-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IEe6cA/7k12gcU+ZJRR1QvD8//wSb4Whc2a+Z2FDDwUDPU/0y0gz7P7qb6PMEiRl XJE19uNXsoh0OiF8pFWvkg== 0000050982-99-000032.txt : 19990402 0000050982-99-000032.hdr.sgml : 19990402 ACCESSION NUMBER: 0000050982-99-000032 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERCONTINENTAL LIFE CORP CENTRAL INDEX KEY: 0000050982 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 221890938 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-07288 FILM NUMBER: 99579752 BUSINESS ADDRESS: STREET 1: THE AUSTIN CENTRE STREET 2: 701 BRAZOS 12TH FL CITY: AUSTIN STATE: TX ZIP: 78701 BUSINESS PHONE: 5124045050 MAIL ADDRESS: STREET 1: 701 BRAZOS STE 1400 STREET 2: ATTN KELLYE S SEEKATZ CITY: AUSTIN STATE: TX ZIP: 78701 FORMER COMPANY: FORMER CONFORMED NAME: INTERCONTINENTAL FINANCIAL CORP DATE OF NAME CHANGE: 19781019 FORMER COMPANY: FORMER CONFORMED NAME: INTERCONTINENTAL LIFE CO DATE OF NAME CHANGE: 19600201 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from to Commission File Number 0-7288 INTERCONTINENTAL LIFE CORPORATION (Exact name of registrant as specified in its charter) Texas 22-1890938 (State of Incorporation) (I.R.S. Employer identification number) 701 Brazos, Suite 1400, Austin, Texas 78701 (Address of Principal Executive Offices) (Zip Code) (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, $.22 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 and (2) has been subject to such filing requirements for the past 90 days. YES X NO -1- The aggregate market value of the voting stock held by non-affiliates of the Registrant on March 15, 1999, based on the closing sales price in The Nasdaq Small-Cap Market ($16.75 per share), was $38,813,636. As of March 15, 1999, Registrant had 4,394,706 shares of its Common Stock outstanding (excluding shares held in Treasury and not entitled to vote). Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] -2- PART I Item 1. Business General InterContinental Life Corporation ("ILCO", the "Company" or the "Registrant") was originally incorporated in 1969 under the laws of the State of New Jersey. During 1997, ILCO transferred its domicile from New Jersey to the State of Texas. This change was approved by vote of the shareholders at the annual meeting of shareholders held on June 19, 1997. Its executive offices are located at 701 Brazos, Suite 1400, Austin, Texas 78701. The Company is principally engaged, through its subsidiaries, in administering existing portfolios of life insurance policies and annuity products. Prior to the end of 1997, the life insurance subsidiaries also administered an in-force book of accident and health insurance business. In December, 1997, the life insurance subsidiaries entered into an agreement, effective as of June 30, 1997, with a third party insurer whereby the obligations under the accident and health insurance and the disability income business of the companies was assumed by the reinsurer. The arrangement provides for an initial period of reinsurance on a coinsurance basis, pending applicable approvals of the assumption arrangement. The Company's insurance subsidiaries are also engaged in the business of marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. Such products are marketed through independent, non-exclusive general agents. The Company is controlled by Financial Industries Corporation ("FIC"), a life insurance holding company, through FIC's ownership of approximately 45% of the Company's outstanding common stock. FIC, ILCO and their insurance subsidiaries have substantially identical managements, and a majority of the directors of ILCO are also directors of FIC and ILCO's and FIC's insurance subsidiaries. Officers allocate their time between ILCO and FIC in accordance with the comparative requirements of both companies and their subsidiaries. Roy F. Mitte, Chairman, President and Chief Executive Officer of FIC, the Company and their insurance subsidiaries, is the beneficial owner of approximately 29.54% of the outstanding shares of FIC's common stock. FIC owns Family Life Insurance Company, a Washington domiciled underwriter of mortgage protection life insurance. The Company was organized in 1969 to be the publicly owned holding company for InterContinental Life Insurance Company ("ILIC"). The Company acquired Standard Life Insurance Company ("Standard Life") in 1986, Investors Life Insurance Company of California ("Investors-CA") and Investors Life Insurance Company of North America ("Investors-NA") in 1988, Meridian Life Insurance Company, renamed Investors Life Insurance Company of Indiana ("Investors-Indiana"), in February 1995, State Auto Life Insurance Company (via merger of that company into Investors- Indiana in 1997) and Grinnell Life Insurance Company (via merger of that company into Investors- Indiana in 1998). -3- Acquisitions Strategy. The Company's strategy has been and continues to be to grow internally and through acquisitions, while maintaining an emphasis on cost controls. Management believes that, under appropriate circumstances, it is more advantageous to acquire companies with books of in-force life insurance than to produce new business, because initial underwriting costs have already been incurred and mature business is generally less likely to terminate, making possible more predictable profit analysis. However, the Company's insurance