UNITED
        STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
        D.C. 20549
  **Form
        10-Q**
  **QUARTERLY
        REPORT PURSUANT TO SECTION 13 OR 15(d)**
 **OF
        THE SECURITIES EXCHANGE ACT OF 1934**
  **For
        the Quarterly Period Ended September 30, 2006**
  **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 I, Austin, Texas 78730**
 (Address
        including Zip Code of Principal Executive Offices)
  **(512)
        404-5000**
 (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 (or for such shorter period that the Registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days. YES  ̈NO x
 
 Indicate
        by check mark whether the Registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer.  See definition of
“accelerated filer and large accelerated filer” in  Rule 12b-2 of the
        Exchange Act.  (Check one):
 
 Large
                  accelerated filer  ̈
              
              Accelerated
                  filerx
              
              Non-accelerated
                  filer  ̈
 
 Indicate
        by check mark whether the Registrant is a shell company (as defined in Rule
        12b-2 of the Act).
 YES
 ̈ NO
x
  The
        number of shares outstanding of Registrant's common stock on March 31, 2007,
        was
        10,210,385.











**Forward-Looking
      Statements**





Except
      for historical factual information set forth in this Form 10-Q of Financial
      Industries Corporation (the “Company” or “FIC”), the statements, analyses, and
      other information contained in this report relating to trends in the Company’s
      operations and financial results, the markets for our products, future results,
      the future development of our business, and the contingencies and uncertainties
      to which we may be subject, as well as other statements including words such
      as
“anticipate,” “believe,” “plan,” “budget,” “could,” “designed,” “estimate,”
“expect,” “intend,” “forecast,” “predict,” “project,” “may,” “might,” “should”
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 financial results
      and economic conditions and are subject to known and unknown risks,
      uncertainties and other factors contemplated by the forward-looking statements.
      These 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 that may affect the profitability of FIC’s insurance products; (5)
      FIC’s ability to develop and maintain effective risk management policies and
      procedures and to maintain adequate reserves for future policy benefits and
      claims; (6) changes in the federal income tax laws and regulations that may
      affect the relative tax advantages of some of FIC’s products; (7) increasing
      competition in the sale of insurance; (8) the effect of regulation and
      regulatory changes or actions, including those relating to regulation of
      insurance products and insurance companies; (9) 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
      accumulation-type products; (10) the performance of our investment
      portfolios; (11) the effect of changes in standards of accounting; (12) the
      effects and results of litigation; (13) business risks and factors described
      elsewhere in this report, including, but not limited to, Item 2–Management’s
      Discussion and Analysis of Financial Condition and Results of Operations and
      Item 3-Quantitative and Qualitative Disclosures about Market Risks in Part
      1,
      and Item 1-Legal Proceedings in Part 2, and (14) other factors discussed in
      the
      Company’s other filings with the SEC, which are available free of charge on the
      SEC’s website at www.sec.gov. You should read carefully the above factors and
      all of the other information contained in this report. Should one or more of
      these risks or uncertainties materialize, or should underlying assumptions
      prove
      incorrect, actual results may vary materially from those indicated. All
      subsequent written and oral forward-looking statements attributable to the
      Company or to persons acting on our behalf are expressly qualified in their
      entirety by reference to these risks and uncertainties. There can be no
      assurance that other factors not currently anticipated by management will not
      also materially and adversely affect our results of operations. Each
      forward-looking statement speaks only as of the date of the particular statement
      and the Company undertakes no obligation to update or revise any forward-looking
      statement, except as required by federal securities laws.











**FINANCIAL
      INDUSTRIES CORPORATION AND
      SUBSIDIARIES**








**INDEX**





Page
                No.**Part
                I - Financial Information**Item
              1. Financial Statements (Unaudited)Condensed
                Consolidated Balance Sheets September 30, 2006 and
                December 31, 2005
            4Condensed
                Consolidated Statements of Operations For the three
                and nine month periods ended September 30, 2006 and September 30,
                2005
            6Condensed
                Consolidated Statements of Cash Flows For the nine
                month periods ended September 30, 2006 and September 30,
                2005
            10Notes
                to Condensed Consolidated Financial
                Statements
            12Item
                2. Management’s Discussion and Analysis of Financial
                Condition and Results of Operations
            19Item
                3. Quantitative and Qualitative Disclosures about Market
                Risk
            25Item
                4.  Controls and Procedures
            26**Part
                II – Other Information**Item
                1.  Legal Proceedings
            27Item
                1A.  Risk Factors
            29Item
                2.  Changes in Securities and Use of
                Proceeds
            29Item
                3.  Defaults Upon Senior
                Securities
            29Item
                4.  Submission of Matters to a Vote of Security
                Holders
            29Item
                5.  Other Information
            29Item
                6.  Exhibits
            29Signatures
            30




*Index*





**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


(In
      thousands) (Unaudited)





September
                30,
              2006
            
            
            December
                31,
              2005
                (1)ASSETSInvestments:Fixed
                maturity securities available for sale, at  fair value
                (amortized cost of $624,838and $605,803 at September 30, 2006 and
                December
                31, 2005, respectively)
            
            $
            607,117
            
            
            $
            593,752Equity
                securities, at fair value (cost of $8,713 and $8,405 at September
                30, 2006
                and December 31, 2005, respectively)
            
            
            11,274
            
            
            
            10,907Policy
                loans
            
            
            35,412
            
            
            
            37,637Real
                estate held for sale
            
            
            -
            
            
            
            130Short-term
                investments
            
            
            16,847
            
            
            
            1,204Total
                investments
            
            
            670,650
            
            
            
            643,630Cash
                and cash equivalents
            
            
            7,393
            
            
            
            63,581Deferred
                policy acquisition costs
            
            
            50,432
            
            
            
            50,805Present
                value of future profits of acquired business
            
            
            14,509
            
            
            
            15,865Agency
                advances and other receivables, net of allowances for doubtful accounts
                of
                $3,395 and $3,513 as of September 30, 2006 and December 31,
                2005
            
            
            13,277
            
            
            
            8,188Reinsurance
                receivables
            
            
            32,526
            
            
            
            38,108Accrued
                investment income
            
            
            7,420
            
            
            
            7,165Due
                premiums
            
            
            1,555
            
            
            
            2,048Property
                and equipment, net
            
            
            720
            
            
            
            1,033Other
                assets
            
            
            2,251
            
            
            
            2,088Separate
                account assets
            
            
            341,841
            
            
            
            342,911Total
                assets
            
            $
            1,142,574
            
            
            $
            1,175,422





(1)
      Derived from audited consolidated financial statements




The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





4
 *Index*




**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS, Continued**


(In
      thousands) (Unaudited)




September
                30,
              2006
            
            
            December
                31,
              2005
                (1)LIABILITIES
                AND SHAREHOLDERS’ EQUITYLiabilities:Policy
                liabilities and contractholder deposit funds:Contractholder
                deposit funds
            
            $
            520,363
            
            
            $
            542,181Future
                policy benefits
            
            
            153,877
            
            
            
            155,970Other
                policy claims and benefits payable
            
            
            8,312
            
            
            
            11,456Notes
                payable
            
            
            15,000
            
            
            
            15,000Deferred
                federal income taxes
            
            
            413
            
            
            
            687Other
                liabilities
            
            
            22,078
            
            
            
            25,146Separate
                account liabilities
            
            
            341,841
            
            
            
            342,911Total
                liabilities
            
            
            1,061,884
            
            
            
            1,093,351Commitments
                and contingencies (See Note 8)Shareholders’
                equity:Common
                stock, $.20 par value, 25,000 shares authorized in 2006 and 2005,
                12,517
                shares issued in 2006 and 2005; 9,870 and 9,849 shares outstanding
                in 2006
                and 2005
            
            
            2,504
            
            
            
            2,504Additional
                paid-in capital
            
            
            70,373
            
            
            
            70,377Accumulated
                other comprehensive loss
            
            
            (13,144
            )
            
            
            (10,339
            )Retained
                earnings
            
            
            43,735
            
            
            
            42,485Common
                treasury stock, at cost, 2,647 and 2,668 shares in 2006 and
                2005
            
            
            (22,778
            )
            
            
            (22,956
            )Total
                shareholders’ equity
            
            
            80,690
            
            
            
            82,071Total
                liabilities and shareholders’ equity
            
            $
            1,142,574
            
            
            $
            1,175,422





(1)
      Derived from audited consolidated financial statements





The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





5
 *Index*




**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


(In
      thousands except per share data) (Unaudited)




Three
                Months Ended September 30,2006
            
            
            2005Revenues:Premiums,
                net
            
            $
            6,152
            
            
            $
            5,925Earned
                insurance charges
            
            
            9,617
            
            
            
            9,919Net
                investment income
            
            
            8,636
            
            
            
            8,108Real
                estate income
            
            
            -
            
            
            
            16Net
                realized investment gains (losses)
            
            
            1
            
            
            
            (703
            )Other
            
            
            1,234
            
            
            
            636Total
                revenues
            
            
            25,640
            
            
            
            23,901Benefits
                and expenses:Policyholder
                benefits and expenses
            
            
            8,056
            
            
            
            11,923Interest
                expense on contractholders deposit funds
            
            
            5,090
            
            
            
            5,434Amortization
                of deferred policy acquisition costs
            
            
            2,329
            
            
            
            2,078Amortization
                of present value of future profits of acquired business
            
            
            544
            
            
            
            715Operating
                expenses
            
            
            7,376
            
            
            
            7,228Interest
                expense
            
            
            364
            
            
            
            297Total
                benefits and expenses
            
            
            23,759
            
            
            
            27,675Income
                (loss) before federal income taxes
            
            
            1,881
            
            
            
            (3,774
            )Provision
                (benefit) for federal income taxes
            
            
            586
            
            
            
            (1,252
            )Net
                income (loss)
            
            $
            1,295
            
            
            $
            (2,522
            )





The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





6
 *Index*




**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS, Continued**


(In
      thousands except per share data) (Unaudited)




Three
                Months Ended September 30,2006
            
            
            2005Net
                Income (Loss) Per Share:Basic:Weighted
                average common shares outstanding
            
            
            9,856
            
            
            
            9,823Basic
                income (loss) per share
            
            $
            0.13
            
            
            $
            (0.26
            )Diluted:Weighted
                average common shares and common share equivalents
            
            
            9,856
            
            
            
            9,823Diluted
                income (loss) per share
            
            $
            0.13
            
            
            $
            (0.26
            )





The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





7
 *Index*




**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS, Continued**


(In
      thousands except per share data) (Unaudited)




Nine
                Months Ended September 30,2006
            
            
            2005Revenues:Premiums,
                net
            
            $
            17,508
            
            
            $
            17,906Earned
                insurance charges
            
            
            29,061
            
            
            
            30,253Net
                investment income
            
            
            25,872
            
            
            
            22,856Real
                estate income
            
            
            -
            
            
            
            563Net
                realized investment gains
            
            
            502
            
            
            
