UNITED
        STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
        D.C. 20549
  **Form
        10-Q**
  **QUARTERLY
        REPORT PURSUANT TO SECTION 13 OR 15(d)**
 **OF
        THE SECURITIES EXCHANGE ACT OF 1934**
  **For
        the Quarterly Period Ended March 31, 2006**
  **Commission
        File Number 0-4690**
  **Financial
        Industries Corporation**
 (Exact
        name of registrant as specified in its charter)
  **TEXAS**
              
              **74-2126975**State
                  of Incorporation
              
              (I.R.S.
                  Employer Identification number)
 
 **6500
        River Place Boulevard, Building I, Austin, Texas 78730**
 (Address
        including Zip Code of Principal Executive Offices)
  **(512)
        404-5000**
 (Registrant's
        Telephone Number)
  Securities
        Registered pursuant to Section 12(b) of the Act: None
  Securities
        Registered pursuant to Section 12(g) of the Act:
  Common
        Stock, $.20 par value
 (Title
        of
        Class)
  Indicate
        by check mark whether the Registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the Registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days. YES  ̈ NO x
 
 Indicate
        by check mark whether the Registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
        one):
 Large
                  accelerated filer ̈
              Accelerated
                  filerx
              Non-accelerated
                  filer ̈
  Indicate
        by check mark whether the Registrant is a shell company (as defined in Rule
        12b-2 of the Act).
 YES  ̈ NO x
  The
        number of shares outstanding of Registrant's common stock on March 31, 2007
        was
        10,210,385.
   
 
  **Forward-Looking
        Statements**
  Except
        for historical factual information set forth in this Form 10-Q of Financial
        Industries Corporation (the “Company” or “FIC”), the statements, analyses, and
        other information contained in this report relating to trends in our 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 products; (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 Risk in Part
        1, and
        Item 1-Legal Proceedings in Part 2, and (14) other factors discussed in the
        Company’s other filings with the SEC, which are available free of charge on the
        SEC’s website at www.sec.gov. You should read carefully the above factors and
        all of the other information contained in this report. Should one or more
        of
        these risks or uncertainties materialize, or should underlying assumptions
        prove
        incorrect, actual results may vary materially from those indicated. All
        subsequent written and oral forward-looking statements attributable to the
        Company or to persons acting on our behalf are expressly qualified in their
        entirety by reference to these risks and uncertainties. There can be no
        assurance that other factors not currently anticipated by management will
        not
        also materially and adversely affect our results of operations. Each
        forward-looking statement speaks only as of the date of the particular statement
        and the Company undertakes no obligation to update or revise any forward-looking
        statement, except as required by federal securities laws.
  
  **FINANCIAL
        INDUSTRIES CORPORATION AND
        SUBSIDIARIES**
 
 **INDEX**
  Page
                    No.Part
                    I - Financial InformationItem
                    1. Financial Statements (Unaudited)Condensed
                    Consolidated Balance Sheets March 31, 2006 and
                    December 31, 2005
                4Condensed
                    Consolidated Statements of Operations For the
                    three months ended March 31, 2006 and March 31, 2005
                6Condensed
                    Consolidated Statements of Cash Flows For the
                    three months ended March 31, 2006 and March 31, 2005
                8Notes
                    to Condensed Consolidated Financial
                    Statements
                10Item
                    2. Management’s Discussion and Analysis of Financial
                    Condition and Results of Operations
                16Item
                    3. Quantitative and Qualitative Disclosures About Market
                    Risk
                22Item
                    4. Controls and Procedures
                23Part
                    II - Other InformationItem
                    1. Legal Proceedings
                24Item
                    1A. Risk Factors
                26Item
                    2. Changes in Securities and Use of
                    Proceeds
                26Item
                    3. Defaults Upon Senior Securities
                26Item
                    4. Submission of Matters to a Vote of Security
                    Holders
                26Item
                    5. Other Information
                26Item
                    6. Exhibits
                26Signatures
                27
 ***Index***
  **FINANCIAL
        INDUSTRIES CORPORATION AND
        SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED BALANCE SHEETS**
 (In
        thousands) (Unaudited)
  March
                    31,
                  2006
                
                December
                    31,
                  2005
                    (1)ASSETSInvestments:Fixed
                    maturity securities available for sale, at fair value (amortized
                    cost of
                    $650,289 and $605,803 at March 31, 2006 and December 31, 2005,
                    respectively)
                
                $
                625,660
                
                $
                593,752Equity
                    securities, at fair value (cost of $8,661 and $8,405 at March
                    31, 2006 and
                    December 31, 2005, respectively)
                
                
                11,202
                
                
                10,907Policy
                    loans
                
                
                36,968
                
                
                37,637Real
                    estate held for sale
                
                
                -
                
                
                130Short-term
                    investments
                
                
                4,929
                
                
                1,204Total
                    investments
                
                
                678,759
                
                
                643,630Cash
                    and cash equivalents
                
                
                10,922
                
                
                63,581Deferred
                    policy acquisition costs
                
                
                52,706
                
                
                50,805Present
                    value of future profits of acquired business
                
                
                16,033
                
                
                15,865Agency
                    advances and other receivables, net of allowances for doubtful
                    accounts of
                    $3,605 and $3,513 as of March 31, 2006 and December 31,
                    2005
                
                
                6,147
                
                
                8,188Reinsurance
                    receivables
                
                
                37,223
                
                
                38,108Accrued
                    investment income
                
                
                7,353
                
                
                7,165Due
                    premiums
                
                
                1,630
                
                
                2,048Property
                    and equipment, net
                
                
                913
                
                
                1,033Deferred
                    federal income taxes
                
                
                2,990
                
                
                -Other
                    assets
                
                
                2,526
                
                
                2,088Separate
                    account assets
                
                
                343,682
                
                
                342,911Total
                    assets
                
                $
                1,160,884
                
                $
                1,175,422
  (1)
        Derived from audited consolidated financial statements
  The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.
  4
 ***Index***
  **FINANCIAL
        INDUSTRIES CORPORATION AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED BALANCE SHEETS, Continued**
 (In
        thousands) (Unaudited)
 
 March
                  31,
                2006
              
              December
                  31,
                2005
                  (1)LIABILITIES
                  AND SHAREHOLDERS’ EQUITYLiabilities:Policy
                  liabilities and contractholder deposit funds:Contractholder
                  deposit funds
              
              $
              534,213
              
              $
              542,181Future
                  policy benefits
              
              
              155,078
              
              
              155,970Other
                  policy claims and benefits payable
              
              
              12,065
              
              
              11,456Notes
                  payable
              
              
              15,000
              
              
              15,000Deferred
                  federal income taxes
              
              
              -
              
              
              687Other
                  liabilities
              
              
              26,772
              
              
              25,146Separate
                  account liabilities
              
              
              343,682
              
              
              342,911Total
                  liabilities
              
              
              1,086,810
              
              
              1,093,351Commitments
                  and contingencies (See Note 7)Shareholders’
                  equity:Common
                  stock, $.20 par value, 25,000 shares authorized in 2006 and 2005,
                  12,517
                  shares issued in 2006 and 2005;9,849
                  shares outstanding in 2006 and 2005
              
              
              2,504
              
              
              2,504Additional
                  paid-in capital
              
              
              70,377
              
              
              70,377Accumulated
                  other comprehensive loss
              
              
              (16,550
              )
              
              (10,339
              )Retained
                  earnings
              
              
              40,699
              
              
              42,485Common
                  treasury stock, at cost, 2,668 shares in 2006 and 2005
              
              
              (22,956
              )
              
              (22,956
              )Total
                  shareholders’ equity
              
              
              74,074
              
              
              82,071Total
                  liabilities and shareholders’ equity
              
              $
              1,160,884
              
              $
              1,175,422
 
 (1)
        Derived from audited consolidated financial statements
  The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.
  5
 ***Index***
  **FINANCIAL
        INDUSTRIES CORPORATION AND
        SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF OPERATIONS**
 (In
        thousands except per share data) (Unaudited)
 
 Three
                  Months Ended March 31,2006
              
              2005Revenues:Premiums,
                  net
              
              $
              5,503
              
              $
              6,104Earned
                  insurance charges
              
              
              9,765
              
              
              10,124Net
                  investment income
              
              
              8,610
              
              
              6,943Real
                  estate income
              
              
              -
              
              
              496Net
                  realized investment gains
              
              
              516
              
              
              360Other
              
              
              657
              
              
              572Total
                  revenues
              
              
              25,051
              
              
              24,599Benefits
                  and expenses:Policyholder
                  benefits and expenses
              
              
              11,822
              
              
              9,867Interest
                  expense on contractholders deposit funds
              
              
              5,223
              
              
              5,500Amortization
                  of deferred policy acquisition costs
              
              
              2,271
              
              
              2,497Amortization
                  of present value of future profits of acquired business
              
              
              605
              
              
              666Operating
                  expenses
              
              
              7,065
              
              
              7,183Interest
                  expense
              
              
              329
              
              
              255Total
                  benefits and expenses
              
              
              27,315
              
              
              25,968Loss
                  before federal income taxes
              
              
              (2,264
              )
              
              (1,369
              )Benefit
                  for federal income taxes
              
              
              (478
              )
              
              (226
              )Net
                  loss
              
              $
              (1,786
              )
              $
              (1,143
              )
  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 March 31,2006
              
              2005Net
                  Loss Per Share:Basic:Weighted
                  average common shares outstanding
              
              
              9,849
              
              
              9,806Basic
                  earnings per share:Net
                  loss per share
              
