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 June 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 o 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
                filer x
            
            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 June 30, 2006 and
                    December 31, 2005
                4Condensed
                    Consolidated Statements of Operations For the three
                    and six month periods ended June 30, 2006 and June 30,
                    2005
                6Condensed
                    Consolidated Statements of Cash Flows For the six
                    month periods ended June 30, 2006 and June 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)


June
                30,
              2006
            
            
            December
                31,
              2005
                (1)ASSETSInvestments:Fixed
                maturity securities available for sale, at  fair value
                (amortized cost of $646,037 and $605,803 at June 30, 2006 and December
                31,
                2005, respectively)
            
            $
            612,546
            
            
            $
            593,752Equity
                securities, at fair value (cost of $8,694 and $8,405 at June 30,
                2006 and
                December 31, 2005, respectively)
            
            
            10,891
            
            
            
            10,907Policy
                loans
            
            
            36,225
            
            
            
            37,637Real
                estate held for sale
            
            
            -
            
            
            
            130Short-term
                investments
            
            
            4,984
            
            
            
            1,204Total
                investments
            
            
            664,646
            
            
            
            643,630Cash
                and cash equivalents
            
            
            13,028
            
            
            
            63,581Deferred
                policy acquisition costs
            
            
            54,178
            
            
            
            50,805Present
                value of future profits of acquired business
            
            
            16,006
            
            
            
            15,865Agency
                advances and other receivables, net of allowances for doubtful accounts
                of
                $3,544 and $3,513 as of June 30, 2006 and December 31,
                2005
            
            
            2,248
            
            
            
            8,188Reinsurance
                receivables
            
            
            33,128
            
            
            
            38,108Accrued
                investment income
            
            
            7,972
            
            
            
            7,165Due
                premiums
            
            
            1,614
            
            
            
            2,048Property
                and equipment, net
            
            
            816
            
            
            
            1,033Deferred
                income taxes
            
            
            5,225
            
            
            
            -Other
                assets
            
            
            2,308
            
            
            
            2,088Separate
                account assets
            
            
            333,251
            
            
            
            342,911Total
                assets
            
            $
            1,134,420
            
            
            $
            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)


June
                30,
              2006
            
            
            December
                31,
              2005
                (1)LIABILITIES
                AND SHAREHOLDERS’ EQUITYLiabilities:Policy
                liabilities and contractholder deposit funds:Contractholder
                deposit funds
            
            $
            526,821
            
            
            $
            542,181Future
                policy benefits
            
            
            154,330
            
            
            
            155,970Other
                policy claims and benefits payable
            
            
            9,698
            
            
            
            11,456Notes
                payable
            
            
            15,000
            
            
            
            15,000Deferred
                federal income taxes
            
            
            -
            
            
            
            687Other
                liabilities
            
            
            24,095
            
            
            
            25,146Separate
                account liabilities
            
            
            333,251
            
            
            
            342,911Total
                liabilities
            
            
            1,063,195
            
            
            
            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; 9,849 shares outstanding in 2006
                and
                2005
            
            
            2,504
            
            
            
            2,504Additional
                paid-in capital
            
            
            70,377
            
            
            
            70,377Accumulated
                other comprehensive loss
            
            
            (21,140
            )
            
            
            (10,339
            )Retained
                earnings
            
            
            42,440
            
            
            
            42,485Common
                treasury stock, at cost, 2,668 shares in 2006 and 2005
            
            
            (22,956
            )
            
            
            (22,956
            )Total
                shareholders’ equity
            
            
            71,225
            
            
            
            82,071Total
                liabilities and shareholders’ equity
            
            $
            1,134,420
            
            
            $
            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 June 30,2006
            
            
            2005Revenues:Premiums,
                net
            
            $
            5,853
            
            
            $
            5,877Earned
                insurance charges
            
            
            9,679
            
            
            
            10,210Net
                investment income
            
            
            8,626
            
            
            
            7,805Real
                estate income
            
            
            -
            
            
            
            51Net
                realized investment gains (losses)
            
            
            (15
            )
            
            
            8,910Other
            
            
            1,417
            
            
            
            674Total
                revenues
            
            
            25,560
            
            
            
            33,527Benefits
                and expenses:Policyholder
                benefits and expenses
            
            
            8,865
            
            
            
            10,069Interest
                expense on contractholders deposit funds
            
            
            5,083
            
            
            
