Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission File Number 0-4690
FINANCIAL INDUSTRIES CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 74-2126975
State of Incorporation (I.R.S. Employer Identification number)
6500 River Place Boulevard, Building One, Austin, Texas 78730
(Address of Principal Executive Offices) (Zip Code)
(512) 404-5050 (Registrant's Telephone Number, including area code)
Securities Registered pursuant to Section 12(b) of the Act: None
Securities Registered pursuant to Section 12(g) of the Act:
Common Stock, $.20 par value
(Title of Class)
- 1 -
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. YES [X] NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES [X] NO [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on February 28, 2003, based on the closing sales price in the Nasdaq
National Market ($14.80), was $118,977,156.
The number of shares outstanding of Registrant's common stock on February 28,
2003 was 9,607,427.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement in connection with the 2003 Annual Meeting of
Shareholders - Part III.
- 2 -
Forward-Looking Statements
Except for historical factual information set forth in this Annual Report on
Form 10-K, the statements, analyses, and other information contained in this
report relating to trends in Financial Industries Corporation(the "Company" or
"FIC")'s operations and financial results, the markets for the Company's
products, the future development of the Company's business, and the
contingencies and uncertainties to which the Company may be subject, as well as
other statements including words such as "anticipate," "believe," "path,"
"estimate," "expect," "intend" and other similar expressions constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. Such statements are made based upon management's current expectations and
beliefs concerning the financial results, economic conditions and are subject to
known and unknown risks, uncertainties and other factors contemplated by the
forward-looking statements. Such factors include, among other things: (1)
general economic conditions and other factors, including prevailing interest
rate levels and stock market performance, which may affect the ability of FIC to
sell its products, the market value of FIC's investments and the lapse rate and
profitability of policies; (2) FIC's ability to achieve anticipated levels of
operational efficiencies and cost-saving initiatives; (3) customer response to
new products, distribution channels and marketing initiatives; (4) mortality,
morbidity and other factors which may affect the profitability of FIC's
insurance products; (5) changes in the Federal income tax laws and regulations
which may affect the relative tax advantages of some of FIC's products; (6)
increasing competition in the sale of insurance and annuities; (7) regulatory
changes or actions, including those relating to regulation of insurance products
and insurance companies; (8) ratings assigned to FIC's insurance subsidiaries by
independent rating organizations such as A.M. Best Company, which FIC believes
are particularly important to the sale of annuity and other accumulation
products; and (9) unanticipated litigation. There can be no assurance that other
factors not currently anticipated by management will not also materially and
adversely affect FIC.
- 3 -
PART I
Item 1. Business
General
Financial Industries Corporation ("FIC", the "Company" or the "Registrant") is a
holding company primarily engaged in the life insurance business through its
ownership of Family Life Insurance Company, ("Family Life") Investors Life
Insurance Company of North America ("Investors Life"), and prior to February 19,
2002, Investors Life Insurance Company of Indiana ("Investors-IN").
FIC was organized as an Ohio corporation in 1968 and was reincorporated in Texas
in 1980. Its executive offices are located at 6500 River Place Boulevard,
Building One, Austin, Texas 78730. Through 1984, FIC's principal business was
the sale and underwriting of life and health insurance, mainly in the midwestern
and southwestern United States. During the period from 1985 to 1987, FIC
acquired a 48.3% equity interest in InterContinental Life Corporation ("ILCO").
ILCO is a Texas corporation which, prior to May 18, 2001, was publicly traded
and was engaged in the sale and underwriting of life insurance and annuities,
through its subsidiaries, Investors Life and Investors-IN (which was merged into
Investors Life on February 19, 2002 with Investors Life as the surviving
entity). On May 18, 2001, FIC acquired the remaining shares of ILCO through a
merger of a subsidiary of FIC with and into ILCO, whereby ILCO shareholders were
issued 1.1 shares of FIC stock for each share of ILCO stock outstanding. See,
"Acquisitions and Consolidations - Acquisition of ILCO." In June 1991, FIC
purchased Family Life, a Washington based life insurance corporation, from
Merrill Lynch Insurance Group, Inc.
FIC and its insurance subsidiaries have substantially identical managements.
Officers allocate their time among FIC and its subsidiaries in accordance with
their comparative requirements.
Acquisitions and Consolidations
Strategy. FIC's business 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 makes possible more predictable profit analysis. It
is also management's belief that the current environment in the life insurance
industry presents attractive opportunities for the Company to acquire life
insurance companies and blocks of insurance policies that compliment 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 benefiting
from economies of scale.
- 4 -
Acquisition of Family Life. FIC acquired Family Life, a Washington based
life insurance corporation, from Merrill Lynch Insurance Group, Inc. on June 12,
1991. 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 Insurance Subsidiaries -- Family Life".
Acquisition of ILCO. In January 1985, FIC acquired 26.53% of ILCO's common
stock. During the period from 1985 to 1987, FIC acquired additional ILCO common
stock resulting in an approximate 48% equity interest in ILCO. On May 18, 2001,
pursuant to an Agreement and Plan of Merger, as amended (the "Merger
Agreement"), dated as of January 17, 2001, among FIC, ILCO, and ILCO Acquisition
Company, a Texas corporation and wholly-owned subsidiary of FIC ("Merger Sub"),
Merger Sub was merged with and into ILCO (the "Merger"). ILCO was the surviving
corporation of the Merger and became a wholly-owned subsidiary of FIC. In
accordance with the Merger Agreement, FIC issued 1.1 shares of common stock, par
value $0.20 per share ("FIC Common Stock"), for each share of common stock, par
value $0.22 per share, of ILCO outstanding at the time of the Merger ("ILCO
Common Stock"). In addition, each share of ILCO Common Stock issuable pursuant
to outstanding options was assumed by FIC and became an option to acquire FIC
Common Stock with the number of shares and exercise price adjusted for the
exchange ratio in the Merger.
ILCO's Acquisitions. Prior to May 18, 2001, ILCO made the following
acquisitions:
Standard Life Insurance Company. In November 1986, ILCO acquired
Standard Life Insurance Company ("Standard Life"), headquartered in
Jackson, Mississippi, for a gross purchase price of $54.5 million.
Investors Life and Investors Life Insurance Company of California. In
December 1988, ILCO, through Standard Life, purchased Investors Life
Insurance Company of California ("Investors-CA") and Investors Life from
CIGNA Corporation for a purchase price of $140 million.
Meridian Life Insurance Company. In February 1995, ILCO, through
Investors Life, 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").
State Auto Life Insurance Company. 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.
- 5 -
Grinnell Life Insurance Company. 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.
Consolidation of Acquired Companies.
Merger of ILIC and Investors-Indiana. 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 and Investors-Indiana merged, 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.
Mergers with Investors Life. Investors Life redomesticated from
Pennsylvania to Washington in December of 1992. Investors-CA merged into
Investors Life on December 31, 1992. Standard Life merged into Investors
Life on June 29, 1993. On February 19, 2002, Investors-IN merged into
Investors Life. In all such mergers, Investors Life was the surviving
entity.
FIC's management believes that the acquisitions and consolidations of its life
insurance subsidiaries have achieved cost savings, such as reduced auditing
expenses involved in auditing combined companies; the savings of expenses and
time resulting from the combined company being examined by one state insurance
department (Washington), rather than four (California, Pennsylvania, Mississippi
and Indiana); 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.
Business of Insurance Subsidiaries
FIC's growth strategies include marketing and selling life insurance and
annuity products through agents of its insurance subsidiaries, Family Life and
Investors Life.
Family Life. Family Life, which was organized in the State of Washington in
1949, specializes in providing mortgage protection life insurance to borrowers
of financial institutions. Currently, Family Life has active relationships with
36 lenders that provide direct access to their customers.
- 6 -
Family Life's mortgage protection business consists of term and universal life
insurance sold to homeowners and is designed to repay or reduce the mortgage
balances of policyholders in the event of their death. This business is sold
primarily to customers of independent financial institutions, often facilitated
by a current 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. A key feature of the Family Life system is the
ability to bill and collect premiums through the policyholder's monthly mortgage
payments. This system enables Family Life to provide a convenient solution to
the financial security needs of the under-served and under-protected low to
moderate income homeowner market.
In 2002, direct statutory premiums received on Family Life's insurance products
totaled $36.4 million. This compares to $40.1 million in 2001 and $43.1 million
in 2000. The reduction in premium is due to the normal runoff of the business.
Family Life is licensed to sell annuity and life insurance products in 48 states
and the District of Columbia (not licensed to sell in New York or New
Hampshire). In 2002, premium income from these products was derived from all
states in which Family Life is licensed, with over half of the amount derived
from California (25%) and Texas (28%).
Family Life's primary distribution channel is its exclusive force of
approximately 200 career agents, who are organized into seven regions. The
mortgage life insurance market has grown rapidly over the past few years and
Family Life expects to maintain and expand its share of that market. Family Life
believes that it is the only nation-wide agent-sold life insurance company
operating through leads from financial institutions. Direct access to mortgage
customers and the convenience of the insured making payments through their
mortgage bill provides Family Life with a competitive advantage. The company is
also in the process of upgrading its product portfolio to offer more competitive
features and benefits, including an option to return premiums paid if the
insured lives to the end of the term period. Going into 2003, the sales
organization was restructured to lower overall acquisition costs in order to
support more competitive products.
In addition to its primary distribution channel, Family Life has expanded its
system to: (1) provide a broader range of products; (2) generate direct mail
mortgage leads; and (3) target higher income homeowners than its traditional
market. This distribution strategy allows some Family Life agents to sell
products of third-party life insurance companies that have entered into
marketing relationships with an FIC subsidiary, ILG Sales Corporation.
Investors Life. Investors Life is engaged primarily in administering
existing portfolios of individual life insurance and annuity policies.
Approximately 73% of the total collected premiums for 2002 were derived from
renewal premiums on insurance and annuity policies sold by FIC's insurance
subsidiaries prior to their acquisition by the Company.
Investors Life is also engaged in marketing and underwriting individual life
insurance and annuity products in 49 states (not licensed in New York), the
District of Columbia and the U.S. Virgin Islands. These products are marketed
through independent, non-exclusive general agents.
- 7 -
Products currently distributed by Investors Life include a new universal life
insurance plan which is expected to rank favorably to similar products relative
to guaranteed and current assumption cash values. Universal life insurance
provides death benefit protection with flexible premium and coverage features,
and the crediting of interest on cash values, at company-declared current
interest rates. 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.
In addition, Investors Life recently introduced a series of level term life
products that feature competitive rates and a guaranteed return of premium
option. The Company also offers fixed annuity products with competitive
guarantees and several other universal life products.
Direct statutory premiums received from all types of life insurance policies
sold by Investors Life were $42.1 million in 2002, as compared to $45.0 million
in 2001 and $46.3 million in 2000. Investors Life received reinsurance premiums
from Family Life of $4.6 million in 2002, pursuant to the reinsurance agreement
for universal life products written by Family Life. In 2002, premium income from
all life insurance policies was derived from all states in which Investors Life
is licensed, with significant amounts derived from Pennsylvania (14%),
California (8%) and Ohio (8%).
Direct deposits from the sale of fixed annuity products were $16.4 million in
2002, as compared to $12.3 million in 2001 and $10.6 million in 2000. Investors
Life also received reinsurance premiums from Family Life of $1.3 million,
pursuant to a reinsurance agreement for annuity products between the two
companies.
Investors Life also receives premium income from health insurance policies. In
2002, premium income from all such policies was $0.3 million, as compared to
$0.6 million in 2001 and $0.7 million in 2000. Since 1997, substantially all of
Investors Life's health insurance business has been reinsured with a third party
reinsurer.
Investors Life also 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, 2002, the assets held in
the separate account were $28.0 million. During 2002, the premium received in
connection with these variable annuity policies was $80,549, which was received
from existing contract owners.
Investors Life also maintains a closed variable annuity separate account, with
approximately $11.9 million of assets as of December 31, 2002. The separate
account was closed to new purchases in 1981 as a result of an IRS ruling that
adversely affected the status of variable annuity separate accounts that invest
in publicly-available mutual funds. The ruling did not adversely affect the
status of in-force contracts.
- 8 -
For the past few years, Investors Life has been marketing a group deposit
administration product, designed for use in connection with the funding of
deferred compensation plans maintained by government employers under section 457
of the Internal Revenue Code. The company has established a marketing
relationship with a third-party administrator based in San Antonio, Texas, which
has established relationships with school districts in Texas. Group deposits
under this program for the year 2000 totaled $1.5 million, deposits in 2001
totaled $0.24 million and deposits in 2002 totaled $0.35 million. At December
31, 2002, 16 school districts held plans with Investors Life.
Investors Life, along with Family Life, participates in the distribution system
involving third-party life insurance companies. The marketing arrangement makes
available, to appointed agents of Investors Life, life insurance and annuity
products not currently being offered by Investors Life. The underwriting risk on
the products sold under this arrangement is assumed by the third-party insurer.
The Company's appointed agents receive commissions on the sales of these
products and the Company's marketing subsidiary receives an override commission.
During 2002, Investors Life and Family Life received revenues of $1.2 million
through this distribution system. At December 31, 2002, Investors Life and
Family Life had relationships with 509 agents actively engaged in this marketing
effort.
Agency Operations
The products of FIC's insurance subsidiaries are marketed and sold through two
divisions:
A. Investors Life Distribution System
Investors Life contracts with independent non-exclusive agents, general agents
and brokers nation-wide to sell its products. Such agents and brokers also sell
insurance products for companies in competition with Investors Life. In order to
attract agents and enhance the sale of its products, Investors Life pays
competitive commission rates and provides other sales inducements. Investors
Life is presently concentrating its efforts on the promotion and sale of fixed
annuity products for retirement income. In addition, the company is also
concentrating its efforts on the promotion and sale of universal life and term
products related to mortgage protection.
Marketing and sales for Investors Life is directed by the Executive Vice
President of Marketing and Sales. The distribution system is organized into 13
regions, each of which has a Regional Vice President ("RVP") who is responsible
for the recruitment and maintenance of the general agents and managing general
agents for individual insurance sales within such region. In late 2002,
Investors Life implemented a plan to restructure the compensation arrangements
for RVPs, so as to minimize fixed costs and improve incentives for growth. Plans
were also developed to put greater emphasis on recruiting Independent Marketing
Organizations on a 100% variable cost basis.
- 9 -
B. Family Life Distribution System
Family Life utilizes a nationwide exclusive agent force to sell its products.
This agent force sells mortgage protection life insurance and annuity products.
The products are sold primarily to lower income customers of client financial
institutions, usually through a list of borrowers provided by the financial
institution. Family Life works closely with the financial institutions to
maintain and ensure that Family Life lead systems, which had been built from the
loan portfolios of each active financial institution, operate effectively.
Family Life agents make courtesy calls to borrowers of the financial
institutions which are active on the Family Life lead system to offer the
borrower the opportunity to purchase mortgage protection insurance (term or
universal life insurance products).
In advance of the passage of the Financial Services Modernization Act (the
"Act") in 1999 (for a discussion of the provisions of this law, refer to the
section entitled "Regulation"), Family Life established a task force to develop
new lead sources for its agents. Although Family Life continues to focus on its
traditional sales approach, it has established a supplemental leads program,
whereby leads are obtained from public records (e.g. county loan records).
Family Life has also developed a strategy to work with lenders as "setup only",
whereby the mortgage institution does not furnish leads, but will collect and
remit premiums. Finally, Family Life is developing new sales methods, including
direct mailings and direct telephone leads.
Sales and Marketing for Family Life is directed by the Executive Vice President
of Marketing and Sales. Sales and marketing focuses on the development and
maintenance of contractual agreements with the financial institutions which
provide referrals to, and collect monthly premiums from, their borrowers for
Family Life insurance plans. As of March, 2003, the Family Life distribution
system consisted of seven regions, each directed by a Regional Vice President.
Investment of Assets
FIC has established and staffed an investment department, which manages
portfolio investments and investment accounting functions for its life insurance
subsidiaries. At December 31, 2002, invested assets totaled $761.2 million.
The general investment objective of the Company 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. 64.9% of FIC's
invested assets are in fixed maturity securities, available for sale. Our fixed
maturity securities portfolio is predominately comprised of low risk, investment
grade, available for sale publicly traded corporate securities, mortgage-backed
securities, and United States Government bonds. All of FIC's invested assets are
invested in the United States. The assets held by Family Life and Investors 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
Company determines the allocation of our assets primarily on the basis of cash
flow and return requirements of our products and secondarily by the level of
investment risk.
- 10 -
The Company's investment objectives include the making of selected investments
in collateralized mortgage obligations. The Company has not invested in
non-agency mortgage-backed securities, which have a greater credit risk than
that of agency mortgage-backed securities.
The other asset categories which comprise at least 5% of FIC's invested assets
include investments in real estate, short-term investments, and policy loans.
For a further discussion of FIC's invested assets see "Item 7 - Management
Discussion and Analysis - Investments."
Data Processing
Since December 1994, the data processing needs of FIC's insurance subsidiaries
have been provided to FIC's Austin, Texas and Seattle, Washington facilities by
FIC Computer Services, Inc., a subsidiary of FIC. See "Item 13 - Certain
Relationships and Related Transactions with Management."
As the provider of data processing for the Company and its subsidiaries, FIC
Computer Services, Inc. utilizes 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.
FIC expects to implement a number of technology projects during 2003 that are
consistent with the Company's strategic direction aimed at improving operational
efficiency and reducing expenses. It is estimated that the new technology
investment will have a net savings of $1.8 million pre-tax or $1.2 million after
tax over the next five years. These savings are based on a 30% growth assumption
for new business sales.
The three major projects scheduled for implementation this year are: (1) a new
business and underwriting automation project that includes six initiatives to
enhance the new business and underwriting environments, including: (a)
automating the policy assembly process; (b) automating sales illustrations; (c)
automating the underwriting and new business form letters; (d) automating
underwriting requirements; (e) implementing a document imaging and workflow
process; and (f) implementing an electronic policy application process for
agents using electronic tablet PCs; (2) an interactive voice response system;
and (3) migration to one new business system. The total cost of these technology
improvements will be approximately $983,000 over five years, with $657,483 of
the cost occurring in year one.
Once these projects are completed, FIC believes that our operating units will
have the ability to handle an increased workload from an acquisition of up to
100,000 policies, as well as handle a 30% increase in new sales growth, with
little or no increase in current staffing levels. In addition to these projects,
there are thirty-two technology initiatives that FIC is currently evaluating in
order to further reduce expenses, improve productivity and improve service in
the next few years.
- 11 -
Reinsurance and Reserves
In accordance with general practices in the insurance industry, FIC's insurance
subsidiaries limit the maximum net losses that may arise from large risks by
reinsuring with other carriers. Such reinsurance provides for a portion of the
mortality risk to be retained by FIC's insurance subsidiaries with the excess
being ceded to a reinsurer at a premium set forth in a schedule based upon the
age and risk classification of the insured. The reinsurance treaties provide for
allowances that help Family Life and Investors Life offset the expense of
writing new business. Investors Life generally retains the first $100,000 to
$250,000 of risk on the life of any individual on its in-force block of life
policies; however it has initiated raising this limit to $250,000 on most of
these policies through recapture. On its in-force block of business, Family Life
generally retains the first $200,000 of risk on the life of any one individual.
On certain new products being written by Family Life (which amount to
approximately one third of Family Life's new business), the entire amount of
risk is reinsured on a percentage basis with Family Life retaining either 50% or
10% of the risk depending on the face amount of the policy. Although Family Life
only retains as little as 10% of the risk, Family Life receives an allowance
from the reinsurer on their portion of the premiums, which allows Family Life to
profit on the 90% of the risk ceded to the reinsurer. This arrangement allows
Family Life to price products more competitively and take certain underwriting
risks which it could not take if it were retaining 100% of the risk. Family Life
still reinsures all of its new business over $200,000, and Investors Life still
reinsures all of its new business over $250,000.
Family Life and Investors Life maintain bulk reinsurance treaties, under which
they reinsured all of the mortality risks under accidental death benefit
policies. The treaties were most recently renegotiated with the current
reinsurer in 2002.
In December 1997, FIC's life insurance subsidiaries entered into a reinsurance
treaty under which all of the contractual obligations and risks under accident
and health and disability income policies were assumed by a third party
reinsurer.
In 1995, Family Life (as the ceding company) entered into a reinsurance
agreement with Investors Life (as the reinsuring company) pertaining to
universal life insurance written by Family Life. The reinsurance agreement is on
a co-insurance basis and applies to all covered business with effective dates on
and after January 1, 1995. The agreement applies to only that portion of the
face amount of the policy that is less than $200,000; face amounts of $200,000
or more are reinsured by Family Life with a third party reinsurer. In 1996,
Family Life (as the ceding company) entered into a reinsurance agreement with
Investors Life (as the reinsuring company), pertaining to annuity contracts
written by Family Life. The agreement applies to contracts written on or after
January 1, 1996. These reinsurance arrangements reflect management's plan to
develop universal life and annuity business at Investors Life, with Family Life
concentrating on the writing of term life insurance products.
- 12 -
Although reinsurance does not eliminate the exposure of FIC's insurance
subsidiaries to losses from risks insured, the net liability of such
subsidiaries will be limited to the portion of the risk retained, provided that
the reinsurers meet their contractual obligations.
FIC's insurance subsidiaries establish and carry as liabilities actuarially
determined reserves that are calculated to meet the Company's future
obligations. Reserves for life insurance policies are based on actuarially
recognized methods using prescribed morbidity and mortality tables in general
use in the United States modified to reflect the Company's actual experience
when appropriate. These reserves are computed at amounts that, with additions
from premiums to be received and with interest on such reserves compounded
annually at certain assumed rates, are expected to be sufficient to meet the
Company's policy obligations at their maturities or in the event of an insured's
death.
Investors Life Loans
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, Inc. ("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 Life to FLC and a
$2.5 million loan provided directly to FIC by Investors-CA (which was
subsequently merged into Investors Life) (referred to as the "Investors Life
Loans"). In addition to the interest provided under the Investors Life Loans,
Investors Life 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. As part of the May 18, 2001 merger
of ILCO with FIC, the option agreement was amended to substitute the 9.9%
provision for a fixed number of shares. The fixed number of shares, 500,411, is
equivalent to the number of shares of FIC's common stock outstanding immediately
prior to the Merger. 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. These notes were paid off to Investors Life in June 2001.
- 13 -
On July 30, 1993, the subordinated indebtedness owed to Merrill Lynch and
its affiliate was prepaid. 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 Life (the "1993 Subordinated
Loans"). The principal amount of the 1993 Subordinated Loans was to be paid 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 1993 Subordinated Loans are
substantially the same as those of the $22.5 million subordinated loans that
Investors Life had previously made to FLC.
In June 1996, the provisions of the Investors Life Loans and the 1993
Subordinated Loans were modified. The 1993 Subordinated Loans were modified as
follows: (a) 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%, and (b) 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%.
As of December 31, 2002, the outstanding principal balance of the 1993
Subordinated Loans was $23.05 million. Since May 18, 2001, ILCO has been a
wholly-owned subsidiary of FIC, and thus the 1993 Subordinated Loans are not an
asset or liability on FIC's balance sheets, but still affect FIC's cash flow due
to its debt servicing obligations.
Regulation
General. The Company and its insurance subsidiaries are subject to
regulation and supervision at both the state and federal level, including
regulation under federal and state securities laws and regulation by the states
in which they are licensed to do business. The state insurance regulation is
designed primarily to protect policy owners. Although the extent of regulation
varies by state, the respective state insurance departments have broad
administrative powers relating to the granting and revocation of licenses to
transact business, licensing of agents, the regulation of trade practices and
premium rates, the approval of form and content of financial statements and the
type and character of investments.
These laws and regulations require the Company's insurance subsidiaries to
maintain certain minimum surplus levels and to file detailed periodic reports
with the supervisory agencies in each of the states in which they do business
and their business and accounts are subject to examination by such agencies at
any time. The insurance laws and regulations of the domiciliary state of the
Company's insurance subsidiaries require that such subsidiaries be examined at
specified intervals. Both Investors Life and Family Life are domiciled in the
state of Washington.
- 14 -
A number of states regulate the manner and extent to which insurance companies
may test for acquired immune deficiency syndrome (AIDS) antibodies in connection
with the underwriting of life insurance policies. To the extent permitted by
law, the Company's insurance subsidiaries consider AIDS information in
underwriting coverage and establishing premium rates. An evaluation of the
financial impact of future AIDS claims is extremely difficult, due in part to
insufficient and conflicting data regarding the incidence of the disease in the
general population and the prognosis for the probable future course of the
disease.
Risk Based Capital Requirements. The National Association of Insurance
Commissioners ("NAIC") has imposed Risk-Based Capital ("RBC") requirements to
evaluate the adequacy of statutory capital and surplus in relation to investment
and insurance risks associated with; (i) asset quality; (ii) mortality and
morbidity; (iii) asset and liability matching; and (iv) other business factors.
The RBC formula is intended to be used by insurance regulators as an early
warning tool to discover potential weakly capitalized companies for the purpose
of initiating regulatory action. The RBC requirements are not intended to be a
basis for ranking the relative financial strength of insurance companies. The
formula also defines a new minimum capital standard which will supplement the
prevailing system of low fixed minimum capital and surplus requirements on a
state-by-state basis.
The RBC requirements provide for four different levels of regulatory attention
in those states that adopt the NAIC regulations, depending on the ratio of the
company's Total Adjusted Capital (which generally consist of its statutory
capital, surplus and asset valuation reserve) to its Authorized Control Level
RBC. A "Company Action Level Event" is triggered if a company's Total Adjusted
Capital is less than 200% but greater than or equal to 150% of its Authorized
Control Level RBC, or if a negative trend has occurred (as defined by the
regulations) and Total Adjusted Capital is less than 250% but more than 200% of
its Authorized Control Level RBC. When a Company Action Level Event occurs, the
company must submit a comprehensive plan to the regulatory authority which
discusses proposed corrective actions to improve its capital position. A
"Regulatory Action Level Event" is triggered if a company's Total Adjusted
Capital is less than 150% but greater than or equal to 100% of its Authorized
Control Level RBC. When a Regulatory Action Level Event occurs, the regulatory
authority will perform a special examination of the company and issue an order
specifying corrective actions that must be followed. An "Authorized Control
Level Event" is triggered if a company's Total Adjusted Capital is less than
100% but greater than or equal to 70% of its Authorized Control Level RBC, and
the regulatory authority may take any action it deems necessary, including
placing the company under regulatory control. A "Mandatory Control Level Event"
is triggered if a company's total adjusted capital is less than 70% of its
Authorized Control Level RBC, and the regulatory authority is mandated to place
the company under its control.
Calculations using the NAIC formula and the statutory financial statements of
the Company's insurance subsidiaries as of December 31, 2002 indicate that the
Total Adjusted Capital of each of the Company's insurance subsidiaries is above
420% of its respective Authorized Control Level RBC.
- 15 -
Solvency Laws Assessments. The solvency or guaranty laws of most states in
which an insurance company does business may require that company to pay
assessments (up to certain prescribed limits) to fund policyholder losses or
liabilities of insurance companies that become insolvent. Recent insolvencies of
insurance companies increase the possibility that such assessments may be
required. These assessments may be deferred or forgiven under most guaranty laws
if they would threaten an insurer's financial strength and, in certain
instances, may be offset against future premium taxes. The insurance companies
record the expense for guaranty fund assessments in the period assessed. For the
year ended December 31, 2002, Family Life received a credit on its guaranty fund
assessments of $68,725, while Investors Life received a credit of $10,484. Those
amounts are net of the amounts that can be offset against future premium taxes
and, in the case of Family Life, the amount is also net of the amount that can
be recovered from Merrill Lynch pursuant to the Stock Purchase Agreement between
FIC and Merrill Lynch. The likelihood and amount of any other future assessments
cannot be estimated and are beyond the control of FIC.
Dividends. One source of cash for FLC to make payments of principal and
interest on the 1993 Subordinated Loans is dividends paid to FLC by Family Life.
Under current Washington law, any proposed payment of an "extraordinary
dividend" requires a 30-day prior notice to the Washington Insurance
Commissioner, during which period the Commissioner can approve the dividend,
disapprove the dividend or fail to comment on the notice, in which case the
dividend is deemed approved at the end of the 30-day period. An "extraordinary
dividend" is a distribution which, together with dividends or distributions paid
during the preceding twelve months, exceeds the greater of (i) 10% of statutory
surplus as of the preceding December 31st or (ii) the statutory net gain from
operations for the preceding calendar year. Payment of a regular dividend
requires that the insurer's earned surplus after dividends or distributions must
be reasonable in relation to the insurer's outstanding liabilities and adequate
to its financial needs. Family Life had earned surplus of $1.48 million and a
net gain from operations of $0.13 million for 2002. Investors Life had earned
surplus of $42.3 million and a net gain from operations of $3.0 million for
2002. Investors Life paid a dividend in 2002 to its parent corporation,
InterContinental Life Corporation, in the amount of $8,556,104.
