UNITED
        STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
      D.C. 20549





**FORM
      10-Q**








(Mark
      One)


**x** **QUARTERLY
      REPORT PURSUANT TO SECTION 13
      OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**




For
      the
      quarterly period ended September 30, 2007


OR





** ̈** **TRANSITION
      REPORT PURSUANT TO SECTION
      13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**





**For
      the transition period
      from                 to             .**





**Commission
      File Number 0-4690**





**Financial
      Industries Corporation**


(Exact
      name of registrant as specified in its charter)








**Texas**
            
            **74-2126975**(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                Employer Identification No.)





**6500
                River Place Boulevard, Building I,****Austin,
                Texas**
            
            **78730**(Address
                of Principal Executive Offices)
            
            (Zip
                Code)





**(512)
      404-5000**


(Registrant's
      telephone number, including area code)








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  x    No   ̈





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 November 6, 2007
      was 10,263,407.













**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 subsidiary by independent rating organizations such as A.M. Best
      Company, which FIC believes are particularly important to the sale of
      accumulation-type products; (10) the performance of our investment portfolios;
      (11) the effect of changes in standards of accounting; (12) the effects and
      results of litigation; (13) business risks and factors described elsewhere
      in
      this report, including, but not limited to, Item 2–Management’s Discussion and
      Analysis of Financial Condition and Results of Operations and Item
      3-Quantitative and Qualitative Disclosures about Market Risks in Part 1, and
      Item 1-Legal Proceedings in Part 2, and (14) other factors discussed in the
      Company’s other filings with the SEC, which are available free of charge on the
      SEC’s website at www.sec.gov. You should read carefully the above factors and
      all of the other information contained in this report. Should one or more of
      these risks or uncertainties materialize, or should underlying assumptions
      prove
      incorrect, actual results may vary materially from those indicated. All
      subsequent written and oral forward-looking statements attributable to the
      Company or to persons acting on our behalf are expressly qualified in their
      entirety by reference to these risks and uncertainties. There can be no
      assurance that other factors not currently anticipated by management will not
      also materially and adversely affect our results of operations. Each
      forward-looking statement speaks only as of the date of the particular statement
      and the Company undertakes no obligation to update or revise any forward-looking
      statement, except as required by federal securities laws.











**FINANCIAL
      INDUSTRIES CORPORATION AND
      SUBSIDIARIES**








**INDEX**





Page
                No.**Part
                I - Financial Information**Item
                1. Financial Statements (Unaudited) Condensed
                Consolidated Balance Sheets September 30, 2007 and December 31,
                2006
            
            4Condensed
                Consolidated Statements of Operations For the three
                and nine month periods ended September 30, 2007 and September 30,
                2006
            
            6Condensed
                Consolidated Statements of Cash Flows For the nine
                month periods ended September 30, 2007 and September 30,
                2006
            
            10Notes
                to Condensed Consolidated Financial
                Statements
            
            12Item
                2. Management’s Discussion and Analysis of Financial
                Condition and Results of Operations
            
            23Item
                3. Quantitative and Qualitative Disclosures About
                Market Risk
            
            31Item
                4.  Controls and
                Procedures
            
            32**Part
                II – Other Information**Item
                1.  Legal Proceedings
            
            34Item
                1A.  Risk Factors
            
            36Item
                2.  Unregistered Sales of Equity Securities
                and Use of Proceeds
            
            36Item
                3.  Defaults Upon Senior
                Securities
            
            36Item
                4.  Submission of Matters to a Vote of
                Security Holders
            
            36Item
                5.  Other Information
            
            36Item
                6.  Exhibits
            
            36Signatures
            
            37





*Index*





**FINANCIAL
      INDUSTRIES CORPORATION AND
      SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS,**


(Unaudited)





September
                30,
            
            
            December
                31,2007
            
            
            2006
                (1)(In
                thousands, except share data)ASSETSInvestments:Fixed
                maturity securities available for sale, at fair value (amortized
                cost of
                $529,950 and $536,618 at September 30, 2007 and December 31, 2006,
                respectively)
            
            $
            512,959
            
            
            $
            520,957Equity
                securities available for sale, at fair value (cost of $7,503 and
                $6,534 at
                September 30, 2007 and December 31, 2006, respectively)
            
            
            10,124
            
            
            
            9,805Policy
                loans
            
            
            28,397
            
            
            
            30,189Short-term
                investments
            
            
            -
            
            
            
            7,473Total
                investments
            
            
            551,480
            
            
            
            568,424Cash
                and cash equivalents
            
            
            33,627
            
            
            
            55,603Deferred
                policy acquisition costs
            
            
            16,468
            
            
            
            14,429Present
                value of future profits of acquired business
            
            
            7,009
            
            
            
            7,749Agency
                advances and other receivables (net of allowances for doubtful accounts
                of
                $228 and $173 as of September 30, 2007 and December 31,
                2006)
            
            
            3,899
            
            
            
            929Reinsurance
                receivables
            
            
            27,305
            
            
            
            29,061Accrued
                investment income
            
            
            6,611
            
            
            
            6,772Due
                premiums
            
            
            256
            
            
            
            237Property
                and equipment, net
            
            
            312
            
            
            
            550Deferred
                income taxes
            
            
            2,821
            
            
            
            1,891Other
                assets
            
            
            1,906
            
            
            
            1,679Separate
                account assets
            
            
            351,650
            
            
            
            350,987Total
                assets
            
            $
            1,003,344
            
            
            $
            1,038,311





(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**


(Unaudited)





September
                30,
            
            
            December
                31,2007
            
            
            2006
                (1)(In
                thousands, except share data)LIABILITIES
                AND SHAREHOLDERS’ EQUITYLiabilities:Policy
                liabilities and contractholder deposit funds:Contractholder
                deposit funds
            
            $
            431,125
            
            
            $
            453,671Future
                policy benefits
            
            
            116,103
            
            
            
            117,097Other
                policy claims and benefits payable
            
            
            8,227
            
            
            
            6,907Notes
                payable
            
            
            15,000
            
            
            
            15,000Other
                liabilities
            
            
            19,779
            
            
            
            33,968Separate
                account liabilities
            
            
            351,650
            
            
            
            350,987Total
                liabilities
            
            
            941,884
            
            
            
            977,630Commitments
                and contingencies (See Note 9)Shareholders’
                equity:Common
                stock, $.20 par value, 25,000,000 shares authorized in 2007 and
                2006,12,533,798 and 12,533,402 shares issued in 2007 and 2006
                respectively; 10,299,207 and 10,210,385 shares outstanding in 2007
                and
                2006, respectively
            
            
            2,507
            
            
            
            2,507Additional
                paid-in capital
            
            
            70,083
            
            
            
            70,046Accumulated
                other comprehensive loss
            
            
            (10,624
            )
            
            
            (9,586
            )Retained
                earnings
            
            
            18,723
            
            
            
            17,703Common
                treasury stock, at cost,  2,234,591 and 2,323,017 shares in 2007
                and 2006, respectively
            
            
            (19,229
            )
            
            
            (19,989
            )Total
                shareholders’ equity
            
            
            61,460
            
            
            
            60,681Total
                liabilities and shareholders’ equity
            
            $
            1,003,344
            
            
            $
            1,038,311




(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**


(Unaudited)





Three
                Months Ended September 30,2007
            
            
            2006(In
                thousands)Revenues:Premiums,
                net
            
            $
            2,094
            
            
            $
            1,701Earned
                insurance charges
            
            
            7,680
            
            
            
            7,927Net
                investment income
            
            
            7,642
            
            
            
            7,280Net
                realized investment gains (losses)
            
            
            (213
            )
            
            
            1Other
            
            
            2,564
            
            
            
            1,234Total
                revenues
            
            
            19,767
            
            
            
            18,143Benefits
                and expenses:Policyholder
                benefits and expenses
            
            
            8,250
            
            
            
            4,862Interest
                expense on contractholders deposit funds
            
            
            4,432
            
            
            
            4,475Amortization
                of deferred policy acquisition costs
            
            
            525
            
            
            
            307Amortization
                of present value of future profits of acquired business
            
            
            262
            
            
            
            242Operating
                expenses
            
            
            3,959
            
            
            
            5,400Interest
                expense
            
            
            372
            
            
            
            364Total
                benefits and expenses
            
            
            17,800
            
            
            
            15,650Income
                from continuing operations before income taxes
            
            
            1,967
            
            
            
            2,493Income
                tax expense
            
            
            380
            
            
            
            882Income
                from continuing operations
            
            
            1,587
            
            
            
            1,611Loss
                from discontinued operations, net of taxes
            
            
            -
            
            
            
            (316
            )Net
                income
            
            $
            1,587
            
            
            $
            1,295








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**


(Unaudited)





Three
                Months Ended September 30,2007
            
            
            2006Net
                Income Per Share:Basic:Weighted
                average common shares outstanding
            
            
            10,278,683
            
            
            
            9,855,611Basic
                earnings per share:Income
                from continuing operations
            
            $
            0.15
            
            
            $
            0.16Discontinued
                operations
            
            
            -
            
            
            
            (0.03
            )Net
                income per share
            
            $
            0.15
            
            
            $
            0.13Diluted:Weighted
                average common shares and dilutive common stock
                outstanding
            
            
            10,278,683
            
            
            
            9,855,611Diluted
                earnings per share:Income
                from continuing operations
            
            $
            0.15
            
            
            $
            0.16Discontinued
                operations
            
            
            -
            
            
            
            (0.03
            )Net
                income per share
            
            $
            0.15
            
            
            $
            0.13








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**


(Unaudited)





Nine
                Months Ended September 30,2007
            
            
            2006(In
                thousands)Revenues:Premiums,
                net
            
            $
            6,414
            
            
            $
            4,280Earned
                insurance charges
            
            
            22,921
            
            
            
            23,900Net
                investment income
            
            
            23,674
            
            
            
            21,832Net
                realized investment gains (losses)
            
            
            (108
            )
            
            
            505Other
            
            
            5,928
            
            
            
            3,308Total
                revenues
            
            
            58,829
            
            
            
            53,825Benefits
                and expenses:Policyholder
                benefits and expenses
            
            
            23,953
            
            
            