            8,567Other
            
            
            3,308
            
            
            
            1,882Total
                revenues
            
            
            76,251
            
            
            
            82,027Benefits
                and expenses:Policyholder
                benefits and expenses
            
            
            28,743
            
            
            
            31,859Interest
                expense on contractholders deposit funds
            
            
            15,396
            
            
            
            16,581Amortization
                of deferred policy acquisition costs
            
            
            6,453
            
            
            
            7,745Amortization
                of present value of future profits of acquired business
            
            
            1,717
            
            
            
            2,038Operating
                expenses
            
            
            20,791
            
            
            
            21,815Interest
                expense
            
            
            1,042
            
            
            
            829Total
                benefits and expenses
            
            
            74,142
            
            
            
            80,867Income
                before federal income taxes
            
            
            2,109
            
            
            
            1,160Provision
                for federal income taxes
            
            
            859
            
            
            
            143Net
                income
            
            $
            1,250
            
            
            $
            1,017





The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





8
 *Index*





**FINANCIAL
        INDUSTRIES CORPORATION AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF OPERATIONS, Continued**
 (In
        thousands except per share data) (Unaudited)


Nine
                Months Ended September 30,2006
            
            
            2005Net
                Income Per Share:Basic:Weighted
                average common shares outstanding
            
            
            9,856
            
            
            
            9,813Net
                income per share
            
            $
            0.13
            
            
            $
            0.10Diluted:Weighted
                average common shares and common share equivalents
            
            
            9,856
            
            
            
            9,813Net
                income per share
            
            $
            0.13
            
            
            $
            0.10





The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





9
 *Index*


**FINANCIAL
        INDUSTRIES CORPORATION AND
        SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS**
 (In
        thousands) (Unaudited)





Nine
                Months Ended September 30,2006
            
            
            2005CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income
            
            $
            1,250
            
            
            $
            1,017Adjustments
                to reconcile net income to net cash provided by  (used in)
                operating activities:Amortization
                of deferred policy acquisition costs
            
            
            6,453
            
            
            
            7,745Amortization
                of present value of future profits of acquired business
            
            
            1,717
            
            
            
            2,038Net
                realized gains on investments
            
            
            (502
            )
            
            
            (9,606
            )Depreciation
            
            
            341
            
            
            
            1,763Increase
                in accrued investment income
            
            
            (255
            )
            
            
            (1,158
            )Decrease
                (increase) in agent advances and other receivables
            
            
            493
            
            
            
            1,520Decrease
                (increase) in due premiums
            
            
            493
            
            
            
            (114
            )Increase
                in deferred policy acquisition costs
            
            
            (5,082
            )
            
            
            (5,802
            )Decrease
                (increase) in other assets
            
            
            (163
            )
            
            
            37Increase
                (decrease) in policy liabilities and accruals
            
            
            (7,396
            )
            
            
            779Decrease
                in other liabilities
            
            
            (3,068
            )
            
            
            (3,567
            )Increase
                in deferred federal income taxes
            
            
            1,172
            
            
            
            1,258Net
                activity from trading securities
            
            
            -
            
            
            
            (759
            )Other,
                net
            
            
            22
            
            
            
            (1,218
            )Net
                cash used in operating activities
            
            
            (4,525
            )
            
            
            (6,067
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Fixed
                maturities purchased
            
            
            (59,840
            )
            
            
            (151,494
            )Real
                estate capital expenditures
            
            
            -
            
            
            
            (544
            )Proceeds
                from sales and maturities of fixed maturities
            
            
            40,641
            
            
            
            59,880Proceeds
                from sales of invested real estate
            
            
            646
            
            
            
            101,067Net
                (increase) decrease in short-term investments
            
            
            (15,643
            )
            
            
            58,312Net
                decrease in policy loans
            
            
            2,225
            
            
            
            1,648Purchase
                of property and equipment
            
            
            (33
            )
            
            
            (307
            )Net
                cash provided by (used in) investing activities
            
            
            (32,004
            )
            
            
            68,562





(continued)





The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





10
 *Index*





**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued**


(In
      thousands) (Unaudited)





Nine
                Months Ended September 30,2006
            
            
            2005CASH
                FLOWS FROM FINANCING ACTIVITIES:Contractholder
                fund deposits
            
            $
            24,273
            
            
            $
            25,376Contractholder
                fund withdrawals
            
            
            (43,932
            )
            
            
            (52,962
            )Net
                cash used in financing activities
            
            
            (19,659
            )
            
            
            (27,586
            )Net
                increase (decrease) in cash
            
            
            (56,188
            )
            
            
            34,909Cash
                and cash equivalents, beginning of year
            
            
            63,581
            
            
            
            52,044Cash
                and cash equivalents, end of period
            
            $
            7,393
            
            
            $
            86,953Supplemental
                Cash Flow Disclosures:Income
                taxes refunded
            
            $
            4,341
            
            
            $
            -Interest
                paid
            
            $
            1,026
            
            
            $
            805Treasury
                stock distributions
            
            $
            174
            
            
            $
            316




The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.





11
 *Index*





**FINANCIAL
      INDUSTRIES CORPORATION AND
      SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**





**1.**
            **Basis
                of Presentation and
                Consolidation**





The
      financial statements included herein have been presented to conform to the
      requirements of Form 10-Q.





The
      accompanying unaudited condensed consolidated financial statements reflect
      all
      adjustments (including normal recurring adjustments) necessary to present fairly
      the consolidated financial position of the Company at September 30, 2006, its
      consolidated results of operations for the three months and nine months ended
      September 30, 2006 and 2005, and its consolidated cash flows for the nine months
      ended September 30, 2006 and 2005 in conformity with accounting principles
      generally accepted in the United States of America (“GAAP”). Interim results are
      not necessarily indicative of full year performance. The December 31, 2005
      condensed consolidated balance sheet data was derived from the audited
      consolidated financial statements included in the Company’s 2005 Annual Report
      on Form 10-K filed with the SEC (“2005 Annual Report”), which includes all
      disclosures required by GAAP. Therefore, these unaudited condensed consolidated
      financial statements should be read in conjunction with the consolidated
      financial statements of the Company included in the 2005 Annual
      Report.





The
      condensed consolidated financial statements include the accounts of Financial
      Industries Corporation (“FIC”) and its wholly owned subsidiaries. Intercompany
      items and transactions have been eliminated.





**2.**
            **Accumulated
                Other Comprehensive Income (Loss) and Comprehensive Income
                (Loss)**





The
      following is a reconciliation of accumulated other comprehensive income (loss)
      from December 31, 2005 to September 30, 2006 (in thousands):





Net
                Unrealized Appreciation (Depreciation) of Equity
                Securities
            
            
            Net
                Unrealized Gain (Loss) on Fixed Maturities Available for
                Sale
            
            
            Other
            
            
            Total
                Accumulated Other Comprehensive Income (Loss)Balance
                at December 31, 2005
            
            $
            1,651
            
            
            $
            (5,914
            )
            
            $
            (6,076
            )
            
            $
            (10,339
            )Current
                Period Change
            
            
            40
            
            
            
            (2,845
            )
            
            
            -
            
            
            
            (2,805
            )Balance
                at September 30, 2006
            
            $
            1,691
            
            
            $
            (8,759
            )
            
            $
            (6,076
            )
            
            $
            (13,144
            )





The
      comprehensive income (loss) for the three and nine months ending September
      30,
      2006 and 2005 is summarized as follows (in thousands):





Three
                Months Ended September 30,
            
            
            Nine
                Months Ended September 30,2006
            
            
            2005
            
            
            2006
            
            
            2005Net
                income (loss)
            
            $
            1,295
            
            
            $
            (2,522
            )
            
            $
            1,250
            
            
            $
            1,017Other
                comprehensive income, net of tax:Unrealized
                gains on securities:Unrealized
                holdings gains (losses) arising during the period
            
            
            7,995
            
            
            
            (4,332
            )
            
            
            (2,796
            )
            
            
            (2,401
            )Reclassification
                adjustments for gains  (losses) included in net
                loss
            
            
            1
            
            
            
            (683
            )
            
            
            (9
            )
            
            
            (311
            )Total
                other comprehensive income (loss)
            
            
            7,996
            
            
            
            (5,015
            )
            
            
            (2,805
            )
            
            
            (2,712
            )Comprehensive
                income (loss)
            
            $
            9,291
            
            
            $
            (7,537
            )
            
            $
            (1,555
            )
            
            $
            (1,695
            )





12
 *Index*





**3.**
            **Earnings
                Per Share**





The
      following table reflects the calculation of basic and diluted earnings (loss)
      per share:





Three
                Months Ended September 30,
            
            
            Nine
                Months Ended September 30,2006
            
            
            2005
            
            
            2006
            
            
            2005(in
                thousands except per share data)BASIC:Net
                income (loss)
            
            $
            1,295
            
            
            $
            (2,522
            )
            
            $
            1,250
            
            
            $
            1,017Weighted
                average common     shares
                outstanding
            
            
            9,856
            
            
            
            9,823
            
            
            
            9,856
            
            
            
            9,813Basic
                income (loss) per share
            
            $
            0.13
            
            
            $
            (0.26
            )
            
            $
            0.13
            
            
            $
            0.10DILUTED:Net
                income (loss)
            
            $
            1,295
            
            
            $
            (2,522
            )
            
            $
            1,250
            
            
            $
            1,017Weighted
                average common     shares
                outstanding
            
            
            9,856
            
            
            
            9,823
            
            
            
            9,856
            
            
            
            9,813Diluted
                income (loss) per share
            
            $
            0.13
            
            
            $
            (0.26
            )
            
            $
            0.13
            
            
            $
            0.10





Options
      to purchase shares of common stock were not included in the computation of
      diluted earnings per share because the inclusion would result in an
      anti-dilutive effect in periods in which a net loss was incurred.





**4.**
            **Net
                Realized Investment Gains**





On
      June
      1, 2005, the Company sold the River Place Pointe office complex to a
      non-affiliated party in an all-cash transaction for a gross sales price of
      $103
      million. The office complex is located in Austin, Texas. Under the terms of
      the
      sale agreement, the Company entered into a lease with the purchaser with respect
      to all of the space in Building One (approximately 76,000 square feet) for
      a
      five-year term at a rate of $28.00 per square foot, which was the prevailing
      rental rate at the time that FIC and its subsidiaries occupied the building
      in
      July 2000. The lease provides the Company with a right of cancellation of the
      lease at March 31, 2008.  The Company will realize a gain of $10.6
      million on the sale, which includes both a realized gain of $8.5 million in
      the
      quarter ended June 30, 2005 and a deferred gain of $2.1 million to be recognized
      as a reduction of office lease expenses over the period from the sale date
      through March 31, 2008. The deferred gain represents an amount equal to the
      estimated excess rent to be paid under the lease agreement through March 31,
      2008 over the prevailing rate at the time of sale.





During
      the third quarter of 2005, the Company identified a fixed maturity security
      which was considered impaired and reduced its carrying value by $1
      million.