              $
              (0.18
              )
              $
              (0.12
              )Diluted:Weighted
                  average common shares and common stock equivalents
              
              
              9,849
              
              
              9,806Diluted
                  earnings per share:Net
                  loss per share
              
              $
              (0.18
              )
              $
              (0.12
              )
 
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.
  7
 ***Index***
  **FINANCIAL
        INDUSTRIES CORPORATION AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS**
 (In
        thousands) (Unaudited)
 
 Three
                  Months Ended March 31,2006
              
              2005CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  loss
              
              $
              (1,786
              )
              $
              (1,143
              )Adjustments
                  to reconcile net loss to net cash provided by(used
                  in) operating activities:Amortization
                  of deferred policy acquisition costs
              
              
              2,271
              
              
              2,497Amortization
                  of present value of future profits of acquired business
              
              
              605
              
              
              666Net
                  realized gains on investments
              
              
              (516
              )
              
              (360
              )Depreciation
              
              
              124
              
              
              926Increase
                  in accrued investment income
              
              
              (188
              )
              
              (563
              )Decrease
                  (increase) in agent advances and other receivables
              
              
              2,926
              
              
              (2,729
              )Decrease
                  in due premiums
              
              
              418
              
              
              117Increase
                  in deferred policy acquisition costs
              
              
              (1,778
              )
              
              (1,832
              )Increase
                  in other assets
              
              
              (438
              )
              
              (179
              )Increase
                  (decrease) in policy liabilities and accruals
              
              
              1,192
              
              
              (257
              )Increase
                  (decrease) in other liabilities
              
              
              1,626
              
              
              (1,715
              )Decrease in
                  deferred federal income taxes
              
              
              (491
              )
              
              (209
              )Net
                  activity from trading securities
              
              
              -
              
              
              554Other,
                  net
              
              
              (189
              )
              
              225Net
                  cash provided by (used in) operating activities
              
              
              3,776
              
              
              (4,002
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Fixed
                  maturities purchased
              
              
              (55,087
              )
              
              (63,367
              )Real
                  estate capital expenditures
              
              
              -
              
              
              (448
              )Proceeds
                  from sales and maturities of fixed maturities
              
              
              10,512
              
              
              16,636Proceeds
                  froms sales of invested real estate
              
              
              646
              
              
              -Net
                  (increase) decrease in short-term investments
              
              
              (3,725
              )
              
              24,382Net
                  decrease in policy loans
              
              
              669
              
              
              685Purchase
                  of property and equipment
              
              
              (7
              )
              
              (107
              )Net
                  cash used in investing activities
              
              
              (46,992
              )
              
              (22,219
              )(continued)
 
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.
  8
 ***Index***
  **FINANCIAL
        INDUSTRIES CORPORATION AND SUBSIDIARIES**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS,** Continued
 (In
        thousands) (Unaudited)
 
 Three
                  Months Ended March 31,2006
              
              2005CASH
                  FLOWS FROM FINANCING ACTIVITIES:Contractholder
                  fund deposits
              
              $
              8,188
              
              $
              8,967Contractholder
                  fund withdrawals
              
              
              (17,631
              )
              
              (16,878
              )Net
                  cash used in financing activities
              
              
              (9,443
              )
              
              (7,911
              )Net
                  decrease in cash
              
              
              (52,659
              )
              
              (34,132
              )Cash
                  and cash equivalents, beginning of year
              
              
              63,581
              
              
              52,044Cash
                  and cash equivalents, end of period
              
              $
              10,922
              
              $
              17,912Supplemental
                  Cash Flow Disclosures:Income
                  taxes refunded
              
              $
              1,227
              
              $
              -Interest
                  paid
              
              $
              330
              
              $
              253Treasury
                  stock distributions
              
              $
              -
              
              $
              38
 
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.
  9
 ***Index***
  **FINANCIAL
        INDUSTRIES CORPORATION AND
        SUBSIDIARIES**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**
 
 **1.**
              **Basis
                  of Presentation and
                  Consolidation**
 
 The
        financial statements included herein have been presented to conform to the
        requirements of Form 10-Q.
 
 The
        accompanying unaudited condensed consolidated financial statements reflect
        all
        adjustments (including normal recurring adjustments) necessary to present
        fairly
        the consolidated financial position of the Company at March 31, 2006, its
        consolidated results of operations for the three months ended March 31, 2006
        and
        2005, and its consolidated cash flows for the three months ended March 31,
        2006
        and 2005 in conformity with accounting principles generally accepted in the
        United States of America (“GAAP”). Interim results are not necessarily
        indicative of full year performance. The December 31, 2005 condensed
        consolidated balance sheet data was derived from the audited consolidated
        financial statements included in the Company’s 2005 Annual Report on Form 10-K
        filed with the SEC (“2005 Annual Report”) which includes all disclosures
        required by GAAP. Therefore, these unaudited condensed consolidated financial
        statements should be read in conjunction with the consolidated financial
        statements of the Company included in the 2005 Annual Report.
 
 The
        condensed consolidated financial statements include the accounts of Financial
        Industries Corporation (“FIC”) and its wholly owned subsidiaries. Intercompany
        items and transactions have been eliminated.
 
 **2.**
              **Accumulated
                  Other Comprehensive Income (Loss)****and Comprehensive Income
                  (Loss)**
 
 The
        following is a reconciliation of accumulated other comprehensive income (loss)
        from December 31, 2005, to March 31, 2006 (in thousands):
  Net
                  Unrealized
                Appreciation
                (Depreciation)
                of
                  Equity
                Securities
              
              Net
                  Unrealized
                Gain
                  (Loss) on
                Fixed
                  Maturities
                Available
                  for
                Sale
              
              Other
              
              Total
                Accumulated
                Other
                Comprehensive
                Income
                  (Loss)Balance
                  at December 31, 2005
              
              $
              1,651
              
              $
              (5,914
              )
              $
              (6,076
              )
              $
              (10,339
              )Current
                  Period Change
              
              
              26
              
              
              (6,237
              )
              
              -
              
              
              (6,211
              )Balance
                  at March 31, 2006
              
              $
              1,677
              
              $
              (12,151
              )
              $
              (6,076
              )
              $
              (16,550
              )
 
 The
        comprehensive income (loss) for the three months ended March 31, 2006 and
        2005
        is summarized as follows (in thousands):
  Three
                  Months Ended March 31,2006
              
              2005Net
                  loss
              
              $
              (1,786
              )
              $
              (1,143
              )Other
                  comprehensive income, net of tax:Unrealized
                  gains on securities:Unrealized
                  holdings losses arising during the period
              
              
              (6,211
              )
              
              (3,701
              )Reclassification
                  adjustments for gains included in net loss
              
              
              -
              
              
              238Total
                  other comprehensive loss
              
              
              (6,211
              )
              
              (3,463
              )Comprehensive
                  loss
              
              $
              (7,997
              )
              $
              (4,606
              )
  10
 ***Index***
 
 **3.**
              **Earnings
                  Per Share**
 
 The
        following table reflects the calculation of basic and diluted earnings (loss)
        per share:
 
 Three
                  Months Ended March 31,2006
              
              2005(in
                  thousands except per share data)BASIC:Net
                  loss
              
              $
              (1,786
              )
              $
              (1,143
              )Weighted
                  average common shares outstanding
              
              
              9,849
              
              
              9,806Basic
                  loss per share
              
              $
              (0.18
              )
              $
              (0.12
              )DILUTED:Net
                  loss
              
              $
              (1,786
              )
              $
              (1,143
              )Weighted
                  average common shares outstanding
              
              
              9,849
              
              
              9,806Diluted
                  loss per share
              
              $
              (0.18
              )
              $
              (0.12
              )
 
 Options
        to purchase shares of common stock were not included in the computation of
        diluted earnings per share because the inclusion would result in an
        anti-dilutive effect in periods in which a net loss was incurred.
 
 **4.**
              **Retiremen****t
                  Plans**
 
 A.
        Family
        Life
 
 Family
        Life has a non-contributory defined benefit pension plan (“Family Life Pension
        Plan”), which covers employees who have completed one year or more of service.
        Under the Family Life Pension Plan, benefits are payable upon retirement
        based
        on earnings and years of credited service.
 
 a.
              The
                  Normal Retirement Date for all employees is the first day of the
                  month
                  coinciding with or next following the later of attainment of age
                  65 or the
                  fifth anniversary of employment.
 
 b.
              The
                  Normal Retirement Benefit is the actuarial equivalent of a life
                  annuity,
                  payable monthly, with the first payment commencing on the Normal
                  Retirement Date. The life annuity is equal to the sum of (1) plus
                  (2):
 
 (1)
              Annual
                  Past Service Benefit: 1.17% of the first $10,000 of Average Final
                  Earnings
                  plus 1 1/2% of the excess of Average Final Earnings over $10,000,
                  all
                  multiplied by the participant’s Credited Past Service. For these purposes,
                  “credited past service” is service prior to April 1, 1967, with respect to
                  employees who were plan participants on December 31,
                  1975.
 