            5,647Amortization
                of deferred policy acquisition costs
            
            
            1,853
            
            
            
            3,170Amortization
                of present value of future profits of acquired business
            
            
            568
            
            
            
            657Operating
                expenses
            
            
            6,350
            
            
            
            7,404Interest
                expense
            
            
            349
            
            
            
            277Total
                benefits and expenses
            
            
            23,068
            
            
            
            27,224Income
                before federal income taxes
            
            
            2,492
            
            
            
            6,303Provision
                for federal income taxes
            
            
            751
            
            
            
            1,621Net
                income
            
            $
            1,741
            
            
            $
            4,682





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 June 30,2006
            
            
            2005Net
                Income Per Share:Basic:Weighted
                average common shares outstanding
            
            
            9,849
            
            
            
            9,810Basic
                earnings per share
            
            $
            0.18
            
            
            $
            0.48Diluted:Weighted
                average common shares and common share equivalents
            
            
            9,849
            
            
            
            9,810Diluted
                earnings per share
            
            $
            0.18
            
            
            $
            0.48





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)





Six
                Months Ended June 30,2006
            
            
            2005Revenues:Premiums,
                net
            
            $
            11,356
            
            
            $
            11,981Earned
                insurance charges
            
            
            19,444
            
            
            
            20,334Net
                investment income
            
            
            17,236
            
            
            
            14,748Real
                estate income
            
            
            -
            
            
            
            547Net
                realized investment gains
            
            
            501
            
            
            
            9,270Other
            
            
            2,074
            
            
            
            1,246Total
                revenues
            
            
            50,611
            
            
            
            58,126Benefits
                and expenses:Policyholder
                benefits and expenses
            
            
            20,687
            
            
            
            19,936Interest
                expense on contractholders deposit funds
            
            
            10,306
            
            
            
            11,147Amortization
                of deferred policy acquisition costs
            
            
            4,124
            
            
            
            5,667Amortization
                of present value of future profits of acquired business
            
            
            1,173
            
            
            
            1,323Operating
                expenses
            
            
            13,415
            
            
            
            14,587Interest
                expense
            
            
            678
            
            
            
            532Total
                benefits and expenses
            
            
            50,383
            
            
            
            53,192Income
                before federal income taxes
            
            
            228
            
            
            
            4,934Provision
                for federal income taxes
            
            
            273
            
            
            
            1,395Net
                income (loss)
            
            $
            (45
            )
            
            $
            3,539





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)


Six
                Months Ended June 30,2006
            
            
            2005Net
                Income Per Share:Basic:Weighted
                average common shares outstanding
            
            
            9,849
            
            
            
            9,808Basic
                earnings per share
            
            $
            -
            
            
            $
            0.36Diluted:Weighted
                average common shares and common share equivalents
            
            
            9,849
            
            
            
            9,808Diluted
                earnings per share
            
            $
            -
            
            
            $
            0.36





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)


Six
                Months Ended June 30,2006
            
            
            2005CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income (loss)
            
            $
            (45
            )
            
            $
            3,539Adjustments
                to reconcile net income to net cash provided by  (used in)
                operating activities:Amortization
                of deferred policy acquisition costs
            
            
            4,124
            
            
            
            5,667Amortization
                of present value of future profits of acquired business
            
            
            1,173
            
            
            
            1,323Net
                realized gains on investments
            
            
            (501
            )
            
            
            (9,270
            )Depreciation
            
            
            239
            
            
            
            1,612Increase
                in accrued investment income
            
            
            (807
            )
            
            
            (891
            )Decrease
                (increase) in agent advances and other receivables
            
            
            10,920
            
            
            
            (1,362
            )Decrease
                in due premiums
            
            
            434
            
            
            
            160Increase in
                deferred policy acquisition costs
            
            
            (3,432
            )
            
            
            (3,873
            )Increase in
                other assets
            
            
            (220
            )
            
            
            (106
            )Decrease
                in policy liabilities and accruals
            
            
            (796
            )
            
            
            (2,561
            )Increase
                (decrease) in other liabilities
            
            
            (1,051
            )
            
            
            893Increase
                (decrease) in deferred federal income taxes
            
            
            (348
            )
            
            
            1,467Net
                activity from trading securities
            
            
            -
            
            
            
            647Other,
                net
            
            
            (186
            )
            
            
            (1,656
            )Net
                cash provided by (used in) operating activities
            
            
            9,504
            
            
            