Valuation Reserves. Life insurance companies are required to establish an
Asset Valuation Reserve ("AVR") consisting of two components: (i) a "default
component," which provides for future credit-related losses on fixed maturity
investments, and (ii) an "equity component," which provides for losses on all
types of equity investments, including equity securities and real estate.
Insurers are also required to establish an Interest Maintenance Reserve ("IMR"),
designed to defer realized capital gains and losses due to interest rate changes
on fixed income investments and to amortize those gains and losses into future
income. The IMR is required to be amortized into statutory earnings on a basis
reflecting the remaining period to maturity of the fixed maturity securities
sold. These reserves are required by state insurance regulatory authorities to
be established as a liability on a life insurer's statutory financial
statements, but do not affect the financial statements prepared in accordance
with Generally Accepted Accounting Principles ("GAAP"). Since dividend payments
are based upon statutory earnings, management believes that the combination of
the AVR and IMR will affect statutory capital and surplus and therefore may
reduce the ability of Investors Life and Family Life to pay dividends to FIC.
- 16 -
Insurance Holding Company Regulation. Family Life and Investors Life are
subject to regulation under the insurance and insurance holding company statutes
of the state of Washington. The insurance holding company laws and regulations
vary from jurisdiction to jurisdiction, but generally require insurance and
reinsurance subsidiaries of insurance holding companies to register with the
applicable state regulatory authorities and to file with those authorities
certain reports describing, among other information, their capital structure,
ownership, financial condition, certain intercompany transactions and general
business operations. The insurance holding company statutes also require prior
regulatory agency approval, or in certain circumstances, prior notice of certain
material intercompany transfers of assets as well as certain transactions
between insurance companies, their parent companies and affiliates.
Under the Washington Insurance Code, unless (i) certain filings are made with
the Washington Department of Insurance, (ii) certain requirements are met,
including a public hearing and (iii) approval or exemption is granted by the
insurance commissioner, no person may acquire any voting security or security
convertible into a voting security of an insurance holding company, such as the
Company, which controls a Washington insurance company, or merge with such a
holding company, if as a result of such transaction such person would "control"
the insurance holding company. "Control" is presumed to exist if a person
directly or indirectly owns or controls 10% or more or the voting securities of
another person.
The insurance holding company regulations generally apply only to insurers
domiciled in a particular state. However, the regulations in certain states also
provide that insurers that are "commercially domiciled" in that state are also
subject to the provisions applicable to domiciled insurers. The test for
determining whether an insurer is commercially domiciled is based on the
percentage of premiums written in the state as compared to the amount of
premiums written everywhere over a measuring period. The applicable percentage
for California is 33%, while for Texas it is 30%. Currently, the insurance
subsidiaries of FIC are not treated as commercially domiciled in any
jurisdiction.
Privacy Legislation. In July 2001, the Financial Services Modernization Act
(referred to in this paragraph as the "Act") of 1999 became applicable to
insurance companies. In general, the Act provides that financial institutions
have certain obligations with respect to the maintenance of the privacy of
customer information. In addition, the Act places new restrictions on disclosure
of nonpublic personal information to third party institutions seeking to utilize
such information in connection with the sale of products or services. A
financial institution may disseminate certain types of customer information to
nonaffiliated third parties if the institution provides clear and conspicuous
disclosure of the institution's privacy policy and the customer authorizes the
release of certain information to third parties. Where the customer permits the
release of the information, the Act restricts disclosure of information that is
non-public in nature but does not prohibit the release of information which can
be obtained from public sources. Although FIC's insurance subsidiaries have not
experienced any adverse effects to their business as a result of the Act to
date, it is too early to assess the Act's long-range effects.
- 17 -
USA Patriot Act. Title III of the USA PATRIOT Act (Public Law 107-56)
(referred to in this section as the "Act"), makes a number of amendments to the
anti-money laundering provisions of the Bank Secrecy Act ("BSA"). The purpose of
the amendments was to facilitate the prevention, detection and prosecution of
international money laundering and the financing of terrorism. The Act requires
every financial institution to establish an anti-money laundering program that
includes: (1) the development of internal policies, procedures, and controls;
(2) the designation of a compliance officer; (3) an ongoing employee training
program; and (4) an independent audit function to test programs.
In October, 2002, the Department of the Treasury (the "Treasury"), released an
interim final rule that temporarily deferred the application of the Act to
certain financial institutions, including insurance companies. Although Treasury
has not yet issued final regulations pertaining to insurance companies, FIC and
its insurance subsidiaries have taken preliminary steps to establish an
anti-money laundering program. These steps include the appointment of a
compliance officer and an internal auditor. In addition, a 'USA PATRIOT Act
taskforce,' consisting of representatives of key departments of the Company, has
been established to develop internal procedures, particularly in relation to the
checking of names involved in certain transactions against the Specially
Designated Nationals and Blocked Persons List prepared by Treasury's Office of
Foreign Assets Control. Until Treasury issues final rules regarding the
insurance industry's compliance with the anti-money laundering provisions of the
Act, FIC's insurance subsidiaries believe that it is too early to predict the
Act's long term effects on their business.
Potential Federal Regulation. Although the federal government generally
does not directly regulate the insurance industry, federal initiatives often
have an impact on the business. Congress and certain federal agencies
periodically investigate the condition of the insurance industry (encompassing
both life and health and property and casualty insurance) in the United States
in order to decide whether some form of federal role in the regulation of
insurance companies would be appropriate. Further, since FIC is a publicly
traded entity, it is subject to regulation by the Securities and Exchange
Commission (SEC), as well as NASDAQ. Under SEC regulations, FIC is required to
file forms under the Securities Act of 1933 and the Securities and Exchange Act
of 1934 with respect to various aspects of its business.
- 18 -
Sarbanes-Oxley. On July 30, 2002, the Sarbanes-Oxley Act of 2002 ("SarbOx")
was signed into law to address corporate and accounting fraud. SarbOx
establishes a new accounting oversight board that will enforce auditing
standards and restricts the scope of services that accounting firms may provide
to their public company audit clients. Among other things, SarbOx also (i)
requires chief executive officers and chief financial officers to certify to the
accuracy of periodic reports filed with the Securities and Exchange Commission
(the "SEC"); (ii) imposes new disclosure requirements regarding internal
controls, off-balance sheet transactions and pro forma (non-GAAP) disclosures;
(iii) accelerates the time frame for reporting of insider transactions and
periodic disclosures by public companies; and (iv) in the future, will require
companies to disclose whether they have adopted a code of ethics for senior
financial officers and whether the audit committee includes at least one "audit
committee financial expert."
SarbOx also requires that the SEC, based on certain enumerated factors, to
regularly and systematically review corporate filings. To deter wrongdoing,
SarbOx: (i) subjects bonuses issued to top executives to disgorgement if a
restatement of a company's financial statements was due to corporate misconduct;
(ii) prohibits an officer or director from misleading or coercing an auditor;
(iii) prohibits insider trades during pension fund "blackout periods;" (iv)
imposes new criminal penalties for fraud and other wrongful acts; and (v)
extends the period during which certain securities fraud lawsuits can be brought
against a company or its officers.
As a publicly reporting company, we are subject to the requirements of
SarbOx and are in the process of complying with, and establishing procedures
for, compliance with SarbOx and related rules issued by the SEC and Nasdaq. At
the present time, and subject to the final rules and regulations the SEC and
Nasdaq may adopt, we anticipate that we will incur additional expense as a
result of SarbOx, but we do not expect that such compliance will have a material
impact on the Company's business.
Federal Income Taxation. The Revenue Reconciliation Act of 1990 amended the
Internal Revenue Code of 1986 to require a portion of the expenses incurred in
selling insurance products to be deducted over a period of years, as opposed to
an immediate deduction in the year incurred. Since this change only affects the
timing of the deductions, it does not affect tax expense as shown on the
Company's financial statements prepared in accordance with GAAP. For the years
ended December 31, 2000, 2001 and 2002, the decreases in Family Life's current
income tax provisions, utilizing the effective tax rates, due to this change
were $177,038, $157,180, and $139,323 respectively. For the years ended December
31, 2000, 2001 and 2002, the decreases in the current income tax provisions of
Investors Life due to this change were $8,368, $294,695, and $279,011
respectively. The change has a negative tax effect for statutory accounting
purposes when the premium income of the Company's insurance subsidiaries
increases, but has a positive tax effect when their premium income decreases.
FIC files a consolidated federal income tax return with its subsidiaries, except
for Investors Life (which files a separate return) and ILG Securities (which
files its own federal income tax return). In accordance with the tax allocation
agreements maintained by those FIC companies which file a consolidated return,
federal income tax expense or benefit is allocated to each entity in the
consolidated group as if such entity were filing a separate return.
- 19 -
Competition
The financial services industry in general, and the market for life insurance
and annuity products in particular, is highly competitive involving many
companies. Agents placing insurance business with Family Life and Investors Life
are compensated on a commission basis. However, some companies pay higher
commissions and charge lower premium rates and many companies have more
resources than FIC's insurance subsidiaries. In addition, consolidations of
insurance and banking institutions, which is permitted under recently-enacted
federal legislation, may adversely affect the ability of Family Life to expand
its customer referral relationships with mortgage lending and servicing
institutions.
The Company believes it can compete effectively by focusing on markets where its
approach to distribution and products provides competitive advantage. This
includes the mortgage protection insurance market. Family Life's delivery system
already provides an advantage in the lower income homeowner market. The company
is also competing effectively for the middle income market through agreements to
offer other insurance company products. In addition, the company is in the
process of developing new mortgage related products with improved benefits and
features. Another target market where the company believes it can compete
effectively is in providing retirement income through fixed annuity products.
Annuities currently available for sale consistently compare favorably to the
industry with respect to agent commission levels and cash values on a guaranteed
basis.
The principal cost and competitive factors that affect the ability of FIC's
insurance subsidiaries to sell their insurance products on a profitable basis
are: (1) the general level of premium rates for comparable products; (2) the
extent of individual policyholders services required to service each product
category; (3) general interest rate levels; (4) competitive commission rates and
related marketing costs; (5) legislative and regulatory requirements and
restrictions; (6) the impact of competing insurance and other financial
products; and (7) the condition of the regional and national economies.
Employees of the Company
At December 31, 2002, the number of employees within FIC and its subsidiaries
was approximately 278 and the number of Regional Vice Presidents employed by the
life insurance subsidiaries of FIC was 23.
- 20 -
Website Access
Our website address is "www.ficgroup.com." Our filings with the Securities and
Exchange Commission (SEC) are available at no cost on our website as soon as
reasonably practicable after the filing of such reports with the SEC.
Segment Information
The principal operations of the Company's insurance subsidiaries are the
underwriting of life insurance and annuities. Accordingly, no separate segment
information is required to be provided by the Registrant for the three-year
period ending December 31, 2002.
Item 2. Properties
FIC's home office is located at River Place Pointe, 6500 River Place Blvd.,
Building One, Austin, Texas. River Place Pointe was purchased by Investors Life
in October 1998. It consists of 47.995 acres of land in Austin, Texas. The
aggregate purchase price for these tracts was $8.1 million. The site development
permit allowed for the construction of seven office buildings totaling 600,000
square feet, with associated parking, drives and related improvements.
Construction on the first section of the project, which consists of four office
buildings, an associated parking garage and related infrastructure was completed
during 2000 and 2001. The second section of construction, which includes three
more office buildings, an associated parking garage and related infrastructure,
was completed in 2002. FIC and its insurance subsidiaries occupy the entire
Building One of River Place Pointe, consisting of approximately 76,143 square
feet of space and approximately 5,000 square feet of Building Four, for records
storage. An associated facility of 10,000 square feet in Cedar Park, Texas, is
leased to house the company's printing operations and warehouse storage. The
monthly rental for the Cedar Park facility is $9,123.
Family Life and Investors Life lease their 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 on
October 31, 2003. The base rental is approximately $17,934 per month, which
includes Family Life's proportionate share of the building's operating expenses,
including parking, 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. Additionally,
Family Life and Investors Life lease 22,100 square feet of warehouse space at
Segalle Business Park, Tukwila, Washington, for the storage of records. The
monthly rental cost is $6,570 and the lease term expires on October 31, 2003.
- 21 -
ILCO leases a building located at 40 Parker Road, Elizabeth, New Jersey. This
building, which was formerly ILCO's headquarters building, contains
approximately 41,000 square feet of office space. The lease, which was signed in
December 1985 and expires in December 2005, calls for a minimum base rental of
$737,940 per annum. The lease provides that all costs including, but not limited
to, those for maintenance, repairs, insurance and taxes be borne by ILCO. ILCO
subleases this space to third parties.
The Company believes that its properties and leased space are adequate to meet
its foreseeable requirements.
Item 3. Legal Proceedings
The Company and its subsidiaries are defendants in certain legal actions related
to the normal business operations of the Company. Management believes that the
resolution of such legal actions will not have a material impact on the
financial statements.
Universal Life Litigation. On January 22, 2002, the Travis County District
Court in Austin, Texas, denied certification to a proposed nationwide class of
plaintiffs who purchased certain universal life insurance policies from INA Life
Insurance Company (which was merged into Investors Life in 1992). The lawsuit,
which was filed in 1996 as a "vanishing premium" life insurance litigation,
initially alleged that the universal life insurance policies sold to plaintiffs
by INA Life Insurance Company utilized unfair sales practices. In April 2001,
the plaintiffs filed an amended complaint, so as to include various post-sale
allegations, including allegations related to the manner in which increases in
the cost of insurance were applied, the allocation of portfolio yields to the
universal life policies and changes in the spread between the earned rate and
the credited rate. Plaintiffs' Motion for Class Certification was denied in its
entirety.
Litigation Relating to the FIC/ ILCO Merger. On the day that FIC and ILCO
each publicly announced the formation of a special committee to evaluate a
potential merger, two class action lawsuits were filed against ILCO, FIC and the
officers and directors of ILCO. The actions allege that a cash consideration in
the proposed merger is unfair to the shareholders of ILCO, that it would prevent
the ILCO shareholders from realizing the true value of ILCO, and that FIC and
the named officers and directors had material conflicts of interest in approving
the transaction. In their initial pleadings, the plaintiffs sought certification
of the cases as class actions and the named plaintiffs as class representatives,
and among other relief, requested that the merger be enjoined (or, if
consummated, rescinded and set aside) and that the defendants account to the
class members for their damages. The defendants believe that the lawsuits are
without merit and intend to vigorously contest the lawsuits. Management is
unable to determine the impact, if any, that the lawsuits may have on the
results of operations of the Company.
- 22 -
Litigation Relating to Former Chairman and CEO. In January, 2003, the
Company filed a lawsuit in Federal District Court in Austin, Texas. The lawsuit
names as defendants Roy F. Mitte ("Mitte"), The Roy F. and Joann Cole Mitte
Foundation (the "Foundation") and Joann Mitte (collectively referred to as the
"Defendants"). Mitte was the Chairman, President and Chief Executive Officer of
FIC until he was placed on administrative leave in August, 2002. The
administrative leave, and the subsequent action by the Board of Directors in
October, 2002 to terminate the employment agreement between FIC and Mitte,
resulted from an investigation conducted by the FIC Audit Committee.
The investigation conducted by the Audit Committee determined that more
than $540,000 in Mitte's personal expenses had been paid by Company funds
without the knowledge or approval of the FIC's officers or directors. In
addition, the investigation disclosed that Mitte had caused an unapproved
transfer of $1 million from the Company to the Foundation, followed by an
ineffective attempt to obtain an unanimous consent of the Board of Directors of
the Company. The Board of Directors has never met to ratify or approve the
donation. The Foundation is a shareholder of FIC.
The Company's claims against Mitte seek the reimbursement of $540,000 of
personal expenses which were paid by the Company for the benefit of Mitte over a
period of years beginning in 1992. In addition, the suit demands that Mitte
reimburse the Company for a payment which he caused to be made to the Foundation
without proper authorization by the Board of Directors.
On March 19, 2003, Mitte filed a counterclaim against the Company alleging
that the Company breached the employment agreement between FIC and Mitte by
refusing to pay Mitte the severance benefits and compensation provided for under
the employment agreement and amendment thereto. The Company believes that it
properly terminated the contract and intends to vigorously defend Mitte's
counterclaim.
The litigation is currently in the preliminary discovery stage.
Other Litigation. Additionally, FIC's insurance subsidiaries are regularly
involved in litigation, both as a defendant and as plaintiff. The litigation
naming the insurance subsidiaries as defendant ordinarily involves our
activities as a provider of insurance protection products. Management does not
believe that such litigation, either individually or in the aggregate, will have
a material adverse effect on the Company's business, financial condition or
results of operations.
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, 2002, to a vote of security holders.
- 23 -
PART II
Item 5. Market for the Registrant's Common Stock and Related Security Holder
Matters
A. Market Information
FIC's common stock is traded on the Nasdaq National Market (Nasdaq symbol:
FNIN). The following table sets forth the quarterly high and low closing prices
for FIC common stock for 2002 and 2001. Quotations are furnished by the National
Association of Securities Dealers Automated Quotation System ("Nasdaq").
Common Stock
Prices
High Low
2002
First Quarter $ 14.51 $13.30
Second Quarter 18.07 13.67
Third Quarter 17.55 14.60
Fourth Quarter 15.87 13.21
2001
First Quarter $ 14.75 $ 9.125
Second Quarter 16.90 11.90
Third Quarter 16.00 12.44
Fourth Quarter 14.90 13.00
B. Holders
As of February 28, 2003 there were approximately 15,473 record holders of FIC
common stock.
C. Dividends
In the year 2000, FIC paid a cash dividend in the amount of $0.18 per share,
which was payable on April 12, 2000, to shareholders of record on April 5, 2000.
In the year 2001, FIC paid three cash dividends. In March 2001, FIC announced
that its board approved the payment of a cash dividend for the year in the
amount of $0.41 per share. The dividend was paid on April 12, 2001, to
shareholders of record as of the close of business on March 19, 2001.
- 24 -
In May 2001, FIC announced that its Board approved a dividend policy. The policy
adopted by the Board anticipated that the Company would declare and pay, on a
semi-annual basis, a dividend on the common stock of the Company so as to
provide to shareholders with an annualized yield of approximately 3% of the
market value (based on the Nasdaq National Market quotation system).
Pursuant to the above-mentioned policy, in May 2001, FIC announced that its
Board of Directors approved the payment of a semi-annual cash dividend in the
amount of $0.25 per common share. The dividend was payable on July 2, 2001, to
record holders as of the close of business on June 18, 2001. On November 27,
2001 a dividend in the amount of $0.21 per common share was approved. This
dividend was payable on December 21, 2001 to record holders as of December 7,
2001.
In May, 2002, the Board of FIC approved a cash dividend of $0.23 per common
share payable on June 21, 2002 to record holders as of June 7, 2002. On December
13, 2002, the Board of Directors met to review and amend the previously-adopted
dividend policy of the Company. The Board adopted a new policy whereby it
anticipates the payment of a dividend on a semi-annual basis; however, the new
policy is designed to reflect a dividend based on the results of operations,
capital requirements and similar financial criteria of the Company, rather than
on the market price of the common stock of the Company. Pursuant to the new
policy, the Board declared a dividend of $0.05 per common share payable on
January 24, 2003 to record holders as of January 3, 2003.
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 subsidiaries. The right of
FIC's insurance subsidiaries to pay dividends is restricted by the insurance
laws of their domiciliary state. See Item 1. Business - Regulation - Dividends.
Further, FLC, which holds all of the stock of Family Life, is restricted from
paying dividends on its common stock by the provisions of the 1993 Subordinated
Loans. See Item 1. Business - Senior Subordinated Loans. FIC (as the successor
to the obligations of FLIIC) is also prohibited from paying dividends on its
stock by the provisions of the $4.5 million subordinated note held by Investors
Life. In order to provide for the payment of the cash dividends declared in 2001
and 2002, FIC received waivers from Investors Life on the above-described
restrictions of the loan agreements, thereby permitting FIC to make the dividend
payments to its shareholders.
- 25 -
Item 6. Selected Financial Data: (Registrant and its Consolidated Subsidiaries)
(In thousands, except per share data)
2002 2001 2000 1999 1998
Restated Restated Restated Restated
Total Revenues $118,715 $98,160 $44,418 $46,244 $52,293
(Loss) income before federal
income tax, equity in net
earnings of affiliates and
cumulative change in
accounting principle (8,358) 12,869 6,787 6,576 8,437
(Loss) income before equity in
net earnings of affiliates and
cumulative change in
accounting principle (5,087) 8,792 5,396 5,555 6,257
Equity in net earnings of
affiliate, net of tax 0 985 2,040 3,406 1,611
(Loss) income before
cumulative change in
accounting principle (5,087) 9,777 7,436 8,961 7,868
Cumulative change in
accounting principle 10,429 0 0 0 0
Net Income $ 5,342 $ 9,777 $ 7,436 $ 8,961 $ 7,868
- 26 -
Common Stock and Common
Stock Equivalents 9,555 7,824 5,055 5,200 5,557
Net income per share $0.56
Basic $1.25 $1.47 $ 1.77 $1.46
Diluted $0.56 $1.24 $1.44 $ 1.72 $1.42
Total Assets $1,311,002 $1,363,857 $289,955 $288,292 $296,164
Long Term Obligations $0 $0 $35,349 $ 41,497 $ 47,645
Cash dividends paid per share $0.28 $0.87 $0.18 $0 $0
In 2002, net income and earnings per share were affected by the cumulative
effect of a change in accounting principle of $10.4 million. This amount
represents the excess of fair value of net assets acquired over cost as of the
beginning of 2002 related to the merger of ILCO with and into a subsidiary of
FIC on May 18, 2001. In the Company's filings for the quarters ended March 31,
2002, June 30, 2002 and September 30, 2002, the company reported a cumulative
effect of a change in accounting principle of $15.7 million. Due to the
restatements, as described below in Item 7, the Company has restated the amount
of the excess of fair value of net assets over acquired cost to $10.4 million.
The Company recorded this cumulative effect in conjunction with adopting
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations," in the first quarter of 2002, as required by SFAS 141.
The results for the year ended December 31, 2001 were affected by the merger of
ILCO with and into a subsidiary of FIC on May 18, 2001. For a description of the
merger transaction, see "Item 7 - Management Discussion & Analysis -
Transactions Affecting Comparability of Results of Operations."
- 27 -
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Following is a discussion and analysis of the financial statements and other
statistical data that management believes will enhance the understanding of
FIC's financial condition and results of operations. This discussion should be
read in conjunction with the financial statements beginning on page F-1.
Forward-Looking Statements
Except for historical factual information set forth in this Management's
Discussion and Analysis, the statements, analyses, and other information
contained in this report relating to trends in the Company's operations and
financial results, the markets for the Company's products, the future
development of the Company's business, and the contingencies and uncertainties
to which the Company may be subject, as well as other statements including words
such as "anticipate," "believe," "path," "estimate," "expect," "intend" and
other similar expressions constitute forward-looking statements under the
Private Securities Litigation Reform Act of 1995. Such statements are made based
upon management's current expectations and beliefs concerning the financial
results, economic conditions and are subject to known and unknown risks,
uncertainties and other factors contemplated by the forward-looking statements.
Such factors include, among other things: (1) general economic conditions and
other factors, including prevailing interest rate levels and stock market
performance, which may effect the ability of FIC to sell its products, the
market value of FIC's investments, and the lapse rate and profitability of
policies; (2) FIC's ability to achieve anticipated levels of operational
efficiencies and cost-saving initiatives; (3) customer response to new products,
distribution channels and marketing initiatives; (4) mortality, morbidity and
other factors which may affect the profitability of FIC's subsidiaries'
insurance products; (5) changes in the Federal income tax laws and regulations
which may affect the relative tax advantages of some of FIC's products; (6)
increasing competition in the sale of life insurance and annuities; (7)
regulatory changes or actions, including those relating to regulation of
insurance products and insurance companies; (8) ratings assigned to FIC's
insurance subsidiaries by independent rating organizations such as A.M. Best
Company, which FIC believes are particularly important to the sale of annuity
and other accumulation products; and (9) unanticipated litigation. There can be
no assurance that other factors not currently anticipated by management will not
also materially and adversely affect FIC.
- 28 -
Introduction
As described in Note 2 to our accompanying consolidated financial statements
included in Item 8 of this Annual Report on Form 10-K and beginning with the
discussion on page F-21, we have restated our financial statements for the
fiscal years ended December 31, 2001, and 2000. The financial information for
all periods included in the following discussion gives effect to the
restatement.
For purposes of this Form 10-K and in accordance with rule 12b-15 under the
Securities Exchange Act of 1934, as amended, each item of the Form 10-K for the
years ended December 31, 2001 and 2000 as originally filed that were affected by
the restatement has been amended to the extent affected and restated in its
entirety. NO ATTEMPT HAS BEEN MADE IN THIS FORM 10-K TO MODIFY OR UPDATE OTHER
DISCLOSURES AS PRESENTED IN THE ORIGINAL FORM 10-K FOR THE YEAR ENDED DECEMBER
31, 2001 OR 2000 EXCEPT AS REQUIRED TO REFLECT THE EFFECTS OF THIS RESTATEMENT.
Restatement.
In the fourth quarter of 2002, the Company identified uncollectible receivables
for which adequate allowance had not been made and policyholder benefits and
expenses that were understated due to an interface error between the policy
administration system and the general ledger. The Company extended its
investigation to determine the years affected and expanded the scope of its
review to include other areas, including certain adjustments that were deemed
not material in prior years. As a result of this review, the Consolidated
Statements of Income for 2001 and 2000 and the Consolidated Balance Sheet for
2001 were restated as follows:
- 29 -
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31,
2001 2000
Previously Previously
Reported Restated Reported Restated
Revenues:
Premiums 35,886 35,887 33,149 33,149
Other 2,808 1,842 6 6
Total Revenues 99,125 98,160 44,418 44,418
Benefits and expenses:
Policyholder benefits and
expenses 27,702 30,149 13,453 13,453
Amortization of present value
of future profits of acquired
businesses 4,715 4,644 3,669 3,569
Amortization of deferred policy
acquisition costs 6,800 6,767 5,329 5,340
Operating expenses 23,046 22,868 11,375 11,159
Total Expenses 83,126 85,291 37,936 37,631
Income before federal income tax
and equity in net earnings of
affiliates 15,999 12,869 6,482 6,787
Provision for federal income taxes:
Current 3,937 3,937 1,521 1,521
Deferred 1,364 140 (237) (130)
Income before equity in net
earnings of affiliates 10,698 8,792 5,198 5,396
Equity in net earnings of affiliates,
net of tax 1,316 985 3,581 2,040
Net Income $12,014 $ 9,777 $8,779 $7,436
Basic earnings per share $1.54 $1.25 $1.74 $1.47
Diluted earnings per share $1.52 $1.24 $1.70 $1.44
- 30 -
CONSOLIDATED BALANCE SHEET
As of December 31,
2001
Previously
Reported Restated
ASSETS
Investments other than investments in affiliate:
Equity securities, at market value (cost
approximates $8,856 at December 31, 2001) $56 $8,279
Invested real estate 61,049 64,051
Total Investments 756,329 767,554
Agency advances and other receivables 30,324 17,309
Property and equipment, net 3,546 785
Deferred policy acquisition costs 80,290 77,137
Present value of future profits of acquired
businesses 31,251 30,530
Other assets 14,074 15,198
Separate account assets 399,264 391,593
Total Assets $1,378,829 $1,363,857
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred federal income taxes 31,920 27,197
Excess of net assets over acquired cost 15,847 10,429
Other liabilities 8,938 17,146
Total liabilities 1,199,353 1,197,420
Shareholders equity:
Accumulated other comprehensive income 2,297 327
Retained earnings 131,462 120,393
Total Shareholders' Equity before
Treasury Stock 201,373 188,334
Total Shareholders' Equity 179,476 166,437
Total Liabilities and Shareholders' Equity $1,378,829 $1,363,857
The consolidated statements of income for the years ended December 31, 2001 and
2000 were restated to reflect the following:
o A reduction in other revenue in 2001 of $966,000 primarily related to a
reclassification of negative goodwill amortization to operating expenses;
o An increase in policyholder benefits and expenses in 2001 of $2.4 million
related to certain death benefits and annuity benefits which were not
recorded due to an interface error between the Company's policy
administration system and its general ledger and a correction of an
unreconciled difference between suspense account balances included in the
Company's general ledger and those included in its policy administration
system.
