Prior to December 2001, ILCO and Investors-IN owned three residential buildings adjacent to the 40 Parker Road building. In December 2001, ILCO and Investors-IN sold these properties for a total purchase price of $380,000, which amount was allocated between ILCO and Investors-IN in accordance with their respective interests in the properties.
Except for historical factual information set forth in this Management's Discussion and Analysis, the statements, analyses, and other information contained in this report relating to trends in the Company's operations and financial results, the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "path," "estimate," "expect," "intend" 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 the financial results, economic conditions and are subject to known and unknown risks, uncertainties and other factors contemplated by the forward-looking statements. Such factors include, among other things: (1) general economic conditions and other factors, including prevailing interest rate levels and stock market performance, which may effect 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 which may affect the profitability of FIC's subsidiaries' insurance products; (5) changes in the Federal income tax laws and regulations which may affect the relative tax advantages of some of FIC's products; (6) increasing competition in the sale of life insurance and annuities; (7) regulatory changes or actions, including those relating to regulation of insurance products and insurance companies; (8) 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 annuity and other accumulation products; and (9) unanticipated litigation. There can be no assurance that other factors not currently anticipated by management will not also materially and adversely affect FIC.
Financial Industries Corporation ("FIC" or the "Company") is a holding company engaged through its subsidiaries in the business of marketing, underwriting and distributing a broad range of life insurance and annuity products in 49 states, the District of Columbia and the U.S. Virgin Islands.
In accordance with Generally Accepted Accounting Principles (GAAP), universal life insurance premiums and annuity deposits received are reflected on FIC's consolidated balance sheets as increases in liabilities for contract holder deposit funds and not as revenues.
Prior to December 1999, FIC owned several parcels of real estate in Jackson, Mississippi, adjacent to an office building known as the Standard Life Building, which building was owned by Investors Life. On December 29, 1999, Investors Life donated the Standard Life Building to the Jackson Redevelopment Authority ("JRA"). Contemporaneously with the donation of the Standard Life Building, Investors Life and FIC sold all of the adjacent parcels they owned to the JRA for a total sale price of $2.5 million, which has been allocated according to the respective ownership interests of Investors Life (approximately 59.28%) and FIC (approximately 40.72%). The donation and sale was made pursuant to the terms of the Donation, Purchase and Sale Agreement dated July 17, 1998. Investors Life claimed an income tax deduction on its 2000 tax return for the donation of the Standard Life Building of $864,231. The donation and sale transaction referenced above resulted in a net of tax gain (GAAP basis) of $1.0 million for ILCO and $0.4 million for FIC (or a combined total of $1.401 million) in 1999.
For the year ended December 31, 2001, FIC's net income was $12,014,000 (basic earnings of $1.54 per common share or diluted earnings of $1.52 per common share) on revenues of $99,125,000 as compared to net income for the year ended December 31, 2000, which was $8,779,000 (basic earnings of $1.74 per common share or diluted earnings of $1.70 per common share) on revenues of $44,418,000 and net income for the year ended December 31, 1999, which was $9,149,000 (basic earnings of $1.81 per common share or diluted earnings of $1.76 per common share) on revenues of $46,244,000.
Income from universal life and annuity charges for the year ended December 31, 2001 was $27.7 million, as compared to $4.3 million for the year 2000 and $4.8 million in 1999. The consolidation of ILCO's operations following the Merger contributed approximately $24 million to earned insurance charges for the year ended December 31, 2001. At Family Life, earned insurance charges declined from $4.3 million in the year 2000 to $3.4 million in the year 2001. The amount is consistently decreasing because Family Life reinsures all of its new universal life and annuity business with Investors Life and thus earned insurance charges received are attributable to a closed, decreasing book of business. At Investors Life and Investors-IN, earned insurance charges increased from $38.5 million in the year 2000 to $39.5 million in the year 2001 (which includes the pre-Merger and post-Merger charges). The face amount of in force universal life policies at Family Life was $870.9 million at December 31, 2000 as compared to $721.1 million at December 31, 2001. The face amount of in force universal life policies at Investors Life and Investors-IN was $4,692.7 million at December 31, 2000 as compared to $4,676.9 million at December 31, 2001.
