UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
      D.C. 20549




**Form
      10-Q**




**QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)**




**For
      the Quarterly Period Ended June 30, 2005**




**Commission
      File Number 0-4690**




**Financial
      Industries Corporation**


(Exact
      name of registrant as specified in its charter)




**TEXAS**
            **74-2126975**State
                of Incorporation
            (I.R.S.
                Employer Identification number)






**6500
      River Place Boulevard, Building I, Austin, Texas 78730**


(Address
      including Zip Code of Principal Executive Offices)




**(512)
      404-5000**


(Registrant's
      Telephone Number)




Securities
      Registered pursuant to Section 12(b) of the Act: None




Securities
      Registered pursuant to Section 12(g) of the Act:




Common
      Stock, $.20 par value


(Title
      of
      Class)




Indicate
      by check mark whether the Registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the Registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. YES  ̈ NO
      x





Indicate
      by check mark whether the Registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):


Large
                accelerated filer ̈
            Accelerated
                filerx
            Non-accelerated
                filer ̈





Indicate
      by check mark whether the Registrant is a shell company (as defined in Rule
      12b-2 of the Act).


YES  ̈ NO x




The
      number of shares outstanding of Registrant's common stock on December 31, 2006
      was 10,208,339.










Forward-Looking
      Statements





Except
      for historical factual information set forth in this Form 10-Q of Financial
      Industries Corporation (the “Company” or “FIC”), the statements, analyses, and
      other information contained in this report relating to trends in the Company’s
      operations and financial results, the markets for our products, future results,
      the future development of our business, and the contingencies and uncertainties
      to which we may be subject, as well as other statements including words such
      as
“anticipate,” “believe,” “plan,” “budget,” “could,” “designed,” “estimate,”
“expect,” “intend,” “forecast,” “predict,” “project,” “may,” “might,” “should”
and other similar expressions constitute forward-looking statements under the
      Private Securities Litigation Reform Act of 1995. Such statements are made
      based
      upon management’s current expectations and beliefs concerning financial results
      and economic conditions and are subject to known and unknown risks,
      uncertainties and other factors contemplated by the forward-looking statements.
      These factors include, among other things: (1) general economic conditions
      and
      other factors, including prevailing interest rate levels and stock market
      performance, which may affect the ability of FIC to sell its products, the
      market value of FIC’s investments and the lapse rate and profitability of
      policies; (2) FIC’s ability to achieve anticipated levels of operational
      efficiencies and cost-saving initiatives; (3) customer response to new products,
      distribution channels and marketing initiatives; (4) mortality, morbidity and
      other factors that may affect the profitability of FIC’s insurance products; (5)
      FIC’s ability to develop and maintain effective risk management policies and
      procedures and to maintain adequate reserves for future policy benefits and
      claims; (6) changes in the federal income tax laws and regulations that may
      affect the relative tax advantages of some of FIC’s products; (7) increasing
      competition in the sale of insurance; (8) the effect of regulation and
      regulatory changes or actions, including those relating to regulation of
      insurance products and insurance companies; (9) ratings assigned to FIC’s
      insurance subsidiaries by independent rating organizations such as A.M. Best
      Company, which FIC believes are particularly important to the sale of
      accumulation-type products; (10) the performance of our investment
      portfolios; (11) the effect of changes in standards of accounting; (12) the
      effects and results of litigation; (13) business risks and factors described
      elsewhere in this report, including, but not limited to, Item 2-Management’s
      Discussion and Analysis of Financial Condition and Results of Operations and
      Item 3-Quantitative and Qualitative Disclosures about Market Risks in Part
      1,
      and Item 1-Legal Proceedings in Part 2, and (14) other factors discussed in
      the
      Company’s other filings with the SEC, which are available free of charge on the
      SEC’s website at www.sec.gov. You should read carefully the above factors and
      all of the other information contained in this report. Should one or more of
      these risks or uncertainties materialize, or should underlying assumptions
      prove
      incorrect, actual results may vary materially from those indicated. All
      subsequent written and oral forward-looking statements attributable to the
      Company or to persons acting on our behalf are expressly qualified in their
      entirety by reference to these risks and uncertainties. There can be no
      assurance that other factors not currently anticipated by management will not
      also materially and adversely affect our results of operations. Each
      forward-looking statement speaks only as of the date of the particular statement
      and the Company undertakes no obligation to update or revise any forward-looking
      statement.







**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**




**INDEX**





Page
                No.**Part
                I - Financial Information**Item
                1. Financial Statements (Unaudited)Condensed
                Consolidated Balance Sheets June 30, 2005
                and December 31, 2004
            4Condensed
                Consolidated Statements of
                Operations For the three and six month periods ended June 30, 2005
                and
                June 30, 2004
            6Condensed
                Consolidated Statements of Cash Flows For the
                six month periods ended June 30, 2005 and June 30,
                2004
            10Notes
                to Condensed Consolidated Financial
                Statements
            12Item
                2. Management’s Discussion and Analysis of Financial
                Condition and Results of Operations
            22Item
                3. Quantitative and Qualitative Disclosures About
                Market Risk
            30Item
                4. Controls and Procedures
            31**Part
                II - Other Information**Item
                1. Legal Proceedings
            32Item
                2. Changes in Securities and Use of
                Proceeds
            35Item
                3. Defaults Upon Senior Securities
            35Item
                4. Submission of Matters to a Vote of Security
                Holders
            35Item
                5. Other Information
            35Item
                6. Exhibits and Reports on Form 8-K
            36


*Index*
  **FINANCIAL
        INDUSTRIES CORPORATION AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED BALANCE
        SHEETS**
 (In
        thousands) (Unaudited)
  June
                    30,
                2005
              
              December
                    31,
                2004
                  (1)ASSETSInvestments:Fixed
                    maturity securities available for sale, at fair value (amortized
                    cost of
                    $552,636 and $500,701 at June 30, 2005 and December 31, 2004,
                    respectively)
              
              $
              555,896
              
              $
              499,155Fixed
                  maturity securities held for trading, at fair value
              
              
              342
              
              
              1,057Equity
                    securities, at fair value (cost of $8,368 and $6,311 at June
                    30, 2005 and
                    December 31, 2004, respectively)
              
              
              10,414
              
              
              8,502Policy
                  loans
              
              
              38,755
              
              
              39,855Investment
                  real estate
              
              
              -
              
              
              76,580Real
                  estate held for sale
              
              
              371
              
              
              589Short-term
                  investments
              
              
              86,982
              
              
              62,514Total
                  investments
              
              
              692,760
              
              
              688,252Cash
                  and cash equivalents
              
              
              53,664
              
              
              52,044Deferred
                  policy acquisition costs
              
              
              47,781
              
              
              50,640Present
                  value of future profits of acquired business
              
              
              16,475
              
              
              17,905Agency
                  advances and other receivables, net of allowances for doubtful
                  accounts of
                  $3,350 and $3,334 as of June 30, 2005 and December 31, 2004
              
              
              9,050
              
              
              10,539Reinsurance
                  receivables
              
              
              39,763
              
              
              36,912Real
                  estate held for use
              
              
              -
              
              
              13,559Accrued
                  investment income
              
              
              6,543
              
              
              5,652Due
                  premiums
              
              
              1,885
              
              
              2,045Property
                  and equipment, net
              
              
              1,229
              
              
              1,244Other
                  assets
              
              
              2,195
              
              
              2,089Separate
                  account assets
              
              
              349,439
              
              
              359,876Total
                  assets
              
              $
              1,220,784
              
              $
              1,240,757




(1)
              Derived
                  from audited financial
                  statements




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




4
 *Index*





**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS** **,
      Continued**


(In
      thousands) (Unaudited)


June
                  30,
              2005
            
            December
                  31,
              2004
                (1)LIABILITIES
                AND SHAREHOLDERS’ EQUITYLiabilities:Policy
                liabilities and contractholder deposit funds:Contractholder
                deposit funds
            
            $
            558,047
            
            $
            572,090Future
                policy benefits
            
            
            157,341
            
            
            160,175Other
                policy claims and benefits payable
            
            
            10,817
            
            
            12,939Notes
                payable
            
            
            15,000
            
            
            15,000Deferred
                federal income taxes
            
            
            6,191
            
            
            3,549Other
                liabilities
            
            
            30,478
            
            
            29,585Separate
                account liabilities
            
            
            349,439
            
            
            359,876Total
                liabilities
            
            
            1,127,313
            
            
            1,153,214Commitments
                and contingencies (See Note 7)Shareholders’
                equity:Common
                stock, $.20 par value, 25,000 shares authorized in 2005 and 2004,
                12,517
                shares issued in 2005 and 2004; 9,813 and 9,804 shares outstanding
                in 2005
                and 2004
            
            
            2,504
            
            
            2,504Additional
                paid-in capital
            
            
            70,406
            
            
            70,398Accumulated
                other comprehensive loss
            
            
            (2,364
            )
            
            (4,667
            )Retained
                earnings
            
            
            46,189
            
            
            42,650Common
                treasury stock, at cost, 2,704 and 2,713 shares in 2005 and 2004
            
            
            (23,264
            )
            
            (23,342
            )Total
                shareholders’ equity
            
            
            93,471
            
            
            87,543Total
                liabilities and shareholders’ equity
            
            $
            1,220,784
            
            $
            1,240,757




(1)
              Derived
                  from audited financial
                  statements




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


5
 *Index*
  **FINANCIAL
        INDUSTRIES CORPORATION AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF
        OPERATIONS**
 (In
        thousands except per share data) (Unaudited)
  Three
                  Months Ended June 30,2005
              
              2004Revenues:Premiums,
                  net
              
              $
              5,877
              
              $
              5,685Earned
                  insurance charges
              
              
              10,210
              
              
              10,468Net
                  investment income
              
              
              7,805
              
              
              8,142Real
                  estate income
              
              
              51
              
              
              397Net
                  realized investment gains
              
              
              8,910
              
              
              (265
              )Other
              
              
              674
              
              
              497Total
                  revenues
              
              
              33,527
              
              
              24,924Benefits
                  and expenses:Policyholder
                  benefits and expenses
              
              
              10,069
              
              
              10,982Interest
                  expense on contractholders deposit funds
              
              
              5,647
              
              
              5,839Amortization
                  of deferred policy acquisition costs
              
              
              3,170
              
              
              2,910Amortization
                  of present value of future profits of acquired business
              
              
              657
              
              
              752Operating
                  expenses
              
              
              7,404
              
              
              8,801Interest
                  expense
              
              
              277
              
              
              210Total
                  benefits and expenses
              
              
              27,224
              
              
              29,494Income
                  (loss) from continuing operations before federal income
                  taxes
              
              
              6,303
              
              
              (4,570
              )Provision
                  (benefit) for federal income taxes
              
              
              1,621
              
              
              (774
              )Net
                  income (loss)
              
              $
              4,682
              
              $
              (3,796
              )




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




6
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS** **,
      Continued**


(In
      thousands except per share data) (Unaudited)




Three
                  Months Ended June 30,2005
              
              2004Net
                  Income (Loss) Per Share:Basic:Weighted
                  average common shares outstanding
              
              
              9,810
              
              
              9,795Basic
                  earnings (loss) per share
              
              $
              0.48
              
              $
              (0.38
              )Diluted:Weighted
                  average common shares and common share equivalents
              
              
              9,810
              
              
              9,795Diluted
                  earnings (loss) per share
              
              $
              0.48
              
              $
              (0.38
              )





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**
 (In
        thousands except per share data) (Unaudited)