subsidiaries continue to market those products that are profitable, as well as develop new products and streamline distribution channels. See "Agency Operations". It is also management's belief that the continuing consolidation in the life insurance industry presents attractive opportunities for the Company to acquire life insurance companies that complement or fit within the Company's existing marketing structure and product lines. The Company's objective is to improve the profitability of acquired businesses by consolidating and streamlining the administrative functions of these businesses, eliminating unprofitable products and distribution channels, applying its marketing expertise to the acquired company's markets and agents, and benefitting from economies of scale. The Company's ability to make future acquisitions will be dependent on its being able to obtain the necessary financing. In addition, since FIC has the same acquisition strategy as ILCO, a conflict of interest could arise in the future between ILCO and FIC with respect to acquisition opportunities. Acquisition of Standard Life. In November 1986, the Company acquired Standard Life, headquartered in Jackson, Mississippi, for a gross purchase price of $54,500,000. A portion of the funds used by the new life insurance company formed by the Company to make the acquisition ("New Standard") was the proceeds of a loan extended to the Company by a national bank in the principal amount of $15,000,000 (the "Standard Term Loan"). This sum was, in turn, loaned by the Company to New Standard, and the loan was evidenced by a surplus debenture. New Standard was merged into Standard Life in June 1988. Acquisition of Investors-NA and Investors-CA. In December 1988, the Company, through Standard Life, purchased Investors-CA and Investors-NA from CIGNA Corporation for a purchase price of $140 million. The Company obtained the funds used for the acquisition from: (a) a senior loan in the amount of $125,000,000 (maturity date December 31, 1996, payable in twenty -seven quarterly installments of $4 million each, commencing on July 1, 1989, followed by four quarterly installments of $4.25 million each) provided by six financial institutions (the "Senior Loan"), (b) a $10,000,000 subordinated loan (a nine-year note, with an interest rate of 13.25%) provided by two insurance and financial service organizations and (c) the sale of $5,000,000 of Class A Preferred Stock (principal amount of $5 million; dividend rate of 13.25%) to CIGNA and $15,000,000 of Class B Preferred Stock (principal amount of $15 million; dividend rate of 13.25%) to the subordinated lenders. Approximately $15,000,000 of these funds were used to discharge the Standard Term Loan. The balance of these funds were loaned by the Company to Standard Life. To evidence this indebtedness, Standard Life issued a $140,000,000 surplus debenture to the Company. In connection with the subordinated debt and preferred stock financing, the Company issued -4- detachable warrants entitling the holders to purchase 1,107,480 shares of the Company's Common Stock at $3.33 per share. In May 1990, the Company effected an exchange agreement with the holders of its Class A Preferred Stock and its Class B Preferred Stock . Under the provisions of the exchange agreement, the holders of the Class A Preferred Stock received $5 million principal amount of a 13.25% 1998 Series Subordinated Notes, due November 1, 1998, together with a make whole amount equal to 13.25% of the then outstanding balance of the Note. The holders of the Class B Preferred Stock received $15 million principal amount of a 13.25% 1999 Series Subordinated Notes, due November 1, 1999. The Company prepaid the subordinated debt and purchased the warrants in early 1993. See "Senior Loan". Acquisition of Investors-Indiana. On February 14, 1995, ILCO, through Investors-NA, purchased from Meridian Mutual Insurance Company the stock of Meridian Life Insurance Company, an Indianapolis-based life insurer, for a cash purchase price of $17.1 million. After the acquisition, Meridian Life changed its name to Investors Life Insurance Company of Indiana ("Investors-Indiana"). Acquisition of State Auto Life. On July 9, 1997, ILCO and Investors-Indiana acquired State Auto Life Insurance Company, an Ohio domiciled life insurer, from State Automobile Mutual Insurance Company, for an adjusted cash purchase price of $11.8 million. In connection with this transaction, the bank group participating in the Senior Loan agreed to defer payment of $4.5 million otherwise payable on April 1, 1997 under the terms of the Senior Loan, and to reduce the amount of the payment otherwise due on July 1, 1997 by $2.5 million. This deferral resulted in extending the maturity date of the Senior Loan to October 1, 1998. Under the terms of the transaction, State Auto Life was merged into Investors-Indiana. Acquisition of Grinnell Life. On June 30, 1998, ILCO, through a subsidiary, acquired Grinnell Life Insurance Company ("Grinnell Life") for an adjusted purchase price of $16.6 million. A portion of the purchase price ($12.37 million) was paid by way of a dividend to the seller immediately prior to the closing of the transaction; the balance of the purchase price was paid by ILCO's subsidiary. As part of the transaction, Grinnell Life was immediately merged with and into that