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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, 2001
[ ] 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)
6500 River Place Boulevard, Building One, Austin, Texas 78730
(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
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The aggregate market value of the voting stock held by non-affiliates of the
Registrant on March 6, 2002, based on the closing sales price in the Nasdaq
National Market ($13.90 per share), was $110,550,495.
The number of shares outstanding of Registrant's common stock on March 6, 2002
was 9,519,751.
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. [ ]
Forward-Looking Statements
Except for historical factual information set forth in this Form 10-K, the
statements, analyses, and other information contained in this report relating to
trends in the Company's operations and financial results, the markets for the
Company's products, the future development of the Company's business, and the
contingencies and uncertainties to which the Company may be subject, as well as
other statements including words such as "anticipate," "believe," "path,"
"estimate," "expect," "intend" and other similar expressions constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. Such statements are made based upon management's current expectations and
beliefs concerning the financial results, economic conditions and are subject to
known and unknown risks, uncertainties and other factors contemplated by the
forward-looking statements. Such factors include, among other things: (1)
general economic conditions and other factors, including prevailing interest
rate levels and stock market performance, which may affect the ability of FIC to
sell its products, the market value of FIC's investments and the lapse rate and
profitability of policies; (2) FIC's ability to achieve anticipated levels of
operational efficiencies and cost-saving initiatives; (3) customer response to
new products, distribution channels and marketing initiatives; (4) mortality,
morbidity and other factors which may affect the profitability of FIC's
insurance products; (5) changes in the Federal income tax laws and regulations
which may affect the relative tax advantages of some of FIC's products; (6)
increasing competition in the sale of insurance and annuities; (7) regulatory
changes or actions, including those relating to regulation of insurance products
and insurance companies; (8) ratings assigned to FIC's insurance subsidiaries by
independent rating organizations such as A.M. Best Company, which FIC believes
are particularly important to the sale of annuity and other accumulation
products; and (9) unanticipated litigation. There can be no assurance that other
factors not currently anticipated by management will not also materially and
adversely affect FIC.
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PART I
Item 1. Business
General
Financial Industries Corporation ("FIC", the "Company" or the "Registrant") is a
holding company primarily engaged in the life insurance business through its
ownership of Family Life Insurance Company, ("Family Life") Investors Life
Insurance Company of North America ("Investors Life"), and prior to February 19,
2002, Investors Life Insurance Company of Indiana.
FIC was organized as an Ohio corporation in 1968 and was reincorporated in Texas
in 1980. Its executive offices are located at 6500 River Place Boulevard,
Building One, Austin, Texas 78730. Through 1984, FIC's principal business was
the sale and underwriting of life and health insurance, mainly in the midwestern
and southwestern United States. During the period from 1985 to 1987, FIC
acquired a 48.3% equity interest in InterContinental Life Corporation ("ILCO").
ILCO is a Texas corporation which, prior to May 18, 2001, was publicly traded
and was engaged in the sale and underwriting of life insurance and annuities,
through its subsidiaries, Investors Life and Investors Life Insurance Company of
Indiana ("Investors-IN"). On May 18, 2001, FIC acquired the remaining shares of
ILCO through a merger of a subsidiary of FIC with and into ILCO, whereby ILCO
shareholders were issued 1.1 shares of FIC stock for each share of ILCO stock
outstanding. See, "Acquisitions and Consolidations - Acquisition of ILCO." In
June 1991, FIC purchased Family Life, a Washington based life insurance
corporation, from Merrill Lynch Insurance Group, Inc.
FIC and its insurance subsidiaries have substantially identical managements.
Officers allocate their time among FIC and its subsidiaries in accordance with
their comparative requirements. The Roy F. and Joann Cole Mitte Foundation (the
"Foundation"), a charitable entity exempt from federal income tax under section
501(a) of the Internal Revenue Code (the "Code") as an organization described in
section 501(c)(3) of the Code, owns 16.31% of the outstanding shares of FIC's
common stock. The sole members of the Foundation are Roy F. Mitte, Chairman,
President and Chief Executive Officer of FIC, and their insurance subsidiaries
and his wife, Joann Cole Mitte.
Acquisitions and Consolidations
Strategy. FIC's business strategy has been and continues to be to grow
internally and through acquisitions, while maintaining an emphasis on cost
controls. Management believes that, under appropriate circumstances, it is more
advantageous to acquire companies with books of in-force life insurance than to
produce new business, because initial underwriting costs have already been
incurred and mature business is generally less likely to terminate, making
possible more predictable profit analysis. 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 obtaining the necessary financing.
-3-
Acquisition of Family Life. FIC acquired Family Life, a Washington based
life insurance corporation, from Merrill Lynch Insurance Group, Inc. on June 12,
1991. Family Life's primary business is the underwriting and sale of mortgage
protection life insurance to customers who are mortgage borrowers from financial
institutions where Family Life has marketing relationships. Family Life
distributes its insurance products primarily through a national career agency
sales force. See "Business of Insurance Subsidiaries -- Family Life".
Acquisition of ILCO. In January 1985, FIC acquired 26.53% of ILCO's common
stock. During the period from 1985 to 1987, FIC acquired additional ILCO common
stock resulting in an approximate 48% equity interest in ILCO. On May 18, 2001,
pursuant to an Agreement and Plan of Merger, as amended (the "Merger
Agreement"), dated as of January 17, 2001, among FIC, ILCO, and ILCO Acquisition
Company, a Texas corporation and wholly-owned subsidiary of FIC ("Merger Sub"),
Merger Sub was merged with and into ILCO (the "Merger"). ILCO was the surviving
corporation of the Merger and became a wholly-owned subsidiary of FIC. In
accordance with the Merger Agreement, FIC issued 1.1 shares of common stock, par
value $0.20 per share ("FIC Common Stock"), for each share of common stock, par
value $0.22 per share, of ILCO outstanding at the time of the Merger ("ILCO
Common Stock"). In addition, each share of ILCO Common Stock issuable pursuant
to outstanding options was assumed by FIC and became an option to acquire FIC
Common Stock with the number of shares and exercise price adjusted for the
exchange ratio in the Merger.
ILCO's Acquisitions. Prior to May 18, 2001, ILCO made the following
acquisitions:
Standard Life Insurance Company. In November 1986, ILCO acquired
Standard Life Insurance Company ("Standard Life"), headquartered in
Jackson, Mississippi, for a gross purchase price of $54.5 million.
Investors Life and Investors Life Insurance Company of California. In
December 1988, ILCO, through Standard Life, purchased Investors Life
Insurance Company of California ("Investors-CA") and Investors Life from
CIGNA Corporation for a purchase price of $140 million.
Meridian Life Insurance Company. In February 1995, ILCO, through
Investors Life, purchased from Meridian Mutual Insurance Company the stock
of Meridian Life Insurance Company, an Indianapolis-based life insurer, for
a cash purchase price of $17.1 million. After the acquisition, Meridian
Life changed its name to Investors Life Insurance Company of Indiana
("Investors-Indiana").
-4-
State Auto Life Insurance Company. In July 1997, ILCO and
Investors-Indiana acquired State Auto Life Insurance Company, an Ohio
domiciled life insurer, from State Automobile Mutual Insurance Company, for
an adjusted cash purchase price of $11.8 million. Under the terms of the
transaction, State Auto Life was merged into Investors-Indiana.
Grinnell Life Insurance Company. On June 30, 1998, ILCO, through a
subsidiary, acquired Grinnell Life Insurance Company ("Grinnell Life") for
an adjusted purchase price of $16.6 million. A portion of the purchase
price ($12.37 million) was paid by way of a dividend to the seller
immediately prior to the closing of the transaction; the balance of the
purchase price was paid by ILCO's subsidiary. As part of the transaction,
Grinnell Life was immediately merged with and into that subsidiary, with
that subsidiary being the surviving entity. Consolidation of Acquired
Companies.
Merger of ILIC and Investors-Indiana. In December 1997,
InterContinental Life Insurance Company ("ILIC"), a subsidiary of ILCO,
transferred its domicile from New Jersey to Indiana. Following completion
of the redomestication, ILIC and Investors-Indiana merged, with ILIC as the
surviving entity in the merger process. Immediately after the merger, ILIC
changed its name to Investors Life Insurance Company of Indiana. As used
hereinafter, the phrase "Investors-IN" shall be used to refer to the merged
entities.
Mergers with Investors Life. Investors Life redomesticated from
Pennsylvania to Washington in December of 1992. Investors-CA merged into
Investors Life on December 31, 1992. Standard Life merged into Investors
Life on June 29, 1993. On February 19, 2002, Investors-IN merged into
Investors Life.
FIC's management believes that the acquisitions and consolidations of its life
insurance subsidiaries have achieved cost savings, such as reduced auditing
expenses involved in auditing combined companies; the savings of expenses and
time resulting from the combined company being examined by one state insurance
department (Washington), rather than four (California, Pennsylvania, Mississippi
and Indiana); the reduction in the number of tax returns and other annual
filings with state insurance departments; and smaller annual fees to do business
and reduced retaliatory premium taxes in most states.
Business of Insurance Subsidiaries
In addition to FIC's strategy of growth through acquisitions, FIC's
insurance subsidiaries market and sell certain life insurance and annuity
products through agents of Investors Life and Family Life.
Family Life. Family Life, which was organized in the State of Washington in
1949, specializes in providing mortgage protection life and accidental death
insurance and annuity products to mortgage borrowers of financial institutions.
Family Life has policies in force with customers of approximately 190 financial
institutions, of which approximately 40 actively provide Family Life with
regular updating of their lists of borrowers.
-5-
Family Life's mortgage protection business consists of term and universal life
insurance sold to borrowers of mortgage debt, designed to repay or reduce the
mortgages of policyholders in the event of their death. This business is sold to
customers of independent 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. In 2001, direct
statutory premiums received on Family Life's insurance products totaled $39.6
million.
Family Life is licensed to sell mortgage life insurance products in 48 states
and the District of Columbia (not licensed in New York or New Hampshire). In
2001, premium income from these products was derived from all states in which
Family Life is licensed, with over half of the amount derived from Texas (27%)
and California (25%).
At December 31, 2001, Family Life's primary distribution channel is its agency
force of approximately 300 career agents, who are organized into 10 regions. 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.
In addition to Family Life's primary distribution channel, Family Life has been
expanding its distribution system to (i) provide a broader range of products;
(ii) generate direct mail leads; and (iii) target higher income customers than
Family Life's traditional market targets. This distribution system involves the
ability of Family Life's agents to sell products of third-party life insurance
companies which have entered into marketing relationships with a subsidiary of
FIC. In 2001, Family Life received $0.7 million of revenues through this system.
At December 31, 2001, Family Life had relationships with 279 agents actively
engaged in this marketing effort.
