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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission File
Number 0-4690
FINANCIAL INDUSTRIES CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 74-2126975
State of Incorporation (I.R.S. Employer
Identification number)
701 Brazos, Suite 1400, Austin, Texas 78701
(Address of Principal Executive Offices) (Zip Code)
(512) 404-5050
(Registrant's Telephone Number)
Securities Registered pursuant to Section 12(b) of the Act: None
Securities Registered pursuant to Section 12(g) of the Act:
Common Stock, $.20 par value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months and
(2) has been subject to such filing requirements for the past 90
days. YES X NO
The aggregate market value of the voting stock held by non-
affiliates of the Registrant on March 16, 1998, based on the
closing sales price in The Nasdaq Small-Cap Market ($18.75 per
share), was $62,757,563.
The number of shares outstanding of Registrant's common stock on
March 16, 1998 was 5,427,965.
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not
be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. [ ]
DOCUMENTS INCORPORATED BY REFERENCE:
A. Reports on Form 10-K of InterContinental Life Corporation
for the fiscal years ended December 31, 1997, 1996 and
1995 are hereby incorporated by reference.
PART I
Item 1. Business
General
Financial Industries Corporation ("FIC", the "Company" or the
"Registrant") is a holding company primarily engaged in the life
insurance business through its ownership of 100% of Family Life
Insurance Company ("Family Life") and its approximately 45.40%
interest in InterContinental Life Corporation ("ILCO"). FIC also
holds options to acquire additional shares, which, if exercised,
would result in FIC owning approximately 60.80% of ILCO's
outstanding shares. FIC s options remain in effect as long as FIC
guarantees certain indebtedness of ILCO (see "Acquisition of
ILCO").
The Registrant was organized as an Ohio corporation in 1968 and was
reincorporated in Texas in 1980. Its executive offices are located
at 701 Brazos, Suite 1400, Austin, Texas 78701. Through 1984,
FIC's principal business was the sale and underwriting of life and
health insurance, mainly in the midwestern and southwestern United
States. In 1985, FIC acquired control of ILCO.
FIC, ILCO and their insurance subsidiaries have substantially
identical managements. Officers allocate their time between FIC
and ILCO in accordance with the comparative requirements of both
companies and their subsidiaries. Roy F. Mitte, Chairman,
President and Chief Executive Officer of FIC, ILCO and their
insurance subsidiaries, is the owner, directly and beneficially, of
approximately 34% of the outstanding shares of FIC's common stock.
Acquisitions
Strategy. The Company's strategy has been and continues to be to
grow internally and through acquisitions, while maintaining an
emphasis on cost controls. Management believes that, under
appropriate circumstances, it is more advantageous to acquire
companies with books of in-force life insurance than to produce new
business, because initial underwriting costs have already been
incurred and mature business is generally less likely to terminate,
making possible more predictable profit analysis. However, Family
Life does continue to market those products that are profitable, as
well as develop new products and streamline distribution channels.
See "Agency Operations". It is also management's belief that the
continuing consolidation in the life insurance industry presents
attractive opportunities for the Company to acquire life insurance
companies that complement or fit within the Company's existing
marketing structure and product lines. The Company's objective is
to improve the profitability of acquired businesses by
consolidating and streamlining the administrative functions of
these businesses, eliminating unprofitable products and
distribution channels, applying its marketing expertise to the
acquired company's markets and agents, and benefitting from
economies of scale. FIC's ability to make future acquisitions will
be dependent on its being able to obtain the necessary financing.
In addition, since ILCO has the same acquisition strategy as FIC,
a conflict of interest could arise in the future between FIC and
ILCO with respect to acquisition opportunities.
Acquisition of ILCO. In January 1985, FIC acquired 26.53% of
ILCO's Common Stock. FIC and Family Life subsequently acquired
additional shares of ILCO's Common Stock and as of March 16, 1998,
FIC owned, directly and indirectly through Family Life,
approximately 45.40% of the outstanding shares of ILCO's Common
Stock. FIC holds options to acquire up to 1,702,155 additional
shares of ILCO's Common Stock. Giving effect to the exercise of
those options, FIC would own, directly and indirectly through
Family Life, approximately 60.80% of the outstanding shares of
ILCO's Common Stock. The exercise price of the options is equal to
the average quoted market price of ILCO's common stock over the
six-month period immediately prior to exercise. In addition, in
the event that any other party should seek to acquire, without the
prior approval of ILCO's Board of Directors, securities aggregating
five percent or more of the outstanding shares of ILCO, FIC would
then have the right to acquire, under the same price formula, that
number of shares of common stock which together with the shares
then owned by FIC, would amount to 51% of the outstanding shares of
ILCO. The consideration for the options was FIC's granting to ILCO
a loan in the principal amount of $1.2 million, FIC's agreement to
guarantee additional ILCO obligations totaling $4.0 million and
FIC's agreement to guarantee ILCO's lease obligation on its
headquarters building upon demand. In addition, FIC guaranteed a
$15.0 million term loan of ILCO. As described under the heading
ILCO s Acquisitions , the current Senior Loan of ILCO is scheduled
to be fully repaid on October 1, 1998. Accordingly, unless ILCO s
Senior Loan is extended, or ILCO otherwise incurs indebtedness
which is guaranteed by FIC, FIC s rights under the 1986 option
agreement would expire on October 1, 1998.
Acquisition of Family Life. FIC acquired Family Life from Merrill
Lynch Insurance Group, Inc. on June 12, 1991. The consideration
for the purchase was $114 million consisting of a cash payment of
$70 million and $44 million of subordinated promissory notes issued
by subsidiaries of FIC to the seller and its affiliates. Family
Life s primary business is the underwriting and sale of mortgage
protection life insurance to customers who are mortgage borrowers
from financial institutions where Family Life has marketing
relationships. Family Life distributes its insurance products
primarily through a national career agency sales force. See
"Business of Family Life Insurance Company".
ILCO's Acquisitions
In November 1986, ILCO acquired Standard Life Insurance Company
("Standard Life"), headquartered in Jackson, Mississippi, for a
gross purchase price of $54.5 million. A portion of the funds used
by the new life insurance company formed by ILCO to make the
acquisition ("New Standard") was the proceeds of a loan extended to
the Company by a national bank in the principal amount of $15.0
million (the "Standard Term Loan"). This sum was, in turn, loaned
by ILCO to New Standard, and the loan was evidenced by a surplus
debenture. New Standard was merged into Standard Life in June
1988.
In December 1988, ILCO, through Standard Life, purchased Investors
Life Insurance Company of California ("Investors-CA") and Investors
Life Insurance Company of North America ("Investors-NA") from CIGNA
Corporation for a purchase price of $140 million. ILCO obtained
the funds used for the acquisition from: (a) a Senior Loan in the
amount of $125.0 million provided by six financial institutions,
(b) a $10.0 million subordinated loan provided by two insurance and
financial service organizations and (c) the sale of $5.0 million of
Class A Preferred Stock to CIGNA and $15.0 million of Class B
Preferred Stock to the subordinated lenders. Approximately $15.0
million of these funds were used to discharge the Standard Term
Loan. The balance of these funds were loaned by ILCO to Standard
Life. To evidence this indebtedness, Standard Life issued a $140.0
million surplus debenture to ILCO. In connection with the
subordinated debt and preferred stock financing, ILCO issued
detachable warrants entitling the holders to purchase 1,107,480
shares of ILCO's Common Stock at $3.33 per share.
In May 1990, ILCO effected an exchange agreement with the holders
of its Class A Preferred Stock and its Class B Preferred Stock.
Under the provisions of the exchange agreement, the holders of the
Class A Preferred Stock received $5 million principal amount of a
13.25% 1998 Series Subordinate Notes, due November 1, 1998,
together with a make whole amount equal to 13.25% of the then
outstanding balance of the Note. The holders of the Class B
Preferred Stock received $15 million principal amount of a 13.25%
1999 Series Subordinated Notes, due November 1, 1999.
ILCO prepaid the subordinated debt and purchased the warrants in
early 1993. See "The ILCO Senior Loan".
In February, 1995, ILCO, through Investors-NA, purchased from
Meridian Mutual Insurance Company the stock of Meridian Life
Insurance Company, an Indianapolis-based life insurer, for a cash
purchase price of $17.1 million. After the acquisition, Meridian
Life changed its name to Investors Life Insurance Company of
Indiana ("Investors-Indiana"). Investors-Indiana is licensed in
ten states and markets a variety of individual life and annuity
products through independent agents.
On July 9, 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. In connection with this transaction, the
bank group participating in the Senior Loan agreed to defer payment
of $4.5 million otherwise payable on April 1, 1997 under the terms
of the Senior Loan, and to reduce the amount of the payment
otherwise due on July 1, 1997 by $2.5 million. This deferral
resulted in extending the maturity date of the Senior Loan to
October 1, 1998. Under the terms of the transaction, State Auto
Life was merged into Investors-Indiana.
In December, 1997, ILIC transferred its domicile from New Jersey to
Indiana. Following completion of the redomestication, ILIC merged
with Investors-Indiana, with ILIC as the surviving entity in the
merger process. Immediately after the merger, ILIC changed its
name to Investors Life Insurance Company of Indiana. As used
hereinafter, the phrase "Investors-IN" shall be used to refer to
the merged entities. As a result of the merger, Investors-IN is
licensed in 44 states. As of December 31, 1997, it had assets of
$153.8 million and capital and surplus of $23.1 million.
Business of Family Life Insurance Company
Family Life, which was organized in the State of Washington in
1949, specializes in providing mortgage protection life, disability
and accidental death insurance and annuity products to mortgage
borrowers of financial institutions. Family Life has policies in
force with customers of approximately 329 financial institutions,
of which approximately 69 actively provide Family Life with regular
updating of their lists of borrowers.
Family Life's mortgage protection business consists of term and
universal life insurance and disability insurance sold to borrowers
of mortgage debt, designed to repay the mortgages of policyholders
in the event of their death or disability. This business is sold
to customers of client financial institutions, usually through a
list of borrowers provided by the financial institution. These
policies often list the lending financial institution as the
primary beneficiary of the life insurance policy. An important
feature of the Family Life product is the ability to bill and
collect premiums through the policyholder's monthly mortgage
payments.
Family Life has annuity products and a variety of life insurance
products, including decreasing term life insurance, universal life
insurance, ten-year level term products, and a whole life insurance
product.
During 1997, 1996 and 1995, Family Life received statutory premium
income from sales of its annuity products and various lines of
insurance as follows: $0.1, $0.2 million and $3.8, respectively,
from annuity products; $45.6, $48.3 million and $51.5 million,
respectively, from individual life; $0.3, $1.0 million and $1.2
million, respectively, from individual accident and health;
$416,870, $469,327 and $483,373, respectively, from group life and
$198,911, $238,128 and $289,749, respectively, from group accident
and health.
Family Life is licensed to sell mortgage life insurance products in
49 states and the District of Columbia. In 1997, premium income
from these products was derived from all states in which Family
Life is licensed, with significant amounts derived from Texas
(25%), California (23%), and Florida (5%).
Family Life's primary distribution channel is its agency force of
approximately 645 career agents (at December 31, 1997), who are
organized into 13 regions. Most of the career agents sell mortgage
life insurance products exclusively for Family Life. The mortgage
life insurance business is very fragmented. Family Life believes
that it is among the larger writers of agent sold mortgage life
insurance in the United States and the only nation-wide agent-sold
life insurance company operating through leads from financial
institutions. Many of Family Life's competitors are life insurance
companies with more resources than Family Life and whose mortgage
life insurance business represents only a small portion of their
total business.
Consolidation and Administration
Following the 1991 acquisition of Family Life by FIC, management
integrated the sales, marketing, underwriting, accounting, contract
and licensing, investments, personnel, data processing, home office
support and other departments of Family Life and the life insurance
subsidiaries of ILCO. Management believes this integration has
resulted in cost savings for Family Life and ILCO's insurance
subsidiaries. During 1992, ILCO's and FIC's insurance operations
were centralized at their headquarters in Austin, Texas, with the
exception of certain services performed in Seattle, Washington.
