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 44.5% interest in InterContinental Life Corporation ("ILCO").
The Registrant was organized as an Ohio corporation in 1968 and was reincorporated in Texas in 1980. Its executive offices are located at 701 Brazos, Suite 1400, Austin, Texas 78701. Through 1984, FIC's principal business was the sale and underwriting of life and health insurance, mainly in the midwestern and southwestern United States. In 1985, FIC acquired control of ILCO.
FIC, ILCO and their insurance subsidiaries have substantially identical managements. Officers allocate their time between FIC and ILCO in accordance with the comparative requirements of both companies and their subsidiaries. Roy F. Mitte, Chairman, President and Chief Executive Officer of FIC, ILCO and their insurance subsidiaries, is the owner, directly and beneficially, of approximately 30.71% of the outstanding shares of FIC's common stock.
Acquisitions
Strategy. The Company's strategy has been and continues to be to grow internally and through acquisitions, while maintaining an emphasis on cost controls. Management believes that, under appropriate circumstances, it is more advantageous to acquire companies with books of in- force life insurance than to produce new business, because initial underwriting costs have already been incurred and mature business is generally less likely to terminate, making possible more predictable profit analysis. However, Family Life does continue to market those products that are profitable, as well as develop new products and streamline distribution channels. See "Agency Operations". It is also management's belief that the continuing consolidation in the life insurance industry presents attractive opportunities for the Company to acquire life insurance companies that complement or fit within the Company's existing marketing structure and product lines. The Company's objective is to improve the profitability of acquired businesses by consolidating and streamlining the administrative functions of these businesses, eliminating unprofitable products and distribution channels, applying its marketing expertise to the acquired company's markets and agents and benefitting from economies of scale. FIC's ability to make future acquisitions will be dependent on its being able to obtain the necessary financing. In addition, since ILCO has the same acquisition strategy as FIC, a conflict of interest could arise in the future between FIC and ILCO with respect to acquisition opportunities.
Acquisition of ILCO. In January, 1985, FIC acquired 26.53% of ILCO's common stock. FIC and Family Life subsequently acquired additional shares of ILCO's common stock and as of March 15, 2000, FIC owned, directly and indirectly through Family Life, approximately 44.5% of the outstanding shares of ILCO's common stock. Prior to September 30, 1998, FIC held options to acquire up to 1,702,155 additional shares of ILCO's common stock. The consideration for the options, which were granted in 1986, was FIC's granting to ILCO a loan in the principal amount of $1.2 million, FIC's agreement to guarantee future loan obligations of ILCO and FIC's agreement to guarantee ILCO's lease obligation on its headquarters building upon demand. As described under the heading "The ILCO Senior Loan", the Senior Loan of ILCO was fully repaid on September 30, 1998. Accordingly, FIC's rights under the 1986 option agreement expired on September 30, 1998.
Acquisition of Family Life. FIC acquired Family Life from Merrill Lynch Insurance Group, Inc. on June 12, 1991. The consideration for the purchase was $114 million consisting of a cash payment of $70 million and $44 million of subordinated promissory notes issued by subsidiaries of FIC to the seller and its affiliates. Family Life's primary business is the underwriting and sale of mortgage protection life insurance to customers who are mortgage borrowers from financial institutions where Family Life has marketing relationships. Family Life distributes its insurance products primarily through a national career agency sales force. See "Business of Family Life Insurance Company".
ILCO's Acquisitions
a. Standard Life. In November, 1986, ILCO acquired Standard Life Insurance Company ("Standard Life"), headquartered in Jackson, Mississippi, for a gross purchase price of $54.5 million.
b. Investors-NA and Investors-CA. 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.
c. Investors-Indiana. In February, 1995, ILCO, through Investors-NA, purchased from Meridian Mutual Insurance Company the stock of Meridian Life Insurance Company, an Indianapolis-based life insurer, for a cash purchase price of $17.1 million. After the acquisition, Meridian Life changed its name to Investors Life Insurance Company of Indiana ("Investors- Indiana").
d. State Auto Life. In July, 1997, ILCO and Investors-Indiana acquired State Auto Life Insurance Company, an Ohio domiciled life insurer, from State Automobile Mutual Insurance Company, for an adjusted cash purchase price of $11.8 million. Under the terms of the transaction, State Auto Life was merged into Investors-Indiana.
e. Investors-IN. In December, 1997, InterContinental Life Insurance Company ("ILIC") , a subsidiary of ILCO, transferred its domicile from New Jersey to Indiana. Following completion of the redomestication, ILIC merged with Investors-Indiana, with ILIC as the surviving entity in the merger process. Immediately after the merger, ILIC changed its name to Investors Life Insurance
Company of Indiana. As used hereinafter, the phrase "Investors-IN" shall be used to refer to the merged entities.
f. Grinnell Life. On June 30, 1998, ILCO, through a subsidiary, acquired Grinnell Life Insurance Company ("Grinnell Life") for an adjusted purchase price of $16.6 million. A portion of the purchase price ($12.37 million) was paid by way of a dividend to the seller immediately prior to the closing of the transaction; the balance of the purchase price was paid by ILCO's subsidiary. As part of the transaction, Grinnell Life was immediately merged with and into that subsidiary, with that subsidiary being the surviving entity.
Business of Family Life Insurance Company
Family Life, which was organized in the State of Washington in 1949, specializes in providing mortgage protection life and accidental death insurance and annuity products to mortgage borrowers of financial institutions. Family Life has policies in force with customers of approximately 227 financial institutions, of which approximately 54 actively provide Family Life with regular updating of their lists of borrowers.
Family Life's mortgage protection business consists of term and universal life insurance sold to borrowers of mortgage debt, designed to repay the mortgages of policyholders in the event of their death. This business is sold to customers of client financial institutions, usually through a list of borrowers provided by the financial institution. These policies often list the lending financial institution as the primary beneficiary of the life insurance policy. An important feature of the Family Life product is the ability to bill and collect premiums through the policyholder's monthly mortgage payments.
Family Life has annuity products and a variety of life insurance products, including decreasing term life insurance, universal life insurance, ten-year level term products, and a whole life insurance product.
Family Life is licensed to sell mortgage life insurance products in 49 states and the District of Columbia. In 1999, premium income from these products was derived from all states in which Family Life is licensed, with significant amounts derived from Texas (25.4%), California (24.8%) and Florida (4.9%).
Family Life's primary distribution channel is its agency force of approximately 607 career agents (at December 31, 1999), who are organized into 22 regions. Most of the career agents sell mortgage life insurance products exclusively for Family Life. The mortgage life insurance business is very fragmented. Family Life believes that it is among the larger writers of agent sold mortgage life insurance in the United States and the only nation-wide agent-sold life insurance company operating through leads from financial institutions. Many of Family Life's competitors are life insurance companies with more resources than Family Life and whose mortgage life insurance business represents only a small portion of their total business.
During 1999, Family Life continued the expansion of its distribution system, to recruit agents whose product portfolio includes a broader range of life and annuity products, in addition to the traditional mortgage protection life insurance products offered by Family Life. While Family Life's traditional sales force consists of agents who are contracted exclusively with the company, agents who participate in the expanded distribution system may have selling relationships with other insurers in addition to Family Life. During 1999, Family Life recruited 438 agents for this marketing effort.
At December 31, 1999, the number of employees within FIC and its subsidiaries, together with the employees of ILCO's insurance subsidiaries, was approximately 312.
Business of InterContinental Life Corporation
ILCO was incorporated in 1969 under the laws of New Jersey. In June, 1997, ILCO transferred its domicile to the State of Texas. Its executive office is located at 701 Brazos, Suite 1400, Austin, Texas 78701.
Operations. ILCO has developed management techniques to reduce operating expenses by centralizing, standardizing and more efficiently performing many functions common to most life insurance companies, such as underwriting and policy administration, accounting and financial reporting, marketing, regulatory compliance, actuarial services and asset management. ILCO has selectively recruited personnel in sales, marketing and various administrative departments.
During 1999, the general insurance expenses of ILCO's insurance subsidiaries were $15,910,308, as compared to $15,172,682 in 1998 and $15,574,265 in 1997. The level of expenses at the ILCO life companies for the year 1999 was affected by the expenses incurred in connection with Year 2000 compliance. For the year 1998, the level of expenses at the ILCO life companies was also affected by expenses incurred in connection with Year 2000 compliance, as well as the expenses incurred in connection with ILCO's acquisition of Grinnell Life Insurance Company. Expenses for the year 1997 were affected primarily from costs incurred in connection with ILCO's acquisition of State Auto Life in July, 1997 and as well as expenses related to the modification of data processing systems for Year 2000 compliance. Management is committed to maintaining the general insurance expenses of ILCO's insurance subsidiaries at a level which will generate an acceptable level of profitability while maintaining the competitive pricing of their insurance products.
Principal Products. ILCO's insurance subsidiaries are engaged primarily in administering existing portfolios of individual life insurance and accident and health insurance policies and annuity products. Approximately 79% of the total collected premiums for 1999 were derived from renewal premiums on insurance policies and annuity products sold by ILCO's insurance subsidiaries prior to their acquisition by ILCO.
ILCO's insurance subsidiaries are also engaged in marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. These products are marketed through independent, non-exclusive general agents.
The products currently being distributed by ILCO's life subsidiaries include several versions of universal life insurance, which provide permanent life insurance which credit company-declared current interest rates. The universal life insurance portfolio of ILCO's insurance subsidiaries consists of flexible premium universal life insurance policies. Under the flexible premium policies, policyholders may vary the amounts of their coverage (subject to minimum and maximum limits) as well as the date of payment and frequency of payments.
Direct statutory premiums received from all types of universal life products were $34.3 million in 1999, as compared to $38.9 million in 1998 and $40.6 million in 1997. Investors-NA received reinsurance premiums from Family Life of $3.2 million in 1999, pursuant to the reinsurance agreement for universal life products written by Family Life. In 1999, 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 (8%), Ohio (9%) and New Jersey (8%).
ILCO's insurance subsidiaries receive premium income from health insurance policies. In 1999, premium income from all health insurance policies was $0.8 million, as compared to $1.0 million in 1998 and $0.9 million in 1997. As described below, the health insurance business of ILCO's subsidiaries is 100% reinsured with a third party reinsurer.
In December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which most of the contractual obligations and risks under accident and health and disability income insurance policies were assumed by a third party reinsurer. The transfer was effective as of July 1, 1997. The decision to dispose of this book of business was based on ILCO's analysis that the business was not generating targeted profit objectives and that the products were not part of the core business of ILCO's subsidiaries. The sale permits the companies to focus on its primary business - life insurance and annuity sales. In connection with the transaction, the total amount of net reserves transferred by the ILCO subsidiaries was $6,327,504. In addition to the transfer of reserves, ILCO's life companies paid the reinsurer $1,037,150 in connection with the transaction, which amount was accounted for as an expense for the year ended December 31, 1997. In 1997, the transferred business generated approximately $791,000 in annualized premiums for ILCO's life subsidiaries.
Investors-NA sponsors a variable annuity separate account, which offers single premium and flexible premium policies. The policies provide for the contract owner to allocate premium payments among four different portfolios of Putnam Variable Trust (the "Putnam Fund"), a series fund which is managed by Putnam Investment Management, Inc. As of December 31, 1999, the assets held in the separate account were $48.4 million. During 1999, the premium income realized in connection with these variable annuity policies was $117,666, which was received from existing contract owners.
Investors-NA also maintains a closed variable annuity separate account, with approximately $19.8 million of assets as of December 31, 1999. The separate account was closed to new purchases in 1981 as a result of an IRS ruling which adversely affected the status of variable annuity separate accounts which invest in publicly-available mutual funds. The ruling did not adversely affect the status of in-force contracts.
Beginning in 1997, ILCO's life company subsidiaries expanded their marketing efforts in the fixed annuity market. Direct deposits from the sale of fixed annuity products were $7.6 million in 1999, as compared to $6.1 million in 1998 and $3.5 million in 1997. Investors-NA also received reinsurance premiums from Family Life of $1.8 million in 1999, pursuant to a reinsurance agreement for annuity products between Investors-NA and Family Life Insurance Company.
Merger of Insurance Subsidiaries. Investors-NA redomesticated from Pennsylvania to Washington in December of 1992. Investors-CA merged into Investors-NA on December 31, 1992. Standard Life merged into Investors-NA on June 29, 1993. The mergers have achieved cost savings, such as reduced auditing expenses involved in auditing one combined company; the savings of expenses and time resulting from the combined company being examined by one state insurance department (Washington), rather than three (California, Pennsylvania and Mississippi); the reduction in the number of tax returns and other annual filings with state insurance departments; and smaller annual fees to do business and reduced retaliatory premium taxes in most states.
In December, 1997, ILIC transferred its domicile from New Jersey to Indiana. Following completion of the redomestication, ILIC merged with Investors-Indiana, with ILIC as the surviving entity in the merger process. Immediately after the merger, ILIC changed its name to Investors Life Insurance Company of Indiana. As used hereinafter, the phrase "Investors-IN" shall be used to refer to the merged entities. As a result of the merger, Investors-IN is licensed in 47 states and the District of Columbia. As of December 31, 1999, it had assets of $ 176.4 million and capital and surplus of $23 million.
ILCO's management believes that these acquisitions and consolidations have caused a reduction in expense and have further strengthened the financial condition of the combined companies.
