-----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, AR63HGRCtPnBL8QhKdljXeP2+jUyiFNhdmiv/kHe9uo1ReCnZAXBphybAt4ZDvXi T99h7/TDnS2MN0IG0ckGWg== 0000050982-99-000072.txt : 19991117 0000050982-99-000072.hdr.sgml : 19991117 ACCESSION NUMBER: 0000050982-99-000072 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 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-Q SEC ACT: SEC FILE NUMBER: 000-04690 FILM NUMBER: 99752949 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-Q 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934 For the Quarterly Period Ended September 30, 1999 Commission File Number 0-4690 FINANCIAL INDUSTRIES CORPORATION (Exact Name of Registrant as specified in its charter) Texas 74-2126975 (State of Incorporation) (I.R.S. Employer Identification Number) The Austin Centre, 701 Brazos, 12th Floor Austin, Texas 78701 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (512) 404-5000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO Number of common shares outstanding ($.20 par value) at end of period: 5,054,661 - 1 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES INDEX PAGE NO. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets September 30, 1999 and December 31, 1998............................ 3 Consolidated Statements of Income For the three and nine month periods ended September 30, 1999 and 1998......................................... 5 Consolidated Statements of Cash Flows For the three and nine month periods ended September 30, 1999 and 1998......................................... 9 Notes to Consolidated Financial Statements...................................13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS......................15 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ...............................................24 PART II Other Information...........................................................26 Signature Page..............................................................28 - 2 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands)
September 30, December 31, 1999 1998 (unaudited) ASSETS Investments other than investments in affiliate: Fixed maturities available for sale at market value (amortized cost of $77,464 and $76,727 at September 30, 1999 and December 31, 1998, respectively) $ 77,820 $ 79,402 Equity securities at market (cost approximates $11 at September 30, 1999 and December 31, 1998) 4 4 Policy loans 3,495 3,155 Short-term investments 25,478 27,589 --------------- ------------- Total investments 106,797 110,150 Cash 2,198 2,601 Investment in affiliate 70,164 70,950 Accrued investment income 1,103 1,209 Agency advances and other receivables 6,519 7,759 Reinsurance receivables 14,949 12,426 Due and deferred premiums 12,154 12,181 Property and equipment, net 1,758 1,758 Deferred policy acquisition costs 51,836 48,510 Present value of future profits of acquired businesses 24,348 28,294 Other assets 4,353 5,392 Separate account assets 324 508 --------------- ------------- Total Assets $ 296,503 $ 301,738 ================ ==============
The accompanying notes are an integral part of these consolidated financial statements - 3 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands)
September 30, December 31, 1999 1998 (unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Policy liabilities and contract holder deposit funds: Future policy benefits $ 60,913 $ 60,069 Contract holder deposit funds 44,681 45,128 Unearned premiums 14 28 Other policy claims and benefits payable 4,282 4,582 ----------------- -------------- 109,890 109,807 Subordinated notes payable to affiliate 43,035 47,645 Deferred federal income taxes 23,709 23,984 Other liabilities 3,516 4,474 Separate account liabilities 324 508 ----------------- -------------- Total Liabilities 180,474 186,418 ----------------- -------------- Commitments and Contingencies Shareholders' equity: Common stock, $.20 par value, 10,000,000 shares authorized; 5,845,300 shares issued, 5,054,661 outstanding in 1999 and 1998 1,169 1,169 Additional paid-in capital 7,225 7,225 Accumulated other comprehensive income 62 5,898 Retained earnings 114,948 108,403 ----------------- -------------- 123,404 122,695 Common treasury stock, at cost, 790,639 at 1999 and 1998. (7,375) (7,375) ----------------- -------------- Total Shareholders' Equity 116,029 115,320 ----------------- -------------- Total Liabilities and Shareholders' Equity $ 296,503 $ 301,738 ================= ==============
The accompanying notes are an integral part of these consolidated financial statements. - 4 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data)
Three Months Ended September 30, 1999 1998 (unaudited) Revenues: Premiums $ 8,516 $ 9,629 Net investment income 1,733 1,949 Earned insurance charges 1,148 1,533 Other 324 350 ---------------- ---------------- 11,721 13,461 Benefits and expenses: Policyholder benefits and expenses 3,557 4,480 Interest expense on contract holders deposit funds 345 577 Amortization of present value of future profits of acquired businesses 1,334 1,541 Amortization of deferred policy acquisition costs 1,354 1,272 Operating expenses 2,728 2,954 Interest expense 532 809 ---------------- ---------------- 9,850 11,633 ---------------- ---------------- Income before federal income tax and equity in net earnings of affiliates 1,871 1,828 Provision for federal income taxes 181 419 ---------------- ---------------- Income before equity in net earnings of affiliates 1,690 1,409 Equity in net earnings of affiliate, net of tax 786 744 ---------------- ---------------- Net income $ 2,476 $ 2,153 ================ ================
The accompanying notes are an integral part of these consolidated statements. - 5 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data)
