FIC's home office is located at River Place Pointe, 6500 River Place Blvd., Building One, Austin, Texas. River Place Pointe was purchased by Investors Life in October 1998. It consists of 47.995 acres of land in Austin, Texas. The aggregate purchase price for these tracts was $8.1 million. The site development permit allowed for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. Construction on the first section of the project, which consists of four office buildings, an associated parking garage and related infrastructure was completed during 2000 and 2001. The second section of construction, which includes three more office buildings, an associated parking garage and related infrastructure, was completed in 2002. FIC and its insurance subsidiaries occupy the entire Building One of River Place Pointe, consisting of approximately 76,143 square feet of space and approximately 5,000 square feet of Building Four, for records storage. An associated facility of 10,000 square feet in Cedar Park, Texas, is leased to house the company's printing operations and warehouse storage. The monthly rental for the Cedar Park facility is $9,123.
Family Life and Investors Life lease their home offices at the Sedgwick James Building, 2101 Fourth Avenue, in Seattle, Washington. The lease currently covers approximately 7,776 rentable square feet of office space for a term expiring on October 31, 2003. The base rental is approximately $17,934 per month, which includes Family Life's proportionate share of the building's operating expenses, including parking, utilities, property taxes, insurance, maintenance and management. Actual increases from those initial operating expenses during the lease term are passed on to Family Life on a proportionate basis. Additionally, Family Life and Investors Life lease 22,100 square feet of warehouse space at Segalle Business Park, Tukwila, Washington, for the storage of records. The monthly rental cost is $6,570 and the lease term expires on October 31, 2003.
For purposes of this Form 10-K and in accordance with rule 12b-15 under the Securities Exchange Act of 1934, as amended, each item of the Form 10-K for the years ended December 31, 2001 and 2000 as originally filed that were affected by the restatement has been amended to the extent affected and restated in its entirety. NO ATTEMPT HAS BEEN MADE IN THIS FORM 10-K TO MODIFY OR UPDATE OTHER DISCLOSURES AS PRESENTED IN THE ORIGINAL FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001 OR 2000 EXCEPT AS REQUIRED TO REFLECT THE EFFECTS OF THIS RESTATEMENT.
The consolidated statements of income for the years ended December 31, 2001 and 2000 were restated to reflect the following:
o Decreases in the expense related to amortization of present value of future profits of acquired business of $71,000 in 2001 and $100,000 in 2000 due to an adjustment in the calculation in this expense;
o An decrease in operating expenses of $179,000 in 2001 and a decrease in operating expenses of $216,000 in 2000 due primarily to a reduction in rent expense from the recognition of a deferred gain related to an operating lease offset by expenses associated with uncollectible receivables, pension expenses and reductions in negative goodwill amortization;
o A decrease in the provision for federal income taxes of $1.2 million in 2001 and an increase of $107,000 in 2000 due to the effect of the restatements on net income before federal income tax and equity in net earnings of affiliates; and
o An increase to invested real estate of $3.0 million primarily due to a reclassification of certain real estate expenditures that were classified as property and equipment;
o A decrease in assets of $13.0 million in agency advances and other receivables primarily due to a write-off of uncollectible agent balances, a write-off of a reinsurance receivable, and a write-off of assets related to an interface error between the Company's policy administration system and its general ledger;
o A decrease to property and equipment of $2.8 million primarily due to a reclassification of property and equipment to invested real estate and a write-off of assets that had not been depreciated since purchase;
o A decrease in assets of $721,000 in present value of future profits of acquired businesses due to an adjustment in the calculation of this asset;
o An increase to assets of $1.1 million of other assets primarily related to the establishment of unrecorded pre-paid pension assets related to Family Life's and ILCO's pension plans;
o A decrease in assets of $7.7 million of separate account assets due to a reclassification of separate account assets to equity securities;
o An increase in liabilities of $8.2 million of other liabilities primarily related to an unreconciled difference between suspense account balances included in the Company's general ledger and those included in its policy administration system.