- 31 -
o Decreases in the expense related to amortization of present value of future
profits of acquired business of $71,000 in 2001 and $100,000 in 2000 due to
an adjustment in the calculation in this expense;
o A decrease in the expense related to the amortization of deferred policy
acquisition costs of $33,000 in 2001 and an increase of $11,000 in 2000 due
to adjustments in assumptions to calculate amortization factors;
o An decrease in operating expenses of $179,000 in 2001 and a decrease in
operating expenses of $216,000 in 2000 due primarily to a reduction in rent
expense from the recognition of a deferred gain related to an operating
lease offset by expenses associated with uncollectible receivables, pension
expenses and reductions in negative goodwill amortization;
o A decrease in the provision for federal income taxes of $1.2 million in
2001 and an increase of $107,000 in 2000 due to the effect of the
restatements on net income before federal income tax and equity in net
earnings of affiliates; and
o Decreases in the equity in net earnings of affiliate of $331,000 in 2001
and $1.5 million in 2000 due to adjustments that decreased ILCO's net
income in 2001 and 2000.
The consolidated balance sheet as of December 31, 2001 was restated to reflect
the following:
o An increase to assets of $8.2 million in FIC's investments in equity
securities to properly reflect the market value of the Company's investment
in the separate account;
o An increase to invested real estate of $3.0 million primarily due to a
reclassification of certain real estate expenditures that were classified
as property and equipment;
o A decrease in assets of $13.0 million in agency advances and other
receivables primarily due to a write-off of uncollectible agent balances, a
write-off of a reinsurance receivable, and a write-off of assets related to
an interface error between the Company's policy administration system and
its general ledger;
o A decrease to property and equipment of $2.8 million primarily due to a
reclassification of property and equipment to invested real estate and a
write-off of assets that had not been depreciated since purchase;
o A decrease in assets of $3.2 million in deferred policy acquisition costs
due to a revision of the factors used to calculate Family Life's deferred
policy acquisition costs;
o A decrease in assets of $721,000 in present value of future profits of
acquired businesses due to an adjustment in the calculation of this asset;
- 32 -
o An increase to assets of $1.1 million of other assets primarily related to
the establishment of unrecorded pre-paid pension assets related to Family
Life's and ILCO's pension plans;
o A decrease in assets of $7.7 million of separate account assets due to a
reclassification of separate account assets to equity securities;
o A decrease in liabilities of $4.7 million related to deferred federal
income taxes;
o A decrease in liabilities of $5.4 million related to a reduction in excess
of net assets over acquired cost related to ILCO goodwill;
o An increase in liabilities of $8.2 million of other liabilities primarily
related to an unreconciled difference between suspense account balances
included in the Company's general ledger and those included in its policy
administration system.
o A decrease of $2.0 million of accumulated other comprehensive income due to
the changes in the accounting treatment for the pre-paid pension asset and
the separate account investment; and
o A decrease in retained earnings of $11.1 million due to the restatements.
Business Overview
Financial Industries Corporation ("FIC" or the "Company") is a holding company
engaged through its subsidiaries in the business of marketing, underwriting and
distributing a broad range of life insurance and annuity products in 49 states,
the District of Columbia and the U.S. Virgin Islands.
The Company's revenues are derived principally from:
* premiums on individual life insurance policies
* product charges from universal life insurance products and annuities
* net investment income and realized investment gains on assets
In accordance with Generally Accepted Accounting Principles ("GAAP"), universal
life insurance premiums and annuity deposits received are reflected on FIC's
consolidated balance sheets as increases in liabilities for contract holder
deposit funds and not as revenues.
Expenses consist principally of insurance benefits provided to policyholders,
interest credited on policyholder account balances, other operating costs and
expenses, which include commissions and general business expenses, net of
expenses deferred, amortization of present value of future profits of acquired
businesses and amortization of deferred policy acquisition costs, and premium
and income taxes. Surrender benefits paid relating to universal life insurance
policies and annuities are reflected as decreases in liabilities for contract
holder deposit funds and not as expenses.
- 33 -
The Company's profitability depends in large part upon: (1) the adequacy of our
product pricing, which is primarily a function of competitive conditions, our
ability to assess and manage trends in mortality and morbidity experience, our
ability to generate investment earnings and our ability to maintain expenses in
accordance with pricing assumptions; (2) the amount of assets under management;
and (3) the maintenance of our target spreads between the rate of earnings on
our investments and credited rates on policyholders' account balances.
Transactions Affecting Comparability of Results of Operations
On May 18, 2001, pursuant to an Agreement and Plan of Merger, as amended (the
"Merger Agreement"), dated as of January 17, 2001, among FIC, InterContinental
Life Corporation ("ILCO"), and ILCO Acquisition Company, a Texas corporation and
wholly-owned subsidiary of FIC ("Merger Sub"), Merger Sub was merged with and
into ILCO (the "Merger"). ILCO was the surviving corporation of the Merger and
became a wholly-owned subsidiary of FIC. In accordance with the Merger
Agreement, FIC issued 1.1 shares of common stock, par value $0.20 per share
("FIC Common Stock"), for each share of common stock, par value $0.22 per share,
of ILCO outstanding at the time of the Merger ("ILCO Common Stock"). In
addition, each share of ILCO Common Stock issuable pursuant to outstanding
options was assumed by FIC and became an option to acquire FIC Common Stock with
the number of shares and exercise price adjusted for the exchange ratio in the
Merger. Prior to the merger, FIC owned approximately 48.1% of ILCO's common
stock. Since ILCO was a wholly-owned subsidiary of FIC for the period from May
18, 2001 to December 31, 2001 and thereafter, the operations of ILCO are
reported on a consolidated basis with FIC in the year end 2001 financial
statements as well as for the year end 2002 financial statements. For the period
from January 1, 2001 to May 17, 2001, and for the year ended December 31, 2000,
FIC's net income includes its equity interest in the net income of ILCO, with
such equity interest being based on FIC's percentage ownership of ILCO.
In 2002, net income and earnings per share were affected by the cumulative
effect of a change in accounting principle of $10.4 million. This amount
represents the excess of fair value of net assets acquired over cost as of the
beginning of 2002 related to the merger of ILCO with and into a subsidiary of
FIC on May 18, 2001. In the Company's filings for the quarters ended March 31,
2002, June 30, 2002 and September 30, 2002, the company reported a cumulative
effect of a change in accounting principle of $15.7 million. Due to the
restatements, as described below in Item 7, the Company has restated the amount
of the excess of fair value of net assets over acquired cost to $10.4 million.
The Company recorded this cumulative effect in conjunction with adopting
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations," in the first quarter of 2002, as required by SFAS 141.
Results of Operations - Three Years Ended December 31, 2002
For the year ended December 31, 2002, FIC's net income was $5,342,000 (basic and
diluted earnings of $0.56 per common share) on revenues of $118,715,000 as
compared to net income for the year ended December 31, 2001, which was
$9,777,000 (basic earnings of $1.25 per common share or diluted earnings of
$1.24 per common share) on revenues of $98,160,000 and net income for the year
ended December 31, 2000, which was $7,436,000 (basic earnings of $1.47 per
common share or diluted earnings of $1.44 per common share) on revenues of
- 34 -
$44,418,000. The net loss for the year ended December 31, 2002, before the
cumulative effect of a change in accounting principle, was $5,087,000 (basic and
diluted earnings of ($0.53) per common share).
The per share results for the year ended December 31, 2002 were affected by the
increase in the number of FIC's common shares outstanding due to the Merger. As
of December 31, 2002, the number of FIC's weighted average common shares
outstanding was 9,555,000, as compared to weighted average shares outstanding of
7,824,000 as of December 31, 2001. The December 31, 2001 weighted average shares
outstanding takes into account the fact that additional shares were issued on
May 18, 2001 due to the Merger and were outstanding only for the period from May
18, 2001 to December 31, 2001. Additionally, net income and earnings per share
were affected by the cumulative effect of a change in accounting principle of
$10.4 million, as described in "Transactions Affecting Comparability of Results
of Operations."
The decrease of $13.9 million in net income for the year 2002, before the
cumulative effect of change in accounting principle, was primarily attributable
to the following factors: (i) a decrease in investment income; (ii) a net
realized loss on investments relating to impairments; (iii) an increase in death
benefits; (iv) an increase in operating expenses and (v) decreases in premium
income. The increase in net income for the year 2001 as compared to 2000 was
primarily attributable to the Merger, which consolidated 100% of ILCO's net
income subsequent to the May 18, 2001 Merger, with FIC's net income.
Revenues.
Premium revenues reported for traditional life insurance products are recognized
when due. Premium income, net of reinsurance ceded, for the year 2002, was $35.7
million, as compared to $35.9 million for the year 2001 and $33.1 million for
the year 2000. This source of revenues is related to the traditional life
insurance book of business of FIC's insurance subsidiaries. For the year ended
December 31, 2002, Investors Life contributed approximately $8.7 million and
Family Life contributed approximately $27.0 million to premium income. The
consolidation of ILCO's operations following the Merger contributed
approximately $5 million and Family Life contributed approximately $31 million
to premium income for the year ended December 31, 2001. At Family Life (which
has been a subsidiary of FIC for all of the year-end periods covered by this
report), first year net collected premiums for traditional life insurance
products in 2002 were $2.6 million as compared to $3.4 million in 2001. The
level of net collected premiums for traditional life insurance products at
Family Life for the year 2002 was $23.7 million, as compared to $25.8 million
for the year 2001 and $27.7 million for the year 2000. The decrease in renewal
premium is attributable to the decrease in the traditional life insurance book
of business.
Income from universal life and annuity charges for the year ended December 31,
2002 was $42.0 million, as compared to $27.7 million for the year 2001 and $4.3
million in 2000. The increase from 2001 to 2002 was primarily attributable to
the contribution of ILCO's operations for the full year in 2002 as compared to
the period from May 18 to December 31 in 2001. The consolidation of ILCO's
operations following the Merger contributed approximately $24.0 million to
- 35 -
earned insurance charges for the year ended December 31, 2001. At Family Life,
earned insurance charges declined from $3.4 million in the year 2001 to $2.8
million in the year 2002. The amount is consistently decreasing because Family
Life reinsures all of its new universal life and annuity business with Investors
Life and thus earned insurance charges received are attributable to a closed,
decreasing book of business. At Investors Life, earned insurance charges
decreased from $39.5 million in the year 2001 to $39.2 million in the year 2002.
The face amount of in force universal life policies at Family Life was $721.1
million at December 31, 2001 as compared to $588.9 million at December 31, 2002.
The face amount of in force universal life policies at Investors Life (including
Investors-IN) was $4,676.9 million at December 31, 2001 as compared to $4,446.1
million at December 31, 2002.
Net investment income for the year ended December 31, 2002 was $40.3 million as
compared to $30.7 million for the year ended December 31, 2001 and $6.9 million
for the year ended December 31, 2000. The increase in net investment income from
year end 2001 to year end 2002 was attributable to the contribution of ILCO's
operations for the full year in 2002 as compared to the period from May 18 to
December 31 in 2001. Approximately $24 million of the increase in net investment
income for the year ended December 31, 2001 as compared to the year ended
December 31, 2000 was attributable to the consolidation of ILCO's operations for
the period from May 18, 2001 to December 31, 2001. At Investors Life net
investment income decreased from $47.9 million in 2001 to $41.7 million in 2002.
The decrease was primarily attributable to lower interest rates on short-term
investments as well as the sale of investments to pay for the continued
construction at River Place Pointe. See "Investments - Real Estate" for a
description of the River Place Pointe investment. The level of net investment
income contributed by the investment portfolio of Family Life for the year ended
December 31, 2002 was $5.6 million. Net investment income at Family Life was
adversely affected by the decline in the level of interest income received from
fixed income and short-term investments. This decline is attributable to lower
interest rates during the period.
Real estate income is primarily earned from the leases on the buildings at River
Place Pointe, an office complex in Austin, Texas, which is owned and being
developed by Investors Life. Net real estate income was $2.6 million for the
year ended December 31, 2002, as compared to $1.9 million for the year ended
December 31, 2001. Investors Life's real estate income was included in FIC's
income statements from May 18, 2001 through December 31, 2001 and for the year
ended December 31, 2002. For the year ended December 31, 2000, FIC did not have
any real estate income.
For the year ended December 31, 2002, FIC had a $2.8 million realized loss on
investments, compared to a $65,000 net realized gain in 2001 and $7,000 gain in
2000. The Company identified one bond at December 31, 2002, which was considered
to be impaired and reduced its carrying value by $463,000. Also at December 31,
2002, the Company determined that its investment in its separate accounts was
impaired and reduced its carrying value by $2.4 million. There were no
impairments in the value of investments in 2001 and 2000 which were considered
other than temporary.
- 36 -
Benefits and Expenses.
Policyholder benefits and expenses were $48.2 million in 2002, as compared to
$30.1 million in 2001 and $13.5 million in 2000. The increase of $18.1 million
from year ended December 31, 2001 to December 31, 2002 was partly attributable
to the inclusion of ILCO's expenses for the full year in 2002 as compared to the
period from May 18 to December 31 in 2001. The consolidation of ILCO's
operations for the period from May 18, 2001 to December 31, 2001 contributed
approximately $19 million to policyholder benefits and expenses for the year
ended December 31, 2001. At ILCO's insurance subsidiaries, the level of
policyholder benefits and expenses was $32.5 million in the year 2000, $32.4
million in the year 2001 and $37.3 million in the year 2002. The increase from
2001 to 2002 is attributable to increases in death benefit claims. At Family
Life, the level of policyholder benefits and expenses decreased from $13.5
million for the year 2000 to $10.1 million for the year 2001 and increased to
$10.7 million for the year 2002, which decreases are attributable to decreases
in death benefit claims as well as decreases in reserves due to higher than
expected lapse rates in Family Life's traditional life business.
Interest expense on contract holders deposit funds was $29.7 million for the
year 2002, as compared to $19.9 million for the year 2001 and $2.2 million for
the year 2000. The increase from 2001 to 2002 was due to the inclusion of ILCO's
expenses for the full year in 2002 as compared to the period from May 18 to
December 31 in 2001. The increase from 2000 to 2001 is primarily attributable to
$17.5 million of interest expense on contract holders deposit funds resulting
from the consolidation of ILCO's operations following the Merger. This expense
is related to payment of interest to policyholders for cash values accumulated
in their accounts.
The expense related to the amortization of present value of future profits of
acquired businesses was $4.6 million for the year ended December 31, 2002, as
compared to $4.6 million at December 31, 2001 and $3.6 million at December 31,
2000. The consolidation of ILCO's amortization expense with FIC's contributed
approximately $1 million for the year ended December 31, 2001.
The costs related to acquiring new business, including certain costs of issuing
policies and certain other variable selling expenses (principally commissions),
are deferred policy acquisition costs ("DAC"). The expense related to the
amortization of DAC was $10.4 million for the year ended December 31, 2002, $6.8
million for the year ended December 31, 2001, and $5.3 million for the year
ended December 31, 2000. A portion of the increase in this expense from 2001 to
2002 is attributable to the Merger. For the year ended December 31, 2002, the
Company has capitalized DAC based on an updated analysis of its cost structure
and assumptions as to product performance. For business written prior to January
1,2002, DAC was amortized using methods and practices which had been adopted at
the time the products were introduced. For 2002, costs capitalized were
approximately $3.3 million less than acquisition costs incurred as determined by
the updated analysis. See "Critical Accounting Policies, Deferred Policies
Acquisition Costs and Present Value of Future Profits of Acquired Business"
herein for a further discussion of capitalization of expenses related to
acquiring new business.
- 37 -
Operating expenses for 2002 were $34.2 million, as compared to $22.9 million in
2001 and $11.2 million in 2000. The consolidation of ILCO's operations
contributed approximately $22.6 million to operating expenses for the year ended
December 31, 2002 as compared to $11.0 million for the period from May 18, 2001
to December 31, 2001. The level of operating expenses for the year 2002
included: (i) expenses related to acquiring new business; (ii) $636,312 related
to the repurchase of James M. Grace's employment contract; (iii) a transfer of
funds of $1 million to the Roy F. and Joann Cole Mitte Foundation which was made
in January, 2002, as compared to a $375,000 donation in 2001; (iv) $448,841 of
costs incurred due to the investigation of the matters described in the
Registrant's Current Report on Form 8-K filed with the Securities and Exchange
Commission on August 15, 2002; and (v) a charge of $799,000 for uncollectible
agent balances. For a further discussion of the repurchase of Mr. Grace's
employment contract and the transfer of funds to the Mitte Foundation, see FIC's
10-K for the year ended December 31, 2001, dated April 1, 2002. The level of
operating expenses for the year 2001 included certain non-recurring expenses
related to the favorable resolution of the vanishing premium litigation (see
"Item 3. Legal Proceedings - Universal Life Litigation") and the implementation
of the correction procedure set forth by the Internal Revenue Service in Rev.
Proc. 2001-42 for Modified Endowment Contracts.
Interest expense for 2002 was $0, as compared to $0.9 million in 2001 and $1.9
million in 2000. The decrease in the amount of interest expenses from 2000 to
2001 is attributable to the scheduled reduction in the amount of outstanding
indebtedness. This interest expense is related to the indebtedness owed to
Investors Life by Family Life Corporation and FIC and for the year ended
December 31, 2001 includes the amount of interest for the period from January 1,
2001 to May 18, 2001. The consolidation of ILCO's operations with those of FIC
for periods following the May 18th Merger results in the elimination of this
interest expense in the consolidated income statements of FIC and thus the
post-Merger interest expense is $0.
The provision for federal income taxes was ($3.3) million in 2002, as compared
to $4.1 million in 2001 and $1.4 million in 2000. The decrease in taxes was due
to the $21.2 million decrease in income (before federal income tax, equity in
net earnings of affiliates and cumulative effect of change in accounting
principle) for the year ended December 31, 2002 compared to the year ended
December 31, 2001. The inclusion of ILCO's results for the period from May 18,
2001 to December 31, 2001 contributed approximately $2.6 million to the level of
federal income taxes for the year 2001 as compared to 2000. Because of the
Merger and subsequent consolidation of FIC and ILCO's provision for federal
income taxes, FIC is not able to utilize the small company tax deduction, which
provided lower tax rates. The increase in federal income taxes due to the loss
of this deduction in 2001 was $343,227. Further, for the year ended December 31,
2000, FIC and ILCO each paid, and were each able to deduct $1 million of excess
compensation. Due to the Merger, the Company incurred approximately $100,000 in
additional federal income taxes in 2001 due to the non-deductibility of a
portion of Roy F. Mitte's salary. However, since Mr. Mitte was not an executive
with the Company on December 31, 2002, which is the relevant date for measuring
deductibility of compensation under section 162(m) of the Code, his entire
compensation for 2002 is deductible and thus the Company will not incur
additional federal income taxes related to excess compensation in 2002.
- 38 -
Results of Operations - Three Months Ended December 31, 2002
as compared to the Three Months Ended December 31, 2001
For the three-month period ended December 31, 2002, FIC's net income before the
cummulative effect of change in accounting principle was (5.8) million (basic
and diluted earnings of (6.0 per common share) on revenues of $26.0 million as
compared to the restated net income of $2.4 million (basic and diluted earnings
of $0.25 per common share) on restated total revenues of $31.9 million in the
last three months of 2001. The decrease in net income and total revenues from
the three-month period ended December 31, 2001 to the same period in 2002 is
attributable to (i) a decrease in investment income; (ii) a net realized loss on
investments relating to impairments; (iii) an increase in death benefits; (iv)
an increase in operating expenses.
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. FIC is an insurance
holding company whose principal assets consist of the outstanding capital stock
of its insurance subsidiaries - Family Life Insurance Company ("Family Life"),
Investors Life Insurance Company of North America ("Investors Life"), and prior
to February 19, 2002, Investors Life Insurance Company of Indiana
("Investors-IN"). Prior to the merger of FIC and ILCO on May 18, 2001, the
principal assets of FIC consisted of the common stock of its insurance
subsidiary, Family Life, and its equity ownership in ILCO. As a holding company,
FIC's ability to meet its cash requirements, pay interest on any debt, pay
expenses related to its affairs and pay dividends on its common stock
substantially depends upon dividends from its subsidiaries.
Prior to June 2001, the principal source of liquidity for FIC and its
wholly-owned subsidiary, Family Life Corporation, consisted of the periodic
payment of principal and interest by Family Life pursuant to the terms of the
surplus debenture issued in connection with the Family Life acquisition from
Merrill Lynch. The surplus debenture was completely paid off as of June 30,
2001. For periods subsequent to June 30, 2001, FIC's available source of
liquidity will be dividends paid to it from its subsidiaries. Applicable state
insurance laws generally restrict the ability of insurance companies to pay cash
dividends in excess of prescribed limitations without prior approval.
The ability of Family Life and Investors Life to pay shareholder dividends is
and will continue to be subject to restrictions set forth in the insurance laws
and regulations of Washington, their domiciliary state. Washington limits how
and when Family Life and Investors Life can pay shareholder dividends by (a)
including the "greater of" standard for payment of dividends to shareholders,
(b) requiring that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and (c) requiring that cash dividends be paid
only from earned surplus. Under the "greater of" standard, an insurer may pay a
dividend in an amount equal to the greater of: (i) 10% of the policyholder
surplus or (ii) the insurer's net gain from operations for the previous year. In
2002, Investors Life paid a dividend to its parent corporation, ILCO, of
$8,556,104 (based upon earned surplus of $48.4 million and net gain from
operations of $8.56 million in the year 2001). ILCO, a holding company, does not
have any restrictions on payments of dividends and paid a dividend of $8,556,104
to FIC in January, 2003. Investors Life had earned surplus of $42.3 million and
a net gain from operations of $3.6 million for 2002 and Family Life had earned
surplus of $1.5 million and a net gain from operations of $0.13 million in 2002.
- 39 -
Sources of cash for FIC's insurance subsidiaries consist of premium payments
from policyholders and annuity holders, charges on policies and contracts,
investment income, and proceeds from the sale of investment assets. These funds
are applied primarily to provide for the payment of claims under insurance and
annuity policies, payment of policy withdrawals, surrenders and loans, operating
expenses, taxes, investments in portfolio securities, and shareholder dividends.
FIC's cash and cash equivalents at December 31, 2002 was $25.0 million as
compared to $7.1 million at December 31, 2001 and $2.7 million at December 31,
2000. The increase in cash and cash equivalents was primarily due to maturities
and early redemptions of fixed income investments that occurred during December,
2002, resulting in an increased cash position pending reinvestment. The $4.4
million increase in cash and cash equivalents at December 31, 2001 from 2000 was
due primarily to the Merger and the cash acquired in the purchase.
FIC's net cash flow provided by operating activities was $7.6 million for the
year 2002. In the year 2001, net cash flow used in by operating activities was
($2.7) million; net cash flow provided by operating activities was $0.3 million
for the year 2000. The increase in cash used in operating activities of $10.3
million from 2002 to 2001 was attributable to a lower than expected level of
surrenders of insurance and annuity policies which contributed to a smaller
decrease in policy liabilities.
Net cash flow provided by investing activities was $20.6 million in 2002, as
compared to $15.4 million in 2001 and $9.1 million in 2000. The increase in
cash provided by investing activities from 2001 to 2002 was primarily
attributable to the increase in cash due to proceeds from the sales and
maturities of fixed maturities. The increase in cash provided by investing
activities from 2001 to 2000 was due to the purchase of ILCO, which provided
$9.1 million, and a $14.8 million increase in proceeds from short-term
investments. These amounts were offset by a ($18.1) million investment in real
estate.
Net cash flow used in financing activities was ($10.3) million in 2002, as
compared to ($13.8) million in 2001 and ($7.3) million in 2000. Payment of cash
dividends to stockholders attributed to $2.2 million of cash used in financing
for 2002, as compared to $6.0 million in 2001 and $0.9 million in 2000; however,
repayment of subordinated notes payable decreased from ($6.1) million in 2000 to
($1.5) million in 2001 and $0 in 2002 due to the Merger. In 2002, contractholder
fund withdrawals exceeded deposits by $8.7 million, while in 2001 withdrawals
exceeded deposits by $4.4 million.
A primary liquidity consideration with respect to life insurance and annuity
products is the risk of early policyholder and contractholder withdrawal.
Deposit fund liabilities for universal life and annuity products as of December
31, 2002 were $557.5 million, as compared to $556.1 million at December 31,
2001. Individual life insurance policies are less susceptible to withdrawal than
are annuity contracts because policyholders may incur surrender charges and
undergo a new underwriting process in order to obtain a new insurance policy. At
December 31, 2002, the bulk of the liabilities for contractholder deposit funds
on FIC's balance sheet, $419.1 million, were related to insurance products, as
compared to only $138.4 million of annuity product liabilities.
- 40 -
The cash requirements of FIC, and its holding company subsidiary, Family Life
Corporation, consist primarily of its service of the indebtedness created in
connection with FIC's ownership of Family Life. As of December 31, 2002, the
investment portfolio of Investors Life included $23.05 million of notes
receivable from affiliates, represented by (i) a loan of $30 million by
Investors Life to Family Life Corporation made in July 1993, in connection with
the prepayment of indebtedness which had been previously issued to Merrill Lynch
as part of the 1991 acquisition of Family Life Insurance Company by a
wholly-owned subsidiary of FIC, and (ii) a loan of $4.5 million by Investors
Life to Family Life Insurance Investment Company made in July 1993, in
connection with the same transaction described above.
The provisions of the notes owned by Investors Life include the following
provisions: (a) the $30 million note provides for 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%, and (b) the $4.5 million note provides for 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%.
Due to the Merger, this indebtedness is not included as a liability on the
consolidated financial statements of FIC. FIC's other liquidity requirements
relate principally to the need for cash flow to meet operating expenses, as well
as the liabilities associated with its insurance subsidiaries' various life
insurance and annuity products.
In 2002, management reviewed the Company's liquidity to determine whether the
cash, cash equivalents and short term investments of the Company were sufficient
to meet the Company's needs for cash for operations, capital requirements and
commitments. Based on such review, management determined that it would be in the
Company's best interest to reduce the amount of dividends paid to shareholders
(see "Item 5- C. Dividends"), to discontinue donations to the Mitte Foundation
and to streamline certain operations of the Company. Based on this review and
the subsequent initiatives set forth by management, management believes that the
cash, cash equivalents and short term investments of FIC and its subsidiaries
are sufficient to meet the needs of its business and to satisfy debt service.
There are no trends, commitments or capital asset requirements that are expected
to have an adverse effect on the liquidity of FIC.
- 41 -
Investments
General
The life insurance subsidiaries of FIC maintain a diversified portfolio of
investments which is supervised by an in-house staff. Investment policies and
significant individual investments are subject to approval by the board of
directors of each of the life insurance subsidiaries, in accordance with
applicable state insurance regulatory requirements. Management regularly
monitors individual assets and the overall asset mix. In the first quarter of
2003, the Board of Directors of FIC enhanced its oversight responsibilities with
respect to portfolio management by establishing an Investment Committee
consisting of three independent directors. In addition to its responsibilities
with respect to the review of investment guidelines, the FIC Investment
Committee monitors internal controls pertaining to the purchase and sale of
investments.
Investment Strategy
The assets of FIC's life insurance subsidiaries must comply with applicable
state insurance laws and regulations. In selecting investments for the
portfolios of its life insurance subsidiaries, the 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 general
investment objective of the Company 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. We determine the allocation of our
assets primarily on the basis of cash flow and return requirements of our
products and secondarily by the level of investment risk.
Another key element of the Company's investment strategy is to avoid large
exposure in other investment categories which the Company believes carry higher
credit or liquidity risks, including private placements, partnerships and bank
participations. These categories accounted for only $26,049 of invested assets
at December 31, 2002 as compared to $45,479 at December 31, 2001.
Overall Composition of Investments.
The diversified portfolio of investments of FIC's life insurance subsidiaries
includes public and private fixed maturity securities and real estate
investments. All of FIC's invested assets are invested in the United States.
Invested assets, excluding separate accounts, totaled $761.2 million and $767.6
million as of December 31, 2002 and December 31, 2001, respectively.
- 42 -
The following table summarizes invested assets by asset category, excluding
separate account assets, as of December 31, 2002 and 2001: (in thousands)
Invested Assets
December 31,
2002 2001
(Restated)
Carrying % of Carrying % of
Value Total Value Total
Fixed maturity securities available
for sale:
Public $493,827 64.9% $501,395 65.3%
Private 0 0
Fixed maturity held to maturity
Public 1,064 0.1 983 0.1
Private 26 * 46 *
Equity securities 6,351 0.8 8,279 1.1
Policy loans 46,607 6.1 49,794 6.5
Mortgage loans 17 * 4,715 0.6
Invested Real estate 75,393 9.9 64,051 8.3
Short-term investments 137,944 18.1 138,291 18.0
Total invested assets 761,229 100% 767,554 100%
* = less than 0.1% of total invested assets
The decrease in invested assets is primarily attributable to a $7.6 million
decrease in the market value of fixed maturities available for sale, a $1.9
million decrease in the market value of equity securities, a $3.2 million
decrease in policy loans, and a $4.7 million decrease in mortgage loans. These
amounts are offset by an $11.3 million increase in invested real estate.