Six
                  Months Ended June 30,2005
              
              2004Revenues:Premiums,
                  net
              
              $
              11,981
              
              $
              12,435Earned
                  insurance charges
              
              
              20,334
              
              
              20,896Net
                  investment income
              
              
              14,748
              
              
              16,633Real
                  estate income
              
              
              547
              
              
              842Net
                  realized investment gains
              
              
              9,270
              
              
              1,854Other
              
              
              1,246
              
              
              1,136Total
                  revenues
              
              
              58,126
              
              
              53,796Benefits
                  and expenses:Policyholder
                  benefits and expenses
              
              
              19,936
              
              
              24,349Interest
                  expense on contractholders deposit funds
              
              
              11,147
              
              
              11,746Amortization
                  of deferred policy acquisition costs
              
              
              5,667
              
              
              6,147Amortization
                  of present value of future profits of acquired business
              
              
              1,323
              
              
              1,698Operating
                  expenses
              
              
              14,587
              
              
              17,149Interest
                  expense
              
              
              532
              
              
              411Total
                  benefits and expenses
              
              
              53,192
              
              
              61,500Income
                    (loss) from continuing operations before federal income taxes
                    and
                    cumulative effect of change in accounting principle
              
              
              4,934
              
              
              (7,704
              )Provision
                  (benefit) for federal income taxes
              
              
              1,395
              
              
              (1,408
              )Income
                  (loss) before cumulative effect of change in accounting
                  principle
              
              
              3,539
              
              
              (6,296
              )Cumulative
                  effect of change in accounting principle
              
              
              -
              
              
              229Net
                  income (loss)
              
              $
              3,539
              
              $
              (6,067
              )





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




8
 *Index*


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


Six
                  Months Ended June 30,2005
              
              2004Net
                  Income (Loss) Per Share:Basic:Weighted
                  average common shares outstanding
              
              
              9,808
              
              
              9,793Basic
                  earnings per share:Income
                    (loss) from continuing operations before cumulative effect of
                    change in
                    accounting principle
              
              $
              0.36
              
              $
              (0.64
              )Cumulative
                  effect of change in accounting principle
              
              
              -
              
              
              0.02Net
                  income (loss) per share
              
              $
              0.36
              
              $
              (0.62
              )Diluted:Weighted
                  average common shares and common share equivalents
              
              
              9,808
              
              
              9,793Diluted
                  earnings per share:Income
                    (loss) from continuing operations before cumulative effect of
                    change in
                    accounting principle
              
              $
              0.36
              
              $
              (0.64
              )Cumulative
                  effect of change in accounting principle
              
              
              -
              
              
              0.02Net
                  income (loss) per share
              
              $
              0.36
              
              $
              (0.62
              )





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




9
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATEDSTATEMENTS OF CASH
      FLOWS**


(In
      thousands) (Unaudited)




Six
                  Months Ended June 30,2005
              
              2004CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income (loss)
              
              $
              3,539
              
              $
              (6,067
              )Adjustments
                  to reconcile net income (loss) to net cash used
                  in operating activities:Amortization
                  of deferred policy acquisition costs
              
              
              5,667
              
              
              6,147Amortization
                  of present value of future profits of acquired business
              
              
              1,323
              
              
              1,698Net
                  realized gains on investments
              
              
              (9,270
              )
              
              (1,854
              )Depreciation
              
              
              1,612
              
              
              1,762Increase
                  in accrued investment income
              
              
              (891
              )
              
              (473
              )Increase
                  in agent advances and other receivables
              
              
              (1,362
              )
              
              (10,742
              )Decrease
                  in due premiums
              
              
              160
              
              
              60Increase
                  in deferred policy acquisition costs
              
              
              (3,873
              )
              
              (3,397
              )Decrease
                  (increase) in other assets
              
              
              (106
              )
              
              702Decrease
                  in policy liabilities and accruals
              
              
              (2,561
              )
              
              (2,246
              )Increase
                  in other liabilities
              
              
              893
              
              
              3,400(Decrease)
                  increase in deferred federal income taxes
              
              
              1,467
              
              
              (382
              )Net
                  activity from trading securities
              
              
              647
              
              
              3,053Other,
                  net
              
              
              (1,656
              )
              
              (310
              )Net
                  cash used in operating activities
              
              
              (4,411
              )
              
              (8,649
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Fixed
                  maturities purchased
              
              
              (91,429
              )
              
              (80,922
              )Real
                  estate capital expenditures
              
              
              (550
              )
              
              (64
              )Proceeds
                  from sales and maturities of fixed maturities
              
              
              37,507
              
              
              104,705Proceeds
                  from sales of invested real estate
              
              
              100,529
              
              
              1,785Net
                  increase in short-term investments
              
              
              (24,468
              )
              
              (49,849
              )Net
                  decrease in policy loans
              
              
              1,100
              
              
              144Purchase
                  of property and equipment
              
              
              (220
              )
              
              (300
              )Net
                  cash provided by (used in) investing activities
              
              
              22,469
              
              
              (24,501
              )(continued)





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




10
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


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


(In
      thousands) (Unaudited)




Six
                  Months Ended June 30,2005
              
              2004CASH
                  FLOWS FROM FINANCING ACTIVITIES:Contractholder
                  fund deposits
              
              $
              17,362
              
              $
              22,925Contractholder
                  fund withdrawals
              
              
              (33,800
              )
              
              (34,476
              )Net
                  cash used in financing activities
              
              
              (16,438
              )
              
              (11,551
              )Net
                  increase (decrease) in cash
              
              
              1,620
              
              
              (44,701
              )Cash
                  and cash equivalents, beginning of year
              
              
              52,044
              
              
              82,436Cash
                  and cash equivalents, end of period
              
              $
              53,664
              
              $
              37,735Supplemental
                  Cash Flow Disclosures:Income
                  taxes paid (refunded)
              
              $
              -
              
              $
              (1,093
              )Interest
                  paid
              
              $
              517
              
              $
              411




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)**





**Basis
      of Presentation and Consolidation**





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





Because
      of the delays in our public reporting and the significant changes we have made
      to our business in the interim, we have included certain information relating
      to
      our business, current officers, and related matters which have occurred
      subsequent to June 30, 2005.





The
      accompanying unaudited condensed consolidated financial statements reflect
      all
      adjustments (including normal recurring adjustments) necessary to present fairly
      the consolidated financial position of the Company at June 30, 2005, its
      consolidated results of operations for the three months and six months ended
      June 30, 2005 and 2004, and its consolidated cash flows for the six months
      ended
      June 30, 2005 and 2004 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, 2004 condensed
      consolidated balance sheet data was derived from the audited financial
      statements included in the Company’s 2004 Annual Report on Form 10-K filed with
      the SEC (“2004 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 2004 Annual Report.





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





**1.**
            **Accumulated
                Other Comprehensive Income (Loss) and Comprehensive Income
                (Loss)**





The
      following is a reconciliation of accumulated other comprehensive income (loss) from
      December 31, 2004 to June 30, 2005 (in thousands):




Net
                          Unrealized
                      Appreciation
                    (Depreciation)
                  of
                    EquitySecurities
              
              Net
                    Unrealized
                  Gain
                      (Loss) on
                  Fixed
                      Maturities
                  Available
                    for
                Sale
              
              Other
              
              Total
                Accumulated
                Other
                Comprehensive
                Income
                  (Loss)Balance
                  at December 31, 2004
              
              $
              1,446
              
              $
              (1,017
              )
              $
              (5,096
              )
              $
              (4,667
              )Current
                  Period Change
              
              
              (96
              )
              
              2,399
              
              
              -
              
              
              2,303Balance
                  at June 30, 2005
              
              $
              1,350
              
              $
              1,382
              
              $
              (5,096
              )
              $
              (2,364
              )




The
      comprehensive income (loss) for the three and six months ending June 30, 2005
      and 2004 is summarized as follows (in thousands):


Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2005
              
              2004
              
              2005
              
              2004Net
                  income (loss)
              
              $
              4,682
              
              $
              (3,796
              )
              $
              3,539
              
              $
              (6,067
              )Other
                  comprehensive income, net of tax:Unrealized
                  gains on securities:Unrealized
                    holdings gains (losses) arising during the period
              
              
              5,631
              
              
              (13,134
              )
              
              1,931
              
              
              (7,860
              )Reclassification
                    adjustments for gains (losses) included in net loss
              
              
              135
              
              
              (168
              )
              
              372
              
              
              221Total
                  other comprehensive income (loss)
              
              
              5,766
              
              
              (13,302
              )
              
              2,303
              
              
              (7,639
              )Comprehensive
                  income (loss)
              
              $
              10,448
              
              $
              (17,098
              )
              $
              5,842
              
              $
              (13,706
              )


12
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


**(Unaudited)**






**2.**
            **Change
                in Accounting Principles**




The
        Company adopted the provisions of Statement of Position (“SOP”) 03-01,
“Accounting and Reporting by Insurance Enterprises for Certain Non-traditional
        Long-Duration Contracts and for Separate Accounts” on January 1, 2004, resulting
        in an increase to income as a cumulative effect of a change in accounting
        principle totaling $229,000, net of taxes, as reflected in the accompanying
        2004
        condensed consolidated statement of operations for the six months ended June
        30,
        2004. The Company has certain universal life insurance products that are
        credited with bonus interest after applicable qualifying periods. The adoption
        of the new accounting principle resulted in a change in the pattern of
        recognition of the bonus interest expense.


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





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




Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2005
              
              2004
              
              2005
              
              2004(in
                  thousands except per share data)BASIC:Income
                  (loss) before cumulative effect of change in accounting
                  principle
              
              $
              4,682
              
              $
              (3,796
              )
              $
              3,539
              
              $
              (6,296
              )Weighted
                  average common shares outstanding
              
              
              9,810
              
              
              9,795
              
              
              9,808
              
              
              9,793Basic
                  income (loss) per share
              
              $
              0.48
              
              $
              (0.38
              )
              $
              0.36
              
              $
              (0.64
              )DILUTED:Income
                    (loss) before cumulative effect of change in accounting
                    principle
              
              $
              4,682
              
              $
              (3,796
              )
              $
              3,539
              
              $
              (6,296
              )Weighted
                  average common shares outstanding
              
              
              9,810
              
              
              9,795
              
              
              9,808
              
              
              9,793Common
                  stock options
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock and common stock equivalents
              
              
              9,810
              
              
              9,795
              
              
              9,808
              
              
              9,793Diluted
                  income (loss) per share
              
              $
              0.48
              
              $
              (0.38
              )
              $
              0.36
              
              $
              (0.64
              )





**4.**
            **Net
                Realized Investment Gains - Sale of Real
                Estate**




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





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





A.
      Family
      Life





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





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


13
 *Index*


**FINANCIAL
        INDUSTRIES CORPORATION AND SUBSIDIARIES**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**
 **(Unaudited)**


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 employees are permitted to enter or re-enter the plan.





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





A
      curtailment occurred on January 1, 2004 when the decision was made to terminate
      the employment of all active participants in the plan as discussed in item
      (d)
      above. Because the
      plan’s unrecognized losses exceeded the decrease in projected benefit obligation
      (“PBO”) caused by the curtailment as of January 1, 2004, the SFAS No. 88
      curtailment charge recognized in the 2004 expense was zero. (The plan was
      subsequently amended to prevent any new or rehired employee from entering or
      reentering the plan in the future. Thus, the plan is now frozen.)





A
      settlement occurred on December 31, 2004 due to the settlement of several former
      employees’ plan obligations through the payment of lump sums. A settlement
      occurs whenever the lump sums paid during the year exceed the sum of the plans
      Service Cost and Interest Cost components of expense for that year. The
      settlement resulted in the recognition of a $399,000 charge to expense for
      2004.