Three Months Ended September 30, 1999 1998 (unaudited) Net Income Per Share Basic: Average weighted shares outstanding 5,055 5,428 ================== ================== Basic earnings per share $ 0.49 $ 0.40 ================== ================== Diluted: Common stock and common stock equivalents 5,203 5,602 ================== ================== Diluted earnings per share $ 0.48 $ 0.38 ================== ==================
The accompanying notes are an integral part of these consolidated financial statements. - 6 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data)
Nine Months Ended September 30, 1999 1998 (unaudited) Revenues: Premiums $ 26,198 $ 29,350 Net investment income 5,187 5,870 Earned insurance charges 3,733 4,698 Other 1,026 1,047 ---------------- ----------------- 36,144 40,965 Benefits and expenses: Policyholder benefits and expenses 11,490 12,384 Interest expense on contract holders deposit funds 1,317 1,783 Amortization of present value of future profits of acquired businesses 3,946 4,810 Amortization of deferred policy acquisition costs 3,737 3,538 Operating expenses 8,450 9,553 Interest expense 1,782 2,210 ---------------- ----------------- TOTAL 30,722 34,278 ---------------- ----------------- Income before federal income tax and equity in net earnings of affiliates 5,422 6,687 Provision for federal income taxes 954 1,552 ---------------- ----------------- Income before equity in net earnings of affiliates 4,468 5,135 Equity in net earnings of affiliate, net of tax 2,077 1,844 ---------------- ----------------- Net income $ 6,545 $ 6,979 ================ =================
The accompanying notes are an integral part of these consolidated statements. - 7 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data)
Nine Months Ended September 30, 1999 1998 (unaudited) Net Income Per Share Basic: Average weighted shares outstanding 5,055 5,428 ================= ================= Basic earnings per share $ 1.29 $ 1.29 ================= ================= Diluted: Common stock and common stock equivalents 5,202 5,604 ================= ================= Diluted earnings per share $ 1.26 $ 1.25 ================= ================
The accompanying notes are an integral part of these consolidated financial statements. - 8 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Three Months Ended September 30, 1999 1998 (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 2,476 $ 2,153 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of present value of future profits of acquired business 1,334 1,541 Amortization of deferred policy acquisition costs 1,354 1,272 Equity in undistributed earnings of affiliate (1,389) (1,260) Changes in assets and liabilities: Decrease in accrued investment income 64 334 Increase in agent advances and other receivables (456) (1,357) Decrease (increase) in due and deferred premiums 288 (437) Increase in deferred policy acquisition costs (2,555) (2,115) Decrease (increase) in other assets 518 (75) Increase in policy liabilities and accruals 928 23 Increase in other liabilities 456 417 (Decrease) increase in deferred federal income taxes (122) 870 Other, net 1,155 (195) ----------------- ------------------ Net cash provided by operating activities $ 4,051 $ 1,171 ----------------- ------------------
The accompanying notes are an integral part of these consolidated financial statements. - 9 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued (in thousands)
Three Months Ended September 30, 1999 1998 (unaudited) CASH FLOWS FROM INVESTING ACTIVITIES Fixed maturities purchased $ (8,561) $ -0- Proceeds from sales and maturities of fixed maturities 4,623 2,377 Increase in policy loans (218) (78) Net change in short-term investments 2,837 (1,886) --------------- -------------- Net cash (used in) provided by investing activities (1,319) 413 --------------- -------------- CASH FLOW FROM FINANCING ACTIVITIES Repayment of subordinated notes payable (1,536) (1,537) --------------- -------------- Net cash used in financing activities (1,536) (1,537) --------------- -------------- Net increase in cash 1,196 47 Cash, beginning of period 1,002 1,210 --------------- -------------- Cash, end of period $ 2,198 $ 1,257 =============== ==============
The accompanying notes are an integral part of these consolidated financial statements. - 10 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Nine Months Ended September 30, 1999 1998 (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 6,545 $ 6,979 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of present value of future profits of acquired business 3,946 4,810 Amortization of deferred policy acquisition costs 3,737 3,538 Equity in undistributed earnings of affiliate (3,867) (3,733) Changes in assets and liabilities: Decrease in accrued investment income 106 266 Increase in agent advances and other receivables (1,283) (2,623) Decrease (increase) in due and deferred premiums 27 (683) Increase in deferred policy acquisition costs (7,063) (6,185) Decrease in other assets 1,039 933 Increase in policy liabilities and accruals 83 144 Decrease in other liabilities (957) (777) (Decrease) increase in deferred federal income taxes (282) 2,128 Other, net 1,084 (404) ---------------- ------------------ Net cash provided by operating activities $ 3,115 $ 4,393 ---------------- ------------------
The accompanying notes are an integral part of these consolidated financial statements. - 11 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued (in thousands)