            19,793Interest
                expense on contractholders deposit funds
            
            
            12,809
            
            
            
            13,480Amortization
                of deferred policy acquisition costs
            
            
            1,459
            
            
            
            764Amortization
                of present value of future profits of acquired business
            
            
            770
            
            
            
            781Operating
                expenses
            
            
            15,889
            
            
            
            15,493Interest
                expense
            
            
            1,097
            
            
            
            1,042Total
                benefits and expenses
            
            
            55,977
            
            
            
            51,353Income
                from continuing operations before income taxes
            
            
            2,852
            
            
            
            2,472Income
                tax expense
            
            
            646
            
            
            
            1,070Income
                from continuing operations
            
            
            2,206
            
            
            
            1,402Loss
                from discontinued operations, net of taxes
            
            
            -
            
            
            
            (152
            )Net
                income
            
            $
            2,206
            
            
            $
            1,250








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**


(Unaudited)





Nine
                Months Ended September 30,2007
            
            
            2006Net
                Income Per Share:Basic:Weighted
                average common shares outstanding
            
            
            10,233,882
            
            
            
            9,855,779Basic
                earnings per share:Income
                from continuing operations
            
            $
            0.22
            
            
            $
            0.14Discontinued
                operations
            
            
            -
            
            
            
            (0.01
            )Net
                income per share
            
            $
            0.22
            
            
            $
            0.13Diluted:Weighted
                average common shares and dilutive common stock
                outstanding
            
            
            10,233,882
            
            
            
            9,855,779Diluted
                earnings per share:Income
                from continuing operations
            
            $
            0.22
            
            
            $
            0.14Discontinued
                operations
            
            
            -
            
            
            
            (0.01
            )Net
                income per share
            
            $
            0.22
            
            
            $
            0.13








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**


(Unaudited)





Nine
                Months Ended September 30,2007
            
            
            2006**Continuing
                Operations:**
            
            (In
                thousands)CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income
            
            $
            2,206
            
            
            $
            1,250Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Loss
                from discontinued operations
            
            
            -
            
            
            
            152Amortization
                of deferred policy acquisition costs
            
            
            1,459
            
            
            
            764Amortization
                of present value of future profits of acquired business
            
            
            770
            
            
            
            781Share-based
                compensation expense
            
            
            272
            
            
            
            -Net
                realized loss (gains) on investments
            
            
            108
            
            
            
            (505
            )Depreciation
            
            
            260
            
            
            
            341Decrease
                (increase) in accrued investment income
            
            
            161
            
            
            
            (174
            )Increase
                in agent advances and other receivables
            
            
            (2,970
            )
            
            
            (8,785
            )Decrease
                in reinsurance receivables
            
            
            1,756
            
            
            
            5,763(Increase)
                decrease in due premiums
            
            
            (19
            )
            
            
            4Increase
                in deferred policy acquisition costs
            
            
            (3,336
            )
            
            
            (1,250
            )Increase
                in other assets
            
            
            (227
            )
            
            
            (85
            )Increase
                (decrease) in policy liabilities and accruals
            
            
            3,522
            
            
            
            (6,505
            )(Decrease)
                increase in other liabilities
            
            
            (14,189
            )
            
            
            13,290Increase
                in deferred federal income taxes
            
            
            437
            
            
            
            458Other,
                net
            
            
            (1,567
            )
            
            
            4,585Net
                cash provided by (used in) operating activities
            
            
            (11,357
            )
            
            
            10,084CASH
                FLOWS FROM INVESTING ACTIVITIES:Fixed
                maturities purchased
            
            
            (74,191
            )
            
            
            (55,676
            )Proceeds
                from sales and maturities of fixed maturities
            
            
            80,055
            
            
            
            37,344Proceeds
                from sales of invested real estate
            
            
            -
            
            
            
            646Net
                change in short-term investments
            
            
            7,473
            
            
            
            (9,681
            )Net
                decrease in policy loans
            
            
            1,792
            
            
            
            2,198Purchase
                of property and equipment
            
            
            (6
            )
            
            
            (33
            )Net
                cash provided by (used in) investing activities
            
            
            15,123
            
            
            
            (25,202
            )(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**


(Unaudited)





Nine
                Months Ended September 30,2007
            
            
            2006(In
                thousands)CASH
                FLOWS FROM FINANCING ACTIVITIES:Contractholder
                fund deposits
            
            $
            17,508
            
            
            $
            21,851Contractholder
                fund withdrawals
            
            
            (43,250
            )
            
            
            (40,813
            )Net
                cash used in financing activities
            
            
            (25,742
            )
            
            
            (18,962
            )Net
                decrease in cash
            
            
            (21,976
            )
            
            
            (34,080
            )Cash
                and cash equivalents, beginning of year
            
            
            55,603
            
            
            
            36,906Cash
                and cash equivalents, end of period
            
            $
            33,627
            
            
            $
            2,826**Discontinued
                Operations:**Net
                cash used in operating activities of discontinued
                operations
            
            $
            -
            
            
            $
            (16,233
            )Net
                cash used in investing activities of discontinued
                operations
            
            
            -
            
            
            
            (5,179
            )Net
                cash used in financing activities of discontinued
                operations
            
            
            -
            
            
            
            (696
            )Decrease
                in cash and cash equivalents
            
            
            -
            
            
            
            (22,108
            )Cash
                and cash equivalents at beginning of year
            
            
            -
            
            
            
            26,675Cash
                and cash equivalents at end of period
            
            $
            -
            
            
            $
            4,567**Supplemental
                Cash Flow Disclosures:**Income
                taxes refunded
            
            $
            -
            
            
            $
            1,227Interest
                paid
            
            $
            1,084
            
            
            $
            1,026**Supplemental
                Schedule of Noncash Financing Activities:**Treasury
                stock distributions
            
            $
            526
            
            
            $
            174








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





11
 *Index*





**FINANCIAL
      INDUSTRIES CORPORATION AND
      SUBSIDIARIES**


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





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





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





The
      accompanying unaudited condensed consolidated financial statements reflect
      all
      adjustments (including normal recurring adjustments) necessary to present fairly
      the consolidated financial position of the Company at September 30, 2007, its
      consolidated results of operations for the three months and nine months ended
      September 30, 2007 and 2006, and its consolidated cash flows for the nine months
      ended September 30, 2007 and 2006 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,
      2006 condensed consolidated balance sheet data was derived from the audited
      consolidated financial statements included in the Company’s 2006 Annual Report
      on Form 10-K filed with the SEC (“2006 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 2006 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.





Adoption
      of New Accounting Pronouncements





*Income
      Taxes*





Effective
      January 1, 2007, the Company adopted Financial Accounting Standards Board
      (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes − an
      Interpretation of FASB Statement No. 109” ("FIN 48"), which clarifies the
      accounting for uncertainty in tax positions.  FIN 48 specifies how tax
      benefits for uncertain tax positions are to be recognized, measured and
      derecognized in financial statements; requires certain disclosures of uncertain
      tax matters; specifies how reserves for uncertain tax positions should be
      classified on the balance sheets; and provides transition and interim period
      guidance, among other provisions.  FIN 48 requires companies to
      determine whether it is “more likely than not” that a tax position will be
      sustained upon examination by the appropriate taxing authorities before any
      part
      of the benefit can be recorded in the financial statements.  As a
      result of the implementation of FIN 48, the Company recognized a $1,441,000
      increase in the liability for unrecognized tax benefits and a $255,000 increase
      in deferred tax assets resulting in a  $1,186,0000 reduction to the
      January 1, 2007 balance of retained earnings.  The Company also
      reclassified, at adoption, $3,522,000 of current tax liabilities (previously
      recorded as a reduction to current tax receivables) and $503,000 of deferred
      tax
      liabilities to the liability for unrecognized tax benefits included within
      other
      liabilities.





*Insurance
      Contracts*





Effective
      January 1, 2007, the Company adopted Statement of Position 05-1, “Accounting by
      Insurance Enterprises for Deferred Acquisition Costs in Connection with
      Modifications or Exchanges of Insurance Contracts” (“SOP 05-1”).  SOP
      05-1 provides guidance on accounting by insurance enterprises for deferred
      policy acquisition costs (“DAC”) on internal replacements of insurance and
      investment contracts other than those specifically described in Statement of
      Financial Accounting Standards (“SFAS”) No. 97, “Accounting and Reporting by
      Insurance Enterprises for Certain Long-Duration Contracts and for Realized
      Gains
      and Losses from the Sale of Investments.”  SOP 05-1 defines an
      internal replacement as a modification in product benefits, features, rights,
      or
      coverages that occurs by the exchange of a contract for a new contract, or
      by
      amendment, endorsement, or rider to a contract, or by the election of a feature
      or coverage within a contract.  It is effective for internal
      replacements occurring in fiscal years beginning after December 15, 2006. The
      adoption of SOP 05-1 did not have a material impact on the Company’s condensed
      consolidated financial statements.





*Servicing
      of Financial Assets*





Effective
      January 1, 2007, the Company adopted SFAS No. 156, “Accounting for Servicing of
      Financial Assets – an amendment of FASB Statement No. 140” (“SFAS
      156”).  Among other requirements, SFAS 156 requires an entity to
      recognize a servicing asset or servicing liability each time it undertakes
      an
      obligation to service a financial asset by entering into a servicing contract
      in
      certain situations.  The adoption of SFAS 156 did not have a material
      impact on the Company’s condensed consolidated financial
      statements.





12
 *Index*





Future
      Adoption of New Accounting Pronouncements





In
      September, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
      157”).  SFAS 157 establishes a common definition for fair value,
      establishes a framework for measuring fair value, and expands disclosures about
      fair value measurements.  SFAS 157 will be applied prospectively and
      is effective for fiscal years beginning after November 15, 2007, and interim
      periods within those fiscal years.  SFAS 157 is not expected to have a
      material impact on the Company’s condensed consolidated financial
      statements.





In
      February, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159
      permits all entities the option to measure most financial instruments and
      certain other items at fair value at specified election dates and to report
      related unrealized gains and losses in earnings.  The fair value
      option will generally be applied on an instrument-by-instrument basis and is
      generally an irrevocable election.  SFAS 159 is effective for fiscal
      years beginning after November 15, 2007.  The Company is evaluating
      which eligible financial instruments, if any, it will elect to account for
      at
      fair value under SFAS 159 and the related impact on the Company’s condensed
      consolidated financial statements.