Fixed Maturity Securities.
The Company's fixed maturity securities portfolio is predominately comprised of
low risk, investment grade, available for sale publicly traded corporate
securities, mortgage-backed securities and United States Government bonds. As of
December 31, 2002, the market value of the fixed maturities available for sale
segment was $493.8 million as compared to an amortized cost of $479.4 million or
an unrealized gain of $14.4 million. The increase reflects unrealized gains on
such investments related to changes in interest rates subsequent to the purchase
of such investments. At December 31, 2001, the market value of the fixed
- 43 -
maturities available for sale segment was $501.4 million as compared to an
amortized cost of $496.7 million. The lower level of assets held in the fixed
maturities available for sale segment is attributable to the early redemption of
longer- term fixed maturity investments by the issuer. The proceeds of these
early redemptions were reinvested in short-term investments at the lower level
of interest rates that prevailed throughout the year 2002. For the year 2003,
the investment objectives of FIC's insurance subsidiaries include a strategy of
reducing the concentration in short-term investments by making selected
investments in medium-term fixed income investments, including CMO instruments.
The investments of FIC's insurance subsidiaries in mortgage-backed securities
included collateralized mortgage obligations ("CMOs") of $175.4 million, and
mortgage-backed pass-through securities of $29.6 million, at December 31, 2002.
Mortgage-backed pass-through securities, sequential CMO's and support bonds,
which comprised approximately 57.8% of the book value of FIC's mortgage-backed
securities at December 31, 2002, are sensitive to prepayment and extension
risks. FIC's insurance subsidiaries have reduced the risk of prepayment
associated with mortgage-backed securities by investing in planned amortization
class ("PAC"), target amortization class ("TAC") instruments and scheduled
bonds. These investments are designed to amortize in a predictable manner by
shifting the risk of prepayment of the underlying collateral to other investors
in other tranches ("support classes") of the CMO. At December 31, 2002, PAC and
TAC instruments and scheduled bonds represented approximately 43.0% of the book
value of FIC's mortgage-backed securities. Sequential and support classes
represented approximately 10.4% of the book value of FIC's mortgage-backed
securities at December 31, 2002. Previously, FIC's insurance subsidiaries have
avoided investments in mortgage-backed securities with increased prepayment
risk, such as interest-only stripped pass-through securities and inverse floater
bonds. Beginning in December 2002, the insurance subsidiaries made selected
investments in CMOs of the inverse floater category. Such instruments, which are
subject to strict quantitative and qualitative standards, carry a higher current
interest rate. Our investment guidelines do not permit the purchase of CMOs
which are interest only or principal only instruments. 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. For the year
2003, the investment objectives of FIC's insurance subsidiaries include a
strategy of reducing the concentration in short-term investments by making
selected investments in a variety of medium-term CMO instruments.
The securities valuation office (SVO) of the National Association of Insurance
Commissioners evaluates all public and private bonds purchased as investments by
insurance companies. The SVO assigns one of six investment categories to each
security it reviews. Category 1 is the highest quality rating, and Category 6 is
the lowest. As of December 31, 2002, the majority of our bonds are investment
grade (Category 1 and 2). The Company's fixed maturities portfolio (including
short-term investments), included only a non-material amount of debt securities
which, in the annual statements of the companies as filed with state insurance
departments, were designated by the SVO as "3" (medium quality) or below.
- 44 -
FIC's short-term investments consist primarily of U.S. Government bonds. The
level of short-term investments at December 31, 2002 was $137.9 million, as
compared to $138.3 million as of December 31, 2001.
Equity Securities.
FIC's equity securities consist primarily of its investment in the separate
account. As of December 31, 2002, the market value of FIC's equity securities
was $6.4 million compared to $8.3 million at December 31, 2001. The decrease
from 2002 to 2001 is related to a decline in the value of the underlying funds
in the separate account.
Real Estate.
Invested real estate at December 31, 2002 was $75.4 million, as compared to
$64.1 million at December 31, 2001. The real estate investment is primarily
related to the development of the River Place Pointe project ("River Place
Pointe") by Investors Life, a subsidiary of ILCO. In October 1998, Investors
Life purchased River Place Pointe, which consisted of two adjoining tracts of
land located in Austin, Texas totaling 47.995 acres. The aggregate purchase
price for these tracts was $8.1 million. Investors Life obtained a Site
Development Permit for the tracts from the City of Austin allowing for the
construction of seven office buildings totaling 600,000 square feet, with
associated parking, drives and related improvements. Construction on the first
section of the Project, which consists of four office buildings, an associated
parking garage, and related infrastructure was completed during 2000 and 2001.
Construction on the second section of the Project, which consists of three
office buildings, an associated parking garage, and related infrastructure, was
completed in 2002.
As of December 31, 2002, Investors Life had invested $93.7 million in the
construction of River Place Pointe, of which $19.7 million is recorded on FIC's
balance sheet as real estate occupied by the Company. Investors Life paid $13.5
million during 2002 for the construction of the project. FIC and its insurance
subsidiaries occupy all of Building One at River Place Pointe, consisting of
approximately 76,143 square feet of space, and additionally occupies
approximately 5,000 square feet of Building Four of River Place Pointe. As of
December 31, 2002, 222,007 rentable square feet of office space was leased to
third party tenants and 281,682 rentable square feet was available for lease.
According to the Federal Deposit Insurance Corporation's ("FDIC") National
Edition of Regional Outlook, Fourth Quarter, 2002 "the vacancy rate in Austin
has risen almost fivefold in three years, the most dramatic increase in the
country the Austin suburban (office) market reported an office vacancy rate of
27.2 percent as of September 30, 2002, the highest in the nation, with about 10
percent attributable to sublease space."
The Company views the River Place Pointe investment as a long term commitment.
Based on this assumption, the Company has examined future anticipated cash flow
on the development and has determined that the investment is not impaired.
- 45 -
Mortgage Loans.
As of December 31, 2002, $0.02 million was invested in mortgage loans as
compared to $4.7 million at December 31, 2001. The Company does not make new
mortgage loans on commercial properties. All of the Company's mortgage loans
were made by its subsidiaries prior to their acquisition by the Company. At
December 31, 2002, none of the mortgage loans held by the Company had defaulted
as to principal or interest for more than 90 days, and none of the Company's
mortgage loans were in foreclosure. The decrease in mortgage loans from 2001 to
2002 was due to the pay off of two mortgage loans during the third quarter of
2002. The Company participated with a third party in two mortgage loans in the
state of New York - Champlain Centre Mall and Salmon Run Mall, with a total
balance due of $4.60 million at June 30, 2002. On June 18, 2002, the Company
agreed to a proposed payoff of these loans at a discount. The borrower paid off
the loans in August, 2002, with a payment of $3.64 million. The Company reduced
the carrying value of the two loans by $0.96 million as of June 30, 2002 as an
impairment of an invested asset.
Policy Loans.
Policy loans totaled $46.6 million at December 31, 2002, as compared to $49.8
million at December 31, 2001.
Critical Accounting Policies
The financial statements contain a summary of FIC's critical accounting
policies, including a discussion of recently-issued accounting pronouncements.
Certain of these policies are considered to be important to the portrayal of
FIC's financial condition, since they require management to make difficult,
complex or subjective judgments, some of which may relate to matters that are
inherently uncertain. These policies include valuation of: investments, deferred
acquisition costs and present value of future profits, and future policy
benefits. For the year 2001, the Company's critical accounting policies also
included the purchase accounting for ILCO.
Cumulative Effect of Accounting Changes. During the first quarter of 2002, the
Company adopted Statement of Financial Accounting Standards ("SFAS") No. 141,
"Business Combinations." SFAS No. 141 eliminates the practice of amortizing and
deferring excess of fair value of net assets acquired over cost and requires
unallocated negative goodwill to be recognized immediately. In accordance with
the standard, FIC ceased negative goodwill amortization on January 1, 2002 and
recognized the unamortized balance of $10.4 million of negative goodwill
acquired in the Merger.
Investments.
The Company's investments primarily consist of fixed maturity securities, which
include bonds, notes and redeemable preferred stocks. Fair values of investments
in fixed securities are based on quoted market prices or dealer quotes. Fixed
maturities are classified as "available for sale" and are reported at fair
value, with unrealized investment gains and losses, net of income taxes,
credited or charged directly to shareholder's equity. Generally accepted
accounting principles require that investments be written down to fair value
when declines in value are considered other than temporary. When such
impairments occur, the decrease in value is reported in net income as a realized
investment loss and a new cost basis is established.
- 46 -
Deferred Acquisition Costs and Present Value of Future Profits.
The costs of acquiring new business, including certain costs of issuing policies
and certain other variable selling expenses (principally commissions), are
deferred policy acquisition costs ("DAC"). DAC is capitalized and then amortized
to reflect an expense in relation to the projected stream of profits (for
universal life and annuity products) or to the premium revenue (for traditional
life products). Such projections require use of certain assumptions, including
interest margins, product loads, mortality rates, persistency rates, and
maintenance expense levels. Effective with respect to new business issued on and
after January 1, 2002, the Company has capitalized DAC based on an updated
analysis of its cost structure and assumptions as to product performance. For
business written previously, DAC is amortized using previously established
methods and practices. Management periodically reviews the assumptions
associated with the amortization models prospectively.
Present value of future profits of acquired business ("PVFP") are the costs
associated with acquiring blocks of insurance from other companies or through
the acquisition of other companies. PVFP is capitalized and amortized in a
manner that matches these costs against the associated revenues.
Future Policy Benefits.
Future policy benefits comprise 15% of FIC's total liabilities at December 31,
2002. These liabilities are estimated using actuarial methods based on
assumptions about premiums, interest yields, investment returns, expenses,
mortality, morbidity, and persistency. These assumptions consider Company
experience and industry standards. The assumptions vary by plan, age at issue,
year of issue and duration.
Purchase Accounting for ILCO.
The acquisition of ILCO was accounted for as a purchase; accordingly, the
results of ILCO's operations from May 18, 2001 to December 31, 2001 and for the
entire year 2002 are included in FIC's consolidated results of operations at
December 31, 2001 and 2002.
For the period from January 1, 2001 to May 17, 2001, and for the year 2000,
FIC's net income includes its equity interest in the net income of ILCO, with
such equity interest being based on FIC's percentage ownership of ILCO.
For a further discussion of accounting standards, see Note 1 to our audited
consolidated financial statements, beginning on page F-13.
- 47 -
Subsequent Events
Solomon Smith Barney Review
In December 2002, the Company received an unsolicited indication of
interest from the Pillar Foundation Group ("Pillar"). As previously publicly
disclosed by the Company, the Company believes that the letters sent to FIC by
Pillar did not constitute an offer. Rather, the letter stated that it was as an
indication of interest to enter into a letter of intent at an undefined future
time with respect to the acquisition of all or part of the outstanding common
shares of FIC at a tentative valuation of $13 to $18 per share. Pillar did not
indicate the source of funds for any such transaction, nor the structure or
timing of any possible transaction. Furthermore, Pillar stated in the letter
that any transaction would be subject to numerous due diligence and other
identified and unnamed conditions, such as determination of a final price,
regulatory and board approvals, and execution by sellers of a satisfactory stock
purchase agreement. In fact, the letter did not state clearly whether Pillar
intended to acquire shares from FIC or from other shareholders. In addition,
Pillar did not have an established reputation in the insurance industry for
consummating transactions of this magnitude and there was no evidence that it
had the financial ability to do so. Because the valuation indicated by Pillar
was below book value and because of the depressed state of the U.S. capital
markets and poor general economic conditions, the Board of Directors concluded
that it would not be in the best interest of the Company's shareholders to
negotiate toward selling the Company for a depressed price in the existing
economic conditions.
Nevertheless, in the exercise of its fiduciary duties, on December 13,
2002, the Board of Directors unanimously approved the appointment of a Special
Committee to review unsolicited indications of interest in the acquisition of
the Company. On January 6, 2003, the Board of Directors unanimously approved a
realignment of the Special Committee to include only independent directors and
it authorized the Special Committee to select an investment banking firm to
perform a valuation analysis of FIC and to explore strategic alternatives to
improve shareholder value, including a sale of FIC. The Special Committee
interviewed four firms and selected Salomon Smith Barney.
Among the alternatives considered by the Special Committee were a sale of
the company consistent with recent unsolicited indications of interest in FIC
and various management alternatives, including an increased operating efficiency
strategy, a growth through acquisitions strategy and a marketing alliances
strategy. Through an exhaustive study of all business projections and financial
assumptions, it was determined that pursuing any or all of the management plan
was more advantageous to shareholder value than the sale, merger, or
consolidation of the company at this time given current market conditions for
sale transactions in the insurance industry and general economic conditions. The
Special Committee ultimately determined, based in part on the analysis performed
by Salomon Smith Barney, that it was in the best interest of FIC's shareholders
at that time to allow FIC's new management to implement its business plan for
FIC. The Board of Directors voted to accept the Special Committee's
recommendation.
- 48 -
Proxy Contest
On January 20, 2003, attorneys representing the Mitte Foundation sent a
demand that the Company hold a special shareholders meeting for the purpose of
removing all members of the board of directors and electing unidentified
directors that would be proposed by the Mitte Foundation, Roy Mitte, Mr. Mitte's
wife, Joann Cole Mitte, and Mr. Mitte's son, Scott Mitte (collectively, the
"Mitte Family"). These attorneys informed the Company that they were prepared to
pursue litigation if their demands were not met. The Mitte Foundation's demand,
if granted by the Company or ordered by a court, would have required holding a
shareholders' meeting without proxy materials of the Company or the
dissemination to shareholders of all appropriate financial and other information
concerning the Company's performance in 2002. Specifically, the federal
securities laws require that each proxy statement furnished to shareholders by
the Company must be accompanied or preceded by an annual report to shareholders
which includes audited financial statements for the prior fiscal year. The Mitte
Foundation demanded that the Company hold a special shareholders' meeting on
February 4, 2003, only fifteen days after the date of the demand letter. The
Company could not have prepared audited financial statements for fiscal year
2002 so soon after the fiscal year, nor was it otherwise required to file such
financial statements by such time under the federal securities laws, which allow
90 days following the end of the fiscal year to prepare such information. As a
result, the Company could not have disseminated proxy materials to its
shareholders in compliance with the federal securities laws. Accordingly, in
light of the Mitte Foundation's demand for a special meeting, the Company
commenced litigation against Mr. Mitte, the Mitte Foundation, and Joann Cole
Mitte which sought to delay the meeting, alleging, among other things, Mr.
Mitte's violation of certain provisions of the securities laws as described
below.
The material allegations made by the Company against the Mitte Family are
set out in detail in the Company's Original Complaint, filed on January 23, 2003
in the United States District Court for the Western District of Texas, Austin
Division, Case No. A03-CA-033SS. The following allegations were made by the
Company in the Complaint:
o The Mitte Family omitted material information required to be disclosed
under Section 13(d) of the Securities Exchange Act of 1934, as amended
(the "Exchange Act") and the regulations issued thereunder, as well as
violated the proxy solicitation rules contained in Regulation 14A of
the Exchange Act;
o Over a ten-year period, Roy Mitte caused FIC to pay, or to reimburse
Mr. Mitte for, personal expenditures of Mr. Mitte or his family, in an
amount exceeding $500,000;
o In January 2002, Roy Mitte caused the transfer of $1,000,000 from FIC
to the Mitte Foundation, in contravention of a promise made by Mr.
Mitte to the Compensation Committee of the Board of Directors that no
such transfers would be sought or made in 2002; and
- 49 -
o FIC has borne significant expenses that properly should have been paid
or reimbursed by the Mitte Foundation.
The following relief was sought by the Company:
o A declaratory judgment that the Company may defer any shareholders'
meeting until, among other things, the Company and Mitte could
properly solicit proxies in compliance with the federal securities
laws;
o A preliminary injunction preventing, among other things, the Mitte
Foundation from demanding that the Company notice a special
shareholders' meeting;
o A monetary judgment against Mr. Mitte for the amount of personal
expenses which he improperly caused FIC to pay or reimburse him;
o A monetary judgment against the Mitte Foundation in the amount of
$1,000,000 and for all sums which FIC has improperly paid or borne on
behalf of the Mitte Foundation;
o A monetary judgment against Mr. Mitte in the amount of $1,000,000, in
the event that the Mitte Foundation fails to repay this amount; and
o Interest, attorneys' fees, and all other sums to which FIC proves
itself justly entitled.
On February 10, 2003, the Company entered into an agreement with the
Foundation pursuant to which they agreed to withdraw their request for a special
meeting in exchange for the Company's agreement that the 2003 Annual Meeting of
Shareholders (the "Meeting") would be held May 9, 2003, with a record date of
March 18, 2003.
On March 19, 2003, Mr. Mitte filed a counterclaim against the Company
alleging breach of contract with respect to the Company's failure to pay Mr.
Mitte severance benefits and compensation that Mr. Mitte claims he is entitled
to receive under his employment agreement with the Company. Mr. Mitte seeks
actual damages, interest and attorney's fees and costs.
The Company has not yet filed an answer to Mr. Mitte's counterclaim. Both
the Mitte Family and the Company are currently engaged in discovery with respect
to the pending litigation. . (See "Item 3. Litigation - Litigation Relating to
Former Chairman and CEO").
On March 28, 2003, the Company filed its Preliminary Proxy with respect to
the Meeting. Amendments to the Preliminary Proxy were filed on April 8, 2003 and
April 14, 2003. More information regarding the proxy contest and the Meeting can
be obtained therein by accessing the preliminary proxy on the SEC's website,
www.sec.gov or the Investor Relations portion of the Company's website at
www.ficgroup.com.
- 50 -
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
"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. The Company does not use derivative financial instruments.
Interest Rate Risk The Company manages the interest rate risk inherent in
our assets relative to the interest rate risk inherent in our liabilities.
Generally, we manage interest rate risk based on the application of a commonly
used model. The model projects the impact of interest rate changes on a range of
factors, including duration and potential prepayment. For example, 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 $16.6 million at December 31, 2002
and $24.6 million at December 31, 2001. For purposes of the foregoing estimate,
fixed maturities, including fixed maturities available for sale, and short-term
investments were taken into account. The market value of such assets was $632.8
million at December 31, 2002 and $640.7 million at December 31, 2001.
The fixed income investments of the Company include certain mortgage-backed
securities. The market value of such securities was $205.4 million at December
31, 2002 and $209.9 million at December 31, 2001. 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 $4.7
million at December 31, 2002 and $6.7 million at December 31, 2001.
Separate account assets have not been included, since gains and losses on those
assets generally accrue to the policyholders.
The Company does not use derivative financial instruments to manager our
exposure to fluctuations in interest rates.
- 51 -
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. 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 April
17, 2003.
2. Consolidated Balance Sheet as of December 31, 2002 and Restated
Consolidated Balance Sheet as of December 31, 2001.
3. Consolidated Statement of Income for the year ended December 31, 2002 and
Restated Consolidated Statements of Income for the years ended December 31,
2001 and 2000.
4. Consolidated Statement of Changes in Shareholders' Equity for the year
ended December 31, 2002, and Restated Consolidated Statements of Changes in
Shareholders' Equity for the years ended December 31, 2001 and 2000.
5. Consolidated Statement of Cash Flows for the year ended December 31, 2002,
and Restated Consolidated Statements of Cash Flows for the years ended
December 31, 2001 and 2000.
6. Notes to Consolidated Financial Statements, as Restated.
7. Consolidated Financial Statement Schedules, as Restated.
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.
- 52 -
Part III
Item 10. Directors and Executive Officers of the Registrant
(a) Directors of the Registrant
The names and ages of the current directors of the Registrant, their principal
occupations or employment during the past five years and other data regarding
them are set forth below. All of the directors, other than Eugene Payne and
Richard A. Kosson, were elected at the 2002 annual shareholders meeting held in
June 2002. Eugene Payne was appointed as a director in August 2002 and Richard
A. Kosson was appointed as a director in December 2002, to fill vacancies
created by resignations of two directors. 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. Barnett 60 1991 Director of FIC since 1991. Vice President, Investments of
Investment Professionals, Inc. from 1996 to present. Vice
President, Investments of Prudential Securities from 1983 to 1996.
Jeffrey H. Demgen 50 1995 Director of FIC since May 1995. Vice President of FIC since
August 1996. Vice President and Director of ILCO since August
1996. Director of Family Life since October 1992. Executive
Vice President of Family Life since August 1996. Senior Vice
President of Family Life from October 1992 to August 1996.
Executive Vice President and Director of Investors Life since
August 1996. Senior Vice President and Director of Investors
Life from October 1992 to June 1995.
Theodore A. Fleron 63 1996 Vice President and Director of FIC since August 1996. Vice
President and Director of ILCO since May 1991. Senior Vice
President, General Counsel, and Director of Investors Life since
July 1992 and Secretary since September 2001. Senior Vice
President, General Counsel, Director and Assistant Secretary of
Family Life since August 1996 and Secretary since September 2001.
W. Lewis Gilcrease 71 2001 Director of FIC since June 2001 and from 1979 to July 1991.
Director of ILCO from 1988 to May 2001. Dentist practicing in
San Marcos, Texas. Chairman of the Strahan Foundation in support
of athletics at Southwest Texas State University.
- 53 -
Name Age Since Director and Other Information
Richard A. Kosson 70 2002 Director of FIC since December 2002. Director of ILCO from 1981
to May 2001. Practicing CPA and Partner, Citrin Cooperman &
Company, LLP. Past Chairman of the NJSCPA Insurance Trust.
M. Scott Mitte 46 2000 Director of FIC since October 2000. Executive Director and
Vice-President of the Roy F. and Joann Cole Mitte Foundation from
1999 to 2002.
Roy F. Mitte 71 1976 Chairman of the Board, President and Chief Executive Office of
FIC from 1976 to October 2002. Chairman of the Board, President
and Chief Executive Officer of ILCO from 1985 to 2002. Chairman
of the Board, President and Chief Executive Officer of Investors
Life from December 1988 to 2002. Chairman of the Board,
President and Chief Executive Officer of Family Life from June
1991 to 2002.
Elizabeth T. Nash 53 2001 Director of FIC since June 2001. Director of ILCO from 1998 to
May 2001. Member of the Texas State University System
Foundation since 2000. President of Seton Hospital Development
Board. Member of the Board of Regents, Texas State University
System from 1993 through 1999, Chairman from 1997 to 1998,
Vice-Chairman from 1996 to 1997. Board member of the Southwest
Texas State University Development Foundation since 1987,
Chairman from 1992 to 1997, Vice-Chairman from 1989 to 1992.
Frank Parker 73 1994 Director of FIC since May 1994. Private investor. Prior to June
1998, 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.
Eugene E. Payne 60 2002 Director of FIC since August 2002 and from 1992 to 2000. Presi-
dent, Chairman and Chief Executive Officer of FIC since November
2002. Vice President of ILCO from December 1988 to 2000 and Dir-
tor of ILCO from May 1989 to 2000. Chief Operations Officer of
Investors Life and Family Life from 1991 to 2000. Chief Marketing
Officer of Investors Life and Family Life from 1988 to 1991.
Professor in the College of Business at Southwest Texas State
University from 2000 to 2002.
- 54 -
Name Age Since Director and Other Information
Thomas C. Richmond 61 1996 Director of FIC since August 1996. Vice President and Secretary
of FIC since September 2001. Director of ILCO from March 1994 to
August 1996 and from December 2001 to present. Executive Vice
President of Investors Life and Family Life since September
2001. Senior Vice President from January 1993 to September 2001
of Investors Life and Family Life. Vice President from March
1989 to January 1993 of Investors Life.
(b) Executive Officers of the Registrant
The following table sets forth the names and ages of the persons who currently
serve as the Company's executive officers together with all positions and
offices held by them with the Company. 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
Eugene E. Payne 60 Chairman of the Board, President and Chief
Executive Officer
George M. Wise, III. 42 Vice President & Chief Financial Officer
Jeffrey H. Demgen 50 Vice President & Chief Marketing Officer
Thomas C. Richmond 61 Vice President & Chief Operating Officer
Theodore A. Fleron 63 Vice President, Secretary & General Counsel
Eugene E. Payne is Chairman, President and Chief Executive Officer of FIC, a
position he has held since November, 2002. He joined FIC in 1989 and served for
twelve years in an executive capacity in every major business area, including
chief operations officer and chief marketing officer. In 2000, Dr. Payne elected
early retirement from FIC and taught management strategy and entrepreneurship as
chairman of the management department at Southwest Texas State University's
College of Business. He returned to FIC as Interim Chairman in August, 2002 and
was elected to his current positions in November, 2002. He also served as a
director of FIC from 1992 to 2000 and as a director of ILCO (currently a
wholly-owned subsidiary of FIC) from 1989 to 2000
- 55 -
George M. Wise, III, is Vice President and Chief Financial Officer, a position
he has held since November 2002. Previously, he was President and Consulting
Actuary for Wise, Mitchell & Associates, Ltd., from December 2001 to November,
2002. From January 1998 to December, 2001, he was President and Consulting
Actuary for Wise & Associates, Inc. In his capacity as a consulting actuary, Mr.
Wise managed actuarial consulting firms which provided actuarial and insurance
consulting services to life and health insurance companies.
Jeffrey H. Demgen has been Vice President of FIC since August 1996 and Chief
Marketing Officer since 1996. He was elected as a director of FIC in May 1995.
Mr. Demgen is not standing for re-election to the FIC Board at the Annual
Meeting. Mr. Demgen has served as a director and vice president of ILCO since
August 1996 and has served as a director and in various management capacities
with FIC's life insurance subsidiaries since 1992.
Thomas C. Richmond has been Vice President of FIC since September 2001 and Chief
Operating Officer since 2001. He became a director of FIC in August 1996. Mr.
Richmond is not standing for re-election to the FIC Board at the annual Meeting.
He has served as a director of ILCO from March 1994 to August 1996 and from
December 2001 to present. He has also served in various management capacities
with FIC's life insurance subsidiaries since 1989.
Theodore A. Fleron, has been Vice President, General Counsel of FIC since 1996,
Secretary of FIC since December, 2002 and has been a director since 1996. He is
also a director of the life insurance subsidiaries of FIC and serves as Senior
Vice President, General Counsel and Secretary of those companies. Mr. Fleron has
been associated with FIC since December 1989 and has been involved in all
aspects of FIC's legal matters, including corporate and federal securities,
insurance regulation and litigation. Previously, he was associated with CIGNA
Corporation and its predecessor, INA Corporation, from 1974 to 1989, where he
served as Senior Counsel in the Law Department.
(c) Identification of certain significant employees
Not applicable.
(d) Family relationships
M. Scott Mitte is Roy F. Mitte's son.
(e) Business experience
The business experience of the executive officers has been outlined in Item 10
(b).
(f) Involvement in Certain Legal Proceedings
None.
- 56 -
(g) Beneficial Ownership Reporting Compliance
The information set forth under the caption "Beneficial Ownership Reporting
Compliance" in the Proxy Statement distributed to shareholders in connection
with FIC's 2003 Annual Meeting of Shareholders (the "Proxy Statement"), which is
to be filed by FIC after the date this Report on Form 10-K is filed, is hereby
incorporated by reference.
Item 11. Executive Compensation
Composition of Board
The business of FIC is managed under the direction of its board of directors.
The board of directors currently consists of eleven directors, five of whom are
independent directors.
Summary Compensation Table
The information set forth under the caption "Summary Compensation Table" in the
Proxy Statement is hereby incorporated by reference.
Option Vesting Upon a Change of Control in 2002
The information set forth under the caption "Options Vesting Upon a Change of
Control in 2002" in the Proxy Statement is hereby incorporated by reference.
Stock Appreciation Rights Granted in 2002
The information set forth under the caption "Stock Appreciation Rights Granted
in 2002" in the Proxy Statement is hereby incorporated by reference.
Option/SAR Grants in Last Fiscal Year
The information set forth under the caption "Option/SAR Grants in Last Fiscal
Year" in the Proxy Statement is hereby incorporated by reference.
Aggregated Option/SAR Exercises in 2002 and 2002 Option/SAR Values
The information set forth under the caption "Aggregated Option/SAR Exercises in
2002 and 2002 Option/SAR Values" in the Proxy Statement is hereby incorporated
by reference.
Defined Benefit Plan
The information set forth under the caption "Defined Benefit Plan" in the Proxy
Statement is hereby incorporated by reference.
- 57 -
Employment Agreements and Change In Control Arrangements
The information set forth under the caption "Employment Agreements and Change in
Control Arrangements" in the Proxy Statement is hereby incorporated by
reference.