Management believes that relocating administrative functions to
Austin has reduced costs and improved the efficiency of the
insurance companies' operations.
At December 31, 1997, the number of employees within FIC and its
subsidiaries, together with the employees of ILCO's insurance
subsidiaries, was approximately 326.
Business of InterContinental Life Corporation
ILCO was incorporated in 1969 under the laws of New Jersey. In
June, 1997, ILCO transferred its domicile to the State of Texas.
Its executive office is located at 701 Brazos, Suite 1400, Austin,
Texas 78701.
Operations. ILCO has developed management techniques to reduce
operating expenses by centralizing, standardizing and more
efficiently performing many functions common to most life insurance
companies, such as underwriting and policy administration,
accounting and financial reporting, marketing, regulatory
compliance, actuarial services and asset management. ILCO has
selectively recruited personnel in sales, marketing and various
administrative departments.
ILCO's centralized management techniques resulted in significant
employee reductions and expense savings in the three life insurance
companies acquired by ILCO in 1986 and 1988. During 1997, the
general insurance expenses of ILCO's insurance subsidiaries were
$15,574,265, as compared to $12,008,163 in 1996 and $13,737,883 in
1995. The increase in 1997, as compared to 1996, resulted primarily
from expenses incurred in connection with ILCO's acquisition of
State Auto Life in July, 1997 and expenses related to the
modification of data processing systems for Y2K compliance.
Management is committed to maintaining the general insurance
expenses of ILCO's insurance subsidiaries at a level which will
generate an acceptable level of profitability while maintaining the
competitive pricing of their insurance products.
Principal Products. ILCO's insurance subsidiaries are engaged
primarily in administering existing portfolios of individual life
insurance and accident and health insurance policies and annuity
products. Approximately 84.7% of the total collected premiums for
1997 were derived primarily from renewal premiums on insurance
policies and annuity products sold by ILCO's insurance subsidiaries
prior to their acquisition by ILCO.
ILCO's insurance subsidiaries are also engaged in marketing and
underwriting individual life insurance and annuity products in 49
states and the District of Columbia. These products are marketed
through independent, non-exclusive general agents.
The products currently being distributed by ILCO s life
subsidiaries include several versions of universal life insurance
and interest-sensitive whole life insurance. Under a whole life
insurance policy, the policyholder pays a level premium over his or
her expected lifetime. The policy combines life insurance
protection with a savings plan that gradually increases in amount
over a period of several years. The universal and
interest-sensitive whole life insurance policies of ILCO's
insurance subsidiaries provide permanent life insurance which
credit company-declared current interest rates. The universal
life insurance portfolio of ILCO's insurance subsidiaries consists
primarily of flexible premium universal life insurance policies.
Under the flexible premium policies, policyholders may vary the
amounts of their coverage (subject to minimum and maximum limits)
as well as the date of payment and frequency of payments.
Direct statutory premiums received from all types of universal life
products were $40.6 million in 1997, as compared to $40.6 million
in 1996 and $42.3 million in 1995. Investors-NA received
reinsurance premiums from Family Life of $1.8 million in 1997,
pursuant to the reinsurance agreement for universal life products
written by Family Life. In 1996, premium income from all life
insurance products was derived from all states in which ILCO's
insurance subsidiaries are licensed, with significant amounts
derived from Pennsylvania (14%), Ohio(9.0%)and New Jersey (8.0%).
Two of ILCO's insurance subsidiaries receive premium income from
health insurance policies. In 1997, premium income from all health
insurance policies was $0.9 in 1997 and 1996 as compared to $1.1
million in 1995.
In December, 1997, ILCO 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 insurance
policies were assumed by a third party reinsurer. The transfer is
effective as of July 1, 1997. The decision to dispose of this book
of business was based on ILCO s analysis that the business was not
generating targeted profit objectives and that the products were
not part of the core business of ILCO s subsidiaries. The sale
permits the companies to focus on its primary business - life
insurance and annuity sales. In connection with the transaction,
the total amount of net reserves transferred by the ILCO
subsidiaries was $6,327,504. In addition to the transfer of
reserves, ILCO s life companies paid the reinsurer $1,037,150 in
connection with the transaction, which amount was accounted for as
an expense for the year ended December 31, 1997. In 1997, the
transferred business generated approximately $791,000 in annualized
premiums for ILCO s life subsidiaries.
Investors-NA sponsors a variable annuity separate account, which
offers single premium and flexible premium policies. The policies
provide for the contract owner to allocate premium payments among
four different portfolios of Putnam Variable Trust (the "Putnam
Fund"), a series fund which is managed by Putnam Investment
Management, Inc. Prior to April, 1995, the underlying investment
vehicle for the variable annuity contracts was the CIGNA Annuity
Funds Group. A substitution of the Putnam Fund for the CIGNA Funds
was completed in April, 1995. The plan of substitution was
approved by the Securities and Exchange Commission. Following such
approval, the plan was submitted to policyholders for approval,
which was obtained. As of December 31, 1997, the assets held in
the separate account were $50,806,145. During 1997, the premium
income realized in connection with these variable annuity policies
was $172,660, which was received from existing contract owners.
Investors-NA also maintains a closed variable annuity separate
account, with approximately $22.3 million of assets as of December
31, 1997. The separate account was closed to new purchases in 1981,
as a result of an IRS ruling which adversely affected the status of
variable annuity separate account which invest in publicly-
available mutual funds. The ruling did not adversely affect the
status of in-force contracts.
During 1997, ILCO s life company subsidiaries expanded their
marketing efforts in the fixed annuity market. Direct deposits from
the sale of fixed annuity products were $3,499,000 in 1997, as
compared to $1,741,000 in 1996, and $2,169,000 in 1995. Investors-
NA also received reinsurance premiums from Family Life of
$3,259,410 in 1997, pursuant to a reinsurance agreement for annuity
products between Investors-NA and Family Life Insurance Company.
Merger of Insurance Subsidiaries. Investors-NA redomesticated from
Pennsylvania to Washington in December of 1992. Investors-CA
merged into Investors-NA on December 31, 1992. Standard Life
merged into Investors-NA on June 29, 1993. The mergers have
achieved cost savings, such as reduced auditing expenses involved
in auditing one combined company; the savings of expenses and time
resulting from the combined company being examined by one state
insurance department (Washington), rather than three (California,
Pennsylvania and Mississippi); the reduction in the number of tax
returns and other annual filings with 45 states; and smaller annual
fees to do business and reduced retaliatory premium taxes in most
states.
In December, 1997, ILIC transferred its domicile from New Jersey to
Indiana. Following completion of the redomestication, ILIC merged
with Investors-Indiana, with ILIC as the surviving entity in the
merger process. Immediately after the merger, ILIC changed its
name to Investors Life Insurance Company of Indiana. As used
hereinafter, the phrase "Investors-IN" shall be used to refer to
the merged entities. As a result of the merger, Investors-IN is
licensed in 44 states. As of December 31, 1997, it had assets of
$153.8 million and capital and surplus of $23.1 million.
ILCO s management believes that these acquisitions and
consolidations have caused a reduction in expense and have further
strengthened the financial condition of the combined companies.
Investment of Assets
The assets held by Family Life and ILCO's life insurance
subsidiaries must comply with applicable state insurance laws and
regulations pertaining to life insurance companies. The investment
portfolios of Family Life and ILCO's life insurance subsidiaries
are tailored by their managements to reflect the nature of the
insurance obligations, business needs, regulatory requirements and
tax considerations relating to the underlying insurance business
with respect to such assets. This is particularly the case with
respect to interest-sensitive life insurance products, where the
investment emphasis is to obtain a targeted margin of profit over
the rate of interest credited to policyholders, while endeavoring
to minimize the portfolio's exposure to changing interest rates.
To reduce the exposure to such rate changes, portfolio investments
are selected so that diversity, maturity and liquidity factors
approximate the duration of associated policyholder liabilities.
The investment objective of Family Life and ILCO's insurance
subsidiaries emphasizes the selection of short to medium term, high
quality fixed income securities, rated Baa-3 (investment grade) or
better by Moody's Investors Service, Inc. At December 31, 1997,
only 0.9% of ILCO's total assets were invested in mortgage loans or
real estate. Non-affiliated corporate debt securities that were
non-investment grade represented 0.7% of ILCO's total assets at
December 31, 1997. ILCO had investments in debt securities of
affiliated companies aggregating approximately $53.8 million as of
December 31, 1997. Family Life does not have investments in
mortgage loans, real estate, non-investment grade debt securities
or affiliates' debt securities.
The investments of Family Life and ILCO's insurance subsidiaries in
mortgage-backed securities included collateralized mortgage
obligations ("CMOs") of $38.9 million and $287.7 million,
respectively, and mortgage-backed pass-through securities of $6.4
million and $42.9 million, respectively, at December 31, 1997.
Mortgage-backed pass-through securities, sequential CMO's, support
bonds and z-accrual bonds, which comprised approximately 39.2% of
the book value of FIC's mortgage-backed securities and 47.6% of the
book value of ILCO's mortgage-backed securities at December 31,
1997, are sensitive to prepayment and extension risks. ILCO and
FIC have reduced the risk of prepayment associated with mortgage-
backed securities by investing in planned amortization class
("PAC"), target amortization class ("TAC") instruments, accretion
directed bonds and scheduled bonds. These investments are designed
to amortize in a predictable manner by shifting the risk of
prepayment of the underlying collateral to other investors in other
tranches ("support classes") of the CMO. At December 31, 1997, PAC
and TAC instruments and accretion directed and scheduled bonds
represented approximately 60.8% of the book value of FIC's
mortgage-backed securities and approximately 49.9% of the book
value of ILCO's mortgage-backed securities. Sequential and support
classes represented approximately 22.8% of the book value of FIC's
mortgage-backed securities and approximately 29.5% of the book
value of ILCO's mortgage-backed securities at December 31, 1997.
In addition, FIC and ILCO limit the risk of prepayment of CMOs by
not paying a premium for any CMOs. ILCO and FIC do not invest in
mortgage-backed securities with increased prepayment risk, such as
interest-only stripped pass-through securities and inverse floater
bonds. FIC does not have any z-accrual bonds, and those bonds
constituted only 3.1% of the book value of ILCO's mortgage-backed
securities at December 31, 1997. The prepayment risk that certain
mortgage-backed securities are subject to is prevalent in periods
of declining interest rates, when mortgages may be repaid more
rapidly than scheduled as individuals refinance higher rate
mortgages to take advantage of the lower current rates. As a
result, holders of mortgage-backed securities may receive large
prepayments on their investments which cannot be reinvested at an
interest rate comparable to the rate on the prepaying mortgages.
Neither FIC nor ILCO made additional investments in CMOs during
1997, and the current investment objectives of both FIC and ILCO do
not contemplate additions to the portfolio of CMO investments
during 1998.
FIC and ILCO do not invest in non-agency mortgage-backed
securities, which have a greater credit risk than that of agency
mortgage-backed securities.
ILCO and FIC do not make new mortgage loans on commercial
properties. Substantially all of ILCO's mortgage loans were made
by its subsidiaries prior to their acquisition by ILCO. At
December 31, 1997, 0.75% of the total book value of mortgage loans
held by ILCO had defaulted as to principal or interest for more
than 90 days, and none of ILCO's mortgage loans were in
foreclosure. During 1997, none of ILCO's mortgage loans were
converted to foreclosed real estate or were restructured while ILCO
owned them. Family Life does not have any mortgage loans.
Another key element of FIC's and ILCO's investment strategy is to
avoid large exposure in other investment categories which
management believes carry higher credit or liquidity risks,
including private placements, partnerships and bank participations.
These categories accounted for approximately 0.49% of ILCO's
invested assets and none of FIC's invested assets at December 31,
1997.
A subsidiary of ILCO, Investors-NA, was the owner and developer of
Bridgepoint Square Offices. Following the completion of the
construction, the project consisted of four office buildings, with
a total rentable space of approximately 364,000 square feet, and
two parking garages. Investors-NA purchased the 20 acre tract of
land for this complex in January, 1995. At that time, the tract
included one completed and fully leased office building, an
adjacent parking garage, and sites for three more office buildings
and another parking garage. Investors-NA completed construction of
the three remaining office buildings and parking garage in 1997.See
Item 2. Properties.