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





The
      following is a reconciliation of accumulated other comprehensive income (loss)
      from December 31, 2006 to September 30, 2007:





Net
                Unrealized
            
            
            Net
                Unrealized
            
            
            
            
            
            TotalAppreciation
            
            
            Gain
                (Loss) on
            
            
            
            
            
            Accumulated(Depreciation)
            
            
            Fixed
                Maturities
            
            
            
            
            
            Otherof
                Equity
            
            
            Available
                for
            
            
            Pension
            
            
            ComprehensiveSecurities
            
            
            Sale
            
            
            Adjustments
            
            
            Income
                (Loss)(In
                thousands)Balance
                at December 31, 2006
            
            $
            2,159
            
            
            $
            (7,676
            )
            
            $
            (4,069
            )
            
            $
            (9,586
            )Current
                Period Change
            
            
            (429
            )
            
            
            (751
            )
            
            
            142
            
            
            
            (1,038
            )Balance
                at September 30, 2007
            
            $
            1,730
            
            
            $
            (8,427
            )
            
            $
            (3,927
            )
            
            $
            (10,624
            )





The
      comprehensive income (loss) for the three and nine months ending September
      30,
      2007 and 2006 is summarized as follows:





Three
                Months Ended
            
            
            Nine
                Months EndedSeptember
                30,
            
            
            September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006(In
                thousands)Net
                income
            
            $
            1,587
            
            
            $
            1,295
            
            
            $
            2,206
            
            
            $
            1,250Other
                comprehensive income (loss), net of tax:Unrealized
                gains (losses) on securities:Unrealized
                holdings gains (losses) arising during the period
            
            
            3,938
            
            
            
            7,820
            
            
            
            (1,072
            )
            
            
            (2,971
            )Reclassification
                adjustments for gains (losses) included in net income
            
            
            (213
            )
            
            
            1
            
            
            
            (108
            )
            
            
            (9
            )Change
                in pension liability
            
            
            70
            
            
            
            175
            
            
            
            142
            
            
            
            175Total
                other comprehensive income (loss)
            
            
            3,795
            
            
            
            7,996
            
            
            
            (1,038
            )
            
            
            (2,805
            )Comprehensive
                income (loss)
            
            $
            5,382
            
            
            $
            9,291
            
            
            $
            1,168
            
            
            $
            (1,555
            )





**3.**
            **Discontinued
                Operations – Sale of Family Life Insurance
                Company**





On
      December 29, 2006, Financial Industries Corporation completed the sale of its
      wholly owned subsidiary, Family Life Insurance Company (“Family Life”), to The
      Manhattan Life Insurance Company (“Manhattan Life”) for $28.0 million in cash.
      In accordance with SFAS 144, the condensed consolidated financial statements
      reflect the operating results of Family Life Insurance Company as discontinued
      operations, adjusted for certain activities as described below.




13
 *Index*





Prior
      to
      the sale, the Company transitioned the sales force of Family Life to a new
      division of Investors Life Insurance Company of North America (“Investors
      Life”), FIC’s remaining insurance subsidiary.  Although Investors Life
      is now selling similar products as those that were sold by Family Life, there
      are notable differences. The insurance is written on Investors Life policy
      forms
      and leads are no longer obtained from lending institutions.  Leads are
      now purchased through other sources and the focus is on a different market
      demographic than the previous Family Life target market. The new division also
      now sells final expense insurance products, which was not a market focus for
      Family Life. Additionally, as a condition of the sales agreement, the new
      division of Investors Life is prohibited from selling products to existing
      policyholders and related customers of Family Life for five years.





In
      connection with the sale of Family Life, Investors Life entered into a
      coinsurance agreement with Family Life pursuant to which Investors Life will
      cede to Family Life (a wholly-owned subsidiary of Manhattan Life) 35% of the
      face amount of mortgage protection term policies written by the Family Sales
      Division during the five-year period beginning April 1, 2007 and ending March
      31, 2012. Such business will be administered by Investors Life, and Investors
      Life will receive allowances for its expenses on the portion of the business
      that is ceded. Accordingly, the Company accrued a deferred revenue liability
      of
      $1.4 million in conjunction with recording the sale of Family Life, equal to
      the
      estimated net present value of future profits expected to be ceded to Manhattan
      Life. The $1.4 million liability reflected the estimated portion of the $28.0
      million sales price of Family Life that was paid by Manhattan Life for the
      value
      of the coinsurance agreement.  Costs associated with the Family Life
      agents while affiliated with Family Life, much of which were capitalized and
      amortized as deferred policy acquisition costs, are included in discontinued
      operations.





Prior
      to
      the sale, Investors Life assumed certain universal life insurance and annuity
      contracts written by Family Life under reinsurance treaties between the
      companies.  Effective September 30, 2006, Family Life and Investors
      Life executed recapture agreements  related to these reinsurance
      treaties effectively terminating these treaties and removing Investors Life
      from
      any liability for life insurance and annuity contracts written by Family Life.
      Accordingly, all revenues and costs associated with these universal life
      insurance and annuity contracts are included in discontinued
      operations.





Also,
      prior to the closing of the sale, the Family Life Pension Plan, along with
      its
      assets and liabilities, was transferred from Family Life to its upstream parent
      company and all current and future obligations of the Family Life Pension Plan
      remain the responsibility of the Company. Accordingly, the Family Life Pension
      Plan liabilities and costs were not included in discontinued
      operations.





Family
      Life owned 648,640 shares of FIC common stock prior to the sale.  Such
      shares were reflected as common treasury stock in the Company’s consolidated
      financial statements.  Immediately preceding and as a condition of the
      sale of Family Life, 324,320 of these shares were acquired by the Company and
      the remaining 324,320 shares remained with Family Life at the time of the
      sale.  Accordingly, the shares that remained with Family Life are now
      reflected as outstanding common stock shares as of December 31,
      2006.





Family
      Life shared certain operating costs, including personnel, premises, equipment
      and software, and other office and administrative expenses with FIC and its
      other subsidiaries through various sharing agreements. These agreements with
      Family Life were terminated upon its sale and Family Life did not retain any
      employees, equipment, software or liability for leases. Accordingly, the
      discontinued operations of Family Life were adjusted to eliminate the estimated
      continuing expenses associated with these shared operating costs.





In
      conjunction with the sale, Family Life also entered into an administrative
      services agreement with the Company for a three month period following the
      sale.  Pursuant to the agreement, the Company provided administrative
      services for Family Life through March 31, 2007, at which time Manhattan Life
      assumed all responsibilities for administering the Family Life
      business.  The Company earned fees totaling $807,000 in the first
      quarter of 2007 for services performed for Family Life in accordance with the
      agreement. See Note 9 regarding litigation with Manhattan Life.





Effective
      with the beginning of the fourth quarter of 2007, the Company made the decision
      to cease sales of mortgage protection term products.  The marketing
      focus for the Company will be on its final expense insurance
      products.  The Company expects this market niche will be a better long
      term strategic fit based on competitive and profitability factors of its
      existing product portfolio.





A
      resulting impact of this decision is the accounting implications for the
      previously described deferred revenue liability recorded in conjunction with
      the
      Family Life coinsurance agreement.  As the Company will no longer sell
      any mortgage term products subject to the coinsurance agreement, the Company
      recognized $1.3 million of the deferred revenue liability in the quarter ended
      September 30, 2007.  This amount was reflected in other income in the
      accompanying condensed consolidated statement of operations.  The
      remaining $100,000 of the original liability balance relates to policies sold
      and recorded in the period from April 1, 2007 through September 30, 2007 which
      were subject to the coinsurance agreement.  This amount will be
      amortized to income in future periods over the lives of these
      policies.  No significant amortization has been recognized through
      September 30, 2007.





14
 *Index*





**4.**
            **Earnings
                Per Share**





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





Three
                Months Ended
            
            
            Nine
                Months EndedSeptember
                30,
            
            
            September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006(Dollars
                in thousands except per share data)Numerator:Income
                from continuing operations
            
            $
            1,587
            
            
            $
            1,611
            
            
            $
            2,206
            
            
            $
            1,402Denominator:Weighted
                average common shares outstanding:Basic
            
            
            10,278,683
            
            
            
            9,855,611
            
            
            
            10,233,882
            
            
            
            9,855,779Common
                stock options
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Diluted
            
            
            10,278,683
            
            
            
            9,855,611
            
            
            
            10,233,882
            
            
            
            9,855,779Per
                share:Basic
            
            $
            0.15
            
            
            $
            0.16
            
            
            $
            0.22
            
            
            $
            0.14Diluted
            
            $
            0.15
            
            
            $
            0.16
            
            
            $
            0.22
            
            
            $
            0.14





**5.**
            **Investments**





The
      Company’s fixed maturity securities reflect gross unrealized losses of $18.2
      million as of September 30, 2007.  Approximately 96% of the unrealized
      losses are related to investment grade securities.  The Company
      believes these unrealized losses are primarily related to increases in market
      interest rates.





Investments
      in fixed maturities in an unrealized loss position are detailed by Standard
      & Poor’s credit rating as follows:




September
                  30, 2007
              
              
              December
                  31, 2006Gross
              
              
              
              
              
              GrossFair
              
              
              Unrealized
              
              
              Fair
              
              
              UnrealizedValue
              
              
              Losses
              
              
              Value
              
              
              Losses(In
                  thousands)AAA
              
              $
              164,900
              
              
              $
              (10,725
              )
              
              $
              194,308
              
              
              $
              (10,182
              )AA
              
              
              48,040
              
              
              
              (507
              )
              
              
              44,657
              
              
              
              (885
              )A
              
              
              169,762
              
              
              
              (4,631
              )
              
              
              138,738
              
              
              
              (3,688
              )BBB
              
              
              43,321
              
              
              
              (1,572
              )
              
              
              40,681
              
              
              
              (1,319
              )BB
                  and other below investment grade
              
              
              18,871
              
              
              
              (726
              )
              
              
              17,296
              
              
              
              (822
              )$
              444,894
              
              
              $
              (18,161
              )
              
              $
              435,680
              
              
              $
              (16,896
              )





15
 *Index*





As
      part
      of the Company’s ongoing investment review, the Company has reviewed its fixed
      maturities and equity securities investment portfolio and concluded that there
      were no additional other-than-temporary impairments as of September 30, 2007
      and
      December 31, 2006. Due to the issuers’ continued satisfaction of the investment
      obligations in accordance with their contractual terms and management’s
      expectation that they will continue to do so, management’s intent and ability to
      hold these securities, as well as the evaluation of the fundamentals of the
      issuers’ financial condition and other objective evidence, the Company believes
      that unrealized losses on these investments at September 30, 2007 and December
      31, 2006 were temporary.