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, 1999, only 2.2% of ILCO's total assets were invested in mortgage loans or real estate. Non-affiliated corporate debt securities that were non-investment grade represented 0.1% of ILCO's total assets at December 31, 1999. ILCO had
investments in debt securities of affiliated companies aggregating approximately $41.5 million as of December 31, 1999. 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 $22.1 million and $178.9 million, respectively, and mortgage-backed pass-through securities of $5.4 million and $29.1 million, respectively, at December 31, 1999. Mortgage-backed pass-through securities, sequential CMO's and support bonds, which comprised approximately 43.9% of the book value of FIC's mortgage- backed securities and 52.0% of the book value of ILCO's mortgage-backed securities at December 31, 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, 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, 1999, PAC and TAC instruments and accretion directed and scheduled bonds represented approximately 56.1% 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 24.1% of the book value of FIC's mortgage-backed securities and approximately 38.0% of the book value of ILCO's mortgage-backed securities at December 31, 1999. In addition, FIC and ILCO limit the risk of prepayment of CMOs by not paying a premium for any CMOs. ILCO and FIC do not invest in mortgage-backed securities with increased prepayment risk, such as interest-only stripped pass-through securities and inverse floater bonds. Neither FIC nor ILCO had any z-accrual bonds as of December 31, 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 1999. For the year 2000, the investment objectives of FIC and ILCO include the making of selected investments in CMOs.
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, 1999, none of the mortgage loans held by ILCO had defaulted as to principal or interest for more than 90 days, and none of the ILCO's mortgage loans were in foreclosure. During 1999, ILCO wrote off the value of approximately $81,000 of principal and interest on mortgage loans which had defaulted as to principal and interest payment for more than 90 days.
Another key element of FIC's and ILCO's investment strategy is to avoid large exposure in other investment categories which management believes carry higher credit or liquidity risks, including
private placements, partnerships and bank participations. These categories accounted for approximately 0.3% of ILCO's invested assets and none of FIC's invested assets at December 31, 1999.
A subsidiary of ILCO, Investors-NA, was the owner and developer of Bridgepoint Square Offices. Following the completion of the construction, the project consisted of four office buildings, with a total rentable space of approximately 364,000 square feet, and two parking garages. Investors-NA purchased the 20 acre tract of land for this complex in January, 1995. At that time, the tract included one completed and fully leased office building, an adjacent parking garage, and sites for three more office buildings and another parking garage. Investors-NA completed construction of the three remaining office buildings and parking garage in 1997. See Item 2.
Item 2. Properties
The Registrant's headquarters are currently located at Austin Centre, 701 Brazos, Suite 1400, Austin, Texas. A subsidiary of ILCO, Investors-NA, purchased Austin Centre, an office-hotel property in downtown Austin in August 1991 for a purchase price of $31,275,000 from an unrelated seller that had previously acquired the property through foreclosure. Austin Centre covers a full city block and is a sixteen story mixed use development consisting of 343,664 square feet of office/retail space (predominately office space), a 314 room hotel and 61 luxury apartments, all united by a 200 foot high glass atrium. The project was completed in October, 1986.
In September, 1995, Investors-NA entered into a contract to sell Austin Centre to an Austin-based real estate investment firm for a purchase price of $62.675 million, less $1 million to be paid to a capital reserve account for the purchaser. The sale was consummated on March 29, 1996. A portion of the sale proceeds equal to the amount that Investors-NA presently had invested in Austin Centre were retained and reinvested by Investors-NA. The balance of the net proceeds of the sale were used to reduce ILCO's bank indebtedness by approximately $15 million.
Following the sale of the Austin Centre, the Company and its affiliates continued to occupy three floors of the office space, under a lease arrangement. The current lease, which was entered into in May, 1997, is for a five (5) year term ending in October, 2002, with options to renew for three successive five (5) year terms thereafter.
Investors-NA is currently in the process of developing an office complex at a site in Austin, Texas. The site consists of 47.995 acres. The Site Development Permit obtained by Investors-NA allows for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. The initial phase of the project ("Phase One") consists of two office buildings, associated parking and the infrastructure for the entire project, which is known as River Place Pointe. Construction on Phase One commenced during the first quarter of 1999. Upon completion of Phase One, the Company plans to move its corporate headquarters to space in one of the buildings. The move is currently scheduled for July, 2000. In connection with the move, Investors-NA (the tenant under the lease of the Austin Centre space) intends to sub-lease said space.
In January, 1995, ILCO, through Investors-NA, purchased, as an investment property, an office building project known as Bridgepoint Office Square in Austin, Texas for a cash purchase price of $9.75 million. The property consists of 20 acres of land with four office building sites and two parking structure sites. The first phase of development of the property was completed in 1986 and consists of a five-story office building with 83,474 square feet of rentable space and a 550-car parking garage.
In the fourth quarter of 1995, construction began on the second office building, containing approximately 109,000 rentable square feet, and the other parking garage containing approximately 871 spaces. That phase of the project was completed in September, 1996. In March, 1996, construction commenced on the third office building, with approximately 79,000 rentable square feet of office space and was completed in December, 1996. Construction began on the fourth building in July, 1996 and was completed in July, 1997. The fourth building contains approximately 92,459 rentable square feet.
On May 3, 1996, Family Life purchased a tract of land adjoining the Bridgepoint Office Square tract for a cash purchase price of $1.3 million. The property consists of 7.1 acres of land with one office building site and one parking structure site. Family Life began construction of the fifth building (known as "Bridgepoint Five") on the new site in January, 1997. In May, 1997, the entire rentable space (approximately 76,793 rentable square feet) contained in the building was leased to a major tenant in the technology business. Construction of the parking garage and the building shell was completed in October, 1997.
On November 24, 1997, Investors-NA and Family Life entered into a contract with Health and Retirement Properties Trust, a Maryland real estate investment trust (the "Purchaser") to sell their respective interests in the Bridgepoint Square Office complex. The aggregate purchase price for the project was $78,000,000. The transaction closed on December 5, 1997. The purchase price was allocated approximately 78.5% to Investors-NA and 21.5% to Family Life. The sale of Bridgepoint Office Square resulted in a net profit to Investors-NA of approximately $14.0 million ($9.1 million after tax) that is included in ILCO's fourth quarter earnings for the year 1997. For Family Life, the sale resulted in a net profit of approximately $4.5 million ($3.2 million after tax) that is included in FIC's fourth quarter earnings for the year 1997.
Prior to December, 1999, FIC owned several parcels of real estate in Jackson, Mississippi, adjacent to an office building which formerly served as the headquarters of Standard Life Insurance Company (the "Standard Life Building"). The Standard Life Building was owned by Investors-NA. This building is 68 years old and contains approximately 85,000 square feet (65,000 net rentable square feet) of office space. On December 29, 1999, Investors-NA donated the Standard Life Building to the Jackson Redevelopment Authority ("JRA"). Contemporaneously with the donation of the Standard Life Building, Investors-NA and FIC sold all of the adjacent parcels they owned to the JRA for a total sale price of $2,500,000.00, which has been allocated according to the respective ownership interests of Investors-NA (approximately 59.28%) and FIC (approximately 40.72%). The donation and sale was made pursuant to the terms of the Donation, Purchase and Sale Agreement dated July 17, 1998. Investors-NA intends to claim an income tax deduction on its upcoming tax return for the donation of the Standard Life Building, which has an appraised value at December 15, 1999 of approximately $3,050,000.00. The donation and sale transaction referenced above resulted in a net gain (GAAP basis) of $0.992 million for ILCO and $0.409 million for FIC (or a combined total of $1.401 million).
Family Life leases its home offices at the Sedgwick James Building, 2101 Fourth Avenue, in Seattle, Washington. The lease currently covers approximately 7,776 rentable square feet of office space for a term expiring in October, 2001. The base rental is approximately $11,200 per month, which includes Family Life's proportionate share of the building's operating expenses, including utilities, property taxes, insurance, maintenance and management. Actual increases from those initial operating expenses during the lease term are passed on to Family Life on a proportionate basis.
The Company believes that its properties and leased space are adequate to meet its foreseeable requirements.
Item 3.
Item 3. Legal Proceedings
The Company and its subsidiaries are defendants in certain legal actions related to the normal business operations of the Company. Management believes that the resolution of such legal actions will not have a material impact on the financial statements.
ILCO and Investors-NA are defendants in a lawsuit which was filed in October, 1996, in Travis County, Texas. CIGNA Corporation, an unrelated company, is also a named defendant in the lawsuit. The named plaintiffs in the suit (a husband and wife), allege that the universal life insurance policies sold to them by INA Life Insurance Company (a company which was merged into Investors-NA in 1992) utilized unfair sales practices. The named plaintiffs seek reformation of the life insurance contracts and an unspecified amount of damages. The named plaintiffs also seek a class action as to similarly situated individuals. No certification of a class has been granted as of the date hereof. ILCO believes that the suit is without merit and intends to vigorously defend this matter.
In August, 1997, another individual filed a similar action in Travis County, Texas against the corporate entities identified above. The lawsuit involves the same type of policy and includes allegations which are substantially identical to the allegations in the first action. The named plaintiff also seeks class certification. ILCO believes that the court would consider class certification with respect to only one of these actions. ILCO also believes that this action is without merit and intends to vigorously defend this matter.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the fiscal year ended December 31, 1999 to a vote of security holders.
PART II
Item 5.
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 1999 and 1998. 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 First Quarter $ 17.375 $ 12.00 Second Quarter 14.00 7.625 Third Quarter 15.50 8.00 Fourth Quarter 10.750 9.250
First Quarter $ 21.25 $ 16.375 Second Quarter 20.50 17.75 Third Quarter 20.25 12.50 Fourth Quarter 19.50 13.625
B. Holders
As of March 15, 2000 there were approximately 14,998 record holders of FIC common stock.
C. Dividends
FIC did not pay a dividend during the years 1976 to 1999. On January 18, 2000, FIC announced that it will pay a cash dividend in the amount of $.18 per share, payable on April 12, 2000, to shareholders of record on April 5, 2000.
The ability of an insurance holding company, such as FIC, to pay dividends to its shareholders may be limited by the company's ability to obtain revenue, in the form of dividends and other payments, from its operating insurance subsidiary or subsidiaries. The right of Family Life to pay dividends is restricted by the insurance laws of its domiciliary state. See Item 1. Business - - Regulation - Surplus Debenture and Dividends. However, FIC does not directly own Family Life's stock but, instead, indirectly owns that stock through a downstream holding company, Family Life Corporation ("FLC"). FLC, which holds all of the stock of Family Life, is restricted from paying dividends on its common stock by the provisions of the notes from Investors-NA. FIC (as the successor to the obligations of FLIIC under the provisions of the $4.5 million subordinated note held by Investors-NA) the immediate parent of FLC and the directly-owned subsidiary of FIC, is prohibited from paying dividends on its stock by the provisions of the $4.5 million subordinated note. In order to provide for the payment of the $.18 per share annual dividend payable on April 12, 2000, FIC requested a waiver from Investors-NA of the above-described restrictions of the loan agreements. Investors-NA granted the requested waiver, thereby permitting FIC to make the dividend payment to its shareholders.
The ability of ILCO to pay dividends to FIC and the other shareholders of ILCO is affected by the receipt of dividends and other payments from its insurance subsidiaries.
Item 6.
Item 6. Selected Financial Data: (Registrant and its Consolidated Subsidiaries) (In thousands, except per share data)
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
For the year ended December 31, 1999, FIC's net income was $9,149,000 (basic earnings of $1.81 per common share or diluted earnings of $1.76 per common share) as compared to $9,218,000 (basic earnings of $1.71 per common share or diluted earnings of $1.66 per common share) for the year ended December 31, 1998 and $16,328,000 (basic earnings of $3.01 per common share or diluted earnings of $2.92 per common share) for the year ended December 31, 1997. Earnings per share are stated in accordance with the requirements of Financial Accounting Standard (FAS) No. 128, which establishes two measures of earnings per share: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that would occur if securities or other contracts to issue common stock were converted or exercised.
Results of Operations
Net income from continuing operations (excluding the gain resulting from Family Life's sale of its interest in Bridgepoint Square Offices in 1997, and ILCO's sale of its interest in Bridgepoint Square Offices in 1997, as described below) was $9,149,000 (basic earnings of $1.81 per common share or diluted earnings of $1.76 per common share) in 1999, as compared to $9,218,000 (basic earnings of $1.71 per common share or diluted earnings of $1.66 per common share) for the year ended December 31, 1998 and $9,300,000 (basic earnings of $1.71 per common share or diluted earnings of $1.66 per common share) for the year ended December 31, 1997.
Net income for the year ended December 31, 1997 includes $3.2 million ($0.57 per common share) resulting from Family Life's sale of its interest in Bridgepoint Square Offices. Family Life purchased undeveloped land at the Bridgepoint site in May, 1996, for a cash purchase price of $1.3 million. The property consists of 7.1 acres of land with one office building site and one parking structure site. Family Life began construction of the building (known as "Bridgepoint Five") in January, 1997. In May, 1997, the entire rentable space (approximately 76,793 rentable square feet) contained in the building was leased to a major tenant in the technology business. Construction of the parking garage and the building shell was completed in October, 1997. In November, 1997, Family Life entered into a contract to sell its interest in the Bridgepoint Square Office complex. The sale also included the adjacent properties developed by ILCO's subsidiary, Investors-NA. The aggregate purchase price for the project was $78 million. The transaction closed on December 5, 1997. The purchase price was allocated approximately 78.5% to Investors-NA and 21.5% to Family Life. The sale resulted in a net profit to Family Life of approximately $4.5 million ($3.2 million after tax) that is included in FIC's earnings for the year 1997.