 (2)
              Annual
                  Future Service Benefit: 1.5578% of the first $10,000 of Average
                  Final
                  Earnings plus 2% of the excess of Average Final Earnings over $10,000,
                  all
                  multiplied by the participant’s Credited Future
                  Service.
 
 c.
              Effective
                  April 1, 1997, the Family Life Pension Plan was amended to provide
                  that
                  the accrual rate for future service is 1.57% of Final Average Earnings
                  multiplied by Credited Service after March 31, 1997, less 0.65%
                  of Final
                  Average Earnings up to Covered Compensation. With respect to service
                  prior
                  to April 1, 1997, the accrual rate described in paragraph (b),
                  above, is
                  applicable, with Average Final Earnings taking into account a
                  participant’s earnings subsequent to April 1,
                  1997.
 
 d.
              Effective
                  March 31, 2004, all employees covered under the plan were terminated.
                  No
                  new or rehired employees are permitted to enter or re-enter the
                  plan.
                  Thus, the plan is frozen.
 
 Average
        Final Earnings are the highest average Considered Earnings during any five
        consecutive years while an active participant. Total Credited Past Service
        plus
        Credited Future Service is limited to 30 years.
  11
 ***Index***
  The
        pension costs for the Family Life Pension Plan include the following components
        at March 31, 2006 and 2005:
 
 Three
                  Months Ended March 31,2006
              
              2005Service
                  cost for benefits earned during the year
              
              $
              -
              
              $
              -Interest
                  cost on projected benefit obligation
              
              
              109,482
              
              
              116,054Expected
                  return on plan assets
              
              
              (101,994
              )
              
              (101,269
              )Amortization
                  of unrecognized prior service cost
              
              
              -
              
              
              -Amortization
                  of unrecognized losses
              
              
              23,460
              
              
              26,226Recognition
                  of net loss due to settlement
              
              
              -
              
              
              -Net
                  periodic benefit cost
              
              $
              30,948
              
              $
              41,011
 
 B.
        ILCO
 
 ILCO
        maintains a retirement plan (“ILCO Pension Plan”) covering substantially all
        employees of the Company and its subsidiaries. The ILCO Pension Plan is a
        non-contributory, defined benefit pension plan, which covers each eligible
        employee who has attained 21 years of age and has completed one year or more
        of
        service. Each participating subsidiary company contributes an amount necessary
        (as actuarially determined) to fund the benefits provided for its participating
        employees.
 
 The
        ILCO
        Pension Plan’s basic retirement income benefit at normal retirement age is 1.57%
        of the participant’s average annual earnings less 0.65% of the participant’s
        final average earnings up to covered compensation multiplied by the number
        of
        his/her years of credited service. For participants who previously participated
        in the ILCO Pension Plan maintained by ILCO for the benefit of former employees
        of the IIP Division of CIGNA Corporation (the IIP Plan), the benefit formula
        described above applies to service subsequent to May 31, 1996. With respect
        to
        service prior to that date, the benefit formula provided by the IIP Plan
        is
        applicable, with certain exceptions applicable to former IIP employees who
        are
        classified as highly compensated employees.
 
 Former
        eligible IIP employees commenced participation automatically. The ILCO Pension
        Plan also provides for early retirement, postponed retirement, and disability
        benefits to eligible employees. Participant benefits become fully vested
        upon
        completion of five years of service, as defined, or attainment of normal
        retirement age, if earlier.
 
 A
        curtailment occurred on December 31, 2004 when the plan was amended to freeze
        accrued benefits for all participants except for Rule of 68 Non-Highly
        Compensated Employees (“NHCEs”). A subsequent curtailment occurred on December
        31, 2005 when the decision was made to amend the plan to freeze accrued benefits
        for Rule of 68 NHCEs effective March 31, 2006. All plan participants accrued
        benefits are now frozen .
 
 The
        pension costs for the ILCO Pension Plan include the following components
        at
        March 31, 2006 and 2005:
 
 Three
                  Months Ended March 31,2006
              
              2005Service
                  cost for benefits earned during the year
              
              $
              3,672
              
              $
              11,448Interest
                  cost on projected benefit obligation
              
              
              262,037
              
              
              261,812Expected
                  return on plan assets
              
              
              (350,036
              )
              
              (344,766
              )Amortization
                  of unrecognized prior service cost
              
              
              -
              
              
              -Amortization
                  of unrecognized losses
              
              
              46,022
              
              
              33,920Recognition
                  of net loss due to settlement
              
              
              -
              
              
              -Net
                  periodic benefit cost
              
              $
              (38,305
              )
              $
              (37,586
              )
  12
 ***Index***
  **5.**
              **Stock
                  Option Plans and Other Equity Incentive
                  Plans**
 
 In
        December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.”
SFAS 123(R) is a revision of SFAS 123, “Accounting for Stock-Based
        Compensation,” which was originally issued by the FASB in 1995. As originally
        issued, SFAS 123 provided companies with the option to either record
        expense for share-based payments under a fair value model, or to simply disclose
        the impact of the expense. SFAS 123(R) requires companies to measure the
        cost of share-based payments to employees using a fair value model, and to
        recognize that cost over the relevant service period. In addition,
        SFAS 123(R) requires that an estimate of future award forfeitures be made
        at the grant date, while SFAS 123 permitted recognition of forfeitures on
        an as incurred basis. SFAS 123(R) was originally effective July 1, 2005,
        but was
        later deferred by the Securities and Exchange Commission and will become
        effective for all awards granted, modified, repurchased, or cancelled by
        the
        Company beginning January 1, 2006. The adoption of this statement on January
        1,
        2006 did not have a material impact on the Company’s consolidated financial
        statements.
 
 **6.**
              **Separate
                  Accounts**
 
 The
        Company’s insurance subsidiary, Investors Life Insurance Company of North
        America (“Investors Life”) had $343.7 million of separate account assets as of
        March 31, 2006 (not including the value of the Company’s own investment in one
        of the accounts), as compared to $342.9 million at the end of 2005. These
        assets
        include (a) two variable annuity separate accounts that permit contractholders
        to allocate their contract values among a selection of third-party mutual
        funds
        and (b) assets held in custodian accounts in connection with investment annuity
        contracts. The investment annuity business is reinsured with Symetra Life
        Insurance Company (formerly Safeco Life Insurance Company), a third-party
        reinsurer, on a 90%/10% coinsurance basis, with Investors Life retaining
        10% of
        such business. Since the reinsurance treaty is on a coinsurance basis, Investors
        Life is contingently liable to the policyholders in the event that the reinsurer
        is unable to fulfill its obligations under the treaty. Investors Life is
        not
        marketing new separate account annuity contracts.
 
 Effective
        June 1, 2006, Investors Life recaptured the previously reinsured investment
        annuity business with Symetra Life resulting in the retention of 100% of
        this
        business. The Company expects the recapture of this previously reinsured
        business to increase revenues in 2006 and future years. However, as this
        is a
        closed block of business, the revenues are expected to decrease as the policies
        in force decline.
 
 **7.**
              **Commitments
                  and Contingencies**
 
 T.
        David Porter v. Financial Industries Corporation
 
 On
        May
        31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis
        County, Texas District Court (the “Court”), against the Company, seeking to
        compel the Company to hold an annual meeting of shareholders. FIC has been
        unable to solicit proxies for an annual meeting because it has not been able
        to
        comply with Rule 14a-3 of the Securities Exchange Act of 1934, which requires
        that the Company provide an annual report containing current financial
        statements to shareholders in connection with an annual meeting.
 
 Mr.
        Porter sued under Article 2.24(B) of the Texas Business Corporation Act,
        which
        provides that if an annual meeting of shareholders is not held within any
        13-month period and a written consent of shareholders has not been executed
        instead of a meeting, any court of competent jurisdiction in the county in
        which
        the principal office of the corporation is located may, on the application
        of
        any shareholder, summarily order a meeting to be held. On August 7, 2006,
        the
        Company entered into an Agreed Order On Plaintiff’s Motion to Compel Annual
        Shareholders Meeting and agreed among other things to hold an annual
        shareholders meeting for the election of directors on December 6, 2006. The
        Company made arrangements for, and was prepared to hold, an annual meeting
        of
        shareholders on December 6, 2006, as required by the Agreed Order, but the
        Company was unable to hold the meeting on the appointed date because no quorum
        was present.
 
 On
        December 12, 2006, FIC filed a Motion for Summary Judgment seeking dismissal
        of
        Porter’s suit on the grounds that the Agreed Order did not dispense with the
        requirement of a quorum; the lack of a quorum was a direct and foreseeable
        result of Mr. Porter’s insistence on a one-sided solicitation and election; FIC
        had complied with its obligations under the Agreed Order and Mr. Porter has
        obtained all relief sought by his petition. FIC’s Motion for Summary Judgment
        remains pending and has not been heard.
 
 Prior
        to
        a hearing on FIC’s Motion for Summary Judgment, Mr. Porter applied for a
        temporary restraining order and temporary injunction requiring the Company
        to
        convene one or more additional meetings of shareholders, contending that
        in the
        absence of a quorum on December 6, Texas law and the Company’s bylaws entitled a
        majority of the shareholders in attendance to choose a date to which the
        meeting
        would be adjourned. The District Court held a hearing on Porter’s application,
        and on December 22, 2006 entered an order requiring among other things that
        FIC
        hold an annual shareholders meeting for the election of directors on January
        16,
        2007, but stating that if a quorum was not present on that date, FIC would
        not
        be required to hold an annual meeting of shareholders at any time before
        July
        17, 2007. The Company made arrangements for, and was prepared to hold, an
        annual
        meeting of shareholders on January 16, 2007, as required by the Court’s order,
        but the Company was again unable to hold the meeting on the appointed date
        because no quorum was present. No further action has been taken by Mr. Porter,
        whose suit remains pending.
  13
 ***Index***
 
 Litigation
        with Equita Financial and Insurance Services of Texas, Inc. and M&W
        Insurance Services, Inc.
 