Investors Life. Investors Life is engaged primarily in administering
existing portfolios of individual life insurance and accident and health
insurance policies and annuity products. Approximately 76.6% of the total
collected premiums for 2001 were derived from renewal premiums on insurance
policies and annuity products sold by FIC's insurance subsidiaries prior to
their acquisition by the Company.
-6-
Investors Life is also engaged in marketing and underwriting individual life
insurance and annuity products in 49 states (not licensed in New York), the
District of Columbia and the U.S. Virgin Islands. These products are marketed
through independent, non-exclusive general agents.
The products currently being distributed by Investors Life include several
versions of universal life flexible premium insurance, which provide permanent
life insurance which credit company-declared current interest rates. Under the
flexible premium policies, policyholders may vary the amounts of their coverage
(subject to minimum and maximum limits) as well as the date of payment and
frequency of payments.
Direct statutory premiums received from all types of universal life products
sold by Investors Life and Investors-IN were $33.3 million in 2001, as compared
to $34.2 million in 2000 and $35.6 million in 1999. Investors Life received
reinsurance premiums from Family Life of $4.7 million in 2001, pursuant to the
reinsurance agreement for universal life products written by Family Life. In
2001, premium income from all life insurance products was derived from all
states in which Investors Life is licensed, with significant amounts derived
from Pennsylvania (14%), California (8%) and Ohio (8%).
Investors Life also receives premium income from health insurance policies. In
2001, premium income from all health insurance policies was $0.6 million, as
compared to $0.7 million in 2000 and $0.8 million in 1999. Since 1997,
substantially all of Investors Life's health insurance business has been
reinsured with a third party reinsurer.
Investors Life also sponsors a variable annuity separate account, which offers
single premium and flexible premium policies. The policies provide for the
contract owner to allocate premium payments among four different portfolios of
Putnam Variable Trust (the "Putnam Fund"), a series fund which is managed by
Putnam Investment Management, Inc. As of December 31, 2001, the assets held in
the separate account were $36.3 million. During 2001, the premium income
realized in connection with these variable annuity policies was $104,028, which
was received from existing contract owners.
Investors Life also maintains a closed variable annuity separate account, with
approximately $15.1 million of assets as of December 31, 2001. The separate
account was closed to new purchases in 1981 as a result of an IRS ruling which
adversely affected the status of variable annuity separate accounts which invest
in publicly-available mutual funds. The ruling did not adversely affect the
status of in-force contracts.
For the past several years, Investors Life has expanded its marketing efforts in
the fixed annuity market. Direct deposits from the sale of fixed annuity
products were $12.3 million in 2001, as compared to $10.6 million in 2000 and
$7.6 million in 1999. Investors Life also received reinsurance premiums from
Family Life of $2.0 million in 2001, pursuant to a reinsurance agreement for
annuity products between Investors Life and Family Life.
For the past few years, Investors Life has been marketing a group deposit
administration product, designed for use in connection with the funding of
deferred compensation plans maintained by government employers under section 457
of the Internal Revenue Code. The company has established a marketing
relationship with a third-party administrator based in San Antonio, Texas, which
has established relationships with school districts in Texas. Annuity premiums
under this program for the year 1999 totaled $0.9 million, premiums in 2000
totaled $1.5 million and premiums in 2001 totaled $0.24 million. At December 31,
2001, 12 school districts held plans with Investors Life. One school district in
Louisiana surrendered its $1.5 million policy with Investors Life during 2001.
-7-
Investors Life, along with Family Life, participates in the distribution system
involving third-party life insurance companies. The marketing arrangement makes
available, to appointed agents of Investors Life, life insurance and annuity
products not currently being offered by Investors Life. The underwriting risk on
the products sold under this arrangement is assumed by the third-party insurer.
The Company's appointed agents receive commissions on the sales of these
products and the Company's marketing subsidiary receives an override commission.
During 2001, Investors Life received revenues of $0.2 million through this
distribution system. At December 31, 2001, Investors Life had relationships with
159 agents actively engaged in this marketing effort.
Employees of the Company
At December 31, 2001, the number of employees within FIC and its subsidiaries
was approximately 313 and the number of Regional Vice Presidents employed by the
life insurance subsidiaries of FIC was 26.
Agency Operations
The products of FIC's insurance subsidiaries are marketed and sold through two
divisions:
A. Investors Life Distribution System
Investors Life contracts with independent non-exclusive agents, general agents
and brokers nation-wide to sell its products. Such agents and brokers also sell
insurance products for companies in competition with Investors Life. In order to
attract agents and enhance the sale of its products, Investors Life pays
competitive commission rates and provides other sales inducements. Investors
Life is presently concentrating its efforts on the promotion and sale of
universal life and fixed annuity products.
Marketing and sales for Investors Life is directed by the Executive Vice
President of Marketing and Sales. The distribution system is organized into 14
regions, each of which has a Regional Vice President ("RVP") who is responsible
for the recruitment and maintenance of the general agents and managing general
agents for individual insurance sales within such region. During 1999, Investors
Life implemented a plan to restructure the compensation arrangements for RVPs,
so as to emphasize the role of personal production by the RVPs. The effect of
this plan during the year 2000 and 2001 was to lower fixed costs for
distribution of Investors Life's products.
-8-
B. Family Life Distribution System
Family Life utilizes a nationwide exclusive agent force to sell its products.
This agent force sells mortgage protection life insurance and annuity products.
The products are sold primarily to 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 effectively.
Family Life agents make courtesy calls to borrowers of the financial
institutions which are active on the Family Life lead system to offer the
borrower the opportunity to purchase mortgage protection insurance (term or
universal life insurance products).
In advance of the passage of the Financial Services Modernization Act (the
"Act") in 1999 (for a discussion of the provisions of this law, refer to the
section entitled "Regulation"), Family Life established a task force to develop
new lead sources for its agents. Although Family Life continues to focus on its
traditional sales approach, it has established a supplemental leads program,
whereby leads are obtained from public records (e.g. county loan records).
Family Life has also developed a strategy to work with lenders as "setup only",
whereby the mortgage institution does not furnish leads, but will collect and
remit premiums. Finally, Family Life is developing new sales methods, including
direct mailings and direct telephone leads.
Sales and Marketing for Family Life is directed by the Executive Vice President
of Marketing and Sales. Sales and marketing focuses on the development and
maintenance of contractual agreements with the financial institutions which
provide referrals to, and collect monthly premiums from, their borrowers for
Family Life insurance plans. As of March 6, 2002, the Family Life distribution
system consisted of 10 regions, each directed by a Regional Vice President.
Investment of Assets
FIC has established and staffed an investment department, which manages
portfolio investments and investment accounting functions for its life insurance
subsidiaries. At December 31, 2001, invested assets totaled $756 million.
The general investment objective of the Company emphasizes the selection of
short to medium term high quality fixed income securities, rated Baa-3
(investment grade) or better by Moody's Investors Service, Inc. 66% of FIC's
invested assets are in fixed maturity securities, available for sale. Our fixed
maturity securities portfolio is predominately comprised of low risk, investment
grade, available for sale publicly traded corporate securities, mortgage-backed
securities, and United States Government bonds. All of FIC's invested assets are
invested in the United States. The assets held by Family Life and Investors Life
must comply with applicable state insurance laws and regulations. In selecting
investments for the portfolios of its life insurance subsidiaries, the Company's
emphasis is to obtain targeted profit margins, while minimizing the exposure to
changing interest rates. This objective is implemented by selecting primarily
short- to medium-term, investment grade fixed income securities. In making such
portfolio selections, the Company generally does not select new investments
which are commonly referred to as "high yield" or "non-investment grade". The
Company determines the allocation of our assets primarily on the basis of cash
flow and return requirements of our products and secondarily by the level of
investment risk.
-9-
The Company's investment objectives include the making of selected investments
in collateralized mortgage obligations. The Company does not invest in
non-agency mortgage-backed securities, which have a greater credit risk than
that of agency mortgage-backed securities.
The other asset categories which comprise at least 5% of FIC's invested assets
include investments in real estate, short-term investments, and policy loans.
For a further discussion of FIC's invested assets see "Item 7 - Management
Discussion and Analysis - Investments."
Data Processing
Since December 1994, the data processing needs of FIC's insurance subsidiaries
have been provided to FIC's Austin, Texas and Seattle, Washington facilities by
FIC Computer Services, Inc., a subsidiary of FIC. See "Item 13 - Certain
Relationships and Related Transactions with Management."
As the provider of data processing for the Company and its subsidiaries, FIC
Computer Services, Inc. utilizes a centralized computer system to process
policyholder records and financial information. In addition, the Company uses
non-centralized computer terminals in connection with its operations.
Competition
There are many life and health insurance companies in the United States. Agents
placing insurance business with Family Life and Investors Life are compensated
on a commission basis. However, some companies pay higher commissions and charge
lower premium rates and many companies have more resources than FIC's insurance
subsidiaries. In addition, consolidations of insurance and banking institutions,
which is permitted under recently-enacted federal legislation, may adversely
affect the ability of Family Life to expand its customer referral relationships
with mortgage lending and servicing institutions.
The principal cost and competitive factors that affect the ability of FIC's
insurance subsidiaries to sell their insurance products on a profitable basis
are: (1) the general level of premium rates for comparable products; (2) the
extent of individual policyholders services required to service each product
category; (3) general interest rate levels; (4) competitive commission rates and
related marketing costs; (5) legislative and regulatory requirements and
restrictions; (6) the impact of competing insurance and other financial
products; and (7) the condition of the regional and national economies.
-10-
Reinsurance and Reserves
In accordance with general practices in the insurance industry, FIC's insurance
subsidiaries limit the maximum net losses that may arise from large risks by
reinsuring with other carriers. Such reinsurance provides for a portion of the
mortality risk to be retained by FIC's insurance subsidiaries with the excess
being ceded to a reinsurer at a premium set forth in a schedule based upon the
age and risk classification of the insured. The reinsurance treaties provide for
allowances that help Family Life and Investors Life offset the expense of
writing new business. Investors Life generally retains the first $100,000 to
$250,000 of risk on the life of any individual. On its in-force block of
business, Family Life generally retains the first $200,000 of risk on the life
of any one individual. On certain new products being written by Family Life
(which amount to approximately one-third of Family Life's new business), the
entire amount of risk is reinsured on a percentage basis with Family Life
retaining 10% of the risk. Although Family Life only retains 10% of the risk,
Family Life retains an allowance from the reinsurer of their portion of the
premiums, which allows Family Life to cede substantially less than 90% of the
incoming premiums. This "first dollar" arrangement allows Family Life to price
products more competitively and take certain underwriting risks which it could
not take if it were retaining 100% of the risk. Family Life still reinsures all
of its new business over $200,000.