FIC's net income is affected by its equity interest in InterContinental Life Corporation ("ILCO") and ILCO's insurance subsidiaries. Net income for the year ended December 31, 1997 includes $3.8 million ($0.68 per common share on a diluted basis) resulting from ILCO's sale of its interest in Bridgepoint Square Offices.
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 $8,829,000 at December 31, 1999, as compared to $12,930,000 at December 31, 1998 and $13,625,000 at December 31, 1997. These statutory earnings are the source to provide for the repayment of the indebtedness incurred in connection with the acquisition of Family Life.
The increase in long-term interest rates during 1999, which was related to general economic conditions, had a negative effect upon the market value of the fixed maturities available for sale segment of the Company's portfolio. As of December 31, 1999, the market value of the fixed maturities available for sale segment was $77.5 million as compared to an amortized value of $78.3 million, or an unrealized loss $0.8 million. The net of tax effect of this decease has been recorded as a decrease in shareholders' equity.
For the year ended December 31, 1999, FIC's income from operations, before federal income tax and equity in net earnings of affiliate, was $7,013,000 (on revenues of $47,313,000) as compared to $8,973,000 (on revenues of $53,607,000) for the year 1998 and $13,411,000 (on revenues of $63,343,000) in the year 1997.
Premiums for the year 1999, net of reinsurance ceded, were $33.96 million, as compared to $38.4 million for the year 1998 and $40.2 million in 1997. Policyholder benefits and expenses were $13.9 million in 1999, as compared to $16.3 million in 1998 and $19.9 million in 1997.
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. For the year 1999, the Company's equity in the net earnings of ILCO, net of federal income tax, was $3,310,000, as compared to $2,613,000 for the year 1998 and $6,458,000 for the year 1997.
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 44.5%) of ILCO's common stock.
The increase in long-term interest rates during 1999, which was related to general economic conditions, had a negative effect upon the market value of the fixed maturities available for sale segment of ILCO's investment portfolio. As of December 31, 1999, the market value of the fixed maturities available for sale segment was $404.2 million as compared to an amortized cost of $411.5 million, or an unrealized loss of $7.3 million. Since FIC owns approximately 44.5% of the common stock of ILCO, such unrealized losses, net of tax, are reflected in FIC's equity interest in ILCO, and had the effect of decreasing the reported value of such equity interest by approximately $2.0 million.
ILCO's results for 1998 include, for the period beginning on June 30, 1998, the operations of Grinnell Life Insurance Company. Grinnell Life was acquired on June 30, 1998, through a subsidiary of ILCO, for an adjusted purchase price of $16.6 million. A portion of the purchase price ($12.37 million) was paid by way of a dividend to the seller immediately prior to the closing of the transaction; the balance of the purchase price was paid by ILCO's subsidiary. As part of the transaction, Grinnell Life was immediately merged with and into that subsidiary, with that subsidiary being the surviving entity.
Liquidity and Capital Resources of ILCO
ILCO is a holding company whose principal assets consist of the common stock of Investors-NA and its subsidiary, Investors-IN. ILCO's primary source of funds consists of payments under the surplus debentures from Investors-NA.
As of December 31, 1997, the outstanding principal balance of ILCO's senior loan obligations was $11.0 million, which reflected the prepayment by the Company of the payment originally scheduled for January 1, 1998. A regular payment, in the amount of $3.7 million, was made on April 1, 1998 and a prepayment of the July 1, 1998 installment, in the amount of $3.7 million, was made on June 30, 1998. The outstanding principal balance of ILCO's senior loan obligations was $3.6 million at June 30, 1998. The final installment on the senior loan obligation scheduled for October 1, 1998, was prepaid on September 30, 1998. As a result, the senior loan obligation of ILCO was fully discharged effective September 30, 1998.
ILCO receives periodic payments of principal and interest from Investors-NA, pursuant to the terms of the Surplus Debentures. The Surplus Debentures were originally issued by Standard Life Insurance Company and their terms were previously approved by the Mississippi Insurance Commissioner. Upon the merger of Standard Life into Investors-NA, the obligations of the Surplus Debentures were assumed by Investors-NA. As of December 31, 1999, the outstanding principal balance of the Surplus Debentures was $0.956 million and $4.94 million, respectively. The terms of the latter debenture provided for final payment of the remaining principal on September 30, 1999. In September, 1999, Investors-NA and ILCO amended the payment schedule to provide for 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 provisions of Washington insurance law apply to the Surplus Debentures. Under the provisions of the Surplus Debentures and current law, no prior approval of the Washington Insurance Commissioner is required for Investors-NA to pay interest or principal on the Surplus Debentures; provided that, after giving effect to such payments, the statutory surplus of Investors-NA is in excess of $10 million (the "surplus floor"). However, Investors-NA has voluntarily agreed with the Washington Insurance Commissioner that it will provide at least five days advance notice of payments which it will make under the surplus debenture. As of December 31, 1999, the statutory surplus of Investors-NA was $72.6 million, an amount substantially in excess of the surplus floor. The funds required by Investors-NA to meet its obligations to the Company under the terms of the Surplus Debentures are derived from operating income generated from insurance and investment operations.
In addition to the payments under the terms of the Surplus Debentures, ILCO has received dividends from its life insurance subsidiaries. Washington's insurance code includes the "greater of" standard for payment of dividends to shareholders, but has a requirement that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. As of December 31, 1999, Investors-NA had earned surplus of $51.6 million. Since the law applies only to dividend payments, the ability of Investors-NA to make principal and interest payments under the Surplus Debentures is not affected. ILCO does not anticipate that Investors-NA will have any difficulty in making principal and interest payments on the Surplus Debentures for the foreseeable future.
Investors-IN is domiciled in the State of Indiana. The transfer of domicile from New Jersey to Indiana was effective December 15, 1997. Under the Indiana insurance code, a domestic insurer may make dividend distributions upon proper notice to the Department of Insurance, as long as the distribution is reasonable in relation to adequate levels of policyholder surplus and quality of earnings. Under Indiana law the dividend must be paid from earned surplus. Extraordinary dividend approval would be required where a dividend exceeds the greater of 10% of surplus or the net gain from operations for the prior fiscal year. Investors-IN had earned surplus of $18.1 million at December 31, 1999.
The Form 10-Ks of ILCO for the years ended December 31, 1999, 1998 and 1997, 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.
Liquidity and Capital Resources
FIC is a holding company whose principal assets consist of the common stock of Family Life and its equity ownership in ILCO. FIC's primary sources of capital consists of cash flow from operations of its subsidiaries and the proceeds from bank and institutional borrowings.
The principal source of liquidity for FIC's subsidiaries consists of the periodic payment of principal and interest by Family Life pursuant to the terms of a Surplus Debenture. The terms of the Surplus Debenture were previously approved by the Washington Insurance Commissioner. Under the provisions of the Surplus Debenture and current law, no prior approval of the Washington Insurance Department is required for Family Life to pay interest or principal on the Surplus Debenture; provided that, after giving effect to such payments, the statutory surplus of Family Life is in excess of 6% of assets (the "surplus floor"). However, Family Life has voluntarily agreed with the Washington Insurance Commissioner that it will provide at least five days advance notice of payments which it will make under the surplus debenture. As of December 31, 1999, the statutory capital and surplus of Family Life was $26.9 million, an amount substantially in excess of the surplus floor. During 1999, Family Life made principal payments of $9.0 million and interest
payments of $1.8 million to Family Life Corporation under the Surplus Debenture. As of December 31, 1999, the principal balance of the Surplus Debenture was $13.9 million. The funds required by Family Life to meet its obligations under the terms of the Surplus Debenture are generated primarily from premium payments from policyholders, investment income and the proceeds from the sale and redemption of portfolio investments.
Washington's insurance code includes the "greater of" standard for dividends but has requirements that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. Family Life does not presently have earned surplus as defined by the regulations adopted by the Washington Insurance Commissioner and, therefore, is not permitted to pay cash dividends. However, since the new law applies only to dividend payments, the ability of Family Life to make principal and interest payments under the Surplus Debenture is not affected. The Company does not anticipate that Family Life will have any difficulty in making principal and interest payments on the Surplus Debenture in the amounts necessary to enable Family Life Corporation to service its indebtedness for the foreseeable future.
The sources of funds for Family Life consist of premium payments from policyholders, investment income and the proceeds from the sale and redemption of portfolio investments. These funds are applied primarily to provide for the payment of claims under insurance and annuity policies, operating expenses, taxes, investments in portfolio securities, shareholder dividends and payments under the provisions of the Surplus Debenture.
FIC's net cash flow provided by operating activities was $2.6 million for the year 1999, as compared to $6.0 million in 1998 and $4.2 million in 1997. Net cash flow used in financing activities was $6.15 million in 1999, as compared to $13.10 million in 1998 and $6.15 million in 1997.
The guaranty commitments of FIC under the loans incurred in connection with the acquisition of Family Life (after taking into account the repayments and new loans which occurred in July, 1993) relate to: (i) the $22.5 million note issued by Family Life Corporation to Investors Life Insurance Company of North America and (ii) the $34.5 million loaned by Investors-NA to two subsidiaries of FIC.
Management believes that its cash, cash equivalents and short term investments are sufficient to meet the needs of its business and to satisfy debt service.
Investments
As of December 31, 1999, the Company's investment assets totaled $105.95 million, as compared to $110.15 million as of December 31, 1998.
The level of short-term investments at the end of 1999 was $24.8 million, as compared to $27.6 million as of December 31, 1998. The fixed maturities available for sale portion represents $77.5 million of investment assets as of December 31, 1999, as compared to $79.4 million at the end of 1998.
The amortized cost of fixed maturities available for sale as of December 31, 1999 was $78.3 million representing a net unrealized loss of $0.8 million. This unrealized loss principally reflects changes in interest rates from the date the respective investments were purchased. To reduce the exposure to interest rate changes, portfolio investments are selected so that diversity, maturity and liquidity factors approximate the duration of associated policyholder liabilities.
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, 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).
Prior to December, 1999, FIC owned several parcels of real estate in Jackson, Mississippi, adjacent to an office building known as the Standard Life Building, which building was owned by Investors- NA. This building is 68 years old and contains approximately 85,000 square feet (65,000 net rentable square feet) of office space. On December 29, 1999, Investors-NA donated the Standard Life Building to the Jackson Redevelopment Authority ("JRA"). Contemporaneously with the donation of the Standard Life Building, Investors-NA and FIC sold all of the adjacent parcels they owned to the JRA for a total sale price of $2,500,000.00, which has been allocated according to the respective ownership interests of Investors-NA (approximately 59.28%) and FIC (approximately 40.72%). The donation and sale was made pursuant to the terms of the Donation, Purchase and Sale Agreement dated July 17, 1998. Investors-NA intends to claim an income tax deduction on its upcoming tax return for the donation of the Standard Life Building, which has an appraised value at December 15, 1999 of approximately $3,050,000.00. The donation and sale transaction referenced above resulted in a net gain (GAAP basis) of $0.992 million for ILCO and $0.409 million for FIC (or a combined total of $1.401 million).
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.
Year 2000 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. In response to the potential operations and policy administration problems caused by the calendar change on January 1, 2000, the Company evaluated its centralized computer systems and developed a plan to reach Y2K compliance (the "Year 2000 Plan"). A central feature of the plan was to convert certain of the centralized systems to a common system which is already in compliance with Y2K requirements.
The Year 2000 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 would 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 converted onto the Company's CK/4 System, a system designed to be Y2K compliant according to the representations of the vendor.
The Company completed this systems conversion and testing prior to January 1, 2000. For the year ended December 31, 1999, the Company incurred an after-tax expense of approximately $283,000 in connection with the Year 2000 Plan, as compared to an after-tax expense of approximately $289,000 for the year 1998 and $253,000 for the year 1997.
With respect to non-centralized systems (i.e., desktop computers), the Company obtained updated software releases and new hardware designed to be Y2K compliant according to the representations of the vendors. The installation of such new PC hardware and software was commenced in early 1999 and was completed during the fourth quarter of 1999.
The Company also faced the risk that one or more of its external suppliers of goods or services ("third party providers") would 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. During 1999, the Company completed an inventory of its third party provider relationships. In order to assess the Y2K readiness of such third party providers, the Company developed and forwarded a detailed questionnaire to such providers. As the responses to the questionnaires were received, the Company evaluated the overall Y2K readiness of its third party provider relationships. The Company did not experience any material problems with its third-party vendors which were related to the Year 2000 date change.
Cautionary Statements for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995
Except for historical factual information set forth in this Management's Discussion and Analysis, certain statements made in this report are forward looking and contain information about financial results, economic conditions and other risks and known uncertainties. The Company cautions the reader that actual results could differ materially from those anticipated by the Company, depending upon the eventual outcome of certain factors, including: (1) heightened competition for new business, (2) significant changes in interest rates and (3) adverse regulatory changes affecting the business of insurance.
Accounting Developments
In February, 1997, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard (FAS) No. 128, "Earnings Per Share," which revises the standards for computing earnings per share previously prescribed by Accounting Principles Board Opinion No. 15, "Earnings Per Share." The Statement establishes two measures of earnings per share: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. The Statement requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with potential dilutive securities outstanding. The Statement also requires a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation. The Statement is effective for interim and annual periods ending after December 15, 1997. Earlier application is not permitted. However, a company may disclose pro forma earnings per share amounts that would have resulted if it had applied the Statement in an earlier period. The Company adopted FAS 128 in its annual financial statements for the year ended December 31, 1997.