Policyholder benefits and expenses were $27.7 million in 2001, as compared to $13.5 million in 2000 and $12.6 million in 1999. The consolidation of ILCO's operations for the period from May 18, 2001 to December 31, 2001 contributed approximately $19 million to policyholder benefits and expenses for the year ended December 31, 2001. At ILCO's insurance subsidiaries, the level of policyholder benefits and expenses decreased from $32.5 million for the year 2000 to $30.0 million for the year 2001 (which includes the pre-Merger and post-Merger expenses), which decrease is attributable to a decrease in death benefit claims. At Family Life, the level of policyholder benefits and expenses decreased from $13.5 million for the year 2000 to $10.1 million for the year 2001, which decrease is attributable to a decrease in death benefit claims as well as a decrease in reserves due to a higher than expected lapse rates in Family Life's traditional life business.
The expense related to the amortization of present value of future profits of acquired businesses was $4.7 million for the year ended December 31, 2001, as compared to $3.7 million at December 31, 2000 and $5.2 million at December 31, 1999. The consolidation of ILCO's amortization expense with FIC's contributed approximately $1 million. The amortization of present value of future profits decreased by $1.5 million from 1999 to 2000, which is in line with the expected amortization of the remaining book of business. The amortization of present value of future profits was relatively level from 2000 to 2001 due to higher than expected lapses at Family Life, which created a higher rate of amortization.
The costs related to acquiring new business, including certain costs of issuing policies and certain other variable selling expenses (principally commissions), are deferred policy acquisition costs. The expense related to the amortization of deferred policy acquisition costs was $6.8 million for the year ended December 31, 2001, $5.3 million for the year ended December 31, 2000, and $5.2 million for the year ended December 31, 1999. The amortization of deferred policy acquisition costs for the current period includes costs associated with Investors Life and Investors-IN only for the period from May 18, 2001 to December 31, 2001, in the amount of approximately $0.5 million.
Operating expenses for 2001 were $23.0 million, as compared to $11.4 million on 2000 and $11.7 million in 1999. The consolidation of ILCO's operations for the period from May 18, 2001 to December 31, 2001 contributed approximately $11 million to operating expenses for the year 2001. The level of operating expenses for the year 2001 included certain non-recurring expenses related to the favorable resolution of the vanishing premium litigation and the implementation of the correction procedure set forth by the Internal Revenue Service in Rev. Proc. 2001-42 for Modified Endowment Contracts. At Family Life, $4.7 million in operating expenses was attributable to commissions paid. The decrease in operating expenses of $365,000 from 1999 to 2000 is due to a reduction of overall operating expenses in 2000 and the reduction of Y2K conversion expenses incurred in 2000 as compared to 1999's expenses.
Interest expense for 2001 was $0.9 million, as compared to $1.9 million in 2000 and $2.4 million in 1999. The decrease in the amount of interest expenses from 2000 to 2001 is attributable to the scheduled reduction in the amount of outstanding indebtedness. This interest expense is related to the indebtedness owed to Investors Life by Family Life Corporation and FIC and includes the amount of interest for the period from January 1, 2001 to May 18, 2001. The consolidation of ILCO's operations with those of FIC for periods following the May 18th Merger results in the elimination of this interest expense in the consolidated income statements of FIC and thus the post-Merger interest expense is $0. The decrease of interest expenses from 1999 to 2000 was consistent with the scheduled pay down of the above-mentioned debt to Investors Life.
Results of Operations - Three Months Ended December 31, 2001 as compared to the Three Months Ended December 31, 2000
For the three-month period ended December 31, 2001, FIC's net income was $3.4 million (basic and diluted earnings of $0.35 per common share) on revenues of $32.4 million as compared to the net income of $2.2 million (basic earnings of $0.43 and diluted earnings of $0.42 per common share) on total revenues of $10.6 million in the last three months of 2000. The increase in net income and total revenues from the three-month period ended December 31, 2000 to the same period in 2001 is primarily attributable to the consolidation of ILCO's operations into FIC's Statements of Income for the fourth quarter of 2001.