**5.**
            **Retirement
                Plans**





A.
      Family
      Life





Family
      Life Insurance Company (“Family Life”) has a non-contributory defined benefit
      pension plan (“Family Life Pension Plan”), which covers employees who have
      completed one year or more of service. Under the Family Life Pension Plan,
      benefits are payable upon retirement based on earnings and years of credited
      service.




a.
              The
                  Normal Retirement Date for all employees is the first day of the
                  month
                  coinciding with or next following the later of attainment of age
                  65 or the
                  fifth anniversary of employment.
 
 b.
              The
                  Normal Retirement Benefit is the actuarial equivalent of a life
                  annuity,
                  payable monthly, with the first payment commencing on the Normal
                  Retirement Date. The life annuity is equal to the sum of (1) plus
                  (2):
 
 (1)
              Annual
                  Past Service Benefit:  1.17% of the first $10,000 of Average
                  Final Earnings plus 1 1/2% of the excess of Average Final Earnings
                  over
                  $10,000, all multiplied by the participant’s Credited Past Service. For
                  these purposes, “credited past service” is service prior to April 1, 1967,
                  with respect to employees who were plan participants on December
                  31,
                  1975.
  13
 *Index*
  (2)
              Annual
                  Future Service Benefit:  1.5578% of the first $10,000 of Average
                  Final Earnings plus 2% of the excess of Average Final Earnings
                  over
                  $10,000, all multiplied by the participant’s Credited Future
                  Service.
 
 c.
              Effective
                  April 1, 1997, the Family Life Pension Plan was amended to provide
                  that
                  the accrual rate for future service is 1.57% of Final Average Earnings
                  multiplied by Credited Service after March 31, 1997, less 0.65%
                  of Final
                  Average Earnings up to Covered Compensation. With respect to service
                  prior
                  to April 1, 1997, the accrual rate described in paragraph (b),
                  above, is
                  applicable, with Average Final Earnings taking into account a
                  participant’s earnings subsequent to April 1,
                  1997.
 
 d.
              Effective
                  March 31, 2004, all employees covered under the plan were
                  terminated.  No new or rehired employees are permitted to enter
                  or re-enter the plan. Thus, the plan is
                  frozen.




Average
      Final Earnings are the highest average Considered Earnings during any five
      consecutive years while an active participant. Total Credited Past Service
      plus
      Credited Future Service is limited to 30 years.





A
      settlement occurred on September 30, 2006 due to the settlement of several
      former employees’ plan obligations through the payment of lump
      sums.  A settlement occurs whenever the lump sums paid during the year
      exceed the sum of the plans Service Cost and Interest Cost components of expense
      for that year.  The settlement resulted in the recognition of a
      $295,736 charge to expense for 2006.





The
      pension costs for the Family Life Pension Plan include the following components
      at September 30, 2006 and 2005:





Three
                Months Ended Sept. 30,
            
            
            Nine
                Months Ended Sept. 30,2006
            
            
            2005
            
            
            2006
            
            
            2005Service
                cost for benefits earned during the year
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Interest
                cost on projected benefit obligation
            
            
            109,482
            
            
            
            116,054
            
            
            
            328,446
            
            
            
            348,162Expected
                return on plan assets
            
            
            (101,994
            )
            
            
            (101,268
            )
            
            
            (305,982
            )
            
            
            (303,805
            )Amortization
                of unrecognized prior service cost
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Amortization
                of unrecognized losses
            
            
            23,460
            
            
            
            26,225
            
            
            
            70,380
            
            
            
            78,677Recognition
                of net loss due to settlement
            
            
            295,736
            
            
            
            -
            
            
            
            295,736
            
            
            
            -Net
                periodic benefit cost
            
            $
            326,684
            
            
            $
            41,011
            
            
            $
            388,580
            
            
            $
            123,034





B.
      ILCO





InterContinental
      Life Corporation (“ILCO”) maintains a retirement plan (“ILCO Pension Plan”)
      covering substantially all employees of the Company and its
      subsidiaries.  The ILCO Pension Plan is a non-contributory, defined
      benefit pension plan, which covers each eligible employee who has attained
      21
      years of age and has completed one year or more of service. Each participating
      subsidiary company contributes an amount necessary (as actuarially determined)
      to fund the benefits provided for its participating employees.





The
      ILCO
      Pension Plan’s basic retirement income benefit at normal retirement age is 1.57%
      of the participant’s average annual earnings less 0.65% of the participant’s
      final average earnings up to covered compensation multiplied by the number
      of
      his/her years of credited service. For participants who previously participated
      in the ILCO Pension Plan maintained by ILCO for the benefit of former employees
      of the IIP Division of CIGNA Corporation (the IIP Plan), the benefit formula
      described above applies to service subsequent to May 31, 1996. With respect
      to
      service prior to that date, the benefit formula provided by the IIP Plan is
      applicable, with certain exceptions applicable to former IIP employees who
      are
      classified as highly compensated employees.





Former
      eligible IIP employees commenced participation automatically. The ILCO Pension
      Plan also provides for early retirement, postponed retirement, and disability
      benefits to eligible employees. Participant benefits become fully vested upon
      completion of five years of service, as defined, or attainment of normal
      retirement age, if earlier.





A
      curtailment occurred on December 31, 2004 when the plan was amended to freeze
      accrued benefits for all participants except for Rule of 68 Non-Highly
      Compensated Employees (“NHCEs”).  A subsequent curtailment occurred on
      December 31, 2005 when the decision was made to amend the plan to freeze accrued
      benefits for Rule of 68 NHCEs effective March 31, 2006.  All plan
      participants accrued benefits are now frozen.





14
 *Index*





The
      pension costs for the ILCO Pension Plan include the following components at
      September 30, 2006 and 2005:





Three
                Months Ended Sept. 30,
            
            
            Nine
                Months Ended Sept. 30,2006
            
            
            2005
            
            
            2006
            
            
            2005Service
                cost for benefits earned during the year
            
            $
            3,672
            
            
            $
            11,448
            
            
            $
            11,016
            
            
            $
            34,344Interest
                cost on projected benefit obligation
            
            
            262,037
            
            
            
            261,812
            
            
            
            786,111
            
            
            
            785,436Expected
                return on plan assets
            
            
            (350,036
            )
            
            
            (344,766
            )
            
            
            (1,050,108
            )
            
            
            (1,034,298
            )Amortization
                of unrecognized prior service cost
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Amortization
                of unrecognized losses
            
            
            46,022
            
            
            
            33,920
            
            
            
            138,066
            
            
            
            101,760Recognition
                of net loss due to settlement
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
                periodic benefit cost
            
            $
            (38,305
            )
            
            $
            (37,586
            )
            
            $
            (114,915
            )
            
            $
            (112,758
            )





**6.**
            **Stock
                Option Plans and Other Equity Incentive
                Plans**





In
      December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.”
SFAS 123(R) is a revision of SFAS 123, “Accounting for Stock-Based
      Compensation,” which was originally issued by the FASB in 1995. As originally
      issued, SFAS 123 provided companies with the option to either record
      expense for share-based payments under a fair value model, or to simply disclose
      the impact of the expense. SFAS 123(R) requires companies to measure the
      cost of share-based payments to employees using a fair value model, and to
      recognize that cost over the relevant service period. In addition,
      SFAS 123(R) requires that an estimate of future award forfeitures be made
      at the grant date, while SFAS 123 permitted recognition of forfeitures on
      an as incurred basis.  SFAS 123(R) was originally effective July 1,
      2005, but was later deferred by the Securities and Exchange Commission and
      will
      become effective for all awards granted, modified, repurchased, or cancelled
      by
      the Company beginning January 1, 2006. The adoption of this statement on January
      1, 2006 did not have a material impact on the Company’s consolidated financial
      statements.





**7.**
            **Separate
                Accounts**





The
      Company’s insurance subsidiary, Investors Life Insurance Company of North
      America (“Investors Life”) had $341.8 million of separate account assets as of
      September 30, 2006 (not including the value of the Company’s own investment in
      one of the accounts), as compared to $342.9 million at the end of 2005. These
      assets include (a) two variable annuity separate accounts that permit
      contractholders to allocate their contract values among a selection of
      third-party mutual funds and (b) assets held in custodian accounts in connection
      with investment annuity contracts. The investment annuity business is reinsured
      with Symetra Life Insurance Company (formerly Safeco Life Insurance Company),
      a
      third-party reinsurer, on a 90%/10% coinsurance basis, with Investors Life
      retaining 10% of such business. Since the reinsurance treaty is on a coinsurance
      basis, Investors Life is contingently liable to the policyholders in the event
      that the reinsurer is unable to fulfill its obligations under the treaty.
      Investors Life is not marketing new separate account annuity
      contracts.





Effective
      June 1, 2006, Investors Life recaptured the previously reinsured investment
      annuity business with Symetra Life resulting in the retention of 100% of this
      business. The Company expects the recapture of this previously reinsured
      business to increase revenues in 2006 and future years. However, as this is
      a
      closed block of business, the revenues are expected to decrease as the policies
      in force decline.





**8.**
            **Commitments
                and Contingencies**





T.
      David Porter v. Financial Industries Corporation





On
      May
      31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis
      County, Texas District Court (the “Court”), against the Company, seeking to
      compel the Company to hold an annual meeting of shareholders. FIC has been
      unable to solicit proxies for an annual meeting because it has not been able
      to
      comply with Rule 14a-3 of the Securities Exchange Act of 1934, which requires
      that the Company provide an annual report containing current financial
      statements to shareholders in connection with an annual meeting.





Mr.
      Porter sued under Article 2.24(B) of the Texas Business Corporation Act, which
      provides that if an annual meeting of shareholders is not held within any
      13-month period and a written consent of shareholders has not been executed
      instead of a meeting, any court of competent jurisdiction in the county in
      which
      the principal office of the corporation is located may, on the application
      of
      any shareholder, summarily order a meeting to be held. On August 7, 2006, the
      Company entered into an Agreed Order On Plaintiff’s Motion to Compel Annual
      Shareholders Meeting and agreed among other things to hold an annual
      shareholders meeting for the election of directors on December 6, 2006. The
      Company made arrangements for, and was prepared to hold, an annual meeting
      of
      shareholders on December 6, 2006, as required by the Agreed Order, but the
      Company was unable to hold the meeting on the appointed date because no quorum
      was present.





15
 *Index*





On
      December 12, 2006, FIC filed a Motion for Summary Judgment seeking dismissal
      of
      Porter’s suit on the grounds that the Agreed Order did not dispense with the
      requirement of a quorum; the lack of a quorum was a direct and foreseeable
      result of Mr. Porter’s insistence on a one-sided solicitation and election; FIC
      had complied with its obligations under the Agreed Order and Mr. Porter has
      obtained all relief sought by his petition. FIC’s Motion for Summary Judgment
      remains pending and has not been heard.