subsidiary, with that subsidiary being the surviving entity. Merger of Insurance Subsidiaries. Investors-NA redomesticated from Pennsylvania to Washington in December of 1992. Investors-CA merged into Investors-NA on December 31, 1992, and Standard Life merged into Investors-NA on June 29, 1993. The mergers have achieved cost savings, such as reduced auditing expenses involved in auditing one combined company; the savings of expenses and time resulting from the combined company being examined by one state insurance department (Washington), rather than three (California, Pennsylvania and Mississippi); the reduction in the number of tax returns and other annual filings with 45 states; and smaller annual fees to do business and reduced retaliatory premium taxes in most states. -5- In December, 1997, ILIC transferred its domicile from New Jersey to Indiana. Following completion of the redomestication, ILIC merged with Investors-Indiana, with ILIC as the surviving entity in the merger process. Immediately after the merger, ILIC changed its name to Investors Life Insurance Company of Indiana. As used hereinafter, the phrase "Investors-IN" shall be used to refer to the merged entities. As a result of the merger, Investors-IN is licensed in 44 states. As of December 31, 1998, it had assets of $188 million and capital and surplus of $23.1 million. Management believes that these acquisitions and consolidations have caused a reduction in expenses and have further strengthened the financial condition of the combined companies. Operations The Company has developed management techniques to reduce operating expenses by centralizing, standardizing and more efficiently performing many functions common to most life insurance companies, such as underwriting and policy administration, accounting and financial reporting, marketing, regulatory compliance, actuarial services and asset management. The Company has selectively recruited personnel in sales, marketing and various administrative departments. The Company's centralized management techniques resulted in significant employee reductions and expense savings in the life insurance companies acquired by the Company. During 1998, the general insurance expenses of the Company's insurance subsidiaries on a statutory basis were $15,172,682, as compared to $15,574,265 in 1997 and $12,008,163 in 1996. The level of expenses for the year 1998 was affected by expenses incurred in connection with Year 2000 compliance (see the discussion under the caption "Data Processing"), as well as the expenses incurred in connection with the acquisition of Grinnell Life Insurance Company. The increase in 1997, as compared to 1996, resulted primarily from expenses incurred in connection with ILCO's acquisition of State Auto Life in July, 1997 and expenses related to the modification of data processing systems for Year 2000 compliance. Management is committed to maintaining the general insurance expenses of the Company's insurance subsidiaries at a level which will generate an acceptable level of profitability while maintaining the competitive pricing of their insurance products. In June 1991, FIC acquired Family Life Insurance Company. Following the acquisition of Family Life by FIC, management integrated the sales, marketing, underwriting, accounting, contract and licensing, investments, personnel, data processing, home office support and other departments of Family Life and the life insurance subsidiaries of ILCO. Management believes this integration has resulted in cost savings for ILCO's insurance subsidiaries and Family Life. During 1992, the Company's insurance operations were centralized at the Company's headquarters in Austin, Texas, with the exception of certain services performed in Seattle, Washington. Management believes that relocating administrative functions to Austin has reduced costs and improved the efficiency of the insurance companies' operations. The number of employees within the Company and its subsidiaries (including employees who also perform administrative services for Family Life) was approximately 322 at December 31, 1998. -6- Principal Products The Company's insurance subsidiaries are engaged primarily in administering existing portfolios of life insurance policies and annuity products. Approximately 80.6 % of the total collected premiums for 1998 were derived from renewal premiums on insurance policies and annuity products sold by the insurance subsidiaries prior to their acquisition by the Company. The Company's insurance subsidiaries are also engaged in marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. These products are marketed through independent, non-exclusive general agents. The products currently being distributed include several versions of universal life insurance, which provide permanent life insurance protection while crediting company-declared current interest rates to the cash value of the policy. The universal life insurance portfolio of the Company's insurance subsidiaries consists primarily of flexible premium universal life insurance policies. Under the flexible premium policies, policyholders may vary the amounts of their coverage (subject to minimum and maximum limits) as well as the date of payment and frequency of payments. Direct statutory premiums received from all types of universal life products were $38.9 million in 1998, as