Family Life maintains a bulk reinsurance treaty, under which it reinsured all of
its risks under accidental death benefit policies. The treaty was most recently
renegotiated with the current reinsurer in January 1997.
As discussed above (see "Business of Insurance Subsidiaries"), in December 1997,
FIC's life insurance subsidiaries entered into a reinsurance treaty under which
all of the contractual obligations and risks under accident and health and
disability income policies were assumed by a third party reinsurer.
In 1995, Family Life (as the ceding company) entered into a reinsurance
agreement with Investors Life (as the reinsuring company) pertaining to
universal life insurance written by Family Life. The reinsurance agreement is on
a co-insurance basis and applies to all covered business with effective dates on
and after January 1, 1995. The agreement applies to only that portion of the
face amount of the policy 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 Life (as the reinsuring company), pertaining to annuity contracts
written by Family Life. The agreement applies to contracts written on or after
January 1, 1996. These reinsurance arrangements reflect management's plan to
develop universal life and annuity business at Investors Life, with Family Life
concentrating on the writing of term life insurance products.
Although reinsurance does not eliminate the exposure of FIC's insurance
subsidiaries to losses from risks insured, the net liability of such
subsidiaries will be limited to the portion of the risk retained, provided that
the reinsurers meet their contractual obligations.
-11-
FIC's insurance subsidiaries 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.
Senior Subordinated Loans
In 1989, as part of the purchase of Family Life from Merrill Lynch Insurance
Group, Inc. ("Merrill Lynch"), FIC organized two downstream holding companies:
Family Life Insurance Investment Corporation ("FLIIC") and Family Life
Corporation ("FLC"). FLIIC was organized as a wholly-owned subsidiary of FIC
and, in turn, was issued all of the outstanding shares of FLC. FLC purchased all
of the outstanding shares of Family Life from Merrill Lynch. A portion of the
consideration for the purchase consisted of a $30 million senior subordinated
note (the "Merrill Lynch Loan"). Following the purchase of the Family Life
shares by FLC, Family Life issued 250,000 previously unissued shares of its
common stock to FLC for a $2.5 million cash payment and immediately thereafter
redeemed from FLC 250,000 shares of its common stock that had been purchased by
FLC from Merrill Lynch. The consideration paid to FLC by Family Life for said
redeemed shares consisted of $2.5 million cash, a newly issued surplus debenture
(an instrument having certain restrictions on payment for the protection of
policyholders) in the principal amount of $97.5 million (the "Family Life
Surplus Debenture") and $14 million principal value of newly issued preferred
shares.
Investors Life Notes. Another part of the financing arrangement to purchase
Family Life included FLC borrowing $25 million from Investors Life (the
"Investors Life Loans"). This amount was represented by a $22.5 million loan
from Investors Life to FLC and a $2.5 million loan provided directly to FIC by
Investors-CA (which was subsequently merged into Investors Life). In addition to
the interest provided under the Investors Life Loans, Investors Life was granted
non-transferable options to purchase FIC common stock, up to a total of 9.9 % of
shares of FIC common stock (currently 500,411 shares) at a price of $2.10 per
share (as adjusted to reflect the five-for-one stock split in November 1996),
equivalent to the then current market price, subject to adjustment to prevent
dilution. The initial terms of the option provided for their expiration on June
12, 1998, if not previously exercised. In connection with the 1996 amendments to
the Investors Life Loans, the expiration date of the options was extended to
September 12, 2006.
On June 12, 1996, the Investors Life Loans were amended to provide for twenty
quarterly principal payments, commencing on December 12, 1996. Additionally,
prior to such date, accrued interest on the $2.5 million subordinated note
issued by FIC to Investors-CA was paid by delivery of additional notes of FIC
having terms identical to the original note, including the payment of interest.
The Investors Life Loans were paid in full as of September 12, 2001; however,
because of the 1993 Subordinated Loans, described in "Family Life Refinancing"
below, the options of Investors Life to purchase FIC common stock did not expire
with the repayment of the Investors Life Loans.
-12-
Family Life Refinancing. In 1993, Investors Life loaned an additional $34.5
million to FLC and FLIIC in the form of subordinated notes so that FLC and FLIIC
could prepay the Merrill Lynch Loan (the "1993 Subordinated Loans"). The 1993
Subordinated Loans consisted of a $30 million loan to FLC and a $4.5 million
loan to FLIIC. The debt restructuring reduced the total indebtedness of FLC and
FLIIC by approximately $15 million. Upon the retirement of the Merrill Lynch
Loan, certain of its provisions were automatically incorporated into the 1993
Subordinated Loans. 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 Merrill Lynch Loan were
transferred to Investors Life. The security interests include all of the issued
and outstanding shares of preferred stock and common stock of FLC and Family
Life. Prior to June 30, 2001, the security also included the Family Life Surplus
Debenture; however, the Family Life Surplus Debenture was paid in full as of
June 30, 2001.
On June 12, 1996, the 1993 Subordinated Loans were also amended as follows: (a)
the $30 million note was amended to provide for forty quarterly principal
payments in the amount of $163,540 each for the period December 12, 1996 to
September 12, 2001; beginning with the principal payment due on December 12,
2001, the amount of the principal payment increases to $1,336,458; the final
quarterly principal payment is due on September 12, 2006; the interest rate on
the note remained at 9%, and (b) the $4.5 million note was amended to provide
for forty quarterly principal payments in the amount of $24,531 each for the
period December 12, 1996 to September 12, 2001; beginning with the principal
payment due on December 12, 2001, the amount of the principal payment increases
to $200,469; the final quarterly principal payment is due on September 12, 2006;
the interest rate on the note remained at 9%.
In December 1998, FLIIC was dissolved. In connection with the dissolution, all
of the assets and liabilities of FLIIC became the obligations of FLIIC's sole
shareholder, FIC. Accordingly, the obligations under the provisions of the $4.5
million note described above are now the obligations of FIC.
As of December 31, 2001, the outstanding principal balance of the 1993
Subordinated Loans was $29.2 million. Since May 18, 2001, ILCO has been a
wholly-owned subsidiary of FIC, and thus the 1993 Subordinated Loans are not an
asset or liability on FIC's balance sheets, but still affect FIC's cash flow due
to its debt servicing obligations.
-13-
Regulation
General. The Company and its insurance subsidiaries are subject to
regulation and supervision at both the state and federal level, including
regulation under federal and state securities laws and regulation by the states
in which they are licensed to do business. The state insurance regulation is
designed primarily to protect policy owners. Although the extent of regulation
varies by state, the respective state insurance departments have broad
administrative powers relating to the granting and revocation of licenses to
transact business, licensing of agents, the regulation of trade practices and
premium rates, the approval of form and content of financial statements and the
type and character of investments.
These laws and regulations require the Company's insurance subsidiaries to
maintain certain minimum surplus levels and to file detailed periodic reports
with the supervisory agencies in each of the states in which they do business
and their business and accounts are subject to examination by such agencies at
any time. The insurance laws and regulations of the domiciliary state of the
Company's insurance subsidiaries require that such subsidiaries be examined at
specified intervals. Both Investors Life and Family Life are domiciled in the
state of Washington. Prior to the merger of Investors Life and Investors-IN in
February 2002, Investors-IN was domiciled in the state of Indiana.
A number of states regulate the manner and extent to which insurance companies
may test for acquired immune deficiency syndrome (AIDS) antibodies in connection
with the underwriting of life insurance policies. To the extent permitted by
law, the Company's insurance subsidiaries consider AIDS information in
underwriting coverage and establishing premium rates. An evaluation of the
financial impact of future AIDS claims is extremely difficult, due in part to
insufficient and conflicting data regarding the incidence of the disease in the
general population and the prognosis for the probable future course of the
disease.
Risk Based Capital Requirements. The National Association of Insurance
Commissioners ("NAIC") has imposed Risk-Based Capital ("RBC") requirements to
evaluate the adequacy of statutory capital and surplus in relation to investment
and insurance risks associated with; (i) asset quality; (ii) mortality and
morbidity; (iii) asset and liability matching; and (iv) other business factors.
The RBC formula is intended to be used by insurance regulators as an early
warning tool to discover potential weakly capitalized companies for the purpose
of initiating regulatory action. The RBC requirements are not intended to be a
basis for ranking the relative financial strength of insurance companies. The
formula also defines a new minimum capital standard which will supplement the
prevailing system of low fixed minimum capital and surplus requirements on a
state-by-state basis.
The RBC requirements provide for four different levels of regulatory attention
in those states that adopt the NAIC regulations, depending on the ratio of the
company's Total Adjusted Capital (which generally consist of its statutory
capital, surplus and asset valuation reserve) to its Authorized Control Level
RBC. A "Company Action Level Event" is triggered if a company's Total Adjusted
Capital is less than 200% but greater than or equal to 150% of its Authorized
Control Level RBC, or if a negative trend has occurred (as defined by the
regulations) and Total Adjusted Capital is less than 250% but more than 200% of
its Authorized Control Level RBC. When a Company Action Level Event occurs, the
company must submit a comprehensive plan to the regulatory authority which
discusses proposed corrective actions to improve its capital position. A
"Regulatory Action Level Event" is triggered if a company's Total Adjusted
Capital is less than 150% but greater than or equal to 100% of its Authorized
Control Level RBC. When a Regulatory Action Level Event occurs, the regulatory
authority will perform a special examination of the company and issue an order
specifying corrective actions that must be followed. An "Authorized Control
Level Event" is triggered if a company's Total Adjusted Capital is less than
100% but greater than or equal to 70% of its Authorized Control Level RBC, and
the regulatory authority may take any action it deems necessary, including
placing the company under regulatory control. A "Mandatory Control Level Event"
is triggered if a company's total adjusted capital is less than 70% of its
Authorized Control Level RBC, and the regulatory authority is mandated to place
the company under its control.
-14-
Calculations using the NAIC formula and the statutory financial statements of
the Company's insurance subsidiaries as of December 31, 2001 indicate that the
Total Adjusted Capital of each of the Company's insurance subsidiaries is above
450% 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. For the
year ended December 31, 2001, Family Life received a credit on its guaranty fund
assessment return of $21,481, while Investors Life and Investors-IN had expenses
of $6,090 and $2,159, respectively. Those amounts are net of the amounts that
can be offset against future premium taxes and, in the case of Family Life, the
amount is also net of the amount that can be recovered from Merrill Lynch
pursuant to the Stock Purchase Agreement between FIC and Merrill Lynch. The
likelihood and amount of any other future assessments cannot be estimated and
are beyond the control of FIC.