In May 1996, Family Life Insurance Company ("FLIC"), an indirect,
100% owned subsidiary of FIC, purchased a 7.1 acre tract adjacent
to the original Bridgepoint Square tract. This second tract
contained one building site and one garage site. In January, 1997,
FLIC began construction on a four-story office building, with
rentable space of approximately 76,793 square feet, and the parking
garage, with 350 parking spaces. In May, 1997, the entire rentable
space in the building was leased to a major tenant in the
technology business. Construction of the parking garage and the
building shell was completed in October, 1997.
In November, 1997, Investors-NA and Family Life entered into a sale
agreement with an independent third party for the sale of their
respective interests in Bridgepoint Square Offices. The
transaction, which closed on December 5,1997, was for an aggregate
price of $78 million. The sale resulted in a net pre-tax profit to
Investors-NA of approximately $14.3 million, and a net pre-tax
profit to Family Life of approximately $4.5 million. See Item 2.
Properties.
FIC and ILCO have established and staffed an investment department,
which manages portfolio investments and investment accounting
functions for their life insurance subsidiaries.
Agency Operations
The products of FIC's and ILCO's insurance subsidiaries are
marketed and sold through two divisions:
A. Investors Life Distribution System
The Investors Life Distribution System sells a wide range of life
insurance and annuity products through an independent, non-
exclusive general agent sales distribution system. The products
sold are issued by subsidiary companies of ILCO.
All marketing and sales for the Company are directed by the
Executive Vice President of Marketing and Sales. The Vice
President for Investors Sales directs Regional Vice Presidents who
are responsible for the recruitment of general agents and managing
general agents for individual insurance sales in the Investors Life
Distribution System.
B. Family Life Distribution System
This nationwide system sells Family Life's products through an
exclusive agent force. This agent force sells mortgage protection
life insurance and annuity products. The products are sold
primarily to middle-income customers of client financial
institutions, usually through a list of borrowers provided by the
financial institution. Family Life works closely with the
financial institutions to maintain and insure that Family Life lead
systems, which had been built from the loan portfolios of each
active financial institution, operate at a level that favors both
parties. Family Life agents make courtesy calls to borrowers of
the financial institutions which are active on the Family Life lead
system to offer the borrower the opportunity to purchase mortgage
protection insurance (term, universal or whole life insurance
products).
Sales and Marketing for Family Life is directed by the Executive
Vice President of Marketing and Sales. Reporting to the Executive
Vice President, the Senior Vice President of Marketing heads the
Family Life marketing organization which is focused on the
development and maintenance of contractual agreements with the
financial institutions which provide referrals to, and collect
monthly premiums from, their borrowers for Family Life insurance
plans. The Senior Vice President for Family Life Sales directs
nine Regional Vice Presidents. The Family Life distribution system
consists of 156 District Sales Managers, and 489 active career
agents.
Data Processing
Pursuant to a data processing agreement with a major service
company, the data processing needs of FIC's and ILCO's insurance
subsidiaries were provided at a central location until November 30,
1994. Since December, 1994, all of those data processing needs have
been provided to ILCO's and FIC's Austin, Texas and Seattle,
Washington facilities by FIC Computer Services, Inc., a new
subsidiary of FIC. See Item 13.- Certain Relationships and Related
Transactions with Management.
As the provider of data processing for the Company and its
subsidiaries and affiliates, 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.
The software programs used by these systems will be affected by
what is referred to as the "Year 2000 problem" or "Y2K problem".
This refers to the limitations of the programming code in certain
existing software programs to recognize date sensitive information
as the year 2000 approaches. Unless modified prior to the year
2000, such systems may not properly recognize such information and
could generate erroneous data or cause a system to fail to operate
properly.
In response to the potential operations and policy administration
problems caused by the computer calendar change on January 1, 2000,
the management of the Company instructed FIC Computer Services,
Inc. to analyze its system capabilities and the operational
requirements of the Company and its respective subsidiaries and
affiliates with respect to the Y2K problem. In 1996, FIC Computer
Services, Inc. conducted the analysis of all of the Company's
systems. After reviewing that analysis, the Company determined that
a plan should be devised to prevent the data processing errors that
may be encountered due to the Y2K problem. In November, 1996, a
three-year plan outlining a proposed solution (the "Plan") was
established and approved by the Company to ensure that all of the
data processing systems would be Y2K compliant or converted onto
Y2K compliant systems. The Company began the major work under this
Plan in 1997 and it is scheduled to be completed by the Fall of
1999.
The Company established this Plan because FIC Computer Services,
Inc.'s analysis revealed that those systems that are not converted
or modified into Y2K compliant systems, may produce policy
administration errors as a result of the calendar change, requiring
that the life insurance subsidiaries manually administer those
policies. This would result in a material increase in
administrative costs incurred by the life insurance subsidiaries of
both ILCO and FIC.
The Company's analysis also indicated that, in addition to
potential policy administration errors in the life insurance
subsidiaries, any machine which contains a microchip is subject to
error due to the Y2K problem. Such an occurrence could not only
create errors in the Company's internal systems, but those of the
Company's suppliers and service providers. In order to prepare for
this contingency, the Plan called for the acquisition of new
mainframe hardware and software, and the modification and
conversion of our telephones, voice mail and desk-top personal
computers.
Additionally, the Company is developing a strategy for obtaining
assurances from its various suppliers and service providers. In
furtherance of this strategy, the Company is creating
questionnaires which it will forward to its suppliers and service
providers regarding the Y2K problem. The questionnaire will request
information regarding that particular supplier's or service
provider's awareness of the Y2K problem, its impact on their
operations, and their plan for addressing any problems as they
relate to that supplier's or service provider's performance of
their contractual obligations to the Company and its subsidiaries.
The Plan calls for an upgrade of the Family Life's administrative
systems by changing individual lines of computer code in order to
modify current operating software such that it will become Y2K
compliant. The administrative systems which are not modified will
be converted onto the Company's CK/4 System; a system designed to
be Y2K compliant according to the representations of the vendor.
Under the Plan, FIC Computer Services, Inc. will utilize its own
personnel, acquire Y2K compliant operating software, and engage the
assistance of outside consultants to facilitate the systems
conversions and modifications. FIC has budgeted approximately
$330,000 for implementation of the Plan. In the event that the Plan
does not achieve full compliance by the target dates, or if
unforeseen matters involving Y2K appear at later dates, the Company
will utilize the staff of FIC Computer Services, Inc. to identify
and resolve such issues as and if they arise.
In order to continuously evaluate the effectiveness of the
modifications and conversions made to the various systems, FIC
Computer Services, Inc. has acquired testing software to simulate
dates on or after January 1, 2000. Additionally, FIC Computer
Services, Inc. runs the systems through model office cycles and
also conducts visual inspections of screen displays to determine
whether the systems are functioning in a Y2K compliant manner.
A material number of policies administered by Family Life, will be
modified rather than converted. The modification of the PMS system
(administering approximately 122,000 policies for Family Life) was
completed in March, 1998. The conversion of the Cypros AP system
(administering approximately 21,400 policies for Family Life) is
scheduled for completion at the end of September, 1999.
A non-material number of Family Life policies are administered by
systems which also administer policies for ILCO and its
subsidiaries. With regard to ILCO and its subsidiaries, the ALIS
system (administering approximately 49,280 policies for Investors-
NA) was converted to CK/4 in January of 1998. The conversion of the
Life 70 system (administering approximately 17,285 policies for
Investors-IN) is scheduled for completion in April, 1999. The
modification of the Lifecomm-B system which is responsible for the
33,375 policies assumed after the acquisition of State Auto Life is
also scheduled for completion in April, 1999. The conversion of the
Lifecomm-A system (administering approximately 65,266 policies for
Investors-NA) is now scheduled for completion in September of 1999.
The various software applications described above are licensed to
the Company or its affiliates under agreements which permit the
Company's and ILCO's subsidiaries to process business on its
computer systems utilizing such software.
In 1997, FIC Computer Services, Inc. purchased new mainframe
hardware and accompanying operating software, which the vendor has
represented to be Y2K compliant. FIC Computer Services, Inc. will
be testing this hardware and software in 1998. The telephone system
has been tested by the maintenance provider for that system and the
Company has received assurances that the telephone system is Y2K
compliant.
With respect to non-centralized systems(i.e., desktop computers),
the Company anticipates that updated software releases will be
commercially available well in advance of the year 2000.
Accordingly, to the extent that such systems rely on date sensitive
information, the Company expects that the effort needed to correct
for Y2K problems will be less time intensive than the effort needed
to achieve compliance for its centralized
Competition
There are many life and health insurance companies in the United
States. Agents placing insurance business with Family Life and
ILCO's insurance subsidiaries are compensated on a commission
basis. However, some companies pay higher commissions and charge
lower premium rates and many companies have more substantial
resources than Family Life and ILCO's insurance subsidiaries. The
principal cost and competitive factors that affect the ability of
Family Life and ILCO's insurance subsidiaries to sell their
insurance products on a profitable basis are: (1) the general
level of premium rates for comparable products; (2) the extent of
individual policyholders services required to service each product
category; (3) general interest rate levels; (4) competitive
commission rates and related marketing costs; (5) legislative and
regulatory requirements and restrictions; (6) the impact of
competing insurance and other financial products; and (7) the
condition of the regional and national economies.
Reinsurance and Reserves
In accordance with general practices in the insurance industry,
Family Life and ILCO's insurance subsidiaries limit the maximum net
losses that may arise from large risks by reinsuring with other
carriers. Such reinsurance provides for a portion of the mortality
risk to be retained by Family Life and the ILCO subsidiaries with
the excess being ceded to a reinsurer at a premium set forth in a
schedule based upon the age and risk classification of the insured.
The reinsurance treaties provide for allowances that help Family
Life and ILCO's insurance subsidiaries offset the expense of
writing new business. Family Life generally retains the first
$200,000 of risk on the life of any one individual. Investors-IN
generally retains the first $60,000 to $100,000 of risk on the life
of any individual, depending on the type of coverage being written.
Investors-NA generally retains the first $250,000 of risk on the
life of any individual.
As discussed above (see Principal Products ), in December, 1997,
FLIC and ILCO s life insurance subsidiary 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 connection with the
transaction, the total amount of net reserves transferred by the
FLIC was $852,688. In addition to the transfer of reserves, FLIC
paid the reinsurer $100,000 in connection with the transaction,
which amount was accounted for as an expense for the year ended
December 31, 1997. In 1997, the accident and health business
generated approximately $735,000 in annualized premiums.
In 1995, Family Life (as the ceding company) entered into a
reinsurance agreement with Investors-NA (as the reinsuring company)
pertaining to universal life insurance written by Family Life. The
reinsurance agreement is on a co-insurance basis and applies to all
covered business with effective dates on and after January 1, 1995.
The agreement applies to only that portion of the face amount of
the policy which is less than $200,000; face amounts of $200,000 or
more are reinsured by Family Life with a third party reinsurer.
In 1996, Family Life (as the ceding company) entered into a
reinsurance agreement with Investors-NA (as the reinsuring
company), pertaining to annuity contracts written by Family Life.
The agreement applies to contracts written on or after January 1,
1996. These reinsurance arrangements reflect management's plan to
develop universal life and annuity business at Investors-NA, with
Family Life concentrating on the writing of term life insurance
products.
Although reinsurance does not eliminate the exposure of FIC's and
ILCO's insurance subsidiaries to losses from risks insured, the net
liability of such subsidiaries will be limited to the portion of
the risk retained, provided that the reinsurers meet their
contractual obligations.
ILCO's insurance subsidiaries and Family Life carry reserves on
their books to meet future obligations under their outstanding
insurance policies. Such reserves are believed to be sufficient to
meet policy obligations as they mature and are calculated using
assumptions for interest, mortality, expenses and withdrawals in
effect at the time the policies were issued.