In
      evaluating whether a decline in value is other than temporary, the Company
      considers several factors including, but not limited to, the following; (1)
      whether the decline is substantial; (2) the duration; (3) the reasons for the
      decline in value (credit event, interest related, or market fluctuations);
      (4)
      the Company’s ability and intent to hold the investments for a period of time to
      allow for a recovery of value; and (5) the financial condition of and near
      term
      prospects of the issuer. The evaluation for other than temporary impairments
      is
      a quantitative and qualitative process, which is subject to risks and
      uncertainties in the determination of whether declines in the fair value of
      investments are other than temporary. The risks and uncertainties include
      changes in general economic conditions, the issuer’s financial condition or near
      term recovery prospects, and the effects of changes in interest
      rates.





**6.**
            **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.





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.





16
 *Index*





The
      pension costs for the Family Life Pension Plan include the following components
      at September 30, 2007 and 2006:





Three
                Months Ended
            
            
            Nine
                Months EndedSeptember
                30,
            
            
            September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006(In
                thousands)Service
                cost for benefits earned during the period
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Interest
                cost on projected benefit obligation
            
            
            104
            
            
            
            110
            
            
            
            312
            
            
            
            328Expected
                return on plan assets
            
            
            (106
            )
            
            
            (102
            )
            
            
            (319
            )
            
            
            (306
            )Amortization
                of unrecognized prior service cost
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Amortization
                of unrecognized losses
            
            
            17
            
            
            
            23
            
            
            
            50
            
            
            
            70Recognition
                of net loss due to settlement
            
            
            -
            
            
            
            296
            
            
            
            -
            
            
            
            296Net
                periodic benefit cost
            
            $
            15
            
            
            $
            327
            
            
            $
            43
            
            
            $
            388





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.





The
      pension (benefit) cost for the ILCO Pension Plan include the following
      components at September 30, 2007 and 2006:





Three
                Months Ended
            
            
            Nine
                Months EndedSeptember
                30,
            
            
            September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006(In
                thousands)Service
                cost for benefits earned during the period
            
            $
            -
            
            
            $
            4
            
            
            $
            -
            
            
            $
            11Interest
                cost on projected benefit obligation
            
            
            267
            
            
            
            262
            
            
            
            802
            
            
            
            786Expected
                return on plan assets
            
            
            (373
            )
            
            
            (350
            )
            
            
            (1,120
            )
            
            
            (1,050
            )Amortization
                of unrecognized prior service cost
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Amortization
                of unrecognized losses
            
            
            19
            
            
            
            46
            
            
            
            58
            
            
            
            138Recognition
                of net loss due to settlement
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
                periodic benefit
            
            $
            (87
            )
            
            $
            (38
            )
            
            $
            (260
            )
            
            $
            (115
            )




17
 *Index*





**7.**
            **Stock-Based
                Compensation**





FIC
      entered into a stock option agreement on February 1, 2007 with it’s chief
      executive officer, William Prouty, pursuant to which Mr. Prouty was issued
      an
      option to purchase 150,000 shares of the common stock of FIC at a price of
      $7.45
      per share. Fifty percent (50%) of the option vested on February 1, 2007, and
      the
      remaining fifty percent (50%) vested on June 21, 2007 (see Note 10 “Related
      Party Transactions”). The option expires on June 21, 2009. Because Mr. Prouty’s
      option was issued as an inducement material to his entering into employment
      with
      FIC, the option was issued outside of FIC’s Incentive Stock Plan.





The
      Company’s annual meeting of shareholders was held on June 29, 2007 at which time
      the shareholders of the Company approved the 2004 Incentive Stock Plan, designed
      to attract, retain and reward key employees, as well as the Stock Option Plan
      For Non-Employee Directors. Subject to adjustments for defined changes in
      capital stock, the total number of shares of common stock reserved and available
      for grant under the 2004 Incentive Stock Plan is 500,000.  In
      accordance with the terms of the 2004 Incentive Stock Plan, 50,000 stock option
      awards were granted to certain executives of the Company on June 29, 2007.
      The
      options vest in either three or four years, and have a ten year
      term.





Subject
      to adjustments for defined changes in capital stock, the total number of shares
      of common stock reserved and available for grant under the Stock Option Plan
      For
      Non-Employee Directors is 400,000. In accordance with the terms of the Stock
      Option Plan For Non-Employee Directors, 175,000 stock option awards were granted
      to eligible members of the Company’s Board of Directors on June 29, 2007. The
      options vest and are exercisable in three equal annual installments beginning
      with the first anniversary of the date on which the option was granted, and
      have
      a ten year term.





The
      Company recognized compensation expense of $272,000, and a related tax benefit
      of $0, for the nine month period ended September 30, 2007 related to the vested
      portion of the options.





The
      fair
      value of the option awards were estimated on the date of grant using a
      Black-Scholes option pricing model. Significant assumptions used in the
      calculation of fair value for each option award in the period ended September
      30, 2007 are as follows:





2004
                Incentive Stock Plan
            
            Option
                Plan for Non-Employee DirectorsExpected
                term of options
            
            6
                years to 6.25 years
            
            6
                yearsExpected
                volatility:Range
            
            22.5%
                to 23.7%
            
            22.3%
                to 22.5%Weighted
                Average
            
            22.9%
            
            22.4%Expected
                dividends
            
            -
            
            -Risk
                free rate:Range
            
            3.4%
                to 4.7%
            
            4.3%
                to 4.9%Weighted
                Average
            
            4.0%
            
            4.6%





The
      expected term is derived using a simplified method calculation as defined in
      SEC
      Staff Accounting Bulletin Topic 14.D.2, for “plain vanilla” options as that term
      is further defined in the bulletin, and represents the period of time that
      the
      options are expected to be outstanding. Volatility is a measure of the amount
      by
      which a financial variable, such as share price, has fluctuated or is expected
      to fluctuate during a period. The calculated volatility was derived from the
      option pricing model utilizing FIC historical share price data. The dividend
      yield is assumed to be zero, since FIC has not paid dividends since 2003, and
      management does not anticipate the payment of such dividends in the near future.
      In accordance with SFAS 123R, the risk-free discount rate approximates the
      rate
      currently available on federal government zero-coupon bonds with a remaining
      term equal to the options expected life.





18
 *Index*





Summary
      information regarding the 2004 Incentive Stock Plan is as follows:





Shares
                Available for Grant
            
            
            Shares
                Outstanding
            
            
            Weighted
                Average Exercise Price
            
            
            Weighted
                Average Remaining Contractual Term
            
            
            Aggregate
                Intrinsic ValueBalance
                at January 1, 2007
            
            
            -
            
            
            
            -
            
            
            
            -Plan
                implementation
            
            
            500,000Shares
                awarded under  separation agreement
            
            
            (60,000
            )Stock
                options:Awarded
            
            
            (50,000
            )
            
            
            50,000
            
            
            $
            8.84Exercised
            
            
            -
            
            
            
            -
            
            
            
            -Forfeited
            
            
            -
            
            
            
            -
            
            
            
            -Cancelled/expired
            
            
            -
            
            
            
            -
            
            
            
            -Balance
                at September 30, 2007
            
            
            390,000
            
            
            
            50,000
            
            
            $
            8.84
            
            
            
            10
            
            
            $
            -Exercisable
                at September 30, 2007
            
            
            
            
            
            
            25,000
            
            
            $
            8.84
            
            
            
            10
            
            
            $
            -





The
      weighted-average grant-date fair value of options granted under the 2004
      Incentive Stock Plan during 2007 was $8.84.





In
      connection with the election of Mr. J. Bruce Boisture as Chief Executive Officer
      and President of FIC in January 2004, the Board of Directors granted Mr.
      Boisture an option to purchase 150,000 shares of FIC common stock, at a per
      share price of $14.00. The grant was conditioned upon the approval by the
      shareholders of FIC of the 2004 Incentive Stock Plan, pursuant to which the
      grant would be made.  In connection with the resignation of Mr.
      Boisture in November 2005, this grant was cancelled and, under the terms of
      his
      Separation Agreement, FIC agreed to issue 60,000 shares of its common stock
      to
      Mr. Boisture on or before June 30, 2007, provided that the Incentive Stock
      Plan
      was approved by the shareholders of FIC. In the event such approval had not
      been
      obtained by June 30, 2007, Mr. Boisture would have received a cash payment
      of
      $465,000, less applicable tax withholding.  The Company’s annual
      meeting of shareholders was held on June 29, 2007 at which time the shareholders
      of the Company approved the 2004 Incentive Stock Plan. Accordingly, at June
      30,
      2007 FIC reserved 60,000 shares out of the 2004 Incentive Stock Plan related
      to
      this agreement. The Company completed the transaction and disbursed the shares
      in the third quarter of 2007. Compensation cost of $465,000 related to this
      Separation Agreement was accrued in the Company’s financial statements at
      December 31, 2005. Based on the closing share price upon shareholder approval
      of
      the 2004 Incentive Stock Plan on June 29, 2007, the Company reduced this accrual
      to $354,000 in the second quarter 2007. In accordance with SFAS No. 128
“Earnings Per Share”, these shares were deemed to no longer be contingently
      issuable shares as of June 30, 2007 since there were no circumstances under
      which the shares would not be issued, and accordingly the 60,000 shares were
      considered outstanding and reflected in the calculation of basic earnings per
      share for the period ended June 30, 2007.