Dividends. Prior to June 2001, payment from Family Life of surplus and
interest on the surplus debenture was the primary source of cash for Family Life
Corporation ("FLC"), a wholly-owned subsidiary of FIC, to make payments on the
1993 Subordinated Loans. Pursuant to the surplus debenture, Family Life paid
principal and interest to FLC in 1999, 2000 and 2001 totaling $10,754,978,
$8,982,244 and $4,111,046, respectively. Since the Family Life Surplus Debenture
was paid off in June 2001, one source of cash for FLC to make payments of
principal and interest on the 1993 Subordinated Loans is dividends paid to FLC
by Family Life. Under current Washington law, any proposed payment of an
"extraordinary dividend" requires a 30-day prior notice to the Washington
Insurance Commissioner, during which period the Commissioner can approve the
dividend, disapprove the dividend or fail to comment on the notice, in which
case the dividend is deemed approved at the end of the 30-day period. An
"extraordinary dividend" is a distribution which, together with dividends or
distributions paid during the preceding twelve months, exceeds the greater of
(i) 10% of statutory surplus as of the preceding December 31st or (ii) the
statutory net gain from operations for the preceding calendar year. Payment of a
regular dividend requires that the insurer's earned surplus after dividends or
distributions must be reasonable in relation to the insurer's outstanding
liabilities and adequate to its financial needs. Family Life did not have earned
surplus in 2000 as defined by the regulations adopted by the Washington
Insurance Commissioner and, therefore, was not permitted to pay cash dividends
during 2001. However, as of December 31, 2001, Family Life had earned surplus of
$0.3 million and a net gain from operations of $4.4 million. Investors Life had
earned surplus of $48.4 million and a net gain from operations of $8.3 million
at December 31, 2001.
-15-
Valuation Reserves. Life insurance companies are required to establish an
Asset Valuation Reserve ("AVR") consisting of two components: (i) a "default
component," which provides for future credit-related losses on fixed maturity
investments, and (ii) an "equity component," which provides for losses on all
types of equity investments, including equity securities and real estate.
Insurers are also required to establish an Interest Maintenance Reserve ("IMR"),
designed to defer realized capital gains and losses due to interest rate changes
on fixed income investments and to amortize those gains and losses into future
income. The IMR is required to be amortized into statutory earnings on a basis
reflecting the remaining period to maturity of the fixed maturity securities
sold. These reserves are required by state insurance regulatory authorities to
be established as a liability on a life insurer's statutory financial
statements, but do not affect the financial statements prepared in accordance
with Generally Accepted Accounting Principles ("GAAP"). Since dividend payments
are based upon statutory earnings, management believes that the combination of
the AVR and IMR will affect statutory capital and surplus and therefore may
reduce the ability of Investors Life and Family Life to pay dividends to FIC.
Insurance Holding Company Regulation. Family Life and Investors Life are
subject to regulation under the insurance and insurance holding company statutes
of the state of Washington and prior to February 2002, Investors-IN was subject
to regulation under the insurance and insurance holding company statutes of the
state of Indiana. 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.
-16-
The insurance holding company regulations generally apply only to insurers
domiciled in a particular state. However, the regulations in certain states also
provide that insurers that are "commercially domiciled" in that state are also
subject to the provisions applicable to domiciled insurers. The test for
determining whether an insurer is commercially domiciled is based on the
percentage of premiums written in the state as compared to the amount of
premiums written everywhere over a measuring period. The applicable percentage
for California is 33% , while for Texas it is 30%. Currently, the insurance
subsidiaries of FIC are not treated as commercially domiciled in any
jurisdiction.
Privacy Legislation. In July 2001, the Financial Services Modernization Act
(referred to in this paragraph as the "Act") of 1999 became applicable to
insurance companies. In general, the Act provides that financial institutions
have certain obligations with respect to the maintenance of the privacy of
customer information. In addition, the Act places new restrictions on disclosure
of nonpublic personal information to third party institutions seeking to utilize
such information in connection with the sale of products or services. A
financial institution may disseminate certain types of customer information to
nonaffiliated third parties if the institution provides clear and conspicuous
disclosure of the institution's privacy policy and the customer authorizes the
release of certain information to third parties. Where the customer permits the
release of the information, the Act restricts disclosure of information that is
non-public in nature but does not prohibit the release of information which can
be obtained from public sources. Although FIC's insurance subsidiaries have not
experienced any adverse effects to their business as a result of the Act to
date, it is too early to assess the Act's long-range effects.
Potential Federal Regulation. Although the federal government generally
does not directly regulate the insurance industry, federal initiatives often
have an impact on the business. Congress and certain federal agencies
periodically investigate the condition of the insurance industry (encompassing
both life and health and property and casualty insurance) in the United States
in order to decide whether some form of federal role in the regulation of
insurance companies would be appropriate. Further, since FIC is a publicly
traded entity, it is subject to regulation by the Securities and Exchange
Commission (SEC), as well as NASDAQ. Under SEC regulations, FIC is required to
file forms under the Securities Act of 1933 and the Securities and Exchange Act
of 1934 with respect to various aspects of its business.
Federal Income Taxation. The Revenue Reconciliation Act of 1990 amended the
Internal Revenue Code of 1986 to require a portion of the expenses incurred in
selling insurance products to be deducted over a period of years, as opposed to
an immediate deduction in the year incurred. Since this change only affects the
timing of the deductions, it does not affect tax expense as shown on the
Company's financial statements prepared in accordance with GAAP. For the years
ended December 31, 1999, 2000 and 2001, the decreases in Family Life's current
income tax provisions, utilizing the effective tax rates, due to this change
were $78,759, $177,038 and $157,180, respectively. For the years ended December
31, 1999, 2000 and 2001, the decreases in the current income tax provisions of
Investors Life and Investors- IN due to this change were $409,193, $8,368 and
$294,695, respectively. The change has a negative tax effect for statutory
accounting purposes when the premium income of the Company's insurance
subsidiaries increases, but has a positive tax effect when their premium income
decreases.
-17-
FIC files a consolidated federal income tax return with its subsidiaries, except
for Investors Life and Investors-IN (which file a separate consolidated return)
and ILG Securities (which files its own federal income tax return). In
accordance with the tax allocation agreements maintained by those FIC companies
which file a consolidated return, federal income tax expense or benefit is
allocated to each entity in the consolidated group as if such entity were filing
a separate return.
Segment Information
The principal operations of the Company's insurance subsidiaries are the
underwriting of life insurance and annuities. Accordingly, no separate segment
information is required to be provided by the Registrant for the three-year
period ending December 31, 2001.
Item 2. Properties
FIC's home office is located at River Place Pointe, 6500 River Place Blvd.,
Building One, Austin, Texas. River Place Pointe was purchased by Investors Life
in October 1998. It consists of 47.995 acres of land in Austin, Texas. The
aggregate purchase price for these tracts was $8.1 million. The site development
permit allows for the construction of seven office buildings totaling 600,000
square feet, with associated parking, drives and related improvements.
Construction on the first section of the project, which consists of four office
buildings, an associated parking garage and related infrastructure was completed
during 2000 and 2001. The second section of construction, which includes three
more office buildings, an associated parking garage and related infrastructure,
is in progress and Investors Life expects completion of this phase by the end of
2002. FIC and its insurance subsidiaries occupy almost the entire Building One
of River Place Pointe, consisting of approximately 74,021 square feet of space.
-18-
Family Life and Investors Life lease their home offices at the Sedgwick James
Building, 2101 Fourth Avenue, in Seattle, Washington. The lease currently covers
approximately 7,776 rentable square feet of office space for a term expiring on
October 31, 2003. The base rental is approximately $16,362 per month, which
includes Family Life's proportionate share of the building's operating expenses,
including utilities, property taxes, insurance, maintenance and management.
Actual increases from those initial operating expenses during the lease term are
passed on to Family Life on a proportionate basis.
ILCO leases a building located at 40 Parker Road, Elizabeth, New Jersey. This
building, which was formerly ILCO's headquarters building, contains
approximately 41,000 square feet of office space. The lease, which was signed in
December 1985 and expires in December 2005, calls for a minimum base rental of
$737,940 per annum. The lease provides that all costs including, but not limited
to, those for maintenance, repairs, insurance and taxes be borne by ILCO. ILCO
subleases this space to third parties.
Prior to December 2001, ILCO and Investors-IN owned three residential buildings
adjacent to the 40 Parker Road building. In December 2001, ILCO and Investors-IN
sold these properties for a total purchase price of $380,000, which amount was
allocated between ILCO and Investors-IN in accordance with their respective
interests in the properties.
The Company believes that its properties and leased space are adequate to meet
its foreseeable requirements.
-19-
Item 3. Legal Proceedings
The Company and its subsidiaries are defendants in certain legal actions related
to the normal business operations of the Company. Management believes that the
resolution of such legal actions will not have a material impact on the
financial statements.
Universal Life Litigation. On January 22, 2002, the Travis County District
Court in Austin, Texas, denied certification to a proposed nationwide class of
plaintiffs who purchased certain universal life insurance policies from INA Life
Insurance Company (which was merged into Investors Life in 1992). The lawsuit,
which was filed in 1996 as a "vanishing premium" life insurance litigation,
initially alleged that the universal life insurance policies sold to plaintiffs
by INA Life Insurance Company utilized unfair sales practices. In April 2001,
the plaintiffs filed an amended complaint, so as to include various post-sale
allegations, including allegations related to the manner in which increases in
the cost of insurance were applied, the allocation of portfolio yields to the
universal life policies and changes in the spread between the earned rate and
the credited rate. Plaintiffs' Motion for Class Certification was denied in its
entirety.
Litigation Relating to the FIC/ ILCO Merger. On the day that FIC and ILCO
each publicly announced the formation of a special committee to evaluate a
potential merger, two class action lawsuits were filed against ILCO, FIC and the
officers and directors of ILCO. The actions allege that a cash consideration in
the proposed merger is unfair to the shareholders of ILCO, that it would prevent
the ILCO shareholders from realizing the true value of ILCO, and that FIC and
the named officers and directors had material conflicts of interest in approving
the transaction. In their initial pleadings, the plaintiffs sought certification
of the cases as class actions and the named plaintiffs as class representatives,
and among other relief, requested that the merger be enjoined (or, if
consummated, rescinded and set aside) and that the defendants account to the
class members for their damages. The defendants believe that the lawsuits are
without merit and intend to vigorously contest the lawsuits. Management is
unable to determine the impact, if any, that the lawsuits may have on the
results of operations of the Company.
Other Litigation. Additionally, FIC's insurance subsidiaries are regularly
involved in litigation, both as a defendant and as plaintiff. The litigation
naming the insurance subsidiaries as defendant ordinarily involves our
activities as a provider of insurance protection products. Management does not
believe that such litigation, either individually or in the aggregate, will have
a material adverse effect on the Company's business, financial condition or
results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the fiscal year ended
December 31, 2001, to a vote of security holders.