compared to $40.6 million in 1997, and $40.6 million in 1996. Investors-NA received reinsurance premiums from Family Life of $2.5 million in 1998, pursuant to the reinsurance agreement for universal life products written by Family Life. In 1998, premium income from all life insurance products was derived from all states in which the Company's insurance subsidiaries are licensed, with significant amounts derived from Pennsylvania (14 %), Ohio (8 %) and New Jersey (8 %). The Company's insurance subsidiaries received premium income from health insurance policies. In 1998, premium income from all health insurance policies was $1.0 million as compared to $0.9 million in each of 1997 and 1996. Premium income from health insurance in 1998 was derived from all of the states in which those two insurance subsidiaries are licensed, with significant amounts derived from Illinois (22 %), New Jersey (16%) and Pennsylvania (15%). As described below, the health insurance business of the Company's subsidiaries is 100% reinsured with a third party reinsurer. In December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which all of the contractual obligations and risks under accident and health insurance policies were assumed by a third party reinsurer. The transfer was effective as of July 1, 1997. These risks and contractual obligations were sold pursuant to, first, a coinsurance reinsurance agreement. Following applicable regulatory approvals, the reinsurer will assume the direct obligations of the companies, on an assumption reinsurance basis. The decision to dispose of this book of business was based on management's analysis that the business was not generating targeted profit objectives and that the products were not part of the core business of the subsidiaries. The sale permits the companies to focus on its primary business - life insurance and annuity sales. In connection with the transaction, -7- the total amount of net reserves transferred by the subsidiaries was $6,327,504. In addition to the transfer of reserves, the life companies paid the reinsurer $1,037,150 in connection with the transaction, which amount was accounted for as an expense for the year ended December 31, 1997. In 1997, the transferred business generated approximately $791,000 in annualized premiums. Investors-NA sponsors a variable annuity separate account, which offers single premium and flexible premium policies. The policies provide for the contract owner to allocate premium payments among four different portfolios of Putnam Variable Trust (the "Putnam Fund"), a series fund which is managed by Putnam Investment Management, Inc. Prior to April, 1995, the underlying investment vehicle for the variable annuity contracts was the CIGNA Annuity Funds Group. A substitution of the Putnam Fund for the CIGNA Funds was completed in April, 1995. The plan of substitution was approved by the Securities and Exchange Commission. Following such approval, the plan was submitted to policyholders for approval, which was obtained. As of December 31, 1998, the assets held in the separate account were $51.3 million. During 1998, the premium income realized in connection with these variable annuity policies was $156,419, which was received from existing contract owners. Investors-NA also maintains a closed variable annuity separate account, with approximately $21.6 million of assets as of December 31, 1998. The separate account was closed to new purchases in 1981, as a result of an IRS ruling which adversely affected the status of variable annuity separate accounts which invest in publicly-available mutual funds. The ruling did not adversely affect the status of in-force contracts. During 1997, ILCO's life companies expanded their marketing efforts in the fixed annuity market. Direct deposits from the sale of fixed annuity products were $6.1 million in 1998, as compared to $3.5 million in 1997, and $1.7 million in 1996. Investors-NA also received reinsurance premiums from Family Life of $1.7 million in 1998, pursuant to a reinsurance agreement for annuity products between Investors-NA and Family Life Insurance Company. During the fourth quarter of 1998, Investors-NA developed a group deposit administration product, designed for use in connection with the funding of deferred compensation plans maintained by government employers under section 457 of the Internal Revenue Code. The company has established a marketing relationship with a third-party administrator based in San Antonio, Texas, which has established relationships with school districts in Texas. The company anticipates that enrollments will commence during the second quarter of 1999. -8- The following table sets forth, for the three years ended December 31, 1998, the combined premium income and other considerations received by the Company's insurance subsidiaries from sales of their various lines of insurance. Year Ended December 31, Type of Insurance Premium 1998 1997 1996 (In thousands) Individual: Life .............................. $ 10,528 $ 10,163 $ 8,780 Accident & Health ................. 994 792 1,035 Total Individual Lines ............ 11,522 10,955 9,815 Group: Life .............................. 2,323 2,639 2,018 Accident & Health ................. 11 40 0 Total Group Lines ................. 2,334 2,679 2,018 Credit: Life .............................. (21) (27) (85) Accident & Health ................. (3) 14 (57) Total Credit Lines ................ (24) (13) (142) Total Premium ..................... 13,832 13,621 11,691 Reinsurance Premiums Ceded ........ (2,942) (2,590) (1,711) Total Net Premium ............. 10,890 11,031 9,980 Amount Received on Investment Type Contracts ......... 48,739 47,862 47,135 Total Premiums and Deposits Received ............. $ 59,629 $ 58,893 $ 57,115