 On
        June
        2, 2005, Equita and M&W Insurance Services, Inc. (“M&W”) filed a civil
        suit in Travis County, Texas District Court against the Company. The suit
        alleges that, in entering into certain agreements with the plaintiffs, the
        Company made certain misrepresentations and omissions as to its business
        and
        financial condition. The agreements referenced in the suit consist of (a)
        an
        option agreement entered into in June 2003 between Equita and the Company,
        granting Equita the right to purchase shares of FIC’s common stock at $16.42 per
        share, if certain sales goals were achieved under an exclusive marketing
        agreement between Equita and a subsidiary of the Company (the “Option
        Agreement”), (b) a stock purchase agreement entered into in June 2003 between
        M&W and the Roy F. and Joann Cole Mitte Foundation, pertaining to the
        purchase of 204,918 shares of FIC’s common stock (the Stock Purchase
        Agreement”), and (c) a registration rights agreement entered into in June 2003
        among the plaintiffs and the Company, whereby the Company agreed to file
        and
        maintain a shelf registration statement with respect to the shares of FIC’s
        common stock purchased by M&W from the Mitte Foundation or which may be
        acquired in the future by Equita under the option agreement (the “Registration
        Rights Agreement,” and, collectively, the “Agreements”).
 
 The
        suit
        alleges that the Company breached the provisions of the Option Agreement
        by
        refusing to indemnify the plaintiffs for losses relating to the alleged breach
        of certain representations and warranties included in the Option Agreement.
        The
        plaintiffs also allege that the Company required M&W to purchase 204,918
        shares of FIC common stock from the Mitte Foundation as a condition of Equita’s
        obtaining, in June 2003, an exclusive marketing agreement with a subsidiary
        of
        the Company pertaining to the distribution of insurance products in the “senior
        market” (the “Marketing Agreement”), and that such requirement was motivated by
        the desire of the Company’s management to obtain certain proxy rights obtained
        under a settlement agreement with the Mitte Foundation and the Mitte family.
        The
        plaintiffs further allege that the Company breached the provisions of the
        Registration Rights Agreement by failing to file a shelf registration with
        the
        SEC with respect to the shares of FIC’s common stock purchased by M&W from
        the Mitte Foundation and the shares which may be acquired in the future by
        Equita under the provisions of the Option Agreement. The plaintiffs seek
        rescission of the Agreements; damages in an amount equal to the $3 million
        that
        M&W paid to acquire FIC shares from the Mitte Foundation, together with
        interest and attorney’s fees and unspecified expenses; and an unspecified amount
        of exemplary damages.
 
 Late
        in
        2005, the Company’s two life insurance subsidiaries, Investors Life and Family
        Life, intervened in the lawsuit to assert claims that Equita had breached
        its
        obligations under the Marketing Agreement with respect to the distribution
        of
        insurance products, thereby causing damages to the life insurance subsidiaries.
        Equita moved to dismiss the intervention, but at a hearing on December 20,
        2005,
        the court denied Equita’s motion. As a result, Investors Life and Family Life
        will be permitted to assert their claims against Equita in this
        lawsuit.
 
 Deposition
        discovery with respect to both the case filed by Equita and M&W, and the
        claims in intervention asserted by Family Life and Investors Life, began
        in
        October of 2006.
 
 In
        response to a motion for partial summary judgment, the Company has stipulated
        to
        certain elements of some of the causes of action asserted by Equita and M&W,
        including that certain representations and warranties made in the Option
        Agreement were partially incorrect, and that FIC was unable to comply with
        certain of its obligations under the Option Agreement. FIC did not stipulate,
        and continues to dispute, other elements of certain of the causes of action
        asserted by Equita and M&W, and disputes other causes of action in their
        entirety.
 
 On
        or
        about May 8, 2007, Equita and M&W amended their petition, removing their
        claims under the Texas Securities Act and common-law fraud. FIC intends to
        vigorously oppose the lawsuit and any effort by Equita and M&W to recover
        damages from FIC, and the life insurance subsidiary intends to vigorously
        prosecute its claims in intervention against Equita.
  14
 ***Index***
  The
        Manhattan Life Insurance Company and Family Life Insurance Company v. Family
        Life Corporation, Investors Life Insurance Company of North America and FIC
        Insurance Services, L.P.
  On
        April
        17, 2007, Manhattan Life and Family Life, filed a civil suit in the
        215 th Judicial
        District Court, Harris County, Texas, against Family Life Corporation, Investors
        Life and FIC Insurance Services, L.P. (“FICIS”), each a subsidiary of the
        Company. The suit alleges that: a) Family Life Corporation breached the Stock
        Purchase Agreement with Manhattan life by competing with Family Life and
        accepting insurance “directly or indirectly” from active accounts of Family
        Life; b) FICIS breached the Administrative Services Agreement with Family
        Life
        by willfully communicating with or willfully assisting with the communication
        by
        its affiliates with policyholders in a manner intended to solicit Family
        Life
        accounts on behalf of Investors Life; c) FICIS breached fiduciary duties
        owed to
        Family Life in the administration and management of the accounts of the policy
        holders of Family Life by assisting in the conversion of Family Life policies
        to
        the policies of Investors Life, and by their actions, Investors Life and
        Family
        Life Corporation aided and abetted such breach of fiduciary duty; and, d)
        Family
        Life Corporation, Investors Life and FICIS have tortiously interfered with
        existing contracts of Family Life with its policyholders, including the Stock
        Purchase Agreement and the Administrative Services Agreement. In addition,
        FICIS
        has filed, and intends to vigorously prosecute,  a
        counterclaim for amounts due and owing by Family Life for services performed
        pursuant to the Administrative Services Agreement. See note 8 regarding the
        sale
        of Family Life Insurance Company.
 
 Management
        Conclusion on Legal Proceedings
 
 In
        the
        opinion of the Company’s management, it is not currently possible to estimate
        the impact, if any, that the ultimate resolution of the foregoing legal
        proceedings will have on the Company’s results of operations, financial position
        or cash flows. Accordingly, no accrual for possible losses has been recorded
        in
        the accompanying consolidated financial statements for such legal proceedings.
 
 Other
        Litigation
 
 FIC
        and
        its insurance subsidiaries are regularly involved in litigation, both as
        a
        defendant and as a plaintiff. The litigation naming the insurance subsidiaries
        as defendant ordinarily involves our activities as a provider of insurance
        products. Management does not believe that any of this other litigation,
        either
        individually or in the aggregate, will have a material adverse effect on
        the
        Company’s results of operations, financial position, or cash flows.
 
 **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.
 
 Prior
        to
        entering into the definitive agreement, Family Life owned 648,640 shares
        of FIC
        common stock. Such shares are reflected as common treasury stock in the
        accompanying consolidated financial statements. Prior to the closing of this
        transaction, the Company acquired from Family Life 324,320 of these shares
        and
        the remaining 324,320 shares remained with Family Life at the time of sale.
        Also, prior to the closing of the sale, the Family Life Pension Plan, along
        with
        its assets and liabilities, was transferred from Family Life Insurance Company
        to its upstream parent company, Family Life Corporation (“FLC”). FLC is wholly
        owned by FIC and all current and future obligations of the Family Life Pension
        Plan are the responsibility of FLC.
 
 In
        conjunction with the sale, the Company’s Investors Life Insurance Company of
        North America (“Investors Life”) subsidiary entered into a coinsurance
        arrangement with Manhattan Life related to sales of certain future insurance
        products historically marketed by Family Life, such as traditional mortgage
        protection term life insurance.
 
 At
        September 30, 2006, Family Life had assets totaling approximately $121.9
        million
        and capital and surplus totaling approximately $16.3 million, as reported
        on a
        statutory basis of accounting for insurance regulatory purposes. The GAAP
        equity
        basis in Family Life, including other adjustments that affected the
        determination of loss from the sale, totaled approximately $52 million on
        the
        sale date. Accordingly, a GAAP loss of $24.4 million resulted from this sale.
 
 Amendment
        of Subordinated Loans
 
 FIC
        and
        FLC have subordinated notes payable to Investors Life with an unpaid balance
        of
        $15.4 million at March 31, 2006 and December 31, 2005. With the approval
        of the
        Texas Department of Insurance, the loans were restructured as of March 9,
        2006.
        As amended, the loans provide for a one year moratorium on principal payments
        for the period from March 12, 2006, to December 12, 2006, with principal
        payments to resume on March 12, 2007, with ten equal quarterly principal
        payments until the maturity date of June 12, 2009. These notes have been
        eliminated in the consolidated financial statements. The Company retired
        these
        subordinated notes payable on December 29, 2006 using a portion of the proceeds
        from the sale of Family Life Insurance Company.
  15
 ***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 March 31, 2006, compared with December 31, 2005, and
        its results of operations for the three months ended March 31, 2006, compared
        with the same period last year. This discussion should be read in conjunction
        with Management’s Discussion and Analysis included in FIC’s Form 10-K for the
        year ended December 31, 2005, to which the reader is directed for additional
        information.
 
 **Results
        of Operations - Three Months Ended March 31, 2006 and 2005**
 
 For
        the
        three-month period ended March 31, 2006, FIC’s net loss was $1.8 million (basic
        and diluted loss of $.18 per common share) on revenues of $25.1 million as
        compared to net loss of $1.1 million (basic and diluted loss of $.12 per
        common
        share) on revenues of $24.6 million in the first three months of
        2005.
 
