liquidity risks, including private placements, partnerships and bank participations. These categories accounted for approximately 1.2% of ILCO's invested assets and none of FIC's invested assets at December 31, 1996. A subsidiary of ILCO, Investors-NA, is the owner and developer of an office complex known as Bridgepoint Square Offices. Once completed, the project will consist of four office buildings, with a total rentable space of 364,000 square feet, and two parking garages. Investors-NA purchased the 20 acre tract of land for this complex in January, 1995. At that time, the tract included one completed and fully leased office building, an adjacent parking garage, and sites for three more office buildings and a second parking garage. Since the purchase, Investors-NA has completed construction on the second parking garage and two of the remaining building sites. Construction is in progress on the fourth building, with a projected completion date in July, 1997. Three of the four buildings are fully occupied by tenants and the fourth is partially leased. Negotiations are in progress with two potential tenants to lease the remaining space in the fourth building. See Item 2. Properties. In May 1996, Family Life Insurance Company, an indirect, 100% owned subsidiary of FIC, purchased a 7.1 acre tract adjacent to the original Bridgepoint Square tract. This second tract contained one building site and one garage site. In January, 1997, Family Life began construction on a four-story office building, with rentable space of approximately 71,500 square feet, and the parking garage, with 350 parking spaces. The projected completion date is September, 1997. Once construction on the building is completed, FIC, ILCO and their related companies will move their headquarters from the current location in the Austin Centre to the new office building. The companies will occupy approximately 50,000 square feet of the building, with the balance to be leased to a third party. FIC and ILCO have established and staffed an investment department, which manages portfolio investments and investment accounting functions for their life insurance subsidiaries. Agency Operations The products of FIC's and ILCO's insurance subsidiaries are marketed and sold through two divisions: A. Investors Life Distribution System Investors Life Distribution System sells a wide range of life insurance and annuity products through an independent, non- exclusive general agent sales distribution system. The products sold are issued by subsidiary companies of ILCO. All marketing and sales for the Company are directed by the Executive Vice President of Marketing and Sales. The Vice President for Investors Sales directs Regional Vice Presidents who are responsible for the recruitment of general agents and managing general agents for individual insurance sales in the Investors Life Distribution System. B. Family Life Distribution System This nationwide system sells Family Life's products through an exclusive agent force. This agent force sells mortgage protection insurance and annuity products. The products are sold primarily to middle-income customers of client financial institutions, usually through a list of borrowers provided by the financial institution. Family Life works closely with the financial institutions to maintain and insure that Family Life lead systems, which had been built from the loan portfolios of each active financial institution, operate at a level that favors both parties. Family Life agents make courtesy calls to borrowers of the financial institutions which are active on the Family Life lead system to offer the borrower the opportunity to purchase mortgage protection insurance (term, universal or whole life insurance products). Sales and Marketing for Family Life is directed by the Executive Vice President of Marketing and Sales. Reporting to the Executive Vice President, the Senior Vice President of Marketing heads the Family Life marketing organization which is focused on the development and maintenance of contractual agreements with the financial institutions which provide referrals to, and collect monthly premiums from, their borrowers for Family Life insurance plans. The Senior Vice President for Family Life Sales directs nine Regional Vice Presidents. The Family Life distribution system consists of 72 District Sales Managers, and 514 active career agents. Data Processing Pursuant to a data processing agreement with a major service company, the data processing needs of ILCO's and FIC's insurance subsidiaries were provided at a central location until November 30, 1994. Effective December 1, 1994, all of those data processing needs have been provided to ILCO's and FIC's Austin, Texas and Seattle, Washington facilities by FIC Computer Services, Inc., a new subsidiary of FIC. See Item 13. Certain Relationships and Related Transactions with Management. Competition There are many life and health insurance companies in the United States. Agents placing insurance business with Family Life and ILCO's insurance subsidiaries are compensated on a commission basis. However, some companies pay higher commissions and charge lower premium rates and many companies have more substantial resources than Family Life and ILCO's insurance subsidiaries. The principal cost and competitive factors that affect the ability of Family Life and ILCO's insurance subsidiaries to sell their insurance products on a profitable basis are: (1) the general level of premium rates for comparable products; (2) the extent of individual policyholders services required to service each product category; (3) general interest rate levels; (4) competitive commission rates and related marketing costs; (5) legislative and regulatory requirements and restrictions; (6) the impact of competing insurance and other financial products; and (7) the condition of the regional and national economies. Reinsurance and Reserves In accordance with general practices in the insurance industry, Family Life and ILCO's insurance subsidiaries limit the maximum net losses that may arise from large risks by reinsuring with other carriers. Such reinsurance provides for a portion of the mortality risk to be retained by Family Life and the ILCO subsidiaries with the excess being ceded to a reinsurer at a premium set forth in a schedule based upon the age and risk classification of the insured. The reinsurance treaties provide for allowances that help Family Life and ILCO's insurance subsidiaries offset the expense of writing new business. Family Life generally retains the first $200,000 of risk on the life of any one individual. ILIC generally retains the first $70,000 of risk on the life of any individual. On group life insurance, the retention level is $50,000 per individual life. Investors-NA generally retains the first $100,000 of risk on the life of any individual. Investors-IN generally retains the first $50,000 of risk on the life of any individual. In 1988, Investors-NA entered into a bulk reinsurance treaty under which it reinsured all of its risks under accidental death benefit policies. ILIC had previously obtained similar bulk reinsurance for accidental death benefit policies. The treaty was renegotiated with another reinsurer, with a new effective date of January 1, 1996. Effective as of January 1, 1997, the treaty was renegotiated with a different reinsurer. In 1993 ILCO's life insurance subsidiaries entered into a quota share reinsurance treaty under which all credit life and health business issued March 1, 1993 and later is 50% reinsured. In 1995, Family Life (as the ceding company) entered into a reinsurance agreement with Investors-NA (as the reinsuring company) pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. In 1996, Family Life (as the ceding company) entered into a reinsurance agreement with Investors-NA (as the reinsuring company), pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. These reinsurance arrangements reflect management's plan to develop universal life and annuity business at Investors-NA, with Family Life concentrating on the writing of term life insurance products. Although reinsurance does not eliminate the exposure of FIC's and ILCO's insurance subsidiaries to losses from risks insured, the net liability of such subsidiaries will be limited to the portion of the risk retained, provided that the reinsures meet their contractual obligations. ILCO's insurance subsidiaries and Family Life carry reserves on their books to meet future obligations under their outstanding insurance policies. Such reserves are believed to be sufficient to meet policy obligations as they mature and are calculated using assumptions for interest, mortality, expenses and withdrawals in effect at the time the policies were issued. Acquisition of Family Life On June 12, 1991 FIC consummated the purchase of all of the outstanding shares of common stock of Family Life, a State of Washington based life insurance corporation, from Merrill Lynch Insurance Group, Inc. ("Merrill Lynch") pursuant to the terms of a definitive Stock Purchase Agreement entered into in March of 1991. The business of Family Life, as reconstituted for sale, consists principally of the underwriting and sale of life insurance to mortgage borrowers through lending institutions. The consideration for the purchase was $114 million consisting of a cash payment of $70 million and $44 million of subordinated promissory notes issued by subsidiaries of FIC to the seller and its affiliates. To effectuate the transaction, FIC organized two downstream holding companies: Family Life Corporation ("FLC"), and Family Life Insurance Investment Corporation ("FLIIC"). FLIIC was organized as a wholly-owned subsidiary of FIC and, in turn, was issued all of the outstanding shares of FLC. FLC purchased 250,000 shares of common stock, being all of the outstanding shares, of Family Life from Merrill Lynch for an $84 million cash payment (including $14 million that had been borrowed by FLIIC from an affiliate of Merrill Lynch) and a $30 million senior subordinated note. Following the purchase of the Family Life shares by FLC, Family Life issued 250,000 previously unissued shares of its common stock to FLC for a $2.5 million cash payment and immediately thereafter redeemed from FLC 250,000 shares of its common stock that had been purchased by FLC from Merrill Lynch. The consideration paid to FLC by Family Life for said redeemed shares consisted of $2.5 million cash, a newly issued surplus debenture (an instrument having certain restrictions on payment for the protection of policyholders) in the principal amount of $97.5 million and $14 million principal value of newly issued preferred shares. As part of the financing arrangement, FLC entered into a senior loan agreement under which $50 million was provided by a group of banks (the "Family Life Senior Loan"). The balance of the financing consisted of a $30 million subordinated note issued by FLC to Merrill Lynch and $14 million borrowed by FLIIC from an affiliate of Merrill Lynch and evidenced by a subordinated note in the principal amount of $12 million and a subordinated note in the principal amount of $2 million (collectively, the "Merrill Lynch Subordinated Loans") and $25 million lent by two insurance company subsidiaries of ILCO (the "Investors Life Subordinated Loans"). The latter amount was represented by a $22.5 million loan from Investors-NA to FLC and a $2.5 million loan provided directly to FIC by Investors-CA. In addition to the interest provided under the Investors Life Subordinated Loans, Investors- NA and Investors-CA were granted by FIC non-transferable options to purchase, in amounts proportionate to their respective loans, up to a total of 9.9 percent of shares of FIC common stock at a price of $10.50 per share, equivalent to the then current market price, subject to adjustment to prevent dilution. The initial terms of the option provided for their expiration on June 12, 1998, if not previously exercised. In connection with the 1996 amendments to the $34.5 million subordinated loans obtained from Investors-NA, the expiration date of the options was extended to September 12, 2006. For a discussion of the 1996 amendments, please refer to Item 13, Certain Relationships and Related Transactions with Management, above. Of the total of $119 million of cash borrowed and notes issued by FIC and its subsidiaries for purposes of the transaction, $114 million constituted the purchase price for Family Life and $5 million was used to pay transaction costs, for working capital and for other related purposes. In connection with the several loans effected for purposes of the transaction, various creditors priorities and normal borrower requirements and restrictions were established and FIC issued its direct guaranty of the respective loans, subject to certain priorities, to the various lending banks, Merrill Lynch and its affiliates, and Investors-NA and Investors-CA. The outstanding shares of common stock of Family Life were also pledged as collateral to the bank lenders and, upon repayment of the bank loan, to Merrill Lynch. The transaction was structured to conform to the requirements of Section 338(h)(10) of the Internal Revenue Code. On July 30, 1993, the Merrill Lynch Subordinated Loans were prepaid. $38 million plus accrued interest was paid to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the Merrill Lynch Subordinated Loans was new subordinated loans totalling $34.5 million that were obtained from Investors-NA. See "The Family Life Refinancing." Family Life Senior and Subordinated Loans Senior Loan. The Senior Loan obligations of FLC were completely paid off on April 17, 1996. During the period that the Senior Loan was in effect, it was a secured and guaranteed five year term loan in the initial principal amount of $50 million. The Senior Loan consisted of separate notes (one for each member of the lending syndicate), with interest payable quarterly and a final maturity date of June 12, 1996. The interest rate of the Senior Loan was subject to periodic change based upon stipulated percentages above a quoted bank base lending rate or Eurodollar rate as such are in effect from time to time. Upon the retirement of the Senior Loan, certain of the its provisions were automatically incorporated into the Investors Life Subordinated Loans which are described in the following section. Those provisions include specified events of default, including, but not limited to, failure to pay principal, interest, commitment fees or other amounts payable when due, failure to maintain certain financial covenants, violation of covenants (including covenants with respect to the maintenance of a minimum net worth), material misrepresentations, defaults under other indebtedness, the loss of any license of an insurance subsidiary of FLC which would have a material adverse effect on FLC, defaults under the FIC guaranty agreement, a fine in an amount in excess of $100,000 imposed upon any insurance subsidiary of FLC by any state insurance regulatory agency, changes in ownership or control of FIC by its controlling person, Roy F. Mitte, or in ILCO by FIC and the occurrence of certain events of bankruptcy. In addition, the security interests furnished to the lenders under the Senior Loan were transferred to Investors-NA. The security interests include all of the issued and outstanding shares of common stock of FLIIC, all of the issued and outstanding shares of preferred stock and common stock of FLC and Family Life and the $97.5 million surplus debenture of Family Life. Investors Life Subordinated Loans. The $22.5 million subordinated senior note issued by FLC to Investors-NA was originally scheduled to mature on June 12, 1998, with principal payments in four equal semi-annual principal installments of $5,625,000 each on December 12, 1996, June 12, 1997, December 12, 1997 and June 12, 1998. Interest is payable semi-annually, at the rate of 11% per annum. Effective as of June 12, 1996, the note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996. The final quarterly principal payment is due on September 12, 2001. The interest rate on the note remains at 11%. The $2.5 million subordinated note issued by FIC to Investors-CA initially provided for interest, payable semi-annually, at the rate of 12% per annum, and its principal is due and payable in full at maturity on June 12, 1998 (the "FIC Note"). As a result of the merger of Investors-CA into Investors-NA, the FIC Note is now owned by Investors-NA. Prior to June 12, 1996, accrued interest on the FIC Note was paid by delivery of additional notes of FIC having terms identical to such original note, including the payment of interest (the "PIK Notes"). Interest payable on and after June 12, 1996 on all of the FIC Note is to be paid in cash. Effective as of June 12, 1996, the FIC Note was amended to provide that the principal balance of the note is to be repaid in twenty quarterly installments of $125,000 each, commencing December 12, 1996 with the final payment due on September 12, 2001. With respect to the PIK Notes, the amendment provided that the principal balance of the notes ($1,977,119) is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, commencing December 12, 1996 with the final payment due on September 12, 2001. The interest rate on both the FIC Note and the PIK Notes remained at 12%. The obligors are allowed to prepay the Investors Life Subordinated Loans, in whole or in part, without premium or penalty. During the time that the Senior Loan was outstanding, the Investors Life Subordinated Loans were subordinated to the Senior Loan and constitute a second lien on the pledged collateral subject to the first lien of the Senior Loan. Repayment of FLC's $22.5 million note is also guaranteed by FIC. The Investors Life Subordinated Loan documents specify events of default, including, but not limited to, failure to pay principal, interest or other amounts payable with respect to the Investors Life Subordinated Loan documents when due, violation of covenants in the Investors Life Subordinated Loan documents (including covenants with respect to the maintenance of a minimum net worth), material misrepresentations, defaults under other indebtedness, and the occurrence of certain events of bankruptcy. The Investors Life Subordinated Loan documents also contain various specified negative, affirmative and financial covenants to be performed or observed by FLC, FIC and their subsidiaries. During the period the Senior Loan was outstanding, the covenants in effect under the Investors Life Subordinated Loan documents were less restrictive than the covenants under the Senior Loan documents but become generally equivalent to the Senior Loan restrictions upon the termination of the Senior Loan. On July 30, 1993, Investors-NA loaned $34.5 million to FLC and FLIIC in the form of subordinated notes in connection with the prepayment of the Merrill Lynch Subordinated Loans. See "The Family Life Refinancing." As of December 31, 1996 the outstanding principal balance of the Investors Life Subordinated Loans, including the loans made by Investors-NA in 1993 was $59,940,193. Options. In addition to the interest provided under the Investors Life Subordinated Loans, Investors-NA and Investors-CA were granted by FIC non-transferable options to purchase, in amounts proportionate to their respective loans, up to a total of 9.9 percent of shares of FIC common stock at a price of $2.10 per share (as adjusted to reflect the five-for-one stock split in November, 1996), equivalent to the then current market price, subject to adjustment to prevent dilution. The initial terms of the option provided for their expiration on June 12, 1998, if not previously exercised. In connection with the 1996 amendments to the $34.5 million subordinated loans obtained from Investors-NA, the expiration date of the options was extended to September 12, 2006. The Family Life Refinancing. On July 30, 1993, the Merrill Lynch Subordinated Loans were prepaid. $38 million plus accrued interest was paid to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the Merrill Lynch Subordinated Loans was new subordinated loans totalling $34.5 million that were obtained from Investors-NA. Prior to the 1996 amendments described below, the principal amount of the new subordinated debt was payable in four equal annual installments in 2000, 2001, 2002 and 2003. The interest rate is 9%. The other terms of the 1993 notes are substantially the same as those of the $22.5 million subordinated loan that Investors-NA had previously made to FLC and that continue to be outstanding. The $34.5 million of new subordinated loans consist of a $30 million loan to FLC and a $4.5 million loan to FLIIC. The debt restructuring reduced the total indebtedness of FLC and FLIIC by approximately $15 million. The transaction resulted in a pre-tax gain of approximately $12 million for the Company in the third quarter of 1993, and the Company estimates that the restructuring of this subordinated debt will result in aggregate interest savings to FLC and FLIIC of approximately $40 million over the next ten years. In recognition of this reduced interest requirement, the interest rate on the surplus debenture of Family Life held by FLC was reduced from 12.5% to 9%. As of June 12, 1996, the provisions of the notes from Investors- NA to FIC, FLC and FLIIC were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996; the final quarterly principal payment is due on September 12, 2001; the interest rate on the note remains at 11%, (b) the $30 million note was amended to provide for forty quarterly principal payments, in the amount of $163,540 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $1,336,458; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, (c) the $4.5 million note was amended to provide for forty quarterly principal payments, in the amount of $24,531 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $200,469; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, (d) the $2.5 million note was amended to provide that the principal balance of the note is to be repaid in twenty quarterly installments of $125,000 each, commencing December 12, 1996 with the final payment due on September 12, 2001; the rate of interest remains at 12%, (e) the Master PIK note, which was issued to provide for the payment in kind of interest due under the terms of the $2.5 million note prior to June 12, 1996, was amended to provide that the principal balance of the note ($1,977,119) is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%. ILCO's Senior and Subordination Loans and Warrants FIC guaranteed ILCO's senior and subordinated loans that were the source of funds used for the acquisition of Investors-NA and Investors-CA. Those loans were as follows: (1) a credit facility in the amount of $135,000,000 composed of the following: (a) a senior loan in the amount of $125,000,000 (the "ILCO Senior Loan") provided by a nationally chartered banking institution (the "Senior Lender") as the lead bank in a lending syndicate consisting of six banks and/or other financial institutions; and (b) a $10,000,000 subordinated loan (the "Subordinated Loan") provided by two insurance and financial service organizations (the "Subordinated Lenders"); and (2) the sale of preferred stock as follows: (a) $5,000,000 of Class A Preferred Stock issued at par to Insurance Company of North America, a CIGNA subsidiary; and (b) $15,000,000 of Class B Preferred Stock issued at par to the Subordinated Lenders. Approximately $15,000,000 of these funds were used to discharge an existing term loan. The balance of these funds were loaned by ILCO to Standard to consummate the purchase under the Acquisition Agreement. To evidence this indebtedness, Standard issued a $140,000,000 surplus debenture to ILCO. In January 1993, ILCO prepaid the Subordinated Loans and amended the ILCO Senior Loan. See "The ILCO Refinancing." In May 1, 1990, ILCO effected an exchange agreement with the holders of its Class A Preferred Stock (principal amount of $5 million; dividend rate of 13.25%) and its Class B Preferred Stock (principal amount of $15 million; dividend rate of 13.25%). Under the provisions of the exchange agreement, the holders of the Class A Preferred Stock received $5 million principal amount of a 13.25% 1998 Series Subordinated Notes, due November 1, 1998, together with a make whole amount equal to 13.25% of the then outstanding balance of the Note. The holders of the Class B Preferred Stock received $15 million principal amount of a 13.25% 1999 Series Subordinated Notes, due November 1, 1999. The ILCO Refinancing. In January, 1993, ILCO prepaid all of its subordinated indebtedness and purchased and cancelled all of the warrants held by certain of its subordinated noteholders. In addition to paying the $30 million aggregate principal amount of the subordinated notes due in 1997, 1998 and 1999 plus accrued interest, ILCO paid approximately $7 million of prepayment penalty, the after-tax effect of which will be a charge against earnings in 1993, and approximately $8 million for the warrants, which will be a charge directly against retained earnings. The warrants had entitled the holders to purchase 1,107,480 shares of ILCO's Common Stock (approximately 24% of the outstanding shares) at an exercise price of $3.33 per share. The currently estimated price that the warrant holders could have required ILCO to pay for the warrants upon exercise of their put option was approximately $29.9 million. The earliest that the put option could have been exercised was December 1993, if such exercise would not have resulted in a default under ILCO's Senior Loan at that time. The purchase and cancellation of the warrants will reduce the number of ILCO's outstanding shares of common stock and common stock equivalents used in the computation of its earnings per share from approximately 7,147,000 shares to approximately 6,040,000 shares. This adjustment in common stock equivalents will affect ILCO's earnings per share for periods after January 29, 1993. However, it will not affect FIC's equity in ILCO's net income. The primary source of the funds used to prepay the subordinated debt and to purchase the warrants was an increase in the outstanding balance of ILCO's Senior Loan from $60 million to $110 million pursuant to an amended and restated credit agreement that the Company entered into on January 29, 1993 with certain banks, including the same agent bank as in the Company's original bank group in 1988. ILCO's prepayment of subordinated debt, purchase of warrants and increase in senior bank indebtedness are referred to herein as the "ILCO Refinancing". The terms of the amended and restated credit facility are substantially the same as the 1988 facility. The interest rate on the $30 million subordinated debt that was replaced by the new ILCO Senior Loan