19
 *Index*





Summary
      information regarding the Stock Option Plan For Non-Employee Directors is as
      follows:





Shares
                Available for Grant
            
            
            Shares
            
            
            Weighted
                Average Exercise Price
            
            
            Weighted
                Average Remaining Contractual Term
            
            
            Aggregate
                Intrinsic ValueBalance
                at January 1, 2007
            
            
            -
            
            
            
            -
            
            
            
            -Plan
                implementation
            
            
            400,000Stock
                options:Awarded
            
            
            (200,000
            )
            
            
            200,000
            
            
            $
            5.89Exercised
            
            
            -
            
            
            
            -
            
            
            
            -Forfeited
            
            
            -
            
            
            
            -
            
            
            
            -Cancelled/expired
            
            
            -
            
            
            
            -
            
            
            
            -Balance
                at September 30, 2007
            
            
            200,000
            
            
            
            200,000
            
            
            $
            5.89
            
            
            
            10
            
            
            $
            -Exercisable
                at September 30, 2007
            
            
            
            
            
            
            -
            
            
            $
            5.89
            
            
            
            10
            
            
            $
            -





The
      weighted-average grant-date fair value of options granted under the Stock Option
      Plan for Non-Employee Directors during 2007 was $5.89.





**8.**
            **Separate
                Accounts**





The
      Company’s insurance subsidiary, Investors Life, had $351.7 million of separate
      account assets as of September 30, 2007 (not including the value of the
      Company’s own investment in one of the accounts), as compared to $351.0 million
      at the end of 2006. 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. 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, which
      increased revenues in 2006, to continue to increase revenues in 2007. However,
      as this is a closed block of business, the revenues are expected to decrease
      as
      the policies in force decline.





Investors
      Life is not marketing new separate account annuity contracts. Previously, the
      investment annuity business was 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.





**9.**
            **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 had not been
      able to solicit proxies for an annual meeting because it had 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.





20
 *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. The Company subsequently filed its 2006 Form
      10-K
      on May 31, 2007 with the SEC and held an annual meeting of shareholders on
      June
      29, 2007. No further action has been taken by Mr. Porter, whose suit remains
      pending.





The
      Company’s attorneys have filed an amended motion for summary judgment seeking a
      final judgment of dismissal of this proceeding; the motion is set for hearing
      in
      late November 2007.





In
      the
      opinion of the Company’s management, it is not currently possible to estimate
      the impact, if any, that the ultimate resolution of this legal proceeding 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 condensed consolidated financial statements for this legal
      proceeding.





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.





21
 *Index*





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.





The
      Company recently reached and consummated a compromise settlement with Equita
      and
      M&W, under the terms of which Equita and M&W, on the one hand, and the
      Company and Investors Life, on the other hand, exchanged mutual releases and
      dismissed all claims between them.  As part of that compromise
      settlement, the Company paid Equita $250,000 on October 25, 2007.  The
      litigation between Equita and M&W, on the one hand, and Family Life—which
      has been sold and no longer is a subsidiary of the Company—remains
      pending.




The
      Company accrued a $250,000 liability as of June 30, 2007 for the probable
      settlement of this suit.  The accrual for this loss was reflected as
      an operating expense in the 2007 second quarter condensed consolidated statement
      of operations.  The final negotiated settlement of $250,000 was
      subsequently paid on October 25, 2007.





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. The Company
      intends to vigorously defend the suit, and has filed an answer denying the
      plaintiffs’ claims. 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
      3
      regarding the sale of Family Life Insurance Company. Discovery began in June
      of
      2007.





In
      the
      opinion of the Company’s management, it is not currently possible to estimate
      the impact, if any, that the ultimate resolution of this legal proceeding 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 condensed consolidated financial statements for this legal
      proceeding.





Other
      Litigation





FIC
      and
      its insurance subsidiary are regularly involved in litigation, both as a
      defendant and as a plaintiff. The litigation naming the insurance subsidiary
      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.





**10.**
            **Related
                Party Transactions**





FIC
      entered into an Engagement Letter (the "Engagement Letter"), dated February
      1,
      2007, between FIC and DLB Capital Fund FNIN, LLC ("DLB"), pursuant to which
      FIC
      agreed to pay DLB $439,996 for management consulting services over the term
      of
      the Engagement Letter, which shall terminate on January 31, 2008, unless
      terminated earlier in accordance with the Engagement Letter.  DLB is a
      Wilton, Connecticut based private equity firm focusing primarily on the
      financial services sector. The group was formed to specialize in management
      buyouts, corporate divestitures, leveraged buyouts, re-capitalizations and
      public to private transactions.  William Prouty is a principal and
      founding member of DLB and shall continue his interest in DLB while serving
      as
      the Chief Executive Officer of FIC.





22
 *Index*





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





**Company
      Overview**





Financial
      Industries Corporation (“FIC” or the “Company”) is a holding company engaged
      primarily in the life insurance business through its ownership of Investors
      Life
      Insurance Company of North America (“Investors Life”).  The Company
      markets and sells life insurance products through agents of Investors Life.
      Until December 29, 2006, the Company also marketed and sold life insurance
      products through another insurance subsidiary, Family Life Insurance Company,
      which was sold at the end of 2006 (see Note 3 in the accompanying condensed
      consolidated financial statements).





Investors
      Life administers an existing portfolio of individual life insurance and annuity
      policies and is licensed to sell individual life insurance and annuity products
      in 49 states (not licensed in New York), the District of Columbia, and the
      U.S.
      Virgin Islands. These products are marketed through independent, non-exclusive
      general agents.  The Company is not currently marketing annuity
      products.





In
      2005,
      Investors Life introduced a new final expense whole life product designed to
      compete in the 50 to 85 year-old population market.  This product is a
      simplified issue product which has allowed Investors Life to enter into the
      niche senior market.  Investors Life also sells mortgage protection
      term insurance products.  However, as previously disclosed in Note 3,
      effective with the beginning of the fourth quarter of 2007, the Company made
      the
      decision to cease sales of mortgage protection term products.  The
      marketing focus for the Company will be on its final expense insurance
      products.





Products
      underwritten by Investors Life also include a universal life insurance plan.
      Universal life insurance provides death benefit protection with flexible premium
      and coverage features, and the crediting of interest on cash values, at
      company-declared current interest rates. Under the flexible premium policies,
      policyholders may vary the amounts of their coverage (subject to minimum and
      maximum limits) as well as the dates of payments and frequency of
      payments.





Investors
      Life also sponsors separate account business. This business includes (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.





In
      addition to sales of it own insurance products, through its affiliate, ILG
      Sales
      Corporation, Investors Life operates a distribution system for the products
      of
      third-party life insurance companies. The marketing arrangement makes available,
      to appointed agents of Investors Life, types of life insurance and annuity
      products not currently being offered by Investors Life. The underwriting risk
      on
      the products sold under this arrangement is assumed by the third-party insurer.
      The Company’s appointed agents receive commissions on the sales of these
      products and the Company’s marketing subsidiary, ILG Sales Corporation, receives
      an override commission.





The
      following discussion addresses the financial condition of Financial Industries
      Corporation (“FIC”) as of September 30, 2007, compared with December 31, 2006,
      and its results of operations for the three and nine month periods ended
      September 30, 2007, compared with the same periods 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, 2006, to which the reader is
      directed for additional information.





**Results
      of Operations – Three Months Ended September 30, 2007 and
      2006**





For
      the
      three-month period ended September 30, 2007, FIC’s net income was $1,587,000
      (basic and diluted income of $0.15 per common share) compared to net income
      of
      $1,295,000 (basic and diluted income of $0.13 per common share) for the
      comparable 2006 period. However, in analyzing the Company’s results of
      operations, a separation of results between continuing and discontinued
      operations provides a more meaningful view.  As previously described
      in Note 3 in the accompanying condensed consolidated financial statements,
      the
      Company sold Family Life on December 29, 2006, resulting in a loss from
      discontinued operations.  Included in net income for the third quarter
      of 2006 is loss from discontinued operations, net of taxes, of
      $316,000.  Income from continuing operations totaled $1,587,000 for
      the three months ended September 30, 2007, while income from continuing
      operations totaled $1,611,000 for the comparable 2006 period.





The
      following sections of this Item 2 reflect Family Life as discontinued operations
      pursuant to SFAS 144 as previously described.  Accordingly, unless
      otherwise noted, amounts and analysis in this Item 2 reflect the continuing
      operations of FIC and its subsidiaries, exclusive of Family
      Life.  References to income and loss from operations are identified as
      continuing operations or discontinued operations, while references to net income
      or net loss reflect the consolidated net results of both continuing and
      discontinued operations.





23
 *Index*





In
      2007,
      FIC’s net income was affected by the following significant items as compared to
      2006 amounts:





·
            Increase
                in premiums earned of $393,000 due primarily to increases in sales
                of
                final expense whole life insurance and mortgage protection term insurance
                products;


·
            Increase
                in net investment income of $362,000 primarily due to improved investment
                yields;


·
            Increase
                in other revenues primarily due to the recognition of $1.3 million
                of
                deferred revenue related to the Company’s coinsurance agreement with
                Family Life;


·
            Increase
                in policyholder benefits and expenses of $3.4 million primarily from
                increases in traditional policy reserve expenses resulting from the
                higher
                traditional premium production and an increase in death benefits
                of $2.2
                million;


·
            Decrease
                in earned insurance charges of $247,000 partially offset by a decrease
                in
                interest expense on contractholders deposit funds of $43,000, both
                due
                primarily to the general runoff of the Company’s universal life insurance
                and annuity business;


·
            Increase
                in amortization of deferred policy acquisition costs of $218,000,
                primarily due to increases in sales of final expense whole life insurance
                and mortgage protection term insurance
                products;


·
            Decrease
                in operating expenses of $1.4 million primarily due to lower audit
                and
                other consulting fees, along with lower compensation
                expenses;


·
            Decrease
                in income tax expense of $502,000, largely impacted by the change
                in the
                valuation allowance for the 2007 third quarter as compared to
                2006.