Prior
      to
      a hearing on FIC’s Motion for Summary Judgment, Mr. Porter applied for a
      temporary restraining order and temporary injunction requiring the Company
      to
      convene one or more additional meetings of shareholders, contending that in
      the
      absence of a quorum on December 6, Texas law and the Company’s bylaws entitled a
      majority of the shareholders in attendance to choose a date to which the meeting
      would be adjourned. The District Court held a hearing on Porter’s application,
      and on December 22, 2006 entered an order requiring among other things that
      FIC
      hold an annual shareholders meeting for the election of directors on January
      16,
      2007, but stating that if a quorum was not present on that date, FIC would
      not
      be required to hold an annual meeting of shareholders at any time before July
      17, 2007. The Company made arrangements for, and was prepared to hold, an annual
      meeting of shareholders on January 16, 2007, as required by the Court’s order,
      but the Company was again unable to hold the meeting on the appointed date
      because no quorum was present.  No further action has been taken by
      Mr. Porter, whose suit remains pending.





Litigation
      with Equita Financial and Insurance Services of Texas, Inc. and M&W
      Insurance Services, Inc.





On
      June
      2, 2005, Equita and M&W Insurance Services, Inc. (“M&W”) filed a civil
      suit in Travis County, Texas District Court against the Company. The suit
      alleges that, in entering into certain agreements with the plaintiffs, the
      Company made certain misrepresentations and omissions as to its business and
      financial condition. The agreements referenced in the suit consist of (a) an
      option agreement entered into in June 2003 between Equita and the Company,
      granting Equita the right to purchase shares of FIC’s common stock at $16.42 per
      share, if certain sales goals were achieved under an exclusive marketing
      agreement between Equita and a subsidiary of the Company (the “Option
      Agreement”), (b) a stock purchase agreement entered into in June 2003 between
      M&W and the Roy F. and Joann Cole Mitte Foundation, pertaining to the
      purchase of 204,918 shares of FIC’s common stock (the Stock Purchase
      Agreement”), and (c) a registration rights agreement entered into in June 2003
      among the plaintiffs and the Company, whereby the Company agreed to file and
      maintain a shelf registration statement with respect to the shares of FIC’s
      common stock purchased by M&W from the Mitte Foundation or which may be
      acquired in the future by Equita under the option agreement (the “Registration
      Rights Agreement,” and, collectively, the “Agreements”).





The
      suit
      alleges that the Company breached the provisions of the Option Agreement by
      refusing to indemnify the plaintiffs for losses relating to the alleged breach
      of certain representations and warranties included in the Option Agreement.
      The
      plaintiffs also allege that the Company required M&W to purchase 204,918
      shares of FIC common stock from the Mitte Foundation as a condition of Equita’s
      obtaining, in June 2003, an exclusive marketing agreement with a subsidiary
      of
      the Company pertaining to the distribution of insurance products in the “senior
      market” (the “Marketing Agreement”), and that such requirement was motivated by
      the desire of the Company’s management to obtain certain proxy rights obtained
      under a settlement agreement with the Mitte Foundation and the Mitte family.
      The
      plaintiffs further allege that the Company breached the provisions of the
      Registration Rights Agreement by failing to file a shelf registration with
      the
      SEC with respect to the shares of FIC’s common stock purchased by M&W from
      the Mitte Foundation and the shares which may be acquired in the future by
      Equita under the provisions of the Option Agreement. The plaintiffs seek
      rescission of the Agreements; damages in an amount equal to the $3 million
      that
      M&W paid to acquire FIC shares from the Mitte Foundation, together with
      interest and attorney’s fees and unspecified expenses; and an unspecified amount
      of exemplary damages.





Late
      in
      2005, the Company’s two life insurance subsidiaries, Investors Life and Family
      Life, intervened in the lawsuit to assert claims that Equita had breached its
      obligations under the Marketing Agreement with respect to the distribution
      of
      insurance products, thereby causing damages to the life insurance
      subsidiaries.  Equita moved to dismiss the intervention, but at a
      hearing on December 20, 2005, the court denied Equita’s motion.  As a
      result, Investors Life and Family Life will be permitted to assert their claims
      against Equita in this lawsuit.





Deposition
      discovery with respect to both the case filed by Equita and M&W, and the
      claims in intervention asserted by Family Life and Investors Life, began in
      October of 2006.





In
      response to a motion for partial summary judgment, the Company has stipulated
      to
      certain elements of some of the causes of action asserted by Equita and M&W,
      including that certain representations and warranties made in the Option
      Agreement were partially incorrect, and that FIC was unable to comply with
      certain of its obligations under the Option Agreement.  FIC did not
      stipulate, and continues to dispute, other elements of certain of the causes
      of
      action asserted by Equita and M&W, and disputes other causes of action in
      their entirety.





16
 *Index*





On
      or
      about May 8, 2007, Equita and M&W amended their petition, removing their
      claims under the Texas Securities Act and common-law fraud.  FIC
      intends to vigorously oppose the lawsuit and any effort by Equita and M&W to
      recover damages from FIC, and the life insurance subsidiary intends to
      vigorously prosecute its claims in intervention against Equita.




The
      Manhattan Life Insurance Company and Family Life Insurance Company v. Family
      Life Corporation, Investors Life Insurance Company of North America and FIC
      Insurance Services, L.P.




On
      April
      17, 2007, Manhattan Life and Family Life, filed a civil suit in the 215th Judicial
      District
      Court, Harris County, Texas, against Family Life Corporation, Investors Life
      and
      FIC Insurance Services, L.P. (“FICIS”), each a subsidiary of the
      Company.  The suit alleges that: a) Family Life Corporation breached
      the Stock Purchase Agreement with Manhattan life by competing with Family Life
      and accepting insurance “directly or indirectly” from active accounts of Family
      Life; b) FICIS breached the Administrative Services Agreement with Family Life
      by willfully communicating with or willfully assisting with the communication
      by
      its affiliates with policyholders in a manner intended to solicit Family Life
      accounts on behalf of Investors Life; c) FICIS breached fiduciary duties owed
      to
      Family Life in the administration and management of the accounts of the policy
      holders of Family Life by assisting in the conversion of Family Life policies
      to
      the policies of Investors Life, and by their actions, Investors Life and Family
      Life Corporation aided and abetted such breach of fiduciary duty; and, d) Family
      Life Corporation, Investors Life and FICIS have tortiously interfered with
      existing contracts of Family Life with its policyholders, including the Stock
      Purchase Agreement and the Administrative Services Agreement. In addition,
      FICIS
      has filed, and intends to vigorously prosecute, a counterclaim for amounts
      due and owing by Family Life for services performed pursuant to the
      Administrative Services Agreement. See note 9 regarding the sale of Family
      Life
      Insurance Company.





Management
      Conclusion on Legal Proceedings





In
      the
      opinion of the Company’s management, it is not currently possible to estimate
      the impact, if any, that the ultimate resolution of the foregoing legal
      proceedings will have on the Company’s results of operations, financial position
      or cash flows. Accordingly, no accrual for possible losses has been recorded
      in
      the accompanying consolidated financial statements for such legal
      proceedings.





Other
      Litigation





FIC
      and
      its insurance subsidiaries are regularly involved in litigation, both as a
      defendant and as a plaintiff. The litigation naming the insurance subsidiaries
      as defendant ordinarily involves our activities as a provider of insurance
      products. Management does not believe that any of this other litigation, either
      individually or in the aggregate, will have a material adverse effect on the
      Company’s results of operations, financial position, or cash flows.





**9.**
            **Subsequent
                Events**





Sale
      of Family Life Insurance Company





On
      December 29, 2006, the Company completed the sale of its wholly owned
      subsidiary, Family Life Insurance Company to The Manhattan Life Insurance
      Company ("Manhattan Life").  The cash sales price was $28.0 million,
      subject to certain post closing adjustments as set forth in the definitive
      agreement dated December 8, 2006.





Prior
      to
      the sale, Family Life owned 648,640 shares of FIC common stock.  Such
      shares are reflected as common treasury stock in the accompanying consolidated
      financial statements.  In conjunction with this transaction, the
      Company acquired from Family Life 324,320 of these shares and the remaining
      324,320 shares remained with Family Life at the time of sale. Also, prior to
      the
      closing of the sale, the Family Life Pension Plan, along with its assets and
      liabilities, was transferred from Family Life Insurance Company to its upstream
      parent company, Family Life Corporation (“FLC”). FLC is wholly owned by FIC and
      all current and future obligations of the Family Life Pension Plan are the
      responsibility of FLC.





In
      conjunction with the sale, Investors Life also entered into a coinsurance
      arrangement with Manhattan Life related to sales of certain future insurance
      products historically marketed by Family Life, such as traditional mortgage
      protection term life insurance.





At
      September 30, 2006, Family Life had assets totaling approximately $121.9 million
      and capital and surplus totaling approximately $16.3 million, as reported on
      a
      statutory basis of accounting for insurance regulatory purposes. The GAAP equity
      basis in Family Life, including other adjustments that affected the
      determination of loss from the sale, totaled approximately $52 million on the
      sale date. Accordingly, a GAAP loss of $24.4 million resulted from this
      sale.





17
 *Index*





Amendment
      of Subordinated Loans





FIC
      and
      FLC have subordinated notes payable to Investors Life with an unpaid balance
      of
      $15.4 million at September 30, 2006 and December 31, 2005.  With the
      approval of the Texas Department of Insurance, the loans were restructured
      as of
      March 9, 2006.  As amended, the loans provided for a one year
      moratorium on principal payments for the period from March 12, 2006, to December
      12, 2006, with principal payments to resume on March 12, 2007, with ten equal
      quarterly principal payments until the maturity date of June 12, 2009. These
      notes have been eliminated in the consolidated financial statements. The
      Company retired these subordinated notes payable on December 29, 2006 using
      a
      portion of the proceeds from the sale of Family Life Insurance
      Company.





18
 *Index*





**ITEM
      2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
      CONDITION AND RESULTS OF OPERATIONS**





The
      following discussion addresses the financial condition of Financial Industries
      Corporation (“FIC”) as of September 30, 2006, compared with December 31, 2005,
      and its results of operations for the three and nine-month periods ended
      September 30, 2006, compared with the same period last year. This discussion
      should be read in conjunction with Management’s Discussion and Analysis included
      in FIC’s Form 10-K for the year ended December 31, 2005, to which the reader is
      directed for additional information.