 In
        2006,
        FIC’s net loss was affected by the following items:
 
 Ÿ
              Decline
                  in premiums earned of $601,000 due primarily to the approximate
                  7%
                  reduction in the number of premium paying traditional insurance
                  policies
                  in-force from the comparable prior
                  period;
 
 Ÿ
              Increase
                  in net investment income of $1.7 million primarily due to reinvestment
                  in
                  fixed maturities of proceeds from the sale of the River Place Pointe
                  office complex in June 2005;
 
 Ÿ
              Decline
                  in real estate income primarily due to the sale of the River Place
                  Pointe
                  office complex;
 
 Ÿ
              Increase
                  in policyholder benefits and expenses of $2.0 million primarily
                  due to the
                  increase in the amount of death
                  benefits.
 
 In
        2005,
        FIC’s net loss was affected by the following items:
 
 Ÿ
              Decline
                  in premiums earned of $646,000 due primarily to the approximate
                  8%
                  reduction in the number of premium paying traditional insurance
                  policies
                  in-force from the comparable prior
                  period;
 
 Ÿ
              Decline
                  in net investment income of $1.5 million due to effects of lower
                  interest
                  rates and the decline of approximately $60 million in total investments,
                  including cash equivalents, from March 31,
                  2004;
 
 Ÿ
              Decrease
                  in net realized investment gains of $1.8 million due to the reduction
                  in
                  sales of securities and real estate during the first quarter of
                  2005;
 
 Ÿ
              Decline
                  in policyholder benefits and expenses of $3.5 million due to the
                  decline
                  in the amount of death benefits and policy
                  surrenders;
 
 Ÿ
              Decline
                  in operating expenses of $1.2
                  million.
 
 The
        above
        described items need to be taken into consideration in drawing comparisons
        between the operating results for the three months ended March 31, 2006 and
        2005.
 
 *Revenues*
 
 Premium
        revenues reported for traditional life insurance products are recognized
        when
        due. Premium revenues for the first three months of 2006, net of reinsurance
        ceded, were $5.5 million, as compared to $6.1 million in the first three
        months
        of 2005. This source of revenues is related to the traditional life insurance
        book of business of FIC’s insurance subsidiaries for both first year and renewal
        premiums. 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.
  16
 ***Index***
  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 three
          months
          ended March 31, 2006 and 2005, annuity deposits and UL premiums totaled
          $8.2
          million and $9.0 million, respectively.
  The
        decline in UL premiums and annuity deposits reflects the net run-off of business
        from the Company’s existing book of business, and declining sales of new UL
        policies. Although the Company is focusing on reversing these trends on an
        overall basis, management has de-emphasized the sale of annuity and UL products
        due primarily to the current interest-rate environment and certain design
        features of FIC’s current annuity products. Most of the Company’s marketing
        efforts are now focused on the sale of traditional life insurance products,
        such
        as mortgage protection term insurance and final expense whole life insurance.
        Liabilities for contractholder funds have declined from $564.9 million at
        March
        31, 2005 to $534.2 million at March 31, 2006.
 
 Earned
        insurance charges totaled $9.8 million for the first three months of 2006,
        compared to $10.1 million in the same period of 2005. These revenues primarily
        consist of UL cost of insurance charges, but also include policy surrender
        charges, and policy administration charges. The decrease in earned insurance
        charges from 2005 to 2006 is primarily due to reduced UL cost of insurance
        charges resulting from the net run-off of business.
 
 Net
        investment income for the first three months of 2006 was $8.6 million as
        compared to $6.9 million in the same period of 2005. The increase in net
        investment income from 2005 to 2006 was primarily attributable to the
        reinvestment into fixed maturity securities of the proceeds, totalling
        approximately $100 million, from the sale of the Company’s River Place Pointe
        office complex.
 
 Real
        estate income is primarily earned from the leases at the Company’s River Place
        Pointe office complex in Austin, Texas. Real estate income (revenues from
        leases
        less associated operating expenses and depreciation) was $0 and $496,000
        for the
        three-month period ended March 31, 2006 and 2005, respectively. In June 2005,
        the Company sold the River Place Pointe property. Also, as of December 31,
        2005,
        the Company owned three remaining real estate properties held for sale with
        a
        total carrying value of $130,000. All three properties were sold in January
        2006. Accordingly, the Company no longer has real estate income in
        2006.
 
 Net
        realized investment gains were $516,000 in the first three months of 2006,
        as
        compared to $360,000 in the first three months of 2005. The realized gains
        for
        2006 were from the sale of the Company’s remaining real estate properties
        classified as held for sale, as previously described. The realized gains
        for
        2005 were primarily from the sales of fixed maturity securities and 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
        $11.8 million in the first three months of 2006, as compared to $9.9 million
        in
        the first three months of 2005. The increase in policyholder benefits and
        expenses in 2006 was primarily attributable to higher death claims.
 
 Interest
        expense on contractholder deposit funds represents interest paid or credited
        to
        contractholders on cash values accumulated in their universal life insurance
        and
        annuity accounts.  Interest
        expense totaled $5.2 million in the first three months of 2006, as compared
        to
        $5.5 million in the same period of the year 2005. As discussed previously,
        the
        decline in UL premiums and annuity deposits reflects the net run-off of business
        from the Company’s existing book of business, and consequently the decrease in
        interest expense in 2006 is primarily attributable to this overall reduction
        in
        the level of contractholder deposit funds.
 
 The
        level
        of market interest rates can effect the interest spread which is the difference
        in the Company’s investment portfolio rate and the interest rates credited on
        policyholder contracts for universal life insurance and annuities. The Company
        responded to lower market rates in 2004 and 2005 by lowering many of the
        credited rates on its policies in these periods. However, universal life
        insurance and annuity policies have contractual minimum guaranteed rates
        and
        credited rates cannot be lower than such minimums. Because many of the Company’s
        policies have minimum guaranteed rates of 4.0%, the market interest rate
        environment in prior periods put pressure on the Company’s interest spread.
        Market rate increases in 2005 and 2006 have improved the Company’s interest
        spread.
 
 Amortization
        of deferred policy acquisition costs (DAC) for the first three months of
        2006
        was $2.3 million, as compared to $2.5 million in the same period in 2005.
        These
        expenses represent the amortization of the costs of producing new business,
        which consists primarily of agents’ commissions and certain policy issuance and
        underwriting costs. For traditional life insurance business, DAC is amortized
        over the estimated premium-paying period of the policies in proportion to
        annual
        premium revenue. For interest sensitive products, these costs are amortized
        in
        relation to the estimated annual gross profits of the policies. The level
        of
        policy lapses and surrenders can also have a significant impact on the amount
        of
        amortization in any reporting period.
  17
 ***Index***
 
 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 $605,000 and $666,000 for
        the
        three months ended March 31, 2006 and 2005, respectively. The amortization
        is
        consistent with the run-off of the acquired blocks of business.
 
 Operating
        expenses for the first three months of 2006 were $7.1 million, as compared
        to
        $7.2 million in the first three months of 2005. The Company has implemented
        many
        cost reduction measures in 2004 and 2005, as well as 2006, and this continues
        to
        be a critical focus for the Company. However, audit, actuarial, accounting
        and
        other consulting and legal expenses continue to represent a significant
        component of operating expenses as the Company completes its delinquent SEC
        filings with a target of becoming current on all filings at the end of the
        second quarter of 2007. These fees totaled $2.6 million and $2.2 million
        for the
        three months ended March 31, 2006 and 2005, respectively.
 
 Interest
        expense was $329,000 and $255,000 for the three months ended March 31, 2006
        and
        2005, respectively. The interest expense relates to debt service on $15 million
        aggregate principal amount of floating rate Senior Notes due 2033 (the “Senior
        Notes”). The Senior Notes bear interest quarterly at the three-month LIBOR rate
        plus 4.2%. The higher interest expense in 2006 is a direct result of the
        increase in the LIBOR rate.
 
 *Taxes*
 
 The
        provision for federal income taxes on loss from operations reflects tax benefits
        totaling $478,000 and $226,000 for the three months ended March 31, 2006
        and
        2005, respectively. These tax amounts equate to effective tax benefit rates
        of
        21.1% and 16.5% for the three months ended March 31, 2006 and 2005,
        respectively. The primary reason for the deviation from the expected statutory
        tax rate of 34% for the Company is due to increases in the valuation allowance
        for deferred tax assets generated by its non-life insurance entities. Deferred
        income tax assets are subject to ongoing evaluation of whether such assets
        will
        be realized. Realization of deferred tax assets is dependent upon the Company's
        generation of sufficient taxable income in the future to recover tax benefits
        that cannot be recovered from taxes paid in prior periods. If future taxable
        income is not expected, the Company establishes a valuation allowance, when
        based on the weight of the available evidence, it is more likely than not
        that
        some portion of the deferred tax assets will not be realized. The Company’s
        deferred tax assets are primarily comprised of net operating losses of FIC
        and
        its non-life insurance subsidiaries.
 
 **Liquidity
        and Capital Resources**
 
 Liquidity
        describes the ability of a company to generate sufficient cash flows to meet
        the
        cash requirements of business operations. FIC is an insurance holding company
        whose principal assets consist of its insurance subsidiaries - Family Life
        Insurance Company (“Family Life”) and Investors Life Insurance Company of North
        America (“Investors Life”). As a holding company, FIC’s ability to pay interest
        and principal on its debt, pay its expenses, and pay dividends on its common
        stock depend substantially upon its receipt of dividends or other cash flow
        from
        these subsidiaries.
 