Acquisition of Family Life
In June, 1991 FIC purchased Family Life, a State of Washington
based life insurance corporation, from Merrill Lynch Insurance
Group, Inc. ("Merrill Lynch"). The business of Family Life, as
reconstituted for sale, consists principally of the underwriting
and sale of life insurance to mortgage borrowers through lending
institutions.
The consideration for the purchase was $114 million consisting of
a cash payment of $70 million and $44 million of subordinated
promissory notes issued by subsidiaries of FIC to the seller and
its affiliates.
To effectuate the transaction, FIC organized two downstream holding
companies: Family Life Corporation ("FLC"), and Family Life
Insurance Investment Corporation ("FLIIC"). FLIIC was organized as
a wholly-owned subsidiary of FIC and, in turn, was issued all of
the outstanding shares of FLC. FLC purchased 250,000 shares of
common stock, being all of the outstanding shares, of Family Life
from Merrill Lynch for an $84 million cash payment (including $14
million that had been borrowed by FLIIC from an affiliate of
Merrill Lynch) and a $30 million senior subordinated note.
Following the purchase of the Family Life shares by FLC, Family
Life issued 250,000 previously unissued shares of its common stock
to FLC for a $2.5 million cash payment and immediately thereafter
redeemed from FLC 250,000 shares of its common stock that had been
purchased by FLC from Merrill Lynch. The consideration paid to FLC
by Family Life for said redeemed shares consisted of $2.5 million
cash, a newly issued surplus debenture (an instrument having
certain restrictions on payment for the protection of
policyholders) in the principal amount of $97.5 million and $14
million principal value of newly issued preferred shares.
As part of the financing arrangement, FLC entered into a Senior
Loan agreement under which $50 million was provided by a group of
banks (the "Family Life Senior Loan"). The balance of the
financing consisted of a $30 million subordinated note issued by
FLC to Merrill Lynch and $14 million borrowed by FLIIC from an
affiliate of Merrill Lynch and evidenced by a subordinated note in
the principal amount of $12 million and a subordinated note in the
principal amount of $2 million (collectively, the "Merrill Lynch
Subordinated Loans") and $25 million lent by two insurance company
subsidiaries of ILCO (the "Investors Life Subordinated Loans").
The latter amount was represented by a $22.5 million loan from
Investors-NA to FLC and a $2.5 million loan provided directly to
FIC by Investors-CA. In addition to the interest provided under
the Investors Life Subordinated Loans, Investors-NA and Investors-
CA were granted by FIC non-transferable options to purchase, in
amounts proportionate to their respective loans, up to a total of
9.9 percent of shares of FIC common stock at a price of $10.50 per
share, equivalent to the then current market price, subject to
adjustment to prevent dilution. The initial terms of the option
provided for their expiration on June 12, 1998, if not previously
exercised. In connection with the 1996 amendments to the $34.5
million subordinated loans obtained from Investors-NA, the
expiration date of the options was extended to September 12, 2006.
For a discussion of the 1996 amendments, please refer to Item 13,
Certain Relationships and Related Transactions with Management,
above.
Of the total of $119 million of cash borrowed and notes issued by
FIC and its subsidiaries for purposes of the transaction, $114
million constituted the purchase price for Family Life and $5
million was used to pay transaction costs, for working capital and
for other related purposes. In connection with the several loans
effected for purposes of the transaction, various creditors
priorities and normal borrower requirements and restrictions were
established and FIC issued its direct guaranty of the respective
loans, subject to certain priorities, to the various lending banks,
Merrill Lynch and its affiliates, and Investors-NA and Investors-
CA. The outstanding shares of common stock of Family Life were
also pledged as collateral to the bank lenders and, upon repayment
of the bank loan, to Merrill Lynch. The transaction was structured
to conform to the requirements of Section 338(h)(10) of the
Internal Revenue Code.
On July 30, 1993, the Merrill Lynch Subordinated Loans were
prepaid. $38 million plus accrued interest was paid to retire the
indebtedness, which had a principal balance of approximately $50
million on July 30, 1993. The primary source of the funds used to
prepay the Merrill Lynch Subordinated Loans was new subordinated
loans totaling $34.5 million that were obtained from Investors-NA.
See "The Family Life Refinancing."
Family Life Senior and Subordinated Loans
Senior Loan. The Senior Loan obligations of FLC were completely
paid off on April 17, 1996. During the period that the Senior Loan
was in effect, it was a secured and guaranteed five year term loan
in the initial principal amount of $50 million. The Senior Loan
consisted of separate notes (one for each member of the lending
syndicate), with interest payable quarterly and a final maturity
date of June 12, 1996. The interest rate of the Senior Loan was
subject to periodic change based upon stipulated percentages above
a quoted bank base lending rate or Eurodollar rate as such are in
effect from time to time.
Upon the retirement of the Senior Loan, certain of the its
provisions were automatically incorporated into the Investors Life
Subordinated Loans which are described in the following section.
Those provisions include specified events of default, including,
but not limited to, failure to pay principal, interest, commitment
fees or other amounts payable when due, failure to maintain
certain financial covenants, violation of covenants (including
covenants with respect to the maintenance of a minimum net worth),
material misrepresentations, defaults under other indebtedness, the
loss of any license of an insurance subsidiary of FLC which would
have a material adverse effect on FLC, defaults under the FIC
guaranty agreement, a fine in an amount in excess of $100,000
imposed upon any insurance subsidiary of FLC by any state insurance
regulatory agency, changes in ownership or control of FIC by its
controlling person, Roy F. Mitte, or in ILCO by FIC and the
occurrence of certain events of bankruptcy. In addition, the
security interests furnished to the lenders under the Senior Loan
were transferred to Investors-NA. The security interests include
all of the issued and outstanding shares of common stock of FLIIC,
all of the issued and outstanding shares of preferred stock and
common stock of FLC and Family Life and the $97.5 million surplus
debenture of Family Life.
Investors Life Subordinated Loans. The $22.5 million subordinated
senior note issued by FLC to Investors-NA was originally scheduled
to mature on June 12, 1998, with principal payments in four equal
semi-annual principal installments of $5,625,000 each on December
12, 1996, June 12, 1997, December 12, 1997 and June 12, 1998.
Interest is payable semi-annually, at the rate of 11% per annum.
Effective as of June 12, 1996, the note was amended to provide for
twenty quarterly principal payments, in the amount of $1,125,000
each, to commence on December 12, 1996. The final quarterly
principal payment is due on September 12, 2001. The interest rate
on the note remains at 11%.
The $2.5 million subordinated note issued by FIC to Investors-CA
initially provided for interest, payable semi-annually, at the rate
of 12% per annum, and its principal is due and payable in full at
maturity on June 12, 1998 (the "FIC Note"). As a result of the
merger of Investors-CA into Investors-NA, the FIC Note is now owned
by Investors-NA. Prior to June 12, 1996, accrued interest on the
FIC Note was paid by delivery of additional notes of FIC having
terms identical to such original note, including the payment of
interest (the "PIK Notes"). Interest payable on and after June 12,
1996 on all of the FIC Note is to be paid in cash. Effective as of
June 12, 1996, the FIC Note was amended to provide that the
principal balance of the note is to be repaid in twenty quarterly
installments of $125,000 each, commencing December 12, 1996 with
the final payment due on September 12, 2001. With respect to the
PIK Notes, the amendment provided that the principal balance of the
notes ($1,977,119) is to be paid in twenty quarterly principal
payments, in the amount of $98,855.95 each, commencing December 12,
1996 with the final payment due on September 12, 2001. The
interest rate on both the FIC Note and the PIK Notes remained at
12%.
The obligors are allowed to prepay the Investors Life Subordinated
Loans, in whole or in part, without premium or penalty. During the
time that the Senior Loan was outstanding, the Investors Life
Subordinated Loans were subordinated to the Senior Loan and
constitute a second lien on the pledged collateral subject to the
first lien of the Senior Loan. Repayment of FLC's $22.5 million
note is also guaranteed by FIC.
The Investors Life Subordinated Loan documents specify events of
default, including, but not limited to, failure to pay principal,
interest or other amounts payable with respect to the Investors
Life Subordinated Loan documents when due, violation of covenants
in the Investors Life Subordinated Loan documents (including
covenants with respect to the maintenance of a minimum net worth),
material misrepresentations, defaults under other indebtedness, and
the occurrence of certain events of bankruptcy.
The Investors Life Subordinated Loan documents also contain various
specified negative, affirmative and financial covenants to be
performed or observed by FLC, FIC and their subsidiaries. During
the period the Senior Loan was outstanding, the covenants in effect
under the Investors Life Subordinated Loan documents were less
restrictive than the covenants under the Senior Loan documents but
become generally equivalent to the Senior Loan restrictions upon
the termination of the Senior Loan.
On July 30, 1993, Investors-NA loaned $34.5 million to FLC and
FLIIC in the form of subordinated notes in connection with the
prepayment of the Merrill Lynch Subordinated Loans. See "The
Family Life Refinancing."
As of December 31, 1997 the outstanding principal balance of the
Investors Life Subordinated Loans, including the loans made by
Investors-NA in 1993 was $53,792,485.
Options. In addition to the interest provided under the Investors
Life Subordinated Loans, Investors-NA and Investors-CA were granted
by FIC non-transferable options to purchase, in amounts
proportionate to their respective loans, up to a total of 9.9
percent of shares of FIC common stock at a price of $2.10 per share
(as adjusted to reflect the five-for-one stock split in November,
1996), equivalent to the then current market price, subject to
adjustment to prevent dilution. The initial terms of the option
provided for their expiration on June 12, 1998, if not previously
exercised. In connection with the 1996 amendments to the $34.5
million subordinated loans obtained from Investors-NA, the
expiration date of the options was extended to September 12, 2006.
The Family Life Refinancing. On July 30, 1993, the Merrill Lynch
Subordinated Loans were prepaid. $38 million plus accrued interest
was paid to retire the indebtedness, which had a principal balance
of approximately $50 million on July 30, 1993.
The primary source of the funds used to prepay the Merrill Lynch
Subordinated Loans was new subordinated loans totaling $34.5
million that were obtained from Investors-NA. Prior to the 1996
amendments described below, the principal amount of the new
subordinated debt was payable in four equal annual installments in
2000, 2001, 2002 and 2003. The interest rate is 9%. The other
terms of the 1993 notes are substantially the same as those of the
$22.5 million subordinated loan that Investors-NA had previously
made to FLC and that continue to be outstanding.
The $34.5 million of new subordinated loans consist of a $30
million loan to FLC and a $4.5 million loan to FLIIC. The debt
restructuring reduced the total indebtedness of FLC and FLIIC by
approximately $15 million. The transaction resulted in a pre-tax
gain of approximately $12 million for the Company in the third
quarter of 1993, and the Company estimates that the restructuring
of this subordinated debt will result in aggregate interest savings
to FLC and FLIIC of approximately $40 million over the next ten
years. In recognition of this reduced interest requirement, the
interest rate on the surplus debenture of Family Life held by FLC
was reduced from 12.5% to 9%.
As of June 12, 1996, the provisions of the notes from Investors-NA
to FIC, FLC and FLIIC were modified as follows: (a) the $22.5
million note was amended to provide for twenty quarterly principal
payments, in the amount of $1,125,000 each, to commence on December
12, 1996; the final quarterly principal payment is due on September
12, 2001; the interest rate on the note remains at 11%, (b) the $30
million note was amended to provide for forty quarterly principal
payments, in the amount of $163,540 each for the period December
12, 1996 to September 12, 2001; beginning with the principal
payment due on December 12, 2001, the amount of the principal
payment increases to $1,336,458; the final quarterly principal
payment is due on September 12, 2006; the interest rate on the note
remains at 9%, (c) the $4.5 million note was amended to provide for
forty quarterly principal payments, in the amount of $24,531 each
for the period December 12, 1996 to September 12, 2001; beginning
with the principal payment due on December 12, 2001, the amount of
the principal payment increases to $200,469; the final quarterly
principal payment is due on September 12, 2006; the interest rate
on the note remains at 9%, (d) the $2.5 million note was amended to
provide that the principal balance of the note is to be repaid in
twenty quarterly installments of $125,000 each, commencing December
12, 1996 with the final payment due on September 12, 2001; the rate
of interest remains at 12%, (e) the Master PIK note, which was
issued to provide for the payment in kind of interest due under the
terms of the $2.5 million note prior to June 12, 1996, was amended
to provide that the principal balance of the note ($1,977,119) is
to be paid in twenty quarterly principal payments, in the amount of
$98,855.95 each, to commence December 12, 1996 with the final
payment due on September 12, 2001; the interest rate on the note
remains at 12%.