In June, 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income", which establishes standards for reporting and display of comprehensive income and its components in a financial statement with the same prominence as other financial statements. Comprehensive income is defined as net income adjusted for changes in stockholders' equity resulting from events other than net income or transactions related to an entity's capital instruments. The Company adopted FAS 130 effective January 1, 1998, with reclassification of financial statements for earlier years.
In June, 1997, the FASB issued FAS No. 131, "Disclosure About Segments of an Enterprise and Related Information", which establishes standards for reporting information about operating segments. Generally, FAS No. 131 requires that financial information be reported on the basis that it is used internally for evaluating performance. The Company adopted FAS No. 131 effective January 1, 1998 and comparative information for earlier years has been restated. This statement does not need to be applied to interim financial statements in the initial year of application. The adoption of FAS No. 131 did not impact upon the Company's reporting of financial information.
In February, 1998, the FASB issued FAS No. 132, "Employers' Disclosures About Pensions and Other Postretirement Benefits", which revises current disclosure requirements for employers' pension and other retiree benefits. FAS No. 132 does not change the measurement or recognition of pension or other postretirement benefit plans. The Company adopted FAS No. 132 effective January 1, 1998, with the effect of such adoption to be reflected in year-end financial statements. The adoption of FAS No. 132 did not have a material impact on the Company's results of operations, liquidity or financial position.
In December, 1997, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments", which provides guidance on accounting for insurance-related assessments. The Company adopted SOP 97-3, effective January 1, 1999. Previously issued financial statements were required to be restated. 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, 1999. As the Company does not have significant investments in derivative financial instruments, the adoption of FAS 133 is not expected to have a material impact on the Company's results of operations, liquidity or financial position.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
General
FIC's principal assets are financial instruments, which are subject to market risks. Market risk is the risk of loss arising from adverse changes in market rates, principally interest rates on fixed rate investments. For a discussion of the Company's investment portfolio and the management of that portfolio to reflect the nature of the underlying insurance obligations of the Company's insurance subsidiaries, please refer to the sections entitled "Acquisition of ILCO" and "Investment of Assets" in Item 1 of this report and the information set forth in Item 7, "Management's Discussion and Analysis of Financial Condition and Operations - Investments".
The following is a discussion of the Company's primary market risk sensitive instruments. It should be noted that this discussion has been developed using estimates and assumptions. Actual results may differ materially from those described below. Further, the following discussion does not take into account actions which could be taken by management in response to the assumed changes in 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 44.5% 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 $9.7 million at December 31, 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 $102.4 million at December 31, 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 $27.3 million at December 31, 1999 and $33.9 million at December 31, 1998. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in the fair market value related to such mortgage- backed securities is estimated to be $1.9 million at December 31, 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 $6.3 million at December 31, 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.
Item 8.
Item 8. Financial Statements and Supplementary Data
The following Financial Statements of the Registrant have been filed as part of this report:
1. Report of PricewaterhouseCoopers LLP, Independent Accountants, dated March 27, 2000.
2. Consolidated Balance Sheets, as of December 31, 1999 and December 31, 1998.
3. Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997.
4. Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997.
5. Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997.
6. Notes to Consolidated Financial Statements.
7. Consolidated Financial Statement Schedules.
Item 9.
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.
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, other than Mr. Chacosky, were elected at the 1999 annual shareholders meeting. Mr.Chacosky was appointed as a director in January, 2000, to fill a vacancy created by an increase in the number of directors which was approved by the Board of Directors in January, 2000. The data supplied below is based on information provided by the directors, except to the extent that such data is known to the Registrant.
Name Age Since Director and Other Information
John D. 57 1991 Director of FIC since 1991. Vice President, Barnett Investment Professionals, Inc. from 1996 to present. Vice President, Investments of Prudential Securities from 1983 to 1996.
Charles K. 42 2000 Director and Vice President of FIC and ILCO Chacosky since January, 2000. Executive Vice President of FLIC since January, 2000. Executive Vice President of Investors-NA and Investors-IN since January, 2000. Senior Manager of PricewaterhouseCoopers, LLP from February, 1997 to December, 1999. Vice President of Germantown Life Insurance from February, 1995 to January, 1997.
Joseph F. 61 1992 Director of FIC since February 29, 1992. Crowe Vice President of FIC from February 29, 1992 to January 3, 1997. Vice President of ILCO from May 1991 to January, 1997. Director of ILCO from May, 1991 until September, 1997. Director and Executive Vice President of Investors-NA and Investors-IN from June, 1991 to January, 1997. Director and Executive Vice President of FLIC from June, 1991 to January, 1997.
Name Age Since Director and Other Information
Jeffrey H. 47 1995 Director of FIC since May, 1995. Vice Demgen President of FIC since August, 1996. Vice President and Director of ILCO since August, 1996. Director of FLIC since October, 1992. Executive Vice President of FLIC since August, 1996. Senior Vice President of FLIC from October, 1992 to August, 1996. Executive Vice President and Director of Investors-NA since August, 1996. Senior Vice President and Director of Investors-NA from October, 1992 to June, 1995. Executive Vice President and Director of Investors-IN since August, 1996. Senior Vice President of Investors-IN from October, 1992 to June, 1995.
Theodore A. 60 1996 Vice President and Director of FIC since Fleron 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 - NA and Investors-IN since July, 1992. Senior Vice President, General Counsel, Director and Assistant Secretary of FLIC since August, 1996.
James M. 56 1976 Vice President, Secretary, Treasurer and Grace Director of FIC since 1976. Vice President and Treasurer of ILCO since January, 1985. Executive Vice President, Treasurer and Director of Investors-IN since 1989. Executive Vice President and Treasurer of Investors-NA since 1989. Director, Executive Vice President and Treasurer of FLIC since 1991.
Dale E. Mitte 65 1994 Director of FIC since 1994. Senior Vice President, Chief Underwriter and Director from January, 1993 to March 5, 1999 of Investors-NA and Investors-IN. Vice President and Chief Underwriter from June, 1991 to March 5, 1999 of FLIC.
Name Age Since Director and Other Information
Roy F. Mitte 68 1976 Chairman of the Board, President and Chief Executive Office of FIC since 1976. Chairman of the Board, President and Chief Executive Officer of ILCO and Investors-IN since 1985. Chairman of the Board, President and Chief Executive Officer of Investors-NA since December, 1988. Chairman of ILG Securities Corporation since December 1988. Chairman of the Board, President and Chief Executive Officer of FLIC since June, 1991.
Frank Parker 70 1994 Private investor. Prior to June, 1997, President of Gateway Tugs, Inc. and Par-Tex Marine, Inc., both of which are located in Brownsville, Texas and were engaged in operating and chartering harbor and intracoastal tug boats. Director of FIC since May, 1994.
Eugene E. 57 1992 Vice President and Director of FIC since Payne 1992. Vice President of ILCO since December, 1988 and Director since May, 1989. Executive Vice President, Secretary and Director of Investors-NA since December, 1988. Executive Vice President since December, 1988 and Director since May, 1989 of Investors-IN. Director, Executive Vice President and Secretary of FLIC since June, 1991.
Thomas C. 58 1996 Director of FIC since August, 1996. Richmond Director of ILCO from March, 1994 to August, 1996. Senior Vice President since January 1993 of Investors -NA and Investors-IN.
Jerome H. 63 1998 President and Professor of Chemistry, Supple Southwest Texas State University since April, 1989. Director of FIC since 1998.
The incumbent directors, other than Dr. Payne, have been nominated for submission to vote of the shareholders for reelection at the 2000 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 1999 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 68 Chairman of the Board, President and Chief Executive Officer
James M. Grace 56 Vice President and Treasurer
Eugene E. Payne 57 Vice President and Secretary
Jeffrey H. Demgen 47 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.
(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) Involvement in Certain Legal Proceedings
None.
(g) 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 5s were required, the Company believes that during the period from January 1, 1999 through December 31, 1999, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were complied with, other than with respect to Mr. Parker, who filed a Form 5 in February, 2000, to report the transfer to him in February, 1998 of 2,000 shares of the Company's common stock upon the dissolution of his employer (Par-Tex Marine).
Item 11.
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth information concerning the compensation of the Company's Chief Executive Officer and each of the three other persons who were serving as executive officers of the Company at the end of 1999 and received cash compensation exceeding $100,000 during 1999:
Annual Compensation
(1) The salaries and bonuses set forth in the table were paid by ILCO, except that FIC and/or Family Life authorized payment of a portion of Mr. Mitte's salary in each of 1997, 1998 and 1999. The executive officers of FIC have also been executive officers of Family Life, the insurance subsidiary of FIC, and ILCO and its insurance subsidiaries. FIC and/or Family Life reimbursed ILCO (or, in the case of Mr. Mitte, authorized payment of) the following amounts as FIC's or Family Life's share of the executive officers' cash compensation and bonus for 1997, 1998 and 1999 (i) Mr. Mitte: $999,746, $1,111,821 and $1,111,821, respectively; (ii) Mr. Grace: $68,150, $64,152 and $62,694, respectively; (iii) Dr. Payne: $68,150 , $61,447 and $61,447, respectively; and (iv) Mr. Demgen: $66,548, $72,173 and $76,500, respectively.
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) The data in this column represents the amount of annual bonus awarded. The bonuses for Mr. Grace, Dr. Payne and Mr. Demgen for the year 1997 represent amounts paid in 1997, but include the bonuses awarded with respect to the years 1996 and 1997. Dr. Payne elected to defer the amounts shown for 1997, 1998 and 1999 into the Company's Non-Qualified Deferred Compensation Plan. The Plan was established in 1997 to permit Mr. Grace and Dr. Payne to defer a portion of their compensation. Under the provisions of the Plan, contributions are invested on a money purchase basis and plan benefits are based on the value of the account at retirement or other distribution. In accordance with applicable tax law requirements, amounts allocated to the Plan are subject to the claims of general creditors of the Company.
Compensation of Directors
Directors who are not officers or employees of the Company are paid a $5,000 annual fee, and are compensated $1,000 for each regular or special meeting of the Board of Directors which they attend in person.
Members of Compensation Committee
The Compensation Committee makes recommendations to the Board of Directors with respect to the Chief Executive Officer's compensation. The members of the Compensation Committee are John D. Barnett, Frank Parker and Jerome H. Supple.
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.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table presents information as of March 15, 2000 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 1,552,206 30.71 %
Family Life Insurance Company 701 Brazos Street Suite 1400 Austin, Texas 78701 272,000 5.38 %
InterContinental Life Corporation 701 Brazos Suite 1400 Austin, Texas 78701 690,161 (1,3) 12.42 % (2)
Investors Life Insurance Company of North America 701 Brazos Suite 1400 Austin, Texas 78701 690,161 (1,3) 12.42 % (2)
Heartland Advisors, Inc. 790 North Milwaukee St. Milwaukee, WI 53202 500,100 9.89 % (4)
Fidelity Management & Research Company 82 Devonshire Street Boston, MA 02109 272,700 5.39% (5)
(1) Of such shares, 145,500 shares are owned by Investors-NA, 44,250 shares are owned by Investors-IN, and 500,411 shares are issuable upon exercise of an option held by Investors- NA. Investors-NA is a direct subsidiary of ILCO. Investors-IN is a direct subsidiary of Investors-NA.
(2) Assumes that outstanding stock options or warrants held by non-affiliated persons have not been exercised and that outstanding stock options held by Investors-NA have been exercised.
(3) See Item 1. Business-Acquisition of Family Life for a description of the options granted to Investors-NA.
(4) As reported to the Company on a Schedule 13(G) filed by Heartland Advisors, Inc. ("Heartland"). According to the Schedule 13(G), the shares are held for various investment advisory accounts and the interest of one such account (Heartland Value Fund, a registered investment company) is more than 5% of the common stock of FIC. A Schedule 13(G) was filed on January 27, 1998, reporting beneficial ownership of 320,400 shares. A Schedule 13(G)/A was filed on January 21, 1999, reporting beneficial ownership of an additional 118,100 shares and a Schedule 13(G)/A was filed on January 12, 2000, reporting beneficial ownership of an additional 61,600 shares.
(5) As reported to the Company on a Schedule 13(G) filed on February 14, 2000, by FMR Corporation, the parent company of Fidelity Management & Research Company ("Fidelity") and Fidelity Management Trust Company. According to the Schedule 13(G) filing, Fidelity acts as investment advisor to the Fidelity Low-Priced Stock Fund, a registered investment company, and the Fund is the beneficial owner of 268,700 shares of FIC common stock. The Schedule 13(G) also states that Fidelity Management Trust Company is the beneficial owner of 4,000 shares of FIC common stock, as a result of its serving as investment manager of certain institutional accounts.
The following table contains information as of March 15, 2000 as to the common stock of the Registrant beneficially owned by each director, nominee and executive officer and by all executive officers and directors of the Registrant as a group. The information contained in the table has been obtained by the Registrant from each director and executive officer, except for the information known to the Registrant. Except as indicated in the notes to the table, each beneficial owner has sole voting power and sole investment power as to the shares listed opposite his name.