-20-
PART II
Item 5. Market for the Registrant's Common Stock and Related
Security Holder Matters
A. Market Information
As of January 2001, FIC's common stock is traded on the Nasdaq National Market
(NASDAQ symbol: FNIN). Prior to January 2001, FIC's common stock was traded on
the Nasdaq Small-Cap Market. The following table sets forth the quarterly high
and low closing prices for FIC common stock for 2001 and 2000. Quotations are
furnished by the National Association of Securities Dealers Automated Quotation
System (NASDAQ).
Common Stock
Prices
High Low
2001
First Quarter $ 14.75 $ 9.125
Second Quarter 16.90 11.90
Third Quarter 16.00 12.44
Fourth Quarter 14.90 13.00
2000
First Quarter $ 10.50 $ 7.25
Second Quarter 10.50 8.00
Third Quarter 9.50 7.875
Fourth Quarter 10.00 8.500
B. Holders
As of March 6, 2002, there were approximately 15,749 record holders of FIC
common stock.
C. Dividends
In the year 2000, FIC paid a cash dividend in the amount of $.18 per share,
which was payable on April 12, 2000, to shareholders of record on April 5, 2000.
In the year 2001, FIC paid three cash dividends. In March 2001, FIC announced
that its board approved the payment of a cash dividend for the year in the
amount of $0.41 per share. The dividend was paid on April 12, 2001, to
shareholders of record as of the close of business on March 19, 2001.
-21-
In May 2001, FIC announced that its Board approved a dividend policy. The policy
adopted by the Board anticipates that the Company will declare and pay, on a
semi-annual basis, a dividend on the common stock of the Company so as to
provide to shareholders with an annualized yield of approximately 3% of the
market value (based on the NASDAQ National Market quotation system). The
implementation of this policy and the future declarations of dividends are
subject to change depending on future circumstances.
Pursuant to the above-mentioned policy, in May 2001, FIC announced that its
Board of Directors approved the payment of a semi-annual cash dividend in the
amount of $.25 per common share. The dividend was payable on July 2, 2001, to
record holders as of the close of business on June 18, 2001. On November 27,
2001 a dividend in the amount of $.21 per common share was approved. This
dividend was payable on December 21, 2001 to record holders as of December 7,
2001.
The ability of an insurance holding company, such as FIC, to pay dividends to
its shareholders may be limited by the company's ability to obtain revenue, in
the form of dividends and other payments, from its subsidiaries. The right of
FIC's insurance subsidiaries to pay dividends is restricted by the insurance
laws of their domiciliary state. See Item 1. Business - Regulation - Dividends.
Further, FLC, which holds all of the stock of Family Life, is restricted from
paying dividends on its common stock by the provisions of the 1993 Subordinated
Loans. See Item 1. Business - Senior Subordinated Loans. FIC (as the successor
to the obligations of FLIIC) is also prohibited from paying dividends on its
stock by the provisions of the $4.5 million subordinated note held by Investors
Life. In order to provide for the payment of the three cash dividends paid in
2001, FIC received waivers from Investors Life on the above-described
restrictions of the loan agreements, thereby permitting FIC to make the dividend
payments to its shareholders.
Item 6. Selected Financial Data: (Registrant and its Consolidated Subsidiaries)
(In thousands, except per share data)
2001 2000 1999 1998 1997
Operating Revenues $ 99,125 $ 44,418 $ 46,244 $ 52,293 $ 63,343
Income before federal
income tax, equity in net
earnings of affiliates 15,999 6,482 7,013 8,973 13,411
Income before equity in
net earnings of affiliates 10,698 5,198 5,839 6,605 9,870
Equity in net earnings of
affiliate, net of tax 1,316 3,581 3,310 2,613 6,458
Net Income 12,014 8,779 9,149 9,218 $ 16,328
Common Stock and
Common Stock
Equivalents 7,898 5,163 5,200 5,557 5,589
Net income per share
Basic $ 1.54 $ 1.74 $ 1.81 $ 1.71 $ 3.01
Diluted $ 1.52 $ 1.70 $ 1.76 $ 1.66 $ 2.92
Total Assets $1,378,829 $ 300,766 $ 294,054 $ 301,738 $ 304,324
Long Term Obligations $ 0 $ 35,349 $ 41,497 $ 47,645 $ 53,792
Cash dividends paid per $ 0.87 $ 0.18 $ 0 $ 0 $ 0
share
-22-
The results for the year ended December 31, 2001 were affected by the merger of
ILCO with and into a subsidiary of FIC on May 18, 2001. For a description of the
merger transaction, see "Item 7 - Management Discussion & Analysis -
Transactions Affecting Comparability of Results of Operations."
The results for the year ended December 31, 1997 were affected by the sale of
property owned by Family Life at Bridgepoint Square ("Bridgepoint") in Austin,
Texas. In January 1995, Investors Life purchased a 20 acre tract of land at
Bridgepoint. Investors Life developed the project, which consisted of four
office buildings, with a total rentable space of approximately 364,000 square
feet, and two parking garages. In May 1996, Family Life purchased a 7.1 acre
tract adjacent to the original Bridgepoint tract. This second tract contained
one building site and one garage site. In January 1997, Family Life began
construction on a four-story office building, with rentable space of
approximately 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
Life and Family Life entered into a sale agreement with an independent third
party for the sale of their respective interests in Bridgepoint. 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 Life of
approximately $14.0 million, and a net pre-tax profit to Family Life of
approximately $4.5 million.
-23-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Following is a discussion and analysis of the financial statements and other
statistical data that management believes will enhance the understanding of
FIC's financial condition and results of operations. This discussion should be
read in conjunction with the financial statements beginning on page F-1.
Forward-Looking Statements
Except for historical factual information set forth in this Management's
Discussion and Analysis, the statements, analyses, and other information
contained in this report relating to trends in the Company's operations and
financial results, the markets for the Company's products, the future
development of the Company's business, and the contingencies and uncertainties
to which the Company may be subject, as well as other statements including words
such as "anticipate," "believe," "path," "estimate," "expect," "intend" and
other similar expressions constitute forward-looking statements under the
Private Securities Litigation Reform Act of 1995. Such statements are made based
upon management's current expectations and beliefs concerning the financial
results, economic conditions and are subject to known and unknown risks,
uncertainties and other factors contemplated by the forward-looking statements.
Such factors include, among other things: (1) general economic conditions and
other factors, including prevailing interest rate levels and stock market
performance, which may effect the ability of FIC to sell its products, the
market value of FIC's investments, and the lapse rate and profitability of
policies; (2) FIC's ability to achieve anticipated levels of operational
efficiencies and cost-saving initiatives; (3) customer response to new products,
distribution channels and marketing initiatives; (4) mortality, morbidity and
other factors which may affect the profitability of FIC's subsidiaries'
insurance products; (5) changes in the Federal income tax laws and regulations
which may affect the relative tax advantages of some of FIC's products; (6)
increasing competition in the sale of life insurance and annuities; (7)
regulatory changes or actions, including those relating to regulation of
insurance products and insurance companies; (8) ratings assigned to FIC's
insurance subsidiaries by independent rating organizations such as A.M. Best
Company, which FIC believes are particularly important to the sale of annuity
and other accumulation products; and (9) unanticipated litigation. There can be
no assurance that other factors not currently anticipated by management will not
also materially and adversely affect FIC.
Overview
Financial Industries Corporation ("FIC" or the "Company") is a holding company
engaged through its subsidiaries in the business of marketing, underwriting and
distributing a broad range of life insurance and annuity products in 49 states,
the District of Columbia and the U.S. Virgin Islands.
The Company's revenues are derived principally from:
premiums on individual life insurance policies
product charges from universal life insurance products and annuities
net investment income and realized investment gains on assets
-24-
In accordance with Generally Accepted Accounting Principles (GAAP), universal
life insurance premiums and annuity deposits received are reflected on FIC's
consolidated balance sheets as increases in liabilities for contract holder
deposit funds and not as revenues.
Expenses consist principally of insurance benefits provided to policyholders,
interest credited on policyholder account balances, other operating costs and
expenses, which include commissions and general business expenses, net of
expenses deferred, amortization of present value of future profits of acquired
businesses and amortization of deferred policy acquisition costs, and premium
and income taxes. Surrender benefits paid relating to universal life insurance
policies and annuities are reflected as decreases in liabilities for contract
holder deposit funds and not as expenses.
The Company's profitability depends in large part upon: (1) the adequacy of our
product pricing, which is primarily a function of competitive conditions, our
ability to assess and manage trends in mortality and morbidity experience, our
ability to generate investment earnings and our ability to maintain expenses in
accordance with pricing assumptions; (2) the amount of assets under management;
and (3) the maintenance of our target spreads between the rate of earnings on
our investments and credited rates on policyholders' account balances.
Transactions Affecting Comparability of Results of Operations
On May 18, 2001, pursuant to an Agreement and Plan of Merger, as amended (the
"Merger Agreement"), dated as of January 17, 2001, among FIC, InterContinental
Life Corporation ("ILCO"), and ILCO Acquisition Company, a Texas corporation and
wholly-owned subsidiary of FIC ("Merger Sub"), Merger Sub was merged with and
into ILCO (the "Merger"). ILCO was the surviving corporation of the Merger and
became a wholly-owned subsidiary of FIC. In accordance with the Merger
Agreement, FIC issued 1.1 shares of common stock, par value $0.20 per share
("FIC Common Stock"), for each share of common stock, par value $0.22 per share,
of ILCO outstanding at the time of the Merger ("ILCO Common Stock"). In
addition, each share of ILCO Common Stock issuable pursuant to outstanding
options was assumed by FIC and became an option to acquire FIC Common Stock with
the number of shares and exercise price adjusted for the exchange ratio in the
Merger. Prior to the merger, FIC owned approximately 48.1% of ILCO's common
stock. Since ILCO was a wholly-owned subsidiary of FIC for the period from May
18, 2001 to December 31, 2001, the operations of ILCO are reported on a
consolidated basis with FIC in the year end 2001 financial statements. For the
period from January 1, 2001 to May 17, 2001, and for the years ended December
31, 2000 and December 31, 1999, FIC's net income includes its equity interest in
the net income of ILCO, with such equity interest being based on FIC's
percentage ownership of ILCO.