Nine Months Ended September 30, 1999 1998 (unaudited) CASH FLOWS FROM INVESTING ACTIVITIES Fixed maturities purchased $ (18,557) $ (9,082) Proceeds from sales and maturities of fixed maturities 17,878 8,749 Increase in policy loans (340) (291) Net change in short-term investments 2,111 1,624 Purchase & retirement of property and equipment 0 (34) ------------- ------------- Net cash provided by investing activities 1,092 966 ------------- ------------- CASH FLOW FROM FINANCING ACTIVITIES Repayment of subordinated notes payable (4,610) (4,610) ------------- ------------- Net cash used in financing activities (4,610) (4,610) ------------ ------------- Net (decrease) increase in cash (403) 749 Cash, beginning of year 2,601 508 ------------- ------------- Cash, end of period $ 2,198 $ 1,257 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. - 12 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The financial statements included herein reflect all adjustments which are, in the opinion of management, necessary to present a fair statement of the interim results. The statements have been prepared to conform to the requirements of Form 10-Q and do not necessarily include all disclosures required by generally accepted accounting principles (GAAP). The reader should refer to Form 10-K for the year ended December 31, 1998, previously filed with the Commission for financial statements prepared in accordance with GAAP. Certain prior year amounts have been reclassified to conform with current year presentation. The consolidated financial statements include the accounts of Financial Industries Corporation ("FIC") and its wholly-owned subsidiaries. The investment of FIC in InterContinental Life Corporation ("ILCO") is presented using the equity method. All significant intercompany items and transactions have been eliminated. NEW ACCOUNTING PRONOUNCEMENTS Comprehensive Income Total comprehensive income for the nine months ended September 30, 1999 and September 30, 1998 is $.71 million and $8.65 million, respectively. The following is a reconciliation of accumulated other comprehensive income from December 31, 1998 to September 30, 1999 (in thousands):
Net Total Net unrealized appreciation accumulated gain on investments (depreciation) other in fixed maturities of equity comprehensive available for sale securities income Balance at December 31, 1998 $ 5,900 $ (2) $ 5,898 Current Period Change (5,836) 0 (5,836) -------- ------ -------- Balance at September 30, 1999 $ 64 $ (2) $ 62 ======== ====== ========
- 13 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NEW ACCOUNTING PRONOUNCEMENTS In December 1997, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting for insurance-related assessments. The Company adopted SOP 97-3 effective January 1, 1999. The adoption of SOP 97-3 did not have a material impact on the Company's results of operations, liquidity or financial position. In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FAS 133 is applicable to financial statements for all fiscal quarters of fiscal years beginning after June 15, 2000 as amended by FAS No 137 "accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statements No. 133. The operations of the Company are not affected by the provisions of FAS No. 133. - 14 - ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATION: For the nine-month period ended September 30, 1999, Financial Industries Corporation's ("FIC") net income was $6,545,000 (basic earnings of $1.29 per common share, or diluted earnings of $1.26 per common share) as compared to $6,979,000 (basic earnings of $1.29 per common share, or diluted earnings of $1.25 per common share) in the first nine months of 1998. Earnings per share are stated in accordance with the requirements of FAS No. 128, which establishes two measures of earnings per share: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that would occur if securities or other contracts to issue common stock were converted or exercised. Results of Operations FIC's income from operations - as determined before federal income tax and equity in net earnings of its affiliate, InterContinental Life Corporation - for the nine-month period ended September 30, 1999, was $5,422,000 (on revenues of $36,144,000), as compared to $6,687,000 (on revenues of $40,965,000) in the first nine months of 1998. Earnings per share (basic and diluted) for the nine-month period ended September 30, 1999 include $.03 per share due to the decrease in the number of common shares outstanding resulting from (i) FIC's purchase on November 17, 1998 of 101,304 shares of FIC's common stock from the Roy F. and Joann Cole Mitte Foundation (the "Foundation"), a Texas non-profit corporation which is controlled by Mr. Mitte and his wife, at a price of $18.625 per share (or a total purchase price of $1,886,787) and (ii) Family Life Insurance Company's purchase on November 17, 1998 of 272,000 shares of FIC's common stock from the Foundation at a price of $18.625 per share (or a total purchase price of $5,066,000). Premiums for the first nine months of 1999, net of reinsurance ceded, were $26.2 million, as compared to $29.4 million in the first nine months of 1998. Policyholder benefits and expenses were $11.5 million in the 1999 period, as compared to $12.4 million in the first nine months of 1998. As of September 30, 1999, the market value of the fixed maturities available for sale segment was $77.8 million as compared to an amortized value of $77.5 million, or an unrealized gain of $0.3 million. The increase reflects unrealized gains on such investments related to changes in interest rates subsequent to the purchase of such investments. There is no assurance that this gain will be realized in the future. The net of tax effect of this increase ($0.2 million at September 30, 1999) has been recorded as an increase in shareholders' equity. As required under the provisions of FAS No. 130, the determination of "Accumulated other comprehensive - 15 - income" includes separate identification of the change in values which occurred during the current period. The operating strategy of the Company's management emphasizes several key objectives: expense management; marketing of competitively priced insurance products which are designed to generate an acceptable level of profitability; maintenance of a high quality portfolio of investment grade securities; and the provision of quality customer service. Equity in Net Income of InterContinental Life Corporation General: For the nine-month period ended September 30, 1999, the Company's equity in the net earnings of InterContinental Life Corporation ("ILCO"), net