            (4,411
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Fixed
                maturities purchased
            
            
            (58,148
            )
            
            
            (91,429
            )Real
                estate capital expenditures
            
            
            -
            
            
            
            (550
            )Proceeds
                from sales and maturities of fixed maturities
            
            
            17,800
            
            
            
            37,507Proceeds
                from sales of invested real estate
            
            
            646
            
            
            
            100,529Net
                increase in short-term investments
            
            
            (3,780
            )
            
            
            (24,468
            )Net
                decrease in policy loans
            
            
            1,412
            
            
            
            1,100Purchase
                of property and equipment
            
            
            (26
            )
            
            
            (220
            )Net
                cash provided by (used in) investing activities
            
            
            (42,096
            )
            
            
            22,469





(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)


Six
                Months Ended June 30,2006
            
            
            2005CASH
                FLOWS FROM FINANCING ACTIVITIES:Contractholder
                fund deposits
            
            $
            16,420
            
            
            $
            17,362Contractholder
                fund withdrawals
            
            
            (34,381
            )
            
            
            (33,800
            )Net
                cash used in financing activities
            
            
            (17,961
            )
            
            
            (16,438
            )Net
                increase (decrease) in cash
            
            
            (50,553
            )
            
            
            1,620Cash
                and cash equivalents, beginning of year
            
            
            63,581
            
            
            
            52,044Cash
                and cash equivalents, end of period
            
            $
            13,028
            
            
            $
            53,664Supplemental
                Cash Flow Disclosures:Income
                taxes refunded
            
            $
            4,341
            
            
            $
            -Interest
                paid
            
            $
            665
            
            
            $
            517Treasury
                stock distributions
            
            $
            -
            
            
            $
            86





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 June 30, 2006, its
      consolidated results of operations for the three months and six months ended
      June 30, 2006 and 2005, and its consolidated cash flows for the six months
      ended
      June 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 June 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
            
            
            (201
            )
            
            
            (10,600
            )
            
            
            -
            
            
            
            (10,801
            )Balance
                at June 30, 2006
            
            $
            1,450
            
            
            $
            (16,514
            )
            
            $
            (6,076
            )
            
            $
            (21,140
            )





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





Three
                Months Ended June 30,
            
            
            Six
                Months Ended June 30,2006
            
            
            2005
            
            
            2006
            
            
            2005Net
                income (loss)
            
            $
            1,741
            
            
            $
            4,682
            
            
            $
            (45
            )
            
            $
            3,539Other
                comprehensive income, net of tax:Unrealized
                gains on securities:Unrealized
                holdings gains (losses) arising  during the
                period
            
            
            (4,580
            )
            
            
            5,631
            
            
            
            (10,791
            )
            
            
            1,931Reclassification
                adjustments for gains  (losses) included in net
                loss
            
            
            (10
            )
            
            
            135
            
            
            
            (10
            )
            
            
            372Total
                other comprehensive income (loss)
            
            
            (4,590
            )
            
            
            5,766
            
            
            
            (10,801
            )
            
            
            2,303Comprehensive
                income (loss)
            
            $
            (2,849
            )
            
            $
            10,448
            
            
            $
            (10,846
            )
            
            $
            5,842




12
 *Index*





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





The
      following table reflects the calculation of basic and diluted earnings (loss)
      per share (amounts in thousands, except per share amounts):





Three
                Months Ended June 30,
            
            
            Six
                Months Ended June 30,2006
            
            
            2005
            
            
            2006
            
            
            2005(in
                thousands except per share data)BASIC:Net
                income (loss)
            
            $
            1,741
            
            
            $
            4,682
            
            
            $
            (45
            )
            
            $
            3,539Weighted
                average common shares outstanding
            
            
            9,849
            
            
            
            9,810
            
            
            
            9,849
            
            
            
            9,808Basic
                income per share
            
            $
            0.18
            
            
            $
            0.48
            
            
            $
            -
            
            
            $
            0.36DILUTED:Net
                income (loss)
            
            $
            1,741
            
            
            $
            4,682
            
            
            $
            (45
            )
            
            $
            3,539Weighted
                average common shares outstanding
            
            
            9,849
            
            
            
            9,810
            
            
            
            9,849
            
            
            
            9,808Diluted
                income per share
            
            $
            0.18
            
            
            $
            0.48
            
            
            $
            -
            
            
            $
            0.36





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 - Sale of Real
                Estate**





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.