 Liquidity
        management is designed to ensure that adequate funds are available to meet
        all
        current and future financial obligations. The Company meets its liquidity
        requirements primarily by funding cash used in operations with cash flows
        provided by investing activities. Proper liquidity management is crucial
        to
        preserve stable, reliable, and cost-effective sources of cash to meet the
        future
        benefit payments under our various insurance and deposit contracts, pay
        operating expenses (including interest and income taxes), and maintain reserve
        requirements. In this process, we focus on our assets and liabilities, and
        the
        impact of changes in both short-term and long-term interest rates, market
        liquidity and other factors. We believe we have the ability to generate adequate
        cash flows to fund obligations as they come due.
 
 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 March
        31,
        2006, Investors Life held $15.4 million of notes receivable from the Company
        (the “Affiliated Notes”) with quarterly interest payments at an annual rate of
        5%. Although this intercompany indebtedness is eliminated on FIC’s condensed
        consolidated balance sheets, it creates a debt service requirement at the
        holding company level.
  18
 ***Index***
 
 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.
  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 March 31, 2006
        were
        $534.2 million, compared to $542.2 million at December 31, 2005. Individual
        life
        insurance policies are less susceptible to withdrawal than are annuity contracts
        because life insurance policyholders may incur surrender charges and undergo
        a
        new underwriting process in order to obtain a new insurance policy. At March
        31,
        2006, the bulk of the liabilities for contractholder deposit funds on FIC’s
        condensed consolidated balance sheet, $375.9 million, represented insurance
        products, as compared to $158.3 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 March 31, 2006 were $10.9 million compared to $63.6 million
        at December 31, 2005. The $52.7 million decrease in cash and cash equivalents
        at
        March 31, 2006 from December 31, 2005 was due primarily to reinvestment of
        cash
        into fixed maturity securities, and contractholder fund withdrawals in excess
        of
        deposits for universal life insurance and annuity products.
  19
 ***Index***
 
 Net
        cash
        provided by operating activities was $3.8 million for the three month period
        ended March 31, 2006, compared to $4.0 million used in operating activities
        for
        the same period of 2005. The predominant changes in net cash used by operating
        activities between 2006 and 2005 are due to 1) decreases in reinsurance
        receivables and agent advances, and 2) increases in other liabilities.
 
 Net
        cash
        used in investing activities was $47.0 million for the three month period
        ended
        March 31, 2006, compared to net cash used in investing activities totalling
        $22.2 million for the same period of 2005. The $24.8 million change in cash
        used
        in investing activities in 2006 compared to 2005 was due primarily to a
        reduction in the level of short-term investments in 2005 as compared to the
        corresponding period of 2006.
 
 Net
        cash
        used in financing activities was $9.4 million in the first three months of
        2006,
        compared to $7.9 million in the first three months of 2005. The components
        of
        the Company’s financing activities are contractholder fund deposits and
        withdrawals for annuity and universal life insurance policies. For the three
        months ended March 31, 2006 and 2005, contractholder fund withdrawals exceeded
        deposits by $9.4 million and $7.9 million respectively. The change in net
        withdrawals in 2006 is due to a decline in deposits in 2006 from 2005 of
        $779,000 combined with an increase in withdrawals of $753,000 for the same
        period, due to an increase in surrenders.
 
 In
        light
        of the information and considerations outlined above, management believes
        at
        this time that the liquidity of FIC and its subsidiaries is sufficient to
        meet
        the needs of its business, including its debt service requirements.
 
 **Financial
        Condition**
 
 During
        the three months ended March 31, 2006, the equity of the shareholders of
        the
        Company (that is, the excess of the Company’s assets over its liabilities)
        decreased by $8.0 million. Changes resulting in the decrease to shareholders’
equity are detailed as follow:
 
 Ÿ
              Net
                  loss for the quarter of $1.8
                  million;
 Ÿ
              $26,000
                  increase from change in net unrealized gains on investments in
                  equity
                  securities; and
 Ÿ
              $6.2
                  million decrease from change in net unrealized losses on investments
                  in
                  fixed maturity securities available for
                  sale
 
 *Assets*
 
 The
        Company’s life insurance subsidiaries have investment management agreements with
        Conning Asset Management (“Conning”). Under these agreements, Conning manages
        the investment security portfolios of the Company’s life insurance subsidiaries
        in accordance with investment policies set by the Company’s Board of Directors.
        The investment policies comply with legal requirements of state insurance
        laws
        and regulations that are applicable to the Company’s insurance company
        subsidiaries. They also emphasize sensitivity to the way that FIC’s liabilities
        are likely to change over time and with changes in general interest rate
        levels.
        In practical terms, this means that the Company focuses almost all of its
        investment in investment-grade securities, keeping the schedule of anticipated
        asset maturities in line with its projected cash needs. It also means that
        the
        Company attempts to keep the duration of its investment assets (a measure
        of the
        sensitivity of their value to changes in interest rates) in line with the
        duration of the Company’s liabilities.
 
 Over
        the
        past several years, the Company has decreased its investment in mortgage-backed
        securities (including asset-backed securities) significantly. This trend
        continued into 2006. Expressed as a percentage of its total investment in
        fixed
        maturities, these ratios were 24.4% and 22.3% at December 31, 2005 and March
        31,
        2006 respectively. Such securities are sensitive to changes in prevailing
        interest rates, since interest rate levels affect the rate at which the
        underlying mortgage obligations are repaid. FIC’s insurance subsidiaries have
        reduced the risk of prepayment associated with mortgage-backed securities
        by
        investing in planned amortization class (“PAC”), target amortization class
        (“TAC”) instruments and scheduled bonds. These investments are designed to
        amortize in a predictable manner by shifting the risk of prepayment of the
        underlying collateral to other investors in other tranches (“support classes”)
        of the CMO.
 
 During
        the first quarter of 2006, net unrealized losses on fixed maturities available
        for sale increased $6.2 million. The increase in unrealized losses was primarily
        related to increases in market interest rates. The Company’s general investment
        philosophy is to hold fixed maturities for long-term investment. Accordingly,
        the Company has the ability and intent to hold securities to maturity or
        until
        they recover in value. The Company does not currently anticipate the need
        to
        sell securities in unrealized loss positions for liquidity
        purposes.
  20
 ***Index***
 
 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 the second quarter of 2005,
        the Company increased its equity securities holdings by investing $2.0 million
        in a corporate bond mutual fund as part of a strategy to increase
        diversification and enhance overall investment performance. As of March 31,
        2006, the market value of FIC’s equity securities was $11.2 million, compared to
        $10.9 million at December 31, 2005.
 
 FIC’s
        real estate investment was primarily related to the River Place Pointe office
        complex (“River Place Pointe”) owned by Investors Life. At March 31, 2005, FIC’s
        investment totaled $89.8 million in this 600,000 sq. ft., seven-building
        office
        complex on 48 acres in Austin, Texas. FIC and its insurance company subsidiaries
        occupied one of the seven buildings. Three of the other buildings were
        substantially leased, but three buildings remained vacant as of March 31,
        2005.
        The project was sold in June 2005, in a cash transaction, for $103 million.
        The
        Company realized a gain of $10.6 million on the sale, which includes both
        a
        realized gain of $8.5 million recorded in 2005 and a deferred gain of $2.1
        million to be recognized as a reduction of office lease expenses over the
        period
        from the sale date through March 31, 2008. The deferred gain represents an
        amount equal to the estimated excess rent to be paid under the lease agreement
        through March 31, 2008 over the prevailing rate at the time of sale. The
        Company’s remaining real estate properties held for sale totaling $130,000 at
        December 31, 2005, were sold in January, 2006.
 
 Investors
        Life had $343.7 million of separate account assets as of March 31, 2006 (not
        including the value of the Company’s own investment in one of the accounts), as
        compared to $342.9 million at the end of 2005. These assets include (a) two
        variable annuity separate accounts that permit contractholders to allocate
        their
        contract values among a selection of third-party mutual funds and (b) assets
        held in custodian accounts in connection with investment annuity contracts.
        The
        investment annuity business is reinsured with Symetra Life Insurance Company
        (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10%
        coinsurance basis, with Investors Life retaining 10% of such business. Since
        the
        reinsurance treaty is on a coinsurance basis, Investors Life is contingently
        liable to the policyholders in the event that the reinsurer is unable to
        fulfill
        its obligations under the treaty. Investors Life is not marketing new separate
        account annuity contracts.
 
 Effective
        June 1, 2006, Investors Life recaptured the previously reinsured investment
        annuity business with Symetra Life resulting in the retention of 100% of
        this
        business. The Company expects the recapture of this previously reinsured
        business to increase revenues in 2006 and future years. However, as this
        is a
        closed block of business, the revenues are expected to decrease as the policies
        in force decline.
 
 *Liabilities*
 
 The
        Company’s insurance-related liabilities (future policy benefits and
        contractholder deposit funds) were $689.3 million at March 31, 2006, compared
        to
        $698.2 million at December 31, 2005. The decrease in these insurance-related
        liabilities reflects the business run-off as previously described.
 
 Deferred
        federal income taxes at December 31, 2005 reflected a net liability of $687,000.
        This deferred tax position changed to a net asset balance of $2,990,000 at
        March
        31, 2006. This significant change in deferred taxes was primarily due to
        tax
        benefits associated with unrealized losses on the Company’s fixed maturity
        securities portfolio, resulting from increases in market interest rates during
        the quarter.
 