-9- Investment of Assets The assets held by the Company's insurance subsidiaries must comply with applicable state insurance laws and regulations pertaining to life insurance companies. The investment portfolio of the Company's insurance subsidiaries is tailored to reflect the nature of the insurance obligations, business needs, regulatory requirements and tax considerations relating to the underlying insurance business with respect to such assets. This is particularly the case with respect to interest-sensitive life insurance and deferred annuity products, where the investment emphasis is to obtain a targeted margin of profit over the rate of interest credited to policyholders, while endeavoring to minimize the portfolio's exposure to changing interest rates. To reduce the exposure to such rate changes, portfolio investments are selected so that diversity, maturity and liquidity factors approximate the duration of associated policyholder liabilities. The investment objective of the Company's insurance subsidiaries emphasizes the selection of short to medium term high quality fixed income securities, rated Baa-3 (investment grade) or better by Moody's Investors Service, Inc. At December 31, 1998, only 1.5% of the Company's total assets were invested in mortgage loans or real estate. Non-affiliated corporate debt securities that were non-investment grade represented 0.3% of the Company's total assets at December 31, 1998. The Company had investments in debt securities of affiliated corporations aggregating approximately $47.6 million as of December 31, 1998. Investments in mortgage-backed securities included collateralized mortgage obligations ("CMOs") of $212.1 million and mortgage-backed pass-through securities of $32.1 million at December 31, 1998. Mortgage-backed pass-through securities, sequential CMOs and support bonds, which comprised approximately 42.6% of the book value of the Company's mortgage-backed securities at December 31, 1998, are sensitive to prepayment and extension risks. The Company has reduced the risk of prepayment associated with mortgage-backed securities by investing in planned amortization class ("PAC"), target amortization class ("TAC") instruments, accretion directed bonds 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. PAC and TAC instruments and accretion directed and scheduled bonds represented approximately 37.8% and sequential and support classes represented approximately 34.6% of the book value of the Company's mortgage-backed securities at December 31, 1998. In addition, the Company limits the risk of prepayment of CMOs by not paying a premium for any CMOs. The Company does not invest in mortgage-backed securities with increased prepayment risk, such as interest-only stripped pass-through securities and inverse floater bonds. 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. The Company did not make additional investments in CMOs during 1998, and the current investment objectives of the Company do not contemplate additions to the portfolio of CMO investments during 1999. -10- The Company does not invest in non-agency mortgage-backed securities, which have a greater credit risk than that of agency mortgage-backed securities. The Company does not make new mortgage loans on commercial properties. Substantially all of the Company's mortgage loans were made by its subsidiaries prior to their acquisition by the Company. At December 31, 1998, 0.8% of the total book value of 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. During 1998, none of the Company's mortgage loans were converted to foreclosed real estate or were restructured while the Company owned them. 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 participation. These categories accounted for approximately 0.4% of the Company's invested assets at December 31, 1998. Investors-NA was the owner and developer of Bridgepoint Square Offices. Following the completion of the construction, the project consisted of four office buildings, with a total rentable space of approximately 364,000 square feet, and two parking garages. Investors-NA purchased the 20 acre tract of land for this complex in January, 1995. At that time, the tract included one completed and fully leased office building, an adjacent parking garage, and sites for three more office buildings and another parking garage. Investors-NA completed construction of the three remaining office buildings and parking garage in 1997. In May 1996, Family Life Insurance Company ("FLIC"), an indirect, 100% owned subsidiary of FIC, purchased a 7.1 acre tract adjacent to the original Bridgepoint Square tract. This second tract contained one building site and one garage site. In January, 1997, FLIC began construction on a four-story office building, with rentable space of approximately 76,793 square feet, and the parking garage, with 350 parking spaces. In May, 1997, the entire rentable space was leased to a major tenant in the technology