ILCO's Senior Loan
FIC guarantees ILCO's Senior Loan that was the source of funds used
for the acquisition of Investors-NA and Investors-CA. The current
Senior Loan of ILCO was originally arranged in connection with the
1988 acquisition of Investors-NA and Investors-CA. In January,
1993, refinanced its Senior Loan. That transaction was done in
connection with the prepayment of the subordinated indebtedness and
the purchase of warrants which had been issued as part of the
financing of the 1988 acquisitions. The terms of the amended and
restated credit facility are substantially the same as the terms
and provisions of the 1988 Senior Loan. The average interest rate
paid by ILCO on its Senior Loan was approximately 8.63% during
1995, 7.76% during 1996 and 7.68% during 1997. The maturity date,
which had been December 31, 1996, was extended to July 1, 1998 for
the Senior Loan.
In February, 1995, ILCO borrowed an additional $15 million under
the Senior Loan to help finance the acquisition of Meridian Life
Insurance Company, and the maturity date of the Senior Loan was
further extended to July 1, 1999. As of December 31, 1995, the
outstanding principal balance of ILCO's Senior Loan obligations was
$59.4 million. In January, 1996, ILCO made a scheduled payment of
$4.5 million under its Senior Loan. In March, 1996, ILCO made the
scheduled payments for April 1st and July 1st, totaling $9 million.
At that same time, ILCO made a payment of $941,000, an additional
payment under the terms of the loan applied to the principal
balance. On April 1, 1996, an optional principal payment in the
amount of $15 million was made, which resulted in advancing the
scheduled payoff date of the Senior Loan to April 1, 1998. In
July, 1996, ILCO made the principal payment for October 1st ($4.5
million), plus an optional principal payment of $0.5 million. In
connection with ILCO's acquisition of State Auto Life Insurance
Company in July, 1997, ILCO's Senior Loan agreement was modified to
extend the maturity date to October 1, 1998.
ILCO's Senior Loan bears interest, at the option of ILCO, at a rate
per annum equal to (i) the Alternate Base Rate (as defined below)
plus the Applicable Margin (as defined below), or (ii) LIBOR
(adjusted for reserves) for interest periods of 1, 2, 3 or 6 months
plus the Applicable Margin. LIBOR is London Inter-Bank Offered
Rates. The Alternate Base Rate for any day is the higher of (a) the
agent bank's corporate base rate as announced from time to time and
(b) the federal funds rate as published by the Federal Reserve Bank
of New York plus 0.5%. The Applicable Margin, depending on the
outstanding principal balance of the Senior Loan, ranges from 0.5%
to 1.25% for loans that bear interest based upon the Alternate Base
Rate and from 1.75% to 2.5% for loans that bear interest based upon
LIBOR. The initial Applicable Margin for Alternate Base Rate loans
is 1.25% and the initial Applicable Margin for LIBOR loans is 2.5%.
The obligations of ILCO under the Senior Loan are secured by: (1)
all of the outstanding shares of stock of Investors-NA, (2) a
$15,000,000 surplus debenture of Investors-NA payable to ILCO,
which had an outstanding principal balance of $5,206,224 as of
December 31, 1997 and (3) a $140,000,000 surplus debenture of
Investors-NA payable to ILCO, which had an outstanding principal
balance of $22,590,000 as of December 31, 1997. The obligations of
ILCO under the Senior Loan are guaranteed by FIC.
The ILCO Senior Loan prohibits the payment by ILCO of cash
dividends on its common stock and contains covenants, including
restrictive covenants that impose limitations on ILCO's and its
subsidiaries' ability to, among other things: (i) make investments;
(ii) create or incur additional debt; (iii) engage in businesses
other than their present and related businesses; (iv) create or
incur additional liens; (v) incur contingent obligations; (vi)
dispose of assets, (vii) enter into transactions with affiliated
companies; and (viii) make capital expenditures; and various
financial covenants, including covenants requiring the maintenance
of a minimum cash flow coverage ratio, minimum consolidated net
worth and minimum statutory surplus of subsidiaries, and a minimum
ratio (360%) of (i) the sum of the statutory capital and surplus,
the asset valuation reserve and one-half of the dividend liability
pertaining to participating policies of each insurance company
subsidiary to (ii) its respective Authorized Control Level RBC (see
"Regulation").
The ILCO Senior Loan specifies events of default, including, but
not limited to, failure to pay amounts under the Senior Loan
documents when due; defaults or violation of covenants under other
indebtedness; defaults under the loans made by Investors-NA to
subsidiaries of FIC; the loss of any license of an insurance
subsidiary of ILCO which would have a material adverse effect on
ILCO; defaults under the FIC guaranty agreement; changes in
ownership or control of FIC or ILCO by its controlling person, Roy
F. Mitte, or in ILCO by FIC; and the occurrence of certain events
of bankruptcy. If Mr. Mitte ceases to control the management of
ILCO solely by reason of (i) his death or (ii) his permanent
inability to perform his usual and customary duties on a full-time
basis on behalf of ILCO and FIC as the result of physical or mental
infirmity, a default will occur, and the banks holding in the
aggregate at least 66 2/3% of the outstanding balance of the Senior
Loan may, on or after 180 days after the date on which such default
occurs, declare the Senior Loan immediately due and payable. Mr.
Mitte's ability to communicate and his mobility are impaired as a
result of a stroke he suffered in May 1991. However, Mr. Mitte
continues to control the management of ILCO and FIC, and Mr.
Mitte's impairments did not constitute a default under the ILCO
Senior Loan. See Item 10(b)-Executive Officers of the Registrant.
The principal balance of the ILCO Senior Loan was $10.96 million as
of December 31, 1997.
Regulation
General. ILCO's insurance subsidiaries and Family Life are subject
to regulation and supervision by the states in which they are
licensed to do business. Such regulation is designed primarily to
protect policy owners. Although the extent of regulation varies by
state, the respective state insurance departments have broad
administrative powers relating to the granting and revocation of
licenses to transact business, licensing of agents, the regulation
of trade practices and premium rates, the approval of form and
content of financial statements and the type and character of
investments.
These laws and regulations require Family Life and ILCO's insurance
subsidiaries to maintain certain minimum surplus levels and to file
detailed periodic reports with the supervisory agencies in each of
the states in which they do business, and their business and
accounts are subject to examination by such agencies at any time.
The insurance laws and regulations of the domiciliary states of
FIC's and ILCO's insurance subsidiaries require that such
subsidiaries be examined at specified intervals. Family Life is
domiciled in the State of Washington. Investors-NA and Investors-
IN are domiciled in the states of Washington and Indiana,
respectively. In December 1992, Investors-NA redomesticated from
Pennsylvania to Washington, and Investors-CA merged into
Investors-NA. In June, 1993, Standard Life merged into
Investors-NA. Prior to December, 1997, Investors-IN was domiciled
in the State of New Jersey. In December, 1997, Investors-IN
transferred its domicile to the State of Indiana.
A number of states regulate the manner and extent to which
insurance companies may test for Acquired Immune Deficiency
Syndrome (AIDS) antibodies in connection with the underwriting of
life insurance policies. To the extent permitted by law, Family
Life and ILCO's insurance subsidiaries consider AIDS information in
underwriting coverages and establishing premium rates. An
evaluation of the financial impact of future AIDS claims is
extremely difficult, due in part to insufficient and conflicting
data regarding the incidence of the disease in the general
population and the prognosis for the probable future course of the
disease.
Risk-Based Capital Requirements. Effective for the 1993 calendar
year, the National Association of Insurance Commissioners ("NAIC")
has adopted Risk-Based Capital ("RBC") requirements to evaluate the
adequacy of statutory capital and surplus in relation to investment
and insurance risks associated with: (i) asset quality; (ii)
mortality and morbidity; (iii) asset and liability matching; and
(iv) other business factors. The states will use the RBC formula
as an early warning tool to discover potential weakly capitalized
companies for the purpose of initiating regulatory action. The RBC
requirements are not intended to be a basis for ranking the
relative financial strength of insurance companies. In addition,
the formula defines a new minimum capital standard which will
supplement the prevailing system of low fixed minimum capital and
surplus requirements on a state-by-state basis.
The RBC requirements provide for four different levels of
regulatory attention in those states that adopt the NAIC
regulations, depending on the ratio of the company's Total Adjusted
Capital (which generally consists of its statutory capital, surplus
and asset valuation reserve) to its Authorized Control Level RBC.
A "Company Action Level Event" is triggered if a company's Total
Adjusted Capital is less than 200% but greater than or equal to
150% of its Authorized Control Level RBC, or if a negative trend
has occurred (as defined by the regulations) and Total Adjusted
Capital is less than 250% but more than 200% of its Authorized
Control Level RBC. When a Company Action Level Event occurs, the
company must submit a comprehensive plan to the regulatory
authority which discusses proposed corrective actions to improve
its capital position. A "Regulatory Action Level Event" is
triggered if a company's Total Adjusted Capital is less than 150%
but greater than or equal to 100% of its Authorized Control Level
RBC. When a Regulatory Action Level Event occurs, the regulatory
authority will perform a special examination of the company and
issue an order specifying corrective actions that must be followed.
An "Authorized Control Level Event" is triggered if a company's
Total Adjusted Capital is less than 100% but greater than or equal
to 70% of its Authorized Control Level RBC, and the regulatory
authority may take any action it deems necessary, including placing
the company under regulatory control. A "Mandatory Control Level
Event" is triggered if a company's Total Adjusted Capital is less
than 70% of its Authorized Control Level RBC, and the regulatory
authority is mandated to place the company under its control.
Calculations using the NAIC formula and the statutory financial
statements of Family Life and ILCO's insurance subsidiaries as of
December 31, 1997 indicate that the Total Adjusted Capital of each
of FIC's and ILCO's insurance subsidiaries is above 680% of its
respective Authorized Control Level RBC.
Solvency Laws Assessments. The solvency or guaranty laws of most
states in which an insurance company does business may require that
company to pay assessments (up to certain prescribed limits) to
fund policyholder losses or liabilities of insurance companies that
become insolvent. Recent insolvencies of insurance companies
increase the possibility that such assessments may be required.
These assessments may be deferred or forgiven under most guaranty
laws if they would threaten an insurer's financial strength and, in
certain instances, may be offset against future premium taxes. The
insurance companies record the expense for guaranty fund
assessments in the period assessed. The net amounts of such
assessments for Family Life and ILCO's insurance subsidiaries were
approximately $16,441 and $70,253 , respectively, in the year ended
December 31, 1997. Those amounts are net of the amounts that can
be offset against future premium taxes and, in the case of Family
Life, the amount is also net of the amount that can be recovered
from Merrill Lynch pursuant to the Stock Purchase Agreement between
FIC and Merrill Lynch. See "Acquisition of Family Life." The
likelihood and amount of any other future assessments cannot be
estimated and are beyond the control of FIC and ILCO.
Surplus Debentures and Dividends. The principal sources of cash
for FLC to make payments of principal and interest on the Family
Life Senior Loan are payments under the surplus debenture of Family
Life Insurance Company (a Washington-domiciled insurer) and
dividends paid by Family Life . Under current Washington law, any
proposed payment of a dividend or distribution which, together with
dividends or distributions paid during the preceding twelve months,
exceeds the greater of (i) 10% of statutory surplus as of the
preceding December 31 or (ii) statutory net gain from operations
for the preceding calendar year is an "extraordinary dividend" and
may not be paid until either it has been approved, or a 60-day
waiting period shall have passed during which it has not been
disapproved, by the Washington Insurance Commissioner. Effective
July 25, 1993, Washington amended its insurance code to retain the
above-described "greater of" standard for dividends, but enacted
requirements that prior notification of a proposed dividend be
given to the Washington Insurance Commissioner and that cash
dividends may be paid only from earned surplus. Family Life does
not presently have earned surplus as defined by the regulations
adopted by the Washington Insurance Commissioner and, therefore, is
not presently permitted to pay cash dividends. However, since the
new law applies only to dividend payments, the ability of Family
Life to make principal and interest payments under the surplus
debenture is not affected.