o A decrease of $2.0 million of accumulated other comprehensive income due to the changes in the accounting treatment for the pre-paid pension asset and the separate account investment; and
The decrease of $13.9 million in net income for the year 2002, before the cumulative effect of change in accounting principle, was primarily attributable to the following factors: (i) a decrease in investment income; (ii) a net realized loss on investments relating to impairments; (iii) an increase in death benefits; (iv) an increase in operating expenses and (v) decreases in premium income. The increase in net income for the year 2001 as compared to 2000 was primarily attributable to the Merger, which consolidated 100% of ILCO's net income subsequent to the May 18, 2001 Merger, with FIC's net income.
earned insurance charges for the year ended December 31, 2001. At Family Life, earned insurance charges declined from $3.4 million in the year 2001 to $2.8 million in the year 2002. 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, earned insurance charges decreased from $39.5 million in the year 2001 to $39.2 million in the year 2002. The face amount of in force universal life policies at Family Life was $721.1 million at December 31, 2001 as compared to $588.9 million at December 31, 2002. The face amount of in force universal life policies at Investors Life (including Investors-IN) was $4,676.9 million at December 31, 2001 as compared to $4,446.1 million at December 31, 2002.
Net investment income for the year ended December 31, 2002 was $40.3 million as compared to $30.7 million for the year ended December 31, 2001 and $6.9 million for the year ended December 31, 2000. The increase in net investment income from year end 2001 to year end 2002 was attributable to the contribution of ILCO's operations for the full year in 2002 as compared to the period from May 18 to December 31 in 2001. Approximately $24 million of the increase in net investment income for the year ended December 31, 2001 as compared to the year ended December 31, 2000 was attributable to the consolidation of ILCO's operations for the period from May 18, 2001 to December 31, 2001. At Investors Life net investment income decreased from $47.9 million in 2001 to $41.7 million in 2002. The decrease was primarily attributable to lower interest rates on short-term investments as well as the sale of investments to pay for the continued construction at River Place Pointe. See "Investments - Real Estate" for a description of the River Place Pointe investment. The level of net investment income contributed by the investment portfolio of Family Life for the year ended December 31, 2002 was $5.6 million. Net investment income at Family Life was adversely affected by the decline in the level of interest income received from fixed income and short-term investments. This decline is attributable to lower interest rates during the period.
For the year ended December 31, 2002, FIC had a $2.8 million realized loss on investments, compared to a $65,000 net realized gain in 2001 and $7,000 gain in 2000. The Company identified one bond at December 31, 2002, which was considered to be impaired and reduced its carrying value by $463,000. Also at December 31, 2002, the Company determined that its investment in its separate accounts was impaired and reduced its carrying value by $2.4 million. There were no impairments in the value of investments in 2001 and 2000 which were considered other than temporary.
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 ("DAC"). The expense related to the amortization of DAC was $10.4 million for the year ended December 31, 2002, $6.8 million for the year ended December 31, 2001, and $5.3 million for the year ended December 31, 2000. A portion of the increase in this expense from 2001 to 2002 is attributable to the Merger. For the year ended December 31, 2002, the Company has capitalized DAC based on an updated analysis of its cost structure and assumptions as to product performance. For business written prior to January 1,2002, DAC was amortized using methods and practices which had been adopted at the time the products were introduced. For 2002, costs capitalized were approximately $3.3 million less than acquisition costs incurred as determined by the updated analysis. See "Critical Accounting Policies, Deferred Policies Acquisition Costs and Present Value of Future Profits of Acquired Business" herein for a further discussion of capitalization of expenses related to acquiring new business.
Operating expenses for 2002 were $34.2 million, as compared to $22.9 million in 2001 and $11.2 million in 2000. The consolidation of ILCO's operations contributed approximately $22.6 million to operating expenses for the year ended December 31, 2002 as compared to $11.0 million for the period from May 18, 2001 to December 31, 2001. The level of operating expenses for the year 2002 included: (i) expenses related to acquiring new business; (ii) $636,312 related to the repurchase of James M. Grace's employment contract; (iii) a transfer of funds of $1 million to the Roy F. and Joann Cole Mitte Foundation which was made in January, 2002, as compared to a $375,000 donation in 2001; (iv) $448,841 of costs incurred due to the investigation of the matters described in the Registrant's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 15, 2002; and (v) a charge of $799,000 for uncollectible agent balances. For a further discussion of the repurchase of Mr. Grace's employment contract and the transfer of funds to the Mitte Foundation, see FIC's 10-K for the year ended December 31, 2001, dated April 1, 2002. The level of operating expenses for the year 2001 included certain non-recurring expenses related to the favorable resolution of the vanishing premium litigation (see "Item 3. Legal Proceedings - Universal Life Litigation") and the implementation of the correction procedure set forth by the Internal Revenue Service in Rev. Proc. 2001-42 for Modified Endowment Contracts.