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




Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2005
              
              2004
              
              2005
              
              2004Service
                  cost for benefits earned during the year
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -Interest
                  cost on projected benefit obligation
              
              
              116,054
              
              
              126,983
              
              
              232,108
              
              
              253,966Expected
                  return on plan assets
              
              
              (101,269
              )
              
              (108,056
              )
              
              (202,537
              )
              
              (216,112
              )Amortization
                  of unrecognized prior service cost
              
              
              -
              
              
              -
              
              
              -
              
              
              -Amortization
                  of unrecognized (gains)/losses
              
              
              26,226
              
              
              19,276
              
              
              52,452
              
              
              38,552Recognition
                  of net loss due to settlement
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  periodic benefit cost
              
              $
              41,011
              
              $
              38,203
              
              $
              82,023
              
              $
              76,406


14
 *Index*


**FINANCIAL
        INDUSTRIES CORPORATION AND SUBSIDIARIES**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**
 **(Unaudited)**




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
      Rule of
      68 Participant is a Participant who was an Employee on December 31, 2004 and
      for
      whom the sum of the Participant’s age in years and fractions thereof and service
      in years and fractions thereof was greater than or equal to 68 years as of
      December 31, 2004. A Rule
      of
      68 NHCE is a Rule of 68 Participant who was not a Highly Compensated Employee,
      as defined under IRC Section 414(q), as of December 31, 2004.) Because the
      plan’s unrecognized losses exceeded the decrease in PBO caused by the
      curtailment as of December 31, 2004, the SFAS No. 88 curtailment charge
      recognized in the 2004 expense was zero.





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




Three
                  Months Ended June 30,
              
              Six
                  Months Ended June 30,2005
              
              2004
              
              2005
              
              2004Service
                  cost for benefits earned during the year
              
              $
              11,448
              
              $
              145,556
              
              $
              22,896
              
              $
              291,112Interest
                  cost on projected benefit obligation
              
              
              261,812
              
              
              283,352
              
              
              523,624
              
              
              566,704Expected
                  return on plan assets
              
              
              (344,766
              )
              
              (342,053
              )
              
              (689,532
              )
              
              (684,106
              )Amortization
                  of unrecognized prior service cost
              
              
              -
              
              
              -
              
              
              -
              
              
              -Amortization
                  of unrecognized (gains)/losses
              
              
              33,920
              
              
              43,775
              
              
              67,840
              
              
              87,550Recognition
                  of net loss due to settlement
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  periodic benefit cost
              
              $
              (37,586
              )
              $
              130,630
              
              $
              (75,172
              )
              $
              261,260





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





The
      Company follows the disclosure-only provisions of SFAS No. 123, “Accounting for
      Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock
      Based Compensation - Transition and Disclosure.” SFAS No. 123 allows companies
      to follow existing accounting rules (APB 25) provided that pro forma disclosures
      are made of what net income and earnings per share would have been had the
      company recognized expense for stock-based awards based on their fair value
      at
      date of grant. The fair value disclosure assumes that fair value of option
      grants were calculated at the date of the grant using the Black-Scholes option
      pricing model. No options were granted to employees for the years ended December
      31, 2005 and 2004.


15
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


**(Unaudited)**





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





**7.**
            **Commitments
                and Contingencies**





Mitte
      Settlement





In
      2002,
      the Company filed a lawsuit against Roy F. Mitte (“Mitte”), The Roy F. and Joann
      Cole Mitte Foundation (the “Foundation”), and Joann Mitte (collectively referred
      to as the “Defendants”). Mitte was the Chairman, President and Chief Executive
      Officer of FIC until he was placed on administrative leave in August, 2002.
      The
      administrative leave, and the subsequent action by the Board of Directors in
      October, 2002, to terminate the employment agreement between the Company and
      Mitte, resulted from an investigation conducted by the FIC Audit Committee.
      Subsequent to the filing of the lawsuit, Mitte filed a counterclaim against
      the
      Company alleging that the Company breached the employment agreement between
      the
      Company and Mr. Mitte by refusing to pay Mitte the severance benefits and
      compensation provided for under the employment agreement and amendment
      thereto.





On
      May
      15, 2003, the Company entered into a settlement agreement with the Defendants
      and Scott Mitte (a director of the Company and the son of Roy Mitte) (the “Mitte
      Parties”). Under the terms of the agreement the Mitte Parties released the
      Company from any past, present or future claims which they may have against
      the
      Company, including any claims which Roy Mitte may assert under his employment
      agreement. In addition, the Company agreed to release the Mitte Parties from
      any
      past, present or future claims which the Company may have against the Mitte
      Parties.





The
      settlement provides for payments aggregating $3 million by the Company to Roy
      Mitte in equal installments of $1 million on June 1, 2003, June 1, 2004 and
      June
      1, 2005, with a provision for acceleration of payments in the event of a change
      in control. The settlement agreement also includes provisions whereby, the
      Company agrees (i) to use reasonable efforts to locate purchasers over a
      two-year period for 1,552,206 shares of FIC common stock owned by the Foundation
      at a price of $14.64 per share, (ii) to purchase (or, alternatively, locate
      a
      purchaser) on or before June 1, 2003 for 39,820 shares of FIC common stock
      owned
      by Roy Mitte and 35,502 shares of common stock held in the ESOP account of
      Roy
      Mitte, at a price of $14.64 per share. The agreement also includes provisions
      related to the continuation of health insurance of Roy and Joann Mitte and
      payment for the cancellation of options held by Roy Mitte to purchase 6,600
      shares of FIC common stock. The Company has recognized a charge of $2.9 million
      in 2003 for the discounted amounts to be paid under the settlement agreement,
      which is reflected in the consolidated statement of operations for the six
      months ended June 30, 2003, as litigation settlement.





As
      a
      condition of the obligations of the Company under the settlement agreement,
      the
      Mitte Parties agreed to grant a limited proxy to the persons named as proxies
      by
      FIC in any proxy statement filed by FIC with the SEC. With respect to the future
      shareholders meetings, the proxy may be voted “for” all nominees for the Board
      of Directors named on FIC’s proxy statement, “against” any proposal by a person
      other than FIC for the removal of any members of the Board of Directors,
“withheld” as to nominees for the Board of Directors proposed by any person
      other than FIC and “against” any proposal by any person other than FIC to amend
      the bylaws or articles of FIC. The proxy also extends to certain matters which
      may be proposed by FIC at the 2004 annual meeting of shareholders, or any later
      annual or special meeting, regarding changes in the ownership percentage
      required in order for a shareholder to call a special meeting of shareholders
      and the elimination of cumulative voting. The granting of the proxy is generally
      conditioned upon the performance of the scheduled purchases of the shares of
      FIC
      common stock owned by the Foundation.


16
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


**(Unaudited)**





T.
      David Porter v. Financial Industries Corporation





On
      May
      31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis
      County, Texas District Court (the “Court”), against the Company, seeking to
      compel the Company to hold an annual meeting of shareholders. FIC has been
      unable to hold an annual meeting at which its shareholders could be fully
      informed, or which could be attended by a substantial portion of its
      shareholders, because the Company is currently unable to comply with Rule 14a-3
      of the Securities Exchange Act of 1934, and thus cannot provide an annual report
      to shareholders or solicit proxies 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 (the “Order”) and agreed among other things to hold an
      annual shareholders meeting for the election of directors on December 6, 2006.
      The Company did in fact appear for a meeting of shareholders on December 6,
      2006, as required by the Agreed Order. In advance of the meeting date, a group
      affiliated with Mr. Porter solicited proxies from FIC shareholders in an effort
      to replace FIC’s Board of Directors; the Company remained unable to solicit
      proxies. However, on the appointed day for
      the
      shareholder meeting - December 6, 2006 - a quorum
      was not in attendance. 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
      has 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. Mr. Porter thereafter 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
      wo uld
      be adjourned. The District Court held a hearing on Porter’s application, and on
      December 22, 2006 entered an order providing among other things that FIC will
      hold an annual shareholders meeting for the election of directors on January
      16,
      2007 at 10:00 a.m., but that if a quorum
      is not present on that date, FIC will not be required to hold an annual meeting
      of shareholders at any time before July 17, 2007. In compliance with the
      December 22, 2006 order, FIC has mailed new notices of the January 16, 2007
      meeting to all shareholders of record as of the October 24, 2006 Record Date.





Litigation
      with Otter Creek Partnership I, L.P.




During
      2003, Otter Creek Management Inc., (“Otter Creek Management”), solicited proxies
      for the Company’s 2003 Annual Meeting of Stockholders (the “2003 Annual
      Meeting”) held on July 31, 2003, seeking the election of seven nominees to the
      Board of Directors of the Company in opposition to the ten candidates selected
      by the then incumbent Board of Directors. Otter Creek Management is an
      investment advisory firm that manages three investment funds that are
      shareholders of the Company: Otter Creek Partners I, LP (“Otter Creek
      Partners”), Otter Creek International Ltd. and HHMI XIII, LLC (together with
      Otter Creek Management and Otter Creek Partners, “Otter Creek”).





In
      connection with this solicitation of proxies, on June 13, 2003, Otter Creek
      Partners commenced a lawsuit in the District Court in Travis County, Texas,
      Cause No. GN302872 (the “Litigation”) seeking, among other things, to compel the
      Company to hold the previously delayed 2003 Annual Meeting. Otter Creek also
      sought in the Litigation to neutralize the effect of a proxy obtained by the
      Company from the Mitte Family (the “Mitte Proxy”) the preceding month whereby
      the incumbent board was able to vote 1,627,610 shares in favor of its
      nominees.





Following
      the initiation of this litigation and a hearing before the court, the court
      ordered the Company not to amend its bylaws in a manner that would adversely
      affect voting or other matters relating to the Annual Meeting and election
      of
      directors and not to reschedule such Annual Meeting scheduled for July 31,
      2003,
      or the record date of the Annual Meeting.





At
      the
      meeting, six of the seven Otter Creek nominees were elected to the Board: R.
      Keith Long, J. Bruce Boisture, Salvador Diaz-Verson Jr., Patrick E. Falconio,
      Richard H. Gudeman and Lonnie L. Steffen. The shares covered by the Mitte Proxy
      were all voted in favor of the incumbent nominees at the 2003 Annual Meeting.
      Had Otter Creek been successful in neutralizing the effect of the Mitte Proxy,
      all seven of the Otter Creek nominees would have been elected.


17
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


**(Unaudited)**




Following
        the 2003 Annual Meeting, Otter Creek and FIC completed a settlement with
        respect
        to the lawsuit in December 2003. Under the settlement agreement, the Company
        reimbursed Otter Creek for $250,000 in proxy expenses in 2003. An additional
        $475,000 of proxy and litigation expenses payable in FIC common stock will
        be
        submitted to the Company’s shareholders for approval at the next Annual Meeting
        of Shareholders. If payment of the additional $475,000 is so approved, the
        amount will be expensed by the Company in the year of approval. The Board
        of
        Directors will recommend that shareholders approve the reimbursement. The
        settlement also included mutual releases between the Company and Otter Creek
        and
        its affiliates. The Chairman of the Board of Directors of the Company, R.
        Keith
        Long, is the President and owner of the General Partner of Otter Creek Partners
        I, L.P.