 *Capital
        Adequacy*
 
 Financial
        intermediaries such as FIC depend on their equity capital to absorb short-term
        fluctuations in asset and liability values in their financial structures.
        They
        also count on equity capital to support the growth of the business. One typical
        measure of the strength of a financial holding company such as FIC is the
        simple
        ratio of its shareholders’ equity to its total assets. For FIC this ratio was
        6.4% at March 31, 2006, compared to 7.0% at December 31, 2005. The inclusion
        of
        separate account assets (which are not relevant for this purpose) reduced
        the
        ratio of shareholders’ equity to total assets by 2.7% and 2.9% at March 31, 2006
        and December 31, 2005, respectively. Management believes that its current
        equity
        capital is sufficient to meet the Company’s current liabilities and to fund
        growth at currently planned levels.
 
 Insurance
        companies are subject to regulation under state law. Among other requirements,
        these state laws and regulations impose capital adequacy requirements on
        insurance companies. Using a calculation that takes into account the quality,
        liquidity, maturities, and amounts of its assets and liabilities, each insurance
        company is required to calculate its “risk-based capital” (or “RBC”). Total
        adjusted capital must exceed 200% of the authorized control level RBC to
        avoid
        supervisory activity by the insurance regulators. As of December 31, 2006,
        the
        total adjusted capital of Investors Life was approximately 584% of its
        authorized control level risk-based capital.
  21
 ***Index***
  State
        regulators also use NAIC IRIS ratios to monitor capital adequacy requirements.
        The NAIC ratios cover 12 categories of financial data with defined “usual”
ranges for each such category. The ratios are intended to provide insurance
        regulators with “early warnings” as to when a company might warrant special
        attention. An insurance company may fall outside of the usual range for one
        or
        more ratios, and such variances may result from specific transactions that
        are,
        by themselves, immaterial or eliminated at the consolidation level. In certain
        states, insurers with more than three IRIS ratios outside of the NAIC usual
        ranges may be subject to increased regulatory oversight. For 2006 Investors
        Life
        had four ratios which were outside the usual ranges, which were primarily
        related to investment income and changes in premium, product mix, and reserving.
        The ratios were outside the usual ranges primarily due to a recapture of
        ceded
        reinsurance by Family Life from Investors Life during 2006. This recapture
        occurred prior to the sale of Family Life. For statutory accounting purposes,
        the recapture affected premium income and change in policy reserves which
        caused
        ratios to fall outside the usual ranges. Excluding the effects of the
        reinsurance recapture, Investors Life would have had only one ratio outside
        the
        usual ranges, which related to investment income.
 
 **ITEM
        3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
        RISK**
 
 *General*
 
 FIC’s
        principal assets are financial instruments, which are subject to market risks.
        Market risk is the risk of loss arising from adverse changes in market rates,
        principally interest yields on fixed rate investments. For a discussion of
        the
        Company’s investment portfolio and the management of that portfolio to reflect
        the nature of the underlying insurance obligations of the Company’s insurance
        subsidiaries, please refer to the information set forth in “Management’s
        Discussion and Analysis of Financial Condition and Results of
        Operations.”
 
 The
        following is a discussion of the Company’s primary market-risk-sensitive
        instruments. It should be noted that this discussion has been developed using
        estimates and assumptions. Actual results may differ materially from those
        described below. Further, the following discussion does not take into account
        actions that could be taken by management in response to the assumed changes
        in
        market rates. In addition, the discussion does not take into account other
        types
        of risks that may be involved in the business operations of the Company,
        such as
        the reinsurance recoveries on reinsurance treaties with third party insurers.
 
 The
        primary market risk to the Company’s investment portfolio is interest rate risk.
        The Company does not use derivative financial instruments.
 
 *Interest-Rate
        Risk*
 
 The
        Company manages the interest-rate risk inherent in its fixed maturity assets
        relative to the interest-rate risk inherent in its liabilities. Generally,
        we
        manage interest-rate risk based on the application of a commonly used model.
        The
        model projects the impact of interest rate changes on a range of factors,
        including duration and potential prepayment. For example, assuming an immediate
        increase of 100 basis points in interest rates, the net hypothetical loss
        in
        fair market value related to the financial instruments included in the Company’s
        condensed consolidated balance sheets is estimated to be $32.6 million at
        March
        31, 2006 and $26.6 million at December 31, 2005. For purposes of the foregoing
        estimate, fixed maturity securities available for sale and short-term
        investments were taken into account. The fair value of such assets was $630.6
        million at March 31, 2006 and $595.0 million at December 31, 2005.
 
 The
        fixed
        income investments of the Company include certain mortgage-backed securities
        (excluding asset backed securities). The market value of such securities
        was
        $139.4 million at March 31, 2006 and $145.5 million at December 31, 2005.
        Assuming an immediate increase of 100 basis points in interest rates, the
        net
        hypothetical loss in the fair value related to such mortgage-backed securities
        is estimated to be $10.8 million at March 31, 2006 and $10.7 million at December
        31, 2005.
 
 Separate
        account assets have not been included, since gains and losses on those assets
        generally accrue to the policyholders.
 
 The
        Company generally does not use derivative financial instruments to manage
        its
        exposure to fluctuations in interest rates.
  22
 ***Index***
  **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 March 31, 2006. Based on its
        evaluation and the identification of material weakness in internal control
        over
        financial reporting described below, and because of an inability to file
        the
        Quarterly Report on Form 10-Q within the statutory time period, FIC’s Chief
        Executive Officer and Chief Financial Officer have concluded that, as of
        March
        31, 2006, FIC’s disclosure controls and procedures were
        ineffective.
 
 Management
        had assessed our internal control over financial reporting as of December
        31,
        2005, the end of our most recent fiscal year. Management based its assessment
        on
        criteria established in Internal Control—Integrated Framework issued by the
        Committee of Sponsoring Organizations of the Treadway Commission. As disclosed
        in the Company’s Annual Report on Form 10−K for the fiscal year ended December
        31, 2005, in performing its assessment of internal control over financial
        reporting, management determined that material weaknesses existed in the
        Company’s internal controls relating to the following areas: control
        environment, risk assessment, control monitoring, financial close and reporting,
        segregation of duties, reconciliations, use of third-party service providers,
        safeguarding of assets, reinsurance, and policy data integrity.
 
 Following
        its identification of the above-described internal control weaknesses, the
        Company has been actively engaged in the implementation of remediation efforts
        to address the material weaknesses in its internal control over financial
        reporting as of March 31, 2006. The Company’s major remediation activities for
        the first quarter of 2006 are described below.
 
 The
        Company and its external auditors previously identified a material weakness
        in
        the overall internal control environment. One of the components of this weakness
        was that the Company had inadequate and incomplete documentation of key controls
        of all business processes across the Company. During the first quarter of
        2006,
        the Company responded to this issue and engaged outside resources to assist
        in
        constructing appropriate internal controls documentation across all major
        process areas of the Company. This new set of documentation was constructed
        and
        implemented during the first quarter of 2006.
 
 In
        addition to the above remediation actions, the Company partially addressed
        a
        reinsurance control issue to help ensure that reinsurance transactions are
        properly recorded. During the first quarter of 2006, the Company improved
        the
        automation of its reinsurance system. Reinsurance change transactions are
        now
        automatically generated in the Company’s reinsurance system when policy changes
        that affect reinsurance information are made in the Company’s primary policy
        administration system. Although improvements have been made in the reinsurance
        internal controls, additional remediation efforts are required in order to
        completely eliminate the reinsurance material weakness described in the
        Company’s Form 10-K of 2005.
  23
 ***Index***
  **PART
        II. OTHER INFORMATION**
 
 **ITEM
        1. LEGAL PROCEEDINGS**
 
 The
        Company and its subsidiaries are defendants in certain legal actions related
        to
        the normal business operations of the Company. Management believes that the
        resolution of such legal actions will not have a material impact on the
        condensed consolidated financial statements.
 
 T.
        David Porter v. Financial Industries Corporation
 
 On
        May
        31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis
        County, Texas District Court (the “Court”), against the Company, seeking to
        compel the Company to hold an annual meeting of shareholders. FIC has been
        unable to solicit proxies for an annual meeting because it has not been able
        to
        comply with Rule 14a-3 of the Securities Exchange Act of 1934, which requires
        that the Company provide an annual report containing current financial
        statements to shareholders in connection with an annual meeting.
 
 Mr.
        Porter sued under Article 2.24(B) of the Texas Business Corporation Act,
        which
        provides that if an annual meeting of shareholders is not held within any
        13-month period and a written consent of shareholders has not been executed
        instead of a meeting, any court of competent jurisdiction in the county in
        which
        the principal office of the corporation is located may, on the application
        of
        any shareholder, summarily order a meeting to be held. On August 7, 2006,
        the
        Company entered into an Agreed Order On Plaintiff’s Motion to Compel Annual
        Shareholders Meeting and agreed among other things to hold an annual
        shareholders meeting for the election of directors on December 6, 2006. The
        Company made arrangements for, and was prepared to hold, an annual meeting
        of
        shareholders on December 6, 2006, as required by the Agreed Order, but the
        Company was unable to hold the meeting on the appointed date because no quorum
        was present.
 
 On
        December 12, 2006, FIC filed a Motion for Summary Judgment seeking dismissal
        of
        Porter’s suit on the grounds that the Agreed Order did not dispense with the
        requirement of a quorum; the lack of a quorum was a direct and foreseeable
        result of Mr. Porter’s insistence on a one-sided solicitation and election; FIC
        had complied with its obligations under the Agreed Order and Mr. Porter has
        obtained all relief sought by his petition. FIC’s Motion for Summary Judgment
        remains pending and has not been heard.
 