Interest expense for 2002 was $0, as compared to $0.9 million in 2001 and $1.9 million in 2000. 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 for the year ended December 31, 2001 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 provision for federal income taxes was ($3.3) million in 2002, as compared to $4.1 million in 2001 and $1.4 million in 2000. The decrease in taxes was due to the $21.2 million decrease in income (before federal income tax, equity in net earnings of affiliates and cumulative effect of change in accounting principle) for the year ended December 31, 2002 compared to the year ended December 31, 2001. The inclusion of ILCO's results for the period from May 18, 2001 to December 31, 2001 contributed approximately $2.6 million to the level of federal income taxes for the year 2001 as compared to 2000. Because of the Merger and subsequent consolidation of FIC and ILCO's provision for federal income taxes, FIC is not able to utilize the small company tax deduction, which provided lower tax rates. The increase in federal income taxes due to the loss of this deduction in 2001 was $343,227. Further, for the year ended December 31, 2000, FIC and ILCO each paid, and were each able to deduct $1 million of excess compensation. Due to the Merger, the Company incurred approximately $100,000 in additional federal income taxes in 2001 due to the non-deductibility of a portion of Roy F. Mitte's salary. However, since Mr. Mitte was not an executive with the Company on December 31, 2002, which is the relevant date for measuring deductibility of compensation under section 162(m) of the Code, his entire compensation for 2002 is deductible and thus the Company will not incur additional federal income taxes related to excess compensation in 2002.
FIC's net cash flow provided by operating activities was $7.6 million for the year 2002. In the year 2001, net cash flow used in by operating activities was ($2.7) million; net cash flow provided by operating activities was $0.3 million for the year 2000. The increase in cash used in operating activities of $10.3 million from 2002 to 2001 was attributable to a lower than expected level of surrenders of insurance and annuity policies which contributed to a smaller decrease in policy liabilities.
The cash requirements of FIC, and its holding company subsidiary, Family Life Corporation, consist primarily of its service of the indebtedness created in connection with FIC's ownership of Family Life. As of December 31, 2002, the investment portfolio of Investors Life included $23.05 million of notes receivable from affiliates, represented by (i) a loan of $30 million by Investors Life to Family Life Corporation made in July 1993, in connection with the prepayment of indebtedness which had been previously issued to Merrill Lynch as part of the 1991 acquisition of Family Life Insurance Company by a wholly-owned subsidiary of FIC, and (ii) a loan of $4.5 million by Investors Life to Family Life Insurance Investment Company made in July 1993, in connection with the same transaction described above.
The provisions of the notes owned by Investors Life include the following provisions: (a) the $30 million note provides for quarterly principal payments, in the amount of $163,540 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $1,336,458; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, and (b) the $4.5 million note provides for quarterly principal payments, in the amount of $24,531 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $200,469; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%.
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.
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 $26,049 of invested assets at December 31, 2002 as compared to $45,479 at December 31, 2001.
The diversified portfolio of investments of FIC's life insurance subsidiaries includes public and private fixed maturity securities and real estate investments. All of FIC's invested assets are invested in the United States. Invested assets, excluding separate accounts, totaled $761.2 million and $767.6 million as of December 31, 2002 and December 31, 2001, respectively.
The decrease in invested assets is primarily attributable to a $7.6 million decrease in the market value of fixed maturities available for sale, a $1.9 million decrease in the market value of equity securities, a $3.2 million decrease in policy loans, and a $4.7 million decrease in mortgage loans. These amounts are offset by an $11.3 million increase in invested real estate.
maturities available for sale segment was $501.4 million as compared to an amortized cost of $496.7 million. The lower level of assets held in the fixed maturities available for sale segment is attributable to the early redemption of longer- term fixed maturity investments by the issuer. The proceeds of these early redemptions were reinvested in short-term investments at the lower level of interest rates that prevailed throughout the year 2002. For the year 2003, the investment objectives of FIC's insurance subsidiaries include a strategy of reducing the concentration in short-term investments by making selected investments in medium-term fixed income investments, including CMO instruments.