Amount and Nature of Percent of Name Beneficial Ownership Class
John Barnett 2,000 * Joseph F. Crowe 1,500 (2) * Charles K. Chacosky -0- (2) Jeffrey H. Demgen -0- (2) Theodore A. Fleron -0- James M. Grace 7,600 (2) * Dale E. Mitte 2,000 * Roy F. Mitte 1,552,206 (1,2) 30.71% Frank Parker 12,000 * Eugene E. Payne -0- Thomas C. Richmond -0- Jerome H. Supple 200 *
All Executive Officers, and Directors as a group (11 persons) 1,577,506 (1,2) 31.21%
* Less than 1%.
(1) As of March 15, 2000, Mr. Mitte, jointly with his wife Joann, owns 1,552,206 common shares of Financial Industries Corporation ("FIC"). The holdings of Mr. Mitte of FIC's common stock constitutes 30.71% of the outstanding common stock of the Company. In addition, Mr. Mitte holds the position of Chairman, President and Chief Executive Officer of ILCO.
(2) No executive officer or director holds any options to acquire FIC common stock. Messrs. Roy Mitte, Grace, Payne, Demgen and Chacosky are executive officers and/or directors of ILCO and beneficially owned approximately 46.9 % of the outstanding shares of ILCO common stock as of March 15, 2000. Since FIC beneficially owns approximately 44.5% of ILCO's common stock, Mr. Roy Mitte's personal holdings are combined with FIC's holdings in determining the percentage of ILCO common stock beneficially owned by Mr. Mitte. ILCO beneficially owned 690,161 shares of FIC common stock (12.42% of outstanding shares, assuming the exercise of outstanding stock options held by an ILCO subsidiary) as of March 15, 2000.
Item 13.
Item 13. Certain Relationships and Related Transactions
For the period January 1, 1999 to December 31, 1999, the Registrant reports the following information in accordance with the provisions of section 229.404 of the Regulations of the U.S. Securities and exchange Commission. Management believes that the transactions described herein were in the ordinary course of business and on terms as favorable to the Registrant and its subsidiaries as if the transactions had involved unaffiliated persons or organizations.
(a) Roy F. Mitte serves as Chairman, President and Chief Executive Officer of both FIC and ILCO. James M. Grace serves as Vice President, Treasurer and Director of both companies; Dr. Payne serves as Vice President, Secretary and Director of both companies; Messrs. Demgen and Fleron serve as Vice Presidents and Directors of both companies. Mr. Roy Mitte holds beneficial ownership of 30.71% of the outstanding shares of the Company (see "Security Ownership of Certain Beneficial Owners").
(b) As part of the financing arrangement for the acquisition of Family Life Insurance Company, Family Life Corporation ("FLC"), a subsidiary of FIC, entered into a Senior Loan agreement under which $50 million was provided by a group of banks. The balance of the financing consisted of a $30 million subordinated note issued by FLC to Merrill Lynch Insurance Group, Ins. ("Merrill Lynch") and $14 million borrowed by another subsidiary of FIC from an affiliate of Merrill Lynch and evidenced by a senior subordinated note in the principal amount of $12 million and a junior subordinated note in the principal amount of $2 million and $25 million lent by two insurance company subsidiaries of ILCO. The latter amount was represented by a $22.5 million loan from Investors-NA to FLC and a $2.5 million loan provided directly to FIC by Investors-CA. In addition to the interest provided under those loans, Investors-NA and Investors-CA were granted by FIC non-transferable options to purchase, in the amounts proportionate to their respective loans, up to a total of 9.9% of shares of FIC's common stock at a price of $10.50 per share ($2.10 per share as adjusted for the five-for-one stock split in November, 1996), equivalent to the then current market price, subject to adjustment to prevent dilution. The original provisions of the options provided for their expiration on June 12, 1998 if not previously exercised. In connection with the 1996 amendments to the subordinated notes, as described below, the expiration date of the options were extended to September 12, 2006.
On July 30, 1993, the subordinated indebtedness owed to Merrill Lynch and its affiliate was prepaid. The Company paid $38 million plus accrued interest to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the subordinated debt was new subordinated loans totaling $34.5 million that FLC and another subsidiary of FIC obtained from Investors-NA. The principal amount of the new subordinated debt is payable in four equal annual installments in 2000, 2001, 2002 and 2003 and bears interest at an annual rate of 9%. The other terms of the new debt are substantially the same as those of the $22.5 million subordinated loans that Investors-NA had previously made to FLC and that continue to be outstanding.
In June, 1996, the provisions of the notes from Investors-NA to FIC, Family Life Corporation ("FLC") and Family Life Insurance Investment Company ("FLIIC") were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996; the final quarterly principal payment is due on September 12, 2001; the interest rate on the note remains at 11%, (b) the $30 million note was amended to provide for forty quarterly principal payments, in the amount of $163,540 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $1,336,458; the final quarterly principal payment is due
on September 12, 2006; the interest rate on the note remains at 9%, (c) the $4.5 million note was amended to provide for forty quarterly principal payments, in the amount of $24,531 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $200,469; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, (d) the $2.5 million note was amended to provide that the principal balance of the note is to be repaid in twenty quarterly installments of $125,000 each, commencing December 12, 1996 with the final payment due on September 12, 2001; the rate of interest remains at 12% and (e) the Master PIK note, which was issued to provide for the payment in kind of interest due under the terms of the $2.5 million note prior to June 12, 1996, was amended to provide that the principal balance of the note ($1,977,119) is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%.
In December, 1998, FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder (FIC). Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC.
(c) The data processing needs of ILCO's and FIC's insurance subsidiaries are provided to ILCO's and FIC's insurance subsidiaries by FIC Computer Services, Inc. ("FIC Computer"), a subsidiary of FIC. Under the provisions of the data processing agreement FIC Computer provides data processing services to each subsidiary for fees equal to such subsidiary's proportionate share of FIC Computer's actual costs of providing those services to all of the subsidiaries. Family Life paid $1,916,350 and ILCO's insurance subsidiaries paid $2,730,189 to FIC Computer for data processing services provided during 1999.
(d) 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.
(e) 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.
(f) Mr. Crowe retired from active service with the Company in January, 1997 and served on the ILCO Board until October, 1997; he continues to serve on the Board of Directors of FIC. Following Mr. Crowe's retirement, the Company entered into a consulting agreement with him. Under the terms of the agreement, Mr. Crowe is to be available for periodic consultation on actuarial matters related to the operations of the life insurance companies. The agreement provide of a payment of $25,000 per year for a period of five-years.
Part IV
Item 14.
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, 1997, 1998 and 1999 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
Consolidated Balance Sheets, September 31, 1999 and 1998
Consolidated Statements of Income, for years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Changes in Shareholders' Equity, for the years ended December 31, 1999, 1998 and 1997
Consolidated Statement of Cash Flows, for the years ended December 31, 1999, 1998 and 1997
Notes to Consolidated Financial Statements
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
Schedule II - Condensed Financial Statements of Registrant
Schedule IV - Reinsurance
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.
3. 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, 1999.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES FORM 10-K--ITEM 14 (a) (1) and (2) LIST OF FINANCIAL STATEMENTS
(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, 1999 and 1998..............................................F-3
Consolidated Statements of Income, for the years ended December 31, 1999, 1998 and 1997............................F-5
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997.............F-7
Consolidated Statements of Cash Flows, for the years ended December 1999, 1998 and 1997...........................F-10
Notes to Consolidated Financial Statements.............................F-12
(2) The following consolidated financial statements of Financial Industries Corporation and Subsidiaries are included:
Schedule I - Summary of Investments Other Than Investments in Related Parties....................................F-40
Schedule II - Condensed Financial Statements of Registrant.............................................................F-41
Schedule IV - Reinsurance..............................................F-44
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 present fairly, in all material respects, the financial position of Financial Industries Corporation and its subsidiaries (the "Company") at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14 (a) (1) on page present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP Dallas, Texas March 27, 2000
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, 1999 1998 (in thousands)
ASSETS Investments other than investments in affiliate: Fixed maturities available for sale at market value (amortized cost of $78,252 and $76,727 at December 31, 1999 and 1998) $ 77,515 $ 79,402 Equity securities at market (cost approximates $11 at December 31, 1999 and 1998) 4 4 Policy loans 3,595 3,155 Short-term investments 24,839 27,589 Total investments 105,953 110,150 Cash and cash equivalents 692 2,601 Investment in affiliate 70,013 70,950 Accrued investment income 1,180 1,209 Agency advances and other receivables 6,885 7,759 Reinsurance receivables 14,848 12,426 Due and deferred premiums 12,392 12,181 Property and equipment, net 1,355 1,758 Deferred policy acquisition costs 52,490 48,510 Present value of future profits of acquired businesses 23,109 28,294 Other assets 4,758 5,392 Separate account assets 379 508 Total Assets $ 294,054 $ 301,738
The accompanying notes are an integral part of these consolidated financial statements
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1999 1998 (in thousands) LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities: Policy liabilities and contract holder deposit funds: Future policy benefits $ 59,783 $ 60,069 Contract holder deposit funds 44,681 45,128 Unearned premiums 14 28 Other policy claims and benefits payable 4,282 4,582 108,760 109,807 Subordinated notes payable to affiliate 41,497 47,645 Deferred federal income taxes 23,222 23,984 Other liabilities 4,079 4,474 Separate account liabilities 379 508
Total Liabilities 177,937 186,418 Commitments and Contingencies (See Notes 6, 8, 12, 14) 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 (loss) (2,454) 5,898 Retained earnings 117,552 108,403 123,492 122,695 Common treasury stock, at cost, 790,639 shares in 1999 and 1998 (7,375) (7,375)
Total Shareholders' Equity 116,117 115,320
Total Liabilities and Shareholders' Equity $ 294,054 $ 301,738
The accompanying notes are an integral part of these consolidated financial statements.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
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, 1999 1998 1997 (in thousands) Net Income Per Share (Note 15) Basic: Average weighted shares outstanding 5,055 5,383 5,428 Basic earnings per share $ 1.81 $ 1.71 $ 3.01 Diluted: Common stock and common stock equivalents 5,200 5,557 5,589 Diluted earnings per share $ 1.76 $ 1.66 $ 2.92
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)
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)
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)
The accompanying notes are an integral part of these consolidated financial statements.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
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 acquiring and administering existing portfolios of individual and annuity products. The Company's insurance subsidiary is also engaged in the business of marketing and underwriting individual life insurance, disability insurance and annuity products in 49 states and the District of Columbia. Such products are marketed through an exclusive career agency system.
Principles of Consolidation
The consolidated financial statements include the accounts of FIC and its wholly-owned subsidiaries at December 31, 1999. The more significant subsidiaries are: Family Life Corporation (FLC), Family Life Insurance Company (Family Life), FIC Realty Services, Inc. (FIC Realty) and FIC Property Management, Inc. (FIC-Property). The Company's approximate 45% investment in InterContinental Life Corporation (ILCO) is presented using the equity method of accounting.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles which differ from statutory accounting principles required by regulatory authorities for the Company's insurance subsidiary. All material intercompany balances and transactions have been eliminated. The following accounting policies describe the accounting principles used in the preparation of the consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results will differ from those estimates.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investments
The Company's general investment philosophy is to hold fixed maturity securities until maturity. However, fixed maturities may be sold prior to their maturity dates in response to changing market conditions, duration of liabilities, liquidity factors, interest rate movements and other investment factors. Accordingly, fixed maturity investments are classified as available for sale and are carried at market value. Unrealized gains and losses on securities available for sale are not recognized in earnings but are reported as a separate component of equity in other accumulated comprehensive income, net of related income taxes.
Premiums and discounts on collateralized mortgage obligations (CMOs) are amortized over the estimated redemption period as opposed to the stated maturity. An adjustment to the investment and investment income is recorded on a retrospective basis to reflect the amounts that would have existed had the new effective yield been applied since the acquisition of the CMOs. The Company endeavors to minimize the portfolio's exposure to interest rate changes inherent in interest-sensitive products by selecting and selling investments so that diversity, maturity and liquidity factors approximate the duration of related policyholder liabilities.
Equity securities are carried at market value. Unrealized gains and losses on equity securities, net of deferred income taxes, if applicable, are reflected directly in shareholders' equity as a component of other comprehensive income. Policy loans represent unpaid balances and do not exceed the cash surrender value of the related policies.
Short-term investments are carried at cost, which approximates market value, and generally consist of those fixed maturities and other investments with maturities less than one year from the date of purchase. Securities pledged as collateral for repurchase agreements are held by the Company's investment custodian until maturity of the repurchase agreement. Provisions of the agreement and procedures adopted by the Company ensure that the market value of the collateral, including accrued interest thereon, is sufficient in the event of default by the counterparty.
The cost of investments sold is determined on the specific identification basis, except for stocks, for which the first-in, first-out method is employed. When an impairment of the value of an investment is considered other than temporary, the decrease in value is reported in net income as a realized investment loss and a new cost basis is established.