business. Construction of the parking garage and the building shell was completed in October, 1997. In November, 1997, Investors-NA and Family Life entered into a sale agreement with an independent third party for the sale of their respective interests in Bridgepoint Square Offices. The transaction, which closed on December 5, 1997, was for an aggregate price of $78 million. The sale resulted in a net pre-tax profit to Investors-NA of approximately $14.0 million, and a net pre-tax profit to Family Life of approximately $4.5 million. See Item 2. Properties. In October, 1998, Investors-NA purchased 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-NA has obtained approval of a site plan development proposal for these tracts. The development permit provides for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. The initial phase of the project ("Phase One") will consist -11- of two office buildings, associated parking and the infrastructure for the entire project. Construction on Phase One began during the first quarter of 1999. The Company has established and staffed an investment department, which manages portfolio investments and investment accounting functions for ILCO's life insurance subsidiaries. Agency Operations ILCO's insurance subsidiaries collectively market through the "Investors" distribution system. Independent non-exclusive agents, general agents and brokers are recruited nation-wide to sell the products. Such agents and brokers also sell insurance products for companies in competition with ILCO's insurance subsidiaries. In order to attract agents and enhance the sale of its products, the Company's insurance subsidiaries pay competitive commission rates and provide other sales inducements. The Investors sales distribution system is presently concentrating its efforts on the promotion and sale of universal life, term life and fixed annuity products. Marketing and sales for all of the Company's insurance subsidiaries are directed by the Executive Vice President of Marketing and Sales. The Senior Vice President for Investors Sales directs Regional Vice Presidents who are responsible for the recruitment and maintenance of the general agents and managing general agents for individual insurance sales. Beginning in 1999, the Company will implement a plan to restructure the compensation arrangements for Regional Vice Presidents, so as to emphasize the role of personal production by the RVPs. Data Processing Since December, 1994, the data processing needs of ILCO's and FIC's insurance subsidiaries have been provided to ILCO's and FIC's Austin, Texas and Seattle, Washington facilities by FIC Computer Services, Inc., a subsidiary of FIC. See Item 13 - Certain Relationships and Related Transactions with Management. As the provider of data processing for the Company and its subsidiaries and affiliates, FIC Computer Services, Inc. utilizes a centralized computer system to process policyholder records and financial information. In addition, the Company uses non-centralized computer terminals in connection with its operations. The software programs used by these systems will be affected by what is referred to as the "Year 2000 problem" or "Y2K problem". This refers to the limitations of the programming code in certain existing software programs to recognize date sensitive information as the year 2000 approaches. Unless modified prior to the year 2000, such systems may not properly recognize such information and could generate erroneous data or cause a system to fail to operate properly. In response to the potential operations and policy administration problems caused by the computer calendar change on January 1, 2000, the management of the Company instructed FIC Computer Services, Inc. to analyze its system capabilities and the operational requirements of the Company and its respective subsidiaries and affiliates with respect to the Y2K problem. In 1996, FIC -12- Computer Services, Inc. conducted the analysis of all of the Company's systems. After reviewing that analysis, the Company determined that a plan should be devised to prevent the data processing errors that may be encountered due to the Y2K problem. In November, 1996, a three-year plan outlining a proposed solution (the "Plan") was established and approved by the Company to ensure that all of the data processing systems would be Y2K compliant or converted onto Y2K compliant systems. The Company began the major work under this Plan in 1997 and it is scheduled to be completed by the Fall of 1999. The Company established this Plan because FIC Computer Services, Inc.'s analysis revealed that those systems that are not converted or modified into Y2K compliant systems, may produce policy administration errors as a result of the calendar change, requiring that the life insurance subsidiaries manually administer those policies. This would result in a material increase in administrative costs incurred by the life insurance subsidiaries of both ILCO and FIC. The Company's analysis also indicated that, in addition to potential policy administration errors in the life insurance subsidiaries, any machine which contains a microchip is subject to error due to the Y2K problem. Such an occurrence could not only create errors in the Company's internal systems, but those of the Company's suppliers and service providers. In order to prepare for