**Results
      of Operations – Three Months Ended September 30, 2006 and
      2005**





For
      the
      three month period ended September 30, 2006, the Company reported net income
      of
      $1.3 million (basic and diluted income $0.13 per common share) on revenues
      of
      $25.6 million compared to a net loss of $2.5 million (basic and diluted loss
      of
      $0.26 per common share) on revenues of $23.9 million for the three month period
      ended September 30, 2005. The three months ended September 30, 2006 and 2005
      include the impact of certain trends and changes in the business of the Company
      which are dominant in the results of the nine months ended September 30, 2006
      and 2005. These items are described in the nine-month results of operations
      below.  Of these results, certain significant items of change between
      the three months ended September 30, 2006 and 2005 which contribute to an
      improvement in net income of $3.8 million between periods are as
      follows:





·
            Increase
                in net investment income of $528,000 primarily due to increased holdings
                in fixed maturities and higher interest
                rates;


·
            Increase
                in other revenues of $598,000, primarily due to additional fee income
                resulting from the termination of a coinsurance agreement by an insurance
                subsidiary of the Company effective June 1, 2006. Under the agreement,
                the
                Company had ceded 90% of the risk associated with certain investment
                annuity policies classified as separate accounts
                business;


·
            Decline
                in realized losses of $704,000 primarily due to a $1 million impairment
                recorded for an investment in a fixed maturity security in
                2005;


·
            Decrease
                in policyholder benefits and expenses of $3.9 million primarily resulting
                from the decline in the amount of death
                claims;


·
            Increase
                in provision for federal income taxes of $1.8
                million.





**Results
      of Operations – Nine Months Ended September 30, 2006 and
      2005**





For
      the
      nine-month period ended September 30, 2006, FIC’s net income was $1.3 million
      (basic and diluted income of $0.13 per common share) on revenues of $76.2
      million as compared to net income of $1.0 million (basic and diluted earnings
      of
      $0.10 per common share) on revenues of $82.0 million in the first nine months
      of
      2005.





In
      2006,
      FIC’s net income was affected by the following items:





·
            Reduction
                in earned insurance charges of $1.2 million primarily due to the
                decline
                in the cost of insurance charges consistent with the trend of run-off
                of
                business;


·
            Increase
                in net investment income of $3.0 million, primarily due to the effects
                of
                higher market interest rates and increased levels of fixed maturity
                securities investments during the nine months of 2006 compared to
                the
                first nine months of 2005;


·
            Reduction
                in net realized investment gains of $8.1 million, primarily due to
                the
                sale of River Place Pointe office complex in
                2005;


·
            Increase
                in other revenues of $1.4 million, principally due to interest received
                on
                a federal income tax refund totaling approximately $0.6 million and
                additional fee income totaling approximately $0.5 million resulting
                from
                the recapture of the coinsurance agreement discussed
                previously;


·
            Decline
                in policyholder benefits and expenses of $3.1
                million,  primarily resulting from a decrease in the amount of
                death benefits;


·
            Decrease
                in interest on contractholders deposit funds of $1.2 million due
                primarily
                to lower funds on deposit;


·
            Decline
                in operating expenses of $1.0
                million;


·
            Increase
                in provision for federal income tax of
                $716,000.





The
      above
      described items need to be taken into consideration in drawing comparisons
      between the operating results for the nine months ended September 30, 2006
      and
      2005.





19
 *Index*





*Revenues*





Premium
      revenues reported for traditional life insurance products are recognized when
      due. Premium income for the first nine months of 2006, net of reinsurance ceded,
      was $17.5 million, as compared to $17.9 million in the first nine months of
      2005. This source of revenues is related to the traditional life insurance
      book
      of business of FIC’s insurance subsidiaries for both first year and renewal
      premiums.





In
      accordance with GAAP, deposits received by FIC in connection with annuity
      contracts and premiums received for universal life (“UL”) insurance policies are
      reflected in FIC’s financial statements as increases in liabilities for
      contractholder deposit funds and not as revenues. Earned insurance charges
      assessed against these deposits are reported as revenue. For the nine months
      ended September 30, 2006 and 2005, annuity deposits and UL premiums totaled
      $24.3 million and $25.4 million, respectively.





The
      decline in UL premiums and annuity deposits reflects the net run-off of business
      from the Company’s existing book of business, and declining sales of new UL
      policies. Although the Company is focusing on reversing these trends on an
      overall basis, management has de-emphasized the sale of annuity and UL products
      due primarily to the current interest-rate environment and certain design
      features of FIC’s current annuity products. Most of the Company’s marketing
      efforts are now focused on the sale of traditional life insurance products,
      such
      as mortgage protection term insurance and final expense whole life insurance.
      Liabilities for contractholder deposit funds have declined from $546.9 million
      at September 30, 2005 to $520.4 million at September 30, 2006.





Earned
      insurance charges totaled $29.1 million for the first nine months of 2006,
      as
      compared to charges of $30.3 million in the same period of 2005. These revenues
      primarily consist of UL cost of insurance charges, but also include policy
      surrender charges, and policy administration charges. The decline in earned
      insurance charges from 2005 to 2006 is primarily due to reduced UL cost of
      insurance charges resulting from the net run-off of business.





Net
      investment income for the first nine months of 2006 was $25.9 million as
      compared to $22.9 million in the same period of 2005. The increase in net
      investment income from 2005 to 2006 was primarily attributable to 1) an increase
      in the income received from the Company’s interest-bearing investments,
      resulting from increasing interest rates during 2006 and 2) an increase in
      total
      investments in fixed maturities, equity securities, and short-term investments
      compared to the first nine months of 2005, primarily due to reinvestment of
      real
      estate sales proceeds into such securities.  The Company’s average
      yield on investments and cash equivalents, excluding real estate, increased
      approximately 33 basis points over the comparable prior period.  The
      Company’s average holdings of investments and cash equivalents, excluding real
      estate, increased approximately $28 million over the comparable prior
      period.





Real
      estate income was primarily earned from the leases on the buildings at the
      Company’s River Place Pointe office complex in Austin, Texas. Real estate income
      (revenues from leases less associated operating expenses and depreciation)
      was
      $0 and $563,000 for the nine-month period ended September 30, 2006 and 2005,
      respectively.  In June 2005, the Company sold the River Place Pointe
      property. Also, as of December 31, 2005, the Company owned three remaining
      real
      estate properties held for sale with a total carrying value of
      $130,000.  All three properties were sold in January
      2006.  Accordingly, the Company no longer has real estate income in
      2006.





Net
      realized investment gains were $502,000 in the first nine months of 2006, as
      compared to $8.6 million in the first nine months of 2005. The realized gains
      for 2006 were primarily from the sale of the Company’s remaining real estate
      properties classified as held for sale, as previously described. The realized
      gains for 2005 were primarily from the sales of fixed maturity securities and
      the Company’s River Place Pointe office complex. As described in Note 4 to the
      accompanying financial statements, the Company recognized a realized gain of
      $8.5 million in the quarter ended June 30, 2005 from the sale of the River
      Place
      Pointe office complex.





Other
      income was $3.3 million in the first nine months of 2006, as compared to $1.9
      million for the same period of 2005. The significant increase in 2006 is
      primarily due to $573,000 of interest income received on Federal income tax
      refunds related to prior year amended tax returns, and increases in fee income
      resulting from the recapture of previously reinsured investment annuity separate
      account business as described in Note 7.





20
 *Index*





*Benefits
      and Expenses*





Policyholder
      benefits and expenses, which consist primarily of death benefit claims, were
      $28.7 million in the first nine months of 2006, as compared to $31.9 million
      in
      the first nine months of 2005. The decline in policyholder benefits and expenses
      in 2006 was primarily attributable to lower death claims.





Interest
      expense on contractholder deposit funds represents interest paid or credited
      to
      contractholders on cash values accumulated in their universal life insurance
      and
      annuity accounts.Interest expense totaled
      $15.4 million in the first nine months of 2006, as compared to $16.6 million
      in
      the same period of the year 2005. As discussed previously, the decline in UL
      premiums and annuity deposits reflects the net run-off of business from the
      Company’s existing book of business, and consequently the decrease in interest
      expense in 2006 is primarily attributable to this overall reduction in the
      level
      of contractholder deposit funds.





The
      level
      of market interest rates can effect the interest spread which is the difference
      in the Company’s investment portfolio rate and the interest rates credited on
      policyholder contracts for universal life insurance and annuities. The Company
      responded to lower market rates in 2004 and 2005 by lowering many of the
      credited rates on its policies in these periods. However, universal life
      insurance and annuity policies have contractual minimum guaranteed rates and
      credited rates cannot be lower than such minimums. Because many of the Company’s
      policies have minimum guaranteed rates of 4.0%, the market interest rate
      environment in prior periods put pressure on the Company’s interest spread.
      Market rate increases in 2005 and 2006 have improved the Company’s interest
      spread.





Amortization
      of deferred policy acquisition costs (DAC) for the first nine months of 2006
      was
      $6.5 million, as compared to $7.7 million in the same period in 2005. These
      expenses represent the amortization of the costs of producing new business,
      which consists primarily of agents’ commissions and certain policy issuance and
      underwriting costs. For traditional life insurance business, DAC is amortized
      over the estimated premium-paying period of the policies in proportion to annual
      premium revenue. For interest sensitive products, these costs are amortized
      in
      relation to the estimated annual gross profits of the policies. The level of
      policy lapses and surrenders can also have a significant impact on the amount
      of
      amortization, which was experienced in the second quarter of 2006. Lower policy
      lapses and surrenders for certain blocks of traditional life business resulted
      in the reduced amortization.





Present
      value of future profits of acquired business (PVFP) is amortized in a similar
      manner as DAC, as previously described, for acquired traditional and interest
      sensitive business. Amortization of PVFP totaled $1.7 million and $2.0 million
      for the nine months ended September 30, 2006 and 2005, respectively. The
      amortization is consistent with the run-off of the acquired blocks of
      business.





Operating
      expenses for the first nine months of 2006 were $20.8 million, as compared
      to
      $21.8 million in the first nine months of 2005. The Company has implemented
      many
      cost reduction measures in 2004 and 2005, as well as 2006, and this continues
      to
      be a critical focus for the Company.  However, audit, actuarial,
      accounting and other consulting, and legal expenses continue to
      represent a significant component of operating expenses as the Company completes
      its delinquent SEC filings with a target of becoming current on all filings
      at
      the end of the second quarter of 2007.  These fees totaled
      approximately $7.3 million and $5.5 million for the nine months ended September
      30, 2006 and 2005, respectively.





Interest
      expense was $1.0 million and $829,000 for the nine months ended September 30,
      2006 and 2005, respectively. The interest expense relates to debt service on
      $15
      million aggregate principal amount of floating rate Senior Notes due 2033 (the
      “Senior Notes”).  The Senior Notes bear interest quarterly at the
      three-month LIBOR rate plus 4.2%. The higher interest expense in 2006 is a
      direct result of the increase in the LIBOR rate.





*Taxes*





The
      provision for federal income taxes on loss from operations, before cumulative
      effect of change in accounting principles, reflects tax provisions totaling
      $859,000 and $143,000 for the nine months ended September 30, 2006 and 2005,
      respectively. These tax amounts equate to effective tax provision rates of
      40.7%
      and 12.3% for the nine months ended September 30, 2006 and 2005, respectively.
      The primary reason for the deviation from the expected statutory tax rate of
      34%
      for the Company is due to increases in the valuation allowance for deferred
      tax
      assets. Deferred income tax assets are subject to ongoing evaluation of whether
      such assets will be realized. Realization of deferred tax assets is dependent
      upon the Company's generation of sufficient taxable income in the future to
      recover tax benefits that cannot be recovered from taxes paid in prior periods.
      If future taxable income is not expected, the Company establishes a valuation
      allowance, when based on the weight of the available evidence, it is more likely
      than not that some portion of the deferred tax assets will not be realized.
      The
      Company’s deferred tax assets are primarily comprised of net operating losses of
      FIC and its non-life insurance subsidiaries.