Prior to December 1999, FIC owned several parcels of real estate in Jackson,
Mississippi, adjacent to an office building known as the Standard Life Building,
which building was owned by Investors Life. On December 29, 1999, Investors Life
donated the Standard Life Building to the Jackson Redevelopment Authority
("JRA"). Contemporaneously with the donation of the Standard Life Building,
Investors Life and FIC sold all of the adjacent parcels they owned to the JRA
for a total sale price of $2.5 million, which has been allocated according to
the respective ownership interests of Investors Life (approximately 59.28%) and
FIC (approximately 40.72%). The donation and sale was made pursuant to the terms
of the Donation, Purchase and Sale Agreement dated July 17, 1998. Investors Life
claimed an income tax deduction on its 2000 tax return for the donation of the
Standard Life Building of $864,231. The donation and sale transaction referenced
above resulted in a net of tax gain (GAAP basis) of $1.0 million for ILCO and
$0.4 million for FIC (or a combined total of $1.401 million) in 1999.
-25-
Results of Operations - Three Years Ended December 31, 2001
For the year ended December 31, 2001, FIC's net income was $12,014,000 (basic
earnings of $1.54 per common share or diluted earnings of $1.52 per common
share) on revenues of $99,125,000 as compared to net income for the year ended
December 31, 2000, which was $8,779,000 (basic earnings of $1.74 per common
share or diluted earnings of $1.70 per common share) on revenues of $44,418,000
and net income for the year ended December 31, 1999, which was $9,149,000 (basic
earnings of $1.81 per common share or diluted earnings of $1.76 per common
share) on revenues of $46,244,000.
Earnings per share for the year ended December 31, 2001, were affected by the
increase in the number of FIC's common shares outstanding and the inclusion of
100% of the operating results of ILCO from the date of the Merger through
December 31, 2001. The increase in outstanding shares is attributable to the
shares issued to ILCO shareholders in connection with the Merger. As of December
31, 2001, the number of FIC's common shares outstanding was 9,498,847, as
compared to 5,054,661 as of December 31, 2000.
The increase in net income for the year 2001 was primarily attributable to the
Merger, which consolidated 100% of ILCO's net income subsequent to the May 18,
2001 Merger, with FIC's net income. Net income for the year 1999 was affected by
the inclusion of $409,000 of net gain from the sale of real estate located in
Jackson, Mississippi.
Revenues.
Premium revenues reported for traditional life insurance products are recognized
when due. Premium income, net of reinsurance ceded, for the year 2001, was $35.9
million, as compared to $33.1 million for the year 2000 and $34.0 million for
the year 1999. The consolidation of ILCO's operations following the Merger
contributed approximately $5 million and Family Life contributed approximately
$31 million to premium income for the year ended December 31, 2001. At Family
Life (which has been a subsidiary of FIC for all of the year-end periods covered
by this report), first year net collected premiums for traditional life
insurance products in 2001 were $3.4 million as compared to $2.2 million in
2000. The level of renewal premiums for traditional life insurance products at
Family Life for the year 2001 was $27.2 million, as compared to $31.4 million
for the year 2000 and $32.0 million for the year 1999. The decrease in renewal
premium is attributable to the decrease in the traditional life insurance book
of business.
-26-
Income from universal life and annuity charges for the year ended December 31,
2001 was $27.7 million, as compared to $4.3 million for the year 2000 and $4.8
million in 1999. The consolidation of ILCO's operations following the Merger
contributed approximately $24 million to earned insurance charges for the year
ended December 31, 2001. At Family Life, earned insurance charges declined from
$4.3 million in the year 2000 to $3.4 million in the year 2001. The amount is
consistently decreasing because Family Life reinsures all of its new universal
life and annuity business with Investors Life and thus earned insurance charges
received are attributable to a closed, decreasing book of business. At Investors
Life and Investors-IN, earned insurance charges increased from $38.5 million in
the year 2000 to $39.5 million in the year 2001 (which includes the pre-Merger
and post-Merger charges). The face amount of in force universal life policies at
Family Life was $870.9 million at December 31, 2000 as compared to $721.1
million at December 31, 2001. The face amount of in force universal life
policies at Investors Life and Investors-IN was $4,692.7 million at December 31,
2000 as compared to $4,676.9 million at December 31, 2001.
Net investment income for the year ended December 31, 2001 was $30.7 million as
compared to $6.9 million for the year ended December 31, 2000 and $6.9 million
for the year ended December 31, 1999. Approximately $24 million of the increase
in net investment income for the year ended December 31, 2001 was attributable
to the consolidation of ILCO's operations for the period from May 18, 2001 to
December 31, 2001. At Investors Life and Investors-IN net investment income
decreased from $50.9 million in 2000 to $47.9 million in 2001. The decrease was
primarily attributable to lower interest rates on short-term investments as well
as the sale of investments to pay for the continued construction at River Place
Pointe. See "Investments - Real Estate" for a description of the River Place
Pointe investment. The level of net investment income contributed by the
investment portfolio of Family Life for the year ended December 31, 2001 was
$6.3 million. Net investment income at Family Life was adversely affected by the
decline in the level of interest income received from fixed income and
short-term investments. This decline is attributable to lower interest rates
during the period. The net investment income was approximately level from the
year ended 1999 and 2000 mainly due to the long term portfolio remaining level
while short term investments were decreasing and the short term rates were
increasing.
Net real estate income was $1.9 million for the year ended December 31, 2001, as
compared to $0 in 2000 and 1999. Real estate income is attributable to the
inclusion of ILCO's investment income with FIC's from the period from May 18,
2001 to December 31, 2001. Real estate income is earned from the leases on the
buildings at River Place Pointe, which is owned by Investors Life. Rental income
was received during the entire year 2001, while the buildings only produced
rental income for the second half of the year 2000.
-27-
Benefits and Expenses.
Policyholder benefits and expenses were $27.7 million in 2001, as compared to
$13.5 million in 2000 and $12.6 million in 1999. The consolidation of ILCO's
operations for the period from May 18, 2001 to December 31, 2001 contributed
approximately $19 million to policyholder benefits and expenses for the year
ended December 31, 2001. At ILCO's insurance subsidiaries, the level of
policyholder benefits and expenses decreased from $32.5 million for the year
2000 to $30.0 million for the year 2001 (which includes the pre-Merger and
post-Merger expenses), which decrease is attributable to a decrease in death
benefit claims. At Family Life, the level of policyholder benefits and expenses
decreased from $13.5 million for the year 2000 to $10.1 million for the year
2001, which decrease is attributable to a decrease in death benefit claims as
well as a decrease in reserves due to a higher than expected lapse rates in
Family Life's traditional life business.
Interest expense on contract holders deposit funds was $19.9 million for the
year 2001, as compared to $2.2 million in each of the years 2000 and 1999. This
increase is primarily attributable to $17.5 million of interest expense on
contract holders deposit funds resulting from the consolidation of ILCO's
operations following the Merger. This expense is related to payment of interest
to policyholders for cash values accumulated in their accounts.
The expense related to the amortization of present value of future profits of
acquired businesses was $4.7 million for the year ended December 31, 2001, as
compared to $3.7 million at December 31, 2000 and $5.2 million at December 31,
1999. The consolidation of ILCO's amortization expense with FIC's contributed
approximately $1 million. The amortization of present value of future profits
decreased by $1.5 million from 1999 to 2000, which is in line with the expected
amortization of the remaining book of business. The amortization of present
value of future profits was relatively level from 2000 to 2001 due to higher
than expected lapses at Family Life, which created a higher rate of
amortization.
The costs related to acquiring new business, including certain costs of issuing
policies and certain other variable selling expenses (principally commissions),
are deferred policy acquisition costs. The expense related to the amortization
of deferred policy acquisition costs was $6.8 million for the year ended
December 31, 2001, $5.3 million for the year ended December 31, 2000, and $5.2
million for the year ended December 31, 1999. The amortization of deferred
policy acquisition costs for the current period includes costs associated with
Investors Life and Investors-IN only for the period from May 18, 2001 to
December 31, 2001, in the amount of approximately $0.5 million.
Operating expenses for 2001 were $23.0 million, as compared to $11.4 million on
2000 and $11.7 million in 1999. The consolidation of ILCO's operations for the
period from May 18, 2001 to December 31, 2001 contributed approximately $11
million to operating expenses for the year 2001. The level of operating expenses
for the year 2001 included certain non-recurring expenses related to the
favorable resolution of the vanishing premium litigation and the implementation
of the correction procedure set forth by the Internal Revenue Service in Rev.
Proc. 2001-42 for Modified Endowment Contracts. At Family Life, $4.7 million in
operating expenses was attributable to commissions paid. The decrease in
operating expenses of $365,000 from 1999 to 2000 is due to a reduction of
overall operating expenses in 2000 and the reduction of Y2K conversion expenses
incurred in 2000 as compared to 1999's expenses.
-28-
Interest expense for 2001 was $0.9 million, as compared to $1.9 million in 2000
and $2.4 million in 1999. The decrease in the amount of interest expenses from
2000 to 2001 is attributable to the scheduled reduction in the amount of
outstanding indebtedness. This interest expense is related to the indebtedness
owed to Investors Life by Family Life Corporation and FIC and includes the
amount of interest for the period from January 1, 2001 to May 18, 2001. The
consolidation of ILCO's operations with those of FIC for periods following the
May 18th Merger results in the elimination of this interest expense in the
consolidated income statements of FIC and thus the post-Merger interest expense
is $0. The decrease of interest expenses from 1999 to 2000 was consistent with
the scheduled pay down of the above-mentioned debt to Investors Life.
The provision for federal income taxes was $5.3 million in 2001, as compared to
$1.3 million in 2000 and $1.2 million in 1999. The inclusion of ILCO's results
for the period from May 18, 2001 to December 31, 2001 contributed approximately
$2.6 million to the level of federal income taxes. Because of the Merger and
subsequent consolidation of FIC and ILCO's provision for federal income taxes,
FIC was not able to utilize the small company tax deduction, which provided
lower tax rates. The increase in federal income taxes due to the loss of this
deduction was $343,227. Further, for the year ended December 31, 2000 and 1999,
FIC and ILCO each paid, and were each able to deduct $1 million of excess
compensation each. Due to the Merger, the Company will incur approximately
$100,000 in additional federal income taxes in 2001 related to excess
compensation since ILCO will only be able to deduct approximately $750,000 of
Mr. Mitte's compensation for 2001.
Results of Operations - Three Months Ended December 31, 2001
as compared to the Three Months Ended December 31, 2000
For the three-month period ended December 31, 2001, FIC's net income was $3.4
million (basic and diluted earnings of $0.35 per common share) on revenues of
$32.4 million as compared to the net income of $2.2 million (basic earnings of
$0.43 and diluted earnings of $0.42 per common share) on total revenues of $10.6
million in the last three months of 2000. The increase in net income and total
revenues from the three-month period ended December 31, 2000 to the same period
in 2001 is primarily attributable to the consolidation of ILCO's operations into
FIC's Statements of Income for the fourth quarter of 2001.