Principal and interest payments on the surplus debenture have
provided sufficient funds to meet debt service obligations of FLC.
Under the provisions of the surplus debenture and current law,
Family Life can pay interest and principal on the surplus debenture
without having to obtain the prior approval of the Washington
Insurance Commissioner; provided that, after giving effect to the
payment of interest or principal on the surplus debenture, the
statutory capital and surplus of Family Life exceeds 6% of its
assets. Pursuant to the surplus debenture, Family Life paid
principal and interest in 1995, 1996 and 1997 totaling $16,052,400,
$13,526,338 and $11,903,287, respectively. Family Life does give
five-days prior notification to the Washington Insurance Department
of each proposed payment on the surplus debenture in accordance
with an agreement between Family Life and the Department. The
Company does not anticipate that Family Life will have any
difficulty in making principal and interest payments on the surplus
debenture in the amounts necessary to enable FLC to service its
indebtedness for the foreseeable future.
Valuation Reserves. Commencing in 1992, the Mandatory Securities
Valuation Reserve ("MSVR") required by the NAIC for life insurance
companies was replaced by a mandatory Asset Valuation Reserve
("AVR") which is expanded to cover mortgage loans, real estate and
other investments. During 1997, a change in the NAIC's AVR
procedures resulted in a one-time reduction in the amount of the
reserves held by Family Life, with a corresponding one-time
increase in the amount of surplus, in the amount of $320,000. A
new mandatory Interest Maintenance Reserve ("IMR"), designed to
defer realized capital gains and losses due to interest rate
changes on fixed income investments and to amortize those gains and
losses into future income, is also effective for 1992. Previously,
realized capital gains attributable to interest rate changes were
credited to the MSVR and had the effect of reducing Family Life's
required MSVR contributions. Effective in 1992, such realized
capital gains are credited to the IMR. The combination of the AVR
and IMR will affect statutory capital and surplus and may reduce
the ability of Family Life to pay dividends and make payments on
the surplus debenture.
Insurance Holding Company Regulation. Family Life is subject to
regulation under the insurance and insurance holding company
statutes of Washington. The insurance holding company laws and
regulations vary from jurisdiction to jurisdiction, but generally
require insurance and reinsurance subsidiaries of insurance holding
companies to register with the applicable state regulatory
authorities and to file with those authorities certain reports
describing, among other information, their capital structure,
ownership, financial condition, certain intercompany transactions
and general business operations. The insurance holding company
statutes also require prior regulatory agency approval or, in
certain circumstances, prior notice of certain material
intercompany transfers of assets as well as certain transactions
between insurance companies, their parent companies and affiliates.
Under the Washington Insurance Code, unless (i) certain filings are
made with the Washington Department of Insurance, (ii) certain
requirements are met, including a public hearing and (iii) approval
or exemption is granted by the insurance commissioner, no person
may acquire any voting security or security convertible into a
voting security of an insurance holding company, such as the
Company, which controls a Washington insurance company, or merge
with such a holding company, if as a result of such transaction
such person would "control" the insurance holding company.
"Control" is presumed to exist if a person directly or indirectly
owns or controls 10% or more or the voting securities of another
person.
Potential Federal Regulation. Although the federal government
generally does not directly regulate the insurance industry,
federal initiatives often have an impact on the business. Congress
and certain federal agencies are investigating the current
condition of the insurance industry (encompassing both life and
health and property and casualty insurance) in the United States in
order to decide whether some form of federal role in the regulation
of insurance companies would be appropriate. Congress is currently
conducting a variety of hearings relating in general to the
solvency of insurers. It is not possible to predict the outcome of
any such congressional activity nor the potential effects thereof
on Family Life.
Congressional initiatives directed at repeal of the McCarran-
Ferguson Act (which exempts the "business of insurance" from most
federal laws, including the antitrust laws, to the extent it is
subject to state regulation) and judicial decisions narrowing the
definition of "business of insurance" for McCarran-Ferguson Act
purposes may limit the ability of insurance companies in general to
share information with respect to rate-setting, underwriting and
claims management practices. Current and proposed federal measures
which may also significantly affect the insurance industry include
minimum solvency requirements and removal of barriers preventing
banks from engaging in the insurance business.
Federal Income Taxation
The Revenue Reconciliation Act of 1990 amended the Internal Revenue
Code of 1986 to require a portion of the expenses incurred in
selling insurance products to be deducted over a period of years,
as opposed to an immediate deduction in the year incurred. Since
this change only affects the timing of the deductions, it does not
affect tax expense as shown on the Company's financial statements
prepared in accordance with GAAP. However, the change will
increase the tax for statutory accounting purposes in the first few
years, which will reduce statutory surplus and, accordingly, may
decrease the amount of cash dividends that Family Life can pay. For
the years ended December 31, 1995, 1996 and 1997, the increases
(decreases) in Family Life's current income tax provisions,
utilizing the effective tax rates, due to this change were $77,498,
$183,358 and ($136,000), respectively. The change has a negative
tax effect for statutory accounting purposes when Family Life's
premium income increases, but has a positive tax effect when its
premium income decreases.
Item 2. Properties
The Registrant's headquarters are currently located at Austin
Centre, 701 Brazos, Suite 1400, Austin, Texas. A subsidiary of
ILCO, Investors-NA, purchased Austin Centre, an office-hotel
property in downtown Austin in August 1991 for a purchase price of
$31,275,000 from an unrelated seller that had previously acquired
the property through foreclosure. Austin Centre covers a full city
block and is a sixteen story mixed use development consisting of
343,664 square feet of office/retail space (predominately office
space), a 314 room hotel and 61 luxury apartments, all united by a
200 foot high glass atrium. The project was completed in October
1986.
In September 1995, Investors-NA entered into a contract to sell
Austin Centre to an Austin-based real estate investment firm for a
purchase price of $62.675 million, less $1 million to be paid to a
capital reserve account for the purchaser. The sale was
consummated on March 29, 1996. A portion of the sale proceeds
equal to the amount that Investors-NA presently had invested in
Austin Centre were retained and reinvested by Investors-NA. The
balance of the net proceeds of the sale were used to reduce ILCO's
bank indebtedness by approximately $15 million.
Following the sale of the Austin Centre, the Company and its
affiliates continued to occupy three floors of the office space,
under a lease arrangement. The current lease, which was entered
into in May, 1997, is for a five (5) year term ending in October,
2002, with options to renew for three successive five (5) year
terms thereafter.
In January, 1995, ILCO, through Investors-NA, purchased, as an
investment property, an office building project known as
Bridgepoint Office Square in Austin, Texas for a cash purchase
price of $9.75 million. The property consists of 20 acres of land
with four office building sites and two parking structure sites.
The first phase of development of the property was completed in
1986 and consists of a five-story office building with 83,474
square feet of rentable space and a 550-car parking garage. The
office space was fully rented.
In the fourth quarter of 1995, construction began on the second
office building, containing approximately 109,000 rentable square
feet, and the other parking garage containing approximately 871
spaces. That phase of the project was completed in September 1996,
and is 100% leased to a major tenant in the technology business.
In March 1996, construction commenced on the third office building,
with approximately 81,000 rentable square feet of office space and
was completed in December, 1996. Investors-NA leased approximately
43,000 square feet of the third office building to the same tenant
which leased all of the space in the second building. The
remaining space was leased in October, 1996 to a major tenant also
in the technology business.
Construction began on the fourth building in July 1996, and was
completed in July, 1997. The fourth building contains approximately
92,459 rentable square feet. In September of 1996, approximately
23,619 rentable square feet were leased to an oil and gas company,
which then expanded its premises to 29,631 under an expansion
option contained in its Lease. Another 8,368 square feet was
leased in March, 1997, to a company involved in the technology
field. In June, 1997, approximately 40,611 rentable square feet was
leased to a tenant in the technology field. In November, 1997
approximately 2967 rentable square feet was leased to a securities
brokerage firm. The remaining 10,882 rentable square feet is
reserved for a health club facility and a retail food outlet.
On May 3, 1996, Family Life purchased a tract of land adjoining the
Bridgepoint Office Square tract for a cash purchase price of $1.3
million. The property consists of 7.1 acres of land with one office
building site and one parking structure site. Family Life began
construction of the fifth building (known as "Bridgepoint Five")
on the new site in January 1997. In May, 1997, the entire rentable
space (approximately 76,793 rentable square feet) contained in the
building was leased to a major tenant in the technology business.
Construction of the parking garage and the building shell was
completed in October, 1997.
On November 24, 1997, Investors-NA and Family Life entered into a
contract with Health and Retirement Properties Trust, a Maryland
real estate investment trust (the "Purchaser") to sell their
respective interests in the Bridgepoint Square Office complex. The
aggregate purchase price for the project was $78,000,000. The
transaction closed on December 5, 1997. The purchase price was
allocated approximately 78.5% to Investors-NA and 21.5% to Family
Life. The sale of Bridgepoint Office Square resulted in a net
profit to Investors-NA of approximately $14.0 million ($9.1 million
after tax) that is included in ILCO's fourth quarter earnings. For
Family Life, the sale resulted in a net profit of approximately
$4.5 million ($3.2 million after tax)that is included in FIC's
fourth quarter earnings.
Pursuant to the terms of the Bridgepoint Sale Agreement, Family
Life is obligated to complete the construction of and tenant
improvements in Bridgepoint Five. At the date on which the
transaction closed, the building shell and adjacent parking garage
had been completed, except for the client briefing center. As of
March, 1998, all tenant improvements had been completed subject to
final inspection.
Family Life leases its home offices at the Sedgwick James
Building, 2101 Fourth Avenue, in Seattle, Washington. The lease
currently covers approximately 7,776 rentable square feet of office
space for a term expiring in October 1998 with an option to renew
for an additional three-year period. The initial base rental is
approximately $11,200 per month, which includes Family Life's
proportionate share of the building's operating expenses, including
utilities, property taxes, insurance, maintenance and management.
Actual increases from those initial operating expenses during the
lease term are passed on to Family Life on a proportionate basis.
ILCO leases a building located at 40 Parker Road, Elizabeth, New
Jersey. This building, which was formerly the ILCO's headquarters
building, contains approximately 41,000 square feet of office
space. The remaining term of the lease is 8 years, and the lease
calls for a minimum base rental of $450,000 per annum. The lease
provides that all costs including, but not limited to, those for
maintenance, repairs, insurance and taxes be borne by ILCO. ILCO
has sub-leased the space in the property 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.
ILCO and Investors-NA are defendants in a lawsuit which was filed
in October, 1996, in Travis County, Texas. CIGNA Corporation, an
unrelated company, is also a named defendant in the lawsuit. The
named plaintiffs in the suit (a husband and wife), allege that the
universal life insurance policies sold to them by INA Life
Insurance Company (a company which was merged into Investors-NA in
1992) utilized unfair sales practices. The named plaintiffs seek
reformation of the life insurance contracts and an unspecified
amount of damages. The named plaintiffs also seek a class action
as to similarly situated individuals. No certification of a class
has been granted as of the date hereof. ILCO believes that the
suit is without merit and intends to vigorously defend this matter.
In August, 1997, another individual filed a similar action in
Travis County, Texas against the corporate entities identified
above. The lawsuit involves the same type of policy and includes
allegations which are substantially identical to the allegations in
the first action. The named plaintiff also seeks class
certification. ILCO believes that the court would consider class
certification with respect to only one of these actions. ILCO also
believes that this action is without merit and intends to
vigorously defend this matter.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the fiscal
year ended December 31, 1997 to a vote of security holders.