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





A.
      Family
      Life





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





a.
            The
                Normal Retirement Date for all employees is the first day of the
                month
                coinciding with or next following the later of attainment of age
                65 or the
                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.





(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.





13
 *Index*





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.





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





Three
                Months Ended June 30,
            
            
            Six
                Months Ended June 30,2006
            
            
            2005
            
            
            2006
            
            
            2005Service
                cost for benefits earned during the year
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Interest
                cost on projected benefit obligation
            
            
            109,482
            
            
            
            116,054
            
            
            
            218,964
            
            
            
            232,108Expected
                return on plan assets
            
            
            (101,994
            )
            
            
            (101,269
            )
            
            
            (203,988
            )
            
            
            (202,537
            )Amortization
                of unrecognized prior service cost
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Amortization
                of unrecognized losses
            
            
            23,460
            
            
            
            26,226
            
            
            
            46,920
            
            
            
            52,452Recognition
                of net loss due to settlement
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
                periodic benefit cost
            
            $
            30,948
            
            
            $
            41,011
            
            
            $
            61,896
            
            
            $
            82,023





B.
      ILCO





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





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





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





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
      June
      30, 2006 and 2005:





Three
                Months Ended June 30,
            
            
            Six
                Months Ended June 30,2006
            
            
            2005
            
            
            2006
            
            
            2005Service
                cost for benefits earned during the year
            
            $
            3,672
            
            
            $
            11,448
            
            
            $
            7,344
            
            
            $
            22,896Interest
                cost on projected benefit obligation
            
            
            262,037
            
            
            
            261,812
            
            
            
            524,074
            
            
            
            523,624Expected
                return on plan assets
            
            
            (350,036
            )
            
            
            (344,766
            )
            
            
            (700,072
            )
            
            
            (689,532
            )Amortization
                of unrecognized prior service cost
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Amortization
                of unrecognized losses
            
            
            46,022
            
            
            
            33,920
            
            
            
            92,044
            
            
            
            67,840Recognition
                of net loss due to settlement
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
                periodic benefit cost
            
            $
            (38,305
            )
            
            $
            (37,586
            )
            
            $
            (76,610
            )
            
            $
            (75,172
            )





**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 $333.3 million of separate account assets as of
      June 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.





Prior
      to
      entering into the definitive agreement, Family Life owned 648,640 shares of
      FIC
      common stock.  Such shares are reflected as common treasury stock in
      the accompanying consolidated financial statements.  Prior to the
      closing of 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, the Company’s Investors Life Insurance Company of
      North America  (“Investors Life”) subsidiary 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.





17
 *Index*





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.





Amendment
      of Subordinated Loans





FIC
      and
      FLC have subordinated notes payable to Investors Life with an unpaid balance
      of
      $15.4 million at June 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 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. 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 June 30, 2006, compared with December 31, 2005, and
      its results of operations for the three and six month periods ended June 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 June 30, 2006 and 2005**





For
      the
      three month period ended June 30, 2006, the Company reported net income of
      $1.7
      million (basic and diluted earnings of $.18 per common share) on revenues of
      $25.6 million compared to net income of $4.7 million (basic and diluted earnings
      of $0.48 per common share) on revenues of $33.5 million for the three month
      period ended June 30, 2005.  The three months ended June 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 six months ended June 30,
      2006
      and 2005.  These items are described in the six-month results of
      operations below.  Of these results, certain significant items of
      change between the three months ended June 30, 2006 and 2005 which result in
      the
      significant change in net income between periods are as follows:





·
            Decrease
                in net realized investment gains of $8.9 million due to the sale
                of the
                River Place Pointe office complex in June,
                2005;


·
            Decrease
                in policyholder benefits and expenses of $1.2 million primarily resulting
                from the decline in the amount of death
                claims;


·
            Decrease
                in amortization of deferred policy acquisition costs of $1.3 million,
                primarily due to improved policy persistency for certain blocks of
                traditional life business;


·
            Decrease
                in operating expenses of $1.1
                million;


·
            Decrease
                in provision for federal income taxes of
                $870,000.





**Results
      of Operations – Six Months Ended June 30, 2006 and 2005**





For
      the
      six-month period ended June 30, 2006, FIC’s net loss was $45,000 (basic and
      diluted earnings of $.00 per common share) on revenues of $50.6 million as
      compared to net income of $3.5 million (basic and diluted earnings of $.36
      per
      common share) on revenues of $58.1 million in the first six months of
      2005.