of federal income tax, was $2,077,000 , as compared to $1,844,000 for the first nine months of 1998. On March 17, 1999, ILCO paid a stock dividend (one share of common stock for each outstanding share of common stock). FIC currently owns 3,590,292 shares of ILCO's common stock. In addition, Family Life currently owns 342,400 shares of ILCO common stock. As a result, FIC currently owns, directly and indirectly through Family Life, 3,932,692 shares (approximately 45%) of ILCO's common stock. Prior to September 30, 1998, FIC held options to acquire (on a pre-dividend basis) an additional 1,702,155 shares. The options were granted under an option agreement between FIC and ILCO which was entered into in March, 1986 ("Option Agreement"). The Option Agreement provided that it continued in effect as long as FIC guaranteed indebtedness of ILCO. Since the Senior Loan of ILCO was fully repaid on September 30, 1998, FIC's rights under the Option Agreement expired on September 30, 1998. As of September 30, 1999, the market value of ILCO's fixed maturities available for sale segment was $409.4 million as compared to an amortized cost of $410.04 million, or an unrealized loss of $0.64 million. The decrease reflects unrealized losses on such investments related to changes in interest rates subsequent to the purchase of such investments. Since FIC owns approximately 45% of the common stock of ILCO, the net of tax effect of this decrease ($0.2 million at September 30, 1999) is included in "Accumulated other comprehensive income" on the Consolidated Balance Sheets and has been recorded as an decrease in shareholders' equity. Liquidity and Capital Resources of ILCO: ILCO is a holding company whose principal assets consist of the common stock of Investors Life Insurance Company of North America ("Investors-NA") and its subsidiary, Investors Life Insurance Company of Indiana (formerly InterContinental Life Insurance Company). ILCO's primary source of funds consists of payments under the surplus debentures from Investors-NA. - 16 - Prior to September 30, 1998, the cash requirements of ILCO consisted primarily of its service of the indebtedness created in connection with the 1988 acquisition of the Investors Life Companies and the 1995 acquisition of Meridian Life Insurance Company (which company was subsequently merged into another life insurance subsidiary of ILCO). As of December 31, 1997, the outstanding principal balance of ILCO's senior loan obligations was $11.0 million, which reflected the prepayment by ILCO of the payment originally scheduled for January 1, 1998. A regular payment in the amount of $3.7 million was made on April 1, 1998, and a prepayment of the July 1, 1998 installment, in the amount of $3.7 million, was made on June 30, 1998. The outstanding principal balance of ILCO's senior loan obligations was $3.6 million at June 30, 1998. The final installment on the senior loan obligation scheduled for October 1, 1998, was prepaid on September 30, 1998. As a result, the senior loan obligation of ILCO was fully discharged effective September 30, 1998. ILCO's principal source of liquidity consists of the periodic payment of principal and interest to it by Investors-NA, pursuant to the terms of the two surplus debentures. The surplus debentures were originally issued by Standard Life Insurance Company and their terms were previously approved by the Mississippi Insurance Commissioner. In connection with the 1993 merger of Standard Life into Investors-NA, the obligations of the surplus debentures were assumed by Investors-NA. As of September 30, 1999, the outstanding principal balances of the surplus debentures were $1.5 million and $6.9 million, respectively. The terms of the latter of the two Surplus Debentures required final payment of the remaining principal balance on September 30, 1999. Effective September 28, 1999, the ILCO and Investors-NA amended the payment schedule to provide payment of the remaining balance in four installments, with the final installment being due July 1, 2000. 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 September 30, 1999, the statutory capital and surplus of Investors-NA was $70.2 million, an amount substantially in excess of the surplus floor. The funds required by Investors-NA to meet its obligations to ILCO under the terms of the surplus debentures are generated from operating income generated from insurance and investment operations. In addition to the payments under the terms of the Surplus Debentures, ILCO has received dividends from its subsidiaries. Washington's insurance code includes the "greater of" standard for payment of dividends to shareholders, but has a requirement that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. Under the "greater of" standard, an insurer may pay a dividend in an amount equal to the greater of (i) 10% of policyholder surplus or (ii) the insurer's net gain from operations for the previous year. As of September 30, 1999, Investors-NA had earned surplus of $46.0 million. - 17 - 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 $17.6 million at September 30, 1999. In June, 1999, Investors-IN paid a dividend in the amount of $3 million to its sole shareholder, Investors-NA. The amount of the dividend was less than the net gain from operations for the prior fiscal year; accordingly, no prior approval was required for the payment of the dividend. Advance notice of the payment was provided to the Indiana Department of Insurance, in accordance with the provisions of the Indiana Insurance Code. The Form 10-Qs of ILCO for the nine-month periods ended September 30, 1999 and September 30, 1998, set forth the business operations and financial results of ILCO and its life insurance subsidiaries. Such 10-Q reports of ILCO, including the discussion by ILCO's management under the caption "Management's Discussion and Analysis of Financial Conditions and Results of Operations" are incorporated herein by reference. Liquidity