PART II
Item 5. Market for the Registrant's Common Stock and Related
Security Holder Matters
A. Market Information
The following table sets forth the quarterly high and low sales
prices for FIC Common Stock in The Nasdaq Small-Cap Market for 1997
and 1996. The quotations set forth in the table have been adjusted
to give retroactive effect to the five-for-one stock split which
was effective November 12, 1996. FIC's NASDAQ trading symbol is
FNIN.
Common Stock
Prices
High Low
1997
First Quarter $13.25 $10.75
Second Quarter 13.25 11.00
Third Quarter 16.25 11.625
Fourth Quarter 20.25 14.75
1996
First Quarter $11.00 $ 6.95
Second Quarter 11.90 7.80
Third Quarter 11.90 8.70
Fourth Quarter 15.00 11.00
B. Stockholders
As of March 17, 1998 there were approximately 15,856 record holders
of FIC Common Stock.
C. Dividends
FIC has not paid a dividend since 1976 and does not expect to pay
a dividend during 1998.
The ability of an insurance holding company, such as FIC, to pay
dividends to its shareholders may be limited by the company's
ability to obtain revenue, in the form of dividends and other
payments, from its operating insurance subsidiary or subsidiaries.
The right of Family Life to pay dividends is restricted by the
insurance laws of its domiciliary state. See Item 1. Business -
Regulation - Surplus Debenture and Dividends. However, FIC does
not directly own Family Life's stock but, instead, indirectly owns
that stock through two downstream holding companies, FLIIC and FLC.
FLC, which holds all of the stock of Family Life, is prohibited
from paying dividends on its common stock by the provisions of the
note from Investors-NA , and FLIIC, the immediate parent of FLC and
the directly-owned subsidiary of FIC, is prohibited from paying
dividends on its stock by the $4.5 million subordinated note of
FLIIC held by Investors-NA, except FLIIC may pay dividends on its
common stock to enable FIC to make scheduled principal and interest
payments on its $2.5 million subordinated note to Investors-NA.
The ability of ILCO to pay dividends to FIC and the other
shareholders of ILCO is affected by the receipt of dividends and
other payments from its insurance subsidiaries. In addition, the
ILCO Senior Loan restricts ILCO from paying any dividends on its
stock during the term of that loan.
Item 6. Selected Financial Data
(Registrant and its Consolidated Subsidiaries)
(In thousands, except per share data)
1997 1996 1995 1994 1993
Operating
Revenues $63,343 $ 59,928 $ 61,541 $ 68,524 $ 74,023
Income (loss)
before federal
income tax,
equity in net
earnings of
affiliates,
extraordinary
items and
cumulative
effect of
change in
accounting
principle of
affiliate 13,411 9,791 10,394 10,610 11,560
Income before
equity in net
earnings of
affiliates,
extraordinary
items and
cumulative
effect of
change in
accounting
principle of
affiliate 9,870 7,145 7,966 8,264 8,587
Equity in net
earnings of
affiliate, net
of tax 6,458 9,012 2,051 1,690 3,038
Income before
extraordinary
items and
cumulative
effect of
change in
accounting
principle of
affiliate 16,328 16,157 10,017 9,954 11,625
Extraordinary
items -0- -0- -0- -0- 5,555
Income before
cumulative
effect of
change in
accounting
principle of
affiliate 16,328 16,157 10,017 9,954 17,180
Cumulative
effect of
change in
accounting
principle of
affiliate, net
of tax
benefit -0- -0- -0- -0- (1,159)
Net Income $ 16,328 $ 16,157 $ 10,017 $ 9,954 $ 16,021
Common Stock
and Common
Stock
Equivalents 5,589 5,568 5,540 5,530 5,555
Net income per
share before
extraordinary
items and
cumulative
effect of
change in
accounting
principle of
affiliate
Basic $ 3.01 $ 2.98 $ 1.85 $ 1.83 $ 2.14
Diluted $ 2.92 $ 2.90 $ 1.81 $ 1.80 $ 2.09
Extraordinary
items
Basic $ 1.02
Diluted -0- -0- -0- -0- $ 1.00
Net income per
share before
cumulative
effect of
change in
accounting
principle of
affiliate
Basic $ 3.01 $ 2.98 $ 1.85 $ 1.83 $ 3.16
Diluted $ 2.92 $ 2.90 $ 1.81 $ 1.80 $ 3.09
Cumulative
effect of
change in
accounting
principle of
affiliate
Basic -0- -0- -0- -0- ($0.21)
Diluted -0- -0- -0- -0- ( 0.21)
Net Income per
share
Basic $ 3.01 $ 2.98 $ 1.85 $ 1.83 $ 2.95
Diluted $ 2.92 $ 2.90 $ 1.81 $ 1.80 $ 2.88
Total
Assets $ 304,324 $287,730 $287,678 $253,100 $277,790
Long Term
Obligations $ 53,792 $ 59,940 $ 67,989 $ 77,819 $ 89,178
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
For the year ended December 31, 1997, FIC's net income was
$16,328,000 (or $2.92 per common share), as compared to $16,157,000
(or $2.90 per common share for the year ended December 31, 1996 and
$10,017,000 (or $1.81 per common share), for the year ended
December 31, 1995. Earnings per share are stated on a diluted
basis, in accordance with the requirements of FAS 128, which
requires that diluted earnings per share reflect the potential
dilution that would occur if securities or other contracts to issue
common stock were converted or exercised. For the years 1996 and
1995, earnings per share have been restated to reflect the effect
of FAS No.128. The net income per share for the year 1995 has been
restated to reflect the effect of the five-for-one stock split
which was effective November 12, 1996.
Results of Operations
Net income from continuing operations (excluding the gain resulting
from Family Life s sale of its interest in Bridgepoint Square
Offices in 1997 , ILCO s sale of its interest in Bridgepoint
Square Offices in 1997, and ILCO s sale of the Austin Centre in
1996, as described below) was $9,300,000 ($1.66 per common share on
a diluted basis) for the year ended December 31, 1997, $9,487,000
($1.70 per common share on a diluted basis) for the year ended
December 31, 1996 and $10,017,000 ($1.81 per common share on a
diluted basis) for the year ended December 31, 1995
Net income for the year ended December 31, 1997 includes $3.2
million ($0.57 per common share) resulting from Family Life s sale
of its interest in Bridgepoint Square Offices. Family Life
purchased undeveloped land at the Bridgepoint site in May, 1996,
for a cash purchase price of $1.3 million. The property consists
of 7.1 acres of land with one office building site and one parking
structure site. Family Life began construction of the building
(known as "Bridgepoint Five") in January 1997. In May, 1997, the
entire rentable space (approximately 76,793 rentable square feet)
contained in the building was leased to a major tenant in the
technology business. Construction of the parking garage and the
building shell was completed in October, 1997. In November, 1997,
Family Life entered into a contract to sell its interest in the
Bridgepoint Square Office complex. The sale also included the
adjacent properties developed by ILCO s subsidiary, Investors-NA.
The aggregate purchase price for the project was $78 million. The
transaction closed on December 5, 1997. The purchase price was
allocated approximately 78.5% to Investors-NA and 21.5% to Family
Life. The sale resulted in a net profit to Family Life of
approximately $4.5 million ($3.2 million after tax)that is included
in FIC's earnings for the year 1997.
FIC's net income is affected by its equity interest in
InterContinental Life Corporation ("ILCO") and ILCO's insurance
subsidiaries. Net income for the year ended December 31, 1997
includes $3.8 million ($0.68 per common share on a diluted basis)
resulting from ILCO s sale of its interest in Bridgepoint Square
Offices. Net income for the year ended December 31, 1996 includes
$7.1 million resulting from ILCO's sale of the Austin Centre, a
hotel/office complex, located in Austin, Texas.
The statutory earnings of Family Life as required to be reported to
insurance regulatory authorities before interest expense, capital
gains and losses, and federal income taxes were $13,625,000 at
December 31, 1997, as compared to $12,734,000 at December 31, 1996
and $14,354,000 at December 31, 1995. These statutory earnings are
the source to provide for the repayment of the indebtedness
incurred in connection with the acquisition of Family Life.
The decline in long-term interest rates during 1997, which was
related to general economic conditions, had a positive effect upon
the market value of the fixed maturities available for sale segment
of the Company's portfolio. As of December 31, 1997, the market
value of the fixed maturities available for sale segment was $81.85
million as compared to an amortized value of $79.06 million, or an
unrealized gain $2.79 million. The net of tax effect of this
increase has been recorded as an increase in shareholders' equity.
There is no assurance that this unrealized gain may be realized in
the future.
For the year ended December 31, 1997, FIC's income from operations,
before federal income tax and equity in net earnings of affiliate,
was $13,411,000(on revenues of $63,343,000), as compared to
$9,791,000 (on revenues of $59,928,000) in the year 1996 and
$10,394,000 (on revenues of $61,541,000) for the year 1995.
Premiums for the year 1997, net of reinsurance ceded, were $40.2
million, as compared to $43.3 million in 1996 and $43.9 million in
1995. Policyholder benefits and expenses were $17.7 million in
1997, as compared to $22.1 million in 1996 and $21.0 million in
1995.
Equity in Net Income of InterContinental Life Corporation
General:
Prior to the acquisition of Family Life in June of 1991, FIC's
primary involvement in the life insurance business was through its
equity interest in ILCO. The Company's equity in the net earnings
of ILCO, net of federal income tax, was $6,458,000, as compared to
$9,012,000 for the year 1996 and $2,051,000 for the year 1995.
The decrease in 1997, as compared to 1996 is primarily attributable
to the effect, in 1996, of ILCO's net income resulting from the
sale of the Austin Centre property.
FIC currently owns 1,795,146 shares of ILCO's common stock, and
holds options to acquire an additional 1,702,155 shares. The
options were granted under an Option Agreement between FIC and ILCO
which was entered into in March, 1986. In addition, Family Life
currently owns 171,200 shares of ILCO common stock. As a result,
FIC currently owns, directly and indirectly through Family Life,
1,966,346 shares (approximately 45.40%) of ILCO's common stock and
holds options to acquire 1,702,155 shares. If all of FIC's rights
under the Option Agreement were to be presently exercised, FIC's
ownership would amount to approximately 60.80% of the issued and
outstanding shares of ILCO's common stock. The option agreement
provides that it continues in effect as long as FIC guarantees
indebtedness of ILCO. The current Senior Loan of ILCO is scheduled
to be fully repaid on October 1, 1998. Accordingly, unless ILCO s
Senior Loan is extended, or ILCO otherwise incurs indebtedness
which is guaranteed by FIC, FIC s rights under the 1986 option
agreement would expire on October 1, 1998.
The decline in long-term interest rates during 1997, which was
related to general economic conditions, had a positive effect upon
the market value of the fixed maturities available for sale segment
of ILCO's investment portfolio. As of December 31, 1997, the
market value of the fixed maturities available for sale segment was
$454.5 million as compared to an amortized cost of $436.8 million,
or an unrealized gain $17.7 million. There is no assurance that
this unrealized gain will be realized by ILCO in the future.
Since FIC owns approximately 45.40% of the common stock of ILCO,
such unrealized gains, net of tax, are reflected in FIC's equity
interest in ILCO, and had the effect of increasing the reported
value of such equity interest by approximately $4.9 million.
ILCO's results for 1997, 1996 and for that portion of 1995
beginning on February 14th, include the operations of Investors
Life Insurance Company of Indiana (formerly known as Meridian Life
Insurance Company and referred to herein as "Pre-Merger Investors-
IN" for purposes of identifying the entity prior to the December
1997 merger transaction described below). Pre-Merger Investors-IN
was purchased by ILCO and Investors Life Insurance Company of North
America ("Investors-NA") for an adjusted purchase price of $17.1
million; the transaction was completed on February 14, 1995. The
name change was completed in May, 1995.