21
 *Index*





**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 its insurance subsidiaries - Family Life
      Insurance Company (“Family Life”) and Investors Life Insurance Company of North
      America (“Investors Life”). As a holding company, FIC’s ability to pay interest
      and principal on its debt, pay its expenses, and pay dividends on its common
      stock depend substantially upon its receipt of dividends or other cash flow
      from
      these subsidiaries.





Liquidity
      management is designed to ensure that adequate funds are available to meet
      all
      current and future financial obligations. The Company meets its liquidity
      requirements primarily by funding cash used in operations with cash flows
      provided by investing activities. Proper liquidity management is crucial to
      preserve stable, reliable, and cost-effective sources of cash to meet the future
      benefit payments under our various insurance and deposit contracts, pay
      operating expenses (including interest and income taxes), and maintain reserve
      requirements. In this process, we focus on our assets and liabilities, and
      the
      impact of changes in both short-term and long-term interest rates, market
      liquidity and other factors.  We believe we have the ability to
      generate adequate cash flows to fund obligations as they come due.





At
      the
      holding company level, FIC’s principal current ongoing liquidity demands relate
      to the payment of principal and interest on its indebtedness. As of September
      30, 2005, Investors Life held $15.4 million of notes receivable from the Company
      (the “Affiliated Notes”) with quarterly interest payments at an annual rate of
      5%.  Although this intercompany indebtedness is eliminated on FIC’s
      condensed consolidated balance sheets, it creates a debt service requirement
      at
      the holding company level.





With
      the
      approval of the Texas Department of Insurance, the Affiliated Notes were
      restructured as of March 9, 2006.  As amended, the loans provide for a
      one year moratorium on principal payments for the period from March 12, 2006,
      to
      December 12, 2006, with principal payments to resume on March 12, 2007, with
      ten
      equal quarterly principal payments until the maturity date of June 12, 2009.
      As
      previously described in Note 9 of the accompanying financial statements, the
      Company retired the Affiliated Notes on December 29, 2006, using a portion
      of
      the proceeds from the sale of Family Life Insurance Company.





The
      holding company’s other principal liquidity requirement is debt service on the
      $15 million of Senior Notes.  These notes require quarterly interest
      payments at a variable interest rate of the three-month LIBOR rate plus 4.2%.
      The principal amount of the Senior Notes must be repaid in a single payment
      in
      2033.




In
      addition to these debt service requirements, the holding company must pay its
      expenses in connection with Board of Directors fees, insurance costs, corporate
      overhead, certain audit and accounting fees, and legal and consulting expenses
      as incurred. The holding company has not paid any dividends to its shareholders
      since early in 2003, and management does not anticipate the payment of such
      dividends in the near future.





In
      June
      2004, FIC, with the approval of the Texas Department of Insurance, formed a
      service company subsidiary and transferred to it many of the administrative
      functions of the insurance companies. The new service company charges each
      insurance company a monthly service fee that is calculated using a formula
      based
      on policies under management, new policies issued, managed assets, and other
      factors. Profits earned by the service company are paid as dividends to the
      holding company, providing an additional source of liquidity at the holding
      company level.




The
      ability of Family Life and Investors Life to pay dividends to FIC and help
      meet
      these holding-company liquidity demands is subject to restrictions set forth
      in
      the insurance laws and regulations of Texas, its domiciliary state. Texas limits
      how and when Family Life and Investors Life can pay such dividends by (a)
      including the “greater of" standard for payment of dividends to shareholders and
      (b) requiring that prior notification of a proposed dividend be given to the
      Texas Department of Insurance. Under the “greater of" standard, an insurer may
      pay a dividend in an amount equal to the greater of: (i) 10% of the capital
      and  surplus or (ii) the insurer's net gain from operations for the
      previous year.




Liquidity
      considerations at FIC’s insurance subsidiaries are different in nature than for
      the holding company. Sources of cash for FIC’s insurance subsidiaries consist of
      premium payments and deposits 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.





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 September 30, 2006
      were $520.4 million, compared to $542.2 million at December 31, 2005. Individual
      life insurance policies are less susceptible to withdrawal than are annuity
      contracts because life insurance policyholders may incur surrender charges
      and
      undergo a new underwriting process in order to obtain a new insurance policy.
      At
      September 30, 2006, the bulk of the liabilities for contractholder deposit
      funds
      on FIC’s balance sheet, $367.5 million, represented insurance products, as
      compared to $152.9 million of annuity product liabilities.





22
 *Index*





Since
      each insurance company holds large portfolios of highly liquid publicly traded
      debt securities, raising cash through asset sales is available should other
      sources of liquidity fail to provide cash as needed. In this regard, however,
      the insurance companies must be concerned about such sales at inopportune times,
      when adverse movements in interest rates may have depressed the market price
      of
      securities so that sales would result in the realization of significant losses.
      To guard against such an outcome, FIC’s management monitors benefits paid and
      surrenders of insurance products to provide projections of future cash
      requirements. Also as part of this monitoring process, FIC performs cash flow
      testing of assets and liabilities at each year-end to evaluate the match between
      the planned maturities of the insurance company assets and the likely liquidity
      needs of the companies over time. Such cash-flow testing, prescribed by
      insurance laws and regulations, models the likely performance of assets and
      liabilities over time, using a wide variety of future interest rate
      scenarios.





There
      can
      be no assurance that future experience regarding benefits and surrenders will
      be
      similar to the historic experience on which such cash-flow testing is based,
      since withdrawal and surrender levels are influenced by such factors as the
      interest-rate environment and general economic conditions as well as the
      claims-paying and financial strength ratings of FIC’s insurance
      subsidiaries.





Cash
      and
      cash equivalents at September 30, 2006 were $7.4 million compared to $63.6
      million at December 31, 2005. The $56.2 million decrease in cash and cash
      equivalents at September 30, 2006 from December 31, 2005 was due primarily
      to
      reinvestment of cash into fixed maturity securities and short-term investments.
      This was partially offset by the net payout of contractholder deposits and
      use
      of cash by operations.





Net
      cash
      used in operating activities was $4.5 million for the nine month period ended
      September 30, 2006, compared to $6.1 million for the same period of 2005. The
      decrease in cash used by operating activities of $1.5 million from 2005 to
      2006
      was primarily attributable to the change in net realized gains in investments
      as
      a result of the sale of the River Place Pointe office complex, agent advances
      and other receivables, policy liabilities and accruals and deferred income
      taxes.





Net
      cash
      used in investing activities was $32 million in the nine month period ended
      September 30, 2006, compared to $68.6 million provided by investing activities
      for the same period of 2005. The cash provided by investing activities in 2005
      was due primarily to proceeds received from the sale of the River Place Pointe
      office complex in 2005. Most of this cash was then reinvested in fixed
      maturities and short-term investments in 2006.





Net
      cash
      used in financing activities was $19.7 million in the first nine months of
      2006,
      compared to cash used in financing activities of $27.6 million in the first
      nine
      months of 2005. The most significant components of the Company’s financing
      activities are contractholder fund deposits and withdrawals for annuity and
      universal life insurance policies.  For the nine months ended
      September 30, 2006 and 2005, contractholder fund withdrawals exceeded deposits
      by $19.7 million and $27.6 million respectively. The change in net withdrawals
      in 2006 is due to a decline in deposits in 2006 from 2005 of $1.1 million and
      a
      decrease in withdrawals of $9.0 million for the same period.





In
      light
      of the information and considerations outlined above, management believes at
      this time that the liquidity of FIC and its subsidiaries is sufficient to meet
      the needs of its business, including its debt service requirements.





**Financial
      Condition**





During
      the nine months ended September 30, 2006, the equity of the shareholders of
      the
      Company (that is, the excess of the Company’s assets over its liabilities)
      declined by $1.4 million. The primary changes resulting in the net decrease
      to
      shareholders’ equity are detailed as follow:





•
            Net
                income for the nine months of $1.3
                million;


•
            $2.8
                million increase in accumulated other comprehensive loss from the
                change
                in net unrealized losses on investments in fixed maturity securities
                available for sale.





*Assets*





The
      Company’s life insurance subsidiaries have investment management agreements with
      Conning Asset Management (“Conning”). Under these agreements, Conning manages
      the investment security portfolios of the Company’s life insurance subsidiaries
      in accordance with investment policies set by the Company’s Board of Directors.
      The investment policies comply with legal requirements of state insurance laws
      and regulations that are applicable to the Company’s insurance company
      subsidiaries. They also emphasize sensitivity to the way that FIC’s liabilities
      are likely to change over time and with changes in general interest rate levels.
      In practical terms, this means that the Company focuses almost all of its
      investment in investment-grade securities, keeping the schedule of anticipated
      asset maturities in line with its projected cash needs. It also means that
      the
      Company attempts to keep the duration of its investment assets (a measure of
      the
      sensitivity of their value to changes in interest rates) in line with the
      duration of the Company’s liabilities.





23
 *Index*





Over
      the
      past several years, the Company has decreased its investment in mortgage-backed
      securities (including asset-backed securities) significantly. This trend
      continued into 2006. Expressed as a percentage of its total investment in fixed
      maturities, these ratios were 24.4% and 22.1% at December 31, 2005 and September
      30, 2006 respectively.  Such securities are sensitive to changes in
      prevailing interest rates, since interest rate levels affect the rate at which
      the underlying mortgage obligations are repaid. 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.





During
      the first nine months of 2006, net unrealized losses on fixed maturities
      available for sale increased $2.8 million.  The increase in unrealized
      losses was primarily related to increases in market interest
      rates.  The Company’s general investment philosophy is to hold fixed
      maturities for long-term investment.  Accordingly, the Company has the
      ability and intent to hold securities to maturity or until they recover in
      value.  The Company does not currently anticipate the need to sell
      securities in unrealized loss positions for liquidity purposes.





FIC’s
      equity securities consist primarily of its investment in the investment funds
      underlying the separate accounts business of Investors Life Insurance Company
      of
      North America (“Investors Life”). However, during 2005, the Company increased
      its equity securities holdings by investing $2.0 million in a corporate bond
      mutual fund as part of a strategy to increase diversification and enhance
      overall investment performance. As of September 30, 2006, the market value
      of
      FIC’s equity securities was $11.3 million, compared to $10.9 million at December
      31, 2005.