was 13.25%. The average interest rate paid by ILCO on ILCO's New Senior Loan was approximately 7.04% during 1994, 8.63% during 1995 and 7.76% during 1996. The maturity date, which had been December 31, 1996, was extended to July 1, 1998 for the new ILCO Senior Loan. On February 14, 1995, ILCO borrowed an additional $15 million under the ILCO Senior Loan to help finance the acquisition of Investors-IN, and the maturity date of the ILCO Senior Loan was further extended to July 1, 1999. As of December 31, 1995, the outstanding principal balance of the ILCO's senior loan obligations was $59.4 million. In January, 1996, the Company made a scheduled payment of $4.5 million under its Senior Loan. In March, 1996, the Company made the scheduled payments for April 1st and July 1st, totaling $9 million. At that same time, the Company made a payment of $941,000, an additional payment under the terms of the loan applied to the principal balance. On April 1, 1996, an optional principal payment in the amount of $15 million was made, which resulted in advancing the scheduled payoff date of the Senior Loan to April 1, 1998. In July, 1996, the Company made the principal payment for October 1st ($4.5 million), plus an optional principal payment of $0.5 million. The ILCO Senior Loan is a secured and guaranteed six and one-half year term loan. A required $26 million principal payment was made on April 1, 1993. Thereafter, the principal is payable in twenty-two quarterly installments of $4.5 million each, commencing on April 1, 1994 and ending on July 1, 1999. ILCO is required to make mandatory payments on the Senior Loan equal to (a) 100% of the net proceeds from the issuance of ILCO's capital stock or debt securities and (b) the applicable percentage of ILCO's annual Excess Cash Flow: 100%, if the outstanding principal balance of the ILCO Senior Loan exceeds $75 million; 75%, if the outstanding balance exceeds $50 million but is equal to or less than $75 million; or 50%, if the outstanding balance is equal to or less than $50 million. Excess Cash Flow is the excess of (i) the sum of ILCO's cash and cash equivalents, principal and interest received by ILCO from surplus debentures, cash dividends received by ILCO and interest income on ILCO's cash equivalents over (ii) the sum of principal and interest paid on ILCO's indebtedness, operating expenses, taxes actually paid and $5 million. The ILCO Senior Loan bears interest, at the option of ILCO, at a rate per annum equal to (i) the Alternate Base Rate (as defined below) plus the Applicable Margin (as defined below), or (ii) LIBOR (adjusted for reserves) for interest periods of 1, 2, 3 or 6 months plus the Applicable Margin. LIBOR is London Inter-Bank Offered Rates. The Alternate Base Rate for any day is the higher of (a) the agent bank's corporate base rate as announced from time to time and (b) the federal funds rate as published by the Federal Reserve Bank of New York plus 0.5%. The Applicable Margin, depending on the outstanding principal balance of the ILCO Senior Loan, ranges from 0.5% to 1.25% for loans that bear interest based upon the Alternate Base Rate and from 1.75% to 2.5% for loans that bear interest based upon LIBOR. The initial Applicable Margin for Alternate Base Rate loans is 1.25% and the initial Applicable Margin for LIBOR loans is 2.5%. The obligations of ILCO under the ILCO Senior Loan are secured by: (1) all of the outstanding shares of stock of Investors-NA, (2) a $15,000,000 surplus debenture of Investors-NA payable to ILCO, which had an outstanding principal balance of $5,706,000 as of December 31, 1996 and (3) a $140,000,000 surplus debenture of Investors-NA payable to ILCO, which had an outstanding principal balance of $32,840,000 as of December 31, 1996. The obligations of ILCO under the ILCO Senior Loan are guaranteed by FIC. The ILCO Senior Loan prohibits the payment by ILCO of cash dividends on ILCO's Common Stock and contains covenants, including restrictive covenants that impose limitations on ILCO's and its subsidiaries' ability to, among other things: (i) make investments; (ii) create or incur additional debt; (iii) engage in businesses other than their present and related businesses; (iv) create or incur additional liens; (v) incur contingent obligations; (vi) dispose of assets; (vii) enter into transactions with affiliated companies; and (viii) make capital expenditures; and various financial covenants, including covenants requiring the maintenance of a minimum cash flow coverage ratio, minimum consolidated net worth and minimum statutory surplus of subsidiaries, and a minimum ratio (360%) of (i) the sum of the statutory capital and surplus, the asset valuation reserve and one-half of the dividend liability pertaining to participating policies of each insurance company subsidiary to (ii) its respective Authorized Control Level RBC (see "Regulation"). The ILCO Senior Loan specifies events of default, including, but not limited to, failure to pay amounts under the ILCO Senior Loan documents when due; defaults or violation of covenants under other indebtedness; certain defaults or violation of certain covenants under the Family Life Senior Loan (which provisions are no longer applicable since the repayment of the Family Life Senior Loan in April, 1996); default under the subordinated loans made by Investors-NA to FLC and FLIIC; the loss of any license of an insurance subsidiary of ILCO which would have a material adverse effect on ILCO; defaults under the FIC guaranty agreement; changes in ownership or control of FIC or ILCO by its controlling person, Roy F. Mitte, or in ILCO by FIC; and the occurrence of certain events of bankruptcy. If Mr. Mitte ceases to control the management of ILCO solely by reason of (i) his death or (ii) his permanent inability to perform his usual and customary duties on a full-time basis on behalf of ILCO and FIC as the result of physical or mental infirmity, a default will occur, and the banks holding in the aggregate at least 66 2/3% of the outstanding balance of the ILCO Senior Loan may, on or after 180 days after the date on which such default occurs, declare the ILCO Senior Loan immediately due and payable. Mr. Mitte's ability to communicate and his mobility are impaired as a result of a stroke he suffered in May 1991. However, Mr. Mitte continues to control the management of the Company, and Mr. Mitte's impairments do not constitute a default under the ILCO Senior Loan. See Item 10(b) "Executive Officers of the Registrant". The principal balance of the ILCO Senior Loan was $24.94 million as of December 31, 1996. Regulation General. ILCO's insurance subsidiaries and Family Life are subject to regulation and supervision by the states in which they are licensed to do business. Such regulation is designed primarily to protect policy owners. Although the extent of regulation varies by state, the respective state insurance departments have broad administrative powers relating to the granting and revocation of licenses to transact business, licensing of agents, the regulation of trade practices and premium rates, the approval of form and content of financial statements and the type and character of investments. These laws and regulations require Family Life and ILCO's insurance subsidiaries to maintain certain minimum surplus levels and to file detailed periodic reports with the supervisory agencies in each of the states in which they do business, and their business and accounts are subject to examination by such agencies at any time. The insurance laws and regulations of the domiciliary states of FIC's and ILCO's insurance subsidiaries require that such subsidiaries be examined at specified intervals. Family Life is domiciled in the State of Washington. Investors-NA and ILIC are domiciled in the states of Washington and New Jersey, respectively. In December 1992, Investors-NA redomesticated from Pennsylvania to Washington, and Investors-CA merged into Investors-NA. In June 1993 Standard Life merged into Investors-NA. Investors-IN is domiciled in the State of Indiana. A number of states regulate the manner and extent to which insurance companies may test for Acquired Immune Deficiency Syndrome (AIDS) antibodies in connection with the underwriting of life insurance policies. To the extent permitted by law, Family Life and ILCO's insurance subsidiaries consider AIDS information in underwriting coverages and establishing premium rates. An evaluation of the financial impact of future AIDS claims is extremely difficult, due in part to insufficient and conflicting data regarding the incidence of the disease in the general population and the prognosis for the probable future course of the disease. Risk-Based Capital Requirements. Effective for the 1993 calendar year, the National Association of Insurance Commissioners ("NAIC") has adopted Risk-Based Capital ("RBC") requirements to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks associated with: (i) asset quality; (ii) mortality and morbidity; (iii) asset and liability matching; and (iv) other business factors. The states will use the RBC formula as an early warning tool to discover potential weakly capitalized companies for the purpose of initiating regulatory action. The RBC requirements are not intended to be a basis for ranking the relative financial strength of insurance companies. In addition, the formula defines a new minimum capital standard which will supplement the prevailing system of low fixed minimum capital and surplus requirements on a state-by-state basis. The RBC requirements provide for four different levels of regulatory attention in those states that adopt the NAIC regulations, depending on the ratio of the company's Total Adjusted Capital (which generally consists of its statutory capital, surplus and asset valuation reserve) to its Authorized Control Level RBC. A "Company Action Level Event" is triggered if a company's Total Adjusted Capital is less than 200% but greater than or equal to 150% of its Authorized Control Level RBC, or if a negative trend has occurred (as defined by the regulations) and Total Adjusted Capital is less than 250% but more than 200% of its Authorized Control Level RBC. When a Company Action Level Event occurs, the company must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve its capital position. A "Regulatory Action Level Event" is triggered if a company's Total Adjusted Capital is less than 150% but greater than or equal to 100% of its Authorized Control Level RBC. When a Regulatory Action Level Event occurs, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. An "Authorized Control Level Event" is triggered if a company's Total Adjusted Capital is less than 100% but greater than or equal to 70% of its Authorized Control Level RBC, and the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. A "Mandatory Control Level Event" is triggered if a company's Total Adjusted Capital is less than 70% of its Authorized Control Level RBC, and the regulatory authority is mandated to place the company under its control. Calculations using the NAIC formula and the statutory financial statements of Family Life and ILCO's insurance subsidiaries as of December 31, 1996 indicate that the Total Adjusted Capital of each of FIC's and ILCO's insurance subsidiaries is above 480% of its respective Authorized Control Level RBC. Solvency Laws Assessments. The solvency or guaranty laws of most states in which an insurance company does business may require that company to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. Recent insolvencies of insurance companies increase the possibility that such assessments may be required. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. The insurance companies record the expense for guaranty fund assessments in the period assessed. The occurrence and amount of such assessments have increased in recent years. The net amounts of such assessments for Family Life and ILCO's insurance subsidiaries were approximately $6,796 and $100,165, respectively, in the year ended December 31, 1996. Those amounts are net of the amounts that can be offset against future premium taxes and, in the case of Family Life, the amount is also net of the amount that can be recovered from Merrill Lynch pursuant to the Stock Purchase Agreement between FIC and Merrill Lynch. See "Acquisition of Family Life." The likelihood and amount of any other future assessments cannot be estimated and are beyond the control of FIC and ILCO. Surplus Debentures and Dividends. The principal sources of cash for FLC to make payments of principal and interest on the Family Life Senior Loan are payments under the surplus debenture of Family Life Insurance Company (a Washington-domiciled insurer) and dividends paid by Family Life . Under current Washington law, any proposed payment of a dividend or distribution which, together with dividends or distributions paid during the preceding twelve months, exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31 or (ii) statutory net gain from operations for the preceding calendar year is an "extraordinary dividend" and may not be paid until either it has been approved, or a 60-day waiting period shall have passed during which it has not been disapproved, by the Washington Insurance Commissioner. Effective July 25, 1993, Washington amended its insurance code to retain the "greater of" standard for dividends but enacted requirements that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. Family Life does not presently have earned surplus as defined by the regulations adopted by the Washington Insurance Commissioner and, therefore, is not presently permitted to pay cash dividends. However, since 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. Principal and interest payments on the surplus debenture have provided sufficient funds to meet debt service obligations of FLC. Under the provisions of the surplus debenture and current law, Family Life can pay interest and principal on the surplus debenture without having to obtain the prior approval of the Washington Insurance Commissioner; provided that, after giving effect to the payment of interest or principal on the surplus debenture, the statutory capital and surplus of Family Life exceeds 6% of its assets. Pursuant to the surplus debenture, Family Life paid principal and interest in 1994, 1995 and 1996 totalling $19,311,960, $16,052,400 and $13,526,338, respectively. Family Life does give five-days prior notification to the Washington Insurance Department of each proposed payment on the surplus debenture in accordance with an agreement between Family Life and the Department. The Company does not anticipate that Family Life will have any difficulty in making principal and interest payments on the surplus debenture in the amounts necessary to enable FLC to service its indebtedness for the foreseeable future. Valuation Reserves. Commencing in 1992, the Mandatory Securities Valuation Reserve ("MSVR") required by the NAIC for life insurance companies was replaced by a mandatory Asset Valuation Reserve ("AVR") which is expanded to cover mortgage loans, real estate and other investments. A new mandatory Interest Maintenance Reserve ("IMR"), designed to defer realized capital gains and losses due to interest rate changes on fixed income investments and to amortize those gains and losses into future income, is also effective for 1992. Previously, realized capital gains attributable to interest rate changes were credited to the MSVR and had the effect of reducing Family Life's required MSVR contributions. Effective in 1992, such realized capital gains are credited to the IMR. As a result of these changes, Family Life is required to accrue greater aggregate asset valuation reserves. The combination of the AVR and IMR will affect statutory capital and surplus and may reduce the ability of Family Life to pay dividends and make payments on the surplus debenture. Insurance Holding Company Regulation. Family Life is subject to regulation under the insurance and insurance holding company statutes of Washington. The insurance holding company laws and regulations vary from jurisdiction to jurisdiction, but generally require insurance and reinsurance subsidiaries of insurance holding companies to register with the applicable state regulatory authorities and to file with those authorities certain reports describing, among other information, their capital structure, ownership, financial condition, certain intercompany transactions and general business operations. The insurance holding company statutes also require prior regulatory agency approval or, in certain circumstances, prior notice of certain material intercompany transfers of assets as well as certain transactions between insurance companies, their parent companies and affiliates. Under the Washington Insurance Code, unless (i) certain filings are made with the Washington Department of Insurance, (ii) certain requirements are met, including a public hearing and (iii) approval or exemption is granted by the insurance commissioner, no person may acquire any voting security or security convertible into a voting security of an insurance holding company, such as the Company, which controls a Washington insurance company, or merge with such a holding company, if as a result of such transaction such person would "control" the insurance holding company. "Control" is presumed to exist if a person directly or indirectly owns or controls 10% or more or the voting securities of another person. Potential Federal Regulation. Although the federal government generally does not directly regulate the insurance industry, federal initiatives often have an impact on the business. Congress and certain federal agencies are investigating the current condition of the insurance industry (encompassing both life and health and property and casualty insurance) in the United States in order to decide whether some form of federal role in the regulation of insurance companies would be appropriate. Congress is currently conducting a variety of hearings relating in general to the solvency of insurers. It is not possible to predict the outcome of any such congressional activity nor the potential effects thereof on Family Life. Congressional initiatives directed at repeal of the McCarran- Ferguson Act (which exempts the "business of insurance" from most federal laws, including the antitrust laws, to the extent it is subject to state regulation) and judicial decisions narrowing the definition of "business of insurance" for McCarran-Ferguson Act purposes may limit the ability of insurance companies in general to share information with respect to rate-setting, underwriting and claims management practices. Current and proposed federal measures which may also significantly affect the insurance industry include minimum solvency requirements and removal of barriers preventing banks from engaging in the insurance business. Federal Income Taxation The Revenue Reconciliation Act of 1990 amended the Internal Revenue Code of 1986 to require a portion of the expenses incurred in selling insurance products to be deducted over a period of years, as opposed to an immediate deduction in the year incurred. Since this change only affects the timing of the deductions, it does not affect tax expense as shown on the Company's financial statements prepared in accordance with GAAP. However, the change will increase the tax for statutory accounting purposes in the first few years, which will reduce statutory surplus and, accordingly, may decrease the amount of cash dividends that Family Life can pay. For the years ended December 31, 1994, 1995 and 1996, the increases in Family Life's current income tax provisions, utilizing the effective tax rates, due to this change were $209,555, $77,498 and $183,358, respectively. The change has a negative tax effect for statutory accounting purposes when Family Life's premium income increases, but has a positive tax effect when its premium income decreases. Item 2. Properties The Registrant's headquarters are currently located at Austin Centre, 701 Brazos, Suite 1400, Austin, Texas. Investors-NA purchased Austin Centre, an office-hotel property in downtown Austin in August 1991 for a purchase price of $31,275,000 from an unrelated seller that had previously acquired the property through foreclosure. Austin Centre covers a full city block and is a sixteen story mixed use development consisting of 343,664 square feet of office/retail space (predominately office space), a 314 room hotel and 61 luxury apartments, all united by a 200 foot high glass atrium. The project was completed in October 1986. In September 1995, Investors-NA (a subsidiary of ILCO) entered into a contract to sell Austin Centre to an Austin-based real estate investment firm for a purchase price of $62.675 million, less $1 million to be paid to a capital reserve account for the purchaser. The sale was consummated on March 29, 1996. A portion of the sale proceeds equal to the amount that Investors- NA presently had invested in Austin Centre were retained and reinvested by Investors-NA. The balance of the net proceeds of the sale were used to reduce ILCO's bank indebtedness by approximately $15 million. On January 31, 1995, ILCO, through Investors-NA, purchased, as an investment property, an office building project known as Bridgepoint Office Square in Austin, Texas for a cash purchase price of $9.75 million. The property consists of 20 acres of land with four office building sites and two parking structure sites. The first phase of development of the property was completed in 1986 and consists of a five-story office building with 83,474 square feet of rentable space and a 550-car parking garage. The office space is fully rented. In the fourth quarter of 1995, construction began on the second office building, containing approximately 109,000 rentable square feet, and the other parking garage containing approximately 871 spaces. That phase of the project was completed in September 1996, and is 100% leased to a major tenant in the technology business. In March 1996, construction commenced on the third office building, with approximately 81,000 rentable square feet of office space and was completed in December, 1996. Investors-NA leased approximately 43,000 square feet of the third office building to the same tenant which leased all of the space in the second building. The remaining space was leased in October, 1996 to a major tenant, also in the technology business. Construction began on the fourth building in July 1996, with a projected completion date of July, 1997. The fourth building contains approximately 92,459 rentable square feet. In September of 1996, approximately 23,619 rentable square feet were leased to an oil and gas company. Another 10,000 square feet was leased in March, 1997, to a company involved in the technology field. Investors-NA is currently negotiating with two other potential tenants to lease the remainder of the rentable square feet in the fourth building. On May 3, 1996, Family Life, purchased a tract of land adjoining the Bridgepoint Office Square tract for a cash purchase price of $1.3 million. The property consists of 7.1 acres of land with one office building site and one parking structure site. Family Life began construction of the fifth building (known as "Bridgepoint Five") on the new site in January 1997. The building, which will have approximately 71,500 square feet of rentable space, is currently projected to be completed in September, 1997. Following completion of the building, ILCO and its related companies will vacate their current headquarters in the Austin Centre and move them to Bridgepoint Five. ILCO and its related companies will occupy approximately 50,000 rentable square feet. Family Life is currently seeking tenants to occupy the remainder of the rentable square feet in the fifth building. Family Life leases its home offices at the Fourth and Blanchard Building, 2121 Fourth Avenue, in Seattle, Washington. The lease currently covers approximately 7,776 rentable square feet of office space for a term expiring in October 1998 with an option to renew for an additional three-year period. The initial base rental is approximately $11,200 per month, which includes Family Life's proportionate share of the building's operating expenses, including utilities, property taxes, insurance, maintenance and management. Actual increases from those initial operating expenses during the lease term are passed on to Family Life on a proportionate basis. ILCO leases a building located at 40 Parker Road, Elizabeth, New Jersey. This building, which was formerly ILCO's headquarters building, contains approximately 41,000 square feet of office space. The remaining term of the lease is 11 years, and the lease calls for a minimum base rental of $450,000 per annum. The lease provides that all costs including, but not limited to, those for maintenance, repairs, insurance and taxes be borne by ILCO. ILCO and ILIC currently occupy a nominal portion of the space in the 40 Parker Road property and have sub-leased the remaining portion. ILIC owns three buildings which are adjacent to the 40 Parker Road building. One building, which is leased to third parties, contains approximately 3,500 square feet of space. The second building contains approximately 2,500 square feet of space and is leased to persons who perform maintenance services for ILIC's and ILCO's properties in Elizabeth, New Jersey. The third building, purchased during 1985, contains approximately 3,500 square feet of space, and is partially leased to third parties and the remainder is used to provide accommodations for employees working at the New Jersey office. Investors-NA owns an office building located at 206 West Pearl Street, Jackson, Mississippi. This building is 66 years old and contains approximately 85,000 square feet of office space. Investors-NA currently occupies a nominal portion of the space in this property and leases space to various commercial tenants. The Company believes that its properties and leased space are adequate to meet its foreseeable requirements. Item 3. Legal Proceedings The Company and its subsidiaries are defendants in certain legal actions related to the normal business operations of the Company. Management believes that the resolution of such legal actions will not have a material impact on the financial statements. ILCO and Investors-NA are defendants in a lawsuit which was filed in October, 1996, in Travis County, Texas. CIGNA Corporation, an unrelated company, is also a named defendant in the lawsuit. The named plaintiffs in the suit (a husband and wife), allege that the universal life insurance policies sold to them by INA Life Insurance Company (a company which was merged into Investors-NA in 1992) utilized unfair sales practices. The named plaintiffs seek reformation of the life insurance contracts