 Prior
        to
        a hearing on FIC’s Motion for Summary Judgment, Mr. Porter applied for a
        temporary restraining order and temporary injunction requiring the Company
        to
        convene one or more additional meetings of shareholders, contending that
        in the
        absence of a quorum on December 6, Texas law and the Company’s bylaws entitled a
        majority of the shareholders in attendance to choose a date to which the
        meeting
        would be adjourned. The District Court held a hearing on Porter’s application,
        and on December 22, 2006 entered an order requiring among other things that
        FIC
        hold an annual shareholders meeting for the election of directors on January
        16,
        2007, but stating that if a quorum was not present on that date, FIC would
        not
        be required to hold an annual meeting of shareholders at any time before
        July
        17, 2007. The Company made arrangements for, and was prepared to hold, an
        annual
        meeting of shareholders on January 16, 2007, as required by the Court’s order,
        but the Company was again unable to hold the meeting on the appointed date
        because no quorum was present. No further action has been taken by Mr. Porter,
        whose suit remains pending.
 
 Litigation
        with Equita Financial and Insurance Services of Texas, Inc. and M&W
        Insurance Services, Inc.
 
 On
        June
        2, 2005, Equita and M&W Insurance Services, Inc. (“M&W”) filed a civil
        suit in Travis County, Texas District Court against the Company. The suit
        alleges that, in entering into certain agreements with the plaintiffs, the
        Company made certain misrepresentations and omissions as to its business
        and
        financial condition. The agreements referenced in the suit consist of (a)
        an
        option agreement entered into in June 2003 between Equita and the Company,
        granting Equita the right to purchase shares of FIC’s common stock at $16.42 per
        share, if certain sales goals were achieved under an exclusive marketing
        agreement between Equita and a subsidiary of the Company (the “Option
        Agreement”), (b) a stock purchase agreement entered into in June 2003 between
        M&W and the Roy F. and Joann Cole Mitte Foundation, pertaining to the
        purchase of 204,918 shares of FIC’s common stock (the Stock Purchase
        Agreement”), and (c) a registration rights agreement entered into in June 2003
        among the plaintiffs and the Company, whereby the Company agreed to file
        and
        maintain a shelf registration statement with respect to the shares of FIC’s
        common stock purchased by M&W from the Mitte Foundation or which may be
        acquired in the future by Equita under the option agreement (the “Registration
        Rights Agreement,” and, collectively, the “Agreements”).
 
 The
        suit
        alleges that the Company breached the provisions of the Option Agreement
        by
        refusing to indemnify the plaintiffs for losses relating to the alleged breach
        of certain representations and warranties included in the Option Agreement.
        The
        plaintiffs also allege that the Company required M&W to purchase 204,918
        shares of FIC common stock from the Mitte Foundation as a condition of Equita’s
        obtaining, in June 2003, an exclusive marketing agreement with a subsidiary
        of
        the Company pertaining to the distribution of insurance products in the “senior
        market” (the “Marketing Agreement”), and that such requirement was motivated by
        the desire of the Company’s management to obtain certain proxy rights obtained
        under a settlement agreement with the Mitte Foundation and the Mitte family.
        The
        plaintiffs further allege that the Company breached the provisions of the
        Registration Rights Agreement by failing to file a shelf registration with
        the
        SEC with respect to the shares of FIC’s common stock purchased by M&W from
        the Mitte Foundation and the shares which may be acquired in the future by
        Equita under the provisions of the Option Agreement. The plaintiffs seek
        rescission of the Agreements; damages in an amount equal to the $3 million
        that
        M&W paid to acquire FIC shares from the Mitte Foundation, together with
        interest and attorney’s fees and unspecified expenses; and an unspecified amount
        of exemplary damages.
  24
 ***Index***
  Late
        in
        2005, the Company’s two life insurance subsidiaries, Investors Life and Family
        Life, intervened in the lawsuit to assert claims that Equita had breached
        its
        obligations under the Marketing Agreement with respect to the distribution
        of
        insurance products, thereby causing damages to the life insurance subsidiaries.
        Equita moved to dismiss the intervention, but at a hearing on December 20,
        2005,
        the court denied Equita’s motion. As a result, Investors Life and Family Life
        will be permitted to assert their claims against Equita in this
        lawsuit.
 
 Deposition
        discovery with respect to both the case filed by Equita and M&W, and the
        claims in intervention asserted by Family Life and Investors Life, began
        in
        October of 2006.
 
 In
        response to a motion for partial summary judgment, the Company has stipulated
        to
        certain elements of some of the causes of action asserted by Equita and M&W,
        including that certain representations and warranties made in the Option
        Agreement were partially incorrect, and that FIC was unable to comply with
        certain of its obligations under the Option Agreement. FIC did not stipulate,
        and continues to dispute, other elements of certain of the causes of action
        asserted by Equita and M&W, and disputes other causes of action in their
        entirety.
 
 On
        or
        about May 8, 2007, Equita and M&W amended their petition, removing their
        claims under the Texas Securities Act and common-law fraud. FIC intends to
        vigorously oppose the lawsuit and any effort by Equita and M&W to recover
        damages from FIC, and the life insurance subsidiary intends to vigorously
        prosecute its claims in intervention against Equita.
  The
        Manhattan Life Insurance Company and Family Life Insurance Company v. Family
        Life Corporation, Investors Life Insurance Company of North America and FIC
        Insurance Services, L.P.
  On
        April
        17, 2007, Manhattan Life and Family Life, filed a civil suit in the
        215 th Judicial
        District Court, Harris County, Texas, against Family Life Corporation, Investors
        Life and FIC Insurance Services, L.P. (“FICIS”), each a subsidiary of the
        Company. The suit alleges that: a) Family Life Corporation breached the Stock
        Purchase Agreement with Manhattan life by competing with Family Life and
        accepting insurance “directly or indirectly” from active accounts of Family
        Life; b) FICIS breached the Administrative Services Agreement with Family
        Life
        by willfully communicating with or willfully assisting with the communication
        by
        its affiliates with policyholders in a manner intended to solicit Family
        Life
        accounts on behalf of Investors Life; c) FICIS breached fiduciary duties
        owed to
        Family Life in the administration and management of the accounts of the policy
        holders of Family Life by assisting in the conversion of Family Life policies
        to
        the policies of Investors Life, and by their actions, Investors Life and
        Family
        Life Corporation aided and abetted such breach of fiduciary duty; and, d)
        Family
        Life Corporation, Investors Life and FICIS have tortiously interfered with
        existing contracts of Family Life with its policyholders, including the Stock
        Purchase Agreement and the Administrative Services Agreement. In addition,
        FICIS
        has filed, and intends to vigorously prosecute, a counterclaim for amounts
        due
        and owing by Family Life for services performed pursuant to the Administrative
        Services Agreement.
 
 Management
        Conclusion on Legal Proceedings
 
 In
        the
        opinion of the Company’s management, it is not currently possible to estimate
        the impact, if any, that the ultimate resolution of the foregoing legal
        proceedings will have on the Company’s results of operations, financial position
        or cash flows. Accordingly, no accrual for possible losses has been recorded
        in
        the accompanying consolidated financial statements for such legal proceedings.
  25
 ***Index***
  Other
        Litigation
 
 FIC
        and
        its insurance subsidiaries are regularly involved in litigation, both as
        a
        defendant and as a plaintiff. The litigation naming the insurance subsidiaries
        as defendant ordinarily involves our activities as a provider of insurance
        products. Management does not believe that any of this other litigation,
        either
        individually or in the aggregate, will have a material adverse effect on
        the
        Company’s results of operations, financial position, or cash flows.
  **ITEM
        1A. RISK FACTORS**
 
 As
        of
        March 31, 2006, there have been no material changes to risk factors as
        previously disclosed in the Company’s 2005 Form 10-K.
  **ITEM
        2. CHANGES IN SECURITIES AND USE OF
        PROCEEDS**
 
 None
  **ITEM
        3. DEFAULTS UPON SENIOR SECURITIES**
 
 None
  **ITEM
        4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
        HOLDERS**
 
 There
        were no matters submitted to a vote of security holders during the first
        quarter
        of 2006.
  **ITEM
        5. OTHER INFORMATION**
 
 None
  **ITEM
        6. EXHIBITS**
 
 (a)
              Exhibits
 
 31.1
              Certification
                  of Chief Executive Officer of FIC pursuant to Section 302 of the
                  Sarbanes-Oxley Act of 2002
 31.2
              Certification
                  of Chief Financial Officer of FIC pursuant to Section 302 of the
                  Sarbanes-Oxley Act of 2002
 32.1
              Certification
                  of Chief Executive Officer of FIC pursuant to 18 U.S.C. Section
                  1350
 32.2
              Certification
                  of Chief Financial Officer of FIC pursuant to 18 U.S.C. Section
                  1350
  26
 ***Index***
  **Signatures**
  Pursuant
        to the requirements of the Securities Exchange Act of 1934, the registrant
        has
        duly caused this report to be signed on its behalf by the undersigned, thereunto
        duly authorized.
  FINANCIAL
                  INDUSTRIES CORPORATION(Registrant)Date:
                  May 31, 2007
              By:/s/ William B. ProutyWilliam
                  B. ProutyChief
                  Executive OfficerDate:
                  May 31, 2007
              By:/s/ Vincent L. KaschVincent
                  L. KaschChief
                  Financial Officer(Principal
                  Accounting and Financial Officer)
   27