Litigation
      with Former Employee of Subsidiary




In
      October 2003, the Company placed Earl Johnson, the then-president of JNT Group,
      Inc. (“JNT”), a subsidiary of FIC that was later sold in December 2003 in the
      sale of the New Era companies, on administrative leave pending an investigation
      of matters related to (1) Johnson’s alleged termination of an employee in
      response to her request for information regarding her workers’ compensation
      rights arising out of an injury and (2) his co-mingled and disorganized
      bookkeeping of JNT’s client accounts with those of a personal business owned by
      Mr. Johnson and run by him at the same office (using the Company’s employees to
      do so). Soon after being interviewed in the course of that investigation, Mr.
      Johnson resigned, alleging good reason under his employment agreement with
      a
      subsidiary of FIC, on the ground that the change in the composition of the
      Board
      of Directors of FIC following the 2003 Annual Meeting of Shareholders resulted
      in a “change of control” under the provisions of his employment agreement. The
      employment agreement provided that if Mr. Johnson were to voluntarily terminate
      his employment for good reason, he would receive compensation and benefits
      for
      the remainder of the three-year term of the agreement and would become fully
      vested in 17,899 restricted shares of FIC stock. The Company notified Mr.
      Johnson that his resignation was not for “good reason” pursuant to his
      employment agreement. Under that agreement, termination without good reason
      results in forfeiture of future salary and benefits, as well as forfeiture
      of
      the restricted shares of FIC common stock.





In
      November 2003, Mr. Johnson and his wife, Carol Johnson, filed suit in Harris
      County, Texas District Court against the Company, FIC Financial Services, Inc.
      (“FICFS”) and an employee of the Company. The suit, which sought an unspecified
      amount of damages and injunctive relief, alleges that the defendants interfered
      with the non-JNT contract and business relationships of the plaintiffs, made
      slanderous statements regarding the plaintiffs, and accessed computer files
      at
      the JNT offices relating to the non-JNT business relationships of the
      plaintiffs, without the consent of the plaintiffs. The suit also alleged
      conspiracy, conversion, and various other torts, all related to the defendants’
investigation of plaintiff’s business practices at JNT.




Subsequently,
      Mr. Johnson filed a demand for arbitration under his employment agreement,
      which
      has a mandatory arbitration clause. In the arbitration, Mr. Johnson sought
      damages for breach of contract and various other benefits relating to the
      termination of his employment contract, totaling $913,133.40. In connection
      with
      the arbitration, FIC submitted a counter-claim, alleging that Mr. Johnson
      committed multiple breaches of his employment agreement, and that he breached
      his fiduciary duty to FIC as a result of his actions in conducting the business
      of JNT, thereby entitling FIC to a dismissal of plaintiff’s claims. Prior to the
      hearing on the arbitration, the Harris County Court ordered that the matters
      raised in that lawsuit by Mr. Johnson (though not Carol Johnson) be combined
      with the arbitration.




An
      arbitration hearing on Johnson’s contract claims was conducted in April 2005. On
      July 21, 2005, the Arbitrator issued an interim award in which he denied all
      of
      Johnson’s claims for breach of contract, as well as Johnson’s claims with
      respect to the restricted shares of FIC stock. In denying Johnson’s claims, the
      Arbitrator concluded that:





(1)
            Johnson
                had committed multiple and material breaches of his employment agreement
                by operating a personal tax and accounting business out of office
                space
                and using employees, utilities and other items, all paid for by FICFS;
                by
                engaging in a self-dealing transaction involving the payment to himself
                of
                $25,000 out of funds held by JNT in a suspense account, an account
                to
                which JNT owed fiduciary duties to its customers and clients; and
                by
                firing an employee of JNT on the same day that the employee inquired
                about
                possible workers compensation benefits in connection with an on-the-job
                injury,





(2)
            Johnson’s
                breaches of his employment agreement occurred prior to the time that
                he
                was placed on administrative leave, thereby precluding him from
                maintaining a breach of contract suit against FIC and FICFS, and


18
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


**(Unaudited)**


(3)
            The
                change in the majority of the Board of Directors of FIC resulting
                from the
                2003 Annual Meeting of FIC’s shareholders did not constitute a “change of
                control” under Johnson’s employment agreement, thereby denying Johnson’s
                claim that he was entitled to a “good reason” termination of his
                employment agreement.





In
      addition, the Arbitrator awarded FICFS $28,000, plus interest at the rate of
      6%
      per annum from July 21, 2005, to the date of payment, with respect to Johnson’s
      unauthorized conversion of funds held in the JNT suspense account. The order
      confirming the arbitration award was signed on February 27, 2006, by the Harris
      County district judge and the Company is currently pursuing collection of the
      judgment. No amounts have been recorded in the Company’s financial statements
      for such judgment.




With
      respect to the matters raised by Mr. Johnson in the Harris County lawsuit,
      which
      were referred by the Court to the arbitration, following his loss in the
      arbitration of the employment agreement, Mr. Johnson notified the Arbitrator
      that he would not pursue arbitration of his other claims. In addition, in May
      2006, Mrs. Johnson filed a notice of non-suit with respect to the claims made
      by
      her in the Harris County lawsuit. Accordingly, this matter is now closed.





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 which 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 purchased 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 2006.


19
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


**(Unaudited)**





In
      response to a motion for partial summary judgment, the Company has stipulated
      to
      certain elements of some of the causes of action asserted by Equita and M&W,
      including that certain representations and warranties made in the Option
      Agreement were partially incorrect, and that FIC was unable to comply with
      certain of its obligations under the Option Agreement. FIC did not stipulate,
      and continues to dispute, other elements of certain of the causes of action
      asserted by Equita and M&W, and disputes other causes of action in their
      entirety. FIC intends to vigorously oppose the lawsuit and any effort by Equita
      and M&W to recover damages from FIC, and the life insurance subsidiaries
      intend to vigorously prosecute their claims in intervention against Equita.




Shareholder
      Claim




The
      Company received a demand letter in April 2004 from a law firm representing
      an
      individual shareholder (Mr. Cook) who owns 530 shares of the Company’s common
      stock, which letter set forth certain allegations and notified the Registrant
      that the shareholder intended to file a shareholder derivative lawsuit (the
      “Demand Letter”).





In
      May
      2004, FIC, by and through its Special Litigation Committee, filed a petition
      in
      the 250th District Court of Travis County, Texas (the “Court”), seeking to have
      the Court appoint a panel of independent and disinterested persons pursuant
      to
      Section H (3) of Article 5.14 of the Texas Business Corporation Act to
      investigate the allegations, and stay any shareholder derivative actions.
      Subsequently, on June 1, 2004, the Court issued an Order appointing Eugene
      Woznicki, Kenneth S. Shifrin, John D. Barnett and F. Gary Valdez as a panel
      of
      independent and disinterested persons (the “Panel”) to make determinations
      contemplated by Section F of Article 5.14 of the Texas Business Corporation
      Act
      in connection with the Demand Letter and staying any shareholder derivative
      actions relating to the letter until the Panel’s review was completed and a
      determination was made by the panel as to what, if any, further action was
      to be
      taken. Messrs. Woznicki, Shifrin and Barnett are independent directors of FIC.
      Mr. Valdez is neither a director nor an employee of FIC. Mr. Valdez is the
      founder and president of Focus Strategies, L.L.C. and is active in various
      community and civic organizations in the Austin, Texas area.





Following
      an extensive review of the claims made by the individual shareholder, the Panel,
      in January 2005, filed with the court a Petition for Declaratory Judgment
      pursuant to the Texas Declaratory Judgments Act and Article 5.14 of the Texas
      Business Corporations Act (the “Petition”). The Petition describes the process
      used by the Panel and its counsel in considering the matters raised in the
      Demand Letter and the submittal provided by counsel for the shareholder. The
      Petition advised the Court that, after consideration of the evidence obtained
      through its inquiry, the Panel had unanimously made a good faith determination
      that the continuation of the Committee’s derivative proceeding and the
      commencement of any further derivative proceedings based on the allegations
      made
      by the individual shareholder was not in the best interests of FIC.





On
      October 10, 2005, the 250th District Court of Travis County, Texas, heard for
      trial on the merits the matters raised by the Panel in the Petition
      ( Financial
      Industries Corporation v. Tom
      Cook (Cause
      No. GN 401513). After consideration of the pleadings, evidence and authorities
      submitted by counsel for the Company, the Court issued a Final Judgment on
      October 10, 2005, in which it ruled that the determinations made by the Panel,
      as reflected in a report submitted to the Court by a Special Litigation
      Committee appointed by the Registrant’s Board of Directors, were made: (1) in
      good faith, (2) after the Panel conducted a reasonable inquiry, and (3) based
      on
      the factors deemed appropriate under the circumstances by the Panel. The Court’s
      ruling otherwise dismissed with prejudice the derivative proceedings involved
      in
      this matter. The Final Judgment was approved as to form and substance by counsel
      for the Registrant and by counsel for the defendant.





***Management
      Conclusion on Legal Proceedings***





In
      the
      opinion of the Company’s management, it is not currently possible to estimate
      the impact, if any, that the ultimate resolution of these foregoing legal
      proceedings will have on the Company’s results of operations, financial
      position, or cash flows.





***Other
      Litigation***





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


20
 *Index*


**FINANCIAL
      INDUSTRIES CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


**(Unaudited)**


**8.**
            **Subsequent
                Events**





Sale
      of Family Life Insurance Company





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




Prior
        to
        the sale, Family Life owned 648,640 shares of FIC common stock. Such shares
        are
        reflected as common treasury stock in the accompanying consolidated financial
        statements. In conjunction with this transaction, the Company acquired from
        Family Life 324,320 of these shares and the remaining 324,320 shares remained
        with Family Life at the time of sale. Also, prior to the closing of the sale,
        the Family Life Pension Plan, along with its assets and liabilities, was
        transferred from Family Life Insurance Company to its upstream parent company,
        Family Life Corporation (“FLC”). FLC is wholly owned by FIC and all current and
        future obligations of the Family Life Pension Plan are the responsibility
        of
        FLC.
  Also
        in
        conjunction with the sale, the Company’s Investors Life subsidiary entered into
        a coinsurance arrangement with Manhattan Life related to sales of certain
        future
        insurance products historically marketed by Family Life, such as traditional
        mortgage life insurance.


At
      September 30, 2006, Family Life had assets totaling approximately $121.9 million
      and capital and surplus totaling approximately $16.3 million, as reported on
      a
      statutory basis of accounting for insurance regulatory purposes. The Company
      has
      not yet completed the preparation of its 2006 consolidated financial statements
      as prepared under GAAP. The estimated GAAP equity basis in Family Life,
      including other adjustments that will affect the determination of loss from
      the
      sale, totals approximately $60 million. Accordingly, management estimates that
      a
      GAAP loss between $30 million and $35 million will result from this sale. The
      foregoing amounts are unaudited and could change significantly upon completion
      of 2006 GAAP financial statements and the audits of such financial statements.





Amendment
      of Subordinated Loans





FIC
      and
      FLC have subordinated notes payable to Investors Life with an unpaid balance
      of
      $15.4 million at June 30, 2005 and December 31, 2004. With the approval of
      the
      Texas Department of Insurance, the loans were restructured as of March 9, 2006.
      As amended, the loans provide for a one year moratorium on principal payments
      for the period from March 12, 2006, to December 12, 2006, with principal
      payments to resume on March 12, 2007, with ten equal quarterly principal
      payments until the maturity date of June 12, 2009. These notes have been
      eliminated in the consolidated financial statements. The Company retired these
      subordinated notes payable on December 29, 2006 using a portion of the
      proceeds from the sale of Family Life Insurance Company.


21
 *Index*





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





The
      following discussion addresses the financial condition of Financial Industries
      Corporation (“FIC”) as of June 30, 2005, compared with December 31, 2004, and
      its results of operations for the three and six month periods ended June 30,
      2005, compared with the same period last year. This discussion should be read
      in
      conjunction with Management’s Discussion and Analysis included in FIC’s Form
      10-K for the year ended December 31, 2004, to which the reader is directed
      for
      additional information.