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





·
            Increase
                in net investment income of $2.5 million primarily due to the effects
                of
                higher market interest rates and an increase in investments held
                in fixed
                maturities and equity securities from June 30, 2005, partially offset
                by a
                decrease in real estate income of
                $547,000;


·
            Decrease
                in net realized investment gains of $8.8 million primarily due to
                the sale
                of the River Place Pointe office complex in June,
                2005;


·
            Decrease
                in amortization of deferred policy acquisition costs of $1.5
                million;


·
            Decrease
                in operating expenses of $1.2
                million;


·
            Decrease
                in provision for federal income taxes of $1.2
                million.





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





*Revenues*





Premium
      revenues reported for traditional life insurance products are recognized when
      due. Premium income for the first six months of 2006, net of reinsurance ceded,
      were $11.4 million, as compared to $12.0 million in the first six months of
      2005. This source of revenues is related to the traditional life insurance
      book
      of business of FIC’s insurance subsidiaries. The decrease in premium income
      reflects the run-off in the Company’s existing traditional life insurance book
      of business for both first year and renewal premiums. The decrease in renewal
      premiums is exceeding first year premium production levels, resulting in the
      overall decline in premium revenues on traditional life insurance
      products.





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 six
      months ended June 30, 2006 and 2005, annuity deposits and UL premiums totaled
      $16.4 million and $17.4 million, respectively.





19
 *Index*





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 $558.0 million
      at June 30, 2005 to $526.8 million at June 30, 2006.





Earned
      insurance charges totaled $19.4 million for the first six months of 2006, as
      compared to charges of $20.3 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 six months of 2006 was $17.3 million as compared
      to $14.7 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 six 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 34 basis points
      over the comparable prior period.  The Company’s average holdings of
      investments and cash equivalents, excluding real estate, increased approximately
      $62 million over the comparable prior period.





Real
      estate income is 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 $547,000 for the six-month period ended June 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 $501,000 in the first six months of 2006, as
      compared to $9.3 million in the first six 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 $2.1 million in the first six months of 2006, as compared to $1.2
      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.





*Benefits
      and Expenses*





Policyholder
      benefits and expenses, which consist primarily of death benefit claims, were
      $20.7 million in the first six months of 2006, as compared to $19.9 million
      in
      the first six months of 2005. The increase in policyholder benefits and expenses
      was primarily attributable to higher 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
      $10.3 million in the first six months of 2006, as compared to $11.1 million
      in
      the same period of 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.





20
 *Index*





Amortization
      of deferred policy acquisition costs (DAC) for the first six months of 2006
      was
      $4.1 million, as compared to $5.7 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 during
      the
      second quarter of 2006 resulted in 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 $1.2 million and $1.3 million
      for the six months ended June 30, 2006 and 2005, respectively. The amortization
      is consistent with the run-off of the acquired blocks of business.





Operating
      expenses for the first six months of 2006 were $13.4 million, as compared to
      $14.6 million in the first six 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 $5.0 million and $4.0 million for the six months ended June 30,
      2006 and 2005, respectively.





Interest
      expense was $678,000 and $532,000 for the six months ended June 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 was $273,000 and $1.4 million for the six
      months ended June 30, 2006 and 2005, respectively. These tax amounts equate
      to
      effective tax provision rates of 120% and 28% for the six months ended June
      30,
      2006 and 2005, respectively. The primary reason for the deviation from the
      expected statutory tax rate of 34% for the Company in 2006 is due to increases
      in the valuation allowance for deferred tax assets generated by its non-life
      insurance entities. 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.





**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.





21
 *Index*





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 June 30,
      2006, 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 June 30, 2006 were
      $526.8 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 June
      30,
      2006, the bulk of the liabilities for contractholder deposit funds on FIC’s
      condensed consolidated balance sheet, $372.0 million, represented insurance
      products, as compared to $154.8 million of annuity product
      liabilities.





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.





22
 *Index*





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 June 30, 2006 were $13.0 million compared to $63.6 million
      at December 31, 2005. The $50.6 million decrease in cash and cash equivalents
      at
      June 30, 2006 from December 31, 2005 was due primarily to reinvestment of cash
      into fixed maturity securities, and contractholder fund withdrawals in excess
      of
      deposits for universal life insurance and annuity products.