**Results
      of Operations – Nine Months Ended September 30, 2007 and
      2006**





For
      the
      nine-month period ended September 30, 2007, FIC’s net income was $2,206,000
      (basic and diluted income of $0.22 per common share) on revenues of $58.8
      million as compared to net income of $1,250,000 (basic and diluted income of
      $.13 per common share) on revenues of $53.8 million in the first nine months
      of
      2006. Included in the net income for the first nine months of 2006 is a loss
      from discontinued operations, net of taxes, of $152,000. Income from continuing
      operations totaled $2,206,000 for the nine months ended September 30, 2007,
      while income from continuing operations totaled $1,402,000 for the comparable
      2006 period.





In
      2007,
      FIC’s net income was affected by the following:





·
            Increase
                in premiums earned of $2.1 million due primarily to increases in
                sales of
                final expense whole life insurance and mortgage protection term insurance
                products;


·
            Increase
                in net investment income of $1.8 million primarily due to dividend
                income
                received on investments in equity securities, along with some improvement
                in investment yields;


·
            Increase
                in other revenues of $2.6 million due primarily to (1) additional
                fees
                earned on separate accounts, (2) fees earned for services performed
                under
                an administrative services agreement with Family Life, and (3) recognition
                of deferred revenue related to the Company’s coinsurance agreement with
                Family Life;


·
            Decrease
                in net realized investment gains of $613,000 primarily due to realized
                gains in 2006 from the sale of the Company’s remaining real estate
                properties classified as held for
                sale;


·
            Increase
                in policyholder benefits and expenses of $4.2 million primarily from
                significantly higher death benefits, along with increases in traditional
                policy reserve expenses resulting from the higher traditional premium
                production;


·
            Decrease
                in earned insurance charges of $979,000 partially offset by a decrease
                in
                interest expense on contractholders deposit funds of $671,000, both
                due
                primarily to the general runoff of the Company’s universal life insurance
                and annuity business;


·
            Increase
                in amortization of deferred policy acquisition costs of $695,000,
                primarily due to increases in sales of final expense whole life insurance
                and mortgage protection term insurance
                products;


·
            Increase
                in operating expenses of $396,000 primarily due to higher audit,
                other
                consulting, and legal fees, as well as for the recognition of compensation
                expense of $272,000 related to the vested portion of options as previously
                discussed in Note 7.





The
      above
      described items need to be taken into consideration in drawing comparisons
      between the operating results for the nine months ended September 30, 2007
      and
      2006.





24
 *Index*





*Revenues*





Premium
      revenues reported for traditional life insurance products are recognized when
      due. Premium income for the first nine months of 2007, net of reinsurance ceded,
      were $6.4 million, as compared to $4.3 million in the first nine months of
      2006.
      This source of revenues is related to the traditional life insurance book of
      business of FIC’s insurance subsidiary for both first year and renewal premiums.
      The increase in premiums is primarily due to increases in sales of final expense
      whole life insurance and mortgage protection term insurance products, along
      with
      decreases in reinsurance premium expenses.





In
      accordance with GAAP, deposits received in connection with annuity contracts
      and
      premiums received for universal life (“UL”) insurance policies are reflected in
      the condensed consolidated financial statements as increases in liabilities
      for
      contractholder deposit funds and not as revenues. Earned insurance charges
      assessed against these deposits are reported as revenue.  For the nine
      months ended September 30, 2007 and 2006, annuity deposits and UL premiums
      totaled $17.5 million and $21.9 million, respectively.





The
      decline in UL premiums and annuity deposits reflects the net run-off of business
      from the Company’s existing book of business, and declining sales of new UL
      policies. Although the Company is focusing on reversing these trends on an
      overall basis, management has de-emphasized the sale of annuity and UL products
      since 2004 due primarily to the interest-rate environment and certain design
      features of FIC’s current annuity products. Most of the Company’s marketing
      efforts have been focused on the sale of traditional life insurance products,
      such as mortgage protection term insurance and final expense whole life
      insurance. In fact, effective with the fourth quarter of 2007, the Company
      is
      focusing primarily on the sale of final expense whole life
      insurance.  Liabilities for contractholder funds have declined from
      $453.7 million at December 31, 2006 to $431.1 million at September 30,
      2007.





Earned
      insurance charges totaled $22.9 million for the first nine months of 2007,
      compared to $23.9 million for the same period of 2006.  These revenues
      primarily consist of UL cost of insurance charges, but also include policy
      surrender charges, and policy administration charges.  The decrease in
      earned insurance charges from 2006 to 2007 is primarily due to reduced UL cost
      of insurance charges resulting from the net run-off of business.  The
      Company is currently not marketing annuities and UL marketing efforts and sales
      are minimal.





Net
      investment income for the first nine months of 2007 was $23.7 million as
      compared to $21.8 million for the same period of 2006. The higher net investment
      income in 2007 versus 2006 was primarily attributable to an increase in dividend
      income earned on the Company’s investments in equity securities totaling
      $772,000.  Dividend income earned on the equity securities totaled
      $969,000 for the first nine months of 2007 as compared to $197,000 for the
      comparable 2006 period.  The remaining increase in net investment
      income is primarily due to improved investment yields.





Net
      realized investment losses were $108,000 in the first nine months of 2007,
      as
      compared to $505,000 of net realized gains in the first nine months of
      2006.  The realized losses for 2007 were primarily from the tender of
      a fixed maturity security in the third quarter resulting in a loss of $305,000,
      partially offset by gains on sales of three other securities throughout the
      previous nine months.  The realized gains for 2006 were from the sale
      of the Company’s remaining real estate properties classified as held for
      sale.





Other
      revenues totaled $5.9 million and $3.3 million for the nine months ended
      September 30, 2007 and 2006, respectively.  Other income for 2006
      includes $573,000 of interest income received in the second quarter of 2006
      on
      federal income tax refunds related to prior year amended returns. The
      significant increase in other revenues in 2007 is partially due to fees earned
      related to the Company’s separate accounts and recognition of deferred revenue
      related to the Company’s coinsurance agreement with Family Life.  As
      previously described in Note 8 of the accompanying condensed consolidated
      financial statements, 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 recapture of this
      previously reinsured separate accounts business increased other revenues in
      2007
      by approximately $995,000 as compared with the corresponding period of
      2006.





Other
      revenues also increased in 2007 due to fees earned for services performed under
      an administrative services agreement with Family Life.  As previously
      described in Note 3 of the accompanying condensed consolidated financial
      statements, Family Life entered into an administrative services agreement with
      the Company for a three month period following the sale of Family
      Life.  Pursuant to the agreement, the Company provided administrative
      services for Family Life through March 31, 2007, at which time Manhattan Life
      assumed all responsibilities for administering the Family Life
      business.  The Company earned fees totaling $807,000 in the first
      quarter of 2007 for services performed for Family Life in accordance with the
      agreement.





25
 *Index*





Other
      revenues for 2007 were also impacted by the recognition of $1.3 million of
      deferred revenue related to the Company’s coinsurance agreement with Family
      Life.  As described in more detail in Note 3 of the accompanying
      condensed consolidated financial statements, in connection with the sale of
      Family Life, Investors Life entered into a coinsurance agreement with Family
      Life pursuant to which it will cede to Family Life (a wholly-owned subsidiary
      of
      Manhattan Life) 35% of the face amount of mortgage protection term policies
      written by the Family Sales Division during the five-year period beginning
      April
      1, 2007 and ending March 31, 2012. Such business will be administered by
      Investors Life, and Investors Life will receive allowances for its expenses
      on
      the portion of the business that is ceded. Accordingly, the Company accrued
      a
      deferred revenue liability of $1.4 million in conjunction with recording the
      sale of Family Life, equal to the estimated net present value of future profits
      expected to be ceded to Manhattan Life.   The $1.4 million
      liability reflected the estimated portion of the $28 million sales price of
      Family Life that was paid by Manhattan Life for the value of the coinsurance
      agreement.





Effective
      with the beginning of the fourth quarter of 2007, the Company made the decision
      to cease sales of mortgage protection term products.  The marketing
      focus for the Company will be on its final expense insurance
      products.  The Company expects this market niche will be a better long
      term strategic fit based on competitive and profitability factors of its
      existing product portfolio.





A
      resulting impact of this decision is the accounting implications for the
      previously described deferred revenue liability.  As the Company will
      no longer sell any mortgage term products subject to the coinsurance agreement,
      the Company recognized $1.3 million of the deferred revenue liability in the
      quarter ended September 30, 2007.  This amount was reflected in other
      revenues.  The remaining $100,000 of the original liability balance
      relates to policies sold and recorded in the period from April 1, 2007 through
      September 30, 2007 which were subject to the coinsurance
      agreement.  This amount will be amortized to income in future periods
      over the lives of these policies.  No significant amortization has
      been recognized through September 30, 2007.





*Benefits
      and Expenses*





Policyholder
      benefits and expenses, which consist primarily of death benefit claims, were
      $24.0 million in the first nine months of 2007, as compared to $19.8 million
      in
      the first nine months of 2006. The higher policyholder benefits and expenses
      in
      2007 versus 2006 were primarily attributable to significantly higher death
      benefits.  However, the increase in traditional premium revenues for
      2007 also caused a corresponding increase in traditional policy reserve
      expenses.





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
      $12.8 million in the first nine months of 2007, as compared to $13.5 million
      in
      the same period of the year 2006.  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 2007 is primarily attributable to this overall reduction
      in
      the level of contractholder deposit funds.





The
      level
      of market interest rates can affect 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 subsequent to 2005 have improved the Company’s interest
      spread.





Amortization
      of deferred policy acquisition costs (DAC) for the first nine months of 2007
      was
      $1,459,000, as compared to $764,000 for the same period in
      2006.  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 in any reporting period.
      The
      increase in amortization in 2007 from the comparable 2006 period is primarily
      due to the increased sales of traditional business by Investors Life since
      the
      third quarter of 2006 and the amortization relating to the DAC capitalized
      on
      these sales.





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 $770,000 and $781,000 for
      the
      nine months ended September 30, 2007 and 2006, respectively. The amortization
      is
      consistent with the run-off of the acquired blocks of business.