**Results
      of Operations - Three Months Ended June 30, 2005 and 2004**


For
        the
        three month period ended June 30, 2005, the Company reported net income of
        $4.7
        million and basic and diluted earnings per common share of $0.48 compared
        to a
        net loss of $3.8 million and basic and diluted loss per common share of $0.38
        for the three month period ended June 30, 2004. The three months ended June
        30,
        2005 and 2004 include the impact of certain trends and changes in the business
        of the Company which are dominant in the results of the six months ended
        June
        30, 2005 and 2004. These items are described in the six-month results of
        operations below. Of these results, certain significant items of change between
        the three months ended June 30, 2005 and 2004 which result in the significant
        change in net income between periods are as follows:
 
 ·
              Increase
                  in net realized gains of $9.2 million primarily due to the sale
                  of River
                  Place Pointe;
 ·
              Decrease
                  in operating expenses of $1.4 million resulting from the reduction
                  of
                  unusual expenses noted below in the six months ended June 30,
                  2004;
 ·
              Increase
                  in provision for federal income taxes of $2.4
                  million.
 
 **Results
        of Operations - Six Months Ended June 30, 2005 and 2004**
 
 For
        the
        six-month period ended June 30, 2005, FIC’s net income was $3.5 million (basic
        and diluted earnings of $.36 per common share) on revenues of $58.1 million
        as
        compared to net loss of $6.1 million (basic and diluted loss of $.62 per
        common
        share) on revenues of $53.8 million in the first six months of
        2004.
 
 In
        2005,
        FIC’s net income (loss) was affected by the following:
 
 ·
              Decrease
                  in net investment income of $1.9 million primarily due to effects
                  of lower
                  market interest rates and the decline in investments held in fixed
                  maturities, equity securities, or short-term investments from June
                  30,
                  2004;
 ·
              Increase
                  in net realized gains of $7.4 million primarily due to the sale
                  of River
                  Place Pointe;
 ·
              Decrease
                  in policyholder benefits and expenses of $4.4 million resulting
                  from the
                  decline in the amount of death claims and policy
                  surrenders;
 ·
              Decrease
                  in operating expenses of $2.6 million resulting from the reduction
                  of
                  unusual expenses in the three months ended June 30,
                  2005;
 ·
              Increase
                  in provision for federal income taxes of $2.8
                  million.
 
 In
        2004,
        FIC’s net loss was affected by the following:
 
 ·
              Significantly
                  higher policyholder benefits and expenses totaling $24.3 million
                  for the
                  six months ended June 30, 2004, compared to $21.5 million for the
                  same
                  period in 2003. A substantial portion of this increase was related
                  to
                  higher death benefits.
  ·
              Effective
                  January 1, 2004, the Company adopted Statement of Position (“SOP”) 03-01,
                  “Accounting and Reporting by Insurance Enterprises for Certain
                  Non-traditional Long-Duration Contracts and for Separate Accounts.” This
                  resulted in recognizing additional income totaling $229,000, net
                  of taxes,
                  as a cumulative effect of change in accounting principle in 2004.
                  The
                  implementation of this SOP changed the pattern of recognition of
                  bonus
                  interest credited to contractholders for certain of the Company’s
                  insurance products.
  ·
              Significant
                  auditing, actuarial, accounting, consulting, and legal fees were
                  incurred
                  throughout 2004, much of which was associated with the internal
                  review of
                  the Company’s financial accounts and resulting restatement of prior years’
                  financial statements as reported in its 2004 Form 10-K filing.
 
 The
        above
        described items need to be taken into consideration in drawing comparisons
        between the operating results for the six months ended June 30, 2005 and
        2004.
  22
 *Index*


*Revenues*
 
 Premium
        revenues reported for traditional life insurance products are recognized
        when
        due. Premium income for the first six months of 2005, net of reinsurance
        ceded,
        was $12.0 million, as compared to $12.4 million in the first six months of
        2004.
        This source of revenues is related to the traditional life insurance book
        of
        business of FIC’s insurance subsidiaries. The decrease in premium income
        reflects the run-off in the Company’s existing traditional life insurance book
        of business for both first year and renewal premiums. The decrease in renewal
        premiums is exceeding first year premium production levels, resulting in
        the
        overall decline in premium revenues on traditional life insurance products.
 
 In
        accordance with GAAP, deposits received by FIC in connection with annuity
        contracts and premiums received for universal life (“UL”) insurance policies are
        reflected in FIC’s financial statements as increases in liabilities for
        contractholder deposit funds and not as revenues. Earned insurance charges
        assessed against these deposits are reported as revenue. For the six months
        ended June 30, 2005 and 2004, annuity deposits and UL premiums totaled $17.4
        million and $22.9 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
        in periods subsequent to 2003 due primarily to the current interest-rate
        environment and certain design features of FIC’s current annuity
        products.
 
 Earned
        insurance charges totaled $20.3 million for the first six months of 2005,
        as
        compared to charges of $20.9 million in the same period of 2004. These revenues
        primarily consist of UL cost of insurance charges, but also include policy
        surrender charges, and policy administration charges. The decline in earned
        insurance charges from 2004 to 2005 is primarily due to reduced UL cost of
        insurance charges resulting from the net run-off of business.
 
 Net
        investment income for the first six months of 2005 was $14.7 million as compared
        to $16.6 million in the same period of 2004. The decrease in net investment
        income from 2004 to 2005 was primarily attributable to 1) a decline in the
        income received from the Company’s interest-bearing investments, resulting from
        decreasing interest rates during 2004 and 2) reduction in total investments
        in
        fixed maturities, equity securities, and short-term investments compared
        to the
        first six months of 2004.
 
 Real
        estate income is primarily earned from the leases on the buildings at the
        Company’s River Place Pointe office complex in Austin, Texas. Real estate income
        (revenues from leases less associated operating expenses and depreciation)
        was
        $547,000 for the six-month period ended June 30, 2005, which is with a slight
        decline from $842,000 in the same period in 2004. This decline is attributable
        primarily to additional operating expenses and depreciation of River Place
        Pointe. In June 2005, the Company sold the River Place Pointe property, and
        accordingly, the Company will no longer have significant real estate-related
        income subsequent to June 1, 2005 as the sales proceeds were reinvested
        primarily in fixed maturity securities.
 
 Net
        realized investment gains were $9.3 million in the first six months of 2005,
        as
        compared to $1.9 million in the first six months of 2004. The realized gains
        for
        2005 were primarily from the
        sale
        of River Place Pointe. The
        office complex was sold in June 2005, in a cash transaction, for $103 million.
        The Company realized a gain of $10.6 million on the sale, which included
        both a
        current realized gain of $8.5 million and a deferred gain of $2.1 million
        to be
        recognized as a reduction of office lease expenses over the period from the
        sale
        date through March 31, 2008. The realized gains for 2004 were primarily from
        the
        sales of fixed maturity securities and one of the Company’s real estate
        properties classified as held for sale.
 
 *Benefits
        and Expenses*
 
 Policyholder
        benefits and expenses, which consist primarily of death benefit claims, were
        $19.9 million in the first six months of 2005, as compared to $24.3 million
        in
        the first six months of 2004. The decrease in policyholder benefits and expenses
        was primarily attributable to both lower death benefit claims and surrenders
        of
        traditional life insurance policies.
 
 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 $11.1 million in the first six months of 2005, as compared
        to
        $11.7 million in the same period of the year 2004. The decrease in interest
        expense in 2005 was primarily attributable to the continued trend of reductions
        in interest rates credited to policyholders, as the Company managed its interest
        spread in response to the low and declining interest rates that characterized
        2005 and 2004.


23
 *Index*


With
      the
      decline in market interest rates, there can be effects on 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 the lower market rates by lowering
      many
      of the credited rates on its policies during 2004 and 2005. 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 recent years has put pressure on the Company’s interest
      spread.





Amortization
      of deferred policy acquisition costs (“DAC”)
      for the first
      six months of 2005 was $5.7 million, as compared to $6.1 million in the same
      period in 2004. 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.





Present
      value of future profits of acquired business (“PVFP”)
      is amortized in
      a similar manner as DAC, as previously described, for acquired traditional
      and
      interest sensitive business. Amortization of PVFP totaled $1.3 million and
      $1.7
      million for the six months ended June 30, 2005 and 2004, respectively. The
      amortization is consistent with the run-off of the acquired blocks of
      business.





Operating
      expenses for the first six months of 2005 were $14.6 million, as compared to
      $17.1 million in the first six months of 2004. This decrease in the level of
      operating expenses is primarily the result of several unusual items occurring
      during the first six months of 2004.





During
      2004, the Company took significant steps to reduce the level of operating
      expenses. Subsequent to the changes in the Board and management in late 2003
      and
      early 2004 a comprehensive review of the Company’s staffing and operational
      structure was performed. This review identified numerous opportunities in these
      areas for reductions in the Company’s cost structure, given the current levels
      of sales and business in force. Accordingly, significant reductions in staffing
      levels were achieved in late 2003 and during 2004.





Although
      cost reduction steps were implemented in 2004, with additional steps taken
      in
      2005, these savings were significantly offset by extraordinary auditing,
      actuarial, accounting and other consulting, and legal expenses associated with
      the reexamination and restatement of the Company’s 2003 consolidated financial
      statements, compliance with Sarbanes-Oxley, and with its litigation matters
      as
      previously described herein.





Interest
      expense was $532,000 and $411,000 for the six months ended June 30, 2005 and
      2004, 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%.





*Taxes*





The
      provision for federal income taxes on loss from operations, before cumulative
      effect of change in accounting principles, reflects a tax provision totaling
      $1.4 million and a tax benefit totaling $1.4 million for the six months ended
      June 30, 2005 and 2004, respectively. These tax amounts equate to effective
      tax
      provision rate of 28% and tax benefit rate of 18% for the six months ended
      June
      30, 2005 and 2004, respectively. The primary reason for the deviation from
      the
      expected statutory tax rate of 34% for the Company is due to increases in the
      valuation allowance for deferred tax assets. Deferred income tax assets are
      subject to ongoing evaluation of whether such assets will be realized.
      Realization of deferred tax assets is dependent upon the Company's generation
      of
      sufficient taxable income in the future to recover tax benefits that cannot
      be
      recovered from taxes paid in prior periods. If future taxable income is not
      expected, the Company establishes a valuation allowance, when based on the
      weight of the available evidence, it is more likely than not that some portion
      of the deferred tax assets will not be realized. The Company’s deferred tax
      assets are primarily comprised of net operating losses of FIC and its non-life
      insurance subsidiaries.


24
 *Index*





*Change
      in Accounting Principle*





Effective
      January 1, 2004, the Company adopted Statement of Position (“SOP”) 03-01,
“Accounting and Reporting by Insurance Enterprises for Certain Non-traditional
      Long-Duration Contracts and for Separate Accounts.” This resulted in recognizing
      additional income totaling $229,000, net of taxes, as a cumulative effect of
      change in accounting principle for the six months ended June 30, 2004. The
      implementation of this SOP resulted in a change in the pattern of recognition
      of
      bonus interest credited to contractholders for certain of the Company’s
      insurance products.








**Liquidity
      and Capital Resources**





Liquidity
      describes the ability of a company to generate sufficient cash flows to meet
      the
      cash requirements of business operations. FIC is an insurance holding company
      whose principal assets consist of its insurance subsidiaries - Family Life
      Insurance Company (“Family Life”) and Investors Life Insurance Company of North
      America (“Investors Life”). As a holding company, FIC’s ability to pay interest
      and principal on its debt, pay its expenses, and pay dividends on its common
      stock depend substantially upon its receipt of dividends or other cash flow
      from
      these subsidiaries.





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





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




With
        the
        approval of the Texas Department of Insurance, the Affiliated Notes were
        restructured as of March 9, 2006. As amended, the loans provide for a one
        year
        moratorium on principal payments for the period from March 12, 2006, to December
        12, 2006, with principal payments to resume on March 12, 2007, with ten equal
        quarterly principal payments until the maturity date of June 12, 2009. As
        previously described in Note 8 of the accompanying financial statements,
        the Company retired the affiliated notes on December 29, 2006, using a portion
        of the proceeds from the sale of Family Life Insurance
        Company.