Compensation of Directors
The information set forth under the caption "Compensation of Directors" in the
Proxy Statement is hereby incorporated by reference.
Compensation Committee Interlocks and Insider Participation
The information set forth under the caption "Compensation Committee Interlocks
and Insider Participation" in the Proxy Statement is hereby incorporated by
reference.
Compensation Committee Report on Executive Compensation
The information set forth under the caption "Compensation Committee Report on
Executive Compensation" in the Proxy Statement is hereby incorporated by
reference.
Performance Graph
The information set forth under the caption "Performance Graph" in the Proxy
Statement is hereby incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters.
The following table presents information as of February 28, 2003 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.
- 58 -
Amount and Nature
Name and Address of of Beneficial Percent
Beneficial Owner Ownership of Class(4)
Roy F. and Joann Cole Mitte
Foundation
6836 Bee Caves Road, Suite 262
Austin, Texas 78746 1,552,206 (1) 16.16 %
Roy F. Mitte
3701 Westlake Drive
Austin, Texas 78746 1,594,326 (1)(2) 16.59 %
Family Life Insurance Company
6500 River Place Blvd.
Austin, Texas 78730 648,640 6.32 %(3)
Investors Life Insurance
Company of North America
6500 River Place Blvd.
Austin, Texas 78730 1,427,073 (4) 12.93 %(5)
Fidelity Management &
Research Company
82 Devonshire Street
Boston, MA 02109 1,307,020 (6) 13.60%
Wellington Management
Company, LLP
75 State Street
Boston, MA 02109 656,800 (7) 6.84%
(1) As reported on a Schedule 13D/A filed by the Roy F. and Joann Cole Mitte
Foundation on February 13, 2003. According to the 13D/A filing, The
Foundation is a not-for-profit corporation organized under the laws of the
State of Texas, and exempt from federal income tax under Section 501(a) of
the Internal Revenue Code of 1986, as amended, as an organization described
in Section 501(c)(3).
(2) Includes 35,520 shares allocated to Mr. Mitte's account under the Employee
Stock Purchase Plan and 6,600 shares which may be acquired pursuant to
options which are exercisable within 60 days. For purposes of this table,
Mr. Mitte is deemed to have beneficial ownership of the shares owned by the
Foundation.
- 59 -
(3) Assumes that outstanding stock options or warrants held by non-affiliated
persons have not been exercised and that outstanding stock options held by
Family Life Insurance Company have been exercised.
(4) Of such shares, 926,662 shares are owned by Investors Life Insurance
Company of North America ("Investors Life") and 500,411 shares are issuable
upon exercise of an option held by Investors Life. All shares are held as
treasury shares.
(5) Assumes that outstanding stock options or warrants held by non-affiliated
persons have not been exercised and that outstanding stock options held by
Investors Life have been exercised.
(6) As reported to the Company on a Schedule 13G filed on June 11, 2001, by FMR
Corporation, the parent company of Fidelity Management & Research Company
("Fidelity") and Fidelity Management Trust Company. The Company also notes
that Fidelity filed a Schedule 13G/A on February 13, 2001, reporting that
the beneficial ownership of Fidelity Low Price Stock Fund, an investment
company registered under the Investment Company Act of 1940, was 340,000
shares. According to the Schedule 13G filings, as amended, Fidelity acts as
investment advisor to the Fidelity Low Priced Stock Fund, and the Fund is
the beneficial owner of 340,000 shares of FIC common stock.
(7) As reported on a Schedule 13G filed by Wellington Management Company, LLP
("WMC") on February 12, 2003. According to the Schedule 13G filing, WMC
acts as investment advisor to certain clients of WMC and such clients have
the right to receive, or the power to direct the receipt of, dividends
from, or the proceeds from the sale of, such securities. The filing further
states that no such client is known to have such right or power with
respect to more than five percent of the common stock of the Company.
The following table contains information as of February 28, 2003 as to the
Common Stock of FIC beneficially owned by (1) each director, (2) each of the
named executive officers, and (c) the directors and executive officers as a
group. In general, "beneficial ownership" refers to shares that a director or
executive officer has the power to vote, or the power to dispose of, and stock
options that are currently exercisable or become exercisable within 60 days of
February 28, 2003. The information contained in the table has been obtained by
the Company from each director and executive officer, except for the information
known to the Company.
- 60 -
Amount and Nature of Percent of
Name Beneficial Ownership (1)(2) Class
Non-Employee Directors:
John Barnett 2,000 *
W. Lewis Gilcrease -0- *
Richard A. Kosson 1,940 *
Michael Scott Mitte 64 (2) *
Elizabeth T. Nash 220 *
Frank Parker 12,000 *
Employee Directors:
Roy F. Mitte 1,594,326 (1)(2)(3) 16.59%
Named Executive Officers:
Jeffrey H. Demgen 14,459 (2)(3) *
Theodore A. Fleron 21,040 (2)(3) *
Eugene E. Payne -0- *
Thomas C. Richmond 18,868 (2)(3) *
George M. Wise, III 500 *
Total of Directors and Officers
As a Group 1,665,417 17.30%
* Less than 1%.
(1) As reported on a Schedule 13D/A filed by the Roy F. and Joann Cole Mitte
Foundation on February 13, 2003. According to the 13D/A filing, The
Foundation is a not-for-profit corporation organized under the laws of the
State of Texas, and exempt from federal income tax under Section 501(a) of
the Internal Revenue Code of 1986, as amended, as an organization described
in Section 501(c)(3). For purposes of this table, Mr. Mitte is deemed to
have beneficial ownership of the shares owned by the Foundation.
(2) Includes shares beneficially acquired through participation in the
Company's 401K Plan and/or the Employee Stock Purchase Plan, which are
group plans for eligible employees.
(3) Include shares issuable upon exercise of options granted under the Stock
Option Plan to executive officers and directors who are also employees of
the Company or its subsidiaries, to the extent that such options are
exercisable within 60 days of February 28, 2003, as follows: Mr. Demgen -
4,400 shares; Mr. Fleron - 4,400 shares; Mr. Mitte - 6,600 shares; and Mr.
Richmond - 4,400 shares.
- 61 -
The following table contains information regarding FIC's equity compensation
plans as of December 31, 2002:
(a) (b) (c)
Number of securities
remaining available
Number of securi- Weighted-average for future issuance
ties to be issued exercise price under equity
upon exercise of of outstanding compensation plans
outstanding options options, warrants (excluding securities
warrants and rights and rights reflected in column (a)
Plan Category
Equity compensation
plans approved by
security holders 208,850 (1) $9.51 231,000
Equity compensation plans
not approved by security
holders 0 0 0
Total 208,850 $9.51 231,000
(1) Shares available to be exercised, as of December 31, 2002, by certain
officers of FIC and its life insurance subsidiaries pursuant to the
InterContinental Life Corporation 1999 Stock Option Plan. On May 18, 2001, each
share of ILCO Common Stock issuable pursuant to outstanding options was assumed
by FIC and became an option to acquire FIC Common Stock with the number of
shares and exercise price adjusted for the exchange ratio in the Merger.
Item 13. Certain Relationships and Related Transactions
The information set forth under the caption "Certain Relationships and Related
Transactions" in the Proxy Statement is hereby incorporated by reference.
Item 14. Controls and Procedures
(a) The chief executive officer and chief financial officer of the Company have
evaluated the effectiveness of the Company's disclosure controls and procedures
pursuant to Rule 13a-14 under the Securities Exchange Act of 1934 as of a date
within 90 days prior to the filing date of this report. Based on that
evaluation, such officers have concluded that the Company's disclosure controls
and procedures, as modified following implementation of the procedures described
in paragraph (b), below, are effective to ensure that material information
relating to the Company and its subsidiaries is made known to such officers in a
timely manner for inclusion in the Company's periodic filings with the SEC.
(b) The financial statements for the year ended December 31, 2002, were prepared
under the general direction of the chief financial officer of the Company (who
joined the Company in November, 2002, and was appointed as Vice President and
Chief Financial Officer November 15, 2002). In connection with the preparation
of such financial statements, the Company identified certain accounting errors
which occurred in the year 2002, as well as prior periods. The identification
and correction of these accounting errors are accounted for in the financial
statements for the year ended December 31, 2002 and the related restatements for
the years ended December 31, 2001 and December 31, 2000. The effect upon the
financial statements for the years 2001 and 2000 resulting from the correction
of these errors is described in this annual Report under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Restatement". As part of their evaluation of the Company's
disclosure controls and procedures, the chief executive officer and the chief
financial officer determined that certain procedures, as described below, needed
to be established or modified in order to ensure that material information
relating to the Company and its subsidiaries are included properly in the
Company's financial filings with the SEC:
- 62 -
1. For the year ended December, 31, 2002, the determination of the amount
of uncollectible agent debit balances was made in accordance with a
newly-established procedure which measures various factors (including the
current level of production of the applicable agent and the persistency
rate of that agent's book of business with the company) pertinent to the
probability that the receivable will be realized. The Company believes
that, if the current procedures had been in place with respect to years
prior to 2002, the amount of agent debit balance receivables included in
the financial statements for such prior years would have approximated the
restated amounts shown in this Annual Report for such prior years.
2. In connection with the implementation of a modification to the
mechanical interface system between the Company's policy administration
system and the general ledger system used to record consolidated
transactions for GAAP reporting purposes, the Company determined that the
manual review procedures which it utilized in connection with the
preparation of the financial statements for prior periods was not correctly
identifying all of the transactions at the policy administration system
level that were not correctly feeding to the general ledger system.
Following implementation of the modification of the mechanical interface
system, the Company identified transactions in addition to those which were
reported in its Form 10-Q for the period ended September 30, 2002 and its
Form 10-Q/A for the period ended June 30, 2002. A description of the
financial effect of the identification and correction of the accounting
errors is included in this Annual Report under the caption "Management's
Discussion and analysis of Financial Condition and results of Operations -
Restatement". The Company believes that the implementation of the
modifications to the mechanical interface system will eliminate these
accounting errors in connection with the preparation of financial
statements for future periods.
3. The restatement of the consolidated balance sheet as of December 31,
2001 includes an increase of approximately $8 million in other liabilities
resulting from a review of suspense account entries at the general ledger
level. The Company has determined that certain suspense account entries had
not been correctly reconciled with respect to prior periods due to the lack
of a systematic review and reconciliation of such entries. In order to
assure the proper reconciliation of suspense account entries in the future,
the Company has reassigned responsibility for such reconciliation to a
separate unit, the Financial Controls Department, with reconciliations to
be completed on a quarterly basis.
- 63 -
Except as described above, there were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their most recent evaluation by the
Company's chief executive officer and chief financial officer.
Part IV
Item 15. 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)
The following consolidated financial statements of Financial Industries
Corporation and Subsidiaries are included in Item 8:
Report of Independent Accountants
Consolidated Balance Sheets, December 31, 2002 and 2001 (Restated)
Consolidated Statements of Income, for years ended December 31, 2002, 2001
(Restated and 2000 (Restated)
Consolidated Statements of Changes in Shareholders' Equity, for the years
ended December 31, 2002, 2001 (Restated) and 2000 (Restated)
Consolidated Statement of Cash Flows, for the years ended December 31,
2002, 2001 (Restated) and 2000 (Restated)
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.
- 64 -
3. Exhibits filed with this report or incorporated herein by reference
are as listed in the Index to Exhibits beginning on Page 71.
(b) Reports on Form 8-K
Registrant filed the following reports on Form 8-K during the fourth quarter of
2002:
1. On November 6, 2002, FIC filed a Current Report on Form 8-K in
connection with (a) the appointment of Dr. Eugene Payne as President,
Chief Executive Officer and Chairman of FIC; and (b) the termination
of the employment agreement between FIC and the former President,
Chief Executive Officer and Chairman, Roy F. Mitte. A press release is
attached to the Form 8-K.
2. On November 18, 2002, FIC filed a Current Report on Form 8-K in
connection with (a) earnings for the nine-month period ended September
30, 2002; (b) restated earnings for the six-month period ended June
30, 2002; and (c) the appointment of George M. Wise, III as the Chief
Financial Officer of the Company. Two press releases are attached to
the Form 8-K.
3. On December 12, 2002, FIC filed a Current Report on Form 8-K in
connection with the receipt of an unsolicited letter from Pillar
Foundation Group regarding their interest in acquiring all or part of
FIC's outstanding common stock. A press release is attached to the
Form 8-K.
4. On December 16, 2002, FIC filed a Current Report on Form 8-K in
connection with (a) the resignation of two employee directors; (b)
declaration of a cash dividend; and (c) steps the Company has taken to
move sales acquisition costs in line with product pricing. A press
release is attached to the Form 8-K.
(c) Exhibits:
The exhibits filed as part of this report and exhibits incorporated herein
by reference to other documents are listed in the Index of Exhibits to this
Annual Report on Form 10-K.
- 65 -
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/ Eugene E. Payne
Eugene E. Payne,
Chairman of the Board, President and Chief Executive Officer
By: /s/ George M. Wise, III
George M. Wise, III
Chief Financial Officer
By: /s/ Nigel S. Walker
Nigel S. Walker
Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons, a majority of the Board of
Directors of the Registrant, on behalf of the Registrant and in the capacities
indicated on April 17, 2003.
/s/ Eugene E. Payne /s/ John D. Barnett
Eugene E. Payne, Director John D. Barnett, Director
/s/ Jeffrey H. Demgen /s/ Theodore A. Fleron
Jeffrey H. Demgen, Director Theodore A. Fleron, Director
/s/ W. Lewis Gilcrease /s/ Richard A. Kosson
W. Lewis Gilcrease, Director Richard A. Kosson, Director
/s/ Elizabeth Nash /s/ Frank Parker
Elizabeth Nash, Director Frank Parker, Director
/s/ Thomas C. Richmond
Thomas C. Richmond, Director
- 66 -
CERTIFICATION
I, Eugene E. Payne, Chief Executive Officer of Financial Industries Corporation
("FIC"), certify that:
1. I have reviewed this annual report on Form 10-K of FIC;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Registrant as of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Registrant's auditors and the audit committee of
Registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
- 67 -
6. The Registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 17, 2003 By: /s/ Eugene E. Payne
Eugene E. Payne
Chief Executive Officer
- 68 -
CERTIFICATION
I, George M. Wise, III, Chief Financial Officer of Financial Industries
Corporation ("FIC"), certify that:
1. I have reviewed this annual report on Form 10-K of FIC;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Registrant as of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Registrant's auditors and the audit committee of
Registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
- 69 -
6. The Registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 17, 2003 By: /s/ George M. Wise, III
George M. Wise, III
Chief Financial Officer
- 70 -
EXHIBIT INDEX
Exhibit Page
No. No. Description of Exhibit
2.1 Agreement and Plan of Merger dated as of January 18, 2001,
by and among FIC, ILCO and ILCO Acqui- sition Corp. (1)
3.1 Articles of Incorporation of FIC (2)
3.2 Certificate of Amendment to the Articles of In- corporation
of FIC, dated November 12, 1996 (3)
3.3 Bylaws of FIC (2)
3.4 Amendment to Bylaws of FIC dated February 29, 1992 (10)
3.5 Amendment to Bylaws of FIC dated June 16, 1992 (10)
3.6 Amendment to Articles of Incorporation of FIC dated May 18,
2001 (13)
10.01 Stock Purchase Agreement, dated as of March 19, 1991, as
amended, by and among Merrill Lynch Insurance Group, Inc.,
Family Life Insurance Company, Family Life Corporation,
Family Life Insurance Investment Company and FIC (4)
10.02 Note, dated June 12, 1991, in the original principal amount
of $2.5 million made by FIC in favor of Investors Life
Insurance Company of California (Investors-CA) and
transferred to Investors Life Insurance Company of North
America (Investors Life) in connection with the merger as of
December 31, 1992 of Investors-CA into Investors Life (4)
10.03 Credit Agreement, dated as of June 12, 1991, among Family
Life Corporation, the Lenders named therein and the Agent
named therein (4)
10.04 Note, dated June 12, 1991, in the original principal amount
of $22.5 million made by Family Life Corporation in favor of
Investors Life (4)
10.05 Note, dated June 12, 1991, in the original principal amount
of $2.5 million made by FIC in favor of Investors Life
Insurance Company of California (4)
10.06 Option Agreement, dated as of June 12, 1991, among FIC,
Investors Life Insurance Company of North America and
Investors Life Insurance Company of California.(4)
10.07 Surplus Debenture, dated as of June 12, 1991, in the
original principal amount of $97.5 million made by Family
Life Insurance Company in favor of Family Life Corporation
(4)
10.08 Note, dated July 30, 1993, in the original principal amount
amount of $30 million made by Family Life Corporation in
favor of Investors Life Insurance Company of North America
(5)
- 71 -
Exhibit Page
No. No. Description of Exhibit
10.09 Note, dated July 30, 1993, in the original principal amount
of $4.5 million made by Family Life Insurance Investment
Company in favor of Investors Life Insurance Company of
North America (5)
10.10 Amendment No. 1 to Note, dated July 30, 1993, between Family
Life Corporation and Investors Life Insurance Company of
North America (5)
10.11 Amendment No. 1 to Note, dated July 30, 1993, between Family
Life Insurance Company and Family Life Corporation (5)
10.12 Guaranty Agreement, dated July 30, 1993, between FIC and
Investors Life Insurance Company of North America (5)
10.13 Guaranty Agreement, dated July 30, 1993, between FIC and
Investors Life Insurance Company of North America.(5)
10.14 Data Processing Agreement, dated as of November 30, 1994
between ILCO and FIC Computer Services, Inc.(6)
10.15 Data Processing Agreement, dated as of November 30, 1994
between Investors Life Insurance Company of North America
and FIC Computer Services, Inc (6)
10.16 Data Processing Agreement, dated as of November 30, 1994
Between Family Life Insurance Company and FIC Computer
Services, Inc.(6)
10.17 Amendment No. 2, dated December 12, 1996, effective June 12,
1996, to the note dated June 12, 1991 in the original
principal amount of $22.5 million made by Family Life
Corporation in favor of Investors Life Insurance Company of
North America (7)
10.18 Amendment No. 1, dated December 12, 1996, effective June 12,
1996, to the note dated June 12, 1991 in the original
principal amount of $2.5 million made by FIC in favor of
Investors Life Insurance Company of California (7)
10.19 Amendment No. 1, dated December 12, 1996, effective June 12,
1996, to the note dated June 12, 1991 in the original
principal amount of $2.5 million made by FIC in favor of
Investors Life Insurance Company of North America (7)
10.20 Amendment No. 1, dated December 12, 1996, effective June 12,
1996, to the note dated July 30, 1993 in the original
principal amount of $30 million made by FIC in favor of
Investors Life Insurance Company of North America (7)
- 72 -
Exhibit Page
No. No. Description of Exhibit
10.21 Amendment No. 1, dated December 12, 1996, effective June 12,
1996, to the note dated July 30, 1993 in the original
principal amount of $4.5 million made by Family Life
Insurance Investment Company in favor of Investors Life
Insurance Company of North America (7)
10.22 Amendment Agreement, dated December 12, 1996, amending the
Option Agreement among FIC, Investors Life Insurance Company
of North America and Investors Life Insurance Company of
California (7)
10.23 Assignment Agreement, dated December 23, 1998, between
Family Life Insurance Investment Company and FIC (8)
10.24 Amendment dated as of April 4, 2001 to Employment Agreement
between the Registrant and Roy F. Mitte (11)
10.25 Amended and Restated Stock Option Grant Agreement (13)
10.26 Employment Agreement of James M. Grace dated January 8, 2001
(12)
10.27 Employment Agreement between Registrant and Jeffrey H.
Demgen dated as of May 1, 2002 and ratified by the Board of
Directors on August 17, 2002, as amended on August 19, 2002
(14)
10.28 Employment Agreement between Registrant and Thomas C.
Richmond dated as of May 1, 2002 and ratified by the Board
of Directors on August 17, 2002 (14)
10.29 Employment Agreement between Registrant and Hans Annarino
dated as of May 1, 2002 and ratified by the Board of
Directors on August 17, 2002 (14)
10.30 Employment Agreement between Registrant and Theodore A.
Fleron dated as of March 22, 2002 and ratified by the Board
of Directors on August 17, 2002 (14)
10.31 Employment Agreement between Registrant and Dr. Eugene E.
Payne dated as of November 4, 2002 and ratified by the Board
of Directors on November 4, 2002 (15)
10.32 Financial Industries Corporation Equity Incentive Plan,
dated November 4, 2002 (15)
10.33 Employment Agreement between Registrant and George M. Wise,
III dated as of December 13, 2002 and ratified by the Board
of Directors on December 13, 2002*
10.34 Employment Agreement between Registrant and Theodore A.
Fleron dated as of December 13, 2002 and ratified by the
Board of Directors on December 13, 2002, superceding Exhibit
10.30*
- 73 -
Exhibit Page
No. No. Description of Exhibit
10.35 Employment Agreement between Registrant and Thomas C.
Richmond dated as of December 13, 2002 and ratified by the
Board of Directors on December 13, 2002, superceding Exhibit
10.28*
21.1 Ex - 75 Subsidiaries of Registrant*
23.1 Ex - 76 Consent of Independent Accountants*
99.1 Ex - 77 Certification dated April 17, 2003, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 *
* Filed herewith.
(1) Incorporated be reference to the Exhibits filed with FIC's Current Report
on Form 8-K dated January 22, 2001.
(2) Incorporated by reference to the Exhibits filed with FIC's Annual Report on
Form 10-K for 1985.
(3) Incorporated by reference to the Exhibits filed with FIC's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1996.
(4) Incorporated by reference to the Exhibits filed with FIC's Current Report
on Form 8-K dated June 25, 1991.
(5) Incorporated by reference to the Exhibits filed with FIC's Annual Report on
Form 10-K for 1993.
(6) Incorporated by reference to the Exhibits filed with FIC's Annual Report on
Form 10-K for 1994.
(7) Incorporated by reference to the Exhibits filed with FIC's Annual Report on
Form 10-K for 1996.
(8) Incorporated by reference to the Exhibits filed with FIC's Annual Report on
Form 10-K for 1998.
(9) Incorporated by reference to the Exhibits filed with FIC's Annual Report on
Form 10-K for 1999.
(10) Incorporated by reference to the Exhibits filed with FIC's S-4 filed on
February 1, 2001.
(11) Incorporated by reference to the Exhibits filed with FIC's 10K/A filed on
April 5, 2001.
(12) Incorporated by reference to the Exhibits filed with ILCO's 10K/A filed on
April 3, 2001.
(13) Incorporated by reference to the Exhibits filed with FIC's Annual Report on
Form 10-K for the year ended December 31, 2001.
(14) Incorporated by reference to the Exhibits filed with FIC's Quarterly Report
on Form 10-Q filed on August 26, 2002, for the six-month period ended June
30, 2002.
(15) Incorporated by reference to the Exhibits filed with FIC's Quarterly Report
on Form 10-Q filed on November 14, 2002, for the nine-month period ended
September 30, 2002.
- 74 -
EXHIBIT 21.1
SUBSIDIARIES OF REGISTRANT
Actuarial Risk Consultants, Inc.
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.
ILCO Acquisition Company
InterContinental Life Corporation
Investors Life Insurance Company of North America
ILG Sales Corporation
ILG Securities Corporation
InterContinental Growth Plans, Inc.
InterContinental Life Agency, Inc.
- 75 -
EXHIBIT 23. 1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-63046) of Financial Industries Corporation of our
report dated April 16, 2003 appearing on page F-2 of this Form 10-K.
PricewaterhouseCoopers LLP
Dallas, Texas
April 16, 2003
- 76 -
EXHIBIT 99.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Financial Industries Corporation ("FIC")
on Form 10-K for the year ended December 31, 2002, as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), we Eugene E. Payne,
Chief Executive Officer, and George M. Wise, III, Chief Financial Officer,
certify pursuant to 18 U.S.C. SECTION 1350, as adopted pursuant to SECTION 906
of the Sarbanes-Oxley Act of 2002, that to our knowledge and belief:
1. The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of FIC.
/s/ Eugene E. Payne /s/ George M. Wise, III
______________________________ ______________________________
Eugene E. Payne George M. Wise, III
Chief Executive Officer Chief Financial Officer
Date: April 17, 2003
- 77 -
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
FORM 10-K--ITEM 15 (a) (1) and (2)
LIST OF FINANCIAL STATEMENTS
TABLE OF CONTENTS
(1) The following consolidated financial statements of Financial Industries
Corporation and Subsidiaries are included in Item 8:
Report of Independent Accountants.......................................F-2
Consolidated Balance Sheets,
December 31, 2002 and 2001, as restated................................F-3
Consolidated Statements of Income for the
years ended December 31, 2002, 2001 and 2000, as restated..............F-5
Consolidated Statements of Changes in
Shareholders' Equity for the years ended
December 31, 2002, 2001 and 2000, as restated.................... .....F-7
Consolidated Statements of Cash Flows for
the years ended December 2002, 2001 and 2000, as restated.............F-10
Notes to Consolidated Financial Statements, as restated................F-13
(2) The following consolidated financial statement schedules of Financial
Industries Corporation and Subsidiaries are included:
Schedule I - Summary of Investments - Other
Than Investments in Related Parties...................................F-54
Schedule II - Condensed Financial Information of Registrant,
as restated...........................................................F-55
Schedule III - Supplementary Insurance Information, as restated........F-58
Schedule IV - Reinsurance, as restated.................................F-59
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.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors and Shareholders of
Financial Industries Corporation:
In our opinion, the accompanying consolidated financial statements listed in the
index appearing under Item 15(a)(1) on page F-1 present fairly, in all material
respect, the financial position of Financial Industries Corporation and its
subsidiaries (the "Company") at December 31, 2002 and 2001, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America. In addition, in our opinion, the
financial statement schedules listed in the index appearing under Item 15(a) (2)
on page F-1 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 of America, 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 our opinion.
As discussed in Note 2, the Company has restated its financial statements for
the years ended December 31, 2001 and 2000.
As discussed in Note 1, during 2002 the Company adopted Statement of Financial
Accounting Standards No. 141, "Business Combinations."
PricewaterhouseCoopers LLP
Dallas, Texas
April 17, 2003
F-2
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
2002 2001
RESTATED
ASSETS (in thousands)
Investments other than investments in affiliate:
Fixed maturities held to maturity, at amortized cost (market
value approximates $1,069 and $1,028 at December 31, 2002
and 2001) $ 1,090 $ 1,029
Fixed maturities available for sale, at market value (amortized
cost of $479,433 and $496,704 at December 31, 2002 and
2001) 493,827 501,395
Equity securities, at market value (cost approximates $6,381
and $8,856 December 31, 2002 and December 31, 2001) 6,351 8,279
Policy loans 46,607 49,794
Mortgage loans 17 4,715
Invested real estate 75,393 64,051
Short-term investments 137,944 138,291
Total investments 761,229 767,554
Cash and cash equivalents 24,975 7,094
Accrued investment income 8,308 8,483
Agency advances and other receivables 19,728 17,309
Reinsurance receivables 12,330 14,709
Due and deferred premiums 11,981 13,411
Real estate held for use 19,702 20,054
Property and equipment, net 1,367 785
Deferred policy acquisition costs 77,210 77,137
Present value of future profits of acquired businesses 23,796 30,530
Other assets 15,739 15,198
Separate account assets 334,637 391,593
Total Assets $1,311,002 $1,363,857
The accompanying notes are an integral part of these
consolidated financial statements
F-3
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
December 31,
2002 2001
RESTATED
LIABILITIES AND SHAREHOLDERS' EQUITY (in thousands)
Liabilities:
Policy liabilities and contract holder deposit funds:
Contractholder deposit funds $ 557,466 $ 556,117
Future policy benefits 172,008 180,953
Other policy claims and benefits payable 17,035 13,985
746,509 751,055
Deferred federal income taxes 25,814 27,197
Excess of net assets acquired over cost 0 10,429
Other liabilities 29,400 17,146
Separate account liabilities 334,637 391,593
Total Liabilities 1,136,360 1,197,420
Commitments and Contingencies (Notes 11 and 13)
Shareholders' equity:
Common stock, $.20 par value, 25,000,000 shares authorized
in 2002 and 2001, 11,856,196 and 11,736,546 shares issued in
2002 and 2001, 9,600,827 and 9,498,847 outstanding in 2002
and 2001 2,372 2,348
Additional paid-in capital 66,541 65,558
Accumulated other comprehensive income 4,949 327
Deferred compensation 0 (292)
Retained earnings 123,046 120,393
Total shareholders' equity before treasury stock 196,908 188,334
Common treasury stock, at cost, 2,255,369 and 2,237,699
shares at 2002 and 2001 (22,266) (21,897)
Total Shareholders' Equity 174,642 166,437
Total Liabilities and Shareholders' Equity $1,311,002 $1,363,857
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
2002 2001 2000
RESTATED RESTATED
Revenues: (in thousands)
Premiums, net $ 35,672 $ 35,887 $ 33,149
Earned insurance charges 41,981 27,710 4,323
Net investment income 40,296 30,719 6,933
Real estate income, net 2,593 1,937 0
Net realized (loss) gain on investments (2,845) 65 7
Other 1,018 1,842 6
118,715 98,160 44,418
Benefits and expenses:
Policyholder benefits and expenses 48,165 30,149 13,453
Interest expense on contractholder deposit funds 29,711 19,936 2,211
Amortization of present value of future profits
of acquired businesses 4,593 4,644 3,569
Amortization of deferred policy acquisition costs 10,427 6,767 5,340
Operating expenses 34,177 22,868 11,159
Interest expense 0 927 1,899
127,073 85,291 37,631
(Loss) income before federal income tax, equity in net
earnings of affiliates and cumulative effect of change
in accounting principle (8,358) 12,869 6,787
Provision (benefit) for federal income taxes:
Current 270 3,937 1,521
Deferred (3,541) 140 (130)
(Loss) income before equity in net earnings of affiliates
and cumulative effect of change in accounting principle (5,087) 8,792 5,396
Equity in net earnings of affiliate, net of tax 0 985 2,040
Net (loss) income before cumulative effect of change in
accounting principle (5,087) 9,777 7,436
Cumulative effect of change in accounting principle 10,429 0 0
Net Income $ 5,342 $ 9,777 $ 7,436
The accompanying notes are an integral part of these
consolidated statements.