Cash and Cash Equivalents
Generally, cash includes cash on hand and on deposit in non-interest bearing accounts. Short term investments with maturities of three months or less at the time of purchase are reported as cash equivalents.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Sale of Real Estate
Prior to December, 1999, FIC owned several parcels of real estate in Jackson, Mississippi, adjacent to an office building which formerly served as the headquarters of Standard Life Insurance Company (the "Standard Life Building"). The Standard Life Building was owned by Investors-NA. This building is 68 years old and contains approximately 85,000 square feet (65,000 net rentable square feet) of office space. On December 29, 1999, Investors-NA donated the Standard Life Building to the Jackson Redevelopment Authority ("JRA"). Contemporaneously with the donation of the Standard Life Building, Investors-NA and Financial Industries Corporation ("FIC") sold all of the adjacent parcels they owned to the JRA for a total sale price of $2,500,000, which has been allocated according to the respective ownership interests of Investors-NA (approximately 59.28%) and FIC (approximately 40.72%). The donation and sale was made pursuant to the terms of the Donation, Purchase and Sale Agreement dated July 17, 1998. Investors-NA intends to claim an income tax deduction of its upcoming tax return for the donation of the Standard Life Building, which has an appraised value at December 15, 1999 of approximately $3,050,000. The donation and sale transaction referenced above resulted in a net gain (GAAP basis) of $992,494 for ILCO and $408,664 for FIC (or a combined total of $1,401,158).
Net income for 1997 includes $4.5 million (before federal income tax) resulting from the sale during the fourth quarter of 1997 of the Bridgepoint Square office complex. The aggregate selling price was $78 million which was allocated approximately 21.5% to Family Life and 78.5% to Investors Life Insurance Company of North America (Investors-NA), a subsidiary of ILCO, in accordance with their respective ownership interests in the Bridgepoint Square office complex. The sale closed on December 5, 1997.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation. Depreciation is provided using straight-line and accelerated methods over estimated useful lives of 5 to 33 years. Maintenance and repairs are charged to expense when incurred.
Deferred Policy Acquisition Costs
The cost of acquiring new business, principally first year commissions and certain expenses of the policy issuance and underwriting departments, which vary with and are primarily related to the production of new business, have been deferred to the extent recoverable. Acquisition costs related to mortgage term life insurance business are deferred and amortized over the premium paying period of the related policies. Acquisition costs related to universal life products are deferred and amortized in proportion to the ratio of estimated annual gross profits to total estimated gross profits over the expected lives of the contracts.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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.
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.
Solvency Laws Assessments
The solvency or guaranty laws of most states in which the Company's insurance subsidiary do business may require the Company's insurance subsidiary to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength, and in certain instances, may be offset against future premium taxes. The Company's insurance subsidiary expense for guaranty fund assessment, from states, which do not allow premium tax offsets, was not material.
Policy Liabilities and Contractholder Deposit Funds
Liabilities for future policy benefits for mortgage life and annuity insurance products are computed using the net level premium method or an actuarially equivalent method. The assumption for future investment yield is 8.5 %. Assumptions for mortality and withdrawal are based on company experience with provision for possible adverse deviation.
Contract holder deposit funds are liabilities for universal life and annuity products. These liabilities consist of deposits received from customers and accumulated at actual credited interest rates on their fund balances less charges for expenses and mortality.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Other Policy Claims and Benefits Payable
The liability for other policy claims and benefits payable represents management's estimate of ultimate unpaid losses on claims and other miscellaneous liabilities to policyholders. Estimated unpaid losses on claims are comprised of losses on claims that have been reported but not yet paid, including estimates of additional development of initial claims estimates, and claims that have been incurred but not reported.
The liability for other policy claims and benefits payable is subject to the impact of changes in claim severity, frequency and other factors. Although there is considerable variability inherent in such estimates, management believes that the liability recorded is adequate.
Federal Income Taxes
In February, 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109). The Company adopted FAS 109 on a prospective basis effective January 1, 1993. FAS 109 mandates the asset and liability method for computing deferred income taxes. Under this method, balance sheet amounts for deferred income taxes are computed based on the tax effect of the differences between the financial reporting and federal income tax basis of assets and liabilities using the tax rates which are expected be in effect when these differences are anticipated to reverse.
Revenue Recognition
Premiums on mortgage life and health products are recognized as revenue over the premium paying period. Benefits and expenses are associated with earned premiums, so as to result in recognition of profits over the life of the contracts.
Revenues for universal life and annuity products consist of contract charges (earned insurance charges) assessed against the fund values and net investment income. Related benefit expenses primarily consist of net investment income credited to the fund values after deductions for investment and risk charges. Revenues for universal life and annuity products consist of net investment income and mortality, administration and surrender charges assessed against the fund values. Related benefit expenses include universal life benefit claims in excess of fund values and net investment income credited to universal life and annuity fund values.
Net Income Per Share
Net income per share is calculated based on two methods, basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. Both methods are presented on the face of the income statement.
New Accounting Pronouncements
In February, 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128, "Earnings Per Share," which revises the standards for computing earnings per share previously prescribed by Accounting Principles Board ("APB") Opinion No. 15, "Earnings Per Share." The Statement establishes two measures of earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. The Statement requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with potential dilutive securities outstanding.
The Statement also requires a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation. The Statement is effective for interim and annual periods ending after December 15, 1997. The Company adopted SFAS No. 128 for the year ended December 31, 1997.
In June, 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income and its components. Comprehensive income is defined as net income adjusted for changes in stockholders' equity resulting from events other than net income or transactions related to an entity's capital instruments. The Company has adopted SFAS 130 for the year ended December 31, 1998 and has restated financial statement presentation for 1997 as required by this pronouncement.
In June, 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for reporting information about operating segments. Generally, SFAS 131 requires that financial information be reported on the basis that is used internally for evaluating performance. The Company adopted SFAS 131 for the year ended December 31, 1998. As described in Note 1, the Company is principally engaged, through its subsidiaries, in administering existing portfolios of individual life insurance and annuity products. The Company's insurance subsidiaries are also engaged in the business of marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. Such products are marketed through an exclusive career agency system. Management considers the Company's insurance operations to constitute one reportable segment. Premium revenues for traditional insurance products and earned insurance charges on universal life and annuity products are presented in the accompanying consolidated statements of income. No single customer accounts for 10% or more of the Company's revenue. The Company has no foreign operations.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
In February, 1998, the FASB issued SFAS No. 132, "Employers Disclosures about Pensions and Other Postretirement Benefits," which revises current disclosure requirements for employers' pension and other retiree benefits. SFAS 132 does not change the measurement or recognition of pension or other postretirement benefit plans. The Company adopted SFAS 132 for the year ended December 31, 1998, and restated disclosures for 1997 as required by this pronouncement.
In December, 1997, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting for insurance-related assessments. The Company adopted SOP 97-3 effective January 1, 1999. Previously issued financial statements should not be restated unless the SOP is adopted prior to the effective date and during an interim period. The adoption of this SOP did not have a material impact on the Company's financial statements.
In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FAS No. 133 is applicable to financial statements for all fiscal quarters of fiscal years beginning after June 15, 2000 as amended by FAS No 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FAS No 133". As the Company does not have significant investments in derivative financial instruments, the adoption of FAS 133 is not anticipated to have a material impact on the Company's results of operations, liquidity or financial position
Reclassification
Certain prior years' amounts have been reclassified to conform with the 1999 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, 1999 and 1998, respectively, were as follows (in thousands):
The amounts of unrealized gains and losses reflected in the balance sheet in accumulated other comprehensive income have been reduced by estimated deferred tax expense (benefit) in the amount of $(258,000) and $937,000 in 1999 and 1998, respectively. The adjustment is made to recognize deferred taxes on the net unrealized gain (loss). Additional deferred tax expense (benefit) of $(149,000) and $313,000 in 1999 and 1998, respectively, have been provided with respect to the Company's portion of ILCO's unrealized appreciation or depreciation in marketable securities.
The amortized value and market value of fixed maturities at December 31, 1999 are shown below by contractual maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Market Value Value (in thousands)
Due in one year $ 9,664 $ 9,655 Due after one year through five years 16,065 15,696 Due after five years through ten years 8,579 8,448 Due after ten years 16,397 16,422 Mortgage-backed securities 27,547 27,294 Total fixed maturities available for sale $ 78,252 $ 77,515
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 1999, 1998 and 1997 were $18,071,000, $16,473,000 and $7,998,000, respectively. There were gains of $4,739 and losses of $0 in 1999 and gains of $5,916 and losses of $16,437 in 1998 and gains of $23,000 and losses of $0 in 1997.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The net change in unrealized investment gains (losses) represents the only component of other comprehensive income for the years ended December 31, 1999, 1998 and 1997. The following is a summary of the change in unrealized investment gains (losses) net of related deferred income taxes which are reflected in accumulated other comprehensive income for the periods presented:
The unrealized gains and losses include the Company's portion of its percentage ownership of ILCO. The amounts included in the total below is $(9,440,000), $(1,044,000) and $6,433,000 for 1999, 1998 and 1997, respectively.
Change in Unrealized Gains (Losses) on Investments 1999 1998 1997 (in thousands)
Fixed maturities $ (12,852) $ (1,170) $ 8,369 Equity securities 2 (52) 11 (12,850) (1,222) 8,380 Deferred federal income taxes (4,498) (428) 2,933 Net change in unrealized gains (losses) on investments $ (8,352) $ (794) $ 5,447
The following table sets forth the reclassification adjustments required for the years ended December 31, 1999, 1998 and 1997:
Reclassification Adjustments 1999 1998 1997 (in thousands)
Unrealized holding gains (losses) on investments arising during the period $ (8,357) $ (790) $ 5,432 Reclassification adjustments for gains included in net income 5 (4) 15 Unrealized gains (losses) on investments, net of reclassification adjustment $ (8,352) $ (794) $ 5,447
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Net Investment Income
The components of net investment income are summarized as follows: Year ended December 31, 1999 1998 1997 (in thousands)
Fixed maturities $ 5,221 $ 5,792 $ 5,853 Other, including short-term investments and policy loans 1,756 2,080 2,336 6,977 7,872 8,189 Investment expenses (49) (64) (83) Net investment income $ 6,928 $ 7,808 $ 8,106
There were no impairments in the value of investments in 1999, 1998 or 1997, which were considered other than temporary.
3. Disclosure about Fair Value of Financial Instruments
The estimated fair values of the Company's financial instruments at December 31, 1999 are as follows: Carrying Fair Amount Value (in thousands)
Financial assets: Fixed maturities $ 77,515 $ 77,515 Policy loans 3,595 3,595 Short-term investments 24,839 24,839 Cash and cash equivalents 692 692 Financial liabilities: Subordinated notes payable to affiliate 41,497 41,497
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
Fixed Maturities
Fair values are based on quoted market prices or dealer quotes.
Policy Loans
Policy loans are, generally, issued with coupon rates below market rates and are considered early payment of the life benefit. As such, the carrying amount of these financial instruments is a reasonable estimate of their fair value.
Cash and Short-term Investments
The carrying amount of these instruments approximates market value.
Subordinated Notes Payable to Affiliate
The fair value is based on the Company's estimate of current market conditions.
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, 1999 excess of cost over net assets acquired of $1,686,000, net of accumulated amortization of $1,644,000, is included in investment in affiliate. At December 31, 1998, these amounts were $1,686,000 and $1,544,000, 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 through its insurance subsidiaries, Investors Life Insurance Company of North America (Investors-NA) and Investors Life Insurance Company of Indiana (Investors-IN). Summarized financial information for ILCO is set forth below:
Balance sheet information: 1999 1998 (in thousands)
Investments $ 678,814 $ 702,086 Deferred policy acquisition costs and present value of future profits 75,429 75,619 Other assets 566,956 572,543 Total Assets $ 1,321,199 $ 1,350,248 Policy liabilities and contract holder deposit funds $ 675,831 $ 694,351 Other liabilities 493,677 501,662 Total liabilities 1,169,508 1,196,013 Common stock, additional paid-in capital and retained earnings 155,403 142,664
Accumulated other comprehensive income (3,712) 11,571
Shareholders' equity 151,691 154,235
Total liabilities and shareholders' equity $ 1,321,199 $ 1,350,248
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Results of Operations: 1999 1998 1997 (in thousands)
Premium income $ 11,132 $ 10,890 $ 11,031 Net investment income 49,913 54,619 57,740 Gain on sale of real estate 112 -0- 14,630 Earned insurance charges 40,447 41,067 40,853 Benefits and expenses 85,466 91,876 96,081 Net income 12,765 11,119 20,540 Basic earnings per share $ 1.45 $ 1.27 $ 2.37 Diluted earnings per share $ 1.45 $ 1.25 $ 2.35
Total market value basis of the Company's investment in ILCO approximated $36,377,401 and $39,326,920 at December 31, 1999 and 1998, respectively. FIC directly or indirectly owns 3,932,692 shares (approximately 45%) of ILCO's outstanding common stock at December 31, 1999, 1998 and 1997.
In January 1985, FIC acquired 26.53% of ILCO's common stock. FIC and Family Life subsequently acquired additional shares of ILCO's common stock and as of March 16, 1998, FIC owned, directly and indirectly through Family Life, approximately 45% of the outstanding shares of ILCO's common stock. Prior to October 1, 1998, FIC held options to acquire up to 1,702,155 additional shares of ILCO Common Stock. As a result of the final repayment on ILCO's Senior Loan on September 30, 1998, FIC's options to acquire shares of ILCO's Common Stock expired.