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




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





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





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


25
 *Index*


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





A
      primary
      liquidity consideration with respect to life insurance and annuity products
      is
      the risk of early policyholder and contractholder withdrawal. Deposit fund
      liabilities for universal life and annuity products as of June 30, 2005 were
      $558.0 million, compared to $572.1 million at December 31, 2004. Individual
      life
      insurance policies are less susceptible to withdrawal than are annuity contracts
      because life insurance policyholders may incur surrender charges and undergo
      a
      new underwriting process in order to obtain a new insurance policy. At June
      30,
      2005, the bulk of the liabilities for contractholder deposit funds on FIC’s
      condensed consolidated balance sheet, $416.6 million, represented insurance
      products, as compared to $141.4 million of annuity product
      liabilities.





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





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


Cash
        and
        cash equivalents at June 30, 2005 were $53.7 million compared to $52.0 million
        at December 31, 2004. The $1.7 million increase in cash and cash equivalents
        at
        June 30, 2005 from December 31, 2004 was due primarily to proceeds from the
        sales of invested real estate, net of reinvestment of much of the proceeds
        in
        fixed maturity securities and short-term investments. This was partially
        offset
        by the net payout of contractholder deposits and use of cash by operations.
 
 Net
        cash
        used in operating activities was $4.4 million for the six month period ended
        June 30, 2005, compared to $8.6 million used in operating activities for
        the
        same period of 2004. The decrease in cash used in operating activities of
        $4.4
        million from 2004 to 2005 was primarily attributable to decreases in other
        receivables primarily due to federal income taxes recoverable and increases
        in
        deferred federal income taxes.
 
 Net
        cash
        provided by investing activities was $22.5 million in the six month period
        ended
        June 30, 2005, compared to net cash used in investing activities of $24.5
        million for the same period of 2004. The $47 million increase in cash provided
        by investing activities in 2004 from 2005 was due primarily to proceeds received
        from the sale of River Place Pointe, offset by reinvestment of these proceeds
        into fixed maturity securities available for sale and short-term
        investments.
 
 Net
        cash
        used in financing activities was $16.4 million in the first six months of
        2005,
        compared to $11.6 million used in the first six months of 2004. The increase
        in
        cash used in financing activities of $4.8 million is attributable to
        contractholder fund deposits and withdrawals for annuity and universal life
        insurance policies. For the six months ended June 30, 2005 and 2004,
        contractholder fund withdrawals exceeded deposits by $16.4 million and $11.6
        million respectively. The change in net withdrawals in 2005 is due to a decline
        in deposits in 2005 from 2004 of $5.5 million and a decrease in withdrawals
        of
        $.7 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.


26
 *Index*


**Financial
        Condition**
 
 During
        the six months ended June 30, 2005, the equity of the shareholders of the
        Company (that is, the excess of the Company’s assets over its liabilities)
        increased by $5.9 million. The primary changes resulting in the increase
        to
        shareholders’ equity are detailed as follows:
 
 ·
              Net
                  income for the six months of $3.5
                  million
 ·
              $2.3
                  million reduction in accumulated other comprehensive loss from
                  change in
                  net unrealized losses on investments in fixed maturity and equity
                  securities available for sale
  *Assets*
 
 In
        2003,
        following a review of the investment portfolios of the life insurance
        subsidiaries of the Company and the poor performance of recent reinvestments
        by
        the former management, the Investment Committee of the Company's then newly
        elected Board of Directors recommended the engagement of a third-party
        investment manager to provide ongoing, professional management of the
        portfolios. In October 2003, the life insurance subsidiaries entered into
        investment management agreements with Conning. Under these agreements, Conning
        manages the investment security portfolios of the Company’s life insurance
        subsidiaries in accordance with investment policies set by the Company’s Board
        of Directors.
 
 The
        Company, working with Conning, also revised the investment policies of its
        insurance subsidiaries. The new policies reiterate compliance with legal
        requirements of state insurance laws and regulations that are applicable
        to the
        Company’s insurance company subsidiaries. They also emphasize sensitivity to the
        way that FIC’s liabilities are likely to change over time and with changes in
        general interest rate levels. In practical terms, this means that the Company
        now 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.
 
 Since
        the
        engagement of Conning as the Company’s investment manager, the Company has
        realigned its portfolio, decreasing its investment in mortgage-backed securities
        (including asset-backed securities) significantly, from 37.4% at December
        31,
        2004 to 31.2% at June 30, 2005, expressed as a percentage of its total
        investment in fixed maturities. Such securities are sensitive to changes
        in
        prevailing interest rates, since interest rate levels affect the rate at
        which
        the underlying mortgage obligations are repaid. FIC’s insurance subsidiaries
        have reduced the risk of prepayment associated with mortgage-backed securities
        by investing in planned amortization class (“PAC”), target amortization class
        (“TAC”) instruments and scheduled bonds. These investments are designed to
        amortize in a predictable manner by shifting the risk of prepayment of the
        underlying collateral to other investors in other tranches (“support classes”)
        of the CMO.
 
 FIC’s
        equity securities consist primarily of its investment in the investment funds
        underlying the separate accounts business of Investors Life Insurance Company
        of
        North America (“Investors Life”). However, during 2005, the Company increased
        its equity security holdings by investing $2.1 million in a corporate bond
        mutual fund as part of a strategy to increase diversification and enhance
        overall investment performance. As of June 30, 2005, the market value of
        FIC’s
        equity securities was $10.4 million, compared to $8.5 million at December
        31,
        2004.
 
 FIC’s
        real estate investment is primarily related to the River Place Pointe office
        complex (“River Place Pointe”) owned by Investors Life. At December 31, 2004,
        FIC’s investment totaled $90.1 million in this 600,000 sq. ft., seven-building
        office complex on 48 acres in Austin, Texas. FIC and its insurance company
        subsidiaries occupy one of the seven buildings. The project was sold in June
        2005, in a cash transaction, for $103 million. The Company realized a gain
        of
        $10.6 million on the sale, which included both a current realized gain of
        $8.5
        million and a deferred gain of $2.1 million to be recognized over the period
        from the sale date through March 31, 2008.
 
 Investors
        Life had $349.4 million of separate account assets as of June 30, 2005 (not
        including the value of the Company’s own investment in one of the accounts), as
        compared to $359.9 million at the end of 2004. These assets include (a) two
        variable annuity separate accounts that permit contractholders to allocate
        their
        contract values among a selection of third-party mutual funds and (b) assets
        held in custodian accounts in connection with investment annuity contracts.
        The
        investment annuity business is reinsured with Symetra Life Insurance Company
        (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10%
        coinsurance basis, with Investors Life retaining 10% of such business. Since
        the
        reinsurance treaty is on a coinsurance basis, Investors Life is contingently
        liable to the policyholders in the event that the reinsurer is unable to
        fulfill
        its obligations under the treaty. Investors Life is not marketing new separate
        account annuity contracts.


27
 *Index*





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





*Liabilities*





The
      Company’s insurance-related liabilities (future policy benefits and
      contractholder deposit funds) were $715.4 million at June 30, 2005, compared
      to
      $732.3 million at December 31, 2004. The decrease in these insurance-related
      liabilities reflects the business run-off as previously described.




During
          the six months ended June 30, 2005, deferred income taxes have increased
          $2.6
          million from December 31, 2004. The change is most notably due to the tax
          effect
          of the current year operating results on the net operating loss position
          of the
          Company, the change in unrealized losses on fixed maturities available
          for sale
          and the change in valuation allowance based on the future realization of
          the
          deferred tax assets. This valuation allowance decreased primarily due to
          the net
          income of the Company resulting in more recoverable deferred tax
          assets.


*Capital
      Adequacy*




Financial
      intermediaries such as FIC depend on their equity capital to absorb short-term
      fluctuations in asset and liability values in their financial structures. They
      also count on equity capital to support the growth of the business. One typical
      measure of the strength of a financial holding company such as FIC is the simple
      ratio of its shareholders’ equity to its total assets. For FIC this ratio was
      7.7% at June 30, 2005, compared to 7.1% at December 31, 2004. If separate
      account assets were not included (which management believes is
      appropriate) this ratio would have been higher by 3.1% and 2.9% at June 30,
      2005 and December 31, 2004, 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.




FIC’s
      insurance subsidiaries 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, 2005, the total adjusted capital of FIC’s insurance subsidiaries, Family
      Life and Investors Life, was approximately 717% and 560% of its authorized
      control level risk-based capital, respectively. The RBC ratio of Investors
      Life
      improved as a result of the June 2005 sale of the River Place Pointe real estate
      investment.





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 2004, each of
      the
      Company’s insurance subsidiaries had six IRIS ratios outside of the usual
      ranges. However, for 2005 Family Life had five ratios and Investors Life had
      two
      ratios which were outside the usual ranges. For Family Life, the ratios outside
      the usual ranges were primarily related to changes in capital and surplus,
      net
      income, investment income, and non-admitted assets. For Investors Life, the
      ratios outside the usual ranges were primarily related to investment income
      and
      changes in premium.





**Critical
      Accounting Policies**





The
      accounting policies below have been identified as critical to the understanding
      of the results of operations and financial position. The application of these
      critical accounting policies in preparing the financial statements requires
      management to use significant judgments and estimates concerning future results
      or other developments, including the likelihood, timing or amount of one or
      more
      future transactions. Actual results may differ from these estimates under
      different assumptions or conditions. On an ongoing basis, estimates, assumptions
      and judgments are evaluated based on historical experience and various other
      information believed to be reasonable under the circumstances. For a detailed
      discussion of other significant accounting policies, see Note 1 - Organization
      and Summary of Significant Accounting Policies in the Notes to Consolidated
      Financial Statements in the Company’s Annual Report on Form 10-K for the year
      ended December 31, 2005.


28
 *Index*





*Accounting
      for Premiums on Universal Life Policies and for Annuity
      Deposits*




In
      accordance with accounting principles generally accepted in the United States
      of
      America (“GAAP”), universal life insurance premiums and annuity deposits
      received are reflected in FIC’s consolidated financial statements as increases
      in liabilities for contractholder deposit funds and not as revenues. Instead,
      revenues from such contracts consist of amounts assessed against policyholder
      account balances for mortality, policy administration and surrender charges,
      and
      are recognized in the period in which the benefits and services are provided.
      Similarly, surrender benefits paid relating to universal life insurance policies
      and annuities are reflected as decreases in liabilities for contractholder
      deposit funds and not as expenses.