Net
      cash
      provided by operating activities was $9.5 million for the six month period
      ended
      June 30, 2006, compared to $4.4 million used in operating activities for the
      same period of 2005. The increase in cash provided by operating activities
      of
      $13.9 million from 2005 to 2006 was primarily attributable to decreases in
      reinsurance and other receivables, as well as increases in policy liabilities
      and accruals.





Net
      cash
      used in investing activities was $42.1 million in the six month period ended
      June 30, 2006, compared to net cash provided by investing activities of $22.5
      million for the same period of 2005. The $64.6 million decrease in cash provided
      by investing activities was due primarily to proceeds received from the sale
      of
      River Place Pointe in 2005, offset by reinvestment of these proceeds into fixed
      maturity securities available for sale and short-term investments.





Net
      cash
      used in financing activities was $18.0 million in the first six months of 2006,
      compared to $16.4 million used in the first six months of 2005. The increase
      in
      cash used in financing activities of $1.6 million is attributable to
      contractholder fund deposits and withdrawals for annuity and universal life
      insurance policies.  For the six months ended June 30, 2006 and 2005,
      contractholder fund withdrawals exceeded deposits by $18.0 million and $16.4
      million respectively. The change in net withdrawals in 2006 is due to a decline
      in deposits in 2006 from 2005 of $942,000 and an increase in withdrawals of
      $581,000 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 six months ended June 30, 2006, the equity of the shareholders of the
      Company (that is, the excess of the Company’s assets over its liabilities)
      decreased by $10.8 million. The primary changes resulting in the decrease to
      shareholders’ equity are detailed as follow:





•
            Net
                loss for the six months of $45,000;


•
            $10.8
                million increase in accumulated other comprehensive loss from change
                in
                net unrealized losses on investments in fixed maturity and equity
                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.





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 21.7% at December 31, 2005 and June
      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.





23
 *Index*





During
      the first six months of 2006, net unrealized losses on fixed maturities
      available for sale increased $10.6 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 security 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 June 30, 2006, the market value of FIC’s
      equity securities was $10.9 million, substantially unchanged from 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.





Investors
      Life had $333.3 million of separate account assets as of June 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.





*Liabilities*





The
      Company’s insurance-related liabilities (future policy benefits and
      contractholder deposit funds) were $681.2 million at June 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 asset balance
      of $5.2 million at June 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 six 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
      6.3% at June 30, 2006, compared to 7.0% at December 31, 2005. The inclusion
      of
      separate account assets (which are not relevant for this purpose) reduced the
      ratio of shareholders’ equity to total assets by 2.6% and 2.9% at June 30, 2006
      and December 31, 2005, respectively. The decline in the 2006 ratio is largely
      due to increases in unrealized losses on the Company’s fixed maturity securities
      portfolio due to rising market interest rates. Management believes that its
      current equity capital is sufficient to meet the Company’s current liabilities
      and to fund growth at currently planned levels.





24
 *Index*





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.





*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 $31.3 million at June
      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 $617.5
      million at June 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
      $133.1 million at June 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 $10.6 million at June 30, 2006 and $10.7 million at December
      31, 2005.





25
 *Index*





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 June 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 June 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 June 30, 2006.  The Company’s major remediation
      activities for the second quarter of 2006 are described below.





The
      Company and its external auditors previously identified a material weakness
      in
      the monitoring of the Company’s internal control environment.  In the
      second quarter of 2006, the Company began the process of evaluating the control
      design and operating effectiveness of all internal controls.  While
      this action enabled the Company to assess its internal controls, this action
      alone does not resolve the material weakness described in the Company’s 2005
      Form 10-K.  Additional remediation efforts are required in order to
      have a sustainable monitoring process, including the establishment of a Company
      Internal Audit function.





In
      addition to the above remediation actions, during the second quarter of 2006
      the
      Company assumed administrative activities for a small group of approximately
      800
      annuities. This group of policies was previously administered by an outside
      party, Symetra Life, as previously described in Note 7 of the accompanying
      consolidated financial statements. New internal control activities were
      established during the second quarter of 2006 in order to ensure that activities
      related to the administration of this group of policies produced reliable
      financial reporting.





26
 *Index*





**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”).





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.





27
 *Index*





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.





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.





28
 *Index*





**ITEM
      1A.  RISK FACTORS**





As
      of
      June 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 second quarter of 2006.





**ITEM
      5.  OTHER INFORMATION**





None





**ITEM
      6.  EXHIBITS AND REPORTS ON FORM
      8-K**





(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