The investments of FIC's insurance subsidiaries in mortgage-backed securities included collateralized mortgage obligations ("CMOs") of $175.4 million, and mortgage-backed pass-through securities of $29.6 million, at December 31, 2002. Mortgage-backed pass-through securities, sequential CMO's and support bonds, which comprised approximately 57.8% of the book value of FIC's mortgage-backed securities at December 31, 2002, are sensitive to prepayment and extension risks. 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. At December 31, 2002, PAC and TAC instruments and scheduled bonds represented approximately 43.0% of the book value of FIC's mortgage-backed securities. Sequential and support classes represented approximately 10.4% of the book value of FIC's mortgage-backed securities at December 31, 2002. Previously, FIC's insurance subsidiaries have avoided investments in mortgage-backed securities with increased prepayment risk, such as interest-only stripped pass-through securities and inverse floater bonds. Beginning in December 2002, the insurance subsidiaries made selected investments in CMOs of the inverse floater category. Such instruments, which are subject to strict quantitative and qualitative standards, carry a higher current interest rate. Our investment guidelines do not permit the purchase of CMOs which are interest only or principal only instruments. The prepayment risk that certain mortgage-backed securities are subject to is prevalent in periods of declining interest rates, when mortgages may be repaid more rapidly than scheduled as individuals refinance higher rate mortgages to take advantage of the lower current rates. As a result, holders of mortgage-backed securities may receive large prepayments on their investments which cannot be reinvested at an interest rate comparable to the rate on the prepaying mortgages. For the year 2003, the investment objectives of FIC's insurance subsidiaries include a strategy of reducing the concentration in short-term investments by making selected investments in a variety of medium-term CMO instruments.
FIC's short-term investments consist primarily of U.S. Government bonds. The level of short-term investments at December 31, 2002 was $137.9 million, as compared to $138.3 million as of December 31, 2001.
FIC's equity securities consist primarily of its investment in the separate account. As of December 31, 2002, the market value of FIC's equity securities was $6.4 million compared to $8.3 million at December 31, 2001. The decrease from 2002 to 2001 is related to a decline in the value of the underlying funds in the separate account.
Invested real estate at December 31, 2002 was $75.4 million, as compared to $64.1 million at December 31, 2001. The real estate investment is primarily related to the development of the River Place Pointe project ("River Place Pointe") by Investors Life, a subsidiary of ILCO. In October 1998, Investors Life purchased River Place Pointe, which consisted of two adjoining tracts of land located in Austin, Texas totaling 47.995 acres. The aggregate purchase price for these tracts was $8.1 million. Investors Life obtained a Site Development Permit for the tracts from the City of Austin allowing for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. Construction on the first section of the Project, which consists of four office buildings, an associated parking garage, and related infrastructure was completed during 2000 and 2001. Construction on the second section of the Project, which consists of three office buildings, an associated parking garage, and related infrastructure, was completed in 2002.
The Company views the River Place Pointe investment as a long term commitment. Based on this assumption, the Company has examined future anticipated cash flow on the development and has determined that the investment is not impaired.
As of December 31, 2002, $0.02 million was invested in mortgage loans as compared to $4.7 million at December 31, 2001. The Company does not make new mortgage loans on commercial properties. All of the Company's mortgage loans were made by its subsidiaries prior to their acquisition by the Company. At December 31, 2002, none of the mortgage loans held by the Company had defaulted as to principal or interest for more than 90 days, and none of the Company's mortgage loans were in foreclosure. The decrease in mortgage loans from 2001 to 2002 was due to the pay off of two mortgage loans during the third quarter of 2002. The Company participated with a third party in two mortgage loans in the state of New York - Champlain Centre Mall and Salmon Run Mall, with a total balance due of $4.60 million at June 30, 2002. On June 18, 2002, the Company agreed to a proposed payoff of these loans at a discount. The borrower paid off the loans in August, 2002, with a payment of $3.64 million. The Company reduced the carrying value of the two loans by $0.96 million as of June 30, 2002 as an impairment of an invested asset.