F-5
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME, Continued
(in thousands except per share data)
Years Ended December 31,
2002 2001 2000
RESTATED RESTATED
Net Income Per Share (Note 14)
Basic:
Average weighted shares outstanding 9,555 7,824 5,055
Basic earnings per share:
Net (loss) income before cumulative effect
of change in accounting principle $ (0.53) $ 1.25 $ 1.47
Cumulative effect of change in accounting
principle 1.09 0 0
Net income $ 0.56 $ 1.25 $ 1.47
Diluted:
Common stock and common stock equivalents 9,555 7,898 5,163
Diluted earnings per share:
Net (loss) income before cumulative effect
of change in accounting principle $ (0.53) $ 1.24 $ 1.44
Cumulative effect of change in accounting
principle 1.09 0 0
Net income $ 0.56 $ 1.24 $ 1.44
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands)
Common Stock Additional
Paid-in
Shares Amount Capital
Balance at December 31, 1999:
As previously reported 5,845 $ 1,169 $ 7,225
Prior period adjustment (Note 2)
As restated 5,845 1,169 7,225
Comprehensive Income (Loss):
Net Income, as restated
Other Comprehensive Income (Loss):
Change in net unrealized loss on
investments in fixed maturities
available for sale, net of tax
Change in net unrealized appreciation
of equity securities, net of tax, as
restated
Total Comprehensive Income (Loss), as restated
Cash Dividends to Shareholders ($0.18 per share)
Balance at December 31, 2000, as restated 5,845 1,169 7,225
Comprehensive Income (Loss):
Net Income, as restated
Other Comprehensive Income (Loss):
Change in net unrealized gain on investments
in fixed maturities available for sale,
net of tax
Change in net unrealized appreciation of equity
securities, net of tax, as restated
Minimum pension liability, net of tax, as restated
Total Comprehensive Income (Loss), as restated
Stock options exercised 47 10 374
Treasury stock purchased
Issuance of shares in exchange for acquired company 5,844 1,169 57,959
Stock based compensation
Cash Dividends to Shareholders ($0.87 per share)
Balance at December 31, 2001, as restated 11,736 2,348 65,558
Comprehensive Income (Loss):
Net Income
Other Comprehensive Income (Loss):
Change in net unrealized gain on investments in
fixed maturities available for sale, net of tax
Change in net unrealized depreciation of equity
securities, net of tax
Minimum pension liability, net of tax
Total Comprehensive Income (Loss)
Stock options exercised 120 24 983
Treasury stock purchased
Stock based compensation
Cash Dividends to Shareholders ($0.28 per share)
Balance at December 31, 2002 11,856 $ 2,372 $ 66,541
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY, Continued
(in thousands)
Net Unrealized
Gain (Loss) on
Net Unrealized Investments in Total
Appreciation Fixed Accumulated
(Depreciation) Maturities Other
of Equity Available for Comprehensive
Securities Sale Other Income (Loss)
Balance at December 31, 1999:
As previously reported $ 0 $ (2,454) $ 0 $ (2,454)
Prior period adjustment (Note 2) 1,417 1,417
As restated 1,417 (2,454) 0 (1,037)
Comprehensive Income (Loss):
Net Income, as restated
Other Comprehensive Income (Loss):
Change in net unrealized loss on investments in
fixed maturities available for sale, net of tax 3,591 3,591
Change in net unrealized appreciation of equity
securities, net of tax, as restated (606) (606)
Total Comprehensive Income (Loss), as restated (606) 3,591 0 2,985
Cash dividends to Shareholders ($0.18 per share)
Balance at December 31, 2000, as restated 811 1,137 0 1,948
Comprehensive Income (Loss):
Net Income, as restated
Other Comprehensive Income (Loss):
Change in net unrealized gain on investments in
fixed maturities available for sale, net of tax 798 798
Change in net unrealized appreciation of equity
securities, net of tax, as restated (1,184) (1,184)
Minimum pension liability, net of tax, as restated (1,235) (1,235)
Total Comprehensive Income (Loss), as restated (1,184) 798 (1,235) (1,621)
Stock options exercised
Treasury stock purchased
Issuance of shares in exchange for acquired
company
Stock based compensation
Cash dividends to Shareholders ($0.87 per share)
Balance at December 31, 2001, as restated (373) 1,935 (1,235) 327
Comprehensive Income (Loss):
Net Income
Other Comprehensive Income (Loss):
Change in net unrealized gain on investments in
fixed maturities available for sale, net of tax 4,666 4,666
Change in net unrealized depreciation of equity
securities, net of tax 353 353
Minimum pension liability, net of tax (397) (397)
Total Comprehensive Income (Loss) 353 4,666 (397) 4,622
Stock options exercised
Treasury stock purchased
Stock based compensation
Cash Dividends to Shareholders ($0.28 per share)
Balance at December 31, 2002 $ (20) $ 6,601 $ (1,632) $ 4,949
The accompanying notes are an integral part of these
consolidated financial statements.
F-8
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY, Continued
(in thousands)
Total
Deferred Retained Treasury Shareholders'
Compensation Earnings Stock Equity
Balance at December 31, 1999:
As previously reported $ 0 $ 117,552 $ (7,375) $ 116,117
Prior period adjustment (Note 2) (7,489) (6,072)
As restated 0 110,063 (7,375) 110,045
Comprehensive Income (Loss):
Net Income, as restated 7,436 7,436
Other Comprehensive Income (Loss):
Change in net unrealized loss on investments in fixed
maturities available for sale, net of tax 3,591
Change in net unrealized appreciation
of equity securities, net of tax, as restated (606)
Total Comprehensive Income (Loss), as restated 0 7,436 0 10,421
Cash Dividends to Shareholders ($0.18 per share) (905) (905)
Balance at December 31, 2000, as restated 0 116,594 (7,375) 119,561
Comprehensive Income (Loss):
Net Income, as restated 9,777 9,777
Other Comprehensive Income (Loss):
Change in net unrealized gain on investments in fixed
maturities available for sale, net of tax 798
Change in net unrealized appreciation of equity
securities, net of tax, as restated (1,184)
Mininum pension liability, net of tax, as restated (1,235)
Total Comprehensive Income (Loss), as restated 0 9,777 0 8,156
Stock options exercised 384
Treasury Stock purchased (2,248) (2,248)
Issuance of shares in exchange for acquired company (12,274) 46,854
Stock based compensation (292) (292)
Cash Dividends to Shareholders ($0.87 per share) (5,978) (5,978)
Balance at December 31, 2001, as restated (292) 120,393 (21,897) 166,437
Comprehensive Income (Loss):
Net Income 5,342 5,342
Other Comprehensive Income (Loss):
Change in net unrealized gain on investments in fixed
maturities available for sale, net of tax 4,666
Change in net unrealized depreciation of equity
securities, net of tax 353
Mininum pension liability, net of tax (397)
Total Comprehensive Income (Loss) 0 5,342 0 9,964
Stock options exercised 1,007
Treasury stock purchased (369) (369)
Stock based compensation 292 292
Cash Dividends to Shareholders ($0.28 per share) (2,689) (2,689)
Balance at December 31, 2002 $ 0 $ 123,046 $ (22,266) $ 174,642
The accompanying notes are an integral part of these
consolidated financial statements.
F-9
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
2002 2001 2000
CASH FLOWS FROM OPERATING RESTATED RESTATED
ACTIVITIES (in thousands)
Net Income $ 5,342 $ 9,777 $ 7,436
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Amortization of present value of future
profits of acquired business 4,593 4,644 3,569
Amortization of deferred policy
acquisition costs 10,427 6,767 5,340
Amortization of negative goodwill 0 (671) 0
Realized loss (gain) on investments 2,845 (65) (7)
Depreciation 3,089 878 0
Cumulative effect of change in accounting
principle (10,429) 0 0
Equity in undistributed earnings of affiliate 0 ( 985) (2,040)
Changes in assets and liabilities:
Decrease in accrued investment income 175 1,047 8
(Increase) decrease in agency advances and
other receivables (2,419) 28,545 (564)
Decrease (increase) in reinsurance
receivables 2,379 0 (2,618)
Decrease (increase) in due and deferred
premiums 1,430 (874) (145)
Increase in deferred policy acquisition costs (10,728) (11,825) (9,000)
(Increase) decrease in other assets (541) 308 772
(Increase) decrease in policy liabilities
and accruals 4,171 (18,672) 211
Increase (decrease) in other liabilities 2,070 (6,107) (848)
Decrease in deferred federal income taxes (4,084) (6,413) (1,256)
Other, net 761 (3,621) (575)
Net cash provided by (used in) operating
activities $ 7,559 $ (2,733) $ 283
The accompanying notes are an integral part of these
consolidated financial statements.
F-10
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
Year Ended December 31,
2002 2001 2000
RESTATED RESTATED
CASH FLOWS FROM INVESTING ACTIVITIES (in thousands)
Fixed maturities purchased (214,747) (116,978) (11,724)
Real estate capital expenditures (13,515) (18,994) 0
Proceeds from sales and maturities of
fixed maturities 242,656 116,181 11,664
Proceeds from payments received on
mortgage loans 3,743 91 0
Net decrease in short-term investments 347 23,976 9,215
Net decrease (increase) in policy loans 3,187 1,946 (104)
Cash acquired in purchase of insurance holding
company 0 9,085 0
Purchase and retirement of property
and equipment (1,064) 138 37
Net cash provided by investing activities 20,607 15,445 9,088
CASH FLOW FROM FINANCING
ACTIVITIES
Repayment of subordinated notes payable 0 (1,537) (6,148)
Cash dividends to shareholders (2,206) (5,978) (905)
Issuance of capital stock 1,007 384 0
Contractholder fund deposits 55,368 23,285 4,978
Contractholder fund withdrawals (64,085) (27,723) (5,255)
Purchase of treasury stock (369) (2,248) 0
Net cash used in financing activities (10,285) (13,817) (7,330)
Net increase in cash 17,881 4,361 2,041
Cash and cash equivalents, beginning of year 7,094 2,733 692
Cash and cash equivalents, end of year $ 24,975 $ 7,094 $ 2,733
Supplemental Cash Flow Disclosures:
Income taxes paid $ 3,335 $ 7,104 $ 1,200
Interest paid $ 0 $ 725 $ 2,073
The accompanying notes are an integral part of these
consolidated financial statements.
F-11
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
Supplemental Schedule of Non-Cash Investing Activities:
The Company purchased the outstanding capital stock of a life insurance holding
company in the second quarter of 2001 for purchase price of approximately $49.1
million. The consolidated statements of cash flows reflect the impact of this
acquisition. This purchase resulted in the Company receiving assets and assuming
liabilities as follows (in thousands):
2001
RESTATED
Assets $ 709,497
Liabilities $ 707,444
The accompanying notes are an integral part of these
consolidated financial statements.
F-12
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 life insurance and annuity products. The Company's
insurance subsidiaries are also engaged in the business of marketing and
underwriting individual life insurance, disability insurance and annuity
products in 49 states, the District of Columbia and the U.S. Virgin Islands.
Such products are marketed through both captive and independent agency systems.
Principles of Consolidation
The consolidated financial statements include the accounts of FIC and its
wholly-owned subsidiaries. All material intercompany balances and transactions
have been eliminated. 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"). Effective on May 18, 2001, the consolidated financial
statements also include the accounts of InterContinental Life Corporation
("ILCO"), Investors Life Insurance Company of North America ("Investors Life"),
Investors Life Insurance Company of Indiana ("Investors-IN") and ILG Sales Corp,
all which were accounted for under the equity method of accounting prior to the
acquisition of the remaining outstanding shares. On February 18, 2002,
Investors-IN was merged into Investors Life with Investors Life as the surviving
entity.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America ("GAAP"), which differ from statutory accounting principles required by
regulatory authorities for the Company's insurance subsidiaries. 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 accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results will differ from those estimates.
Investments
The Company's general investment philosophy is to hold fixed maturity securities
until maturity. However, fixed maturities may be sold prior to their maturity
dates in response to changing market conditions, duration of liabilities,
liquidity factors, interest rate movements and other investment factors.
Accordingly, substantially all the Companies 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 accumulated other
comprehensive income, net of effect on other balance sheet accounts and related
income taxes.
F-13
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
While collateralized mortgage obligations ("CMOs") are carried at market value,
premiums and discounts on CMOs are amortized over stated maturity of the CMOs,
with consideration given to estimates of prepayments in the amortization of
those premiums and discounts.
Equity securities are classified as available for sale and are carried at market
value. Equity securities include investments in the Company's own separate
accounts, which are carried at estimated fair 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 accumulated other
comprehensive income.
Mortgage loans and policy loans are recorded at unpaid balances.
Short-term investments are carried at cost, which approximates market value, and
generally consist of those fixed maturities and other investments with
maturities of 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.
Realized gains and losses on disposal of investments are included in net income.
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. Costs
of debt securities and equity securities are adjusted for impairments, which are
declines in value that are considered to be other than temporary. When
impairment of the value of an investment is considered other than temporary, the
decrease in value is reported in net income as a realized investment loss and a
new cost basis is established. In evaluating whether a decline in value is other
than temporary, the Company considers several factors including, but not limited
to, the following:
(1) whether the decline is substantial; (2) the duration; (3) the reasons
for the decline in value (credit event, interest related or market
fluctuations); (4) the Company's ability and intent to hold the investments
for a period of time to allow for a recovery of value; and (5) the
financial condition of and near term prospects of the issuer.
Invested Real Estate
Invested real estate is stated at cost less accumulated depreciation.
Depreciation is provided using straight-line and accelerated methods over
estimated useful lives of 5 to 40 years. Real estate income is reported net of
expenses incurred to operate the properties and depreciation expenses.
F-14
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The Company's management reviews the performance of real estate investments on
an on-going basis for impairment as well as when events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Management indentifies properties it intends to sell and properties
it intends to hold for use. Currently management intends to hold for use all
invested real estate. For each asset held for use, the Company applies a
probability-weighted estimation approach to recovery of the carrying amount of
the asset to determine if the sum of expected future cash flows (undiscounted
and without interest charges) of the asset exceeds it carrying amount. If the
sum of expected future cash flows (undiscounted and without interest charges) is
less than the net book value of the asset, the excess of the net book value over
the Company's estimate of fair value of the asset is charged to current
earnings. The Company's estimate of fair value of the asset then becomes the new
cost basis of the asset and this new cost basis is then depreciated over the
asset's remaining life. Based on the application of the above policy, the
Company has determined that no impairment is considered to exist with respect to
its invested real estate as of December 31, 2002 and 2001.
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.
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 3 to 8 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 traditional
life insurance products are deferred and amortized to expense using actuarial
methods that include the same assumptions used to estimate future policy
benefits. Acquisition costs related to interest sensitive 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.
Recoverability of deferred acquisition costs is evaluated periodically.
Present Value of Future Profits on Acquired Businesses
The present value of future profits of acquired traditional life business 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 balance is accreted at
rates from 7.0% to 11.0%.
F-15
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
For interest-sensitive products, these costs are amortized in relation to the
present value, using the current credited interest rate, of expected gross
profits of the policies over the anticipated coverage period. Retrospective
adjustments of these amounts for interest sensitive products are made
periodically upon the revision of estimates of current or future gross profits
to be realized from a group of policies.
Recoverability of present value of future profits is evaluated periodically by
comparing the current estimate of future profits to the unamortized asset
balances.
Real Estate Held for Use
Real estate held for use represents real estate occupied by the Company and is
carried at cost less accumulated depreciation. Depreciation is provided using
straight-line over estimated useful lives of 40 years. Accumulated depreciation
on real estate occupied by Company is $1,073,738 and $639,736 as of December 31,
2002 and 2001, respectively.
Separate Accounts
Separate account assets and liabilities, carried at market value, represent
policyholder funds maintained in accounts having specific investment objectives.
The net investment income, gains and losses of these accounts, less applicable
contract charges, generally accrue directly to the policyholders and are not
included in the Company's statement of income, with the exception of the gains
and losses in the Company's seed money in the separate accounts, which are
included in other income in the income statement.
Solvency Laws Assessments
The solvency or guaranty laws of most states in which the Company's insurance
subsidiaries do business may require the Company's insurance subsidiaries to pay
assessments (up to certain prescribed limits) to fund policyholder losses or
liabilities of insurance companies that become insolvent. These assessments may
be deferred or forgiven under most guaranty laws if they would threaten an
insurer's financial strength, and in certain instances, may be offset against
future premium taxes. The Company's insurance subsidiaries 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 related to traditional life products are
accrued as premium revenue is recognized. The liabilities are computed using the
net level premium method, or an equivalent actuarial method, based upon industry
and Company experience of investment yields, mortality and withdrawals,
including provisions for possible adverse deviation.
F-16
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Contract holder deposit funds represent liabilities for universal life and
annuity products. These liabilities consist of deposits received from customers
and are accumulated at actual credited interest rates on their fund balances
less charges for expenses and mortality.
Excess of Net Assets Acquired Over Cost
The excess of net assets acquired over cost, or negative goodwill, is presented
net of accumulated amortization. Prior to January 1, 2002, the excess of net
assets acquired over cost was amortized generally in accordance with expected
revenues of the related policies. During the first quarter of 2002, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations." SFAS No. 141 eliminates the practice of amortizing and deferring
excess of fair value of net assets acquired over cost and requires unallocated
negative goodwill to be recognized immediately. In accordance with the standard,
FIC ceased negative goodwill amortization on January 1, 2002 and recognized the
unamortized balance of $10.4 million of negative goodwill acquired in the
acquisition of ILCO as a cumulative effect of a change in accounting principle.
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 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
The Company computes deferred income taxes utilizing the asset and liability
method. Under this method, balance sheet amounts for deferred income taxes are
computed based on the tax effect of the differences between the financial
reporting and federal income tax bases of assets and liabilities using the tax
rates which are expected to be in effect when these differences are anticipated
to reverse.
Revenue Recognition
Premiums on traditional life and health products are recognized as revenue when
due. Benefits and expenses are associated with earned premiums, so as to result
in recognition of net profits over the lives of the contracts.
Proceeds from investment-related products and universal life products are
recorded as liabilities when received. Revenues for investment-related and
universal life products consist of net investment income, mortality charges,
administration charges and surrender charges.
F-17
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Stock Option Plans and Other Equity Incentive Plans
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," ("APB 25") and related Interpretations in accounting
for its stock option plans, which are described more fully in Note 10. No
compensation cost has been recognized by the Company in the accompanying income
statement for its stock option plans, with the exception of the amortization of
deferred compensation costs related to the acquisition of ILCO. During 2002, the
remaining deferred compensation costs were amortized as the related stock
options became fully vested in accordance with their original contractual terms.
The Company follows the disclosure-only provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock
Based Compensation - Transition and Disclosure." SFAS No. 123 allows companies
to follow existing accounting rules (APB 25) provided that pro forma disclosures
are made of what net income and earnings per share would have been had the
company recognized expense for stock-based awards based on their fair value at
date of grant. The fair value disclosure assumes that fair value of option
grants were calculated at the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions:
2002 2001
Expected dividend yield 1.0% 3.0 %
Expected volatility 37% 45 - 52%
Risk-free interest rate 2.23 - 2.72% 3.11 - 4.72%
Expected holding period - years 1 2 - 4
For purpose of pro forma disclosures, the estimated fair value of the options is
amortized to expense over the options' vesting period. Pro forma income
information is as follows (in thousands except for net income per share) for the
year ended December 31:
2002 2001
RESTATED
Net income as reported $ 5,342 $ 9,777
Pro forma compensation expense,
net of tax benefits 560 74
Pro forma net income $ 4,782 $ 9,703
Net income per share:
Basic as reported $ 0.56 $ 1.25
Diluted as reported $ 0.56 $ 1.24
Basic - Pro Forma $ 0.50 $ 1.24
Diluted - Pro Forma $ 0.50 $ 1.23
No FIC options were granted during the year ended December 31, 2000.
F-18
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
When stock appreciation rights are granted, the Company recognizes compensation
expense equal to the amount by which the quoted market price of the Company's
common stock exceeds the exercise price at the measurement date. Compensation
expense is accrued as a charge to expense over the period or periods the
employee performs the related services. Compensation accrued during the service
period is adjusted in subsequent periods up to the measurement date for changes,
either increases or decreases, in the quoted market value of the shares of the
enterprise's stock covered by the grant, but shall not be adjusted below zero.
The offsetting adjustment is made to compensation expense of the period in which
changes in the market value occur.
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. 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 computation of
diluted earnings per share does not assume conversion, exercise or contingent
issuance of securities that would result in an increase in earnings per share
amounts or a decrease in loss per share amounts (antidilution). Both methods are
presented on the face of the accompanying consolidated statements of income.
New Accounting Pronouncements
During 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 143 ("SFAS 143"), "Accounting for Asset
Retirement Obligations", which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS 143 is effective for financial
statements issued for fiscal years beginning after June 15, 2002, the adoption
of which did not materially affect FIC's results of operations, liquidity or
financial position.
In May 2002, the FASB issued SFAS No. 145, "Rescission of FAS Nos. 4, 44, and
64, Amendment of SFAS No.13, and Technical Corrections," as of April 2002. This
Statement rescinds FASB Statement No. 4, "Reporting Gains and Losses from
Extinguishment of Debt" and SFAS No. 64, "Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements." This Statement also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. SFAS No.145
is effective for financial statements issued for fiscal years beginning after
May 15, 2002, and is not expected to affect FIC's results of operations,
liquidity or financial position.
The American Institute of Certified Public Accountants ("AICPA") also recently
issued Statement of Position No. 01-06 ("SOP 01-06") "Accounting by Certain
Entities (Including Entities with Trade Receivables) That Lend to or Finance the
Activities of Others." The guidance in SOP 01-06 relating to financing and
lending activities is explicitly applicable to insurance companies. SOP 01-06
reconciles and conforms the accounting and financial reporting guidance
presently contained in other accounting guidance. SOP 01-06 is effective for
financial statements issued for fiscal years beginning after December 15, 2001.
The Company's accounting practices for its lending activities are already
consistent with the guidance contained in SOP 01-06. The adoption of SOP 01-06
did not have a significant effect on the Company's financial statements.
F-19
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002, the adoption of which is not expected to materially affect FIC's results
of operations, liquidity or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure." The statement amends SFAS No.123 to
provide alternative methods of transition for voluntary change to the fair value
based method of accounting for stock-based employee compensation. In addition,
SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. SFAS No. 148 improves the prominence and
clarity of the pro forma disclosures required by SFAS No. 123 by prescribing a
specific tabular format and by requiring disclosure in the "Summary of
Significant Accounting Policies" or its equivalent. In addition, SFAS No. 148
improves the timeliness of those disclosures by requiring their inclusion in
financial reports for interim periods. SFAS No. 148 is effective for financial
statements for fiscal years ending after December 15, 2002. FIC continues to
account for its stock option plans under APB 25 and related interpretations as
allowed by this statement. FIC has adopted the disclosure provisions of SFAS No.
148.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial measurement provisions of FIN 45 are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002. The
disclosure requirements of FIN 45 are effective for years ending after
December 15, 2002. FIN 45 did not have a material effect on the Company.
In January 2003, the FASB issued Interpretation No. 46 "Consolidation of
Variable Interest Entities, an interpretation of ARB 51" ("FIN 46"). The primary
objectives of FIN 46 are to provide guidance on the identification of entities
for which control is achieved through means other than through voting rights
("variable interest entities" or "VIEs") and how to determine when and which
business enterprise should consolidate the VIE (the "primary beneficiary"). This
new model for consolidation applies to an entity which either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entity's activities
without receiving additional subordinated financial support from other parties.
In addition, FIN 46 requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make additional
disclosures. FIN 46 is not expected to have a material effect on the Company.
F-20
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Reclassification
Certain prior years' amounts have been reclassified to conform with the 2002
presentation.
2. Restatement
In the fourth quarter of 2002, the Company identified uncollectible receivables
for which adequate allowance had not been made and policyholder benefits and
expenses that were understated due to an interface error between the policy
administration system and the general ledger. The Company extended its
investigation to determine the years affected and expanded the scope of its
review to include other areas, including certain adjustments that were deemed
not material in prior years. As a result of this review, the financial
statements for 2001 and 2000 were restated for the following items. Previously
reported unaudited quarterly financial data was also restated as discussed in
Note 16.
1. Family Life did not properly apply the accounting requirements of SFAS
No. 87, "Employers' Accounting for Pensions," in accounting for its
defined benefit pension plan. The Company had accounted for its
pension expense on a cash basis. As a result, the Company had not
properly recognized pension expense or benefit and had not recorded a
prepaid pension asset in years prior to January 1, 2000.
2. Agency advances and other receivables had not been analyzed for
collectibility and contained balances pertaining to agents that should
have been written off.
3. Depreciation on certain property and equipment had not been recorded
since purchase.
4. Certain lease incentives had been recognized in income as received in
1997 instead of being deferred and recognized over the lease period.
Further, certain other lease termination benefits had been deferred
instead of being recognized in income in the period the lease was
terminated.
5. Deferred acquisition cost amortization for traditional life policies
issued prior to January 1, 2002 had been calculated using amortization
factors which did not properly take into account the pattern of
commission expense recognized on these policies, which understated
amortization of these costs in early years of the policies and
overstated amortization of these costs in later years of the policies.
Also, deferred acquisition cost amortization for universal life
policies issued prior to January 1, 2002 was based on undiscounted
estimates of future gross profits, which overstated amortization of
these costs.
6. Present value of future profits amortization had not reflected certain
adjustments that reduced the present value of future profits asset.
7. Certain death benefit and annuity benefit expenses incurred during the
years ended 1999, 2000, 2001 and 2002 were not recorded due to an
interface error between the Company's policy administration system and
its general ledger.
F-21
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
8. ILCO's financial statements also required adjustment. ILCO had been
accounted for as an investment of the Company under the equity method of
accounting prior to May 18, 2001 and consolidated after that date. ILCO's
financial statements required adjustment for the following items:
a. ILCO had not recorded dividend and capital gain distributions
prior to 1998 on its investment in one of its variable annuity
separate accounts (which understated ILCO January 1, 2000
retained earnings) and had not recorded unrealized gains or
losses to adjust the carrying value of its investment in the
separate account to market value (which understated ILCO January
1, 2000 accumulated other comprehensive income).
b. Agency advances and other receivables and other assets had not
been analyzed for recoverability and contained balances that
should have been written off.
c. Certain adjustments to reinsurance recoverables that related to
periods prior to January 1, 2000 were recorded during 2000.
d. ILCO did not properly apply the accounting requirements of SFAS
No. 87, "Employers' Accounting for Pensions," in accounting for
its defined benefit pension plan. ILCO had accounted for its
pension expense on a cash basis. As a result, the Company had not
properly recognized pension expense or benefit and had not
recorded a prepaid pension asset in years prior to January 1,
2000.
e. Certain lease incentives had been recognized in income as
received in 1997 instead of being deferred and recognized over
the lease period. Further, certain other lease termination
benefits had been deferred instead of being recognized in income
in the period the lease was terminated.
f. An unreconciled difference between suspense account balances
included in the Company's general ledger and those included in
its policy administration system resulted in an unsupported net
asset (included in other liabilities on the consolidated balance
sheet) that should have been written off.