The ability of Family Life and Investors Life to pay shareholder dividends is and will continue to be subject to restrictions set forth in the insurance laws and regulations of Washington, their domiciliary state. Washington limits how and when Family Life and Investors Life can pay shareholder dividends by (a) including the "greater of" standard for payment of dividends to shareholders, (b) requiring that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and (c) requiring that cash dividends be paid only from earned surplus. Under the "greater of" standard, an insurer may pay a dividend in an amount equal to the greater of : (i) 10% of the policyholder surplus or (ii) the insurer's net gain from operations for the previous year. In 2001, Investors Life paid a dividend to its parent corporation, ILCO, of $11,082,586 (based upon earned surplus of $54.7 million and net gain from operations of $11.1 million in the year 2000). ILCO, a holding company, does not have any restrictions on payments of dividends and paid a dividend of $11,082,586 to FIC in December 2001. Family Life did not have earned surplus in 2000 as defined by the regulations adopted by the Washington Insurance Commissioner and, therefore, was not permitted to pay cash dividends during 2001. The $5.9 million in payments required by Family Life under the surplus debenture (which was paid off in June 2001) contributed to Family Life's absence of earned surplus in 2000. As of December 31, 2001, Investors Life had earned surplus of $48.4 million and a net gain from operations of $8.3 million, and Family Life had earned surplus of $0.3 million and a net gain from operations of $4.4 million. Family Life's earned surplus in 2001 was negatively affected by a $4.7 million increase in its reserves for flexible premium universal life insurance. This increase was the result of an implementation of Washington's interpretation with respect to reserve methodology for flexible premium universal life insurance policies, which interpretation differs from that of the NAIC.
FIC's cash and cash equivalents at December 31, 2001 was $7.1 million as compared to $2.7 million at December 31, 2000 and $0.7 million at December 31, 1999. The $4.4 million increase in cash and cash equivalents at December 31, 2001 from 2000 was due primarily to a the Merger and the cash acquired in the purchase. The increase in cash and cash equivalents from 1999 to 2000 was primarily attributable to an increase in cash flow from investing activities due to a decrease in short-term invested assets.
FIC's net cash flow used in operating activities was ($6.5) million for the year 2001, as compared to ($2.2) million for the year 2000 and ($0.5) million for the year 1999. The decrease in cash used in operating activities of ($4.3) million from 2000 to 2001 was attributable to a higher than expected level of surrenders of insurance and annuity policies which contributed to a larger decrease in policy liabilities. The decrease in cash used in operating activities from 1999 to 2000 can be attributed to an increase in deferred federal income taxes of $2.0 million.
As of December 31, 2001, the outstanding balance of such indebtedness was $29.2 million on the 1993 Subordinated Loan granted by Investors Life. Due to the Merger, this indebtedness is not included as a liability on the consolidated financial statements of FIC. FIC's other liquidity requirements relate principally to the need for cash flow to meet operating expenses, as well as the liabilities associated with its insurance subsidiaries' various life insurance and annuity products.
The assets held by Family Life and Investors Life must comply with applicable state insurance laws and regulations. In selecting investments for the portfolios of its life insurance subsidiaries, the Company's emphasis is to obtain targeted profit margins, while minimizing the exposure to changing interest rates. This objective is implemented by selecting primarily short- to medium-term, investment grade fixed income securities. In making such portfolio selections, the Company generally does not select new investments which are commonly referred to as "high yield" or "non-investment grade". We determine the allocation of our assets primarily on the basis of cash flow and return requirements of our products and secondarily by the level of investment risk.
Another key element of the Company's investment strategy is to avoid large exposure in other investment categories which the Company believes carry higher credit or liquidity risks, including private placements, partnerships and bank participations. These categories accounted for only $45,479 of invested assets at December 31, 2001 as compared to $0. The private placements are holdings of Investors Life and thus were not on the consolidated balance sheet of FIC for the year 2000.
Our fixed maturity securities portfolio is predominately comprised of low risk, investment grade, available for sale publicly traded corporate securities, mortgage-backed securities and United States Government bonds. As of December 31, 2001, the market value of the fixed maturities available for sale segment was $501.4 million as compared to an amortized cost of $496.7 million or an unrealized gain of $4.7 million. The increase reflects unrealized gains on such investments related to changes in interest rates subsequent to the purchase of such investments. A portion ($0.8 million) of the unrealized gain has been recorded as a decrease in deferred policy acquisition costs and present value of future profits of acquired businesses on the consolidated balance sheet. The net of tax effect of the remainder of this increase ($2.5 million) has been recorded as accumulated other comprehensive income as an increase in shareholders' equity.