*Investments*




The
        Company’s principal investments are in fixed maturity securities and real
        estate; all of which are exposed to three primary sources of investment risk:
        credit, interest rate and liquidity. The fixed maturity securities, which
        are
        all classified as available for sale, are carried at their fair value in
        the
        Company’s balance sheet, with unrealized gains or losses recorded in accumulated
        other comprehensive income. The investment portfolio is monitored regularly
        to
        ensure that investments which may be other than temporarily impaired are
        identified in a timely fashion and properly valued, and that impairments
        are
        charged against earnings as realized investment losses. The valuation of
        the
        investment portfolio involves a variety of assumptions and estimates, especially
        for investments that are not actively traded. Fair values are obtained from
        a
        variety of external sources. The Company has a policy and process in place
        to
        identify securities that could potentially have an impairment that is
        other-than-temporary. This process involves monitoring market events that
        could
        impact issuers’ credit ratings, business climate, management changes, litigation
        and government actions, and other similar factors. This process also involves
        monitoring late payments, downgrades by rating agencies, key financial ratios,
        financial statements, revenue forecasts and cash flow projections as indicators
        of credit issues. At the end of each quarter, all securities are reviewed
        where
        fair value is less than ninety percent of amortized cost for six months or
        more
        to determine whether impairments should be recorded. The analysis focuses
        on
        each issuer’s ability to service its debts and the length of time the security
        has been trading below cost. This quarterly process includes an assessment
        of
        the credit quality of each investment in the entire securities portfolio.
        The
        Company considers relevant facts and circumstances in evaluating whether
        the
        impairment of a security is other-than-temporary. Relevant facts and
        circumstances considered include (1) the length of time the fair value has
        been
        below cost, (2) the financial position of the issuer, including the current
        and
        future impact of any specific events, and (3) the Company’s ability and intent
        to hold the security to maturity or until it recovers in value. To the extent
        the Company determines that a security is deemed to be other than temporarily
        impaired, the difference between amortized cost and fair value is charged
        to
        income as a realized investment loss. There are a number of significant risks
        and uncertainties inherent in the process of monitoring impairments and
        determining if an impairment is other-than-temporary. These risks and
        uncertainties include (1) the risk that the Company’s assessment of an issuer’s
        ability to meet all of its contractual obligations will change based on changes
        in the credit characteristics of that issuer, (2) the risk that the economic
        outlook will be worse than expected or have more of an impact on the issuer
        than
        anticipated, (3) the risk that fraudulent information could be provided to
        the
        Company’s investment professionals who determine the fair value estimates and
        other-than-temporary impairments, and (4) the risk that new information obtained
        by the Company or changes in other facts and circumstances lead the Company
        to
        change its intent to hold the security to maturity or until it recovers in
        value. Any of these situations could result in a charge to income in a future
        period.


*Real
      Estate*




The
      Company monitors the performance of its real estate properties on an ongoing
      basis and identifies properties it intends to hold for investment and properties
      it intends to sell. Properties held for investment are classified as investment
      real estate and are stated at cost less accumulated depreciation. Depreciation
      is provided using straight-line methods over estimated useful lives of 5 to
      40
      years, or for leasehold improvements the minimum lease term if shorter. Real
      estate income is reported net of expenses incurred to operate the properties
      and
      depreciation expenses. The Company reviews its investment real estate properties
      on an on-going basis for impairment using a probability-weighted estimation
      of
      the expected net undiscounted future cash flows. If the expected net
      undiscounted future cash flows are less than the net book value of the property,
      the excess of the net book value over the Company’s estimate of fair value of
      the asset is recognized as a realized loss in the consolidated statement of
      operations and the new cost basis is depreciated over the property’s remaining
      life.




Properties
        that are identified for sale and actively marketed by the Company are classified
        as real estate held for sale and are stated at the lower of cost less
        accumulated depreciation or net realizable value. No depreciation is recorded
        while the property is classified as held for sale. Net realizable value is
        determined by the Company based on the estimated selling price less direct
        costs
        of the sale.


29
 *Index*


*Deferred
      Policy Acquisition Costs and Present Value of Future Profits of Acquired
      Business*




The
      costs
      of acquiring new business, including certain costs of issuing policies and
      certain other variable selling expenses (principally commissions), are included
      in deferred policy acquisition costs (“DAC”). DAC is capitalized and then
      amortized to reflect an appropriate expense in relation to the projected stream
      of profits (for universal life and annuity products) or to the premium revenue
      stream (for traditional life products). Similarly, when existing blocks of
      business are acquired, an intangible capital asset (termed “present value of
      future profits of acquired business” or “PVFP”) reflecting the costs of
      acquiring the business is created and then amortized relative to the expected
      revenues and profitability of the block.




Projections
      used to determine the rate of amortization of DAC and PVFP require extensive
      assumptions about, among other things, interest margins, product loads,
      mortality rates, persistency rates, and maintenance expense levels. In setting
      the levels of DAC and PVFP amortization, important assumptions must also be
      made
      about the appropriate level at which blocks of policies will be aggregated
      for
      testing the acceptability of amortization schedules, and views vary widely
      on
      this topic. These
      assumptions involve judgment and are compared to actual experience on an ongoing
      basis. Significant changes in these assumptions can impact the carrying balance
      of DAC and PVFP and produce changes that must be reflected in the current
      period’s income as an unlocking adjustment. Loss
      recognition is evaluated periodically on an aggregate basis that combines
      deferred policy acquisition costs with the present value of future profits
      on
      acquired business.





*Future
      Policy Benefits*




FIC’s
      liability for future policy benefits accounted for 13.9% of its total
      liabilities at June 30, 2005, or 20.2% after excluding liabilities associated
      with separate accounts. These liabilities for future policy benefits, referred
      to as reserves, are estimated using actuarial methods based on assumptions
      about
      future receipts of premiums, interest yields, investment returns, expenses,
      mortality, morbidity, and persistency. These assumptions consider Company
      experience and industry standards. The assumptions vary by plan, age at issue,
      year of issue, and duration. They include estimates, shaped by judgment and
      experience, and have a substantial impact on the reported financial condition
      of
      the Company. Differences between actual experience and assumptions used in
      the
      pricing of these policies and in the establishment of liabilities may result
      in
      variability of future results in amounts which may be material.





*Deferred
      Taxes*





The
      Company computes deferred income taxes utilizing the asset and liability method.
      Under this method, balance sheet amounts for deferred income taxes are computed
      based on the tax effect of the differences between the financial reporting
      and
      federal income tax bases of assets and liabilities using the tax rates which
      are
      expected to be in effect when these differences are anticipated to reverse.
      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. 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.





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





*General*





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





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





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


30
 *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 $28.3 million at
        June
        30, 2005 and $28.1 million at December 31, 2004. For purposes of the foregoing
        estimate, fixed maturity securities available for sale, and held for trading,
        and short-term investments were taken into account. The fair value of such
        assets was $643.2 million at June 30, 2005 and $562.7 million at December
        31,
        2004.


The
      fixed
      income investments of the Company include certain mortgage-backed securities
      (excluding asset backed securities). The market value of such securities was
      $166.7 million at June 30, 2005 and $179.1 million at December 31, 2004.
      Assuming an immediate increase of 100 basis points in interest rates, the net
      hypothetical loss in the fair value related to such mortgage-backed securities
      is estimated to be $10.6 million at June 30, 2005 and $14.1 million at December
      31, 2004.





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





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


**ITEM
                  4.**
              **CONTROLS
                  AND PROCEDURES**





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





Management
      has completed an evaluation of the effectiveness of the design and operation
      of
      the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under
      the Securities Exchange Act of 1934, as amended. This evaluation has allowed
      management to make conclusions, as set forth below, regarding the state of
      the
      Company’s disclosure controls and procedures as of June 30, 2005. Based on its
      evaluation and the identification of material weakness in internal control
      over
      financial reporting described below, and because of an inability to file the
      Quarterly Report on Form 10-Q within the statutory time period, FIC’s Chief
      Executive Officer and Chief Financial Officer have concluded that, as of June
      30, 2005, FIC’s disclosure controls and procedures were
      ineffective.





Management
      had assessed our internal control over financial reporting as of December 31,
      2004, 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, 2004, in performing its assessment of internal control over financial
      reporting, management determined that material weaknesses existed in the
      Company’s internal controls relating to the following areas: control
      environment, risk assessment, control monitoring, financial close and reporting,
      segregation of duties, reconciliations, use of third-party service providers,
      safeguarding of assets, reinsurance, and policy data integrity.





Following
      its identification of the above-described internal control weaknesses, the
      Company has been actively engaged in the implementation of remediation efforts
      to address the material weaknesses in its internal control over financial
      reporting as of June 30, 2005. There have been no significant changes in the
      Company’s internal controls or in other factors that could significantly affect
      internal controls subsequent to the date of the evaluation referred to in this
      Item.


31
 *Index*





**PART
      II. OTHER INFORMATION**





**ITEM
                1.**
            **LEGAL
                PROCEEDINGS**





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





***T.
      David Porter v. Financial Industries Corporation***




On
        May
        31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis
        County, Texas District Court (the “Court”), against the Company, seeking to
        compel the Company to hold an annual meeting of shareholders. FIC has been
        unable to hold an annual meeting at which its shareholders could be fully
        informed, or which could be attended by a substantial portion of its
        shareholders, because the Company is currently unable to comply with Rule
        14a-3
        of the Securities Exchange Act of 1934, and thus cannot provide an annual
        report
        to shareholders or solicit proxies 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 (the “Order”) and agreed among other things to hold an
        annual shareholders meeting for the election of directors on December 6,
        2006.
        The Company did in fact appear for a meeting of shareholders on December
        6,
        2006, as required by the Agreed Order. In advance of the meeting date, a
        group
        affiliated with Mr. Porter solicited proxies from FIC shareholders in an
        effort
        to replace FIC’s Board of Directors; the Company remained unable to solicit
        proxies. However, on the appointed day for the shareholder meeting - December
        6,
        2006 - a quorum was not in attendance. 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 has 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. Mr.
        Porter thereafter 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 providing among other things that FIC will hold an annual
        shareholders meeting for the election of directors on January 16, 2007 at
        10:00
        a.m., but that if a quorum is not present on that date, FIC will not be required
        to hold an annual meeting of shareholders at any time before July 17, 2007.
        In
        compliance with the December 22, 2006 order, FIC has mailed new notices of
        the
        January 16, 2007 meeting to all shareholders of record as of the October
        24,
        2006 Record Date.


***Litigation
      with Otter Creek Partnership I, L.P.***





During
      2003, Otter Creek Management Inc., (“Otter Creek Management”), solicited proxies
      for the Company’s 2003 Annual Meeting of Stockholders (the “2003 Annual
      Meeting”) held on July 31, 2003, seeking the election of seven nominees to the
      Board of Directors of the Company in opposition to the ten candidates selected
      by the then incumbent Board of Directors. Otter Creek Management is an
      investment advisory firm that manages three investment funds that are
      shareholders of the Company: Otter Creek Partners I, LP (“Otter Creek
      Partners”), Otter Creek International Ltd. and HHMI XIII, LLC (together with
      Otter Creek Management and Otter Creek Partners, “Otter Creek”).





In
      connection with this solicitation of proxies, on June 13, 2003, Otter Creek
      Partners commenced a lawsuit in the District Court in Travis County, Texas,
      Cause No. GN302872 (the “Litigation”) seeking, among other things, to compel the
      Company to hold the previously delayed 2003 Annual Meeting. Otter Creek also
      sought in the Litigation to neutralize the effect of a proxy obtained by the
      Company from the Mitte Family (the “Mitte Proxy”) the preceding month whereby
      the incumbent board was able to vote 1,627,610 shares in favor of its
      nominees.





Following
      the initiation of this litigation and a hearing before the court, the court
      ordered the Company not to amend its bylaws in a manner that would adversely
      affect voting or other matters relating to the Annual Meeting and election
      of
      directors and not to reschedule such Annual Meeting scheduled for July 31,
      2003,
      or the record date of the Annual Meeting.


32
 *Index*


At
      the
      meeting, six of the seven Otter Creek nominees were elected to the Board: R.
      Keith Long, J. Bruce Boisture, Salvador Diaz-Verson Jr., Patrick E. Falconio,
      Richard H. Gudeman and Lonnie L. Steffen. The shares covered by the Mitte Proxy
      were all voted in favor of the incumbent nominees at the 2003 Annual Meeting.
      Had Otter Creek been successful in neutralizing the effect of the Mitte Proxy,
      all seven of the Otter Creek nominees would have been elected.