FIC’s
      real estate investment was primarily related to the River Place Pointe office
      complex (“River Place Pointe”) owned by Investors Life. At March 31, 2005, FIC’s
      investment totaled $89.8 million in this 600,000 sq. ft., seven-building office
      complex on 48 acres in Austin, Texas. FIC and its insurance company subsidiaries
      occupied one of the seven buildings. Three of the other buildings were
      substantially leased, but three buildings remained vacant as of March 31, 2005.
      The project was sold in June 2005, in a cash transaction, for $103 million.
      The
      Company realized a gain of $10.6 million on the sale, which included both a
      realized gain of $8.5 million recorded in 2005 and a deferred gain of $2.1
      million to be recognized as a reduction of office lease expenses over the period
      from the sale date through March 31, 2008. The deferred gain represents an
      amount equal to the estimated excess rent to be paid under the lease agreement
      through March 31, 2008 over the prevailing rate at the time of sale. The
      Company’s remaining real estate properties held for sale totaling $130,000 at
      December 31, 2005, were sold in January, 2006.





Agency
      advances and other receivables totaled $13.3 million and $8.2 million at
      September 30, 2006 and December 31, 2005, respectively. The $5.1 million
      increase was primarily due to a receivable related to a securities transaction,
      where a security matured at quarter end but the cash was not received until
      after September 30, 2006, thereby resulting in the receivable balance. This
      increase was partially offset by a reduction in current federal income taxes
      receivable.





Investors
      Life had $341.8 million of separate account assets as of September 30, 2006
      (not
      including the value of the Company’s own investment in one of the accounts), as
      compared to $342.9 million at the end of 2005. These assets include (a) two
      variable annuity separate accounts that permit contractholders to allocate
      their
      contract values among a selection of third-party mutual funds and (b) assets
      held in custodian accounts in connection with investment annuity contracts.
      The
      investment annuity business is reinsured with Symetra Life Insurance Company
      (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10%
      coinsurance basis, with Investors Life retaining 10% of such business. Since
      the
      reinsurance treaty is on a coinsurance basis, Investors Life is contingently
      liable to the policyholders in the event that the reinsurer is unable to fulfill
      its obligations under the treaty. Investors Life is not marketing new separate
      account annuity contracts.





Effective
      June 1, 2006, Investors Life recaptured the previously reinsured investment
      annuity business with Symetra Life resulting in the retention of 100% of this
      business. The Company expects the recapture of this previously reinsured
      business to increase revenues in 2006 and future years. However, as this is
      a
      closed block of business, the revenues are expected to decrease as the policies
      in force decline.





24
 *Index*





*Liabilities*





The
      Company’s insurance-related liabilities (future policy benefits and
      contractholder deposit funds) were $674.2 million at September 30, 2006,
      compared to $698.2 million at December 31, 2005. The decrease in these
      insurance-related liabilities reflects the business run-off as previously
      described.





Deferred
      federal income taxes at December 31, 2005 reflected a net liability of
      $687,000.  This deferred tax position changed to a net liability of
      $413,000 at September 30, 2006.  This significant change in deferred
      taxes was primarily due to tax benefits associated with unrealized losses on
      the
      Company’s fixed maturity securities portfolio, resulting from increases in
      market interest rates during the first nine months of 2006.





*Capital
      Adequacy*




Financial
      intermediaries such as FIC depend on their equity capital to absorb short-term
      fluctuations in asset and liability values in their financial structures. They
      also count on equity capital to support the growth of the business. One typical
      measure of the strength of a financial holding company such as FIC is the simple
      ratio of its shareholders’ equity to its total assets. For FIC this ratio was 7%
      at September 30, 2006 and December 31, 2005. If separate account assets were
      not
      included (which management believes is appropriate) this ratio would have been
      higher by 3% and 2.9% at September 30, 2006 and December 31, 2005, respectively.
      Management believes that its current equity capital is sufficient to meet the
      Company’s current liabilities and to fund growth at currently planned
      levels.




Insurance
      companies are subject to regulation under state law. Among other requirements,
      these state laws and regulations impose capital adequacy requirements on
      insurance companies. Using a calculation that takes into account the quality,
      liquidity, maturities, and amounts of its assets and liabilities, each insurance
      company is required to calculate its “risk-based capital” (or “RBC”). Total
      adjusted capital must exceed 200% of the authorized control level RBC to avoid
      supervisory activity by the insurance regulators. As of December 31, 2006,
      the
      total adjusted capital of Investors Life was approximately 584% of its
      authorized control level risk-based capital.





State
      regulators also use NAIC IRIS ratios to monitor capital adequacy requirements.
      The NAIC ratios cover 12 categories of financial data with defined “usual”
ranges for each such category. The ratios are intended to provide insurance
      regulators with “early warnings” as to when a company might warrant special
      attention. An insurance company may fall outside of the usual range for one
      or
      more ratios, and such variances may result from specific transactions that
      are,
      by themselves, immaterial or eliminated at the consolidation level. In certain
      states, insurers with more than three IRIS ratios outside of the NAIC usual
      ranges may be subject to increased regulatory oversight. For 2006 Investors
      Life
      had four ratios which were outside the usual ranges, which were primarily
      related to changes in investment income and changes in premium, product mix,
      and
      reserving. The ratios were outside the usual ranges primarily due to a recapture
      of ceded reinsurance by Family Life from Investors Life during
      2006.  This recapture occurred prior to the sale of Family
      Life.  For statutory accounting purposes, the recapture affected
      premium income and change in policy reserves which caused ratios to fall outside
      the usual ranges.  Excluding the effects of the reinsurance recapture,
      Investors Life would have had only one ratio outside the usual ranges, which
      related to investment income.





**ITEM
      3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**





*General*





FIC’s
      principal assets are financial instruments, which are subject to market risks.
      Market risk is the risk of loss arising from adverse changes in market rates,
      principally interest yields on fixed rate investments. For a discussion of
      the
      Company’s investment portfolio and the management of that portfolio to reflect
      the nature of the underlying insurance obligations of the Company’s insurance
      subsidiaries, please refer to the information set forth in “Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.”





The
      following is a discussion of the Company’s primary market-risk-sensitive
      instruments. It should be noted that this discussion has been developed using
      estimates and assumptions. Actual results may differ materially from those
      described below. Further, the following discussion does not take into account
      actions that could be taken by management in response to the assumed changes
      in
      market rates. In addition, the discussion does not take into account other
      types
      of risks that may be involved in the business operations of the Company, such
      as
      the reinsurance recoveries on reinsurance treaties with third party
      insurers.





The
      primary market risk to the Company’s investment portfolio is interest rate
      risk.  The Company does not use derivative financial
      instruments.





25
 *Index*





*Interest-Rate
      Risk*





The
      Company manages the interest-rate risk inherent in its fixed maturity assets
      relative to the interest-rate risk inherent in its liabilities. Generally,
      we
      manage interest-rate risk based on the application of a commonly used model.
      The
      model projects the impact of interest rate changes on a range of factors,
      including duration and potential prepayment. For example, assuming an immediate
      increase of 100 basis points in interest rates, the net hypothetical loss in
      fair market value related to the financial instruments included in the Company’s
      condensed consolidated balance sheets is estimated to be $31.1 million at
      September 30, 2006 and $26.6 million at December 31, 2005. For purposes of
      the
      foregoing estimate, fixed maturity securities available for sale and short-term
      investments were taken into account. The fair value of such assets was $624.0
      million at September 30, 2006 and $595.0 million at December 31,
      2005.





The
      fixed
      income investments of the Company include certain mortgage-backed securities
      (excluding asset backed securities). The market value of such securities was
      $134.4 million at September 30, 2006 and $145.5 million at December 31, 2005.
      Assuming an immediate increase of 100 basis points in interest rates, the net
      hypothetical loss in the fair value related to such mortgage-backed securities
      is estimated to be $10.4 million at September 30, 2006 and $10.7 million at
      December 31, 2005.





Separate
      account assets have not been included, since gains and losses on those assets
      generally accrue to the policyholders.





The
      Company generally does not use derivative financial instruments to manage its
      exposure to fluctuations in interest rates.





**ITEM
      4. CONTROLS AND PROCEDURES**





The
      Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) or
      15d-15(e) of the Exchange Act, are designed to ensure that information required
      to be disclosed in its reports filed with the SEC is recorded, processed,
      summarized and reported within the time periods specified in the Commission’s
      rules and forms, and that such information is accumulated and communicated
      to
      its management, including its Chief Executive Officer and Chief Financial
      Officer, as appropriate, to allow for timely discussions regarding required
      disclosure. In designing and evaluating the disclosure controls and procedures,
      management recognizes that any controls and procedures, no matter how well
      designed and operated, can provide only reasonable assurance of achieving the
      desired control objectives and are subject to certain limitations, including
      the
      exercise of judgment by individuals, the inability to identify unlikely future
      events, and the inability to eliminate misconduct completely. As a result,
      there
      can be no assurance that the Company’s disclosure controls and procedures will
      prevent all errors or fraud or ensure that all material information will be
      made
      known to management in a timely fashion.





Management
      has completed an evaluation of the effectiveness of the design and operation
      of
      the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under
      the Securities Exchange Act of 1934, as amended. This evaluation has allowed
      management to make conclusions, as set forth below, regarding the state of
      the
      Company’s disclosure controls and procedures as of September 30,
      2006.  Based on its evaluation and the identification of material
      weakness in internal control over financial reporting described below, and
      because of an inability to file the Quarterly Report on Form 10-Q within the
      statutory time period, FIC’s Chief Executive Officer and Chief Financial Officer
      have concluded that, as of September 30, 2006, FIC’s disclosure controls and
      procedures were ineffective.





Management
      had assessed our internal control over financial reporting as of December 31,
      2005, the end of our most recent fiscal year. Management based its assessment
      on
      criteria established in Internal Control—Integrated Framework issued by the
      Committee of Sponsoring Organizations of the Treadway Commission. As disclosed
      in the Company’s Annual Report on Form 10−K for the fiscal year ended December
      31, 2005, in performing its assessment of internal control over financial
      reporting, management determined that material weaknesses existed in the
      Company’s internal controls relating to the following areas: control
      environment, risk assessment, control monitoring, financial close and reporting,
      segregation of duties, reconciliations, use of third-party service providers,
      safeguarding of assets, reinsurance, and policy data integrity.





Following
      its identification of the above-described internal control weaknesses, the
      Company has been actively engaged in the implementation of remediation efforts
      to address the material weaknesses in its internal control over financial
      reporting as of September 30, 2006. The Company’s major remediation activities
      for the third quarter of 2006 are described below.





During
      the third quarter of 2006, the Company continued to improve reinsurance
      processing by installing new software to automatically generate reinsurance
      transactions when reinsurance related policy changes were made on the Company’s
      second largest policy administration system.  Although improvements
      have been made in the reinsurance internal controls, additional remediation
      efforts are required in order to completely eliminate the reinsurance material
      weakness described in the Company’s 2005 Form 10-K.





26
 *Index*





In
      addition to the above remediation actions, during the third quarter of 2006
      the
      Company moved its internal stock transfer processing to an outside service
      provider.  New internal control activities were established during the
      third quarter of 2006 in order to ensure that activities related to the
      administration by this group produced reliable financial reporting.