and an unspecified amount of damages. The named plaintiffs also seek a class action as to similarly situated individuals. No certification of a class has been granted as of the date hereof. ILCO believes that the suit is without merit and intends to vigorously defend this matter. Item 4. Submission of Matters to a Vote of Security Holders A Special Meeting of the Shareholders of FIC was held on November 12, 1996, for the purpose of obtaining the vote of the shareholders on a proposal to amend the Articles of Incorporation to: (i) increase the number of authorized shares of common stock from 3,304,200 shares to 10,000,000 shares and (ii) to reduce the par value of the common stock from $1.00 to $.20. These amendments to the Articles of Incorporation were related to the implementation of the five-for-one stock split authorized by the Board of Directors on September 27, 1996. PART II Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters A. Market Information The following table sets forth the quarterly high and low sales prices for FIC Common Stock in The Nasdaq Small-Cap Market for 1996 and 1995. The quotations set forth in the table have been adjusted to give retroactive effect to the five-for-one stock split which was effective November 12, 1996. FIC's NASDAQ trading symbol is FNIN. Common Stock Prices High Low 1996 First Quarter $11.00 $ 6.95 Second Quarter 11.90 7.80 Third Quarter 11.90 8.70 Fourth Quarter 15.00 11.00 1995 First Quarter $ 6.80 $ 5.60 Second Quarter 8.10 5.60 Third Quarter 8.50 7.30 Fourth Quarter 7.90 6.60 B. Stockholders As of March 17, 1997 there were approximately 16,126 record holders of FIC Common Stock. C. Dividends FIC has not paid a dividend since 1976 and does not expect to pay a dividend during 1997. The ability of an insurance holding company, such as FIC, to pay dividends to its shareholders may be limited by the company's ability to obtain revenue, in the form of dividends and other payments, from its operating insurance subsidiary or subsidiaries. The right of Family Life to pay dividends is restricted by the insurance laws of its domiciliary state. See Item 1. Business - Regulation - Surplus Debenture and Dividends. However, FIC does not directly own Family Life's stock but, instead, indirectly owns that stock through two downstream holding companies, FLIIC and FLC. FLC, which holds all of the stock of Family Life, is prohibited from paying dividends on its common stock by the provisions of the note from Investors-NA , and FLIIC, the immediate parent of FLC and the directly-owned subsidiary of FIC, is prohibited from paying dividends on its stock by the $4.5 million subordinated note of FLIIC held by Investors-NA, except FLIIC may pay dividends on its common stock to enable FIC to make scheduled principal and interest payments on its $2.5 million subordinated note to Investors-NA. The ability of ILCO to pay dividends to FIC and the other shareholders of ILCO is affected by the receipt of dividends and other payments from its insurance subsidiaries. In addition, the ILCO Senior Loan restricts ILCO from paying any dividends on its stock during the term of that loan. Item 6. Selected Financial Data (Registrant and its Consolidated Subsidiaries) (In thousands, except per share data) 1996 1995 1994 1993 1992 Operating Revenues $59,928 $ 61,541 $ 68,524 $ 74,023 $ 83,531 Income (loss) before federal income tax, equity in net earnings of affiliates, extraordinary items and cumulative effect of change in accounting principle of affiliate 9,791 10,394 10,610 11,560 12,179 Income before equity in net earnings of affiliates, extraordinary items and cumulative effect of change in accounting principle of affiliate 7,145 7,966 8,264 8,587 8,831 Equity in net earnings of affiliate, net of tax 9,012 2,051 1,690 3,038 4,761 Income before extraordinary items and cumulative effect of change in accounting principle of affiliate 16,157 10,017 9,954 11,625 13,592 Extraordinary items -0- -0- -0- 5,555 -0- Income before cumulative effect of change in accounting principle of affiliate 16,157 10,017 9,954 17,180 13,592 Cumulative effect of change in accounting principle of affiliate, net -0- -0- -0- (1,159) -0- of tax benefit Net Income $16,157 $ 10,017 $ 9,954 $ 16,021 $ 13,592 Common Stock and Common Stock Equivalents 5,568 5,540 5,530 5,555 5,565 Net income per share before extraordinary items and cumulative effect of change in accounting principle of affiliate $ 2.90 $ 1.81 $ 1.80 $ 2.09 $ 2.44 Extraordinary items -0- -0- -0- 1.00 -0- Net income per share before cumulative effect of change in accounting principle of affiliate 2.90 1.81 1.80 3.09 2.44 Cumulative effect of change in accounting principle of affiliate -0- -0- -0- ( 0.21) 0.00 Net Income per share $ 2.90 $ 1.81 $ 1.80 $ 2.88 $ 2.44 Total Assets $287,730 $287,678 $253,100 $277,790 $311,497 Long Term Obligations $59,940 $ 67,989 $ 77,819 $ 89,178 $113,015 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations For the year ended December 31, 1996, FIC's net income was $16,157,000 (or $2.90 per common share), as compared to $10,017,000 (or $1.81 per common share for the year ended December 31, 1995 and $9,954,000 (or $1.80 per common share), for the year ended December 31, 1994. The net income per share for the years 1995 and 1994 has been restated to reflect the effect of the five-for-one stock split which was effective November 12, 1996. FIC's net income is affected by its equity interest in InterContinental Life Corporation ("ILCO") and ILCO's insurance subsidiaries. Net income for the year ended December 31, 1996 includes $7.1 million resulting from ILCO's sale of the Austin Centre, a hotel/office complex, located in Austin, Texas. The sale was completed by Investors Life Insurance Company of North America ("Investors-NA"), a wholly-owned subsidiary of ILCO. The selling price was $62.675 million, less $1 million paid to a capital reserve account for the purchaser. The property was purchased in 1991 for $31.275 million. A portion of the sale proceeds, equal to the book value of the property, net of improvements and amortization ($36.8 million), was retained and reinvested by Investors-NA. The balance of the proceeds of the sale, net of federal income tax, was used to reduce the ILCO's senior loan obligations by $15 million. The sale closed on March 29, 1996. The Company and its affiliates will continue to occupy space on three floors of the office tower as its headquarters, under a lease which runs through September 30, 1997. In September, 1997, the Company and its affiliates will move its headquarters to a new, 71,500 square foot office building know as Bridgepoint Five. That project, which is currently under construction on a 7.1 acre site owned by Family Life Insurance Company, is located in Austin, Texas, adjacent to the 20-acre office building site which is being developed by Investors-NA. The Bridgepoint Five site was purchased by Family Life in May, 1996, for a cash purchase price of $1.3 million. The statutory earnings of Family Life as required to be reported to insurance regulatory authorities before interest expense, capital gains and losses, and federal income taxes were $12,734,000 at December 31, 1996, as compared to $14,354,000 at December 31, 1995 and $18,944,000 at December 31, 1994. These statutory earnings are the source to provide for the repayment of the indebtedness incurred in connection with the acquisition of Family Life. The decline in long-term interest rates during 1996, which was related to general economic conditions, had a positive effect upon the market value of the fixed maturities available for sale segment of the Company's portfolio. As of December 31, 1996, the market value of the fixed maturities available for sale segment was $83.8 million as compared to an amortized value of $83.0 million, or an unrealized gain $.8 million. The net of tax effect of this increase has been recorded as an increase in shareholders' equity. There is no assurance that this unrealized gain may be realized in the future. 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. The consolidated balance sheets at December 31, 1996 include Separate Account assets of Family Life in the amount of $0.45 million. The Separate Account is maintained by Family Life, which was acquired by FIC on June 12, 1991. Under the provisions of the purchase agreement between FIC and Merrill Lynch Insurance Group, Inc., certain life insurance companies affiliated with Merrill Lynch agreed to assume (on an assumption reinsurance basis) the variable annuity contracts related to such Separate Account assets. The transfer of these assets, in accordance with the provisions of the reinsurance agreement, is subject to certain regulatory approvals. During the year 1996, Merrill Lynch received regulatory approvals in several additional jurisdictions. As a result, Separate Account assets in the amount of $8.1 million were transferred out of Family Life, in accordance with the provisions of the 1991 agreements. The Company has not obtained a definitive date from Merrill Lynch as to when the remaining regulatory approvals will be obtained, so as to enable Family Life to complete the transfer of Separate Account assets. Equity in Net Income of InterContinental Life Corporation General: Prior to the acquisition of Family Life in June of 1991, FIC's primary involvement in the life insurance business was through its equity interest in ILCO. The Company's equity in the net earnings of ILCO, net of federal income tax, was $9,012,000, as compared to $2,051,000 for the year 1995 and $1,690,000 for the year 1994. The increase in 1996 is primarily attributable to ILCO's net income resulting from the sale of the Austin Centre property. FIC currently owns 1,795,146 shares of ILCO's common stock, and holds options to acquire 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. In addition, Family Life currently owns 171,200 shares of ILCO common stock. As a result, FIC currently owns, directly and indirectly through Family Life, 1,966,346 shares (approximately 46%) of ILCO's common stock and holds options to acquire 1,702,155 shares. If all of FIC's rights under the Option Agreement were to be presently exercised, FIC's ownership would amount to approximately 61.5% of the issued and outstanding shares of ILCO's common stock. The decline in long-term interest rates during 1996, which was related to general economic conditions, had a positive effect upon the market value of the fixed maturities available for sale segment of ILCO's investment portfolio. As of December 31, 1996, the market value of the fixed maturities available for sale segment was $453.9 million as compared to an amortized cost of $451.6 million, or an unrealized gain $ 2.3 million. There is no assurance that this unrealized gain will be realized by ILCO in the future. Since FIC owns approximately 46% of the common stock of ILCO, such unrealized gains, net of tax, are reflected in FIC's equity interest in ILCO, and had the effect of increasing the reported value of such equity interest by approximately $5.3 million. ILCO's results for 1996, and for that portion of 1995 beginning on february 14th, include the operations of Investors Life Insurance Company of Indiana (formerly known as Meridian Life Insurance Company). Investors Life Insurance Company of Indiana ("Investors-IN") was purchased by ILCO and Investors Life Insurance Company of North America ("Investors-NA") for an adjusted purchase price of $17.1 million; the transaction was completed on February 14, 1995. The name change was completed in May, 1995. Liquidity and Capital Resources of ILCO: ILCO is a holding company whose principal assets consist of the common stock of Investors-NA and its subsidiaries, InterContinental Life Insurance Company ("ILIC") and, since February, 1995, Investors-IN. ILCO's primary source of funds consists of payments under the surplus debentures from Investors- NA. The cash requirements of ILCO consist primarily of its service of the indebtedness created in connection with the 1988 acquisition of the Investors Life Companies and the 1995 acquisition of Investors-IN. As of December 31, 1995, the unpaid principal of ILCO's senior loan was $59.4 million. In January, 1996, ILCO made a scheduled payment of $4.5 million under its Senior Loan. In March, 1996, ILCO made the scheduled payments for April 1st and July 1st, totaling $9 million. At that same time, ILCO made a payment of $941,000, an additional payment under the terms of the loan applied to the principal balance. On April 1, 1996, an optional principal payment in the amount of $15 million was made. In July, 1996, ILCO made the principal payment for October 1st ($4.5 million), plus an optional principal payment of $0.5 million, thereby reducing the total amount of the outstanding Senior Loan to $24.94 million. 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 its terms were previously approved by the Mississippi Insurance Commissioner. One of the surplus debentures, in the original amount of $15 million, was issued in connection with the 1986 acquisition of Standard Life by ILCO; the other, in the original amount of $140 million was issued in connection with the 1988 acquisition by ILCO of the Investors Life Companies. Upon the merger of Standard Life into Investors-NA, the obligations of the surplus debentures were assumed by Investors-NA. As of December 31, 1996, the outstanding principal balance of the surplus debentures was $5.7 million and $32.8 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 December 31, 1996, the statutory capital and surplus of Investors-NA was $53.8 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 Standard Life (now, from Investors-NA). Washington's insurance code includes the "greater of" standard for payment of dividends to shareholders, but has a requirement that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. As of December 31, 1996, Investors-NA had earned surplus of $5,205,100. Since the law applies only to dividend payments, the ability of Investors-NA to make principal and interest payments under the Surplus Debentures is not affected. ILCO does not anticipate that Investors-NA will have any difficulty in making principal and interest payments on the Surplus Debentures in the amounts necessary to enable ILCO to service the Senior Loan for the foreseeable future. ILIC is domiciled in the State of New Jersey. Under the New Jersey insurance code, a domestic insurer may make dividend distributions upon proper notice to the Department of Insurance, as long as the distribution is reasonable in relation to adequate levels of policyholder surplus and quality of earnings. Any dividend must be paid from earned surplus. A proposed payment of a dividend or distribution which, together with dividends or distributions paid during the preceding twelve months, exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31 or (ii) statutory net gain from operations for the preceding calendar year is treated as an "extraordinary dividend" and may not be paid until either it has been approved, or a waiting period shall have passed during which it has not been disapproved, by the insurance commissioner. ILIC had earned surplus of $7,026,282 at December 31, 1996. Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance code, a domestic insurer may make dividend distributions upon proper notice to the Department of Insurance, as long as the distribution is reasonable in relation to adequate levels of policyholder surplus and quality of earnings. Under Indiana law the dividend must be paid from earned surplus. Extraordinary dividend approval would be required where a dividend exceeds the greater of 10% of surplus or the net gain from operations for the prior fiscal year. Investors-IN had earned surplus of $12,510,153 at December 31, 1996. The Form 10-Ks of ILCO for the years ended December 31, 1996, 1995 and 1994, set forth the business operations and financial results of ILCO and its life insurance subsidiaries. Such 10-K reports of ILCO, including the discussion by ILCO's management under the caption "Management's Discussion and Analysis of Financial Conditions and Results of Operations" are incorporated herein by reference. Results of Operations For the year ended December 31, 1996, FIC's income from operations, before federal income tax and equity in net earnings of affiliate, was $9,791,000 (on revenues of $59,928,000), as compared to $10,394,000 (on revenues of $61,541,000) in the year 1995 and $10,610,000 (on revenues of $68,524,000) for the year 1994. Premiums for the year 1996, net of reinsurance ceded, were $43.3 million, as compared to $43.9 million in 1995 and $48.9 million in 1994. Policyholder benefits and expenses were $22.1 million in 1996, as compared to $21.0 million in 1995 and $21.8 million in 1994. In 1995, Family Life entered into a reinsurance agreement with Investors-NA pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. In 1996, Family Life entered into a reinsurance agreement with Investors-NA, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. These reinsurance arrangements reflect management's plan to develop universal life and annuity business at Investors-NA, with Family Life concentrating on the writing of term life insurance products. Liquidity and Capital Resources FIC is a holding company whose principal assets consist of the common stock of Family Life and its equity ownership in ILCO. FIC's primary sources of capital consists of cash flow from operations of its subsidiaries and the proceeds from bank and institutional borrowings. The cash requirements of FIC and its subsidiaries consist primarily of its service of the indebtedness created in connection with its ownership of Family Life. As of September 30, 1996 the outstanding balance of such indebtedness was $61.5 million on the Subordinated Notes granted by Investors-NA. On April 17, 1996, the Senior Loan granted by a group of banks was completely paid off; the balance as of March 31, 1996 had been $4.67 million. The principal source of liquidity for FIC's subsidiaries consists of the periodic payment of principal and interest by Family Life pursuant to the terms of a Surplus Debenture. The terms of the Surplus Debenture were previously approved by the Washington Insurance Commissioner. Under the provisions of the Surplus Debenture and current law, no prior approval of the Washington Insurance Department is required for Family Life to pay interest or principal on the Surplus Debenture; provided that, after giving effect to such payments, the statutory surplus of Family Life is in excess of 6% of assets (the "surplus floor"). However, Family Life has voluntarily agreed with the Washington Insurance Commissioner that it will provide at least five days advance notice of payments which it will make under the surplus debenture. As of December 31, 1996, the statutory capital and surplus of Family Life was $24.9 million, an amount substantially in excess of the surplus floor. During 1996, Family Life made principal payments of $9.4 million and interest payments of $4.1 million to Family Life Corporation under the Surplus Debenture. As of December 31, 1996, the principal balance of the Surplus Debenture was $40.5 million. The funds required by Family Life to meet its obligations under the terms of the Surplus Debenture are generated primarily from premium payments from policyholders, investment income and the proceeds from the sale and redemption of portfolio investments. Washington's insurance code includes the "greater of" standard for dividends but has requirements that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. Family Life does not presently have earned surplus as defined by the regulations adopted by the Washington Insurance Commissioner and, therefore, is not permitted to pay cash dividends. However, since the new law applies only to dividend payments, the ability of Family Life to make principal and interest payments under the Surplus Debenture is not affected. The Company does not anticipate that Family Life will have any difficulty in making principal and interest payments on the Surplus Debenture in the amounts necessary to enable Family Life Corporation to service its indebtedness for the foreseeable future. The sources of funds for Family Life consist of premium payments from policy holders, 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 $9.7 million in 1996, as compared to $9.1 million in 1995 and $5.3 million in 1994. Net cash flow used in financing activities was $8.05 million in 1996, as compared to $9.8 million in 1995 and $11.4 million in 1994. 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 relate to the ILCO Senior Loan, with an outstanding balance at December 31, 1996 of $24.9 million. 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 $22.50 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 December 31, 1996, the Company's investment assets totaled $111.7 million, as compared to $112.6 million as of December 31, 1995 and $107.1 million as of December 31, 1994. The level of short-term investments at the end of 1996 was $25.6 million, as compared to $27.2 million as of December 31, 1995. The fixed maturities available for sale portion represents $83.8 million of investment assets as of December 31, 1996, as compared to $83.6 million at the end of 1995. The amortized cost of fixed maturities available for sale as of December 31, 1996 was $83.0 million representing a net unrealized gain of $.8 million. This unrealized gain principally reflects changes in interest rates from the date the respective investments were purchased. To reduce the exposure to interest rate changes, portfolio investments are selected so that diversity, maturity and liquidity factors approximate the duration of associated policyholder liabilities. The assets held by Family Life must comply with applicable state insurance laws and regulations. In selecting investments for the portfolios of its life insurance subsidiaries, the Company's emphasis is to obtain targeted profit margins, while minimizing the exposure to changing interest rates. This objective is implemented by selecting primarily short- to medium-term, investment grade fixed income securities. In making such portfolio selections, the Company generally does not select new investments which are commonly referred to as "high yield" or "non-investment grade". The fixed maturities portfolio of Family Life, as of December 31, 1996, consisted solely of fixed maturities investments which, in the annual statements of the companies, as filed with state insurance departments, were designated under the National Association of Insurance Commissioners ("NAIC") rating system as a "1" (highest quality). Management believes that the absence of "high-yield" or "non- investment grade" investments (as defined above) in the portfolios of its life insurance subsidiary enhances the ability of the Company to service its debt, provide security to its policyholders and to credit relatively consistent rates of return to its policyholders. Accounting Developments In March, 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to be Disposed Of." This statement required that long lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In addition, the statement requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying amount or fair value less cash to sell. SFAS No. 121 is effective for fiscal years beginning after 1995. The Company plans to adopt SFAS No. 121 effective January 1, 1996. Management does not anticipate that adoption or this standard will have a material impact on the Company's financial statements. During 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based Compensation," which encourages companies to adopt the fair value based method of accounting for stock-based compensation. This method requires the recognition of compensation expense equal to the fair value of such equity securities at the date of the grant. This statement also allows companies to continue to account for stock-based compensation under the intrinsic value based method, as prescribed by Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," with footnote disclosure of the pro forma effects of the fair value based method. SFAS No. 123 is effective for transactions entered into in years that begin after December 15, 1995. The Company plans to adopt SFAS No. 123 during 1996 by continuing to account for stock-based compensation under the intrinsic value method and disclosing the pro forma effects of the fair value method in the footnotes to the financial statements. Item 8. Financial Statements and Supplementary Data The following Financial Statements of the Registrant have been filed as part of this report: 1. Report of Price Waterhouse LLP, Independent Accountants, dated March 27, 1996. 2. Consolidated Balance Sheets, as of December 31, 1996 and December 31, 1995. 3. Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994. 4. Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994. 5. Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994. 6. Notes to Consolidated Financial Statements. 7. Consolidated Financial Statement Schedules. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure No independent accountant who audited the Registrant's financial statements has resigned or been dismissed during the two most recent fiscal years. Part III Item 10. Directors and Executive Officers of the Registrant (a) Directors of the Registrant The names and ages of the current directors of the Registrant, their principal occupations or employment during the past five years and other data regarding them are set forth below. All of the directors were elected at the 1995 annual shareholders meeting. The data supplied below is based on information provided by the directors, except to the extent that such data is known to the Registrant. Director Principal Occupation Name Age Since and Other Information Roy F. Mitte 65 1976 Chairman of the Board, President and Chief Executive Officer of FIC. Chairman of the Board, President and Chief Executive Officer of ILCO and InterContinental Life Insurance Company since January 1985. President of ILCO since April 1985. Chairman of the Board, President and Chief Executive Officer of Investors Life Insurance Company of North America since December 1988. Chairman of the Board, President and Chief Executive Officer of Family Life Insurance Company since June 1991. Chairman of the Board, President and Chief Executive Officer of Investors Life Insurance Company of Indiana since February 1995. Chairman, ILG Securities Corporation since December 1988. James M. Grace 53 1976 Vice President, Secretary, Treasurer and Director of FIC. Vice President and Treasurer of ILCO since January 1985. Executive Vice President, Treasurer and Director of InterContinental Life Insurance Company since 1989. Executive Vice President and Treasurer of Investors Life Insurance Company of North America since 1989. Executive Vice President, Treasurer and Director of Family Life Insurance Company since June 1991. Director, Executive Vice President and Treasurer of Investors Life Insurance Company of Indiana since February 1995. John D. Barnett 54 1991 Vice President-Investments, Investment Professionals, Inc. since August 1996. Vice President-Investments of Prudential Securities from April 1983 to July 1996. Eugene E. Payne 54 1992 Vice President and Director of FIC since February 29, 1992. Vice President of ILCO since December 1988 and Director of ILCO since May 1989. Executive Vice President, Secretary and Director of Investors Life Insurance Company of North America since December 1988. Executive Vice President since December 1988 and Director since May 1989 of InterContinental Life Insurance Company. Executive Vice President, Secretary and Director of Family Life Insurance Company since June 1991. Director, Executive Vice President and Secretary of Investors Life Insurance Company of Indiana since February 1995. Joseph F. Crowe 58 1992 Vice President of FIC from February 29, 1992 to January 3, 1997, when he retired from active service with the Company. Director of FIC since February 29, 1992. Vice President of ILCO from May 1991 to January 1997. Director of ILCO since May 1991. Executive Vice President of Investors Life Insurance Company of North America and InterContinental Life Insurance Company from June 1991 to January 1997. Director of Investors Life Insurance Company of North America and InterContinental Life Insurance Company since June 1991. Executive Vice President of Family Life Insurance Company from June 1991 to January 1997. Director of Family Life Insurance Company since June 1991. Executive Vice President of Investors Life Insurance Company of Indiana from February 1995 to January 1997. Director of Investors Life Insurance Company of Indiana since February 1995. From December 1986 to March 1991, Executive Vice President of Personal Financial Security Division of Aetna Life & Casualty Company. Theodore A. Fleron 57 1996 Vice President and Director of FIC since August 1996. Vice President and Director of ILCO since May 1991. Assistant Secretary of ILCO since June 1990. Senior Vice President, General Counsel, Assistant Secretary and Director of Investors Life Insurance Company of North America and InterContinental Life Insurance Company since July 1992. General Counsel, Assistant Secretary and Director of Investors Life Insurance Company of North America and InterContinental Life Insurance Company from January 1989 to July 1992. Senior Vice President, General Counsel, Director and Assistant Secretary of Investors Life Insurance Company of Indiana since June 1995. Senior Vice President, General Counsel, Director and Assistant Secretary of Family Life Insurance Company since August 1996. Dale E. Mitte 62 1994 Senior Vice President since January 1993 and Vice President, Chief Underwriter and Director since December 1988 of Investors Life Insurance Company of North America and InterContinental Life Insurance Company. Director from June 1991 to April 1992 and Vice President and Chief Underwriter since June 1991 of Family Life Insurance Company. Director, Senior Vice President and Chief Underwriter of Investors Life Insurance Company of Indiana since June 1995. Leonard A. Nadler 54 1994 Senior Managing Director of Julien J. Studley, Inc. since 1995. President, Leonard Nadler Associates, Inc., a commercial real estate brokerage company located in Los Angeles, California, for more than five years prior to 1995. Frank Parker 67 1994 President, Gateway Tugs, Inc. and Par-Tex Marine, Inc., both of which are located in Brownsville, Texas and are engaged in operating and chartering harbor and intracoastal tug boats, for more than the last five years. Jeffrey H. Demgen 44 1995 Director of FIC since May 1995. Vice President of FIC since August 1996. Vice President and Director of ILCO since August 1996. Director of Family Life Insurance Company since October 1992. Executive Vice President of Family Life Insurance Company since August 1996. Senior Vice President of Family Life Insurance Company from October 1992 to August 1996. Executive Vice President and Director of Investors Life Insurance Company of North America since August 1996. Senior Vice President and Director of Investors Life Insurance Company of North America from October 1992 to June 1995. Executive Vice President of InterContinental Life Insurance Company since August 1996. Senior Vice President of InterContinental Life Insurance Company from October 1992 to June 1995. Executive Vice President and Director of Investors Life Insurance Company of Indiana since August 1996. Senior Vice President of United Insurance Company of America from September 1984 to July 1992. Thomas C. Richmond 55 1996 Director of FIC since August 1996. Director of ILCO from March 1994 to August 1996. Director from March 1989 to February 1990, Senior Vice President since January 1993 and Vice President from March 1989 to January 1993 of Investors Life Insurance Company of North America and InterContinental Life Insurance Company. Senior Vice President of Family Life Insurance Company since June 1991. Senior Vice President of Investors Life Insurance Company of Indiana since June 1995. Mr. Nadler and his wife were general partners of a single-asset partnership that owned The Palmilla Apartments, a 26 unit apartment complex in Hollywood, California. In March 1992, a receiver for that property was appointed by stipulation of the parties in connection with the conveyance of that property to the mortgagee. The receiver was discharged by stipulation of the parties in September 1992. The incumbent directors have been nominated for submission to vote of the shareholders for reelection at the 1997 annual shareholders' meeting. (b) Executive Officers of the Registrant The following table sets forth the names and ages of the persons who served as the Registrant's Executive Officers during 1996 together with all positions and offices held by them with the Registrant. Officers are elected to serve at the will of the Board of Directors or until their successors have been elected and qualified. Name Age Positions and Offices Roy F. Mitte 65 Chairman of the Board, President and Chief Executive Officer James M. Grace 53 Vice President, Secretary, and Treasurer Eugene E. Payne 54 Vice President Joseph F. Crowe1 58 Vice President Roger H. Hamm2 52 Vice President Jeffrey H. Demgen3 44 Vice President In May 1991, Roy F. Mitte suffered a stroke, resulting in partial paralysis affecting his speech and mobility. Mr. Mitte continues to make the requisite decisions in his capacity as Chief Executive Officer, although his ability to communicate and his mobility are impaired. 1. Mr. Crowe retired from active service with the Company as of January 3, 1997. He will continue to service on the Board of Directors. 2. Mr. Hamm resigned as Director of the Company as of August 26, 1996. His appointment as a Vice President of the Company was terminated on that date. 3. Mr. Demgen was appointed a Vice President of the Company on August 26, 1996. (c) Identification of certain significant employees Not applicable. (d) Family relationships Dale E. Mitte is Roy F. Mitte's brother. (e) Business experience All of the executive officers of the Company are members of the Board of Directors, and their business experience has been outlined in Item 10 (a). (f) Compliance with Section 16(a) of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of beneficial ownership on Form 3 and changes in beneficial ownership on Form 4 and 5 with the Securities and Exchange Commission. Officers, directors and greater than ten-percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on review of the copies of such forms furnished to the Company, or written representations that no Form 5's were required, the Company believes that during the period from January 1, 1996 through December 31, 1996, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were complied with, except as follows: (i) Frank Parker filed a Form 5 in February, 1997, to report the purchase in June, 1996 of 2,000 shares (10,000 shares as adjusted to reflect the five-for-one stock split effective November 12, 1996) of FIC common stock; and (ii) Eugene E. Payne filed a Form 5 in February, 1997, to report the purchase in August, 1996, of 347 shares (1,735 shares as adjusted to reflect the five- for-one stock split effective November 12, 1996) of FIC common stock. Thomas C. Richmond and Theodore A. Fleron each filed a Form 5 in February, 1997, to report his appointment as a Director of the Company as of August 26, 1996 and to report no beneficial ownership of FIC common stock. Item 11. Executive Compensation Summary Compensation Table The following table sets forth information concerning the compensation of the Company's Chief Executive Officer and each of the four other persons who were serving as executive officers of the Company at the end of 1995 and received cash compensation exceeding $100,000 during 1996 Annual Compensation Name and All Other Principal Salary(1) Bonus(1) Other(2) Compensation Position Year ($) ($) ($) ($) Roy F. Mitte, Chairman of Board, President and Chief 1996 503,500 -0- -0- 2,446,397 3 Executive 1995 503,500 -0- -0- 1,120,513 4 Officer 1994 503,500 1,076,159 5 -0- 1,376,663 6 James M. Grace, Vice President, 1996 15,000 -0- -0- Secretary and 1995 195,000 10,000 -0- -0- Treasurer 1994 195,000 2,500 -0- -0- 195,000 Eugene E. Payne, 1996 15,000 -0- -0- Vice 1995 195,000 10,000 -0- -0- President 1994 195,000 5,000 -0- -0- Joseph F. 195,000 Crowe, 1996 15,000 -0- -0- Vice 1995 10,000 -0- -0- President 1994 196,500 5,500 -0- -0- 195,000 Jeffrey 195,000 H. Demgen, Vice Presi- dent 7 1996 7,500 -0- -0- 102,500 (1) The salaries and bonuses set forth in the table were paid by ILCO, except that $216,857 of Mr. Mitte's salary in 1996, $216,857 of Mr. Mitte's salary in 1995 and $251,700 of Mr. Mitte's salary and $538,080 of his bonus in 1994 were paid by Family Life. The executive officers of FIC have also been executive officers of Family Life, the insurance subsidiary of FIC, and ILCO and its insurance subsidiaries. Family Life reimbursed ILCO (or, in the case of Mr. Mitte, paid Mr. Mitte directly) the following amounts as Family Life's share of the executive officers' cash compensation for 1994, 1995 and 1996: $789,780, $216,857 and $216,857, respectively, for Mr. Mitte; $70,590, $88,293 and $83,987, respectively, for Mr. Grace; $126,750, $79,875 and $83,987, respectively, for Dr. Payne; $68,250, $88,293 and $84,633, respectively, for Mr. Crowe; and $46,125 (1996 only) for Mr. Demgen. Mr. Mitte and FIC are parties to an employment agreement, providing for the employment of Mr. Mitte as Chairman, President and Chief Executive Officer of the Company. The agreement, which was initially effective February 25, 1982, provides for five-year terms and for automatic renewals for successive five-year periods, unless otherwise terminated in accordance with the terms of the agreement. The agreement provides that the level of compensation will be fixed each year by agreement, but not less than $120,000 per year. In addition, the agreement provides that Mr. Mitte is entitled to reimbursement for reasonable business expenses and to participate in all fringe benefit plans and arrangements available generally to employees of the Company. (2) Does not include the value of perquisites and other personal benefits because the aggregate amount of any such compensation does not exceed the lesser of $50,000 or 10 percent of the total amount of annual salary and bonus for any named individual. (3) During 1996, ILCO paid Mr. Mitte: (i) $1,862,000 for the cancellation in 1996 of options to purchase 121,500 shares of the Company's common stock, plus interest at the rate of 8% per year on such amount for a one year period (for a total of $2,011,737); (ii) $120,700 for the federal income tax reimbursement relating to the cancellation in 1995 of options to purchase 50,000 shares of the Company's common stock; and (iii) $313,960 for the federal income tax reimbursement relating to the 1996 options cancellation described above in this footnote. Each of these payments was made pursuant to the contract referred to in footnote 4. (4) In 1989, ILCO's Board of Directors granted Mr. Mitte options to purchase 600,000 shares of ILCO's Common Stock. In October 1992, Mr. Mitte surrendered to ILCO for cancellation options to purchase 120,000 shares. ILCO and Mr. Mitte entered into a contract in 1993 providing for the cancellation of 240,000 options for an aggregate amount of $3,237,120 in 1993 and the cancellation in subsequent years of the remaining options for an aggregate amount of $3,610,240. In addition, the Company agreed to pay Mr. Mitte the amount necessary to ensure that Mr. Mitte will receive the same amount, after federal income tax, that he would have received if the options had been cancelled in 1992. During 1995, Mr. Mitte was paid $836,582 for the cancellation in 1995 of options to purchase 50,000 shares of ILCO's Common Stock, $156,323 for the federal income tax reimbursement relating to the cancellation in 1994 of options to purchase 68,500 shares and $127,608 as the final payment relating to the cancellation in 1993 of options to purchase 240,000 shares. These option cancellation payments were made pursuant to the contract referred to above. FIC's Compensation Committee made a recommendation to FIC's Board of Directors, which it adopted, that, in lieu of paying Mr. Mitte a bonus as it has in the past, FIC pay $407,000 of these option cancellation payments to Mr. Mitte, with the balance of $713,513 being paid by ILCO. (5) ILCO's Compensation Committee made a recommendation to ILCO's Board of Directors, which the Board adopted, that a bonus be paid to Mr. Mitte to enable him to pay off the $650,000 loan that ILCO had made to Mr. Mitte in 1989 and to reimburse him for the amount of federal income tax payable on the bonus. Since ILCO and FIC have usually each paid one-half of Mr. Mitte's cash compensation, FIC's Board of Directors, acting on the recommendation of its Compensation Committee, subsequently authorized FIC to pay $500,000 of that bonus to Mr. Mitte. Therefore, FIC paid $500,000, and ILCO paid $576,159, of the bonus. (6) During 1994, ILCO paid Mr. Mitte $997,520 for the cancellation in 1994 of options to purchase 68,500 shares of ILCO's Common Stock and $379,143 for the federal income tax reimbursement relating to the cancellation in 1993 of options to purchase 240,000 shares. Both of these payments were made pursuant to the contract referred to in footnote (4). (7) Mr. Demgen became an executive officer of FIC and ILCO in August 1996. Compensation of Directors Directors who are not officers or employees of the Company are paid a $5,000 annual fee, and are compensated $1,000 for each regular or special meeting of the Board of Directors which they attend in person. Members of Compensation Committee The Compensation Committee makes recommendations to the Board of Directors with respect to the Chief Executive Officer's compensation. The members of the Compensation Committee are John D. Barnett, Leonard A. Nadler and Frank Parker. Compensation Committee Interlocks and Insider Participation Roy F. Mitte determines the compensation of all executive officers of FIC, other than the Chief Executive Officer. Mr. Mitte is the Chairman of the Board, President and Chief Executive Officer of FIC and ILCO. He also determines the compensation of all executive officers of ILCO, other than the Chief Executive Officer. Item 12. Security Ownership of Certain Beneficial Owners and Management The following table presents information as of March 14, 1997 as to all persons who, to the knowledge of the Registrant, were the beneficial owners of five percent (5%) or more of the Common Stock of the Registrant. Amount and Nature Name and Address of of Beneficial Percent Beneficial Owner Ownership of Class Roy F. Mitte, Chairman of the Board, President and Chief Executive Officer, 701 Brazos Suite 1400, Austin, Texas 78701 1,866,520 1 34.39% 1 InterContinental Life Corporation 701 Brazos Suite 1400, Austin, Texas 78701 727,115 2,4 12.19% 3 Investors Life Insurance Company of North America 701 Brazos Suite 1400 Austin, Texas 78701 727,115 2,4 12.19% 3 (1) These shares are held jointly by Mr. Mitte with his wife Joann C. Mitte. (2) Of such shares, 145,500 shares are owned by Investors-NA, 44,250 shares are owned by ILIC, and 537,365 shares are issuable upon exercise of an option held by Investors-NA. Investors-NA is a direct subsidiary of ILCO. ILIC is a direct subsidiary of Investors-NA. (3) Assumes that outstanding stock options or warrants held by other persons have not been exercised. (4) See Item 1. Business-Acquisition of Family Life for a description of the options granted to Investors-NA. The following table contains information as of March 14, 1997 as to the Common Stock of the Registrant beneficially owned by each director, nominee and executive officer and by all executive officers and directors of the Registrant as a group. Messrs. Barnett, Crowe, Demgen, Hamm, Parker, Payne and Spears did not beneficially own any shares of FIC as of March 14, 1997. The information contained in the table has been obtained by the Registrant from each director and executive officer, except for the information known to the Registrant. Except as indicated in the notes to the table, each beneficial owner has sole voting power and sole investment power as to the shares listed opposite his name. Amount and Nature of Percent of Name Beneficial Ownership Class John Barnett -0- Joseph F. Crowe -0- 2 Jeffrey H. Demgen -0- 2 Theodore A. Fleron -0- James M. Grace 5,600 2 * Dale E. Mitte 2,000 * Roy F. Mitte 1,866,520 1,2 34.39% Leonard A. Nadler 1,665 * Frank Parker 10,000 * Eugene E. Payne 5,360 2 * Thomas C. Richmond -0- All Executive Officers, Nominees and Directors as a group (11 persons) 1,891,145 1,2 34.84% (1) These shares are held by Mr. Mitte jointly with his wife Joann C. Mitte. (2) No executive officer or director holds any options to acquire FIC Common Stock. Messrs. Roy Mitte, Grace, Payne, Crowe and Demgen are executive officers and/or directors of ILCO and beneficially owned approximately 63.9% of the outstanding shares of ILCO common stock as of March 14, 1997. Since FIC beneficially owns 61.5% of ILCO Common Stock, Mr. Roy Mitte's personal holdings are combined with FIC's holdings in determining the percentage of ILCO Common Stock beneficially owned by Mr. Mitte. ILCO beneficially owned 727,115 shares of FIC Common Stock (12.19% of the outstanding shares) as of March 14, 1997. * Less than 1%. Item 13. Certain Relationships and Related Transactions The obligations of ILCO under the ILCO Senior Loan are guaranteed by FIC. FIC presently owns 1,966,346 shares of ILCO Common Stock, constituting 46.17% of such shares outstanding, and holds options to acquire an additional 1,702,155 shares at the average bid price of such shares during the six-month period preceding the date of any such purchase. In the event that such options were to be fully exercised, the total number of ILCO's shares owned by FIC would constitute 61.54% of ILCO's outstanding Common Stock. Roy F. Mitte serves as Chairman, President and Chief Executive Officer of both FIC and ILCO. James M. Grace serves as Vice President, Treasurer and Director of both companies and Secretary of FIC; Dr. Payne serves as Vice President and Director of both companies and Secretary of ILCO; Messrs. Demgen and Fleron serve as Vice Presidents and Directors of both companies; and Mr. Crowe serves as a Director of both companies and, until his retirement in January, 1997, served as a Vice President of both companies. Mr. Roy Mitte holds beneficial ownership of 34.39% of the outstanding shares of the Company (see "Security Ownership of Certain Beneficial Owners"). Mr. Mitte was granted an option to purchase 600,000 shares of the common stock of ILCO (as adjusted to reflect a three-for-one split in February 1990) on May 8, 1989 in equal annual installments of 150,000 shares each. Each installment was subject to the approval of the Board of Directors, and would be exercisable for a period of ten years from the date of grant at a price of $1.00 per share (as adjusted). The Board of Directors voted to award installments of 150,000 shares in each of 1989, 1990, 1991 and 1992. In October 1992 Mr. Mitte surrendered to ILCO for cancellation options to purchase 120,000 shares. ILCO and Mr. Mitte entered into an agreement in 1993 providing for the cancellation of the remaining optionstopurchase480,000shares. SeeItem11.Executive Compensation. In May 1989, the Board of Directors of ILCO granted Roy F. Mitte the right to borrow up to $650,000 from ILCO to be used solely for the purchase of FIC common stock pursuant to Mr. Mitte's then existing options. A principal purpose of said loan was to enable Mr. Mitte to maintain his equity position in FIC, as required under the terms of the lending agreements entered into in connection with the purchase of the Investors Life Companies (see "Acquisition of Investors Life Companies"). Said loan, which was exercised on June 1, 1989, carried no interest and was payable in five years. The loan was paid in full in 1994. See Item 11. Executive Compensation. When it acquired Austin Centre, Investors-NA leased the hotel to FIC Realty Services, Inc. ("FIC Realty"), a subsidiary of FIC, pursuant to which FIC Realty pays monthly rent to Investors-NA in an amount equal to 95% of the net operating profits of the hotel for the preceding month (excess of all hotel revenues over all hotel expenses, including insurance, utilities and property taxes). Any net operating loss for a month is carried forward and deducted from the net operating profit for the next month that has such a profit. During 1996, FIC Realty paid $658,509 of rent to Investors-NA pursuant to this lease. FIC Realty has delegated the management of the hotel to an unrelated third party pursuant to a management agreement, but FIC Realty bears most of the economic risks in operating the hotel. As an inducement to FIC Realty's agreeing to bear those risks, Investors-NA has agreed to provide funds to pay expenses in operating the hotel to the extent that the cash flow from such operations is not sufficient to do so. This arrangement was terminated upon the sale by Investors-NA of the Austin Centre in March, 1996. FIC Realty conducts the leasing activities for the Bridgepoint Square properties owned by Investors-NA. In payment for such services, FIC Realty receives a commission of 4% of the gross rent under each lease which is negotiated by it. During 1996, Investors-NA paid commissions in the amount of $100,811 to FIC Realty. Alcoholic beverages had been sold at the hotel by an unrelated third party pursuant to a lease it had with FIC Realty until September 30, 1994. Commencing October 1, 1994, all alcoholic beverages sales have been conducted by Atrium Beverage Corporation ("Atrium Beverage"), a new subsidiary of FIC Realty. Atrium Beverage subleases from FIC Realty space in the hotel for the storage, service and sale of alcoholic beverages pursuant to which Atrium Beverage pays monthly rent to FIC Realty of $12,500. The sublease provides that the rent paid during each calendar year will be reduced to the extent necessary to insure that Atrium Beverage's net operating profit from alcoholic beverage sales is not less than 5% of its gross receipts from such sales. Atrium Beverage and FIC Realty are also parties to a management agreement whereby FIC Realty manages Atrium Beverage's alcoholic beverage operations at the hotel for a monthly fee equal to 28% of the gross receipts from alcoholic beverages sales. During 1996, Atrium Beverage paid FIC Realty rent and management fees totalling $117,998. All of that amount was included in the hotel revenues of FIC Realty for purposes of determining its net operating profits under the hotel lease agreement with Investors- NA. Investors-NA entered into a management agreement in September 1991 with FIC Property Management, Inc. ("FIC Management"), a subsidiary of FIC, whereby it appointed FIC Management to manage, lease and operate the office tower, retail areas, underground parking garage and common areas of Austin Centre. FIC Management is paid fees in an amount equal to 5% of the net operating profit that Investors-NA receives from the properties managed and leased by FIC Management. During 1996, Investors-NA paid $33,027 of fees to FIC Management under this agreement. This arrangement was terminated upon the sale by Investors-NA of the Austin Centre in March, 1996. As part of the financing arrangement for the acquisition of Family Life, a $22.5 million loan was made by Investors-NA to FLC, a subsidiary of FIC, and a $2.5 million loan was made by Investors-CA to FIC. In addition to the interest provided under those loans, Investors-NA and Investors-CA were granted by FIC non-transferable options to purchase, in the amounts proportionate to their respective loans, up to a total of 9.9 percent of shares of FIC's common stock at a price of $10.50 per share, equivalent to the then current market price, subject to adjustment to prevent dilution. As a result of the FIC's five- for-one stock split, which was effective November 12, 1996, the option price is currently $2.10 per share. The options will expire on June 12, 1998 if not previously exercised. In connection with the 1996 amendments to the subordinated notes, as described below, the expiration date of the options were extended to September 12, 2006. On July 30, 1993, the subordinated indebtedness owed to Merrill Lynch and its affiliate was prepaid. The Company paid $38 million plus accrued interest to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the subordinated debt was new subordinated loans totalling $34.5 million that FLC and another subsidiary of FIC obtained from Investors-NA. The principal amount of the new subordinated debt is payable in four equal annual installments in 2000, 2001, 2002 and 2003 and bears interest at an annual rate of 9%. The other terms of the new debt are substantially the same as those of the $22.5 million subordinated loans that Investors-NA had previously made to FLC and that continue to be outstanding. As of June 12, 1996, the provisions of the notes from Investors- NA to FIC, FLC and FLIIC were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996; the final quarterly principal payment is due on September 12, 2001; the interest rate on the note remains at 11%, (b) the $30 million note was amended to provide for forty quarterly principal payments, in the amount of $163,540 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $1,336,458; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, (c) the $4.5 million note was amended to provide for forty quarterly principal payments, in the amount of $24,531 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $200,469; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, (d) the $2.5 million note was amended to provide that the principal balance of the note is to be repaid in twenty quarterly installments of $125,000 each, commencing December 12, 1996 with the final payment due on September 12, 2001; the rate of interest remains at 12%, (e) the Master PIK note, which was issued to provide for the payment in kind of interest due under the terms of the $2.5 million note prior to June 12, 1996, was amended to provide that the principal balance of the note ($1,977,119) is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%. FIC was reimbursed by ILCO for rental expense and certain other operating expenses incurred during 1996 on behalf of ILCO. The amount of such reimbursement was approximately $305,000. Pursuant to a data processing agreement with a major service company, the data processing needs of ILCO's and FIC's insurance subsidiaries were provided at a central location until November 30, 1994. Commencing December 1, 1994, all of those data processing needs are provided to ILCO's and FIC's Austin, Texas and Seattle, Washington facilities by FIC Computer Services, Inc. ("FIC Computer"), a new subsidiary of FIC. Each of FIC's and ILCO's insurance subsidiaries has entered into a data processing agreement with FIC Computer whereby FIC Computer provides data processing services to each subsidiary for fees equal to such subsidiary's proportionate share of FIC Computer's actual costs of providing those services to all of the subsidiaries. Family Life paid $1,055,639 and ILCO's insurance subsidiaries paid $2,243,234 to FIC Computer for data processing services provided during 1996. In 1995, Family Life entered into a reinsurance agreement with Investors-NA pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. In 1996, Family Life entered into a reinsurance agreement with Investors-NA, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) The following documents have been filed as part of this report: 1. Financial Statements (See Item 8) ILCO Form 10-K as of December 31, 1994, 1995 and 1996 and the Financial Statements contained therein are hereby incorporated by reference. The following consolidated financial statements of Financial Industries Corporation and Subsidiaries are included in Item 8: Report of Independent Accountants . . . . . . . . . . .F-2 Consolidated Balance Sheets, December 31, 1996 and 1995. . . . . . . . . . . . . . .F-3 Consolidated Statements of Income, for years ended December 31, 1996, 1995 and 1994. . . . . .F-5 Consolidated Statements of Changes in Shareholders' Equity, for the years ended December 31, 1996, 1995 and 1994. . . . . . . . . . . .F-8 Consolidated Statement of Cash Flows, for the years ended December 31, 1995, 1994 and 1993. . . . . .F-9 Notes to Consolidated Financial Statements. . . . . . .F-11 2. The following consolidated financial statement schedules of Financial Industries Corporation and Subsidiaries are included: Schedule I - Summary of Investments Other Than Investments in Related Parties. . . . . . . . . . F-39 Schedule III - Condensed Financial Statements of Registrant. . . . . . . . . . . F-40 Schedule IV - Indebtedness of and to Related Parties. . . . . . . . . . F-43 Schedule VI - Reinsurance Ceded and Assumed. . . F-44 Schedule VII - Guarantees of Securities of Other Issuers. . . . . . . . . . . F-45 All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore, have been omitted. 