and Capital Resources: FIC is a holding company whose principal assets consist of the common stock of Family Life and its equity ownership in ILCO. FIC's primary sources of capital consists of cash flow from operations of its subsidiaries. The cash requirements of FIC and its subsidiaries consist primarily of its service of the indebtedness created in connection with its ownership of Family Life. As of September 30, 1999, the outstanding balance of such indebtedness was $43.0 million on the Subordinated Notes granted by Investors-NA. The principal source of liquidity for FIC's subsidiaries consists of the periodic payment of principal and interest by Family Life pursuant to the terms of a Surplus Debenture. The terms of the Surplus Debenture were previously approved by the Washington Insurance Commissioner. Under the provisions of the Surplus Debenture and current law, no prior approval of the Washington Insurance Department is required for Family Life to pay interest or principal on the Surplus Debenture; provided that, after giving effect to such payments, the statutory surplus of Family Life is in excess of 6% of assets (the "surplus floor"). However, Family Life has voluntarily agreed with the Washington Insurance Commissioner that it will provide at least five days advance notice of payments which it will make under the surplus debenture. As of September 30, 1999, the statutory capital and surplus of Family Life was $27.6 million, an amount substantially in excess of the surplus floor. As of September 30, 1999, the principal balance of the Surplus Debenture was $16.1 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. - 18 - Washington's insurance code includes the "greater of" standard for dividends but has requirements that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. Family Life does not presently have earned surplus as defined by the regulations adopted by the Washington Insurance Commissioner and, therefore, is not permitted to pay cash dividends. However, since the new law applies only to dividend payments, the ability of Family Life to make principal and interest payments under the Surplus Debenture is not affected. The Company does not anticipate that Family Life will have any difficulty in making principal and interest payments on the Surplus Debenture in the amounts necessary to enable Family Life Corporation to service its indebtedness for the foreseeable future. The sources of funds for Family Life consist of premium payments from policyholders, investment income and the proceeds from the sale and redemption of portfolio investments. These funds are applied primarily to provide for the payment of claims under insurance and annuity policies, operating expenses, taxes, investments in portfolio securities, shareholder dividends and payments under the provisions of the Surplus Debenture. FIC's net cash flow provided by operating activities was $3.1 million in the first nine months of 1999, as compared to $4.4 million in the first nine months of 1998. Net cash flow used in financing activities was $4.6 million in the first nine months of 1999, as compared to $4.6 million in the first nine months of 1998. In connection with the purchase of the Investors Life Companies by ILCO and the purchase of Family Life by a wholly-owned subsidiary of FIC, FIC guaranteed the payment of the indebtedness created in connection with such acquisitions. After giving effect to the refinancing of the ILCO Senior Loan and the repayment of the ILCO Subordinated Loans, the guaranty commitments of FIC with respect to the debt obligations of ILCO related to the ILCO Senior Loan. The outstanding principal balance of ILCO's senior loan obligations was $3.6 million at June 30, 1998. The final installment on the Senior Loan obligation scheduled for October 1, 1998, was prepaid on September 30, 1998. As a result, the Senior Loan obligation of ILCO was fully discharged effective September 30, 1998, relieving FIC of the guaranty commitments with respect to the debt obligations of ILCO. The guaranty commitments of FIC under the loans incurred in connection with the acquisition of Family Life (after taking into account the repayments and new loans which occurred in July, 1993) relate to: (i) the $22.5 million note issued by Family Life Corporation to Investors Life Insurance Company of North America, and (ii) the $34.5 million loaned by Investors-NA to two subsidiaries of FIC. Management believes that its cash, cash equivalents and short term investments are sufficient to meet the needs of its business and to satisfy debt service. There are no trends, commitments or capital asset requirements that are expected to have an adverse effect on the liquidity of FIC. - 19 - Investments As of September 30, 1999, the Company's investment assets totaled $106.8 million, as compared to $110.2 million as of December 31, 1998. The level of short-term investments at September 30, 1999 was $25.5 million, as compared to $27.6 million as of December 31, 1998. The fixed maturities available for sale portion represents $77.8 million of investment assets as of September 30, 1999, as compared to $79.4 million at December 31, 1998. The amortized cost of fixed maturities available for sale as of September 30, 1999 was $77.5 million representing a net unrealized gain of $0.3 million. This unrealized gain principally reflects changes in interest rates from the date the respective investments were purchased. To reduce the exposure to interest rate changes, portfolio investments are selected so that diversity, maturity and liquidity factors approximate the duration of associated policyholder liabilities. The assets held by Family Life must comply with applicable state insurance laws and regulations. In selecting investments for the portfolios of its life insurance subsidiaries, the Company's emphasis is to obtain targeted profit margins, while minimizing the exposure to changing interest rates. This objective is