**PART
      II.  OTHER INFORMATION**





**ITEM
      1.  LEGAL PROCEEDINGS**





The
      Company and its subsidiaries are defendants in certain legal actions related
      to
      the normal business operations of the Company. Management believes that the
      resolution of such legal actions will not have a material impact on the
      condensed consolidated financial statements.





T.
      David Porter v. Financial Industries Corporation




On
      May
      31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis
      County, Texas District Court (the “Court”), against the Company, seeking to
      compel the Company to hold an annual meeting of shareholders. FIC has been
      unable to solicit proxies for an annual meeting because it has not been able
      to
      comply with Rule 14a-3 of the Securities Exchange Act of 1934, which requires
      that the Company provide an annual report containing current financial
      statements to shareholders in connection with an annual meeting.





Mr.
      Porter sued under Article 2.24(B) of the Texas Business Corporation Act, which
      provides that if an annual meeting of shareholders is not held within any
      13-month period and a written consent of shareholders has not been executed
      instead of a meeting, any court of competent jurisdiction in the county in
      which
      the principal office of the corporation is located may, on the application
      of
      any shareholder, summarily order a meeting to be held. On August 7, 2006, the
      Company entered into an Agreed Order On Plaintiff’s Motion to Compel Annual
      Shareholders Meeting and agreed among other things to hold an annual
      shareholders meeting for the election of directors on December 6, 2006. The
      Company made arrangements for, and was prepared to hold, an annual meeting
      of
      shareholders on December 6, 2006, as required by the Agreed Order, but the
      Company was unable to hold the meeting on the appointed date because no quorum
      was present.





On
      December 12, 2006, FIC filed a Motion for Summary Judgment seeking dismissal
      of
      Porter’s suit on the grounds that the Agreed Order did not dispense with the
      requirement of a quorum; the lack of a quorum was a direct and foreseeable
      result of Mr. Porter’s insistence on a one-sided solicitation and election; FIC
      had complied with its obligations under the Agreed Order and Mr. Porter has
      obtained all relief sought by his petition. FIC’s Motion for Summary Judgment
      remains pending and has not been heard.





Prior
      to
      a hearing on FIC’s Motion for Summary Judgment, Mr. Porter applied for a
      temporary restraining order and temporary injunction requiring the Company
      to
      convene one or more additional meetings of shareholders, contending that in
      the
      absence of a quorum on December 6, Texas law and the Company’s bylaws entitled a
      majority of the shareholders in attendance to choose a date to which the meeting
      would be adjourned. The District Court held a hearing on Porter’s application,
      and on December 22, 2006 entered an order requiring among other things that
      FIC
      hold an annual shareholders meeting for the election of directors on January
      16,
      2007, but stating that if a quorum was not present on that date, FIC would
      not
      be required to hold an annual meeting of shareholders at any time before July
      17, 2007. The Company made arrangements for, and was prepared to hold, an annual
      meeting of shareholders on January 16, 2007, as required by the Court’s order,
      but the Company was again unable to hold the meeting on the appointed date
      because no quorum was present.  No further action has been taken by
      Mr. Porter, whose suit remains pending.





Litigation
      with Equita Financial and Insurance Services of Texas, Inc. and M&W
      Insurance Services, Inc.





On
      June
      2, 2005, Equita and M&W Insurance Services, Inc. (“M&W”) filed a civil
      suit in Travis County, Texas District Court against the Company. The suit
      alleges that, in entering into certain agreements with the plaintiffs, the
      Company made certain misrepresentations and omissions as to its business and
      financial condition. The agreements referenced in the suit consist of (a) an
      option agreement entered into in June 2003 between Equita and the Company,
      granting Equita the right to purchase shares of FIC’s common stock at $16.42 per
      share, if certain sales goals were achieved under an exclusive marketing
      agreement between Equita and a subsidiary of the Company (the “Option
      Agreement”), (b) a stock purchase agreement entered into in June 2003 between
      M&W and the Roy F. and Joann Cole Mitte Foundation, pertaining to the
      purchase of 204,918 shares of FIC’s common stock (the Stock Purchase
      Agreement”), and (c) a registration rights agreement entered into in June 2003
      among the plaintiffs and the Company, whereby the Company agreed to file and
      maintain a shelf registration statement with respect to the shares of FIC’s
      common stock purchased by M&W from the Mitte Foundation or which may be
      acquired in the future by Equita under the option agreement (the “Registration
      Rights Agreement,” and, collectively, the “Agreements”).





27
 *Index*





The
      suit
      alleges that the Company breached the provisions of the Option Agreement by
      refusing to indemnify the plaintiffs for losses relating to the alleged breach
      of certain representations and warranties included in the Option Agreement.
      The
      plaintiffs also allege that the Company required M&W to purchase 204,918
      shares of FIC common stock from the Mitte Foundation as a condition of Equita’s
      obtaining, in June 2003, an exclusive marketing agreement with a subsidiary
      of
      the Company pertaining to the distribution of insurance products in the “senior
      market” (the “Marketing Agreement”), and that such requirement was motivated by
      the desire of the Company’s management to obtain certain proxy rights obtained
      under a settlement agreement with the Mitte Foundation and the Mitte family.
      The
      plaintiffs further allege that the Company breached the provisions of the
      Registration Rights Agreement by failing to file a shelf registration with
      the
      SEC with respect to the shares of FIC’s common stock purchased by M&W from
      the Mitte Foundation and the shares which may be acquired in the future by
      Equita under the provisions of the Option Agreement. The plaintiffs seek
      rescission of the Agreements; damages in an amount equal to the $3 million
      that
      M&W paid to acquire FIC shares from the Mitte Foundation, together with
      interest and attorney’s fees and unspecified expenses; and an unspecified amount
      of exemplary damages.





Late
      in
      2005, the Company’s two life insurance subsidiaries, Investors Life and Family
      Life, intervened in the lawsuit to assert claims that Equita had breached its
      obligations under the Marketing Agreement with respect to the distribution
      of
      insurance products, thereby causing damages to the life insurance
      subsidiaries.  Equita moved to dismiss the intervention, but at a
      hearing on December 20, 2005, the court denied Equita’s motion.  As a
      result, Investors Life and Family Life will be permitted to assert their claims
      against Equita in this lawsuit.





Deposition
      discovery with respect to both the case filed by Equita and M&W, and the
      claims in intervention asserted by Family Life and Investors Life, began in
      October of 2006.





In
      response to a motion for partial summary judgment, the Company has stipulated
      to
      certain elements of some of the causes of action asserted by Equita and M&W,
      including that certain representations and warranties made in the Option
      Agreement were partially incorrect, and that FIC was unable to comply with
      certain of its obligations under the Option Agreement.  FIC did not
      stipulate, and continues to dispute, other elements of certain of the causes
      of
      action asserted by Equita and M&W, and disputes other causes of action in
      their entirety.





On
      or
      about May 8, 2007, Equita and M&W amended their petition, removing their
      claims under the Texas Securities Act and common-law fraud.  FIC
      intends to vigorously oppose the lawsuit and any effort by Equita and M&W to
      recover damages from FIC, and the life insurance subsidiary intends to
      vigorously prosecute its claims in intervention against Equita.




The
      Manhattan Life Insurance Company and Family Life Insurance Company v. Family
      Life Corporation, Investors Life Insurance Company of North America and FIC
      Insurance Services, L.P.




On
      April
      17, 2007, Manhattan Life and Family Life, filed a civil suit in the 215th Judicial
      District
      Court, Harris County, Texas, against Family Life Corporation, Investors Life
      and
      FIC Insurance Services, L.P. (“FICIS”), each a subsidiary of the
      Company.  The suit alleges that: a) Family Life Corporation breached
      the Stock Purchase Agreement with Manhattan life by competing with Family Life
      and accepting insurance “directly or indirectly” from active accounts of Family
      Life; b) FICIS breached the Administrative Services Agreement with Family Life
      by willfully communicating with or willfully assisting with the communication
      by
      its affiliates with policyholders in a manner intended to solicit Family Life
      accounts on behalf of Investors Life; c) FICIS breached fiduciary duties owed
      to
      Family Life in the administration and management of the accounts of the policy
      holders of Family Life by assisting in the conversion of Family Life policies
      to
      the policies of Investors Life, and by their actions, Investors Life and Family
      Life Corporation aided and abetted such breach of fiduciary duty; and, d) Family
      Life Corporation, Investors Life and FICIS have tortiously interfered with
      existing contracts of Family Life with its policyholders, including the Stock
      Purchase Agreement and the Administrative Services Agreement. In addition,
      FICIS
      has filed, and intends to vigorously prosecute, a counterclaim for amounts
      due
      and owing by Family Life for services performed pursuant to the Administrative
      Services Agreement.





Management
      Conclusion on Legal Proceedings





In
      the
      opinion of the Company’s management, it is not currently possible to estimate
      the impact, if any, that the ultimate resolution of the foregoing legal
      proceedings will have on the Company’s results of operations, financial position
      or cash flows. Accordingly, no accrual for possible losses has been recorded
      in
      the accompanying consolidated financial statements for such legal
      proceedings.





28
 *Index*





Other
      Litigation





FIC
      and
      its insurance subsidiaries are regularly involved in litigation, both as a
      defendant and as a plaintiff. The litigation naming the insurance subsidiaries
      as defendant ordinarily involves our activities as a provider of insurance
      products. Management does not believe that any of this other litigation, either
      individually or in the aggregate, will have a material adverse effect on the
      Company’s results of operations, financial position, or cash flows.





**ITEM
      1A.  RISK FACTORS**





As
      of
      September 30, 2006, there have been no material changes to risk factors as
      previously disclosed in the Company’s 2005 Form 10-K.





**ITEM
      2.  CHANGES IN SECURITIES AND USE OF
      PROCEEDS**





None





**ITEM
      3.  DEFAULTS UPON SENIOR
      SECURITIES**





None





**ITEM
      4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS**





There
      were no matters submitted to a
      vote of security holders during the third quarter of 2006.





**ITEM
      5.  OTHER INFORMATION**





None





**ITEM
      6.  EXHIBITS**





(a)
            Exhibits





31.1
            Certification
                of Chief Executive Officer of FIC pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002


31.2
            Certification
                of Chief Financial  Officer of FIC pursuant to Section 302 of
                the Sarbanes-Oxley Act of 2002


32.1
            Certification
                of Chief Executive Officer of FIC pursuant to 18 U.S.C. Section
                1350


32.2
            Certification
                of Chief Financial Officer of FIC pursuant to 18 U.S.C. Section
                1350





29
 *Index*





**Signatures**




Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned, thereunto
      duly authorized.




FINANCIAL
                INDUSTRIES CORPORATION(Registrant)Date:
                May 31, 2007
            By:
            /s/
                William B. ProutyWilliam
                B. ProutyChief
                Executive OfficerDate:
                May 31, 2007
            By:
            /s/
                Vincent L. KaschVincent
                L. KaschChief
                Financial Officer(Principal
                Accounting and Financial Officer)






30