Following
        the 2003 Annual Meeting, Otter Creek and FIC completed a settlement with
        respect
        to the lawsuit in December 2003. Under the settlement agreement, the Company
        reimbursed Otter Creek for $250,000 in proxy expenses in 2003. An additional
        $475,000 of proxy and litigation expenses payable in FIC common stock will
        be
        submitted to the Company’s shareholders for approval at the next Annual Meeting
        of Shareholders. If payment of the additional $475,000 is so approved, the
        amount will be expensed by the Company in the year of approval. The Board
        of
        Directors will recommend that shareholders approve the reimbursement. The
        settlement also included mutual releases between the Company and Otter Creek
        and
        its affiliates. The Chairman of the Board of Directors of the Company, R.
        Keith
        Long, is the President and owner of the General Partner of Otter Creek Partners
        I, L.P.
  ***Litigation
      with Former Employee of Subsidiary***




In
      October 2003, the Company placed Earl Johnson, the then-president of JNT Group,
      Inc. (“JNT”), a subsidiary of FIC that was later sold in December 2003 in the
      sale of the New Era companies, on administrative leave pending an investigation
      of matters related to (1) Johnson’s alleged termination of an employee in
      response to her request for information regarding her workers’ compensation
      rights arising out of an injury and (2) his co-mingled and disorganized
      bookkeeping of JNT’s client accounts with those of a personal business owned by
      Mr. Johnson and run by him at the same office (using the Company’s employees to
      do so). Soon after being interviewed in the course of that investigation, Mr.
      Johnson resigned, alleging good reason under his employment agreement with
      a
      subsidiary of FIC, on the ground that the change in the composition of the
      Board
      of Directors of FIC following the 2003 Annual Meeting of Shareholders resulted
      in a “change of control” under the provisions of his employment agreement. The
      employment agreement provided that if Mr. Johnson were to voluntarily terminate
      his employment for good reason, he would receive compensation and benefits
      for
      the remainder of the three-year term of the agreement and would become fully
      vested in 17,899 restricted shares of FIC stock. The Company notified Mr.
      Johnson that his resignation was not for “good reason” pursuant to his
      employment agreement. Under that agreement, termination without good reason
      results in forfeiture of future salary and benefits, as well as forfeiture
      of
      the restricted shares of FIC common stock.





In
      November 2003, Mr. Johnson and his wife, Carol Johnson, filed suit in Harris
      County, Texas District Court against the Company, FIC Financial Services, Inc.
      (“FICFS”) and an employee of the Company. The suit, which sought an unspecified
      amount of damages and injunctive relief, alleges that the defendants interfered
      with the non-JNT contract and business relationships of the plaintiffs, made
      slanderous statements regarding the plaintiffs, and accessed computer files
      at
      the JNT offices relating to the non-JNT business relationships of the
      plaintiffs, without the consent of the plaintiffs. The suit also alleged
      conspiracy, conversion, and various other torts, all related to the defendants’
investigation of plaintiff’s business practices at JNT.




Subsequently,
      Mr. Johnson filed a demand for arbitration under his employment agreement,
      which
      has a mandatory arbitration clause. In the arbitration, Mr. Johnson sought
      damages for breach of contract and various other benefits relating to the
      termination of his employment contract, totaling $913,133.40. In connection
      with
      the arbitration, FIC submitted a counter-claim, alleging that Mr. Johnson
      committed multiple breaches of his employment agreement, and that he breached
      his fiduciary duty to FIC as a result of his actions in conducting the business
      of JNT, thereby entitling FIC to a dismissal of plaintiff’s claims. Prior to the
      hearing on the arbitration, the Harris County Court ordered that the matters
      raised in that lawsuit by Mr. Johnson (though not Carol Johnson) be combined
      with the arbitration.




An
      arbitration hearing on Johnson’s contract claims was conducted in April 2005. On
      July 21, 2005, the Arbitrator issued an interim award in which he denied all
      of
      Johnson’s claims for breach of contract, as well as Johnson’s claims with
      respect to the restricted shares of FIC stock. In denying Johnson’s claims, the
      Arbitrator concluded that:





(1)
            Johnson
                had committed multiple and material breaches of his employment agreement
                by operating a personal tax and accounting business out of office
                space
                and using employees, utilities and other items, all paid for by FICFS;
                by
                engaging in a self-dealing transaction involving the payment to himself
                of
                $25,000 out of funds held by JNT in a suspense account, an account
                to
                which JNT owed fiduciary duties to its customers and clients; and
                by
                firing an employee of JNT on the same day that the employee inquired
                about
                possible workers compensation benefits in connection with an on-the-job
                injury,





(2)
            Johnson’s
                breaches of his employment agreement occurred prior to the time that
                he
                was placed on administrative leave, thereby precluding him from
                maintaining a breach of contract suit against FIC and FICFS, and


33
 *Index*


(3)
            The
                change in the majority of the Board of Directors of FIC resulting
                from the
                2003 Annual Meeting of FIC’s shareholders did not constitute a “change of
                control” under Johnson’s employment agreement, thereby denying Johnson’s
                claim that he was entitled to a “good reason” termination of his
                employment agreement.





In
      addition, the Arbitrator awarded FICFS $28,000, plus interest at the rate of
      6%
      per annum from July 21, 2005, to the date of payment, with respect to Johnson’s
      unauthorized conversion of funds held in the JNT suspense account. The order
      confirming the arbitration award was signed on February 27, 2006, by the Harris
      County district judge and the Company is currently pursuing collection of the
      judgment. No amounts have been recorded in the Company’s financial statements
      for such judgment.




With
      respect to the matters raised by Mr. Johnson in the Harris County lawsuit,
      which
      were referred by the Court to the arbitration, following his loss in the
      arbitration of the employment agreement, Mr. Johnson notified the Arbitrator
      that he would not pursue arbitration of his other claims. In addition, in May
      2006, Mrs. Johnson filed a notice of non-suit with respect to the claims made
      by
      her in the Harris County lawsuit. Accordingly, this matter is now closed.





***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 which 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 purchased 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 the Equita and M&W, and the
        claims in intervention asserted by Family Life and Investors Life, began
        in
        October of 2006.
 
 In
        response to a motion for partial summary judgment, the Company has stipulated
        to
        certain elements of some of the causes of action asserted by Equita and M&W,
        including that certain representations and warranties made in the Option
        Agreement were partially incorrect, and that FIC was unable to comply with
        certain of its obligations under the Option Agreement. FIC did not stipulate,
        and continues to dispute other elements of certain of the causes of action
        asserted by Equita and M&W, and disputes other causes of action in their
        entirety. FIC intends to vigorously oppose the lawsuit and any effort by
        Equita
        and M&W to recover damages from FIC, and the life insurance subsidiaries
        intend to vigorously prosecute their claims in intervention against
        Equita.


34
 *Index*


***Shareholder
      Claim***




The
      Company received a demand letter in April 2004 from a law firm representing
      an
      individual shareholder (Mr. Cook) who owns 530 shares of the Company’s common
      stock, which letter set forth certain allegations and notified the Registrant
      that the shareholder intended to file a shareholder derivative lawsuit (the
      “Demand Letter”).





In
      May
      2004, FIC, by and through its Special Litigation Committee, filed a petition
      in
      the 250th District Court of Travis County, Texas (the “Court”), seeking to have
      the Court appoint a panel of independent and disinterested persons pursuant
      to
      Section H (3) of Article 5.14 of the Texas Business Corporation Act to
      investigate the allegations, and stay any shareholder derivative actions.
      Subsequently, on June 1, 2004, the Court issued an Order appointing Eugene
      Woznicki, Kenneth S. Shifrin, John D. Barnett and F. Gary Valdez as a panel
      of
      independent and disinterested persons (the “Panel”) to make determinations
      contemplated by Section F of Article 5.14 of the Texas Business Corporation
      Act
      in connection with the Demand Letter and staying any shareholder derivative
      actions relating to the letter until the Panel’s review was completed and a
      determination was made by the panel as to what, if any, further action was
      to be
      taken. Messrs. Woznicki, Shifrin and Barnett are independent directors of FIC.
      Mr. Valdez is neither a director nor an employee of FIC. Mr. Valdez is the
      founder and president of Focus Strategies, L.L.C. and is active in various
      community and civic organizations in the Austin, Texas area.





Following
      an extensive review of the claims made by the individual shareholder, the Panel,
      in January 2005, filed with the court a Petition for Declaratory Judgment
      pursuant to the Texas Declaratory Judgments Act and Article 5.14 of the Texas
      Business Corporations Act (the “Petition”). The Petition describes the process
      used by the Panel and its counsel in considering the matters raised in the
      Demand Letter and the submittal provided by counsel for the shareholder. The
      Petition advised the Court that, after consideration of the evidence obtained
      through its inquiry, the Panel had unanimously made a good faith determination
      that the continuation of the Committee’s derivative proceeding and the
      commencement of any further derivative proceedings based on the allegations
      made
      by the individual shareholder was not in the best interests of FIC.





On
      October 10, 2005, the 250th District Court of Travis County, Texas, heard for
      trial on the merits the matters raised by the Panel in the Petition
      ( Financial
      Industries Corporation v. Tom
      Cook (Cause
      No. GN 401513). After consideration of the pleadings, evidence and authorities
      submitted by counsel for the Company, the Court issued a Final Judgment on
      October 10, 2005, in which it ruled that the determinations made by the Panel,
      as reflected in a report submitted to the Court by a Special Litigation
      Committee appointed by the Registrant’s Board of Directors, were made: (1) in
      good faith, (2) after the Panel conducted a reasonable inquiry, and (3) based
      on
      the factors deemed appropriate under the circumstances by the Panel. The Court’s
      ruling otherwise dismissed with prejudice the derivative proceedings involved
      in
      this matter. The Final Judgment was approved as to form and substance by counsel
      for the Registrant and by counsel for the defendant.





***Other
      Litigation***





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





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





None





**ITEM
                3.**
            **DEFAULTS
                UPON SENIOR SECURITIES**





None





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





There
      were no matters submitted to a vote of security holders during the second
      quarter of 2005.





**ITEM
                5.**
            **OTHER
                INFORMATION**





None


35
 *Index*





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





(a)
            Exhibits





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





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





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


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


(b)
              Reports
                  on Form 8-K
 
 (i)  On
        May 6,
        2005 the Registrant filed a Current Report on Form 8-K.  The current report
        disclosed Appointment of a Principal Officer whereby the Board of the Company
        elected Michael P. Hydanus as Senior Vice President - Operations as of May
        3,
        2005.
  (ii)  On
        May
        20, 2005 the Registrant filed a Current Report on Form 8-K.  The current
        report made a Regulation FD Disclosure regarding 2003 consolidated financial
        statements prepared in conformity with accounting principles generally accepted
        in the United States of America ("GAAP").
  (iii)  On May
        24, 2005 the Registrant filed a Current Report on Form 8-K.  The current
        report disclosed a Temporary Suspension of Trading under Registrant’s Employee
        Benefit Plan, the InterContinental Life Corporation Employees Savings and
        Investment Plan, effective June 20, 2005 to August 22, 2005.
  (iv)  On
        June
        3, 2005 the Registrant filed a Current Report on Form 8-K.  The current
        report made a Regulation FD Disclosure regarding a press release issued
        announcing completion of the sale of River Place Pointe by the Company on
        June
        1, 2005.
  (v)  On
        June
        14, 2005 the Registrant filed a Current Report on Form 8-K.  The current
        report made a Regulation FD Disclosure regarding the issuance of a shareholder
        letter by the Company regarding a delay in filing the 2003 10-K and 2004
        financial documents.
  36


**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:
                January 12, 2007
            By:/s/
                Michael P. HydanusMichael
                P. HydanusInterim
                President and Chief Executive OfficerDate:
                January 12, 2007
            By:/s/
                Vincent L. KaschVincent
                L. KaschChief
                Financial Officer(Principal
                Accounting and Financial Officer)






37