2. Exhibits filed with this report or incorporated herein by reference are as listed in the Index to Exhibits on Page Ex-1. (b) Reports on Form 8-K No reports on Form 8-K were filed during the last quarter of the fiscal year ended December 31, 1995. SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Financial Industries Corporation (Registrant) By:/s/ Roy F. Mitte By:/s/ James M. Grace Roy F. Mitte, Chairman of James M. Grace, Treasurer, the Board, President and Principal Accounting and Chief Executive Officer and Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 27, 1997. /s/ Roy F. Mitte Roy F. Mitte, Director /s/ James M. Grace James M. Grace, Director /s/ Eugene E. Payne Eugene E. Payne, Director /s/ Joseph F. Crowe Joseph F. Crowe, Director /s/ Jeffrey H. Demgen Jeffrey H. Demgen, Director /s/ Roger H. Hamm Roger H. Hamm, Director /s/ Robert F. Spears Robert F. Spears, Director /s/ Dale E. Mitte Dale E. Mitte, Director /s/ John D. Barnett John D. Barnett, Director /s/ Leonard A. Nadler Leonard A. Nadler, Director /s/ Frank Parker Frank Parker, Director FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES FORM 10-K--ITEM 14 (a) (1) and (2) LIST OF FINANCIAL STATEMENTS TABLE OF CONTENTS (1) The following consolidated financial statements of Financial Industries Corporation and Subsidiaries are included in Item 8: Report of Independent Accountants........................F-2 Consolidated Balance Sheets, December 31, 1996 and 1995..F-3 Consolidated Statements of Income, for the years ended December 31, 1996, 1995 and 1994........................F-5 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994....F-7 Consolidated Statements of Cash Flows, for the years ended December 1996, 1995 and 1994............................F- 10 Notes to Consolidated Financial Statements...............F- 12 (2) The following consolidated financial statements schedules of Financial Industries Corporation and Subsidiaries are included: Schedule I - Summary of Investments Other Than Investments i n R e l a t e d Parties.........................................F-41 Schedule III - Condensed Financial Statements of Registrant...............................................F- 42 Schedule IV - Indebtedness of and to Related Parties.....F- 45 Schedule VI - Reinsurance Ceded and Assumed..............F- 46 Schedule VII - Guarantees of Securities of Other Issuers.F- 47 All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore, have been omitted. REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Financial Industries Corporation In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a) (1) and (2) on page F-1 present fairly, in all material respects, the financial position of Financial Industries Corporation and its subsidiaries (the Company) at December 31, 1996 and 1995 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. Price Waterhouse LLP Dallas, Texas March 25, 1997 FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, (in thousands) 1996 1995 ASSETS Investments other than investment in affiliate: Fixed maturities available for sale at market value (amortized cost of $82,969 and $79,961 at December 31, 1996 and 1995) $ 83,833 $ 83,632 Equity securities at market (cost approximates $11 at December 31, 1996 and 1995) 4 4 Policy loans 2,286 1,774 Short-term investments 25,615 27,180 Total investments 111,738 112,590 Cash 308 1,414 Investment in affiliate 52,925 45,736 Accrued investment income 1,233 1,102 Agency advances and other receivables 7,825 10,368 Reinsurance receivables 6,159 2,383 Due and deferred premiums 10,651 9,726 Property and equipment, net 8,799 7,452 Deferred policy acquisition costs 41,333 36,537 Present value of future profits of acquired businesses 40,604 45,415 Deferred financing costs -0- 168 Other assets 5,706 6,264 Separate account assets 449 8,523 Total Assets $ 287,730 $ 287,678 The accompanying notes are an integral part of these consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, (in thousands) 1996 1995 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Policy liabilities and contractholder deposit funds: Future policy benefits $ 59,340 $ 54,909 Contractholder deposit funds 41,434 41,456 Unearned premiums 129 132 Other policy claims and benefits 5,164 5,836 payable 106,067 102,333 -0- 6,765 Senior loans Subordinated notes payable to 59,940 61,224 affiliate 17,952 14,783 Deferred federal income taxes 11,248 11,315 Other liabilities 449 8,523 Separate account liabilities 195,656 204,943 Total Liabilities Commitments and Contingencies (See Note 4, 8, 12, 14) Shareholders' equity: Common stock, $.20 par value, 10,000,000 shares authorized; 5,845,300 shares 1,169 1,169 issued, 5,427,965 outstanding in 1996 7,225 7,225 and 1995 Additional paid-in capital Net unrealized gain on 1,220 8,052 investments in fixed maturities available for sale 25 11 Net unrealized appreciation of equity 82,857 66,700 securities 92,496 83,157 Retained earnings (422) (422) Common treasury stock, at cost, 417,335 92,074 82,735 shares in 1996 and 1995 Total Shareholders' Equity $ 287,730 $ 287,678 Total Liabilities and Shareholders' Equity The accompanying notes are an integral part of these consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1996 1995 1994 (in thousands) Revenues: Premiums $ 43,336 $ 43,899 $ 48,872 Net investment income 7,363 7,643 7,449 Net realized (loss) gain on sale of investments -0- -0- (23) Earned insurance charges 5,569 7,059 8,911 Other 3,660 2,940 3,315 59,928 61,541 68,524 Benefits and expenses: Policyholder benefits and expenses 22,096 21,011 21,837 Interest expense on contract- holders deposit funds 2,239 2,143 2,124 Amortization of present value of future profits of acquired businesses 4,811 5,297 11,447 Amortization of deferred policy acquisition costs 4,185 3,755 2,955 Operating expenses 12,975 14,317 14,689 Interest expense 3,831 4,624 4,862 50,137 51,147 57,914 Income before federal income tax and equity in net earnings of affiliates 9,791 10,394 10,610 Provision for federal income taxes: Current (1,165) (717) (82) Deferred 3,811 3,145 2,428 Income before equity in net earnings of affiliates 7,145 7,966 8,264 Equity in net earnings of affiliate, net of tax 9,012 2,051 1,690 Net Income $ 16,157 $ 10,017 $ 9,954 The accompanying notes are an integral part of these consolidated statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data) Years Ended December 31, 1996 1995 1994 (in thousands) Net Income Per Share (Note 15) Common stock and common stock equivalents 5,568 5,540 5,530 Net income per share of common stock $ 2.90 $ 1.81 $ 1.80 The accompanying notes are an integral part of these consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands) Additional Common Stock Paid-in Shares Amount Capital Balance at December 31, 1993 5,845 $ 1,169 $ 7,225 Net income Change in net unrealized loss on investments in fixed maturities available for sale Change in net unrealized appreciation (depreciation) of equity securities Balance at December 31, 1994 5,845 1,169 7,225 Net Income Change in net unrealized loss on investments in fixed maturities available for sale Change in net unrealized appreciation (depreciation) of equity securities Balance at December 31, 1995 5,845 1,169 7,225 Net Income Change in net unrealized gain on investments in fixed maturities available for sale Change in net unrealized appreciation (depreciation) of equity securities Balance at December 31, 5,845 $ 1,169 $ 7,225 1996 The accompanying notes are an integral part of these consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands) Net Unrealized Net (Loss) Gain on Unrealized Investments in Appreciation F i x e d Maturities of Equity Available For Securities Sale Balance at December 31, 1993 $ 67 $ 4,856 Net income Change in net unrealized loss on investments in fixed maturities available for sale (17,714) Change in net unrealized appreciation (depreciation) of equity securities (68) Balance at December 31, 1994 (1) (12,858) Net Income Change in net unrealized loss on investments in fixed maturities available for sale 20,910 Change in net unrealized appreciation (depreciation) of equity securities 12 Balance at December 31, 1995 11 8,052 Net Income Change in net unrealized gain on investments in fixed maturities available for sale (6,832) Change in net unrealized appreciation (depreciation) of equity securities 14 Balance at December 31, 1996 $ 25 $ 1,220 The accompanying notes are an integral part of these consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands) Common Total Retained T r e a s u r y Shareholders' Earnings Stock Equity Balance at December 31, 1993 $46,729 $ (422) $59,624 Net income 9,954 9,954 Change in net unrealized loss on investments in fixed maturities available for sale (17,714) Change in net unrealized appreciation (depreciation) of equity securities (68) Balance at December 31, 1994 56,683 (422) 51,796 Net Income 10,017 10,017 Change in net unrealized loss on investments in fixed maturities available for sale 20,910 Change in net unrealized appreciation (depreciation) of equity securities 12 Balance at December 31, 1995 66,700 (422) 82,735 Net Income 16,157 16,157 Change in net unrealized gain on investments in fixed maturities available for sale (6,832) Change in net unrealized appreciation (depreciation) of equity securities 14 Balance at December 31, 1996 $82,857 $ (422) $92,074 The accompanying notes are an integral part of these consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 1996 1995 1994 (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 16,157 $ 10,017 $ 9,954 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of present value of future profits of acquired businesses 4,811 5,297 11,447 Amortization of deferred policy acquisition costs 4,185 3,755 2,955 Financing costs amortized 168 221 654 Depreciation on property and equipment -0- -0- 120 Equity in undistributed earnings of affiliate (12,558) (5,043) (4,673) Changes in assets and liabilities: Decrease (Increase) in accrued investment income (131) 64 (71) Increase in agent advances and other receivables (1,233) (3,586) (1,924) Increase in due premiums (925) (12) (1,847) Increase in deferred policy acquisition costs (8,981) (10,318) (9,610) Decrease (Increase) in other assets 558 22 (1,704) Increase in policy liabilities and accruals 3,734 4,388 233 Increase (Decrease) in other liabilities (67) 1,508 (2,655) Increase in policy loans (512) (543) (361) (Decrease) Increase in deferred federal income taxes 3,169 7,773 (1,261) Other, net 1,330 (4,475) 4,081 Net cash provided by operating activities $ 9,705 $ 9,068 $ 5,338 The accompanying notes are an integral part of these consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued Year Ended December 31, 1996 1995 1994 (in thousands) CASH FLOWS FROM INVESTING ACTIVITIES Fixed maturities purchased $(4,245) $ (1,051) $(11,206) Proceeds from sales and maturities of fixed maturities 1,265 4,504 3,679 Net decrease in short-term investments 1,565 1,185 11,963 Purchase & retirement of property and equipment (1,347) (3,395) -0- Net cash provided by (used in) investing activities (2,762) 1,243 4,436 CASH FLOWS FROM FINANCING ACTIVITIES Issuance of subordinated notes payable 253 465 413 Repayment of senior loan and subordinated notes (6,765) (10,295) (11,772) Repayment of subordinated notes payable (1,537) -0- -0- Net cash used in financing activities (8,049) (9,830) (11,359) Net increase (decrease) in cash (1,106) 481 (1,585) Cash, beginning of year 1,414 933 2,518 Cash, end of year 308 $ 1,414 $ 933 Supplemental Cash Flow Disclosures: Income taxes paid $ 125 $ 150 $ 1,725 Interest paid $ 4,300 $ 4,107 $ 4,645 The accompanying notes are an integral part of these consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Summary of Significant Accounting Policies Organization Financial Industries Corporation (FIC or the "Company") is principally engaged, through its subsidiaries, in administering existing portfolios of individual and group life insurance, disability insurance policies and annuity products. The Company's insurance subsidiary is also engaged in the business of marketing and underwriting individual life insurance, disability insurance and annuity products in 49 states and the District of Columbia. Such products are marketed through independent, non- exclusive general agents. Principles of Consolidation The consolidated financial statements include the accounts of FIC and its wholly-owned subsidiaries at December 31, 1996. The more significant subsidiaries are Family Life Insurance Investment Company (FLIIC), Family Life Corporation (FLC), Family Life Insurance Company (Family Life) and Financial Industries Corporation Realty Services. The Company's approximate 46% investment in InterContinental Life Corporation (ILCO) is presented using the equity method of accounting. Basis of Presentation The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles which differ from statutory accounting principles required by regulatory authorities for the Company's insurance subsidiary. All material intercompany balances and transactions have been eliminated. The following accounting policies describe the accounting principles used in the preparation of the consolidated financial statements. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results will differ from those estimates. Investments The Company's general investment philosophy is to hold fixed maturity securities until maturity. However, fixed maturities may be sold prior to their maturity dates in response to changing market conditions, duration of liabilities, liquidity factors, interest rate movements and other investment factors. Accordingly, FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS fixed maturity investments are classified as available for sale and are carried at market value. Unrealized gains and losses on securities available for sale are not recognized in earnings but are reported as a separate component of equity, net of related income taxes. Premiums and discounts on collateralized mortgage obligations (CMOs) are amortized over the estimated redemption period as opposed to the stated maturity. An adjustment to the investment and investment income is recorded on a retrospective basis to reflect the amounts that would have existed had the new effective yield been applied since the acquisition of the CMO's. The Company endeavors to minimize the portfolio's exposure to interest rate changes inherent in interest-sensitive products by selecting and selling investments so that diversity, maturity and liquidity factors approximate the duration of related policyholder liabilities. Equity securities are carried at market values. Unrealized gains and losses on equity securities, net of deferred income taxes, if applicable, are reflected directly in shareholders' equity. Policy loans represent unpaid balances and do not exceed the cash surrender value of the related policies. Short-term investments are carried at cost, which approximates market value, and generally consist of those fixed maturities and other investments with maturities less than one year from the date of purchase. Securities pledged as collateral for repurchase agreements are held by the Company's investment custodian until maturity of the repurchase agreement. Provisions of the agreement and procedures adopted by the Company ensure that the market value of the collateral, including accrued interest thereon, is sufficient in the event of default by the counterparty. The cost of investments sold is determined on the specific identification basis, except for stocks, for which the first-in, first-out method is employed. When impairment of the value of an investment is considered other than temporary, the decrease in value is reported in net income as a realized investment loss and a new cost basis is established. Cash and Cash Equivalents Generally, cash includes cash on hand and on deposit in noninterest bearing accounts. Short term investments with maturities of three months or less at the time of purchase are reported as cash equivalents. Property and Equipment Property and equipment is stated at cost less accumulated depreciation. Depreciation is provided using straight-line and accelerated methods over estimated useful lives of 10 to 33 years. Maintenance and repairs are charged to expense when incurred. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued Deferred Policy Acquisition Costs The cost of acquiring new business, principally first year commissions and certain expenses of the policy issuance and underwriting departments, which vary with and are primarily related to the production of new business, have been deferred to the extent recoverable. Acquisition costs related to mortgage life business are deferred and amortized over the premium paying period of the related policies. Acquisition costs related to universal life products are deferred and amortized in proportion to the ratio of estimated annual gross profits to total estimated gross profits over the expected lives of the contracts. Present Value of Future Profits on Acquired Businesses The present value of future profits of acquired businesses (See Note 5) is amortized over the premium paying period of the related policies in proportion to the ratio of the annual premium revenue to total anticipated premium revenue applicable to such policies. Interest on the unamortized present value of future profits is accreted at approximately 8.5% per annum. The fair value of the net assets acquired exceeded the purchase price and negative goodwill associated with the purchase has been netted against the calculated amount of present value of future profits. The negative goodwill is being amortized over seven years using the straight line method of amortization. Deferred Financing Costs Financing costs associated with the Company's Senior Loan was deferred and was amortized over the borrowing period using the interest method. Separate Accounts Separate account assets, carried at market value, and liabilities represent policyholder funds maintained in accounts having specific investment objectives. The net investment income, gains and losses of these accounts, less applicable contract charges, accrue directly to the policyholders. The separate account business was fully reinsured to Merrill Lynch at the date of sale through an assumption reinsurance agreement which is pending regulatory approval. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued Guaranty Fund Assessment The solvency or guaranty laws of most states in which the Company's insurance subsidiaries do business may require the Company's insurance subsidiaries to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength, and in certain instances, may be offset against future premium taxes. The Company's insurance subsidiary records the expense for guaranty fund assessment from states which do not allow premium tax offsets in the period assessed. The Company's insurance subsidiary recorded expenses of $6,796, $189,929 and $148,301 in the years ended December 31, 1996, 1995 and 1994, respectively, as a result of such assessments. Policy Liabilities and Contractholder Deposit Funds Liabilities for future policy benefits for mortgage life insurance products are computed using the net level premium method or an actuarial equivalent method. The assumption for future investment yield is 8 1/2%. Assumptions for mortality and withdrawal are based on company experience with some provision for possible adverse deviation. Contractholder deposit funds are liabilities for universal life products. These liabilities consist of deposits received from customers and accumulated at actual credited interest rates on their fund balances less charges for expenses and mortality. Other Policy Claims and Benefits Payable The liability for other policy claims and benefits payable represents management's estimate of ultimate unpaid losses on claims and other miscellaneous liabilities to policyholders reduced by amounts anticipated to be recovered from reinsurance. Estimated unpaid losses on claims are comprised of losses on claims that have been reported but not yet paid, including estimates of additional development of initial claims estimates, and claims that have been incurred. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued The liability for other policy claims and benefits payable is subject to the impact of changes in claim severity, frequency and other factors. Although there is considerable variability inherent in such estimates, management believes that the liability recorded is adequate. Federal Income Taxes In February, 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). The Company adopted SFAS 109 on a prospective basis effective January 1, 1991. SFAS 109 mandates the asset and liability method for computing deferred income taxes. Under this method, balance sheet amounts for deferred income taxes are computed based on the tax effect of the differences between the financial reporting and federal income tax bases of assets and liabilities using the tax rates which are expected be in effect when these differences are anticipated to reverse. In accordance with SFAS 109, total tax expense is the amount of income taxes expected to be payable for the current year plus (or minus) the deferred income tax expense (or benefit) represented by the change in the deferred income tax accounts at the beginning and end of the year. The effect of changes in tax rates and federal income tax laws are reflected in income from continuing operations in the period such changes are enacted. The tax effect of future taxable temporary differences (liabilities) and future deductible temporary differences (assets) are separately calculated and recorded when such differences arise. A valuation allowance, reducing any recognized deferred tax asset, must be recorded if it is determined that it is more likely than not that such deferred tax asset will not be realized. In accordance with the SFAS 109, tax benefits associated with the utilization of net operating losses are recognized as a reduction of the current tax provision and are not recognized as extraordinary items in the accompanying statement of operations. Under the previous accounting method (APB 11), the utilization of net operating losses in computing the federal income tax provision was recorded as an extraordinary item. There was no cumulative effect of the change in accounting method related to income taxes as January 1, 1991 was the date of adoption of SFAS 109. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued Revenue Recognition Premiums on mortgage life and health products are recognized as revenue over the premium paying period. Benefits and expenses are associated with earned premiums, so as to result in recognition of profits over the life of the contracts. Revenues for investment-related products consist of contract charges (earned insurance charges) assessed against the fund values and net investment income. Related benefit expenses primarily consist of net investment income credited to the fund values after deductions for investment and risk charges. Revenues for universal life products consist of net investment income and mortality, administration and surrender charges assessed against the fund values. Related benefit expenses include universal life benefit claims in excess of fund values and net investment income credited to universal life fund values. Net Income Per Share Net income per share is based on the weighted average number of shares of common stock and common stock equivalents outstanding during each year (See Note 15). New Accounting Pronouncements During 1995, the FASB issued FAS No. 123 "Accounting for Stock- Based Compensation," which encourages companies to adopt the fair value based method of accounting for stock-based compensation. This method requires the recognition of compensation expense equal to the fair value of such equity securities at the date of the grant. This statement also allows companies to continue to account for stock-based compensation under the intrinsic value based method, as prescribed by Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," with footnote disclosure of the pro forma effects of the fair value based method. FAS No. 123 is effective for transactions entered into in years that begin after December 15, 1995. The Company adopted FAS No. 123 during 1996 and will continue to account for stock-based compensation under the intrinsic value method and disclose the fair value method, if any, in the footnotes to the financial statements. Reclassification Certain prior years' amounts have been reclassified to conform with the 1996 presentation. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 2. Investments Fixed Maturities Investments in fixed maturities by category at December 31, 1996 and 1995, respectively, were as follows (in thousands): Gross Gross Amortized Unrealized Unrealized Market U.S. Treasury Cost Gains Losses Value securities and obligations of U.S. government agencies and corporations $18,125 $ 928 $ 10 $19,043 States, municipalities and political subdivisions 2,955 67 -0- 3,022 Corporate securities 21,475 299 330 21,444 Mortgage-backed securities 40,414 321 411 40,324 Total Fixed Maturities available for sale $82,969 $ 1,615 $ 751 $83,833 Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value U.S. Treasury securities and obligations of U.S. government agencies and corporations $18,124 $ 1,569 $ -0- $19,693 States, municipalities and political subdivisions 4,945 58 2 5,001 Corporate securities 10,243 431 12 10,662 Mortgage-backed securities 46,649 1,737 110 48,276 Total Fixed Maturities available for sale $79,961 $ 3,795 $ 124 $83,632 The amortized value and market value of fixed maturities at December 31, 1996 are shown below by contractual maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Market Value Value FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (in thousands) Due in one year $ 5,500 $ 5,524 Due after one year through five years 12,222 12,593 Due after five years through ten years 8,088 7,983 Due after ten years 16,761 17,425 Mortgage-backed securities 40,398 40,308 Total Fixed Maturities available for sale $82,969 $83,833 To reduce the exposure to market rate changes, portfolio investments are selected so that diversity, maturity, and liquidity factors approximate the duration of associated policyholder liabilities. Proceeds from maturities of investments in fixed maturities during 1996 and 1995 were $1,265,000 and $4,504,000, respectively. There were no gains or losses in 1996 and 1995. Net Investment Income The components of net investment income are summarized as follows: Year Ended December 31, 1996 1995 1994 (in thousands) Fixed maturities $ 5,891 $ 5,742 $ 5,684 Other, including short-term investments and policy loans 1,553 1,990 1,836 Investment expenses (81) (89) (71) Net investment income $ 7,363 $ 7,643 $ 7,449 There were no impairments in the value of investments in 1996, 1995 or 1994, which were considered other than temporary. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 3. Disclosure about Fair Value of Financial Instruments The estimated fair values of the Company's financial instruments at December 31, 1996 are as follows: Carrying Fair Amount Value (in thousands) Financial assets: Fixed maturities $ 83,833 $ 83,833 Policy loans $ 2,286 $ 2,286 Short-term investments $ 25,615 $ 25,615 Cash and cash equivalents $ 308 $ 308 Financial liabilities: Subordinated notes payable to affiliate $ 59,940 $ 59,940 Note payable $ 4,738 $ 4,738 Other $ 359 $ 359 The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Fixed Maturities Fair values are based on quoted market prices or dealer quotes. Policy Loans Policy loans are, generally, issued with coupon rates below market rates and are considered early payment of the life benefit. As such, the carrying amount of these financial instruments is a reasonable estimate of their fair value. Cash and Short-term Investments The carrying amount of these instruments approximates market value. Subordinated Notes Payable to Affiliate The fair value is based on the Company's estimate of current market conditions. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 4. Investment in InterContinental Life Corporation The Company carries its investment in ILCO on the equity method of accounting. At December 31, 1996, excess of cost over net assets acquired of $1,686,000, net of accumulated amortization of $1,344,000,is included in investment in affiliate. At December 31, 1995, these amounts were $1,686,000 and $1,244,000, respectively. Amortization of this excess is reflected in equity in net earnings of affiliate. ILCO is primarily engaged in the sale and administration of life insurance products. Summarized financial information for ILCO is set forth below: Balance sheet information: 1996 1995 (in thousands) Investments $ 661,141 $ 669,537 Deferred policy acquisition costs and present value of future profits 72,178 73,532 Other assets 530,623 572,224 Total Assets $ 1,263,942 $1,315,293 Policy liabilities and contractholder deposit funds $ 673,306 $ 689,680 Other liabilities 477,275 528,528 Total liabilities 1,150,581 1,218,208 Common stock, additional paid-in capital and retained earnings 110,581 83,399 Net unrealized gain 2,780 13,686 Shareholders' equity 113,361 97,085 Total liabilities and shareholders' equity $ 1,263,942 $1,315,293 FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 4. Investment in InterContinental Life Corporation, (continued) Results of operations: 1996 1995 1994 (in thousands) Premium income $ 9,980 $ 11,694 $ 14,317 Net investment income $ 59,836 $ 64,781 $ 57,553 Earned insurance charges $ 42,238 $ 42,324 $ 39,370 Benefits and expenses $ 96,801 $105,907 $ 99,142 Net income $ 26,938 $ 10,714 $ 9,917 Net income per share available to common shareholders $ 5.12 $ 2.11 $ 1.93 Total market value basis of the Company's investment in ILCO approximated $26,054,085 and $25,562,498 at December 31, 1996 and 1995, respectively. FIC directly or indirectly owns 1,966,346 shares (approximately 46%, 47%, and 48%) of ILCO's outstanding common stock at December 31, 1996, 1995 and 1994, respectively. The Company holds options to purchase up to 1,702,155 additional shares of ILCO's authorized but unissued common stock at a price equal to the average market value during the six months preceding the exercise date. If exercised, the total number of shares subject to the Agreement, together with the 1,966,346 shares already owned, would constitute 61.81% of the then issued and outstanding shares of ILCO's common stock, assuming no other options or warrants held by other parties were exercised. In the event that any other party seeks to acquire ILCO's outstanding shares without prior approval of FIC's Board of Directors, the Company has the right to acquire, under the same pricing formula, the number of shares of common stock which, when added to the number of shares then owned by the Company, will amount to 51% of the outstanding shares of ILCO. The consideration for the options was FIC's granting to ILCO a loan in the principal amount of $1,200,000, FIC's agreement to guarantee additional ILCO obligations totaling $4,000,000 and FIC's agreement to guarantee ILCO's lease obligation on its headquarters building upon demand. In addition, FIC guaranteed a $15,000,000 term loan of ILCO. On January 29, 1993, ILCO prepaid all of the Subordinated Notes Payable and purchased and canceled all of the detachable warrants associated with the preferred stock. The primary source of funds for this debt prepayment and warrant cancellation was an increase in the outstanding balance of the Senior Loan from $60 million to $110 million pursuant to an amended and restated credit agreement that was entered into on January 29, 1993 (the "New Senior Loan"). The terms of the New Senior Loan, which matures on July 1, 1999, are substantially the same as the Senior Loan. Interest is payable at the Company's option based on (1) the managing FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued bank's corporate base rate plus 1.25% declining to 0.5% as principal declines, or (2) LIBOR plus 2.5% declining to 1.75%. The Company has guaranteed the New Senior Loan. On February 14, 1995, ILCO, through its subsidiary Investors Life Insurance Company of North America (Investors-NA), purchased Meridian Life Insurance Company (Meridian Life), a life insurer domiciled in the State of Indiana, for $17.1 million. At December 31, 1994, Meridian Life had total assets of approximately $101 million and statutory capital and surplus of approximately $11 million. The acquisition was partially financed through a $15 million increase in indebtedness of ILCO's Senior Loan. This additional indebtedness is guaranteed by FIC. Maturities of the Senior Loans over the next three years are as follows: (in thousands) 1997 18,080 1998 6,864 1999 -0- $24,944 The Company has further agreed that, upon demand by ILCO, it will guarantee performance under ILCO's lease of office facilities located in Elizabeth, New Jersey. This agreement will remain in effect for as long as any portion of the loan or any indebtedness guaranteed by the Company remains outstanding. In connection with ILCO's Senior Loans, the net assets of ILCO which aggregate $113,361,000 and $97,085,000 at December 31, 1996 and 1995, respectively, are restricted from paying dividends. The amount of net realized gains included in net earnings of ILCO is $15,262,000, $281,000,and $452,000, for the years ended December 31, 1996, 1995 and 1994, respectively. 5. Acquisition of Business In 1991, the Company acquired Family Life, a Washington domiciled life insurance company, from Merrill Lynch Insurance Group, Inc. Present value of future profits of $87,726,000 was recorded as a result of the purchase. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued An analysis of the present value of future profits follows: 1996 1995 (in thousands) Balance at beginning of year $ 45,415 $ 50,712 Accretion of Interest 3,798 4,419 Amortization during the period (8,609) (9,716) Present value of future profits at December 31 $ 40,604 $ 45,415 Anticipated amortization of the present value of future profits net of interest accretion for each of the next five years is as follows (in thousands): 1997 $ 6,466 1998 $ 6,529 1999 $ 5,280 2000 $ 4,272 2001 $ 3,454 At purchase, the present value of future profits was calculated using a discount rate of approximately 15%. Interest is accreted on the unamortized portion at approximately 8.5%. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 6. Senior Loan and Subordinated Notes Payable Following is a summary of outstanding debt at December 31: 1996 1995 (in thousands) Senior loan: A loan payable to a syndicate of banks beginning with a $1.5 million payment on October 1, 1991, a $2 million payment on January 1, 1992 and each subsequent quarter in 1992, a $2.25 million payment on January 1, 1994 and each subsequent quarter through April 1, 1996 with a final payment of the unpaid balance on June 12, 1996. Interest is payable at the Company's option based on (1) the managing bank's corporate base rate plus 2% or (2) LIBOR plus 3%. The rate in effect at December 31, 1995 was 8.81%. $ -0- $ 6,765 Subordinated senior notes payable to Investors-NA beginning with a $1,125,000 payment on December 12, 1996 and each subsequent quarter through September 12, 2001. Interest is payable on a quarterly basis at 11%. 21,375 22,500 Subordinated notes payable to Investors-NA beginning with a $223,856 payment on December 12, 1996 and each subsequent quarter through September 12, 2001. Interest is payable on a quarterly basis at 12%. 4,253 4,224 Subordinated notes payable to Investors-NA beginning with a $188,071 payment on December 12, 1996 and each subsequent quarter through September 12, 2001, a payment of $1,536,927 on December 12, 2001 and each subsequent quarter through June 12, 2006 with a final payment of $1,536,967 on September 12, 2006. Interest is payable on a quarterly basis at 9%. 34,312 34,500 Total senior loans and subordinated notes payable. $ 59,940 $ 67,989 FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued The Senior Loan was secured by the following: (1) All of the issued and outstanding shares of common stock of FLIIC. (2) All of the issued and outstanding shares of preferred stock and common stock of FLC and Family Life. (3) A $97.5 million surplus debenture of Family Life. The Senior Loan was guaranteed by FIC for FLC. The Senior Loan documents also required FLC to make additional mandatory principal payments on the Senior Loan, which, in general, reduce the quarterly principal payments in the inverse order of their due dates. Those additional payments were required in specified situations in which the amount of Family Life's statutory capital and surplus exceed a certain formula. FLC has Excess Cash Flow (as defined) or FLC or Family Life receives proceeds from reinsurance of life insurance policies in force in one transaction or a series of related transactions or sales of assets or issuances of stock or debt securities. The Senior Loan may be prepaid, in whole or in part, without penalty or premium. The Senior Loan agreement specified various negative, affirmative and financial covenants made by the Company. The Subordinated Notes Payable agreement also specifies various specified negative, affirmative and financial covenants to be observed by the Company. During the period the Senior Loan was outstanding, the covenants in effect under the Subordinated Notes Payable were substantially less restrictive than those under the Senior Loan agreement but became generally equivalent to the Senior Loan restrictions upon termination of the Senior Loan. On July 30, 1993, the Merrill Lynch Subordinated Loans were prepaid. Approximately $38 million plus accrued interest was paid to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the Merrill Lynch Subordinated Loans was new subordinated loans totalling $34.5 million that were obtained from Investors-NA. The terms, other than maturity and interest rate of the new debt, are substantially the same as those of the $22.5 million subordinated loan that Investors-NA had previously made to FLC and that continues to be outstanding. The subordinated loans consist of a $30 million loan to FLC and a $4.5 million loan to FLIIC. The debt restructuring reduced the total indebtedness of FLC and FLIIC by approximately $15 million. The obligors are allowed to prepay the Investors-NA Subordinated Loans, in whole or in part, without premium or penalty. The FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued Investors-NA Subordinated Loans were subordinated to the Senior Loan and now constitute a lien on the Pledged Collateral. Repayment of the Investors-NA Subordinated Loans is also guaranteed by the Company. Aggregate maturities of the Subordinated Notes Payable are as follows: (in thousands) 1997 $ 6,148 1998 6,148 1999 6,148 2000 6,148 2001 6,148 Thereafter 29,200 $59,940 7. Federal Income Taxes The Company files a consolidated federal income tax return with its non-life subsidiaries. The Company's life insurance subsidiary files a separate federal income tax return. The U.S. federal income tax provision (benefit) charged to continuing operations was as follows: 1996 1995 1994 (in thousands) Current $(1,165) $ (717) $ (82) Deferred 3,811 3,145 2,428 Total provision for income taxes $ 2,646 $2,428 $2,346 The provision for income taxes is less than the amount of income tax determined by applying the U.S. statutory income tax rate of 35% to pre-tax income from continuing operations before extraordinary item as a result of the following differences: FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 1996 1995 1994 (in thousands) Income taxes at the statutory rate $3,427 $3,638 $3,714 Increase (decrease) in taxes resulting from: Small life insurance company deduction -0- (411) (581) Dividends received deduction (771) (770) (775) Net operating loss carryforwards -0- -0- -0- Tax rate differential (98) (104) (106) Other items, net 88 75 94 Total provision for income taxes $2,646 $2,428 $2,346 Provision has not been made for state and foreign income tax expense since this expense is minimal. Deferred taxes are recorded for temporary differences between the financial reporting bases and the federal income tax bases of the Company's assets and liabilities. The sources of these differences and the estimated tax effect of each are as follows: 1996 1995 Deferred Tax Liability: (in thousands) Equity in net earnings of affiliate $ 3,400 $ 2,509 Excess pension Benefit 436 436 Deferred policy acquisition costs 10,268 8,514 Present value of future profits 5,851 4,210 Guaranty fund assessments 589 698 Deferred and uncollected premium 3,602 3,284 Unrealized appreciation on marketable securities 355 1,712 Other taxable temporary differences 3,838 2,320 Total deferred tax liability 28,339 23,683 Deferred Tax Asset: Policy reserves 9,553 8,567 Net operating loss carry forward 513 -0- Alternative minimum tax credit 146 113 Accrued liabilities 175 220 Total deferred tax assets, net 10,387 8,900 Net deferred tax liability $17,952 $14,783 Deferred federal income tax expense (benefit) of $(1,357,000) and FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued $4,465,000 for 1996 and 1995, respectively have been provided on the unrealized appreciation (depreciation) of marketable securities and included in the deferred tax liability. This decrease in deferred tax liability has been recorded as a reduction to the equity adjustment due to the net change in unrealized appreciation or depreciation and has not been reflected in the deferred income tax expense. In accordance with the Tax Reform Act of 1986, Family Life is eligible for a special deduction allowed to small life insurance companies equal to 60 percent of tentative life insurance company taxable income, subject to certain limitations. Provisions for U.S. income taxes has not been made on a portion of the undistributed earnings of ILCO from the date of the Company's investment since the Company expects such earnings to be remitted in the form of dividends. The Company has provided for the tax on the undistributed earnings of ILCO net of the dividends received deduction expected to be allowed when such dividends are paid. The Company expects that additional deferred taxes would be payable on the undistributed earnings of ILCO if the Company should sell its investment. At December 31, 1996, no IRS examinations were underway for the Company or its subsidiaries. 8. Reinsurance Family Life reinsures portions of certain policies it writes, thereby providing greater diversification of risk and minimizing exposure on larger policies. The Company's retention on any one individual ranges from $-0- to $200,000 depending on the risk. Policy liabilities and contractholder deposit funds are reported in the consolidated financial statements before considering the effect of reinsurance ceded. The insurance subsidiary remains liable to the extent the reinsurance companies are unable to meet their obligation under the reinsurance agreements. Under the provisions of the purchase agreement between the Company and Merrill Lynch, certain life insurance companies affiliated with Merrill Lynch agreed to assume (on an assumption reinsurance basis) certain single premium whole life and annuity products written by Merrill Lynch's insurance division on Family Life's paper. The transfer of these reserves, in accordance with the reinsurance agreement, is subject to certain regulatory approvals. The amount remaining under this agreement that had not yet been approved for transfer to Merrill Lynch was $116,310 and FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued $1,939,799 at December 31, 1996 and 1995, respectively. These amounts are not reflected in the liability for future policy benefits as they are ceded at 100% to Merrill Lynch pending the approval of the assumption agreement. The amounts in the consolidated financial statements for reinsurance ceded are as follows: December 31, 1996 1995 1994 (in thousands) Future policy benefits $ 5,729 $ 1,784 $ 1,548 Unearned premiums $ 4 $ 5 $ 6 Other policy claims and benefits payable $ 426 $ 594 $ 631 For the twelve months ended December 31, 1996 1995 1994 (in thousands) Premiums $ 6,259 $ 1,531 $ 918 Policyholder benefits and expenses $ 670 $ 372 $ 536 Estimated amounts recoverable from reinsurers on paid claims were $43,857 and $10,866 in 1996 and 1995, respectively. These amounts were included in other receivables in the consolidated financial statements at December 31, 1996 and 1995. 9. Shareholders' Equity The Company's ability to pay dividends to its shareholders is affected, in part, by receipt of dividends from Family Life and ILCO. Under current Washington law any proposed payment of dividends or distribution by the insurance subsidiary which, together with dividends or distributions paid during the preceding twelve months, exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31, or (ii) statutory net gain from operations, is called an "extraordinary dividend" and may not be paid until either it has been approved, or a waiting period shall have passed during which it has not been disapproved, by the insurance commissioner. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued Effective July 25, 1993 Washington amended its insurance code to retain the "greater of" standard but enacted requirements that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that dividends may be paid only from earned surplus. Family Life does not presently have earned surplus as defined by the regulations adopted by the Washington Insurance Commissioner and, therefore, is not presently permitted to pay cash dividends. However, the Company does not directly own its life insurance subsidiary's stock, but instead, indirectly owns that stock through two downstream holding companies, FLIIC and FLC, whose ability to pay dividends to the Company is significantly limited by some of the subordinated notes referred to in Note 6 during the terms of those loans. Consolidated net assets of FLIIC and FLC aggregated $44,704,000, and $56,490,000, respectively at December 31, 1996 and $42,483,000 and $54,170,000, respectively at December 31, 1995. The ability of ILCO to pay dividends to the Company and the other shareholders of ILCO is affected by receipt of dividends from its insurance subsidiaries, which are generally limited by law to the greater of their net income for the prior year or 10% of capital and surplus. In addition, ILCO's senior loan restricts it from paying any dividends on its common stock during the term of that loan. Capital and surplus of Family Life as reported to insurance regulators and as determined in accordance with statutory 29 Accounting practices aggregates approximately $24,919,158 and $25,794,540 at December 31, 1996 and 1995, respectively. Statutory net income aggregated approximately $9,153,000 and $9,245,000 for the years ended December 31, 1996 and 1995, respectively. The Company employed no permitted statutory accounting practices that individually or in the aggregate materially affected statutory surplus or risk-based capital at December 31, 1996 or 1995. The Company's Articles of Incorporation were amended during 1996 to: (i) increase the number of authorized shares of common stock from 3,304,200 shares to 10,000,000 shares and (ii) to reduce the par value of the common stock from $1.00 to $.20. These amendments to the Articles of Incorporation were related to the implementation of the five-for-one stock split in 1996, authorized by the Board of Directors. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 10. Options In connection with the subordinated senior notes and subordinated notes payable to Investors-NA, Investors-NA was granted non-transferrable options to purchase, in amounts proportionate to their respective loans, up to a total of 9.9 percent of the common shares of FIC. The option price is $2.10 per share (adjusted to reflect the five-for-one stock split in 1996), equivalent to the then current market price, subject to adjustment to prevent the effect of dilution. The options expire at the time of final repayment of each of the respective loans. 11. Retirement Plans and Employee Stock Plans Retirement Plan Family Life has a non-contributory defined benefit pension plan which covers employees who have completed one year or more of service. Under the plan, benefits are payable upon retirement based on earnings and years of credited service. a. The Normal Retirement Date for all employees is the first day of the month coinciding with or next following the later of attainment of age 65 or the completion of five years of service, but not later than age 70. b. The Normal Retirement Benefit is the actuarial equivalent of a life annuity, payable monthly, with the first payment commencing on the Normal Retirement Date. The life annuity is equal to the sum of (1) plus (2): (1) Annual Past Service Benefit: 1.17% of the first $10,000 of Average Final Earnings plus 1 1/2% of the excess of Average Final Earnings over $10,000, all multiplied by the participant's Credited Past Service. For these purposes, "credited past service" is service prior to April 1, 1967, with respect to employees who were plan participants on December 31, 1975. (2) Annual Future Service Benefit: 1.5578% of the first $10,000 of Average Final Earnings plus 2% of the excess of Average Final Earnings over $10,000, all multiplied by the participant's Credited Future Service. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued Retirement Plan Average Final Earnings are the highest average Considered Earnings during any five consecutive years while an active participant. Total Credited Past Service plus Credited Future Service is limited to 40 years. The pension costs for the plan includes the following components: 1996 1995 (in thousands) Service cost-benefits earned during the period $ 81 $ 73 Interest cost on projected benefit obligation 497 563 Return on plan assets (690) (705) Amortization -0- -0- Pension benefit $ (112) $ (69) The following summarizes the funded status of the plan at December 31: 1996 1995 (in thousands) Actuarial present value of: Vested benefit obligation 6,227 $ 6,554 Accumulated benefit obligation $ 6,227 $ 6,554 Projected benefit obligation $ 6,563 $ 6,990 Plan assets at market value 8,990 8,673 Plan assets in excess of projected benefit obligations 2,427 1,683 Unrecognized net gain (838) (206) Prepaid pension asset $ 1,589 $ 1,477 The significant assumptions for the plans are as follows: The discount rate for projected benefit obligations was 7.75% and 7.0% for the years ended December 31, 1996 and 1995, respectively. The assumed long-term rate of compensation increases was 6.0% for the years ended December 31, 1996 and 1995, respectively. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued The long-term rate of return on plan assets was 8.0% for the years ended December 31, 1996 and 1995. During 1995, the ILCO Employee Stock Ownership Plan and the ILCO Savings and Investment Plan were amended to allow for the addition of Family Life as a participating employer, thus allowing Family Life employees to participate in the plans. Stock Option Plans In 1984, the Company's shareholders adopted a qualified stock option plan for officers and key employees. The aggregate amount of the common shares on which options may be granted is limited to 200,000 shares. The option price will not be less than 100% of the fair market price of the optioned shares on the date the option is granted. As of December 31, 1996, no options had been granted under this plan. 12. Leases Family Life, occupies office facilities under lease agreements with unrelated third parties which expire over the next year. Certain office space leases may be renewed at the option of the Company. Rent expense in 1996, 1995 and 1994 was $886,189, $896,688, and $835,637 respectively. Minimum annual rentals are as follows: (in thousands) 1997 $ 315 1998 0 1999 0 2000 0 2001 0 Total $ 315 13. Related Party Transactions FIC Management was paid fees in an amount equal to 5% of the net operating profit that Investors-NA received from the properties managed and leased by FIC Management. During 1996, 1995 and 1994, Investors-NA paid $141,838, $183,864, and $106,460 under this agreement. Effective January 1, 1993, ILCO's insurance subsidiaries and Family Life entered into an agreement with Investors-NA to lease office space in the Austin Centre. The annual rent is $1,119,705 and the lease is for a period of 5 years. Family Life's portion of the annual rent is 37.5%. On March 29, 1996 Investors-NA sold the Austin Centre to an Austin-based real estate investment firm for a purchase price of $62.7 million, less $1 million paid to a capital reserve account FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued for the purchase. As part of the financing arrangement for the acquisition of Family Life, a $22.5 million loan was made by Investors-NA to Family Life Corporation, a subsidiary of FIC, and a $2.5 million loan was made to FIC. Interest during 1996, 1995 and 1994 on the loans aggregated $2,997,049, $2,939,622 and $2,891,269, respectively. At December 31, 1996 and 1995 accrued interest was $143,083 and $165,658, respectively. In addition to the interest provided under those loans, Investors-NA was granted by FIC 107,473 non-transferable options to purchase, in the amounts proportionate to their respective loans, up to a total of 9.9 percent of shares of FIC's common stock. The option price is $10.50 per share, equivalent to the then current market price, subject to adjustment to prevent the effect of dilution. As a result of the five-for-one stock split implemented by FIC, effective in November 1996, the exercise price of the options was changed to $2.10 per share. The initial terms of the option provided for their expiration on June 12, 1998, if not previously exercised. In connection with the 1996 amendments to the subordinated loans held by Investors-NA, the expiration date of the options was extended to September 12, 2006. On July 30, 1993, Investors-NA loaned $34.5 million to two subsidiaries of FIC in connection with the prepayment of the subordinated loans owed to the seller. Interest during 1996 and 1995 on these notes was $4,260,750 and $3,105,000 and accrued interest at December 31, 1996 and 1995 was $154,404 and $1,293,750. (See Note 6) FIC is reimbursed by ILCO for rental expense and certain other operating expenses. The amount of such reimbursement was approximately, $305,000, $830,000, and $585,000 in 1996, 1995 and 1994, respectively. Pursuant to a Service Agreement between Family Life and Investors NA, the Company reimbursed Investors NA for certain operating expenses incurred on behalf of FLIC totaling approximately $14 million, $15 million, and $13 million in 1996, 1995 and 1994, respectively. At December 31, 1996 and 1995, 145,500 and 44,250 shares of the Company's stock were owned by Investors-NA and InterContinental Life Insurance Company, respectively. The Company has guaranteed the obligations of its subsidiaries under the senior loan and the subordinated loan referred to in Note 6 and also guaranteed the debt refinanced in 1993. The Company has also guaranteed certain financial obligations of ILCO, as disclosed in Note 4. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued On May 8, 1989, ILCO'S Board of Directors granted Mr. Mitte, Chairman and CEO of FIC and ILCO, an option to purchase 600,000 shares (as adjusted for the three-for-one stock split effective February 15, 1990) of the Common Stock of ILCO in equal annual installments of 150,000 shares each. In 1992, the Chairman surrendered for cancellation 120,000 of these options. In October of 1993, the Company entered into an agreement with the Chairman whereby the Chairman agreed to surrender all of his remaining common stock options between 1993 and 1996. Pursuant to this agreement, all the remaining 121,500 options were surrendered through December 31, 1996. FIC Computer Services, Inc. (FIC Computer), a subsidiary of FIC, provides data processing services to each subsidiary for proportionate fees equal to FIC Computer's cost. Investors-NA, Investors-IN and ILIC paid $2,243,234, $1,655,486 and $181,971 to FIC Computer for data processing services provided during 1996, 1995 and 1994, respectively. In December 1995, Family Life entered into a reinsurance agreement with Investors-NA (an insurance company subsidiary of ILCO and an affiliated company of Family Life), pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. The arrangement reflects management's plan to concentrate on the writing of term life insurance, with Investors-NA to develop universal life business. In 1996, Investors-NA entered into a reinsurance agreement with Family Life, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. These reinsurance arrangements reflect management's plan to develop universal life and annuity business at Investors-NA, with Family Life concentrating on the writing of term life insurance products. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 14. Commitments and Contingencies The Company and its subsidiaries are defendants in certain legal actions related to the normal business operations of the Company. Management believes that the resolution of such matters will not have a material impact on the financial statements. 15. Net Income Per Share (in thousands except per share data) Net income per share was determined by dividing net income available to common shareholders by common stock and common stock equivalents. Changes in the market price of the Company's common stock also impacts the number of common options and warrants which are considered dilutive under the treasury stock method of calculating the weighted average common stock and common stock equivalents. For the years ended December 31, 1996, 1995 and 1994, weighted average common stock and common stock equivalents are calculated as follows: FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 1996 1995 1994 Net income $16,157 $10,017 $ 9,954 Net income available to common shareholders $16,157 $10,017 $ 9,954 Weighted average common shares outstanding, less treasury stock 5,428 5,428 5,428 Dilutive common share equivalents: Common stock options 537 537 537 Effect of ILCO ownership of common stock options (249) (255) (255) Less: Assumed repurchase of shares using the treasury stock method (112) (160) (165) Effect of ownership of ILCO on treasury shares 52 75 75 Effect of ILCO ownership of common shares (88) (90) (90) Common stock and common stock equivalents 5,568 5,535 5,530 Net income per share available to common shareholders $ 2.90 $ 1.81 $ 1.80 FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 16. Business Concentration The Company's insurance subsidiary, Family Life provides mortgage protection life, disability and accidental death insurance to mortgage borrowers of financial institutions. For marketing purposes a significant number of these financial institutions provide Family Life with customer lists. In 1996, premium income from these products was derived from forty-nine states with concentrations of approximately 23% and 24% in California and Texas, respectively. In 1995, these amounts were 23% and 23%, respectively. 17. Quarterly Financial Data (unaudited) (in thousands, except per share data) Three Months Three Months Ended Ended March 31, June 30, 1996 1995 1996 1995 Total revenues $15,014 $15,370 $15,073 $16,744 Net income $ 8,616 $ 2,661 $ 2,778 $ 2,767 Three Months Three Months Ended Ended September 30, December 31, 1996 1995 1996 1995 Total revenues $14,978 $15,293 $14,863 $14,134 Net income $ 2,165 $ 2,358 $ 2,598 $ 2,231 FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued 17. Quarterly Financial Data (unaudited), continued (in thousands, except per share data) Three Months Three Months Ended Ended March 31, June 30, 1996 1995 1996 1995 Net income per share $ 1.55 $ .48 $ .50 $ .50 Three Months Three Months Ended Ended September 30, December 31, 1996 1995 1996 1995 Net income per share $ .39 $ .43 $ .47 $ .40 FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1996 (in thousands) Column A Column B Column C Column D Amount Shown on the Amortized Fair Balance Type of Investment Cost Value Sheet Fixed maturities: Bonds: United States Government and government agencies and authorities $ 18,125 $ 19,043 $ 19,043 States, municipalities and political subdivisions 2,955 3,022 3,022 Corporate securities 21,475 21,444 21,444 Mortgage-backed securities 40,414 40,324 40,324 Total fixed maturities 82,969 83,833 83,833 Equity securities: Common stocks: Industrial and miscellaneous other 11 4 4 Total equity securities 11 4 4 Policy loans 2,286 2,286 2,286 Short-term investments 25,615 25,615 25,615 Total investments $110,881 $111,738 $111,738 FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY) SCHEDULE III - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT BALANCE SHEETS DECEMBER 31, 1996 1995 (in thousands) ASSETS Cash $ 52 $ 71 Short-term Investments 1,926 -0- Long-Term bonds 16 16 Common Stock 4 4 Investments in subsidiaries* 90,815 84,012 Property, plant and equipment, net 6,176 6,202 Other assets 1,086 1,088 Accounts receivable 57 60 $100,132 $91,453 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Subordinated notes payable $ 4,253 $ 4,221 Other liabilities and intercompany payables 3,805 4,499 8,058 8,720 Shareholders' equity: Common stock, $.20 par value, 10,000,000 shares authorized; 5,845,300 shares issued, 5,427,965 shares outstanding in 1996 and 1995 1,169 1,169 Additional paid-in capital 7,225 7,225 Net unrealized gain on investments in fixed maturities available for sale 1,220 8,052 Net unrealized appreciation of equity securities held by insurance subsidiary 25 9 Retained earnings (including $78,745 and $61,680 of undistributed earnings of subsidiaries at December 31, 1996 and 1995, respectively) 82,857 66,700 92,496 83,155 Common Treasury stock, at cost, 417,335 shares in 1996 and 1995 (422) (422) Total shareholders' equity 92,074 82,733 Total liabilities and shareholders' equity $100,132 $91,453 *Eliminated in consolidation FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY) SCHEDULE III - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT, STATEMENTS OF INCOME DECEMBER 31, 1996 1995 (in thousands) Income $ 811 $ 885 Operating expenses 461 456 Interest expense* 977 897 1,438 1,353 Income (loss) from operations (627) (468) Equity in undistributed earnings from subsidiaries 16,784 10,485 Net income $16,157 $10,017 *In consolidation, $179 is reported as a reduction in equity in earnings of unconsolidated subsidiary. FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY) SCHEDULE III - CONDENSED STATEMENTS OF REGISTRANT,Continued STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996 1995 (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 16,157 $ 10,017 Adjustments to reconcile net income to net cash used in operating activities: Decrease in accounts receivables 3 19 Increase in investment in subsidiaries* (13,619) (7,244) Decrease in other assets 2 113 Decrease in other liabilities and intercompany payables (694) (17) Decrease in property and equipment 26 (3,395) Net cash used in operating activities 1,875 (507) CASH FLOWS FROM FINANCING ACTIVITIES Net change in short-term investments (1,926) -0- Subordinated notes payable issued to Investors-NA 32 462 Net cash provided by financing activities (1,894) 462 Decrease in cash (19) (45) Cash, beginning of year 71 116 Cash, end of year $ 52 $ 71 *Eliminated in consolidation FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES SCHEDULE IV-INDEBTEDNESS OF AND TO RELATED PARTIES DECEMBER 31, 1996 AND 1995 (in thousands) Column A Balance at Column C Column D Column E Begin- Column B Amounts Amounts Balance ning of Addi- Collect- Written End of Name of Creditor Period tions ed Off Period December 31, 1996 Investors Life Insurance Company - North America $22,500 -0- $1,125 -0- $21,375 Investors Life Insurance Company - North America $ 4,224 253 224 -0- $ 4,253 Investors Life Insurance Company - North America $30,000 -0- 164 -0- $29,836 Investors Life Insurance Company - North America $ 4,500 -0- 25 -0- $ 4,475 December 31, 1995 Investors Life Insurance Company - North America $22,500 -0- -0- -0- $22,500 Investors Life Insurance Company - North America $ 3,759 465 -0- -0- $ 4,224 Investors Life Insurance Company - North America $30,000 -0- -0- -0- $30,000 Investors Life Insurance Company - North America $ 4,500 -0- -0- -0- $ 4,500 FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES SCHEDULE VI-REINSURANCE CEDED AND ASSUMED FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (in thousands) Percent- Ceded To Assumed age Of Direct Other From Other Net Amount Amount Companies Companies Amount Assumed 1996 Life Insurance in-force $8,324,406 $ 365,103 $ 5,772 $7,965,075 0.07% Premium: Life insurance $ 55,124 $ 6,257 $ 64 $ 48,931 0.13% Accident-health insurance 1,244 1 0 1,243 0.00% Total $ 56,368 $ 6,258 $ 64 $ 50,174 0.13% 1995 Life Insurance in-force $8,677,064 $ 314,826 $ 4,162 $8,366,400 0.05% Premium: Life insurance $ 57,269 $ 1,526 $ 56 $ 55,799 0.10% Accident-health insurance 1,471 5 0 1,466 0.00% Total $ 58,740 $ 1,531 $ 56 $ 57,265 0.10% FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES SCHEDULE VII - GUARANTEES OF SECURITIES OF OTHER ISSUERS DECEMBER 31, 1996 (in thousands) Column A Name of Issuer of Securities Guaranteed by Period For Which Statement is Filed InterContinental Life Corporation Column B Title of Issue of Each Class of Securities Guaranteed Credit Agreement Dated as of January 29, 1993 Column C Total Amount Guaranteed and Outstanding $24,944 Column D Amount Owned by Person or Persons for Which Statement is Filed -0- Column E Amount in Treasury of Issues of Securities Guaranteed -0- Column F Nature of Guarantee Guarantee of Principal and Interest Column G Nature of Any Default By Issuer of Securities Guaranteed in Principal Interest Sinking Fund or Redemption Provision or Payment of Dividends None EXHIBIT INDEX Exhibit No. Page Nos. Description 3 The current Articles of Incorporation and Bylaws of Registrant. Exhibit 3 to Registrant's Report on Form 10-K filed for the year 1985 is hereby incorporated by reference. 3(a) Certificate of Amendment to the Articles of Incorporation of Registrant, dated November 12, 1996, filed as an exhibit with Registrant's 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference. 10(ah) Guaranty Agreement dated as of December 28, 1988 from Registrant to a group of banks on Senior Loan to ILCO, filed as an exhibit with Registrant's Form 10-K for the year ended December 31, 1989 and incorporated herein by reference. 10(ai) Guaranty Agreement, dated as of December 1, 1988, on loan to ILCO on the Note Purchase Agreement between ILCO and a Connecticut based insurance/financial services company; a guaranty agreement in substantially identical form was provided by FIC to each of the seven other entities participating in said loan, filed as an exhibit with Registrant's Form 10-K for the year ended December 31, 1989 and incorporated herein by reference. 10(aj) Guaranty Agreement, dated as of July 30, 1990, issued by the Registrant to a holder of ILCO's 1999 Series Subordinated Notes; a guaranty agreement in substantially identical form was provided by the Registrant to each of the holders of said notes. *10(ak) Stock Purchase Agreement by and among Merrill Lynch Insurance Group, Inc., Family Life Insurance Company, Family Life Corporation, Family Life Insurance Investment Company and Financial Industries Corporation dated as of March 19, 1991, as amended. *10(al) Note dated June 12, 1991 in the amount of $30 million made by a subsidiary of the Registrant in favor of Merrill Lynch Insurance Group, Inc. *10(am) Note dated June 12, 1991 in the amount of $12 million made by a subsidiary of the Registrant to Merrill Lynch & Co., Inc. *10(an) Note dated June 12, 1991 in the amount of $2 million made by a subsidiary of the Registrant in favor of the Seller under the Stock Purchase Agreement dated as of March 19, 1991. *10(ao) Performance and Payment Guaranty Agreement dated June 12, 1991 by Registrant in favor of the Seller under the Stock Purchase Agreement dated as of March 19, 1991. *10(ap) Payment Guaranty Agreement dated June 12, 1991 by Registrant in favor of the Seller under the Stock Purchase Agreement dated as of March 19, 1991. *10(aq) InterCreditor Agreement dated June 12, 1991 among Investors Life Insurance Company of North America, Investors Life Insurance Company of California, Merrill Lynch Insurance Group, Inc., and Merrill Lynch & Co., Inc. *10(ar) Credit Agreement dated as of June 12, 1991 among Family Life Corporation (a subsidiary of the Registrant), the Lenders named therein and the Agent. *10(as) Guaranty Agreement by Registrant of the $50 million loan to Family Life Corporation in favor of the bank lenders under the Credit Agreement dated as of June 12, 1991. *10(at) Guaranty Agreement by a subsidiary of the Registrant on the $50 million loan to Family Life Corporation in favor of the bank lenders under the Credit Agreement dated as of June 12, 1991. *10(au) Pledge Agreement by Family Life Corporation (a subsidiary of the Registrant) in favor of the bank lenders under the Credit Agreement dated as of June 12, 1991. *10(aw) Pledge Agreement by Family Life Insurance Investment Company (a subsidiary of the Registrant) in favor of the bank lenders under the Credit Agreement dated as of June 12, 1991. *10(ax) Note dated June 12, 1991 in the amount of $22.5 million made by a subsidiary of the Registrant in favor of Investors Life Life Insurance Company of North America. *10(ay) Note dated June 12, 1991 in the amount of $2.5 million made by the Registrant in favor of Investors Life Insurance Company of California. *10(az) InterCreditor Agreement among Investors Life Insurance Company of North America, Investors Life Insurance Company of California, and the Agent under the Credit Agreement dated as of June 12, 1991. *10(aaa) Option Agreement by the Registrant in favor of Investors Life Insurance Company of North America and Investors Life Insuance Company of California. 10(aab) Hotel Lease Agreement dated as of August 22, 1991 between Investors Life Insuarnce Company of North America and FIC Realty Services, Inc. as exhibit 10(aab) by Registrant on Form 10-K for the year ended December 31, 1991 is hereby incorporated by reference. 10(aac) Management Agreement dated as of September 4, 1991 between Investors Life Insurance Company of North America and FIC Property Management Inc. filed as exhibit 10(aac) by Registrant on Form 10-K for the year ended December 31, 1991 is hereby incorporated by reference. 10(aad) Stock Option Agreement dated March 8, 1986 betweem ILCO and Registrant filed as exhibit 10(aad) by Registrant on Form 10-K for the year ended December 31, 1992 is hereby incorporated by reference. 10(aae) Amended and Restated Guaranty of Registrant dated January 29, 1993 filed as exhibit 10 (aae) by Registrant on Form 10-K for the year ended December 31, 1992 is hereby incorporated by reference. 10(aaf) Surplus Debenture dated as of June 12, 1991 in the amount of $97.5 million made by Family Life Insurance Company in favor of Family Life Corporation filed as exhibit 10 (aaf) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference. 10(aag) Note dated July 30, 1993 in the amount of $30 million made by Family Life Corporation in favor of Investor Life Insurance Company of North America filed as exhibit 10(aag) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference. Life Corporation filed as exhibit 10(aaf) by 10(aah) Note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America filed as exhibit 10(aah) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference. 10(aai) Amendment No. 1 dated July 30, 1993 between Family Life Corporation and Investors Life Insurance Company of North America amending $22.5 million note filed as exhibit 10(aai) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference. 10(aaj) Amendment No. 1 dated July 30, 1993 between Family Life Insurance Company and Family Life Corporation amending $97.5 million Surplus Debenture filed as exhibit 10(aaj) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference. 10(aak) Guaranty Agreement dated July 30, 1993 by Registrant of the $30 million loan to Family Life Corporation in favor of Investors Life Insurance Company of North America filed as exhibit 10(aak) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference. 10(aal) Guaranty Agreement dated July 30, 1993 by Registrant of the $4.5 million loan to Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America filed as exhibit 10(aal) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference. 10(aam) Letter agreement dated May 26, 1993 among Family Life Corporation, Family Life Insurance Investment Company, Merrill Lynch & Co., Inc. and Merrill Lynch Group, Inc. filed as exhibit 10(aam) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference. 10(aan) Waiver and Amendment Agreement dated as of July 23, 1993 among Family Life Corporation, the Lenders named therein and the Agent filed as exhibit 10(aan) by Registrant on Form 10-K for the year ended December 31, 1994 is hereby incorporate by reference. 10(aao) Waiver and Amendment Agreement dated as of December 14, 1993 among Family Life Corporation, the Lenders named therein and the Agent filed as exhibit 10(aao) by Registrant on Form 10-K for the year ended December 31, 1994 is hereby incorporated by reference. 10(aap) Data Processing Agreement dated as of November 30, 1994 between InterContinental Life Insurance Company and FIC Computer Services, Inc filed as exhibit 10(aap) by Registrant on Form 10-K for the year ended December 31, 1994 is hereby incorporated by reference. 10(aaq) Data Processing Agreement dated as of November 30, 1994 between Investors Life Insurance Company of North America and FIC Computer Services, Inc filed as exhibit 10(aaq) by Registrant on Form 10-K for the year ended December 31, 1994 is hereby incorporated by Reference. 10(aar) Data Processing Agreement dated as of November 30, 1994 between Family Life Insurance Company and FIC Computer Services, Inc filed as exhibit 10(aar) by Registrant on Form 10-K for the year ended December 31, 1994 is hereby incorporated by reference. 10(aas) Lease Agreement dated as of September 30, 1994 between FIC Realty Services, Inc. and Atrium Beverage Corporation filed as exhibit 10(aas) by Registrant on Form 10-K for the year ended December 31, 1994 is hereby incorporated by reference. 10(aat) Management Agreement dated as of September 30, 1994 between HCD Austin Corporation as agent for FIC Realty Services, Inc. and Atrium Beverage Corporation filed as exhibit 10(aat) by Registrant on Form 10-K for the year ended December 31, 1994 is hereby incorporated by reference. 10(aau) Amendment Agreement dated as of July 31, 1995 among Family Life Corporation, the Lenders named therein and the Agent filed as exhibit 10(aau) by Registrant on Form 10-K for the year ended December 31, 1995 is hereby incorporated by reference. 10(aav) 122 Amendment No. 2 dated December 12, 1996, effective June 12, 1996 to the note dated June 12, 1991 in the amount of $22.5 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America. 10(aaw) 126 (i) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated June 12, 1991 in the amount of $2.5 million made by Financial Industries Corporation in favor of Investors Life Insurance Company of California. 129 (ii) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the "payment in kind" provisions of the note dated June 12, 1991 in the amount of $2.5 million made by Financial Industries Corporation in favor of Investors Life Insurance Company of North America. 10(aax) 132 Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated July 30, 1993 in the amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America. 10(aay) 137 Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America. 10(aaz) 141 Amendment Agreement dated December 12, 1996 amending the Option Agreement by Financial Industries Corporation in favor of Investors Life Insurance Company of North America and Investors Life Insurance Company of California. 21 143 Subsidiaries of Registrant. 