The amount of net realized gains included in net earnings of ILCO is $1,289,000, $642,000 and $9,623,000, for the years ended December 31, 1999, 1998 and 1997, 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:
1999 1998 (in thousands)
Balance at beginning of year $ 28,294 $ 34,437 Accretion of interest 2,154 2,667 Amortization during the period (7,339) (8,810) Present value of future profits at December 31 $ 23,109 $ 28,294
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):
2000 $ 5,784 2001 $ 4,426 2002 $ 3,158 2003 $ 2,459 2004 $ 1,915
At purchase, the present value of future profits was calculated using a discount rate of approximately 15%. Interest is accredited on the unamortized portion at approximately 8.5%.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
6. Subordinated Notes Payable
Following is a summary of outstanding debt at December 31:
1999 1998 (in thousands)
Subordinated senior notes payable to Investors-NA beginning with a $1,125,000 payment on December 12, 1996 and each subsequent quarter through September 12, 2001. Interest is payable on a quarterly basis at 11% $ 7,875 $ 12,375
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% 1,567 2,463
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% 32,055 32,807
Total subordinated notes payable $ 41,497 $ 47,645
The obligors are allowed to prepay the Investors-NA Subordinated Loans, in whole or in part, without premium or penalty. The Investors-NA Subordinated Loans were subordinated to the Senior Loan and now constitute a lien on the Pledged Collateral. Repayment of the Investors-NA Subordinated Loans is also guaranteed by the Company.
Aggregate maturities of the Subordinated Notes Payable are as follows: (in thousands)
2000 $6,148 2001 6,148 2002 6,148 2003 6,148 2004 6,148 Thereafter 10,757 $41,497
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
7. Income Taxes
The Company files a consolidated federal income tax return with its non-life subsidiaries. The Company's life insurance subsidiary files a separate federal income tax return.
The U.S. federal income tax provision (benefit) charged to continuing operations was as follows: 1999 1998 1997 (in thousands)
Current $ 335 $ 119 $ 1,348 Deferred 839 2,249 2,193 Total provision for income tax $ 1,174 $ 2,368 $ 3,541
The provision for income taxes is less than the amount of income tax determined by applying the U.S. statutory income tax rate of 35% to pre-tax income from continuing operations as a result of the following differences: 1999 1998 1997 (in thousands)
Income taxes at the statutory rate $ 2,454 $ 3,141 $ 4,694 Increase (decrease) in taxes resulting from: Small life insurance company deduction (608) (238) (499) Dividends received deduction (526) (586) (649) Tax rate differential (70) (90) (135) Non-deductible compensation 17 38 -0- Other items, net (93) 103 130 Total provision for income taxes $ 1,174 $ 2,368 $ 3,541
Provision has not been made for state and foreign income tax expense since this expense is minimal. Premium taxes are paid to various states where premium revenue is earned. Premium taxes are included in the statement of income as operating expenses.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Deferred taxes are recorded for temporary differences between the financial reporting bases and the federal income tax bases of the Company's assets and liabilities. The sources of these differences and the estimated tax effect of each are as follows:
Deferred tax liability: 1999 1998 (in thousands)
Equity in net earnings of affiliate $ 4,815 $ 4,414 Excess pension benefit 436 436 Deferred policy acquisition costs 14,582 13,072 Present value of future profits 7,798 8,221 Guaranty fund assessments 219 388 Deferred and uncollected premium 4,213 4,141 Unrealized (depreciation) appreciation on marketable securities (406) 1,250
Other taxable temporary differences 4,927 5,314
Total deferred tax liability 36,584 37,236
Deferred tax asset: Policy reserves 11,397 12,123 Net operating loss carry forward 1,785 957 Alternative minimum tax credit 122 114 Accrued liabilities 58 58
Total deferred tax assets, net 13,362 13,252
Net deferred tax liability $ 23,222 $ 23,984
An additional deferred federal income (asset) liability of $(1,656,000) and $(97,000) for 1999 and 1998, respectively, have been provided on the unrealized appreciation (depreciation) of marketable securities and included in the balance of the deferred tax liability. This increase or decrease in deferred tax liability has been recorded as reduction or increase to the equity adjustment due to the net change in unrealized appreciation or depreciation and has not been reflected in the deferred income tax expense, included in net income from operations.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Family Life is eligible for a special deduction allowed to small life insurance companies equal to 60 percent of tentative life insurance company taxable income, subject to certain limitations.
Provision for U.S. income taxes has not been made on a portion of the undistributed earnings of ILCO from the date of the Company's investment since the Company expects such earnings to be remitted in the form of dividends. The Company has provided for the tax on the undistributed earnings of ILCO net of the dividends received deduction expected to be allowed when such dividends are paid. The Company expects that additional deferred taxes would be payable on the undistributed earnings of ILCO if the Company should sell its investment.
8. Reinsurance
Family Life reinsures portions of certain policies it writes, thereby providing greater diversification of risk and minimizing exposure on larger policies. The Company's retention on any one individual ranges from $-0- to $200,000 depending on the risk.
Policy liabilities and contract holder deposit funds are reported in the consolidated financial statements before considering the effect of reinsurance ceded. The insurance subsidiary remains liable to the extent the reinsurance companies are unable to meet their obligation under the reinsurance agreements.
Under the provisions of the purchase agreement between the Company and Merrill Lynch, certain life insurance companies affiliated with Merrill Lynch agreed to assume (on an assumption reinsurance basis) certain single premium whole life and annuity products written by Merrill Lynch's insurance division on Family Life's paper. The transfer of these reserves, in accordance with the reinsurance agreement, is subject to certain regulatory approvals.
The amount remaining under this agreement that had not yet been approved for transfer to Merrill Lynch was $116,070 and $115,524 at December 31, 1999 and 1998, respectively.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The amounts in the consolidated financial statements for reinsurance ceded are as follows:
December 31, 1999 1998 1997 (in thousands)
Future policy benefits $ 14,512 $ 11,950 $ 9,765 Unearned premiums 46 28 90 Other policy claims and benefits payable 290 448 1,279 $ 14,848 $ 12,426 $ 11,134
For the years ended 1999 1998 1997 (in thousands)
Premiums $ 1,091 $ 1,419 $ 1,112 Policyholder benefits and expenses $ 2,260 $ 2,479 $ 1,697
Estimated amounts recoverable from reinsurers on paid claims were $32,243 and $4,603 in 1999 and 1998, respectively. These amounts were included in other receivables in the consolidated financial statements at December 31, 1999 and 1998.
9. Shareholders' Equity
The Company's ability to pay dividends to its shareholders is affected, in part, by receipt of dividends from Family Life and ILCO.
Family Life is domiciled in the state of Washington. Under current Washington law any proposed payment of dividends or distribution by the insurance subsidiary which, together with dividends or distributions paid during the preceding twelve months, exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31 or (ii) statutory net gain from operations, is called an "extraordinary dividend" and may not be paid until either it has been approved, or a waiting period shall have passed during which it has not been disapproved, by the insurance commissioner.
Effective July 25, 1993 Washington amended its insurance code to retain the "greater of" standard but enacted requirements that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that dividends may be paid only from earned surplus. Family Life does not presently have earned surplus as defined by the regulations adopted by the
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Washington Insurance Commissioner and, therefore, is not presently permitted to pay cash dividends.
However, the Company does not directly own its life insurance subsidiary's stock, but instead indirectly owns that stock through a downstream holding company, FLC, whose ability to pay dividends to the Company is significantly limited by some of the subordinated notes referred to in Note 6 during the terms of those loans. Consolidated net assets FLC aggregated approximately $64,235,000 and $54,514,000 at December 31, 1999 and 1998, respectively.
The ability of ILCO to pay dividends to the Company and the other shareholders of ILCO is affected by receipt of dividends from its insurance subsidiaries, which are generally limited by law to the greater of their net income for the prior year or 10% of capital and surplus.
Capital and surplus of Family Life as reported to insurance regulators and as determined in accordance with statutory accounting practices prescribed or permitted by the state of Washington aggregates approximately $26,874,275 and $30,294,446 at December 31, 1999 and 1998, respectively. Statutory net income aggregated approximately $6,703,705, $10,473,492 and $13,302,000 for the years ended December 31, 1999, 1998 and 1997, 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, 1999 or 1998.
In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The NAIC is now considering amendments to the Codification guidance that would also be effective upon implementation. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, e.g. deferred income taxes are recorded. The Company has not estimated the potential effect of the Codification guidance on statutory net income and statutory capital and surplus. However, the actual effect of adoption could differ as changes are made to the Codification guidance, prior to its recommended effective date of January 1, 2001.
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% 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.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
11. Retirement Plans and Employee Stock Plans
Retirement Plan
Family Life has a non-contributory defined benefit pension plan which covers employees who have completed one year or more of service. Under the plan, benefits are payable upon retirement based on earnings and years of credited service.
a. The Normal Retirement Date for all employees is the first day of the month coinciding with or next following the later of attainment of age 65 or the completion of five years of service, but not later than age 70.
b. The Normal Retirement Benefit is the actuarial equivalent of a life annuity, payable monthly, with the first payment commencing on the Normal Retirement Date. The life annuity is equal to the sum of (1) plus (2):
(1) Annual Past Service Benefit: 1.17% of the first $10,000 of Average Final Earnings plus 1 1/2% of the excess of Average Final Earnings over $10,000, all multiplied by the participant's Credited Past Service. For these purposes, "credited past service" is service prior to April 1, 1967, with respect to employees who were plan participants on December 31, 1975.
(2) Annual Future Service Benefit: 1.5578% of the first $10,000 of Average Final Earnings plus 2% of the excess of Average Final Earnings over $10,000, all multiplied by the participant's Credited Future Service.
c. Effective April 1, 1997, the Family Life pension plan was amended to provide that the accrual rate for future service is 1.57% of Final Average Earnings multiplied by Credited Service after March 31, 1997, less .65% of Final Average Earnings up to Covered Compensation. With respect to service prior to April 1, 1997, the accrual rate described in paragraph (b), above, is applicable, with Average Final Earnings taking into account a participant's earnings subsequent to April 1, 1997.
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.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The pension costs for the plan includes the following components: 1999 1998 1997 (in thousands)
Service cost for benefits earned during the year $ 52 $ 59 $ 88
Interest cost on projected benefit obligation 500 452 509
Expected return on plan assets (535) (633) (719)
Pension benefit $ 17 $ (122) $ (122)
The following summarizes the status of the plan at December 31: 1999 1998 (in thousands)
Change in benefit obligation: Benefit obligation at beginning of year $ 7,690 $ 6,683 Service cost 52 59 Interest cost 500 452 Benefits paid (1,581) (897) (Gain)/Loss due to change in assumptions 0 525 (Gain)/Loss due to experience 18 868 Benefit obligation at end of year $ 6,679 $ 7,690
Change in plan assets: Fair value of plan assets at beginning of year $ 7,721 $ 8,361 Actual return on plan assets 212 495 Benefits paid (1,581) (898)
Fair value of plan assets at end of year $ 6,352 $ 7,958
Funded Status: Funded status at end of year $ (327) $ 268 Unrecognized actuarial net (gain) loss 2,143 1,564 Prepaid pension expense at end of year $ 1,816 $ 1,832
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The significant assumptions for the plans are as follows:
The discount rate for projected benefit obligations was 7.25%, 7.25% and 7.75% for the years ended December 31, 1999, 1998 and 1997, respectively.
The assumed long-term rate of compensation increases was 5.0%, 5.0% and 6.0% for the years ended December 31, 1999, 1998 and 1997, respectively.
The assumed long-term rate of return on plan assets was 8.0% for the years ended December 31, 1999, 1998 and 1997.
During 1995, the ILCO Employee Stock Ownership Plan and the ILCO Savings and Investment Plan were amended to allow for the addition of Family Life as a participating employer, thus allowing Family Life employees to participate in the plans.
In 1997, the ILCO Savings and Investment Plan was amended to provide for a matching contribution by participating companies. The match, which is in the form of shares of ILCO common stock, is equal to 100% of an eligible participant's elective deferral contributions, as defined in the Plan, not to exceed 1% of the participant's plan compensation. Allocations are made on a quarterly basis to the account of participants who have at least 250 hours of service in that quarter.
Effective May 1, 1998, the 401(k) Plan was amended to provide for the merger of the ESOP into the 401(k) Plan. In connection with the merger, certain features under the ESOP were preserved for the benefit of employees previously participating in the ESOP with regard to all benefits accrued under the ESOP through the date of merger.
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, 1999, 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.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Rent expense in 1999, 1998 and 1997 was $591,947, $628,979 and $781,104 respectively. Minimum annual rentals are as follows:
(in thousands) 2000 $ 478 2001 471 2002 320 2003 19 2004 -0- Thereafte - 0- Total $ 1,288
13. Related Party Transactions
The obligations of ILCO under the ILCO Senior Loan were guaranteed by FIC. FIC presently owns 3,932,692 shares of ILCO Common Stock, constituting 44.5% of such shares outstanding. The current Senior Loan of ILCO was fully repaid on September 30, 1998. Accordingly FIC's rights under the 1986 option agreement expired on September 30, 1998.
FIC Property, a subsidiary of FIC, conducted the leasing activities for the Bridgepoint Square properties previously owned by Investors-NA. In connection with the December, 1997 sale of Bridgepoint Square Offices by Investors-NA and Family Life Insurance Company, FIC Realty received a commission in the amount of $156,000, of which $122,538 was paid by Investors-NA and $33,462 by Family Life.