implemented by selecting primarily short- to medium-term, investment grade fixed income securities. In making such portfolio selections, the Company generally does not select new investments which are commonly referred to as "high yield" or "non-investment grade". The fixed maturities portfolio of Family Life, as of September 30, 1999, consisted solely of fixed maturities investments which, in the annual statements of the companies, as filed with state insurance departments, were designated under the National Association of Insurance Commissioners ("NAIC") rating system as a "1" (highest quality). The investments of Family Life and ILCO's insurance subsidiaries in mortgage-backed securities included collateralized mortgage obligations ("CMOs") of $22.1 million and $182.1 million, respectively, and mortgage-backed pass-through securities of $5.6 million and $30.7 million, respectively, at September 30, 1999. Mortgage-backed pass-through securities, sequential CMO's and support bonds, which comprised approximately 44.1% of the book value of FIC's mortgage-backed securities and 52.0% of the book value of ILCO's mortgage-backed securities at September 30, 1999, are sensitive to prepayment and extension risks. ILCO and FIC have reduced the risk of prepayment associated with mortgage-backed securities by investing in planned amortization class ("PAC"), target amortization class ("TAC") instruments and scheduled bonds. These investments are designed to amortize in a predictable manner by shifting the risk of prepayment of the underlying collateral to other investors in other tranches ("support classes") of the CMO. At September 30, 1999, PAC and TAC instruments and scheduled bonds represented approximately 55.9% of the book value of FIC's mortgage-backed securities and approximately 48.0% of the book value of ILCO's mortgage-backed securities. Sequential and support classes represented approximately 24.0% of the book value of FIC's mortgage-backed securities and approximately 37.6% of the book value of ILCO's mortgage-backed securities at September 30, 1999. In addition, FIC and ILCO limit the risk of prepayment of CMOs by not paying a premium for any CMOs. ILCO and FIC do not invest in mortgage-backed securities - 20 - with increased prepayment risk, such as interest-only stripped pass-through securities and inverse floater bonds. Neither FIC nor ILCO had any z-accrual bonds as of September 30, 1999. The prepayment risk that certain mortgage-backed securities are subject to is prevalent in periods of declining interest rates, when mortgages may be repaid more rapidly than scheduled as individuals refinance higher rate mortgages to take advantage of the lower current rates. As a result, holders of mortgage-backed securities may receive large prepayments on their investments which cannot be reinvested at an interest rate comparable to the rate on the prepaying mortgages. Neither FIC nor ILCO made additional investments in CMOs during 1998 and the first three quarters of 1999. The current investment objectives of both FIC and ILCO do not contemplate additions to the portfolio of CMO investments during the remainder of 1999. Management believes that the absence of "high-yield" or "non-investment grade" investments (as defined above) in the portfolios of its life insurance subsidiary enhances the ability of the Company to service its debt, provide security to its policyholders and to credit relatively consistent rates of return to its policyholders. Y2K Compliance The Company and its subsidiaries utilize a centralized computer system to process policyholder records and financial information. In addition, the Company uses non-centralized computer terminals in connection with its operations. The software programs used in connection with these systems will be affected by what is referred to as the "Y2K date problem". This refers to the limitations of the programming code in certain existing software programs to recognize date sensitive information as the year 2000 approaches. Unless modified prior to the year 2000, such systems may not properly recognize such information and could generate erroneous data or cause a system to fail to operate properly. The Company has evaluated its centralized computer systems and has developed a plan to reach Y2K compliance. A central feature of the plan is to convert most of the centralized systems to a common system which is already in compliance with Y2K requirements. The Company has completed this system conversion, except as it relates to the conversion of approximately 560 active policies and additional testing of previously completed conversions. The Company has increased the budget for the implementation and completion of the Plan from the prior years estimate. As of December 31, 1997, the Company had budgeted approximately $330,000 for implementing the Plan. Based on its current analysis, the Company expects that the cost of implementing and completing the Plan will result in an after-tax expense of approximately $898,000 for the three-year (1997 - 1999) conversion period. For the three month period ended September 30, 1999, the Company has incurred an after tax expense of approximately $34,400 in connection with the completion of the Plan. Between January 1, 1997 and September 30, 1999, the Company has expended approximately 84% of the three-year expected after-tax cost discussed above. The Plan called for an upgrade of the Family Life's administrative systems by changing individual lines of computer code in order to modify current operating software such that it will become Y2K compliant. This process included approximately 29 sub-systems which provide data input to the main systems. The administrative systems which were not modified were - 21 - converted onto the Company's CK/4 System, a system designed to be Y2K compliant according to the representations of the vendor. The systems which administer a substantial number of Family Life policies will be