The financial statements contain a summary of FIC's critical accounting policies, including a discussion of recently-issued accounting pronouncements. Certain of these policies are considered to be important to the portrayal of FIC's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. These policies include valuation of: investments, deferred acquisition costs and present value of future profits, and future policy benefits. For the year 2001, the Company's critical accounting policies also included the purchase accounting for ILCO.
The costs of acquiring new business, including certain costs of issuing policies and certain other variable selling expenses (principally commissions), are deferred policy acquisition costs ("DAC"). DAC is capitalized and then amortized to reflect an expense in relation to the projected stream of profits (for universal life and annuity products) or to the premium revenue (for traditional life products). Such projections require use of certain assumptions, including interest margins, product loads, mortality rates, persistency rates, and maintenance expense levels. Effective with respect to new business issued on and after January 1, 2002, the Company has capitalized DAC based on an updated analysis of its cost structure and assumptions as to product performance. For business written previously, DAC is amortized using previously established methods and practices. Management periodically reviews the assumptions associated with the amortization models prospectively.
The acquisition of ILCO was accounted for as a purchase; accordingly, the results of ILCO's operations from May 18, 2001 to December 31, 2001 and for the entire year 2002 are included in FIC's consolidated results of operations at December 31, 2001 and 2002.
For the period from January 1, 2001 to May 17, 2001, and for the year 2000, FIC's net income includes its equity interest in the net income of ILCO, with such equity interest being based on FIC's percentage ownership of ILCO.
Among the alternatives considered by the Special Committee were a sale of the company consistent with recent unsolicited indications of interest in FIC and various management alternatives, including an increased operating efficiency strategy, a growth through acquisitions strategy and a marketing alliances strategy. Through an exhaustive study of all business projections and financial assumptions, it was determined that pursuing any or all of the management plan was more advantageous to shareholder value than the sale, merger, or consolidation of the company at this time given current market conditions for sale transactions in the insurance industry and general economic conditions. The Special Committee ultimately determined, based in part on the analysis performed by Salomon Smith Barney, that it was in the best interest of FIC's shareholders at that time to allow FIC's new management to implement its business plan for FIC. The Board of Directors voted to accept the Special Committee's recommendation.
The material allegations made by the Company against the Mitte Family are set out in detail in the Company's Original Complaint, filed on January 23, 2003 in the United States District Court for the Western District of Texas, Austin Division, Case No. A03-CA-033SS. The following allegations were made by the Company in the Complaint:
o The Mitte Family omitted material information required to be disclosed under Section 13(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and the regulations issued thereunder, as well as violated the proxy solicitation rules contained in Regulation 14A of the Exchange Act;
o Over a ten-year period, Roy Mitte caused FIC to pay, or to reimburse Mr. Mitte for, personal expenditures of Mr. Mitte or his family, in an amount exceeding $500,000;
o FIC has borne significant expenses that properly should have been paid or reimbursed by the Mitte Foundation.
o A declaratory judgment that the Company may defer any shareholders' meeting until, among other things, the Company and Mitte could properly solicit proxies in compliance with the federal securities laws;
o Interest, attorneys' fees, and all other sums to which FIC proves itself justly entitled.
On February 10, 2003, the Company entered into an agreement with the Foundation pursuant to which they agreed to withdraw their request for a special meeting in exchange for the Company's agreement that the 2003 Annual Meeting of Shareholders (the "Meeting") would be held May 9, 2003, with a record date of March 18, 2003.
The Company has not yet filed an answer to Mr. Mitte's counterclaim. Both the Mitte Family and the Company are currently engaged in discovery with respect to the pending litigation. . (See "Item 3. Litigation - Litigation Relating to Former Chairman and CEO").
On March 28, 2003, the Company filed its Preliminary Proxy with respect to the Meeting. Amendments to the Preliminary Proxy were filed on April 8, 2003 and April 14, 2003. More information regarding the proxy contest and the Meeting can be obtained therein by accessing the preliminary proxy on the SEC's website, www.sec.gov or the Investor Relations portion of the Company's website at www.ficgroup.com.
3. Consolidated Statement of Income for the year ended December 31, 2002 and Restated Consolidated Statements of Income for the years ended December 31, 2001 and 2000.
5. Consolidated Statement of Cash Flows for the year ended December 31, 2002, and Restated Consolidated Statements of Cash Flows for the years ended December 31, 2001 and 2000.