FIC's short-term investments consist primarily of U.S. Government bonds. The level of short-term investments at December 31, 2001 was $138.3 million, as compared to $15.6 million as of December 31, 2000. This increase is also primarily attributable to the inclusion of the assets of ILCO in the consolidated financial statements of FIC.
As of December 31, 2001, Investors Life had expended $84.5 million in the construction of River Place Pointe. Investors Life expects to pay $13.1 million during 2002 to finish construction on the project. FIC and its insurance subsidiaries occupy almost the entire Building One of River Place Pointe, consisting of approximately 74,021 square feet of space. As of December 31, 2001, 289,873 rentable square feet of office space was leased and 98,623 rentable square feet was available for lease. Upon the completion of the second section of the project, which includes three more office buildings, there will be 294,398 additional rentable square feet available for lease. At December 31, 2001, the office vacancy rate in Austin, Texas, was 19.9% according to a study released by the Federal Deposit Insurance Corporation. The study also found that Austin had the highest percent of new office real estate space under construction in relation to existing space at December 31, 2001. Mortgage Loans.
Policy loans totaled $49.8 million at December 31, 2001, as compared to $3.7 million at December 31, 2000. The increase was attributable to the inclusion of ILCO's assets on the Consolidated Balance Sheets following the Merger. ILCO's Balance Sheets at December 31, 2000 included $48.4 million in policy loans.
Management believes that the absence of "high-yield" or "non-investment grade" investments (as defined above) in the portfolios of FIC's life insurance subsidiaries enhances the ability of the Company to service its debt, provide security to its policyholders and to credit relatively consistent rates of return to its policyholders.
Costs of acquiring individual life insurance and annuities, principally commissions and certain expenses related to policy issuance, underwriting and marketing, all of which vary with and are primarily related to the production of new business, are deferred. Acquisition costs relating to traditional life insurance, including term insurance, are amortized in relation to anticipated premiums. Universal life costs are amortized in relation to estimated gross profits, and annuity contracts employ a level yield method. For life insurance, a 15 to 20-year amortization period is used, and a 7 to 20-year period is employed for annuities.
Future policy benefits comprise 15% of FIC's total liabilities at December 31, 2001. These liabilities are estimated using actuarial methods based on assumptions about premiums, interest yields, investment returns, expenses, mortality, morbidity, and persistency. These assumptions consider Company experience and industry standards. The assumptions vary by plan, age at issue, year of issue and duration. Purchase Accounting for ILCO.
The acquisition of ILCO was accounted for as a purchase; accordingly, the results of ILCO's operations since the May 18, 2001 Merger are included in FIC's consolidated results of operations at December 31, 2001. The fair values of the assets acquired and liabilities assumed at the date of acquisition were estimated based on an analysis, as of May 18, 2001, of the acquired book of business. The allocation of the purchase price to the net assets acquired resulted in excess of net assets acquired over cost, or negative goodwill.
Upon adoption of Statement of Financial Accounting Standards No. 141 (FAS 141), "Business Combinations," during the first quarter of 2002, the amount of any unamortized deferred credit related to the negative goodwill arising from the Merger shall be recognized and reported as the effect of a change in accounting principle. The effect of the accounting change and related income tax effects shall be presented in the income statement between the captions "extraordinary items" and "net income".
For a further discussion of accounting standards, see Note 1 to our audited consolidated financial statements, beginning on page.
Family Life incurred and paid $155,000 of death benefits as a result of the September 11, 2001 events. The Company is not aware of any unreported losses or claims resulting of such events.
On February 19, 2002, Investors-IN was merged with and into Investors Life, whereby Investors Life was the surviving corporation. The merger was approved by the Washington Department of Insurance in January 2002 and by the Indiana Department of Insurance in February 2002. Investors Life will assume all of the assets and liabilities of Investors-IN .
2. Consolidated Balance Sheets, as of December 31, 2001 and December 31, 2000.