modified rather than converted. The modification of the PMS system (administering approximately 100,880 policies for Family Life) was completed in March, 1998. The conversion of the Cypros AP system (administering approximately 22,210 active policies for Family Life) was completed in October of 1999. A small number of Family Life policies are administered by systems which also administer policies for ILCO and its subsidiaries. With regard to ILCO and its subsidiaries, the ALIS system (administering approximately 42,000 active policies for Investors-NA at the time of conversion) was converted to CK/4 in January of 1998. The conversion of the Life 70 system (administering approximately 15,300 active policies for Investors-IN) was completed in May of 1999. The modification of the Lifecomm-B system which is responsible for the administration of approximately 16,900 active policies assumed after ILCO's acquisition of State Auto Life was also completed. As of June 30, 1999, the Lifecomm-A system administered approximately 57,140 active policies for Investors-NA and 2000 active policies for Family Life. As of September 30, 1999, the conversion of all but approximately 6,130 active policies for Investors- NA and 560 active policies for Family Life had been completed. The majority of those conversions were completed in November, and the Company expects the conversion of the remaining Lifecomm-A policies to be completed before the end of November, 1999. The Company also faces the risk that one or more of its external suppliers of goods or services ("third party providers") will not be in a position to properly interact with the Company due to the inability of such third party provider to resolve its own Y2K issues. The Company has completed an inventory of its third party provider relationships. In order to assess the Y2K readiness of such third party providers, the Company has developed and forwarded a detailed questionnaire to such providers. The Company has received responses and assurances of Y2K readiness from all of its mission critical external suppliers, as well as many of its non-mission critical suppliers. The receipt and evaluation of responses is on-going, and the Company will consider whether to continue relationships with external suppliers who fail to respond to the questionnaire. In 1997, FIC Computer Services - a subsidiary of FIC which provides data processing services for the Company and its affiliates - purchased new mainframe hardware and accompanying operating software, which the vendor has represented to be Y2K compliant. This hardware and software was tested in 1998. The telephone system has been tested by the maintenance provider for that system and the Company has received assurances that the telephone system is Y2K compliant. With respect to non-centralized systems (i.e., desktop computers), the Company has obtained updated software releases and new hardware designed to be Y2K compliant according to the representations of the vendors. The Company expects that the effort needed to correct for Y2K problems on such systems will be less time intensive than the effort needed to achieve - 22 - compliance for its centralized systems. The installation of such new PC hardware and software was commenced in early 1999, and was completed in mid-November, 1999. In the event that a major administrative system fails to operate properly due to the Y2K problem, or the Company does not complete the necessary systems conversions prior to January 1, 2000, the Company has developed a plan to respond to such a contingency. FIC Computer Services has assigned certain personnel to be members of an emergency response team to resolve Y2K operations problems. Additionally, insurance policies would be administered manually if the necessary systems conversions were not completed prior to January 1, 2000, or subsequent Y2K operations problems persist. Manual policy administration would require additional personnel. If substantial additional personnel become necessary for manual policy administration, the training and salary expenses of such personnel could materially affect the Company's business and results of operations. The Company is not able to estimate the likelihood that manual administration will be needed or the amount of any expense which it would incur in connection with such manual administration. Cautionary Statements for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995 Except for historical factual information set forth in this Management's Discussion and Analysis, certain statements made in this report are forward looking and contain information about financial results, economic conditions, Y2K risks and other risks and known uncertainties. The Company cautions the reader that actual results could differ materially from those anticipated by the Company, depending upon the eventual outcome of certain factors, including: (1) heightened competition for new business, (2) significant changes in interest rates, (3) adverse regulatory changes affecting the business of insurance and (4) adverse changes in the Y2K readiness of the Company or its significant third party providers. Accounting Developments In December, 1997, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments", which provides guidance on accounting for insurance-related assessments. The Company adopted SOP 97-3, effective January 1, 1999. The adoption of SOP 97-3 did not have a material impact on the Company's results of operations, liquidity or financial position. In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FAS No. 133 is applicable to financial statements for all fiscal quarters of fiscal years beginning after June 15, 2000, as amended by FAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133." As the Company does not have significant - 23 - investments in derivative financial instruments, the adoption of FAS No. 133 does not have a material impact on the Company's results of operations, liquidity or financial position. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK GENERAL: FIC's principal assets are financial instruments, which are subject to market risks. Market risk is the risk of loss arising from adverse changes in market rates, principally interest rates on fixed rate investments. For a discussion of the Company's investment portfolio and the management of that portfolio to reflect the nature of the underlying insurance obligations of the Company's insurance subsidiaries, please refer to the information set forth in Item 2 "Management's Discussion and Analysis of Financial Conditions and Results of Operation - Investments" of this report. The following is a discussion of the Company's primary market risk sensitive instruments. It should be noted that this discussion has been developed using estimates and assumptions. Actual results may differ materially from those described below. Further, the following discussion does not take into account actions which could be taken by management in response to the assumed changes in market rates. In addition, the discussion does not take into account other types of risks which may be involved in the business operations of the Company, such as the reinsurance recoveries on reinsurance treaties with third party insurers. The primary market risk to the Company's investment portfolio is interest rate risk. Since the Company own approximately 45% of the common stock of ILCO, the interest rate risk of ILCO's fixed income portfolio has an effect on the value of FIC's "investment in affiliate". The Company does not use derivative financial instruments. INTEREST RATE RISK: (A) FIC'S FIXED INCOME INVESTMENTS: Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in fair market value related to the financial instruments segment of the Company's balance sheet is estimated to be $3.5 million at September 30, 1999 and $2.5 million at December 31, 1998. For purposes of the foregoing estimate, the following categories of the Company's fixed income investments were taken into account: (i) fixed maturities, including fixed maturities available for sale, and (ii) short-term investments. The market value of such assets was $103.3 million at September 30, 1999 and $107.0 million at December 31, 1998. The fixed income investments of the Company include certain mortgage-backed securities. The market value of such securities was $27.9 million at September 30, 1999 and $33.9 million at December 31, 1998. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in the fair market value related to such - 24 - mortgage-backed securities is estimated to be $1.5 million at September 30, 1999 and $1.2 million at December 31, 1998. (B) FIC'S INVESTMENT IN AFFILIATE: The value of FIC's investment in affiliate is affected by the amount of unrealized gains and losses, net of tax, in the investment portfolio of its affiliate, ILCO. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in value, net of tax, related to the Company's investment in affiliate is estimated to be $6.4 million at September 30, 1999 and $4.6 million at December 31, 1998. The hypothetical effect of the interest rate risk on fair values was estimated by applying a commonly used model. The model projects the impact of interest rate changes on a range of factors, including duration and potential prepayment. - 25 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES Part II. Other Information ITEM 1. LEGAL PROCEEDINGS The Company and its subsidiaries are defendants in certain legal actions related to the normal business operations of the Company. Management believes that the resolution of such legal actions will not have a material impact upon the financial statements. ILCO and Investors-NA are defendants in a lawsuit which was filed in October, 1996, in Travis County, Texas. CIGNA Corporation, an unrelated Company, is also a named defendant in the lawsuit. The named plaintiffs in the suit (a husband and wife), allege that the universal life insurance policies sold to them by INA Life Insurance Company (a company which was merged into Investors- NA in 1992) utilized unfair sales practices. The named plaintiffs seek reformation of the life insurance contracts and an unspecified amount of damages. The named plaintiffs also seek a class action as to similarly situated individuals. No certification of a class has been granted as of the date hereof. The Company believes that the suit is without merit and intends to vigorously defend this matter. In August, 1997, another individual filed a similar action in Travis County, Texas against the corporate entities identified above. The lawsuit involves the same type of policy and includes allegations which are substantially identical to the allegations in the first action. The named plaintiff also seeks class certification. The Company believes that the court would consider class certification with respect to only one of these actions. The Company also believes that this action is without merit and intends to vigorously defend this matter. ITEM 2. CHANGES IN SECURITIES None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None - 26 - ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Form 10-K Annual Report of Registrant for the year ended December 31, 1998 heretofore filed by Registrant with the Securities and Exchange Commission, which is hereby incorporated by reference. (b) Reports on Form 8-K: None - 27 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FINANCIAL INDUSTRIES CORPORATION /S/ JAMES M. GRACE James M. Grace, Treasurer Date: November 12, 1999 - 28 - EX-27 2 FDS --
7 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED INITS ENTIRETY BY REFERENCES 1,000 9-MOS DEC-31-1999 SEP-30-1999 77,820 0 0 4 0 0 106,797 2,198 14,949 51,836 296,503 60,913 14 44,681 4,282 43,035 0 0 1,169 114,860 296,503 26,198 5,187 0 1,026 11,490 3,737 8,450 7,499 954 6,545 0 0 0 6,545 1.29 1.26 0 0 0 0 0 0 0
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