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of business operations. FIC is an insurance
holding company whose principal assets consist of the outstanding capital stock
of its insurance subsidiaries - Family Life Insurance Company ("Family Life"),
Investors Life Insurance Company of North America ("Investors Life"), and prior
to February 19, 2002, Investors Life Insurance Company of Indiana
("Investors-IN"). Prior to the merger of FIC and ILCO on May 18, 2001, the
principal assets of FIC consisted of the common stock of its insurance
subsidiary, Family Life - and its equity ownership in ILCO. As a holding
company, FIC's ability to meet its cash requirements, pay interest on any debt,
pay expenses related to its affairs and pay dividends on its common stock
substantially depends upon dividends from its subsidiaries.
-29-
Prior to June 2001, the principal source of liquidity for FIC and its
wholly-owned subsidiary, Family Life Corporation, consisted of the periodic
payment of principal and interest by Family Life pursuant to the terms of the
surplus debenture issued in connection with the Family Life acquisition from
Merrill Lynch. During 2001, Family Life made principal payments of $5.9 million
and interest payments of $0.2 million to Family Life Corporation pursuant to the
terms of the surplus debenture. The surplus debenture was completely paid off as
of June 30, 2001. For periods subsequent to June 30, 2001, FIC's available
source of liquidity will be dividends paid to it from its subsidiaries.
Applicable state insurance laws generally restrict the ability of insurance
companies to pay cash dividends in excess of prescribed limitations without
prior approval.
The ability of Family Life and Investors Life to pay shareholder dividends is
and will continue to be subject to restrictions set forth in the insurance laws
and regulations of Washington, their domiciliary state. Washington limits how
and when Family Life and Investors Life can pay shareholder dividends by (a)
including the "greater of" standard for payment of dividends to shareholders,
(b) requiring that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and (c) requiring that cash dividends be paid
only from earned surplus. Under the "greater of" standard, an insurer may pay a
dividend in an amount equal to the greater of : (i) 10% of the policyholder
surplus or (ii) the insurer's net gain from operations for the previous year. In
2001, Investors Life paid a dividend to its parent corporation, ILCO, of
$11,082,586 (based upon earned surplus of $54.7 million and net gain from
operations of $11.1 million in the year 2000). ILCO, a holding company, does not
have any restrictions on payments of dividends and paid a dividend of
$11,082,586 to FIC in December 2001. Family Life did not have earned surplus in
2000 as defined by the regulations adopted by the Washington Insurance
Commissioner and, therefore, was not permitted to pay cash dividends during
2001. The $5.9 million in payments required by Family Life under the surplus
debenture (which was paid off in June 2001) contributed to Family Life's absence
of earned surplus in 2000. As of December 31, 2001, Investors Life had earned
surplus of $48.4 million and a net gain from operations of $8.3 million, and
Family Life had earned surplus of $0.3 million and a net gain from operations of
$4.4 million. Family Life's earned surplus in 2001 was negatively affected by a
$4.7 million increase in its reserves for flexible premium universal life
insurance. This increase was the result of an implementation of Washington's
interpretation with respect to reserve methodology for flexible premium
universal life insurance policies, which interpretation differs from that of the
NAIC.
Prior to the merger of Investors Life and Investors-IN in February 2002,
Investors-IN was domiciled in the State of Indiana. Under the Indiana insurance
code, a domestic insurer may make dividend distributions upon proper notice to
the Department of Insurance, as long as the distribution is reasonable in
relation to adequate levels of policyholder surplus and quality of earnings.
Under Indiana law the dividend must be paid from earned surplus. Investors-IN
had earned surplus of $26.5 million at December 31, 2001 and earned surplus of
$21.3 million at December 31, 2000. Investors-IN did not make any dividend
payments during 2001.
-30-
Sources of cash for FIC's insurance subsidiaries consist of premium payments
from policyholders and annuity holders, charges on policies and contracts,
investment income, and proceeds from the sale of investment assets. These funds
are applied primarily to provide for the payment of claims under insurance and
annuity policies, payment of policy withdrawals, surrenders and loans, operating
expenses, taxes, investments in portfolio securities, and shareholder dividends.
FIC's cash and cash equivalents at December 31, 2001 was $7.1 million as
compared to $2.7 million at December 31, 2000 and $0.7 million at December 31,
1999. The $4.4 million increase in cash and cash equivalents at December 31,
2001 from 2000 was due primarily to a the Merger and the cash acquired in the
purchase. The increase in cash and cash equivalents from 1999 to 2000 was
primarily attributable to an increase in cash flow from investing activities due
to a decrease in short-term invested assets.
FIC's net cash flow used in operating activities was ($6.5) million for the year
2001, as compared to ($2.2) million for the year 2000 and ($0.5) million for the
year 1999. The decrease in cash used in operating activities of ($4.3) million
from 2000 to 2001 was attributable to a higher than expected level of surrenders
of insurance and annuity policies which contributed to a larger decrease in
policy liabilities. The decrease in cash used in operating activities from 1999
to 2000 can be attributed to an increase in deferred federal income taxes of
$2.0 million.
Net cash flow provided by investing activities was $12.0 million in 2001, as
compared to $9.1 million in 2000 and $1.7 million in 1999. The increase in cash
provided by investing activities from 2000 to 2001 was due to the purchase of
ILCO, which provided $9.1 million, and a $14.8 million increase in proceeds from
short-term investments. These amounts were offset by a ($18.1) million
capitalization of real estate. The increase in cash provided by investing from
1999 to 2000 was primarily attributable to proceeds from a net decrease in short
term investments.
Net cash flow used in financing activities was ($1.1) million in 2001, as
compared to ($4.8) million in 2000 and ($3.1) million in 1999. Payment of cash
dividends to stockholders attributed to $6.0 million of cash used in financing
for 2001, as compared to only $0.9 million in 2000 and $0 in 1999; however,
repayment of subordinated notes payable decreased from ($6.1) million in 2000 to
($1.5) million in 2001 due to the Merger. Contractholder deposits provided $35.9
million to cash from financing activities in 2001 and contractholder withdrawals
used ($27.7) million which was an increase from 2000 and 1999 due to the
inclusion of ILCO's cash flows for the period following the Merger.
A primary liquidity consideration with respect to life insurance and annuity
products is the risk of early policyholder and contractholder withdrawal.
Deposit fund liabilities for universal life and annuity products as of December
31, 2001 were $556.1 million. Individual life insurance policies are less
susceptible to withdrawal than are annuity contracts because policyholders may
incur surrender charges and undergo a new underwriting process in order to
obtain a new insurance policy. At December 31, 2001, the bulk of the liabilities
for contractholder deposit funds on FIC's balance sheet, $416.1 million, were
related to insurance products, as compared to only $140.0 million of annuity
product liabilities.
-31-
The cash requirements of FIC, and its holding company subsidiary, Family Life
Corporation, consist primarily of its service of the indebtedness created in
connection with FIC's ownership of Family Life. As of December 31, 2001, the
investment portfolio of Investors Life included $29.2 million of notes
receivable from affiliates, represented by (i) a loan of $30 million by
Investors Life to Family Life Corporation made in July 1993, in connection with
the prepayment of indebtedness which had been previously issued to Merrill Lynch
as part of the 1991 acquisition of Family Life Insurance Company by a
wholly-owned subsidiary of FIC, and (ii) a loan of $4.5 million by Investors
Life to Family Life Insurance Investment Company made in July 1993, in
connection with the same transaction described above. Prior to September 12,
2001, the investment portfolio of Investors Life also included a $22.5 million
loan from Investors Life to Family Life Corporation and a $2.5 million loan from
Investors-CA (which was subsequently merged into Investors Life) to FIC and $2.0
million of additions to the $2.5 million note made in accordance with the terms
of such note, which loans were fully paid on September 12, 2001.
The provisions of the notes owned by Investors Life include the following
provisions: (a) the $30 million note provides for quarterly principal payments,
in the amount of $163,540 each for the period December 12, 1996 to September 12,
2001; beginning with the principal payment due on December 12, 2001, the amount
of the principal payment increases to $1,336,458; the final quarterly principal
payment is due on September 12, 2006; the interest rate on the note remains at
9%, and (b) the $4.5 million note provides for quarterly principal payments, in
the amount of $24,531 each for the period December 12, 1996 to September 12,
2001; beginning with the principal payment due on December 12, 2001, the amount
of the principal payment increases to $200,469; the final quarterly principal
payment is due on September 12, 2006; the interest rate on the note remains at
9%.
As of December 31, 2001, the outstanding balance of such indebtedness was $29.2
million on the 1993 Subordinated Loan granted by Investors Life. Due to the
Merger, this indebtedness is not included as a liability on the consolidated
financial statements of FIC. FIC's other liquidity requirements relate
principally to the need for cash flow to meet operating expenses, as well as the
liabilities associated with its insurance subsidiaries' various life insurance
and annuity products.
Given the historical cash flow of our subsidiaries and the current financial
results, management believes that the cash, cash equivalents and short term
investments of FIC and its subsidiaries are sufficient to meet the needs of its
business and to satisfy debt service. There are no trends, commitments or
capital asset requirements that are expected to have an adverse effect on the
liquidity of FIC.
-32-
Investments
Overall Composition of Investments.
Invested assets, excluding separate accounts, totaled $756.3 million and $99.1
million as of December 31, 2001 and December 31, 2000, respectively. The
increase is primarily attributable to the inclusion of ILCO's invested assets on
FIC's Consolidated Balance Sheets after the May 18th Merger. 66% of FIC's
invested assets are in fixed maturity securities, available for sale. All of
FIC's invested assets are invested in the United States. The most significant
differences between the portfolio composition as of December 31, 2001 as
compared to December 31, 2000 are investments in real estate, mortgage loans,
and fixed maturities held to maturity, as well as an increase in investments in
policy loans. Prior to the May 18, 2001 Merger, FIC did not have any invested
real estate, mortgage loans, or fixed maturities held to maturity.
The assets held by Family Life and Investors Life must comply with applicable
state insurance laws and regulations. In selecting investments for the
portfolios of its life insurance subsidiaries, the Company's emphasis is to
obtain targeted profit margins, while minimizing the exposure to changing
interest rates. This objective is implemented by selecting primarily short- to
medium-term, investment grade fixed income securities. In making such portfolio
selections, the Company generally does not select new investments which are
commonly referred to as "high yield" or "non-investment grade". We determine the
allocation of our assets primarily on the basis of cash flow and return
requirements of our products and secondarily by the level of investment risk.
Another key element of the Company's investment strategy is to avoid large
exposure in other investment categories which the Company believes carry higher
credit or liquidity risks, including private placements, partnerships and bank
participations. These categories accounted for only $45,479 of invested assets
at December 31, 2001 as compared to $0. The private placements are holdings of
Investors Life and thus were not on the consolidated balance sheet of FIC for
the year 2000.