ILCO's results for 1997 include, for the period beginning on July
9th, the operations of State Auto Life Insurance Company. That
company was acquired from State Automobile Mutual Insurance
Company, for an adjusted cash purchase price of $11.8 million. In
connection with this transaction, the bank group participating in
the ILCO Senior Loan agreed to defer payment of $4.5 million
otherwise payable on April 1, 1997 under the terms of the ILCO
Senior Loan, and to reduce the amount of the payment otherwise due
on July 1, 1997 by $2.5 million. This deferral resulted in
extending the maturity date of the ILCO Senior Loan to October 1,
1998. Under the terms of the transaction, State Auto Life was
merged into Pre-Merger Investors-IN. The closing of the
transaction took place on July 9, 1997.
In December, 1997, ILIC, an indirect subsidiary of ILCO,
transferred its domicile from New Jersey to Indiana. Following
completion of the redomestication, ILIC merged with Pre-Merger
Investors-IN, with ILIC as the surviving entity in the merger
process. Immediately after the merger, ILIC changed its name to
Investors Life Insurance Company of Indiana. As used hereinafter,
the phrase "Investors-IN" shall be used to refer to the merged
entities. As a result of the merger, Investors-IN is licensed in
44 states. As of December 31, 1997, it had assets of $153.8 million
and capital and surplus of $23.1 million.
Liquidity and Capital Resources of ILCO:
ILCO is a holding company whose principal assets consist of the
common stock of Investors-NA and its subsidiary, Investors Life
Insurance Company of Indiana (formerly InterContinental Life
Insurance Company). ILCO's primary source of funds consists of
payments under the surplus debentures from Investors-NA.
As of December 31, 1996, the outstanding principal balance of
ILCO's Senior Loan obligations was $24.9 million. ILCO made
scheduled principal payments under its Senior Loan on January 1,
1997 and July 1, 1997, reducing the principal balance to $11.0
million at December 31, 1997.
ILCO's principal source of liquidity consists of the periodic
payment of principal and interest to it by Investors-NA, pursuant
to the terms of the two surplus debentures. The surplus debentures
were originally issued by Standard Life Insurance Company and its
terms were previously approved by the Mississippi Insurance
Commissioner. One of the surplus debentures, in the original
amount of $15 million, was issued in connection with the 1986
acquisition of Standard Life by ILCO; the other, in the original
amount of $140 million was issued in connection with the 1988
acquisition by ILCO of the Investors Life Companies. Upon the
merger of Standard Life into Investors-NA, the obligations of the
surplus debentures were assumed by Investors-NA. As of December
31, 199, the outstanding principal balance of the surplus
debentures was $5.2 million and $22.6 million, respectively. Since
Investors-NA is domiciled in the State of Washington, the
Washington insurance law applies to the administration of the terms
of the surplus debentures. Under the provisions of the surplus
debentures and current law, no prior approval of the Washington
Insurance Commissioner is required for Investors-NA to pay interest
or principal on the surplus debentures; provided that, after giving
effect to such payments, the statutory surplus of Investors-NA is
in excess of $10 million (the "surplus floor"). However,
Investors-NA has voluntarily agreed with the Washington Insurance
Commissioner that it will provide at least five days advance notice
of payments which it will make under the surplus debenture. As of
December 31, 1997, the statutory capital and surplus of Investors-
NA was $73.9 million, an amount substantially in excess of the
surplus floor. The funds required by Investors-NA to meet its
obligations to ILCO under the terms of the surplus debentures are
generated from operating income generated from insurance and
investment operations.
In addition to the payments under the terms of the Surplus
Debentures, ILCO has received dividends from Standard Life (now,
from Investors-NA). Washington's insurance code includes the
"greater of" standard for payment of dividends to shareholders, but
has a requirement that prior notification of a proposed dividend be
given to the Washington Insurance Commissioner and that cash
dividends may be paid only from earned surplus. As of December 31,
1997, Investors-NA had earned surplus of $32.9 million. Since the
law applies only to dividend payments, the ability of Investors-NA
to make principal and interest payments under the Surplus
Debentures is not affected. ILCO does not anticipate that
Investors-NA will have any difficulty in making principal and
interest payments on the Surplus Debentures in the amounts
necessary to enable ILCO to service the Senior Loan for the
foreseeable future.
Investors-IN, formerly known as ILIC, is domiciled in the State of
Indiana. The transfer of domicile from New Jersey to Indiana was
effective December 15, 1997. Under the Indiana insurance code, a
domestic insurer may make dividend distributions upon proper notice
to the Department of Insurance, as long as the distribution is
reasonable in relation to adequate levels of policyholder surplus
and quality of earnings. Under Indiana law the dividend must be
paid from earned surplus. Extraordinary dividend approval would be
required where a dividend exceeds the greater of 10% of surplus or
the net gain from operations for the prior fiscal year.
Investors-IN had earned surplus of $18.1 million at December 31,
1997.
The Form 10-Ks of ILCO for the years ended December 31, 1997, 1996
and 1995, set forth the business operations and financial results
of ILCO and its life insurance subsidiaries. Such 10-K reports of
ILCO, including the discussion by ILCO's management under the
caption "Management's Discussion and Analysis of Financial
Conditions and Results of Operations" are incorporated herein by
reference.
Liquidity and Capital Resources
FIC is a holding company whose principal assets consist of the
common stock of Family Life and its equity ownership in ILCO.
FIC's primary sources of capital consists of cash flow from
operations of its subsidiaries and the proceeds from bank and
institutional borrowings.
The cash requirements of FIC and its subsidiaries consist primarily
of its service of the indebtedness created in connection with its
ownership of Family Life. As of September 30, 1996 the outstanding
balance of such indebtedness was $61.5 million on the Subordinated
Notes granted by Investors-NA. On April 17, 1996, the Senior Loan
granted by a group of banks was completely paid off.
The principal source of liquidity for FIC's subsidiaries consists
of the periodic payment of principal and interest by Family Life
pursuant to the terms of a Surplus Debenture. The terms of the
Surplus Debenture were previously approved by the Washington
Insurance Commissioner. Under the provisions of the Surplus
Debenture and current law, no prior approval of the Washington
Insurance Department is required for Family Life to pay interest or
principal on the Surplus Debenture; provided that, after giving
effect to such payments, the statutory surplus of Family Life is in
excess of 6% of assets (the "surplus floor"). However, Family Life
has voluntarily agreed with the Washington Insurance Commissioner
that it will provide at least five days advance notice of payments
which it will make under the surplus debenture. As of December 31,
1997, the statutory capital and surplus of Family Life was $30.4
million, an amount substantially in excess of the surplus floor.
During 1997, Family Life made principal payments of $8.65 million
and interest payments of $3.3 million to Family Life Corporation
under the Surplus Debenture. As of December 31, 1997, the
principal balance of the Surplus Debenture was $31.9 million. The
funds required by Family Life to meet its obligations under the
terms of the Surplus Debenture are generated primarily from premium
payments from policyholders, investment income and the proceeds
from the sale and redemption of portfolio investments.
Washington's insurance code includes the "greater of" standard for
dividends but has requirements that prior notification of a
proposed dividend be given to the Washington Insurance Commissioner
and that cash dividends may be paid only from earned surplus.
Family Life does not presently have earned surplus as defined by
the regulations adopted by the Washington Insurance Commissioner
and, therefore, is not permitted to pay cash dividends. However,
since the new law applies only to dividend payments, the ability of
Family Life to make principal and interest payments under the
Surplus Debenture is not affected. The Company does not anticipate
that Family Life will have any difficulty in making principal and
interest payments on the Surplus Debenture in the amounts necessary
to enable Family Life Corporation to service its indebtedness for
the foreseeable future.
The sources of funds for Family Life consist of premium payments
from policy holders, investment income and the proceeds from the
sale and redemption of portfolio investments. These funds are
applied primarily to provide for the payment of claims under
insurance and annuity policies, operating expenses, taxes,
investments in portfolio securities, shareholder dividends and
payments under the provisions of the Surplus Debenture.
FIC's net cash flow provided by operating activities was $5.2
million in 1997, as compared to $9.7 million in 1996 and $9.1
million in 1995. Net cash flow used in financing activities was
$6.1 million in 1997, as compared to $8.05 million in 1996 and $9.8
million in 1995.
In connection with the purchase of the Investors Life Companies by
ILCO and the purchase of Family Life by a wholly- owned subsidiary
of FIC, FIC guaranteed the payment of the indebtedness created in
connection with such acquisitions. The guaranty commitments of FIC
with respect to the debt obligations of ILCO relate to the ILCO
Senior Loan, with an outstanding balance at December 31, 1997 of
$10.96 million.
The guaranty commitments of FIC under the loans incurred in
connection with the acquisition of Family Life (after taking into
account the repayments and new loans which occurred in July, 1993)
relate to: (i) the $22.5 million note issued by Family Life
Corporation to Investors Life Insurance Company of North America,
and (ii) the $34.5 million loaned by Investors-NA to two
subsidiaries of FIC.
Management believes that its cash, cash equivalents and short term
investments are sufficient to meet the needs of its business and to
satisfy debt service.
Investments
As of December 31, 1997, the Company's investment assets totaled
$119.1 million, as compared to $111.7 million as of December 31,
1996.
The level of short-term investments at the end of 1997 was $34.5
million, as compared to $25.6 million as of December 31, 1996. The
fixed maturities available for sale portion represents $81.9
million of investment assets as of December 31, 1997, as compared
to $83.8 million at the end of 1996. The amortized cost of fixed
maturities available for sale as of December 31, 1997 was $79.06
million representing a net unrealized gain of $2.79 million. This
unrealized gain principally reflects changes in interest rates from
the date the respective investments were purchased. To reduce the
exposure to interest rate changes, portfolio investments are
selected so that diversity, maturity and liquidity factors
approximate the duration of associated policyholder liabilities.
The assets held by Family Life must comply with applicable state
insurance laws and regulations. In selecting investments for the
portfolios of its life insurance subsidiaries, the Company's
emphasis is to obtain targeted profit margins, while minimizing the
exposure to changing interest rates. This objective is implemented
by selecting primarily short- to medium-term, investment grade
fixed income securities. In making such portfolio selections, the
Company generally does not select new investments which are
commonly referred to as "high yield" or "non-investment grade".
The fixed maturities portfolio of Family Life, as of December 31,
1997, consisted solely of fixed maturities investments which, in
the annual statements of the companies, as filed with state
insurance departments, were designated under the National
Association of Insurance Commissioners ("NAIC") rating system as a
"1" (highest quality).
Management believes that the absence of "high-yield" or "non-
investment grade" investments (as defined above) in the portfolios
of its life insurance subsidiary enhances the ability of the
Company to service its debt, provide security to its policyholders
and to credit relatively consistent rates of return to its
policyholders.
Y2K Compliance
The Company and its subsidiaries utilize a centralized computer
system to process policyholder records and financial information.
In addition, the Company uses non-centralized computer terminals
in connection with its operations. The software programs used in
connection with these systems will be affected by what is referred
to as the "Y2K date problem". This refers to the limitations of
the programming code in certain existing software programs to
recognize date sensitive information as the year 2000 approaches.
Unless modified prior to the year 2000, such systems may not
properly recognize such information and could generate erroneous
data or cause a system to fail to operate properly.
The Company has evaluated its centralized computer systems and has
developed a plan to reach Y2K compliance. A central feature of
the plan is to convert most of the centralized systems to a common
system which is already in compliance with Y2K requirements. The
Company is in the process of this systems conversion and
anticipates that the project will be completed in advance of the
year 2000.
The Plan calls for an upgrade of the Family Life's administrative
systems by changing individual lines of computer code in order to
modify current operating software such that it will become Y2K
compliant. The administrative systems which are not modified will
be converted onto the Company's CK/4 System; a system designed to
be Y2K compliant according to the representations of the vendor.
Under the Plan, The Company will utilize the services of personnel
of its affiliate, FIC Computer Services, Inc., to acquire Y2K
compliant operating software, and engage the assistance of outside
consultants to facilitate the systems conversions and
modifications. The Company has budgeted approximately $330,000 for
implementation of the Plan. In the event that the Plan does not
achieve full compliance by the target dates, or if unforeseen
matters involving Y2K appear at later dates, the Company will
utilize the staff of FIC Computer Services to identify and resolve
such issues as an