As part of the financing arrangement for the acquisition of Family Life, a $22.5 million loan was made by Investors-NA to FLC, a subsidiary of FIC, and a $2.5 million loan was made by Investors Life Insurance Company of California (Investors-CA), which was merged into Investors-NA in 1992, to FIC. In addition to the interest provided under those loans, Investors- NA and Investors-CA were granted by FIC non-transferable options to purchase, in the amounts proportionate to their respective loans, up to a total of 9.9% of shares of FIC's common stock at a price of $10.50 per share, equivalent to the then current market price, subject to adjustment to prevent dilution. As a result of the FIC's five-for-one stock split, which was effective November 12, 1996, the option price is currently $2.10 per share. The options originally were to expire on June 12, 1998 if not previously exercised. In connection with the 1996 amendments to the subordinated notes, as described below, the expiration date of the options were extended to September 12, 2006.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
On July 30, 1993, the subordinated indebtedness owed to Merrill Lynch and its affiliate was prepaid. The Company paid $38 million plus accrued interest to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the subordinated debt was new subordinated loans totaling $34.5 million that FLC and Family Life Insurance Investment Company ("FLIIC"), another subsidiary of FIC, obtained from Investors-NA. The principal amount of the new subordinated debt is payable in four equal annual installments in 2000, 2001, 2002 and 2003 and bears interest at an annual rate of 9%. The other terms of the new debt are substantially the same as those of the $22.5 million subordinated loans that Investors-NA had previously made to FLC and that continue to be outstanding.
As of June 12, 1996, the provisions of the notes from Investors-NA to FIC, FLC and FLIIC were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 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% and (e) the Master PIK note, which was issued to provide for the payment in kind of interest due under the terms of the $2.5 million note prior to June 12, 1996, was amended to provide that the principal balance of the note $1,977,119 is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%.
In December, 1998, FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder, FIC. Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
FIC was reimbursed by ILCO for rental expense and certain other miscellaneous expenses incurred during 1997 on behalf of ILCO. The amount of such reimbursement was approximately $822,000.
Data processing services are provided to ILCO's and FIC's Austin, Texas and Seattle, Washington facilities by FIC Computer Services, Inc. ("FIC Computer"), a subsidiary of FIC. Each of FIC's and ILCO's insurance subsidiaries has entered into a data processing agreement with FIC Computer whereby FIC Computer provides data processing services to each subsidiary for fees equal to such subsidiary's proportionate share of FIC Computer's actual costs of providing those services to all of the subsidiaries. Family Life paid $1,916,350, $1,610,397 and $824,425 and ILCO's insurance subsidiaries paid $2,730,189, $2,818,095 and $3,010,110 to FIC Computer for data processing services provided during 1999, 1998 and 1997, respectively.
In 1995, Family Life entered into a reinsurance agreement with Investors-NA pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer.
In 1996, Family Life entered into a reinsurance agreement with Investors-NA, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996.
Pursuant to a Service Agreement between Family Life and Investors NA, the Company reimbursed Investors NA for certain operating expenses incurred on behalf of FLIC totaling approximately $13 million, $11 million, and $14 million in 1999, 1998 and 1997, respectively.
In November, 1998, FIC purchased 101,304 shares of FIC's common stock from the Roy F. and Joann Cole Mitte Foundation (the "Foundation"), a Texas non-profit corporation which is controlled by Mr. Mitte and his wife, at a price of $18.625 per share (or a total purchase price of $1,886,787). At the same time, Family Life purchased 272,000 shares of FIC's common stock from the Foundation at a price of $18.625 per share (or a total purchase price of $5,066,000). Mr. Mitte and his wife had previously donated the shares to the Foundation. The shares are included in common treasury stock in the Company's financial statements at cost.
14. Commitments and Contingencies
The Company and its subsidiaries are defendants in certain legal actions related to the normal business operations of the Company. Management believes that the resolution of such matters will not have a material impact on the financial statements.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
15. Net Income Per Share (in thousands except per share data)
The following table reflects the calculation of basic and diluted earnings per share:
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 1999, premium income from these products was derived from forty-nine states with concentrations of approximately 25% and 25% in California and Texas, respectively. In 1998, these amounts were 24% and 25%, respectively.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
17. Quarterly Financial Data (unaudited)(in thousands, except per share data)
18. Subsequent Events
On January 18, 2000, FIC announced that it will pay a cash dividend in the amount of $.18 per share, payable on April 12, 2000 to shareholders of record on April 5, 2000.
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT BALANCE SHEETS December 31, 1999 1998 ASSETS (in thousands)
Cash and cash equivalents $ 70 $ 55 Short-term investments 1,037 57 Long-term bonds 16 16 Investments in subsidiaries* 130,399 131,333 Property and equipment, net 105 509 Other assets 965 968 Accounts receivable 100 126
Total assets $ 132,692 $ 133,064
LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Subordinated notes payable $ 5,748 $ 6,742 Other liabilities and intercompany payables 5,761 5,936
Total liabilities 11,509 12,678
Shareholders' equity Common stock, $.20 par value, 10,000,000 shares authorized; 5,845,300 shares issued, 5,054,661 shares outstanding in 1999 and 1998 1,169 1,169 Additional paid-in capital 7,225 7,225
Accumulated other comprehensive income (2,454) 5,898 Retained earnings (including $115,363 and $106,037 of undistributed earnings of subsidiaries at December 31, 1999 and 1998) 117,552 108,403 123,492 122,695 Common treasury stock, at cost, 518,639 shares in 1999 and 1998 respectively (2,309) (2,309)
Total shareholders' equity 121,183 120,386
Total liabilities and shareholders' equity $ 132,692 $ 133,064
* $62,144 and $60,383 are eliminated in consolidation in 1999 and 1998, respectively.
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT, STATEMENTS OF INCOME FOR THE YEARS ENDED December 31, (in thousands) 1999 1998 1997
Income $ 629 $ 89 $ 1,375
Expenses: Operating expenses 193 436 1,136 Interest expense* 613 769 869 806 1,205 2,005 Loss from operations (177) (1,116) (630) Equity in undistributed earnings from subsidiaries 9,326 10,334 16,958 Net income $ 9,149 $ 9,218 $ 16,328
*In consolidation, $282 is reported as a reduction in equity in earnings of unconsolidated subsidiary.
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT STATEMENTS OF CASH FLOWS
*Eliminated in consolidation
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES SCHEDULE IV-REINSURANCE FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 and 1997 (in thousands)
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Financial Industries Corporation (Registrant)
By:/s/ Roy F. Mitte By:/s/ James M. Grace Roy F. Mitte, Chairman of James M. Grace, Treasurer, the Board, President and Principal Accounting and Chief Executive Officer and Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 29, 2000.
/s/ Roy F. Mitte /s/ James M. Grace Roy F. Mitte, Director James M. Grace, Director
/s/ Eugene E. Payne /s/ Jeffrey H. Demgen Eugene E. Payne, Director Jeffrey H. Demgen, Director
/s/ Joseph F. Crowe /s/ Thomas C. Richmond Joseph F. Crowe, Director Thomas C. Richmond, Director
/s/ Theodore A. Fleron /s/ Charles K. Chacosky Theodore A. Fleron, Director Charles K. Chacosky, Director
/s/ Dale E. Mitte Dale E. Mitte, Director
/s/ John D. Barnett John D. Barnett, Director
/s/ Jerome H. Supple Jerome H. Supple, Director
/s/ Frank Parker Frank Parker, Director
EXHIBIT INDEX
Exhibit Page Description No. Nos.
3 The current Articles of Incorporation and Bylaws of Registrant. Exhibit 3 to Registrant's Report on Form 10-K filed for the year 1985 is hereby incorporated by reference.
3(a) Certificate of Amendment to the Articles of Incorporation of Registrant, dated November 12, 1996, filed as an exhibit with Registrant's 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference.
10(ah) Guaranty Agreement dated as of December 28, 1988 from Registrant to a group of banks on Senior Loan to ILCO, filed as an exhibit with Registrant's Form 10-K for the year ended December 31, 1989 and incorporated herein by reference.
10(ai) Guaranty Agreement, dated as of December 1, 1988, on loan to ILCO on the Note Purchase Agreement between ILCO and a Connecticut based insurance/financial services company; a guaranty agreement in substantially identical form was provided by FIC to each of the seven other entities participating in said loan, filed as an exhibit with Registrant's Form 10-K for the year ended December 31, 1989 and incorporated herein by reference.
10(aj) Guaranty Agreement, dated as of July 30, 1990, issued by the Registrant to a holder of ILCO's 1999 Series Subordinated Notes; a guaranty agreement in substantially identical form was provided by the Registrant to each of the holders of said notes.
*10(ak) Stock Purchase Agreement by and among Merrill Lynch Insurance Group, Inc., Family Life Insurance Company, Family Life Corporation, Family Life Insurance Investment Company and Financial Industries Corporation dated as of March 19, 1991, as amended.
*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.
Ex-1
*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.
Ex-2
*10(ax) Note dated June 12, 1991 in the amount of $22.5 million made by a subsidiary of the Registrant in favor of Investors Life Insurance Company of North America.
*10(ay) Note dated June 12, 1991 in the amount of $2.5 million made by the Registrant in favor of Investors Life Insurance Company of California.
*10(az) InterCreditor Agreement among Investors Life Insurance Company of North America, Investors Life Insurance Company of California, and the Agent under the Credit Agreement dated as of June 12, 1991.
*10(aaa) Option Agreement by the Registrant in favor of Investors life Insurance Company of North America and Investors Life Insurance Company of California.
10(aab) Hotel Lease Agreement dated as of August 22, 1991 between Investors Life Insurance Company of North America and FIC Realty Services, Inc. filed as exhibit 10(aab) by Registrant on Form 10-K for the year ended December 31, 1991 is hereby incorporated by reference.
10(aac) Management Agreement dated as of September 4, 1991 between Investors Life Insurance Company of North America and FIC Property Management, Inc. filed as exhibit 10(aac) by Registrant on Form 10-K for the year ended December 31, 1991 is hereby incorporated by reference.
10(aad) Stock Option Agreement dated March 8, 1986 between ILCO and Registrant filed as exhibit 10(aad) by Registrant on Form 10-K for the year ended December 31, 1992 is hereby incorporated by reference.
10(aae) Amended and Restated Guaranty of Registrant dated January 29, 1993 filed as exhibit 10(aae) by Registrant on Form 10-K for the year ended December 31, 1992 is hereby incorporation by reference.
10(aaf) Surplus Debenture dated as of June 12, 1991 in the amount of $97.5 million made by Family Life Insurance Company in favor of Family Life Corporation filed as exhibit 10(aaf) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference.
Ex-3
10(aag) Note dated July 30, 1993 in the amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America filed as exhibit 10(aag) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference.
10(aah) Note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America filed as exhibit 10(aah) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference.
10(aai) Amendment No. 1 dated July 30, 1993 between Family Life Corporation and Investors Life Insurance Company of North America amending $22.5 million note filed as exhibit 10(aai) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference.
10(aaj) Amendment No. 1 dated July 30, 1993 between Family Life Insurance Company and Family Life Corporation amending $97.5 million Surplus Debenture filed as exhibit 10(aaj) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference.
10(aak) Guaranty Agreement dated July 30, 1993 by Registrant of the $30 million loan to Family Life Corporation in favor of Investors Life Insurance Company of North America filed as exhibit 10(aak) by Registrant on Form 10-K for the year ended December 31, 1993 is hereby incorporated by reference.
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.
Ex-4
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
Ex-5
10-K for the year ended December 31, 1995 is hereby incorporated by reference.
10(aav) Amendment No. 2 dated December 12, 1996, effective June 12, 1996 to the note dated June 12, 1991 in the amount of $22.5 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America filed as exhibit 10(aav) by Registrant on Form 10-K for the year ended December 31, 1996 is hereby incorporated by reference.
10(aaw) (i) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated June 12, 1991 in the amount of $2.5 million made by Financial Industries Corporation in favor of Investors Life Insurance Company of California filed as exhibit 10(aaw)(i) by Registrant on Form 10-K for the year ended December 31, 1996 is hereby incorporated by reference.
(ii) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the "payment in kind" provisions of the note dated June 12, 1991 in the amount of $2.5 million made by Financial Industries Corporation in favor of Investors Life Insurance Company of North America filed as exhibit 10(aaw)(ii) by Registrant on Form 10-K for the year ended December 31, 1996 is hereby incorporated by reference.
10(aax) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated July 30, 1993 in the amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America filed as exhibit 10(aax) by Registrant on Form 10-K for the year ended December 31, 1996 is hereby incorporated by reference.
10(aay) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America filed as exhibit 10(aay) by Registrant on Form 10-K for the year ended December 31, 1996 is hereby incorporated by reference.
Ex-6
10(aaz) Amendment Agreement dated December 12, 1996 amending the Option Agreement by Financial Industries Corporation in favor of Investors Life Insurance Company of North America and Investors Life Insurance Company of California filed as exhibit 10(aaz) Registrant on Form 10-K for the year ended December 31, 1996 is hereby incorporated by reference.
10(aaaa) ** Assignment Agreement dated December 23, 1998, from Family Life Insurance Investment Company to Financial Industries Corporation, assigning the 9% Senior Subordinated Note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America.
21 Ex-8 Subsidiaries of Registrant.
28 Report on Form 10-K filed by ILCO for the year ended December 31, 1999 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.
** Filed as an Exhibit with Registrant's Current Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference.
Ex-7
EXHIBIT 21
Subsidiaries of Registrant
Family Life Corporation
Family Life Insurance Company
Financial Industries Service Corporation
Financial Industries Securities Corporation
Financial Industries Service Corporation of Mississippi, Inc.
Financial Industries Sales Corporation of Southern California, Inc.
FIC Realty Services, Inc.
FIC Property Management, Inc.
FIC Computer Services, Inc.
Ex-8