Fixed Maturity Securities.
Our fixed maturity securities portfolio is predominately comprised of low risk,
investment grade, available for sale publicly traded corporate securities,
mortgage-backed securities and United States Government bonds. As of December
31, 2001, the market value of the fixed maturities available for sale segment
was $501.4 million as compared to an amortized cost of $496.7 million or an
unrealized gain of $4.7 million. The increase reflects unrealized gains on such
investments related to changes in interest rates subsequent to the purchase of
such investments. A portion ($0.8 million) of the unrealized gain has been
recorded as a decrease in deferred policy acquisition costs and present value of
future profits of acquired businesses on the consolidated balance sheet. The net
of tax effect of the remainder of this increase ($2.5 million) has been recorded
as accumulated other comprehensive income as an increase in shareholders'
equity.
-33-
The investments of FIC's insurance subsidiaries in mortgage-backed securities
included collateralized mortgage obligations ("CMOs") of $170.7 million, and
mortgage-backed pass-through securities of $31.2 million, at December 31, 2001.
Mortgage-backed pass-through securities, sequential CMO's and support bonds,
which comprised approximately 46.8% of the book value of FIC's mortgage-backed
securities at December 31, 2001, are sensitive to prepayment and extension
risks. FIC's insurance subsidiaries have reduced the risk of prepayment
associated with mortgage-backed securities by investing in planned amortization
class ("PAC"), target amortization class ("TAC") instruments and scheduled
bonds. These investments are designed to amortize in a predictable manner by
shifting the risk of prepayment of the underlying collateral to other investors
in other tranches ("support classes") of the CMO. At December 31, 2001, PAC and
TAC instruments and scheduled bonds represented approximately 53.2% of the book
value of FIC's mortgage-backed securities. Sequential and support classes
represented approximately 31.3% of the book value of FIC's mortgage-backed
securities at December 31, 2001. In addition, FIC's insurance subsidiaries limit
the risk of prepayment of CMOs by not paying a premium for any CMOs. FIC's
insurance subsidiaries do not invest in mortgage-backed securities with
increased prepayment risk, such as interest-only stripped pass-through
securities and inverse floater bonds. FIC's insurance subsidiaries did not have
any z-accrual bonds as of December 31, 2001. The prepayment risk that certain
mortgage-backed securities are subject to is prevalent in periods of declining
interest rates, when mortgages may be repaid more rapidly than scheduled as
individuals refinance higher rate mortgages to take advantage of the lower
current rates. As a result, holders of mortgage-backed securities may receive
large prepayments on their investments which cannot be reinvested at an interest
rate comparable to the rate on the prepaying mortgages. For the year 2002, the
investment objectives of FIC's insurance subsidiaries include the making of
selected investments in CMOs.
The securities valuation office (SVO) of the National Association of Insurance
Commissioners evaluates all public and private bonds purchased as investments by
insurance companies. The SVO assigns one of six investment categories to each
security it reviews. Category 1 is the highest quality rating, and Category 6 is
the lowest. As of December 31, 2001, the majority of our bonds, 99.8%, are
investment grade (Category 1 and 2). The Company's fixed maturities portfolio
(including short-term investments), included only a non-material amount (0.2% of
total fixed maturities and short-term investments) of debt securities which, in
the annual statements of the companies as filed with state insurance
departments, were designated by the SVO as "3" (medium quality) or below. This
number is attributable to mortgage bonds which Investors Life owns in a
California utility, which has been downgraded to a "6" (lowest quality) rating
by the NAIC. As of December 31, 2001, Investors Life owned bonds in Southern
California Edison which were purchased for $0.98 million and had a market value
as of December 31, 2001 of $0.94 million. Prior to December 31, 2001, Investors
Life also owned mortgage bonds in Pacific Gas & Electric which were sold during
2001 at a loss of $170,263 and Southern California Edison which were sold during
2001 at a loss of $187,305, and Investors-IN also owned bonds in Southern
California Edison which were sold at a loss of $26,906 during 2001.
FIC's short-term investments consist primarily of U.S. Government bonds. The
level of short-term investments at December 31, 2001 was $138.3 million, as
compared to $15.6 million as of December 31, 2000. This increase is also
primarily attributable to the inclusion of the assets of ILCO in the
consolidated financial statements of FIC.
-34-
Real Estate.
Invested real estate at December 31, 2001 was $61.0 million. At December 31,
2000, FIC did not have any assets invested in real estate. The change is
attributable to the consolidation of ILCO's financial results with FIC following
the May 18th Merger. The real estate investment is primarily related to the
development of the River Place Pointe project ("River Place Pointe") by
Investors Life, a subsidiary of ILCO. In October 1998, Investors Life purchased
River Place Pointe, two adjoining tracts of land located in Austin, Texas
totaling 47.995 acres. The aggregate purchase price for these tracts was $8.1
million. Investors Life obtained a Site Development Permit for the tracts from
the City of Austin allowing for the construction of seven office buildings
totaling 600,000 square feet, with associated parking, drives and related
improvements. Construction on the first section of the Project, which consists
of four office buildings, an associated parking garage, and related
infrastructure was completed during 2000 and 2001. Construction on the second
section continued during the third and fourth quarter of 2001, including work on
buildings six and seven. Completion of the entire project is expected by the end
of 2002.
As of December 31, 2001, Investors Life had expended $84.5 million in the
construction of River Place Pointe. Investors Life expects to pay $13.1 million
during 2002 to finish construction on the project. FIC and its insurance
subsidiaries occupy almost the entire Building One of River Place Pointe,
consisting of approximately 74,021 square feet of space. As of December 31,
2001, 289,873 rentable square feet of office space was leased and 98,623
rentable square feet was available for lease. Upon the completion of the second
section of the project, which includes three more office buildings, there will
be 294,398 additional rentable square feet available for lease. At December 31,
2001, the office vacancy rate in Austin, Texas, was 19.9% according to a study
released by the Federal Deposit Insurance Corporation. The study also found that
Austin had the highest percent of new office real estate space under
construction in relation to existing space at December 31, 2001.
Mortgage Loans.
As of December 31, 2001, only $4.7 million was invested in mortgage loans as
compared to $0 at December 31, 2000. The increase is due to the inclusion of
Investors Life's assets on FIC's consolidated balance sheet for the year 2001.
At December 31, 2000, ILCO's Balance Sheets included a $4.9 million investment
in mortgage loans. The Company does not make new mortgage loans on commercial
properties. Substantially all of the Company's mortgage loans were made by its
subsidiaries prior to their acquisition by the Company. At December 31, 2001,
none of the mortgage loans held by the Company had defaulted as to principal or
interest for more than 90 days, and none of the Company's mortgage loans were in
foreclosure.
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Policy Loans.
Policy loans totaled $49.8 million at December 31, 2001, as compared to $3.7
million at December 31, 2000. The increase was attributable to the inclusion of
ILCO's assets on the Consolidated Balance Sheets following the Merger. ILCO's
Balance Sheets at December 31, 2000 included $48.4 million in policy loans.
Management believes that the absence of "high-yield" or "non-investment grade"
investments (as defined above) in the portfolios of FIC's life insurance
subsidiaries 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.
Critical Accounting Policies
The financial statements contain a summary of FIC's critical accounting
policies, including a discussion of recently-issued accounting pronouncements.
Certain of these policies are considered to be important to the portrayal of
FIC's financial condition, since they require management to make difficult,
complex or subjective judgments, some of which may relate to matters that are
inherently uncertain. These policies include valuation of : investments,
deferred acquisition costs and present value of future profits, and future
policy benefits. For the year 2001, the Company's critical accounting policies
also included the purchase accounting for ILCO.
Investments.
The Company's investments primarily consist of fixed maturity securities, which
include bonds, notes and redeemable preferred stocks. Fair values of investments
in fixed securities are based on quoted market prices or dealer quotes. Fixed
maturities are classified as "available for sale" and are reported at fair
value, with unrealized investment gains and losses, net of income taxes,
credited or charged directly to shareholder's equity. When an impairment of the
value of an investment is considered other than temporary, the decrease in value
is reported in net income as a realized investment loss and a new cost basis is
established.
Deferred Acquisition Costs and Present Value of Future Profits.
Costs of acquiring individual life insurance and annuities, principally
commissions and certain expenses related to policy issuance, underwriting and
marketing, all of which vary with and are primarily related to the production of
new business, are deferred. Acquisition costs relating to traditional life
insurance, including term insurance, are amortized in relation to anticipated
premiums. Universal life costs are amortized in relation to estimated gross
profits, and annuity contracts employ a level yield method. For life insurance,
a 15 to 20-year amortization period is used, and a 7 to 20-year period is
employed for annuities.
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Future Policy Benefits.
Future policy benefits comprise 15% of FIC's total liabilities at December 31,
2001. These liabilities are estimated using actuarial methods based on
assumptions about premiums, interest yields, investment returns, expenses,
mortality, morbidity, and persistency. These assumptions consider Company
experience and industry standards. The assumptions vary by plan, age at issue,
year of issue and duration.
Purchase Accounting for ILCO.
The acquisition of ILCO was accounted for as a purchase; accordingly, the
results of ILCO's operations since the May 18, 2001 Merger are included in FIC's
consolidated results of operations at December 31, 2001. The fair values of the
assets acquired and liabilities assumed at the date of acquisition were
estimated based on an analysis, as of May 18, 2001, of the acquired book of
business. The allocation of the purchase price to the net assets acquired
resulted in excess of net assets acquired over cost, or negative goodwill.
Upon adoption of Statement of Financial Accounting Standards No. 141 (FAS 141),
"Business Combinations," during the first quarter of 2002, the amount of any
unamortized deferred credit related to the negative goodwill arising from the
Merger shall be recognized and reported as the effect of a change in accounting
principle. The effect of the accounting change and related income tax effects
shall be presented in the income statement between the captions "extraordinary
items" and "net income".
For the period from January 1, 2001 to May 17, 2001, and for the years 2000 and
1999, FIC's net income includes its equity interest in the net income of ILCO,
with such equity interest being based on FIC's percentage ownership of ILCO.
For a further discussion of accounting standards, see Note 1 to our audited
consolidated financial statements, beginning on page F-13.
Events of September 11, 2001
Family Life incurred and paid $155,000 of death benefits as a result of the
September 11, 2001 events. The Company is not aware of any unreported losses or
claims resulting of such events.
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Subsequent Events
Merger of Investors Life and Investors-IN.
On February 19, 2002, Investors-IN was merged with and into Investors Life,
whereby Investors Life was the surviving corporation. The merger was approved by
the Washington Department of Insurance in January 2002 and by the Indiana
Department of Insurance in February 2002. Investors Life will assume all of the
asse