28 Report on Form 10-K filed by ILCO for the year ended December 31, 1996 is hereby incorporated by reference in its entirety. * Filed as an Exhibit with Registrant's Current Report on Form 8-K dated June 25, 1991, and incorporated herein by reference. Exhibit 10 (aav) FAMILY LIFE CORPORATION AMENDMENT NO. 2 TO 11% SUBORDINATED SENIOR NOTE DATED JUNE 12, 1991 This Waiver and Amendment Agreement (the "Agreement") is entered into effective as of June 12, 1996, by and between Family Life Corporation (the "Company") and Investors Life Insurance Company of North America (the "Payee"). WITNESSETH: WHEREAS, the Company is the obligor and Payee is the payee under that certain 11% Subordinated Senior Note dated June 12, 1991, due June 12, 1998, in the principal amount of $22,500,000 (the "1991 Note"); and WHEREAS the Company is also the obligor under that certain Senior Subordinated Note dated July 30, 1993, due July 30, 2003, in the principal amount of $30,000,000 (the "1993 Note"); and WHEREAS, the Company has proposed a modification of the payment schedule and the due dates under each of the 1991 Note and the 1993 Note; and WHEREAS, the Company has requested Payee to waive certain provisions of the 1991 Note, as and to the extent hereinafter set forth; and WHEREAS, the Company and Payee desire to amend the 1991 Note as hereinafter set forth. NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not otherwise defined in this Agreement shall have the meanings attributed to such terms in the 1991 Note, as previously amended. 2. Waiver. Payee hereby waives any provision of the 1991 Note and any Event of Default created thereby by reason of the amendment of the 1993 Note as set forth in Exhibit A hereto. 3. Amendment to 1991 Note. The 1991 Note is hereby amended as follows: a. The description of the 1991 Note which appears on the first page thereof is changed from "Subordinated Senior Note due June 12, 1998" to "Subordinated Senior Note due September 12, 2001". b. The Payment Schedule attached to the 1991 Note is revised in its entirety to read as follows: Unpaid Principal Principal Balance Date of Payment Amount Paid Outstanding 06/12/96 $22,500,000 12/12/96 $1,125,000 $21,375,000 03/12/97 $1,125,000 $20,250,000 06/12/97 $1,125,000 $19,125,000 09/12/97 $1,125,000 $18,000,000 12/12/97 $1,125,000 $16,875,000 03/12/98 $1,125,000 $15,750,000 06/12/98 $1,125,000 $14,624,000 09/12/98 $1,125,000 $13,500,000 12/12/98 $1,125,000 $12,375,000 03/12/99 $1,125,000 $11,250,000 06/12/99 $1,125,000 $10,125,000 09/12/99 $1,125,000 $ 9,000,000 12/12/99 $1,125,000 $ 7,875,000 03/12/00 $1,125,000 $ 6,750,000 06/12/00 $1,125,000 $ 5,625,000 09/12/00 $1,125,000 $ 4,500,000 12/12/00 $1,125,000 $ 3,375,000 03/12/01 $1,125,000 $ 2,250,000 06/12/01 $1,125,000 $ 1,125,000 09/12/01 $1,125,000 $ -0- 4. Representations and Warranty. The Company hereby represents and warrants to Payee that after giving effect to the waiver and amendment herein contained (i) all of the representations and warranties contained in the 1991 Note are true and correct as of the date hereof, (ii) no Event of Default exists or is continuing and (iii) the Company has performed all of the agreements on its part to be performed prior to the date hereof as set forth in the 1991 Note. 5. Reference to and Effect on the 1991 Note. a. On or after the date of this Agreement, each reference in the 1991 Note, as amended by Amendment No. 1 dated July 30, 1993, to "this Note", "hereof", or words of like import and each reference to the 1991 Note in other documents shall mean and be a reference to the 1991 Note as amended hereby. b. Except as specifically amended and waived above, all of the terms, conditions and covenants of the 1991 Note shall remain unaltered and in full force and effect and shall continue to be binding upon the Company in all respects and are hereby ratified and confirmed. c. The execution, delivery and effectiveness of this Agreement shall not, except as expressly provided herein, operate as a waiver of (i) any right, power or remedy of the Payee under the 1991 Note or (ii) any Event of Default under the 1991 Note. IN WITNESS WHEREOF, the Company and Payee have executed this Agreement as of the 12th day of December, 1996. FAMILY LIFE CORPORATION By: Title: INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA By: Title: Consent of Guarantor Financial Industries Corporation, as guarantor under the Guaranty Agreement dated June 12, 1991, in favor of Investors Life Insurance Company of North America ("Investors-NA"), with respect to a loan in the amount of $22,500,000 from Investors-NA to Family Life Corporation, which loan is evidenced by a Subordinated Senior Note dated June 12, 1991 (the 1991 Guaranty") hereby consents to the Amendment Agreement dated as of June 12, 1996 and hereby confirms and agrees that the 1991 Guaranty is, and shall continue to be, in full force and effect and is hereby confirmed and ratified in all respects. This Consent is executed and delivered as of December 12, 1996. FINANCIAL INDUSTRIES CORPORATION By: Title: Exhibit 10 (aaw)(i) FINANCIAL INDUSTRIES CORPORATION AMENDMENT NO. 1 TO 12% SUBORDINATED NOTE DATED JUNE 12, 1991 This Waiver and Amendment Agreement (the "Agreement") is entered into effective as of June 12, 1996, by and between Financial Industries Corporation (the "Company") and Investors Life Insurance Company of North America, as successor to the interests of Investors Life Insurance Company of California (the "Payee"). WITNESSETH: WHEREAS, the Company is the obligor and Payee is the payee under that certain 12% Subordinated Note dated June 12, 1991, due June 12, 1998, in the principal amount of $2,500,000 (the "1991 Note"); and WHEREAS the Company is also the obligor under that certain Master Subordinated PIK Note dated June 12, 1991, due June 12, 1998 (the "PIK Note"); and WHEREAS, the Company has proposed a modification of the payment schedule and the due dates under each of the 1991 Note and the PIK Note; and WHEREAS, the Company has requested Payee to waive certain provisions of the 1991 Note, as and to the extent hereinafter set forth; and WHEREAS, the Company and Payee desire to amend the 1991 Note as hereinafter set forth. NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not otherwise defined in this Agreement shall have the meanings attributed to such terms in the 1991 Note, as previously amended. 2. Waiver. Payee hereby waives any provision of the 1991 Note and any Event of Default created thereby by reason of the amendment of the PIK Note as set forth in Exhibit A hereto. 3. Amendment to 1991 Note. The 1991 Note is hereby amended as follows: a. The description of the 1991 Note which appears on the first page thereof is changed from "Subordinated Note due June 12, 1998" to "Subordinated Note due September 12, 2001". b. The Payment Schedule attached to the 1991 Note is revised in its entirety to read as follows: Unpaid Principal Principal Balance Date of Payment Amount Paid Outstanding 06/12/96 $ 2,500,000 12/12/96 $ 125,000 $ 2,375,000 03/12/97 $ 125,000 $ 2,250,000 06/12/97 $ 125,000 $ 2,125,000 09/12/97 $ 125,000 $ 2,000,000 12/12/97 $ 125,000 $ 1,875,000 03/12/98 $ 125,000 $ 1,750,000 06/12/98 $ 125,000 $ 1,625,000 09/12/98 $ 125,000 $ 1,500,000 12/12/98 $ 125,000 $ 1,375,000 03/12/99 $ 125,000 $ 1,250,000 06/12/99 $ 125,000 $ 1,125,000 09/12/99 $ 125,000 $ 1,000,000 12/12/99 $ 125,000 $ 875,000 03/12/00 $ 125,000 $ 750,000 06/12/00 $ 125,000 $ 625,000 09/12/00 $ 125,000 $ 500,000 12/12/00 $ 125,000 $ 375,000 03/12/01 $ 125,000 $ 250,000 06/12/01 $ 125,000 $ 125,000 09/12/01 $ 125,000 $ -0- 4. Representations and Warranty. The Company hereby represents and warrants to Payee that after giving effect to the waiver and amendment herein contained (i) all of the representations and warranties contained in the 1991 Note are true and correct as of the date hereof, (ii) no Event of Default exists or is continuing and (iii) the Company has performed all of the agreements on its part to be performed prior to the date hereof as set forth in the 1991 Note. 5. Reference to and Effect on the 1991 Note. a. On or after the date of this Agreement, each reference in the 1991 Note to "this Note", "hereof", or words of like import and each reference to the 1991 Note in other documents shall mean and be a reference to the 1991 Note as amended hereby. b. Except as specifically amended and waived above, all of the terms, conditions and covenants of the 1991 Note shall remain unaltered and in full force and effect and shall continue to be binding upon the Company in all respects and are hereby ratified and confirmed. c. The execution, delivery and effectiveness of this Agreement shall not, except as expressly provided herein, operate as a waiver of (i) any right, power or remedy of the Payee under the 1991 Note or (ii) any Event of Default under the 1991 Note. IN WITNESS WHEREOF, the Company and Payee have executed this Agreement as of the 12th day of December, 1996. FINANCIAL INDUSTRIES CORPORATION By: Title: INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA By: Title: Exhibit 10 (aaw) (ii) FINANCIAL INDUSTRIES CORPORATION AMENDMENT NO. 1 TO MASTER SUBORDINATED PIK NOTE DATED JUNE 12, 1991 This Waiver and Amendment Agreement (the "Agreement") is entered into effective as of June 12, 1996, by and between Financial Industries Corporation (the "Company") and Investors Life Insurance Company of North America, as successor to the interests of Investors Life Insurance Company of California (the "Payee"). WITNESSETH: WHEREAS, the Company is the obligor and Payee is the payee under that certain Master Subordinated PIK Note dated June 12, 1991, due June 12, 1998 (the "PIK Note"); and WHEREAS the Company is also the obligor under that certain 12% Subordinated Note dated June 12, 1991, due June 12, 1998, in the principal amount of $2,500,000 (the "1991 Note"); and WHEREAS, the Company has proposed a modification of the payment schedule and the due dates under each of the PIK Note and the 1991 Note; and WHEREAS, the Company has requested Payee to waive certain provisions of the PIK Note, as and to the extent hereinafter set forth; and WHEREAS, the Company and Payee desire to amend the PIK Note as hereinafter set forth. NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not otherwise defined in this Agreement shall have the meanings attributed to such terms in the PIK Note, as previously amended. 2. Waiver. Payee hereby waives any provision of the PIK Note and any Event of Default created thereby by reason of the amendment of the 1991 Note as set forth in Exhibit A hereto. 3. Amendment to PIK Note. The PIK Note is hereby amended as follows: a. The description of the PIK Note which appears on the first page thereof is changed from "Master Subordinated PIK Note due June 12, 1998" to "Master Subordinated PIK Note due September 12, 2001". b. The Payment Schedule attached to the PIK Note is revised in its entirety to read as follows: Unpaid Principal Principal Balance Date of Payment Amount Paid Outstanding 06/12/96 $ 1,977,119.00 12/12/96 $ 98,855.95 $ 1,878,263.05 03/12/97 $ 98,855.95 $ 1,779,407.10 06/12/97 $ 98,855.95 $ 1,680,551.15 09/12/97 $ 98,855.95 $ 1,581,695.20 12/12/97 $ 98,855.95 $ 1,482,839.25 03/12/98 $ 98,855.95 $ 1,383,983.30 06/12/98 $ 98,855.95 $ 1,285,127.35 09/12/98 $ 98,855.95 $ 1,186,271.40 12/12/98 $ 98,855.95 $ 1,087,415.45 03/12/99 $ 98,855.95 $ 988,559.50 06/12/99 $ 98,855.95 $ 889,703.55 09/12/99 $ 98,855.95 $ 790,847.60 12/12/99 $ 98,855.95 $ 691,991.65 03/12/00 $ 98,855.95 $ 593,135.70 06/12/00 $ 98,855.95 $ 494,279.75 09/12/00 $ 98,855.95 $ 395,423.80 12/12/00 $ 98,855.95 $ 296,567.85 03/12/01 $ 98,855.95 $ 197,711.90 06/12/01 $ 98,855.95 $ 98,855.95 09/12/01 $ 98,855.95 $ -0- 4. Representations and Warranty. The Company hereby represents and warrants to Payee that after giving effect to the waiver and amendment herein contained (i) all of the representations and warranties contained in the PIK Note are true and correct as of the date hereof, (ii) no Event of Default exists or is continuing and (iii) the Company has performed all of the agreements on its part to be performed prior to the date hereof as set forth in the PIK Note. 5. Reference to and Effect on the PIK Note. a. On or after the date of this Agreement, each reference in the PIK Note to "this Note", "hereof", or words of like import and each reference to the PIK Note in other documents shall mean and be a reference to the PIK Note as amended hereby. b. Except as specifically amended and waived above, all of the terms, conditions and covenants of the PIK Note shall remain unaltered and in full force and effect and shall continue to be binding upon the Company in all respects and are hereby ratified and confirmed. c. The execution, delivery and effectiveness of this Agreement shall not, except as expressly provided herein, operate as a waiver of (i) any right, power or remedy of the Payee under the PIK Note or (ii) any Event of Default under the PIK Note. IN WITNESS WHEREOF, the Company and Payee have executed this Agreement as of the 12th day of December, 1996. FINANCIAL INDUSTRIES CORPORATION By: Title: INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA By: Title: Exhibit 10(aax) FAMILY LIFE CORPORATION AMENDMENT NO. 1 TO 9% SUBORDINATED SENIOR NOTE DATED JULY 30, 1993 This Waiver and Amendment Agreement (the "Agreement") is entered into effective as of June 12, 1996, by and between Family Life Corporation (the "Company") and Investors Life Insurance Company of North America (the "Payee"). WITNESSETH: WHEREAS, the Company is the obligor and Payee is the payee under that certain 9% Subordinated Senior Note dated July 30, 1993, due July 30, 2003, in the principal amount of $30,000,000 (the "1993 Note"); and WHEREAS the Company is also the obligor under that certain 11% Senior Subordinated Note dated June 12, 1991, due June 12, 1998, in the principal amount of $22,500,000 (the "1991 Note"); and WHEREAS, the Company has proposed a modification of the payment schedule and the due dates under each of the 1993 Note and the 1991 Note; and WHEREAS, the Company has requested Payee to waive certain provisions of the 1993 Note, as and to the extent hereinafter set forth; and WHEREAS, the Company and Payee desire to amend the 1993 Note as hereinafter set forth. NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not otherwise defined in this Agreement shall have the meanings attributed to such terms in the 1993 Note, as previously amended. 2. Waiver. Payee hereby waives any provision of the 1993 Note and any Event of Default created thereby by reason of the amendment of the 1991 Note as set forth in Exhibit A hereto. 3. Amendment to 1993 Note. The 1993 Note is hereby amended as follows: a. The description of the 1993 Note which appears on the first page thereof is changed from "Subordinated Senior Note due July 30, 2003" to "Subordinated Senior Note due September 12, 2006". b. The Payment Schedule attached to the 1993 Note is revised in its entirety to read as follows: Unpaid Principal Principal Balance Date of Payment Amount Paid Outstanding 06/12/96 $30,000,000 12/12/96 $ 163,540 $29,836,460 03/12/97 $ 163,540 $29,672,920 06/12/97 $ 163,540 $29,509,380 09/12/97 $ 163,540 $29,345,840 12/12/97 $ 163,540 $29,182,300 03/12/98 $ 163,540 $29,018,760 06/12/98 $ 163,540 $28,855,220 09/12/98 $ 163,540 $28,691,680 12/12/98 $ 163,540 $28,528,140 03/12/99 $ 163,540 $28,364,600 06/12/99 $ 163,540 $28,201,060 09/12/99 $ 163,540 $28,037,520 12/12/99 $ 163,540 $27,873,980 03/12/00 $ 163,540 $27,710,440 06/12/00 $ 163,540 $27,546,900 09/12/00 $ 163,540 $27,383,360 12/12/00 $ 163,540 $27,219,820 03/12/01 $ 163,540 $27,056,280 06/12/01 $ 163,540 $26,892,740 09/12/01 $ 163,540 $26,729,200 12/12/01 $1,336,458 $25,392,742 03/12/02 $1,336,458 $24,056,284 06/12/02 $1,336,458 $22,719,826 09/12/02 $1,336,458 $21,383,368 12/12/02 $1,336,458 $20,046,910 03/12/03 $1,336,458 $18,710,452 06/12/03 $1,336,458 $17,373,994 09/12/03 $1,336,458 $16,037,536 12/12/03 $1,336,458 $14,701,078 03/12/04 $1,336,458 $13,364,620 06/12/04 $1,336,458 $12,028,162 09/12/04 $1,336,458 $10,691,704 12/12/04 $1,336,458 $ 9,355,246 Unpaid Principal Principal Balance Date of Payment Amount Paid Outstanding 03/12/05 $1,336,458 $ 8,018,788 06/12/05 $1,336,458 $ 6,682,330 09/12/05 $1,336,458 $ 5,345,872 12/12/05 $1,336,458 $ 4,009,414 03/12/06 $1,336,458 $ 2,672,956 06/12/06 $1,336,458 $ 1,336,498 09/12/06 $1,336,498 $ -0- 4. Representations and Warranty. The Company hereby represents and warrants to Payee that after giving effect to the waiver and amendment herein contained (i) all of the representations and warranties contained in the 1993 Note are true and correct as of the date hereof, (ii) no Event of Default exists or is continuing and (iii) the Company has performed all of the agreements on its part to be performed prior to the date hereof as set forth in the 1993 Note. 5. Reference to and Effect on the 1993 Note. a. On or after the date of this Agreement, each reference in the 1993 Note to "this Note", "hereof", or words of like import and each reference to the 1993 Note in other documents shall mean and be a reference to the 1993 Note as amended hereby. b. Except as specifically amended and waived above, all of the terms, conditions and covenants of the 1993 Note shall remain unaltered and in full force and effect and shall continue to be binding upon the Company in all respects and are hereby ratified and confirmed. c. The execution, delivery and effectiveness of this Agreement shall not, except as expressly provided herein, operate as a waiver of (i) any right, power or remedy of the Payee under the 1993 Note or (ii) any Event of Default under the 1993 Note. IN WITNESS WHEREOF, the Company and Payee have executed this Agreement as of the 12th day of December 1996. FAMILY LIFE CORPORATION By: Title: INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA By: Title: Consent of Guarantor Financial Industries Corporation, as guarantor under the Guaranty Agreement dated July 30, 1993, in favor of Investors Life Insurance Company of North America ("Investors-NA"), with respect to a loan in the amount of $30,000,000 from Investors-NA to Family Life Corporation, which loan is evidenced by a Subordinated Senior Note dated July 30, 1993 (the 1993 Guaranty") hereby consents to the Amendment Agreement dated as of June 12, 1996, and hereby confirms and agrees that the 1993 Guaranty is, and shall continue to be, in full force and effect and is hereby confirmed and ratified in all respects. This Consent is executed and delivered as of December 12, 1996. FINANCIAL INDUSTRIES CORPORATION By: Title: Exhibit 10 (aay) FAMILY LIFE INSURANCE INVESTMENT COMPANY AMENDMENT NO. 1 TO 9% SUBORDINATED SENIOR NOTE DATED JULY 30, 1993 This Amendment Agreement (the "Agreement") is entered into effective as of June 12, 1996, by and between Family Life Insurance Investment Company (the "Company") and Investors Life Insurance Company of North America (the "Payee"). WITNESSETH: WHEREAS, the Company is the obligor and Payee is the payee under that certain 9% Subordinated Senior Note dated July 30, 1993, due July 30, 2003, in the principal amount of $4,500,000 (the "1993 Note"); and WHEREAS, the Company has proposed a modification of the payment schedule and the due dates under the 1993 Note; and WHEREAS, the Company and Payee desire to amend the 1993 Note as hereinafter set forth. NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not otherwise defined in this Agreement shall have the meanings attributed to such terms in the 1993 Note, as previously amended. 2. Amendment to 1993 Note. The 1993 Note is hereby amended as follows: a. The description of the 1993 Note which appears on the first page thereof is changed from "Subordinated Senior Note due July 30, 2003" to "Subordinated Senior Note due September 12, 2006". b. The Payment Schedule attached to the 1993 Note is revised in its entirety to read as follows: Unpaid Principal Principal Balance Date of Payment Amount Paid Outstanding 06/12/96 $ 4,500,000 12/12/96 $ 24,531 $ 4,475,469 03/12/97 $ 24,531 $ 4,450,938 06/12/97 $ 24,531 $ 4,426,407 09/12/97 $ 24,531 $ 4,401,876 12/12/97 $ 24,531 $ 4,377,345 03/12/98 $ 24,531 $ 4,352,814 06/12/98 $ 24,531 $ 4,328,283 09/12/98 $ 24,531 $ 4,303,752 12/12/98 $ 24,531 $ 4,279,221 03/12/99 $ 24,531 $ 4,254,690 06/12/99 $ 24,531 $ 4,230,159 09/12/99 $ 24,531 $ 4,205,628 12/12/99 $ 24,531 $ 4,181,097 03/12/00 $ 24,531 $ 4,156,566 06/12/00 $ 24,531 $ 4,132,035 09/12/00 $ 24,531 $ 4,107,504 12/12/00 $ 24,531 $ 4,082,973 03/12/01 $ 24,531 $ 4,058,442 06/12/01 $ 24,531 $ 4,033,911 09/12/01 $ 24,531 $ 4,009,380 12/12/01 $ 200,469 $ 3,808,911 03/12/02 $ 200,469 $ 3,608,442 06/12/02 $ 200,469 $ 3,407,973 09/12/02 $ 200,469 $ 3,207,504 12/12/02 $ 200,469 $ 3,007,035 03/12/03 $ 200,469 $ 2,806,566 06/12/03 $ 200,469 $ 2,606,097 09/12/03 $ 200,469 $ 2,405,628 12/12/03 $ 200,469 $ 2,205,159 03/12/04 $ 200,469 $ 2,004,690 06/12/04 $ 200,469 $ 1,804,221 09/12/04 $ 200,469 $ 1,603,752 12/12/04 $ 200,469 $ 1,403,283 03/12/05 $ 200,469 $ 1,202,814 06/12/05 $ 200,469 $ 1,002,345 09/12/05 $ 200,469 $ 801,876 12/12/05 $ 200,469 $ 601,407 03/12/06 $ 200,469 $ 400,938 06/12/06 $ 200,469 $ 200,469 09/12/06 $ 200,469 $ -0- 3. Representations and Warranty. The Company hereby represents and warrants to Payee that after giving effect to the amendment herein contained (i) all of the representations and warranties contained in the 1993 Note are true and correct as of the date hereof, (ii) no Event of Default exists or is continuing and (iii) the Company has performed all of the agreements on its part to be performed prior to the date hereof as set forth in the 1993 Note. 4. Reference to and Effect on the 1993 Note. a. On or after the date of this Agreement, each reference in the 1993 Note to "this Note", "hereof", or words of like import and each reference to the 1993 Note in other documents shall mean and be a reference to the 1993 Note as amended hereby. b. Except as specifically amended and waived above, all of the terms, conditions and covenants of the 1993 Note shall remain unaltered and in full force and effect and shall continue to be binding upon the Company in all respects and are hereby ratified and confirmed. c. The execution, delivery and effectiveness of this Agreement shall not, except as expressly provided herein, operate as a waiver of (i) any right, power or remedy of the Payee under the 1993 Note or (ii) any Event of Default under the 1993 Note. IN WITNESS WHEREOF, the Company and Payee have executed this Agreement as of the 12th day of December 1996. FAMILY LIFE INSURANCE INVESTMENT COMPANY By: Title: INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA By: Title: Consent of Guarantor Financial Industries Corporation, as guarantor under the Guaranty Agreement dated July 30, 1993, in favor of Investors Life Insurance Company of North America ("Investors-NA"), with respect to a loan in the amount of $4,500,000 from Investors-NA to Family Life Insurance Investment Company, which loan is evidenced by a Subordinated Senior Note dated July 30, 1993 (the 1993 Guaranty") hereby consents to the Amendment Agreement dated as of June 12, 1996 and hereby confirms and agrees that the 1993 Guaranty is, and shall continue to be, in full force and effect and is hereby confirmed and ratified in all respects. This Consent is executed and delivered as of December 12, 1996. FINANCIAL INDUSTRIES CORPORATION By: Title: Exhibit 10 (aaz) FINANCIAL INDUSTRIES CORPORATION AMENDMENT NUMBER 1 TO THE MARCH 21, 1991 OPTION AGREEMENT This Amendment Agreement (hereinafter the "Amendment") is made by Financial Industries Corporation ("FIC"), effective as of June 12, 1996, in favor of Investors Life Insurance Company of North America, individually and as successor-in-interest to Investors Life Insurance Company of California. Reference is made to that certain option agreement dated March 21, 1991 by FIC in favor of Investors Life Insurance Company of North America and Investors Life Insurance Company of California (the "Option Agreement"). All capitalized terms not defined herein shall have the meanings established in the Option Agreement. WITNESSETH: WHEREAS, Investors Life Insurance Company of North America and Investors Life Insurance Company of California granted loans to FIC, or subsidiaries thereof, in the amounts of $22.5 million and $2.5 million (the "Loans") in connection with the acquisition of Family Life Insurance Company by FIC. As partial consideration for said loans, FIC entered into the option agreement referenced herein, providing for a grant to Investors Life Insurance Company of North America and Investors Life Insurance Company of California of certain options to purchase a total of 9.9% of the common stock of FIC at a price of $10.50 per share; and WHEREAS, Investors Life Insurance Company of California was merged into Investors Life Insurance Company of North America, and Investors Life Insurance Company of North America thereby became the surviving organization and successor-in-interest to Investors Life Insurance Company of California; and WHEREAS, upon recommendation of the Board of Directors of FIC and the approval of a majority of the shareholders of FIC, the common stock of FIC was split on a five-for-one basis with a record date of November 12, 1996; and WHEREAS, Investors Life Insurance Company of North America (hereinafter "Investors-NA) and FIC agreed to amend the payment schedules of the Loans; and WHEREAS, Investors-NA and FIC wish to extend the period in which the options may be exercised and provide a written recognition of the effect of the five-for-one split on the per share price for the exercise of those options under the original terms of the Option Agreement. NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, FIC agrees as follows: 1. The expiration date for the exercise of the options as provided in paragraph two of the Option Agreement shall be changed to June 12, 2006. Furthermore, FIC acknowledges that the price per share under the Option Agreement ($10.50) has been adjusted to account for the five- for-one split of FIC common stock in accordance with the dilution provisions in paragraph one of the Option Agreement. Therefore, the resulting price per share is $2.10. Except as otherwise noted herein, the terms and conditions of the Option Agreement will remain in full force and effect. Executed this 12th day of December, 1996 by: FINANCIAL INDUSTRIES CORPORATION By: Roy F. Mitte President EXHIBIT 21 Subsidiaries of Registrant Family Life Corporation Family Life Insurance Investment Company Family Life Insurance Company Financial Industries Service Corporation Financial Industries Securities Corporation Financial Industries Service Corporation of Mississippi, Inc. Financial Industries Sales Corporation of Southern California, Inc. FIC Realty Services, Inc. FIC Property Management, Inc. FIC Computer Services, Inc. Atrium Beverage Corporation EX-27 2
7 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1995 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1995 DEC-31-1995 83,632 0 0 4 0 0 112,590 1,414 2,383 36,537 287,678 54,909 132 41,456 5,836 67,989 0 0 1,169 81,566 287,678 43,889 7,643 0 4,807 21,011 3,755 16,184 10,394 2,428 10,017 0 0 0 10,017 9.04 9.04 0 0 0 0 0 0 0
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