9. The negative goodwill recognized as a result of the Company's
acquisition of the remaining common shares of ILCO on May 18, 2001 and
related amortization of negative goodwill in 2001 was adjusted to reflect
the impact on ILCO of the above items.
10. Deferred federal income tax balances were adjusted for the above items.
F-22
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Net income for 2001 was decreased from amounts previously reported by $2,237,000
and net income for 2000 was decreased by $1,343,000 as a result of the
restatement, as follows (in thousands except per share data):
2001 2000
As 2001 As 2000
Previously As Previously As
Reported Restated Reported Restated
Income before federal income
tax and equity in net earnings of
affiliates $ 15,999 $ 12,869 $ 6,482 $ 6,787
Income before equity in net
earnings of affiliates 10,698 8,792 5,198 5,396
Equity in net earnings of affiliate,
net of tax 1,316 985 3,581 2,040
Net income $ 12,014 $ 9,777 $ 8,779 $ 7,436
Basic earnings per share $ 1.54 $ 1.25 $ 1.74 $ 1.47
Diluted earnings per share $ 1.52 $ 1.24 $ 1.70 $ 1.44
The change in net income for each year was due to the following adjustments that
increased (decreased) net income for the years ended December 31, 2001 and 2000
(in thousands):
2001 2000
Premiums $ 1 $ 0
Negative goodwill amortization (296) 0
Policyholder benefits and expenses (2,447) 0
Amortization of present value of
future profits 71 100
Amortization of deferred policy
acquisition costs 33 (11)
Provision for uncollectible
receivables (401) (155)
Pension expense (91) (132)
Rent expense 0 503
Provision for deferred federal
income taxes 1,224 (107)
Equity in net earnings of affiliate
(ILCO), net of tax (331) (1,541)
Net income $ (2,237) $ (1,343)
F-23
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The decrease of $331,000 in 2001 and $1,541,000 in 2000 in the Company's equity
in net earnings of affiliate, net of tax, was due to the following adjustments
that increased (decreased) the Company's equity in ILCO's net income for the
year ended December 31, 2001 and 2000 (in thousands):
2001 2000
Premiums and policyholder benefits
ceded to reinsurers $ 0 $ ( 204)
Policyholder benefits and expenses (358) (1,727)
Pension expense 0 (9)
Rent expense 0 277
Provision for deferred federal
income taxes 26 122
Equity in net earnings of affiliate,
net of tax $ (331) $ (1,541)
The Company accounted for its investment in ILCO under the equity method of
accounting prior to its acquisition of ILCO's remaining outstanding common
shares on May 18, 2001. The Company owned approximately 48% of ILCO's
common shares during the period from January 1, 2001 to May 18, 2001 and
during the year ended December 31, 2000. The above adjustments to equity in
net earnings of affiliate, net of tax, are therefore equal to approximately
48% of the related adjustments to ILCO's net income for the period from
January 1, 2001 to May 18, 2001 and during the year ended December 31,
2000, prior to related tax effects. The above adjustments decreased ILCO's
net income for the period January 1, 2001 through May 18, 2001 by $484,000
and decreased ILCO's reported net income of $12.1 million for the year
ended December 31, 2000 by $2.3 million (Note 5).
Total shareholders equity at January 1, 2000 was decreased by $6,072,000, from
$116.1 million to $110.3 million. The decrease in total shareholders' equity was
due to a decrease of $7,489,000 in retained earnings as of January 1, 2000,
offset by an increase in accumulated other comprehensive income of $1,417,000 as
of January 1, 2000. The effects of the restatement on the Company's retained
earnings, accumulated other comprehensive income and total shareholders' equity
were as follows as of January 1, 2000 (in thousands):
January 1, 2000
As Previously January 1, 2002
Reported As Restated
Retained earnings $ 117,552 $ 110,063
Accumulated other
comprehensive income $ (2,454) $ (1,037)
Total shareholders' equity $ 116,117 $ 110,045
The change in the Company's retained earnings, accumulated other comprehensive
income and total shareholders' equity at January 1, 2000 was due to the
following adjustments that increased (decreased) retained earnings, accumulated
other comprehensive income and total shareholders' equity at January 1, 2000 (in
thousands):
F-24
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
January
January 1, 2000 1, 2000
Accumulated Total
January 1, 2000 Other Share-
Retained Comprehensive holders'
Earnings Income Equity
Agency advances and
other receivables $ (2,273) $ 0 $ (2,273)
Property and
equipment, net (1,247) 0 (1,247)
Deferred policy
acquisition costs (3,243) 0 (3,243)
Present value of future
profits 87 0 87
Prepaid pension asset 707 0 707
Deferred rent revenue (350) 0 (350)
Deferred federal
income taxes 2,212 0 2,212
Investment in affiliate
(ILCO) (3,382) 1,417 (1,965)
Total $ (7,489) $ 1,417 $(6,072,000)
Investment in affiliate (ILCO) was deceased by $1,965,000 (of which $3,382,000
decreased retained earnings and $1,417,000 increased accumulated other
comprehensive income) due to the following adjustments that increased
(decreased) the Company's equity in ILCO's retained earnings, accumulated other
comprehensive income and total shareholders' equity at January 1, 2000 (in
thousands):
January 1
January 1, 2000 2000
January 1, Accumulated Total
2000 Other Share-
Retained Comprehensive holders'
Earnings Income Equity
Equity securities $ 1,124 $ 2,180 $ 3,304
Agency advances and
other receivables (2,105) 0 (2,105)
Reinsurance 204 204
receivables 0
Prepaid pension asset 2,343 0 2,343
Other assets (374) 0 (374)
Deferred rent revenue (238) 0 (238)
Other liabilities (3,427) 0 (3,427)
Deferred federal
income taxes (909) (763) (1,672)
Investment in affiliate $ (3,382) $ 1,417 $ (1,965)
F-25
FINANICAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The Company accounted for its investment in ILCO under the equity method of
accounting prior to its acquisition of ILCO's remaining outstanding common
shares on May 18, 2001. The Company owned approximately 48% of ILCO's common
shares at January 1, 2000. The above adjustments to investment in affiliate are
therefore equal to approximately 48% of the related adjustments to ILCO's
retained earnings, accumulated other comprehensive income and total
shareholders' equity at January 1, 2000, prior to related tax effects. The above
adjustments decreased ILCO's reported retained earnings of $151.9 million at
January 1, 2000 by $7.1 million, increased ILCO's reported accumulated other
comprehensive income (loss) of ($3.7 million) at January 1, 2000 by $3.0 million
and decreased ILCO's reported total shareholders' equity of $151.7 million by
$4.1 million.
3. Investments
Fixed Maturities
Investments in fixed maturities by category at December 31, 2002 and 2001,
respectively, were as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses
Fixed maturities available for sale as
of December 31, 2002:
U.S. treasury securities and
obligations of U.S. government
agencies and corporations $ 25,325 $ 3,809 $ 428 $ 28,706
States, municipalities and political
subdivisions 6,060 331 0 6,391
Corporate securities 248,424 5,335 445 253,314
Mortgage-backed securities 199,624 6,743 951 205,416
Total fixed maturities available for
sale 479,433 16,218 1,824 493,827
Fixed maturities held to maturity:
Corporate securities 1,090 3 24 1,069
Total fixed maturities $ 480,523 $ 16,221 $ 1,848 $ 494,896
F-26
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
Fixed maturities available for sale as
of December 31, 2001:
U.S. Treasury securities and
obligations of U.S. government
agencies and corporations $ 22,992 $ 2,307 $ 14 $ 25,285
States, municipalities and political
subdivisions 8,072 292 0 8,364
Corporate securities 261,812 718 4,674 257,856
Mortgage-backed securities 203,828 6,123 61 209,890
Total fixed maturities available for
sale 496,704 9,440 4,749 501,395
Fixed maturities held to maturity:
Corporate securities 1,029 0 1 1,028
Total fixed maturities available for
sale $ 497,733 $ 9,440 $ 4,750 $ 502,423
The amortized values and market values of fixed maturities at December 31, 2002
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.
Fixed Maturities Available for Sale
Amortized Market
Value Value
(in thousands)
Due in one year or less $ 9,735 $ 9,657
Due after one year through five years 25,222 27,250
Due after five years through ten years 27,837 29,827
Due after ten years 217,014 221,677
Mortgage-backed securities 199,625 205,416
Total fixed maturities available for sale $ 479,433 $ 493,827
F-27
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANICAL STATEMENT, Continued
Fixed maturities held to maturity mature after ten years.
Proceeds from sales of investments in fixed maturities during 2002, 2001 and
2000 were $72,799,651, $41,700,711 and $1,050,000, respectively. On these sales,
there were gains of $1,077,281 and losses of $99,425 in 2002, gains of $217,459
and losses of $201,655 in 2001 and gains of $1,575 and losses of $0 in 2000.
The net change in unrealized investment gains (losses) represents a component of
accumulated other comprehensive income for the years ended December 31, 2002,
2001 and 2000. The following is a summary of the change in unrealized investment
gains (losses), net of the effect on other balance sheet accounts and related
deferred income taxes, that 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 prior to May 18, 2001. The
amount included in the total below is $5,554,000 for 2000.
Change in Unrealized Gains (Losses) on Investments
2002 2001 2000
RESTATED RESTATED
(in thousands)
Fixed maturities $ 9,703 $ 1,449 $ 7,017
Equity securities 543 (1,822) (932)
Gross unrealized gains (losses) 10,246 (373) 6,085
Effect on other balance sheet
accounts (2,526) (221) (1,492)
Deferred federal income taxes (2,701) 208 (1,608)
Net change in unrealized gains
(losses) on investments $ 5,019 $ (386) $ 2,985
The following table sets forth the reclassification adjustments required for the
years ended December 31, 2002, 2001 and 2000:
2002 2001 2000
RESTATED RESTATED
(in thousands)
Reclassification Adjustments
Unrealized holding gains (losses)
on investments arising during
the period, net of tax $ 3,170 $ (344) $ 2,990
Reclassification adjustments for
(gains) losses included in
net income, net of tax 1,849 (42) (5)
Unrealized gains (losses) on
investments, net of reclassification
adjustment, net of tax $ 5,019 $ (386) $ 2,985
F-28
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The Company's insurance subsidiaries are required to maintain assets on deposit
with state regulatory authorities. Such assets are included in fixed maturities
and have an aggregate fair value of $12,024,359 and $16,363,363 at December 31,
2002 and 2001, respectively.
Net Investment Income
The components of net investment income are summarized as follows:
Year ended December 31,
2002 2001 2000
(in thousands)
Fixed maturities $ 32,934 $ 23,878 $ 5,493
Other, including short-term
investments and policy loans 7,464 7,268 1,483
Gross investment income 40,398 31,146 6,976
Investment expenses (102) (427) (43)
Net investment income $ 40,296 $ 30,719 $ 6,933
Other than temporary impairments
The Company identified one bond at December 31, 2002, which was considered to be
impaired and reduced its carrying value by $463,000. Also at December 31, 2002,
the Company determined that its investment in its separate accounts was impaired
and reduced its carrying value by $2.4 million. There were no impairments in the
value of investments in 2001 or 2000 which were considered other than temporary.
Mortgage loans
The Company participated with a third party in two mortgage loans in New York
state, Champlain Centre Mall and Salmon Run Mall, with a total balance due of
$4.60 million at June 30, 2002. On June 18, 2002, the Company agreed to a
proposed payoff of these loans at a discount. The borrower paid off the loans in
August, 2002 with a payment of $3.64 million. The Company reduced the carrying
value of the two loans by $0.96 million as of June 30, 2002 as an impairment of
an invested asset. The impairment loss is included in realized losses on
investments in the income statement.
Invested real estate
Investors Life purchased property known as River Place Pointe in October 1998.
It consists of 47.995 acres of land in Austin, Texas. The aggregate purchase
price for these tracts was $8.1 million. The site development permit allowed for
the construction of seven office buildings totaling 600,000 square feet, with
associated parking, drives and related improvements. Construction on the first
section of the project, which consisted of four office buildings, an associated
parking garage, and related infrastructure was completed during 2000 and 2001.
The second section of construction, which included three more office buildings,
an associated parking garage, and related infrastructure, was completed by the
end of 2002. FIC and its insurance subsidiaries occupy Building One of River
F-29
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Place Pointe, consisting of approximately 76,143 square feet of space and
approximately 5,000 square feet of Building Four. Approximately 222,007 sq. ft.
of the remaining 320,691 sq. ft. from Buildings Two, Three and Four is leased to
third parties. The remaining buildings are not leased. At December 31, 2002
invested real estate includes approximately $73.98 million relating to the River
Place Pointe property, not including $19.70 million reported as real estate
occupied by Company. Real estate income as of December 31, 2002 and 2001 was
$2.59 million and $1.94 million, net of real estate expenses of $4.1 million and
$1.58 million, respectively.
Accumulated depreciation on invested real estate as of December 31, 2002 is
$2.1 million.
Non-income producing investments
The Company has no non-income producing investments as of December 31, 2002,
2001 and 2000, other than non-leased buildings of the River Place Pointe real
estate investment.
4. Disclosure about Fair Value of Financial Instruments
The estimated fair values of the Company's financial instruments at December 31,
2002 are as follows:
Carrying Amount Fair Value
(in thousands)
Financial assets:
Fixed maturities $ 494,917 $ 494,896
Equity securities 6,351 6,351
Policy loans 46,607 46,607
Mortgage loans 17 17
Short-term investments 137,944 137,944
Separate account assets 334,637 334,637
Cash and cash equivalents 24,975 24,975
Financial liabilities:
Separate account liabilities 334,637 334,637
Deferred annuities 123,527 119,993
Supplemental contracts 13,936 13,525
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
F-30
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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.
Mortgage loans
The fair value of mortgage loans is estimated using a discounted cash flow
analysis using rates for BBB-rated bonds with similar coupon rates and
maturities.
Separate account assets and liabilities
Separate account assets and liabilities represent the market value of
policyholder funds maintained in accounts having specific investment objectives.
Cash and short-term investments
The carrying amount of these instruments approximates market value.
Deferred annuities and supplemental contracts
The fair value of deferred annuities is estimated using cash surrender values.
Fair values for supplemental contracts is estimated using a discounted cash flow
analysis, based on interest rates currently offered on similar products.
5. Investment in InterContinental Life Corporation
Prior to the acquisition of ILCO on May 18, 2001, FIC carried its investment in
ILCO on the equity method of accounting. For the period from January 1, 2001 to
May 17, 2001, FIC's net income includes its equity interest in the net income of
ILCO, with such equity interest being based on FIC's percentage ownership of
ILCO. ILCO is primarily engaged in the sale and administration of life insurance
products through its insurance subsidiary, Investors Life. Summarized financial
information for ILCO for the period from January 1, 2001 to May 17, 2001 and the
year ended December 31, 2000 is set forth below, (in thousands):
F-31
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
January 1 to
May 18, 2001 January 1 to 2000
As Previously May 18, 2001 As Previously 2000
Reported As Restated Reported As Restated
Results of Operations:
Premium income $ 3,834 $ 3,835 $ 10,873 $ 9,875
Net investment income $ 19,288 $ 19,288 $ 50,893 $ 50,893
Earned insurance charges $ 15,386 $ 15,386 $ 38,500 $ 38,500
Benefits and expenses $ 32,296 $ 33,042 $ 84,669 $ 87,137
Net income $ 4,493 $ 4,009 $ 12,066 $ 9,813
Basic earnings per share $ 0.54 $ 0.48 $ 1.45 $ 1.18
Diluted earnings per share $ 0.54 $ 0.48 $ 1.45 $ 1.18
The amount of net realized gains (losses) included in net earnings of ILCO is
$(3,000) for the year ended December 31, 2000 and $100,000 for the period from
January 1, 2001 to May 17, 2001.
On May 18, 2001, ILCO Acquisition Company ("ILCO Acquisition"), a Texas
corporation and wholly-owned subsidiary of FIC, merged with and into ILCO. As a
result of the merger, ILCO Acquisition subsequently ceased to exist, and ILCO
continued as the surviving corporation, as a wholly-owned subsidiary of FIC.
Each share of ILCO common stock issued and outstanding immediately prior to the
merger, other than shares of ILCO common stock held as treasury shares by ILCO
(but excluding shares of ILCO common stock held by any of ILCO's subsidiaries,
whether or not treated as treasury shares of ILCO on a consolidated basis under
generally accepted accounting principles) or shares of ILCO common stock held by
FIC, were converted into the right to receive 1.1 shares of FIC common stock. In
addition, each option to purchase ILCO common stock was assumed by FIC and
became an option to purchase FIC common stock with the number of shares and the
exercise price adjusted for the exchange ratio in the merger.
The consideration for the transaction was $49.1 million, represented by the
issuance of 4.7 million shares of FIC stock, at $10 per share, to ILCO
shareholders and other direct costs of the merger. The $10 per share price was
calculated based on the average price of FIC common stock on the two days
immediately preceding and following the date of the merger agreement between FIC
and ILCO. Prior to the merger, FIC owned approximately 48.1% of ILCO's common
stock. The acquisition of ILCO was accounted for as a purchase; accordingly, the
results of ILCO's operations are included in the consolidated results of
operations from the date of the acquisition to December 31, 2001. Assets
acquired and liabilities assumed were recorded at their fair values as of the
acquisition date. The allocation of the purchase price to the net assets
acquired over costs resulted in excess of net assets acquired of approximately
$11.3 million after reduction of certain non current, non financial assets as
required by GAAP. FIC amortized $684,000 of excess of net assets acquired over
cost in 2001, which amount is included in operating expenses in the consolidated
statement of income. This allocation is based on an analysis, as of May 18,
2001, of the acquired book of business.
F-32
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The pro forma unaudited results of operations for the twelve months ended
December 31, 2001 and 2000, assuming the ILCO acquisition had been consummated
as of the beginning of the respective periods, are as follows:
Twelve Months Ended
December 31
(UNAUDITED)
(In thousands, except per share data)
2001 2000
RESTATED RESTATED
Total Revenues $ 136,225 $ 143,522
Net Income $ 9,633 $ 16,371
Net Income per share:
Basic $ 1.00 $ 1.68
Diluted $ 0.99 $ 1.65
6. Present Value of Future Profits of Acquired Businesses
An analysis of the present value of future profits follows:
2002 2001
RESTATED
(in thousands)
Balance at beginning of year $ 30,530 $ 19,627
Present value of acquired business from
consolidation of acquired company 0 16,816
Effect of unrealized gain on investments (2,141) (1,269)
Accretion of interest 2,385 2,305
Amortization during the period (6,978) (6,949)
Present value of future profits at
December 31 $ 23,796 $ 30,530
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):
2003 $ 4,365
2004 $ 3,563
2005 $ 3,007
2006 $ 2,525
2007 $ 2,203
F-33
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
At purchase, the present value of future profits was calculated using a discount
rate of approximately 15%. Interest is accreted on the unamortized portion at
approximately 7.0% to 11.0%.
7. Income Taxes
The Company files a consolidated federal income tax return with its
subsidiaries, except for Investors Life, Investors-IN and ILG Securities, which
file separate returns. In accordance with the Company's tax allocation
agreement, federal income tax expense or benefit is allocated to each member of
the consolidated group as if each member were filing a separate return.
The U.S. federal income tax provision (benefit) charged to continuing operations
was as follows:
2002 2001 2000
RESTATED RESTATED
(in thousands)
Current $ 270 $ 3,937 $ 1,521
Deferred (3,541) 140 (130)
Total provision for income tax $ (3,271) $ 4,077 $ 1,391
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:
2002 2001 2000
RESTATED RESTATED
(in thousands)
Income taxes at the statutory
rate $ (2,925) $ 4,508 $ 2,375
Increase (decrease) in taxes
resulting from:
Small life insurance company
deduction 0 (104) (382)
Dividends received deduction (15) (429) (477)
Tax rate differential 0 0 (65)
Non-deductible compensation (346) 443 16
Other items, net 15 (341) (76)
Total provision for income
taxes $ (3,271) $ 4,077 $ 1,391
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.
F-34
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:
2002 2001
RESTATED
Deferred tax liability: (in thousands)
Excess pension benefit $ 1,778 $ 1,777
Deferred policy acquisition costs 20,957 20,286
Present value of future profits 7,174 9,050
Deferred and uncollected premium 6,002 6,955
Reinsurance recoverable 3,116 3,925
Unrealized (depreciation) appreciation on
marketable securities 4,876 1,642
Other taxable temporary differences 2,795 3,100
Total deferred tax liability 46,698 46,735
Deferred tax asset:
Policy reserves 10,871 11,716
Net operating loss carry forward 4,083 3,263
Alternative minimum tax credit 346 347
Uncollected agent balances 1,306 1,076
Other receivables 2,308 2,308
Charitable contribution carryforward 424 0
Accrued liabilities 1,546 828
Total deferred tax assets, net 20,884 19,538
Net deferred tax liability $ 25,814 $ 27,197
An additional deferred federal income tax charge of $3,234,000 and $159,000 for
2002 and 2001, respectively, has been provided on the unrealized appreciation
(depreciation) of marketable securities and is included in the balance of the
deferred tax liability. This increase or decrease in deferred tax liability has
been recorded as a 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.
F-35
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
As a result of the acquisition of ILCO, the bases of ILCO's assets and
liabilities were adjusted as described more fully in Note 5 of these financial
statements. The adjustments to asset bases for financial reporting purposes
results in adjustments that reduce the taxable temporary differences between
financial reporting and tax purposes. As such, the Company's deferred tax
liability was reduced by approximately $13.8 million. This adjustment was also
reflected in the recorded financial reporting bases in assets acquired.
Under the provisions of pre-1984 life insurance company income tax regulations,
a portion of "gain from operations" of Investors Life was not subject to current
taxation but was accumulated, for tax purposes, in special tax memorandum
accounts designated as "policyholders' surplus accounts." Subject to certain
limitations,"policyholders' surplus" is not taxed until distributed or the
insurance company no longer qualifies to be taxed as a life insurance company.
The accumulation in this account for Investors Life at December 31, 2002 was
$12,582,000. Federal income tax of $4,404,000 would be due if the entire balance
is distributed at a tax rate of 35%.
The Company does not anticipate any transactions that would cause any part of
the policyholders' surplus accounts to become taxable and, accordingly, deferred
taxes have not been provided on such amounts. At December 31, 2002, Investors
Life has approximately $173,000,000, in the aggregate in its shareholders'
surplus account from which distributions could be made without incurring any
federal tax liability.
At December 31, 2002, the Company and its non-life wholly-owned subsidiaries
have net operating loss carry forwards of approximately $11.7 million, which
will begin to expire in 2008.
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, for years 1999 through 2001. Under
current law, FIC's insurance subsidiaries are no longer eligible for this
special deduction subsequent to 2001.
8. Reinsurance
Family Life and Investors Life reinsure portions of certain policies they write,
thereby providing greater diversification of risk and minimizing exposure on
larger policies. Generally, the reinsurer receives a proportionate part of the
premiums less commissions and is liable for a corresponding part of benefit
payments. The Company's retention on any one individual ranges from $0 to
$250,000 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 subsidiaries remain liable to the extent the reinsurance
companies are unable to meet their obligation under the reinsurance agreements.
F-36
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The components of reinsurance receivables as presented in the consolidated
financial statements are as
follows:
December 31,
2002 2001
(in thousands)
Future policy benefits $ 6,366 $ 8,263
Unearned premiums 658 937
Other policy claims and
benefits payable 5,306 5,509
$ 12,330 $ 14,709
The amounts in the consolidated statements of income have been reduced by
reinsurance ceded as follows:
For the years ended
2002 2001 2000
(in thousands)
Premiums $ 3,232 $ 2,414 $ 839
Policyholder benefits and
expenses $ 3,754 $ 3,389 $ 1,515
Estimated amounts recoverable from reinsurers on paid claims are $1,987,883 and
$2,486,455 in 2002 and 2001, respectively. These amounts are included in
reinsurance receivables in the consolidated financial statements at December 31,
2002 and 2001.
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 Investors Life. Family Life and
Investors Life are 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. As of December 31, 2001, Family
Life and Investors Life have earned surplus as defined by the regulations
adopted by the Washington Insurance Commissioner and, therefore, are presently
permitted to pay cash dividends. In December 2002, Investors Life paid a cash
dividend to ILCO of $8,556,104.
F-37
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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 $24,673,837 and
$23,520,637 at December 31, 2002 and 2001, respectively. Statutory net income
aggregated approximately $131,314, $4,419,303 and $5,024,926 for the years ended
December 31, 2002, 2001 and 2000, respectively.
Capital and surplus of Investors 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 $55,819,415 and
$63,837,560 at December 31, 2002 and 2001, respectively. Statutory net income
aggregated approximately $2,996,204, $8,325,275 and $11,082,693 for the years
ended December 31, 2002, 2001 and 2000, respectively.
The effect on the statutory capital and surplus and statutory net income amounts
of the restatement adjustments described in Note 2 will be reflected, to the
extent applicable, in Family Life's and Investor Life's next statutory filings.
The Company employed no permitted statutory accounting practices that
individually or in the aggregate materially affected statutory surplus or
risk-based capital of its insurance subsidiaries at December 31, 2002 or 2001.
In 1998, the NAIC adopted the Codification of Statutory Accounting Principles
guidance, which replaced the current Accounting Practices and Procedures manual
as the NAIC's primary guidance on statutory accounting. 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 implemented the changes from Codification in the first
quarter of 2001 for all its insurance subsidiaries. The primary change as a
result of Codification for each insurance subsidiary related to the recognition
of deferred taxes. The effect of the accounting change was $3,005,586, $870,069
and $3,088,332 at January 1, 2001 for Investors Life, Investors-IN and Family
Life, respectively, as a result of Codification and resulted in a corresponding
increase in statutory surplus for each insurance subsidiary.
10. Retirement Plans and Employee Stock Plans
Retirement Plans
A. Family Life
Family Life has a non-contributory defined benefit pension plan ("Family Life
Pension Plan"), which covers employees who have completed one year or more of
service. Under the Family Life Pension 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):
F-38
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(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 0.65% of Final Average Earnings up to Covered Compensation. With
respect to service prior to April 1, 1997, the accrual rate desribed
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.
The pension costs for the Family Life Pension Plan includes the following
components:
2002 2001 2000
(in thousands)
Service cost for benefits
earned during the year $ 66 $ 66 $ 61
Interest cost on projected
benefit obligation 541 490 472
Expected return on plan assets (321) (414) (401)
Pension expense $ 286 $ 142 $ 132
F-39
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The following summarizes the funded status of the Family Life Pension Plan at
December 31:
2002 2001
(in thousands)
Change in benefit obligation:
Benefit obligation at beginning of year $ 7,222 $ 6,841
Service cost 66 66
Interest cost 541 490
Benefits paid (451) (175)
Loss due to change in assumptions 1,077 0
Benefit obligation at end of year $ 8,455 $ 7,222
Change in plan assets:
Fair value of plan assets at beginning of year $ 6,570 $ 6,394
Actual return on plan assets 365 344
Employer contributions 141 7
Benefits paid (451) (175)
Fair value of plan assets at end of year $ 6,625 $ 6,570
Funded Status:
Funded status at end of year $ (352) $ 1,684
Unrecognized actuarial net gain (145) (135)
Additional minimum liability (611) (1,901)
Accrued pension expense at end of year $ (1,108) $ (352)
The significant assumptions for the plans are as follows:
The discount rate for projected benefit obligations was 6.75%, 7.25% and
7.25% for the years ended December 31, 2002, 2001 and 2000, respectively.
The assumed long-term rate of compensation increases was 5.0% for the years
ended December 31, 2002, 2001 and 2000.
The assumed long-term rate of return on plan assets was 8.0% for the years ended
December 31, 2002, 2001 and 2000.
F-40
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
B. ILCO
ILCO maintains a retirement plan ("ILCO Pension Plan") covering substantially
all employees of the Company and its subsidiaries. The ILCO Pension Plan is a
non-contributory, defined benefit pension plan, which covers each eligible
employee who has attained 21 years of age and has completed one year or more of
service. Each participating subsidiary company contributes an amount necessary
(as actuarially determined) to fund the benefits provided for its participating
employees.
The ILCO Pension Plan's basic retirement income benefit at normal retirement age
is 1.57% of the participant's average annual earnings less 0.65% of the
participant's final average earnings up to covered compensation multiplied by
the number of his/her years of credited service. For participants who previously
participated in the ILCO Pension Plan maintained by ILCO for the benefit of
former employees of the IIP Division of CIGNA Corporation (the IIP Plan), the
benefit formula described above applies to service subsequent to May 31, 1996.
With respect to service prior to that date, the benefit formula provided by the
IIP Plan is applicable, with certain exceptions applicable to former IIP
employees who are classified as highly compensated employees.