26
 *Index*





Operating
      expenses for the first nine months of 2007 were $15.9 million, as compared
      to
      $15.5 million in the first nine months of 2006. 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 continued to represent a
      significant component of operating expenses as the Company completed its
      delinquent SEC filings with the filing of Form 10-Q for the period ended March
      31, 2007.  These fees totaled $5.4 million and $4.9 million for the
      nine months ended September 30, 2007 and 2006, respectively. As the Company
      is
      now current with its SEC filing requirements, significant reductions are
      anticipated going forward in these audit, actuarial, accounting and consulting
      expenses. The Company has, in fact, already experienced significant reductions
      in these fees in the third quarter of 2007, as previously noted in discussion
      of
      operating results for the three months ended September 30,
      2007.  Additionally, as previously described in Note 7 – Stock-Based
      Compensation - the Company recognized compensation expense of $272,000 for
      the nine month period ended September 30, 2007 related to the vested portion
      of
      the options.





Interest
      expense was $1.1 million and $1.0 million for the nine months ended September
      30, 2007 and 2006, 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 2007 is a direct result of the increase in the LIBOR rate. Interest expense
      for the nine months ended September 30, 2007 and 2006 reflects an average annual
      interest rate of approximately 9.8% and 9.3%, respectively.





*Taxes*





The
      provision for income taxes of $646,000 on income from continuing operations
      reflects an effective tax rate of 22.7% for the nine months ended September
      30,
      2007.  The provision for federal income taxes of $1,070,000 on income
      from continuing operations reflects an effective tax rate of 43.3% for the
      nine
      months ended September 30, 2006. The primary reason for the deviation from
      the
      expected statutory tax rate of 34% for the Company is due to changes 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 subsidiary, 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 Investors Life.





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.





As
      of
      September 30, 2006, Investors Life held $15.4 million of notes receivable from
      FIC that represented the remaining indebtedness related to the Family Life
      acquisition.  Although this intercompany indebtedness was eliminated
      on FIC’s consolidated balance sheets, it created a debt service requirement at
      the holding company level. These notes were paid off by FIC on December 29,
      2006
      using proceeds from the sale of Family Life.





At
      the
      holding company level, FIC’s principal current ongoing liquidity demands relate
      to debt service on $15 million of senior notes that it issued in May
      2003.  These notes require quarterly interest payments at a variable
      interest rate of the three-month LIBOR rate plus 4.2% (which yielded an average
      rate of approximately 9.8% for the first nine months of  2007). The
      principal amount of the notes must be repaid in a single payment in
      2033.





27
 *Index*





In
      addition to debt service, 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 2003, and management does not anticipate the payment of such dividends
      in
      the near future.





The
      ability of Investors Life to pay dividends to FIC and 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 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 policyholder surplus or (ii) the insurer’s statutory
      net gain from operations for the previous year. Pursuant to statutory
      limitations, the maximum dividend payment which could be made in 2007, without
      prior approval by the Texas Department of Insurance, is $5,540,000. Investors
      Life did not make any dividend payments to its parent company in 2006, or for
      the period ended September 30, 2007.




In
      June
      2004, FIC, with the approval of the Texas Department of Insurance, created
      FIC
      Insurance Services, L.P., a service company subsidiary, and transferred to
      it
      many of the administrative functions of the insurance companies. The new service
      company charges Investors Life 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. Profits earned by the service company have decreased
      in
      2007, as fees have declined due to the sale of Family Life on December 29,
      2006.  This agreement with the service company was terminated by
      Family Life upon the sale of Family Life to The Manhattan Life Insurance
      Company.  Additionally, the Company amended the service agreement in
      October 2007 at the request of the Texas Department of
      Insurance.  Under the revised terms of the agreement, the fees charged
      to Investors Life will be limited to actual costs incurred.  This will
      effectively negate the ability to generate future profits, except from
      non-related external sources, which will limit future dividend capabilities
      of
      the service company.





Liquidity
      considerations at Investors Life are different in nature than for the holding
      company. Sources of cash for Investors Life consist of premium payments and
      deposits from policyholders and annuity holders, charges on policies and
      contracts, investment income, and proceeds from the sale of investment assets.
      These funds are applied primarily to provide for the payment of claims under
      insurance and annuity policies, payment of policy withdrawals, surrenders and
      loans, operating expenses, taxes, investments in portfolio securities, and
      shareholder dividends.





A
      primary
      liquidity consideration with respect to life insurance and annuity products
      is
      the risk of early policyholder and contractholder withdrawal. Deposit fund
      liabilities for universal life and annuity products as of September 30, 2007
      were $431.1 million, compared to $453.7 million at December 31, 2006. Individual
      life insurance policies are less susceptible to withdrawal than are annuity
      contracts because life insurance policyholders may incur surrender charges
      and
      undergo a new underwriting process in order to obtain a new insurance policy.
      At
      September 30, 2007, the bulk of the liabilities for contractholder deposit
      funds
      on FIC’s condensed consolidated balance sheet, $302.7 million, represented
      insurance products, as compared to $128.4 million of annuity product
      liabilities.





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





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





Cash
      and
      cash equivalents at September 30, 2007 were approximately $33.6 million compared
      to $55.6 million at December 31, 2006. The $22.0 million decrease in cash and
      cash equivalents at September 30, 2007 from December 31, 2006 was due primarily
      to cash flows used in financing activities, and to decreases in other
      liabilities.





28
 *Index*





Net
      cash
      used in operating activities was $11.4 million for the nine month period ended
      September 30, 2007, compared to $10.1 million provided by operating activities
      for the same period of 2006. The predominant changes in net cash used in
      operating activities between 2007 and 2006 are due to payments of $15.2 million
      in the first quarter of 2007 for amounts due for unsettled transactions for
      purchased securities and decreases in other liabilities.





Net
      cash
      provided by investing activities was $15.1 million for the nine month period
      ended September 30, 2007, compared to net cash used in investing activities
      totaling $25.2 million for the same period of 2006. The significant decrease
      in
      cash used in investing activities was due primarily to higher levels of sales
      and maturities of fixed maturity securities in 2007 totaling $80.1 million
      versus $37.3 million for the comparable 2006 period.  Additionally,
      purchases of fixed maturity securities totaled $74.2 million in 2007 compared
      to
      $55.7 million in 2006.





Net
      cash
      used in financing activities was $25.7 million in the first nine months of
      2007,
      compared to $19.0 million in the first nine months of 2006. The components
      of
      the Company’s financing activities are contractholder fund deposits and
      withdrawals for annuity and universal life insurance policies.  For
      the nine months ended September 30, 2007 and 2006, contractholder fund
      withdrawals exceeded deposits resulting in the net cash used in financing
      activities. While contractholder fund deposits totaled $17.5 million,
      contractholder fund withdrawals were $43.3 million in the first nine months
      of
      2007. The increased net withdrawals in 2007 compared to 2006 is due to a decline
      in deposits in 2007 from 2006 of $4.3 million, coupled with an increase in
      withdrawals of $2.4 million for the same period.





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





**Financial
      Condition**





During
      the nine months ended September 30, 2007, the equity of the shareholders of
      the
      Company (that is, the excess of the Company’s assets over its liabilities)
      increased by $779,000.  Changes resulting in the increase to
      shareholders’ equity are detailed as follow:





·
            Net
                income for the period of
                $2,206,000.





·
            Reduction
                to beginning retained earnings of $1,186,000 for the implementation
                of FIN
                48 related to income taxes as described in Note 1 to the accompanying
                condensed consolidated financial
                statements.





·
            Combined
                net increase of $797,000 in additional paid-in capital and common
                treasury
                stock for items as detailed below:





o
            $272,000
                related to the issuance of stock options during the first nine months
                of
                2007 as described in Note 7 to the accompanying condensed consolidated
                financial statements.





o
            $354,000
                for common shares issued to Mr. Boisture as described in Note 7 to
                the
                accompanying condensed consolidated financial
                statements.





o
            $171,000
                for common shares issued in lieu of cash for portions of Company
                Board of
                Directors fees.





·
            Net
                increase in accumulated other comprehensive loss of $1,038,000 for
                items
                as detailed below:





o
            Increase
                in net unrealized losses on fixed maturities available for sale of
                $751,000.





o
            Decrease
                in appreciation of investments in equity securities of
                $429,000.





o
            Decrease
                in pension liability of $142,000.





*Assets*





The
      Company’s life insurance subsidiary has an investment management agreement with
      Conning Asset Management (“Conning”). Under this agreement, Conning manages the
      investment security portfolio of the Company’s life insurance subsidiary 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 subsidiary.
      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.





29
 *Index*





Over
      the
      past several years, the Company has decreased its investment in mortgage-backed
      securities (including asset-backed securities) significantly. This trend
      continued into 2006 and 2007. Expressed as a percentage of its total investment
      in fixed maturities, these ratios were 22.0% and 20.5% at December 31, 2006
      and
      September 30, 2007 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 subsidiary has 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.





The
      Company’s investment portfolio does not have significant exposure to the
      subprime mortgage market.  The portfolio holds $3.9 million par value
      of home-equity loan asset-backed securities.  The securities have
      Standard & Poor’s ratings of AAA, were purchased in early 2003, and are
      comprised of loans originated in 2002.  The performance of the
      underlying collateral, pools of fixed-rate mortgage loans, has been satisfactory
      and the loans have paid down to under 50% of original par value. As of September
      30, 2007 the aggregate unrealized loss on these bonds is approximately $52,000,
      which management believes can be primarily attributed to increases in market
      interest rates.





During
      the first nine months of 2007, net unrealized losses on fixed maturities
      available for sale increased $1.3 million, prior to the effects of DAC and
      deferred taxes.  The increase in unrealized losses was primarily
      related to increases in market interest rates.  While interest rates
      have fluctuated rather significantly during 2007, the market interest rates
      at
      September 30, 2007 are now once again very comparable with rates at year end
      2006.





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”). As of September 30, 2007, the market value of
      FIC’s equity securities was $10,124,000, compared to $9,805,000 at December 31,
      2006. The Company also received dividend income totaling $969,000 in the first
      nine months of 2007 related to these equity investments.





Agency
      advances and other receivables were $3.9 million and $929,000 at September
      30,
      2007 and December 31, 2006, respectively.  The increase was primarily
      related to the implementation of FIN 48 as described in Note 1 to the
      accompanying condensed consolidated financial statements.  Liabilities
      for unrecognized tax benefits, previously recorded as a reduction to current
      tax
      receivables, were reclassified and reported as other liabilities at March 31,
      2007 in accordance with the new reporting requirements of FIN 48.





Investors
      Life had $351.7 million of separate account assets as of September 30, 2007
      (not
      including the value of the Company’s own investment in one of the accounts), as
      compared to $351.0 million at the end of 2006. 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.
      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, which increased revenues in 2006, to continue to increase revenues
      in
      2007. However, as this is a closed block of business, the revenues are expected
      to decrease as the policies in force decline. Investors Life is not marketing
      new separate account annuity contracts. Previously, the investment annuity
      business was 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.





*Liabilities*





The
      Company’s insurance-related liabilities (future policy benefits and
      contractholder deposit funds) were $547.2 million at September 30, 2007,
      compared to $570.8 million at December 31, 2006. The decrease in these
      insurance-related liabilities reflects the business run-off as previously
      described.





30
 *Index*





Other
      liabilities, which totaled $19.8 million at September 30, 2007, compared to
      $34.0 million at December 31, 2006, consist primarily of accrued expenses,
      policyholder suspense liabilities, pension plan liabilities, amounts due on
      unsettled security transactions, and amounts held as agent or trustee. The
      decrease in other liabilities is partially due to amounts due for unsettled
      transactions for purchased securities. There were no amounts due for unsettled
      transactions at September 30, 2007, compared to a balance of $15.2 million
      at
      December 31, 2006.  This decrease from unsettled transactions was
      partially offset by the reporting of a liability for unrecognized tax benefits
      totaling $5.5 million resulting from the implementation of FIN 48 as disclosed
      in Note 1 to the accompanying condensed consolidated financial
      statements.





*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 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 6.1% at
      September 30, 2007, compared to 5.8% at December 31, 2006. The inclusion of
      separate account assets (which are not relevant for this purpose) reduced the
      ratio of shareholders’ equity to total assets by 3.3% and 3.0% at September 30,
      2007 and December 31, 2006, respectively. Management believes that its current
      equity capital is sufficient to meet the Company’s current liabilities and to
      fund growth at currently planned levels.





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





State
      regulators also use NAIC IRIS ratios to monitor capital adequacy
      requirements.  The NAIC ratios cover 12 categories of financial data
      with defined “usual” ranges for each such category. The ratios are intended to
      provide insurance regulators with “early warnings” as to when a company might
      warrant special attention. An insurance company may fall outside of the usual
      range for one or more ratios, and such variances may result from specific
      transactions that are, by themselves, immaterial or eliminated at the
      consolidation level. In certain states, insurers with more than three IRIS
      ratios outside of the NAIC usual ranges may be subject to increased regulatory
      oversight. For 2006 Investors Life had four ratios which were outside the usual
      ranges, which were primarily related to 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
      subsidiary, 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.





31
 *Index*





*Interest-Rate
      Risk*





The
      Company manages the interest-rate risk inherent in its fixed maturity assets
      relative to the interest-rate risk inherent in its liabilities. Generally,
      we
      manage interest-rate risk based on the application of a commonly used
      model.  The model projects the impact of interest rate changes on a
      range of factors, including duration and potential prepayment.  For
      example, assuming an immediate increase of 100 basis points in interest rates,
      the net hypothetical loss in fair market value related to the financial
      instruments included in the Company’s condensed consolidated balance sheets is
      estimated to be $26.9 million at September 30, 2007 and $26.1 million at
      December 31, 2006. For purposes of the foregoing estimate, fixed maturity
      investments were taken into account. The fair value of such assets was $513.0
      million at September 30, 2007 and $521.0 million at December 31,
      2006.





The
      fixed
      income investments of the Company include certain mortgage-backed securities
      (excluding asset-backed securities). The market value of such securities was
      $100.0 million at September 30, 2007 and $106.3 million at December 31,
      2006.  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 $8.6 million at September 30,
      2007
      and $8.6 million at December 31, 2006.





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





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





**ITEM
      4. CONTROLS AND PROCEDURES**





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





Management
      has completed an evaluation of the effectiveness of the design and operation
      of
      the Company's disclosure controls and procedures pursuant to Rule 13a-15 under
      the Securities Exchange Act of 1934, as amended. This evaluation has allowed
      management to make conclusions, as set forth below, regarding the state of
      the
      Company's disclosure controls and procedures as of September 30,
      2007.  Based on its evaluation and the identification of material
      weaknesses in internal control over financial reporting described below, FIC's
      Chief Executive Officer and Chief Financial Officer have concluded that, as
      of
      September 30, 2007, FIC's disclosure controls and procedures were
      ineffective.





Management
      has assessed our internal control over financial reporting as of December 31,
      2006, 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, 2006, 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, control monitoring, financial close and reporting, reinsurance,
      policy holder benefits and accounts payable and expenditures.





During
      the first quarter of 2007, although there were no significant internal control
      changes implemented during that time, FIC implemented an Internal Controls
      Remediation Plan which is designed to resolve all previously identified material
      weaknesses by the end of the 2007 fiscal year.





In
      the
      second quarter of 2007, the Company improved its control monitoring abilities
      by
      hiring a Director of Internal Audit who began work on June 12,
      2007.  The Company also made security changes in its general ledger
      system in order to properly segregate duties associated with accounts payable
      and vendor maintenance functions.  In addition, as part of the
      re-examination and re-engineering of the Financial Close and Reporting process,
      the Company began establishing a new closing schedule in order to ensure that
      all financial closing and reporting events occur in a manner that will lead
      to
      timely financial statement filings.  The closing schedule and related
      procedures will continue to be enhanced and developed at a more detail level
      throughout the remainder of 2007.





32
 *Index*





Part
      of
      the Company’s plan was to resolve a material weakness involving the accuracy of
      supplemental contract payments by the end of the second quarter of
      2007.  As previously disclosed in the Company’s 2007 first quarter
      Form 10-Q, the Company changed the expected resolution date of this item to
      July
      31, 2007.  Although the new controls have now been implemented, the
      related control deficiency will not be considered fully remediated until the
      new
      controls have operated for a sufficient period of time and tested to prove
      operational effectiveness.





In
      the  third quarter of 2007, the Company further enhanced the
      segregation of duties within the general ledger application for accounts payable
      and vendor file master functions with the September 2007 upgrade of the Sungard
      EAS General Ledger System to the most current version.  Effective
      October 15, 2007, the Company hired an experienced Internal Controls Coordinator
      who will be responsible for independently monitoring and testing the Company’s
      internal controls.  The Company established additional controls to
      ensure accurate computation of reinsurance premiums and has been monitoring
      all
      existing controls to ensure they are performed as designed.  The
      Company also took action to improve its control environment by establishing
      and
      implementing a training program to periodically and continuously educate
      employees on internal controls.





For
      the
      fourth quarter of 2007, the Company intends to complete its work regarding
      the
      re-examination and re-engineering of the Financial Close and Reporting
      process.  The Company also plans to design and implement an anti-fraud
      program; implement new disclosure policies and procedures; review, correct
      and
      improve internal controls documentation; establish formalized policies and
      procedures in all departments; and implement controls to ensure that purchases
      are properly authorized and recorded.





At
      this
      time, the Company does not anticipate any changes to the above remediation
      plans
      and expects to resolve all material weaknesses by the end of 2007.





33
 *Index*





**PART
      II.  OTHER INFORMATION**





**ITEM
      1.  LEGAL PROCEEDINGS**





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 had not been
      able to solicit proxies for an annual meeting because it had 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. The Company subsequently filed its 2006 Form
      10-K
      on May 31, 2007 with the SEC and held an annual meeting of shareholders on
      June
      29, 2007. No further action has been taken by Mr. Porter, whose suit remains
      pending.





The
      Company’s attorneys have filed an amended motion for summary judgment seeking a
      final judgment of dismissal of this proceeding; the motion is set for hearing
      in
      late November 2007.





In
      the
      opinion of the Company’s management, it is not currently possible to estimate
      the impact, if any, that the ultimate resolution of this legal proceeding 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 condensed consolidated financial statements for this legal
      proceeding.





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”).





34
 *Index*





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





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





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





The
      Company recently reached and consummated a compromise settlement with Equita
      and
      M&W, under the terms of which Equita and M&W, on the one hand, and the
      Company and Investors Life, on the other hand, exchanged mutual releases and
      dismissed all claims between them.  As part of that compromise
      settlement, the Company paid Equita $250,000 on October 25, 2007.  The
      litigation between Equita and M&W, on the one hand, and Family Life—which
      has been sold and no longer is a subsidiary of the Company—remains
      pending.




The
      Company accrued a $250,000 liability as of June 30, 2007 for the probable
      settlement of this suit.  The accrual for this loss was reflected as
      an operating expense in the 2007 second quarter condensed consolidated statement
      of operations.  The final negotiated settlement of $250,000 was
      subsequently paid on October 25, 2007.





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. The Company
      intends to vigorously defend the suit, and has filed an answer denying the
      plaintiffs’ claims. 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
      3
      regarding the sale of Family Life Insurance Company. Discovery began in June
      of
      2007.





In
      the
      opinion of the Company’s management, it is not currently possible to estimate
      the impact, if any, that the ultimate resolution of this legal proceeding 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 condensed consolidated financial statements for this legal
      proceeding.





35
 *Index*





Other
      Litigation





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





**ITEM
      1A.  RISK FACTORS**





As
      of
      September 30, 2007, there have been no material changes to risk factors as
      previously disclosed in the Company’s 2006 Form 10-K.





**ITEM
      2.  UNREGISTERED SALES OF EQUITY SECURITIES AND
      USE OF PROCEEDS**





None





**ITEM
      3.  DEFAULTS UPON SENIOR
      SECURITIES**





None





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




There
      were no matters submitted to a vote of security holders during the third quarter
      of 2007.




**ITEM
      5.  OTHER INFORMATION**





None





**ITEM
      6.  EXHIBITS**





(a)
            Exhibits





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


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


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


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





36
 *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:
                November 9, 2007
            
            By:
            /s/
                William B. ProutyWilliam
              B. ProutyChief
              Executive OfficerDate:
                November 9, 2007
            
            By:
            /s/
                Vincent L. KaschVincent
              L. KaschChief
              Financial Officer(Principal
              Accounting and Financial Officer)






37