Former eligible IIP employees commenced participation automatically. The ILCO
Pension Plan also provides for early retirement, postponed retirement and
disability benefits to eligible employees. Participant benefits become fully
vested upon completion of five years of service, as defined, or attainment of
normal retirement age, if earlier.
The pension benefit (costs) for the ILCO Pension Plan includes the following
components:
2002 2001
(In thousands)
Service cost for benefits
earned during the period $ 544 $ 465
Interest cost on projected
benefit obligation 1,023 965
Expected return on plan assets (1,267) (1,327)
Amortization of unrecognized
prior service cost 0 (11)
Pension expense $ 300 $ 92
F-41
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The following summarizes the funded status of the ILCO Pension Plan at December
31:
2002 2001
(in thousands)
Change in benefit obligation:
Benefit obligation at beginning of period $ 14,492 $ 13,552
Service cost 544 465
Interest cost 1,023 965
Benefits paid (603) (490)
Loss due to change in assumptions 916 0
Benefit Obligation at end of year $ 16,372 $ 14,492
Change in plan assets:
Fair value of plan assets at beginning of year $ 17,293 $ 16,835
Actual return on plan assets 1,124 948
Benefits paid (603) (490)
Fair value of plan assets at end of year $ 17,814 $ 17,293
Funded Status:
Funded status at end of year $ 4,771 $ 4,863
Unrecognized prior service cost (300) (92)
Unrecognized actuarial net loss 0 0
Prepaid pension expense at end of year $ 4,471 $ 4,771
The significant assumptions for the ILCO Pension Plan are as follows:
The discount rate for projected benefit obligations was 6.75% and 7.25% in 2002
and 2001, respectively. The assumed long-term rate of compensation increases was
5.0% for 2002 and 2001. The assumed long-term rate of return on plan assets was
8.0% for 2002 and 2001. There were no assumed expenses as a percentage for 2002
and 2001.
F-42
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Savings and Investment Plan
ILCO maintains a Savings and Investment ("401(k) Plan") that allows eligible
employees who have met a one-year service requirement to make contributions to
the 401(k) Plan on a tax-deferred basis. A 401(k) Plan participant may elect to
contribute up to 16% of eligible earnings on a tax deferred basis, subject to
certain limitations applicable to "highly compensated employees" as defined in
the Internal Revenue Code. 401(k) Plan participants may allocate contributions,
and earnings thereon, between investment options selected by participants. The
Account Balance of each Participant attributable to employee contributions is
100% vested at all times.
During 1995, the 401(k) Plan was amended to allow for the addition of Family
Life as a participating employer, thus allowing Family Life employees to
participate in the 401(k) Plan.
In 1997, the 401(k) Plan was amended to provide for a matching contribution. The
match, which was in the form of shares of ILCO common stock, prior to the
acquisition of the remaining outstanding common stock of ILCO by FIC on May 18,
2001, and is in the form of FIC common stock thereafter, is equal to 100% of an
eligible participant's elective deferral contributions, as defined in the 401(k)
Plan, not to exceed a maximum percentage of the participant's plan compensation.
Initially, the maximum percentage was 1%. Effective January 1, 2000, the 401(k)
Plan was amended to increase the maximum percentage to 2%. Allocations are made
on a quarterly basis to the account of participants who have at least 250 hours
of service in that quarter. The total costs recognized by the Company relating
to the 401(k) Plan was $90,985 and $95,878 for 2002 and 2001. In 2001, the
401(k) Plan was amended and restated to comply with the Economic Growth and Tax
Relief Reconciliation Act of 2001.
ILCO maintained an Employee Stock Ownership Plan ("ESOP Plan") and a related
trust for the benefit of its employees and Family Life employees. The ESOP Plan
generally covered employees who had attained the age of 21 and had completed one
year of service. Vesting of benefits to employees was based on number of years
of service. Effective May 1, 1998, the 401(k) Plan was amended to provide for
the merger of the ESOP Plan into the 401(k) Plan. In connection with the merger,
certain features under the ESOP Plan were preserved for the benefit of employees
previously participating in the ESOP Plan with regard to all benefits accrued
under the ESOP Plan through the date of merger. The merger was effected on
December 26, 2001. No contributions were made to the ESOP Plan in 2001. At
December 31, 2002, the 401(k) Plan had a total of 514,469 shares of FIC stock,
which are allocated to participants.
401(k) Plan shares are treated as issued and outstanding in calculating the
Company's earnings per share. Dividends to shareholders in the 401(k) Plan are
treated by the Company as dividends to outside shareholders and are a direct
charge to retained earnings.
F-43
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Stock Option Plans
A. ILCO Stock Option Plan
Under ILCO's 1999 Non-qualified Stock Option Plan (the "ILCO Stock Option Plan")
options to purchase shares of ILCO's common stock were granted to certain
employees of ILCO, its subsidiaries and affiliates.
The ILCO Stock Option Plan became effective on May 18, 1999 (the "Effective
Date"). The exercise price of the options is equal to 100% of the fair market
value on the date of grant, but in no case less than $7.50 per share ($6.818 per
share as adjusted for the exchange ratio in the merger). A portion of the
options become exercisable on the next anniversary of the Effective Date
following the date of grant. No options may be exercised after the sixth
anniversary of the Effective Date. All options must be exercised in one year
from the date the options become exercisable. The number of options that become
exercisable on each anniversary of the Effective Date, prior to the sixth
anniversary, is equal to 100% of the total options granted divided by the number
of years between the next anniversary of the Effective Date following the date
of grant and the sixth anniversary of the Effective Date.
Subsequent to May 18, 2001, each share of ILCO common stock issuable pursuant to
outstanding options was assumed by the Company and became an option to acquire
FIC common stock. The number of shares and the exercise price were adjusted for
the exchange ratio in the merger (see Note 5). The related charge was included
in equity as deferred compensation. The weighted average information for 2001
below is calculated from the date of merger, May 18, 2001, to December 31, 2001.
After the merger in 2001, 22,000 options were granted at prices ranging from
$13.00 to $14.30. 26,400 options were cancelled and 47,150 options were
exercised. In 2002, 33,000 options were granted at prices ranging from $13.42 to
$14.00, 42,350 were cancelled and 119,650 were exercised.
The following table summarizes activity under ILCO's Stock Option Plan for the
year ended December 31, 2002 and 2001:
Weighted Weighted
2002 Average 2001 Average
Options Exercise Options Exercise
(000's) Price (000's) Price
Outstanding on May 18, 2001
and beginning of year 338 $ 8.76 389 $ 8.38
Granted 33 13.74 22 13.65
Exercised (120) 8.56 (47) 8.21
Cancelled (42) 9.52 (26) 8.18
Outstanding at end of year 209 $ 9.51 338 $ 8.76
Options exercisable at end of year 209 $ 9.51 50 $ 8.54
Weighted average fair value of
options granted during the year $ 2.09 $ 2.54
F-44
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANICAL STATEMENTS, Continued
B. FIC Stock Option Plan
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, 2002, no options had been granted
under the FIC Stock Option Plan.
C. Stock Appreciation Rights Granted in 2002
On November 4, 2002, FIC adopted an Equity Incentive Plan (the "Plan"). The
purpose of the Plan is to provide motivation to key employees of the Company and
its subsidiaries to put forth maximum efforts toward the continued growth,
profitability, and success of the Company and its subsidiaries by providing
incentives to such key employees through performance-related incentives,
including, but not limited to, the performance of the Common Stock of the
Company. Toward this objective, stock appreciation rights or performance units
may be granted to key employees of the Company and its subsidiaries on the terms
and subject to the conditions set forth in the Plan. On November 4, 2002, the
Company granted stock appreciation rights ("SARs") with respect to 30,000 shares
of the Common Stock of the Company, pursuant to terms and provisions of the
Plan. The exercise price of each unit is $14.11, which was 100% of the Fair
Market Value of the Common Stock of the Company on the date of such grant.
11. Leases
The Company and its subsidiaries occupy office facilities under lease agreements
which expire at various dates through 2005. Certain office space leases may be
renewed at the option of the Company.
Rent expense in 2002, 2001 and 2000 was $2,844,186, $1,695,425 and $184,840
respectively. Minimum annual rentals are as follows:
(in thousands)
2003 $ 1,216
2004 941
2005 842
2006 96
2007 24
Thereafter 0
Total $ 3,119
12. Related Party Transactions
Prior to May 18, 2001, FIC owned 48.1% of ILCO's common stock. Significant
related party transactions are as follows:
F-45
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
In 1989, as part of the purchase of Family Life from Merrill Lynch Insurance
Group, Inc. ("Merrill Lynch"), FIC organized two downstream holding companies:
Family Life Insurance Investment Corporation ("FLIIC") and Family Life
Corporation ("FLC"). FLIIC was organized as a wholly-owned subsidiary of FIC
and, in turn, was issued all of the outstanding shares of FLC. FLC purchased all
of the outstanding shares of Family Life from Merrill Lynch. A portion of the
consideration for the purchase consisted of a $30 million senior subordinated
note (the "Merrill Lynch Loan"). Following the purchase of the Family Life
shares by FLC, Family Life issued 250,000 previously unissued shares of its
common stock to FLC for a $2.5 million cash payment and immediately thereafter
redeemed from FLC 250,000 shares of its common stock that had been purchased by
FLC from Merrill Lynch. The consideration paid to FLC by Family Life for said
redeemed shares consisted of $2.5 million cash, a newly issued surplus debenture
(an instrument having certain restrictions on payment for the protection of
policyholders) in the principal amount of $97.5 million (the "Family Life
Surplus Debenture") and $14 million principal value of newly issued preferred
shares.
Another part of the financing arrangement to purchase Family Life included FLC
borrowing $25 million from Investors Life (the "Investors Life Loans"). This
amount was represented by a $22.5 million loan from Investors Life to FLC and a
$2.5 million loan provided directly to FIC by Investors-CA (which was
subsequently merged into Investors Life). In addition to the interest provided
under the Investors Life Loans, Investors Life was granted non-transferable
options to purchase FIC common stock, up to a total of 9.9 % of shares of FIC
common stock (currently 500,411 shares) at a price of $2.10 per share (as
adjusted to reflect the five-for-one stock split in November 1996), equivalent
to the then current market price, subject to adjustment to prevent dilution. The
initial terms of the option provided for their expiration on June 12, 1998, if
not previously exercised. In connection with the 1996 amendments to the
Investors Life Loans, the expiration date of the options was extended to
September 12, 2006.
On June 12, 1996, the Investors Life Loans were amended to provide for twenty
quarterly principal payments, commencing on December 12, 1996. Additionally,
prior to such date, accrued interest on the $2.5 million subordinated note
issued by FIC to Investors-CA was paid by delivery of additional notes of FIC
having terms identical to the original note, including the payment of interest.
The Investors Life Loans were paid in full as of September 12, 2001; however,
because of the 1993 Subordinated Loans, described in "Family Life Refinancing"
below, the options of Investors Life to purchase FIC common stock did not expire
with the repayment of the Investors Life Loans.
In 1993, Investors Life loaned an additional $34.5 million to FLC and FLIIC in
the form of subordinated notes so that FLC and FLIIC could prepay the Merrill
Lynch Loan (the "1993 Subordinated Loans"). The 1993 Subordinated Loans
consisted of a $30 million loan to FLC and a $4.5 million loan to FLIIC.
On June 12, 1996, the 1993 Subordinated Loans were also amended as follows: (a)
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 remained at 9%, and (b) 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 remained at 9%.
F-46
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
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.
As of December 31, 2002, the outstanding principal balance of the 1993
Subordinated Loans was $23.05 million.
In 1995, Family Life entered into a reinsurance agreement with Investors Life
pertaining to universal life insurance written by Family Life. The reinsurance
agreement is on a co-insurance basis and applies to all covered business with
effective dates on and after January 1, 1995. The agreement applies to only that
portion of the face amount of the policy which is less than $200,000; face
amounts of $200,000 or more are reinsured by Family Life with a third party
reinsurer.
In 1996, Family Life entered into a reinsurance agreement with Investors Life,
pertaining to annuity contracts written by Family Life. The agreement applies to
contracts written on or after January 1, 1996.
On January 8, 2001, the Company donated $375,000 to the Roy F. and Joann Cole
Mitte Foundation (the "Foundation"). The Foundation is a charitable entity
exempt from federal income tax under section 501(a) of the Code as an
organization described in section 501(c)(3) of the Code, and owns 16.31% of the
outstanding shares of FIC's common stock. The sole members of the Foundation are
Roy F. Mitte, former Chairman, President and Chief Executive Officer of FIC,
ILCO and their insurance subsidiaries and his wife, Joann Cole Mitte. On January
2, 2002, FIC made a transfer of $1,000,000 to the Foundation. This transfer is
the subject of ongoing litigation between the Company and the former Chairman,
President and CEO, as described in Note 13.
13. 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.
F-47
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Universal Life Litigation. On January 22, 2002, the Travis County District Court
in Austin, Texas, denied certification to a proposed nationwide class of
plaintiffs who purchased certain universal life insurance policies from INA Life
Insurance Company (which was merged into Investors Life in 1992). The lawsuit,
which was filed in 1996 as a "vanishing premium" life insurance litigation,
initially alleged that the universal life insurance policies sold to plaintiffs
by INA Life Insurance Company utilized unfair sales practices. In April 2001,
the plaintiffs filed an amended complaint, so as to include various post-sale
allegations, including allegations related to the manner in which increases in
the cost of insurance were applied, the allocation of portfolio yields to the
universal life policies and changes in the spread between the earned rate and
the credited rate. Plaintiffs' Motion for Class Certification was denied in its
entirety.
Litigation Relating to the FIC/ ILCO Merger. On the day that FIC and ILCO each
publicly announced the formation of a special committee to evaluate a potential
merger, two class action lawsuits were filed against ILCO, FIC and the officers
and directors of ILCO. The actions allege that a cash consideration in the
proposed merger is unfair to the shareholders of ILCO, that it would prevent the
ILCO shareholders from realizing the true value of ILCO, and that FIC and the
named officers and directors had material conflicts of interest in approving the
transaction. In their initial pleadings, the plaintiffs sought certification of
the cases as class actions and the named plaintiffs as class representatives,
and among other relief, requested that the merger be enjoined (or, if
consummated, rescinded and set aside) and that the defendants account to the
class members for their damages. The defendants believe that the lawsuits are
without merit and intend to vigorously contest the lawsuits. Management is
unable to determine the impact, if any, that the lawsuits may have on the
results of operations of the Company.
Litigation Relating to Former Chairman and CEO. In January, 2003, the Company
filed a lawsuit in Federal District Court in Austin, Texas. The lawsuit names as
defendants Roy F. Mitte ("Mitte"), The Roy F. and Joann Cole Mitte Foundation
(the "Foundation") and Joann Mitte (collectively referred to as the
"Defendants"). Mitte was the Chairman, President and Chief Executive Officer of
FIC until he was placed on administrative leave in August, 2002. The
administrative leave, and the subsequent action by the Board of Directors in
October, 2002 to terminate the employment agreement between FIC and Mitte,
resulted from an investigation conducted by the FIC Audit Committee.
The investigation conducted by the Audit Committee determined that more than
$540,000 in Mitte's personal expenses had been paid by Company funds without the
knowledge or approval of the FIC's officers or directors. In addition, the
investigation disclosed that Mitte had caused an unapproved transfer of $1
million from the Company to the Foundation, followed by an ineffective attempt
to obtain an unanimous consent of the Board of Directors of the Company. The
Board of Directors has never met to ratify or approve the donation. The
Foundation is a shareholder of FIC.
The Company's claims against Mitte seek the reimbursement of $540,000 of
personal expenses which were paid by the Company for the benefit of Mitte over a
period of years beginning in 1992. In addition, the suit demands that Mitte
reimburse the Company for a payment which he caused to be made to the Foundation
without proper authorization by the Board of Directors.
On March 19, 2003, Mitte filed a counterclaim against the Company alleging that
the Company breached the employment agreement between FIC and Mitte by refusing
to pay Mitte the severance benefits and compensation provided for under the
employment agreement and amendment thereto. The Company believes that it
properly terminated the contract and intends to vigorously defend Mitte's
counterclaim.
F-48
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The litigation is currently in the preliminary discovery stage.
Other Litigation. Additionally, FIC's insurance subsidiaries are regularly
involved in litigation, both as a defendant and as plaintiff. The litigation
naming the insurance subsidiaries as defendant ordinarily involves our
activities as a provider of insurance protection products. Management does not
believe that such litigation, either individually or in the aggregate, will have
a material adverse effect on the Company's business, financial condition or
results of operations.
14. Net Income Per Share
The following table reflects the calculation of basic and diluted earnings per
share:
December 31,
2002 2001 2000
RESTATED RESTATED
(Amounts in thousands, except per share amounts)
Basic:
Net income available to common
shareholders $ 5,342 $ 9,777 $ 7,436
Weighted average common shares
outstanding 9,555 7,824 5,055
Basic earnings per share $ 0.56 $ 1.25 $ 1.47
Diluted:
Net income available to common
shareholders $ 5,342 $ 9,777 $ 7,436
Weighted average common shares
outstanding 9,555 7,824 5,055
Common stock options 0 224 258
Effect of shares ILCO owns of FIC 0 0 (91)
Repurchase of treasury stock 0 (150) (59)
Common stock and common stock
equivalents 9,555 7,898 5,163
Diluted earnings per share $ 0.56 $ 1.24 $ 1.44
Options to purchase 208,850 shares of common stock at prices ranging from $8.18
to $14.30 were outstanding at December 31, 2002, but were not included in the
computation of diluted earnings per share because the inclusion would result in
an antidilutive effect in periods where a loss from continuing operations was
incurred.
F-49
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
15. Business Concentration
One of the Company's insurance subsidiaries, 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 2002, premium
income from these products was derived from 48 states with concentrations of
approximately 25% and 28% in California and Texas, respectively. In 2001, these
amounts were 25% and 27%, respectively.
In 2002 and 2001, premium income from Investors Life's life insurance products
was derived from all states in which Investors Life is licensed, with
significant amounts derived from Pennsylvania (14% and 14%), California (8% and
8%), and Ohio (8% and 8%).
16. Quarterly Financial Data (unaudited)
Previously reported unaudited quarterly financial data has been restated for the
effects of the adjustments described in Note 2 to the extent applicable, as
follows (in thousands, except per share data):
Three Months Three Months
Ended Ended
March 31, March 31,
2002 2001 2002 2001
AS PREVIOUSLY FILED AS RESTATED
Total revenues $32,239 $10,603 $32,240 $10,603
Net income before cumulative effect
of change in accounting principle $ 1,157 $ 2,083 $ 582 $ 1,873
Cumulative effect of change in
accounting principle 15,727 0 10,429 0
Net income $16,884 $ 2,083 $11,011 $ 1,873
Basic earnings per share:
Net income before cumulative effect
of change in accounting principle $ 0.12 $ 0.41 $ 0.06 $ 0.37
Cumulative effect of change in
accounting principle 1.66 0 1.10 0
Net income $ 1.78 $ 0.41 $ 1.16 $ 0.37
Diluted earnings per share:
Net income before cumulative effect
of change in accounting principle $ 0.12 $ 0.40 $ 0.06 $ 0.36
Cumulative effect of change in
accounting principle 1.64 0 1.09 0
Net income $ 1.76 $ 0.40 $ 1.15 $ 0.36
F-50
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Quarterly Financial Data (unaudited) (continued)
(in thousands, except per share data)
Three Months Three Months
Ended Ended
June 30, June 30,
2002 2001 2002 2001
AS PREVIOUSLY FILED AS RESTATED
Total revenues $ 30,002 $ 22,114 $ 30,003 $ 22,114
Net income before cumulative effect of change in
accounting principle $ 215 $ 2,766 $ (247) $ 2,359
Cumulative effect of change in accounting principle 0 0 0 0
Net income $ 215 $ 2,766 $ (247) $ 2,359
Basic earnings per share:
Net income before cumulative effect of change in
accounting principle $ 0.02 $ 0.38 $ (0.03) $ 0.33
Cumulative effect of change in accounting principle 0 0 0 0
Net income $ 0.02 $ 0.38 $ (0.03) $ 0.33
Diluted earnings per share:
Net income before cumulative effect of change in
accounting principle $ 0.02 $ 0.38 $ (0.03) $ 0.33
Cumulative effect of change in accounting principle 0 0 0 0
Net income $ 0.02 $ 0.38 $ (0.03) $ 0.33
F-51
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Quarterly Financial Data (unaudited) (continued)
(in thousands, except per share data)
Three Months Three Months
Ended Ended
September 30, September 30,
2002 2001 2002 2001
AS PREVIOUSLY FILED AS RESTATED
Total revenues $ 30,519 $ 33,965 $ 30,520 $ 33,506
Net income before cumulative
effect of change in accounting
principle $ 899 $ 3,806 $ 377 $ 3,007
Cumulative effect of change in
accounting principle 0 0 0 0
Net income $ 899 $ 3,806 $ 377 $ 3,007
Basic earnings per share:
Net income before cumulative effect
of change in accounting principle $ 0.09 $ 0.40 $ 0.04 $ 0.32
Cumulative effect of change in
accounting principle 0 0 0 0
Net income $ 0.09 $ 0.40 $ 0.04 $ 0.32
Diluted earnings per share:
Net income before cumulative
effect of change in accounting
principle $ 0.09 $ 0.40 $ 0.04 $ 0.32
Cumulative effect of change in
accounting principle 0 0 0 0
Net income $ 0.09 $ 0.40 $ 0.04 $ 0.32
F-52
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Quarterly Financial Data (unaudited) (continued)
(in thousands, except per share data)
Three
Months Ended Three Months Ended
December 31, 2002 December 31, 2001
AS AS
PREVIOUSLY RESTATED
FILED
Total revenues $25,953 $32,443 $ 31,937
Net income before cumulative
effect of change in accounting
principle $(5,800) $ 3,359 $ 2,403
Cumulative effect of change in
accounting principle 0 0 0
Net income $(5,800) $ 3,359 $ 2,403
Basic earnings per share:
Net income before cumulative
effect of change in accounting
principle $ (0.60) $ 0.35 $ 0.25
Cumulative effect of change in
accounting principle 0 0 0
Net income $ (0.60) $ 0.35 $ 0.25
Diluted earnings per share:
Net income before cumulative effect
of change in accounting principle $ (0.60) $ 0.35 $ 0.25
Cumulative effect of change in
accounting principle 0 0 0
Net income $ (0.60) $ 0.35 $ 0.25
F-53
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN
INVESTMENTS IN RELATED PARTIES
December 31, 2002
(in thousands)
Amount
Shown on
Amortized Fair Balance
Type of Investment Cost Value Sheet
Fixed Maturities Available for Sale:
Bonds:
United States Government and
government agencies and authorities $ 25,325 $ 28,706 $ 28,706
States, municipalities and political
subdivisions 6,060 6,391 6,391
Corporate securities 248,424 253,314 253,314
Mortgage-backed securities 199,624 205,416 205,416
Total fixed maturities available
for sale 479,433 493,827 493,827
Fixed maturities held to maturity 1,090 1,069 1,090
Total fixed maturities 480,523 494,896 494,917
Equity securities:
Common Stocks:
Industrial and miscellaneous other 59 29 29
Seed money investment in Separate
Accounts 6,322 6,322 6,322
Total equity securities 6,381 6,351 6,351
Policy loans 46,607 46,607 46,607
Short-term investments 137,944 137,944 137,944
Total investments $ 671,455 $ 685,798 $ 685,819
F-54
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
December 31,
2002 2001
RESTATED
ASSETS (in thousands)
Cash and cash equivalents $ 383 $ 684
Short-term investments 0 1,300
Long-term bonds 16 16
Investments in subsidiaries* 210,180 198,195
Property, plant and equipment, net 69 69
Other assets 964 965
Accounts receivable 398 95
Total assets $ 212,010 $ 201,324
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Subordinated notes payable $ 3,007 $ 3,809
Other liabilities and intercompany payables 16,218 12,935
Total liabilities 19,225 16,744
Shareholders' equity
Common stock, $.20 par value, 25,000,000
authorized; 11,856,196 and 11,736,546
shares issued in 2002 and 2001, 9,600,827
and 9,498,847 shares outstanding in 2002
and 2001 2,372 2,348
Additional paid-in capital 66,541 65,558
Accumulated other comprehensive income 4,949 327
Deferred compensation 0 (292)
Retained earnings (including $134,396 and
$126,998 of undistributed earnings of
subsidiaries at December 31, 2002
and 2001) 123,046 120,393
Total shareholders' equity before treasury stock 196,908 188,334
Common treasury stock, at cost, 625,695 and 608,025
shares in 2002 and 2001, respectively (4,123) (3,754)
Total shareholders' equity 192,785 184,580
Total liabilities and shareholders' equity $ 212,010 $ 201,324
* $210,180 and $198,195 are eliminated in consolidation in 2002 and 2001,
respectively.
F-55
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT,
STATEMENTS OF INCOME
FOR THE YEARS ENDED
December 31,
(in thousands)
2002 2001 2000
RESTATED RESTATED
Income $ 12 $ 67 $ 26
Expenses:
Operating expenses 1,756 790 147
Interest expense 312 400 515
2,068 1,190 662
Loss from operations (2,056) (1,123) (636)
Equity in undistributed
earnings from subsidiaries 7,398 10,900 8,072
Net income $ 5,342 $ 9,777 $ 7,436
F-56
FINANCIAL INDUSTRIES CORPORATION (PARENT COMPANY)
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED
December 31,
(in thousands)
2002 2001 2002
CASH FLOWS FROM OPERATING ACTIVITIES RESTATED RESTATED
Net income $ 5,342 $ 9,777 $ 7,436
Adjustments to reconcile net income to net
cash used in operating activities:
(Increase) decrease in accounts
receivables (303) 487 (482)
Increase in investment in
subsidiaries* (11,985) (65,973) (11,269)
Decrease (increase) in other assets 1 (258) (34)
Increase in other liabilities and
intercompany payables 3,283 6,258 916
Other 4,431 59,305 4,597
Net cash provided by operating activities 769 9,596 1,164
CASH FLOWS FROM FINANCING
ACTIVITIES
Net change in short-term investments 1,300 (1,150) 887
Change in subordinated notes payable
to Investors Life (802) (946) (993)
Cash dividend to shareholders (2,206) (5,978) (905)
Purchase of treasury stock (369) (1,445) 0
Issuance of capital stock 1,007 384 0
Net cash used in financing activities (1,070) (9,135) (1,011)
(Decrease) increase in cash (301) 461 153
Cash and cash equivalents, beginning
of year 684 223 70
Cash and cash equivalents, end of year $ 383 $ 684 $ 223
*Eliminated in consolidation
F-57
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
December 31, 2002
(in thousands)
Future policy
Deferred benefits, Other Policy
Policy losses,claims Claims and
Acquisition and loss Benefits Premium
Costs expenses (1) Payable Revenue
2002 $ 77,210 $ 729,474 $ 17,035 $ 35,672
2001, As restated $ 77,137 $ 737,070 $ 13,985 $ 35,887
2000, As restated $ 52,907 $ 105,763 $ 2,931 $ 33,149
Benefits, Amortization
claims, of Deferred
Net losses and Policy Other
Investment Settlement Acquisition Operating
Income expenses (2) Costs Expenses
2002 $ 42,889 $ 77,876 $ 10,427 $ 34,177
2001, As restated $ 32,656 $ 50,085 $ 6,767 $ 22,856
2000, As restated $ 6,933 $ 15,664 $ 5,340 $ 11,159
(1) Includes contractholder funds
(2) Includes interest expense on contractholder funds
F-58
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SCHEDULE IV-REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 and 2000
(in thousands)
Percentage
Gross Ceded to Assumed of Amount
Direct Other From Other Assumed
Amount Companies Companies Net Amount To Net
2002
Life Insurance in-force $10,736,157 $1,274,843 $ 0 $ 9,461,314 0.00%
Premium:
Life insurance $ 38,402 $ 2,783 $ 0 $ 35,619 0.00%
Accident & health
insurance 502 449 0 53 0.00%
Total Premium $ 38,904 $ 3,232 $ 0 $ 35,672 0.00%
2001, as restated
Life Insurance in-
force $12,107,319 $1,074,286 $ 0 $11,033,033 0.00%
Premium:
Life insurance $ 37,619 $ 1,821 $ 7 $ 35,805 0.02%
Accident & health
insurance 675 593 0 82 0.00%
Total Premium $ 38,294 $ 2,414 $ 7 $ 35,887 0.02%
2000, as restated
Life insurance in-
force $ 7,006,301 $ 552,467 $ 5,067 $ 6,458,901 0.08%
Premium:
Life insurance $ 33,499 $ 448 $ 51 $ 33,102 0.15%
Accident & health
insurance 438 391 0 47 0.00%
Total Premium $ 33,937 $ 839 $ 51 $ 33,149 0.15%
F-59