this contingency, the Plan called for the acquisition of new mainframe hardware and software, and the modification and conversion of the Company's telephones, voice mail and desk-top personal computers. The Plan calls for a conversion of certain systems onto the Company's CK/4 System, a system which is designed to be Y2K compliant according to the representations of the vendor. Those systems which are not converted will be upgraded by changing individual lines of computer code in order to modify current operating software such that it will become Y2K compliant. Under the Plan, FIC Computer Services, Inc. will utilize its own personnel, acquire Y2K compliant operating software, and engage the assistance of outside consultants to facilitate the systems conversions and modifications. The Company is in the process of this systems conversion and anticipates that the project will be completed in advance of the year 2000. The Company has increased the budget for the implementation and completion of the Plan from the prior years estimate. As of December 31, 1997, the Company had budgeted approximately $470,000 for implementing the Plan. Based on its current analysis, the Company expects that the cost of implementing and completing the Plan will result in an after-tax expense of approximately $587,000 for the three-year (1997 - 1999) conversion period. For the twelve month period ended December 31, 1998, the Company has incurred an after tax expense of approximately $158,000 in connection with the completion of the Plan. Between January 1, 1997 and December 31, 1998, the Company has expended approximately 50.7% of the three-year expected after-tax cost discussed above. In the event that the Plan does not achieve full compliance by the target dates, or if unforeseen matters involving Y2K appear before or after January 1, 2000, the Company will utilize the staff of FIC Computer Services, Inc. to identify and resolve such issues as and if they arise. -13- In order to continuously evaluate the effectiveness of the modifications and conversions made to the various systems, FIC Computer Services, Inc. has acquired testing software to simulate dates on or after January 1, 2000. Additionally, FIC Computer Services, Inc. runs the systems through model office cycles and also conducts visual inspections of screen displays to determine whether the systems are functioning in a Y2K compliant manner. As of March 1, 1999, FIC Computer Services, Inc. estimated that it had completed the necessary conversions and modifications on the administrative systems which process approximately 66 % of the insurance policies for the Company and its subsidiaries. This included the conversion of the ALIS System (administering approximately 42,000 active policies) to CK/4 in February, 1998, the System 38 (administering approximately 9,400 active policies) conversion in January, 1997, the TI System (administering approximately 5,240 active policies) conversion to CK/4 in July, 1998 and the conversion of the Lifecomm-B system (which is responsible for approximately 18,000 policies assumed after the acquisition of State Auto Life) in February,1999. The conversion of the Life 70 system (administering approximately 16,120 active policies for Investors-IN) is scheduled for completion in May, 1999. The conversion of the Lifecomm-A system (administering approximately 62,410 active policies for Investors-NA) is scheduled for completion in September of 1999. The modification of one of the Company's smaller systems which administers approximately 3,680 active credit life policies was completed on schedule in December, 1998. The modification of a smaller system which administers approximately 15,550 active industrial life policies is scheduled for completion in June of 1999. The various software applications described above are licensed to the Company under agreements which permit the Company's subsidiaries to process business on its computer systems utilizing such software. In 1997, FIC Computer Services, Inc. purchased new mainframe hardware and accompanying operating software, which the vendor has represented to be Y2K compliant. FIC Computer Services, Inc. has completed the installation and testing of such new mainframe hardware and software for compliance with the requirements of the Year 2000 conversion. In addition, FIC Computer Services has purchased certain third-party software which is run on the mainframe. This software has been represented by the vendor as being in compliance with Year 2000 requirements. Testing is currently being done on such third-party software, which testing is expected to be completed by September 1, 1999. The telephone system, which includes both PBX and voice mail systems, has been tested by the maintenance provider for that system and the Company has received assurances that the telephone system is Y2K compliant. With respect to non-centralized systems (i.e., desktop computers), the Company has obtained updated software releases and new hardware designed to be Y2K compliant according to the representations of the vendors. The Company expects that the effort needed to correct for Y2K problems on such systems will be less time intensive than the effort needed to achieve compliance for its centralized systems. The installation of such new PC hardware and software was commenced in early 1999 and is expected to be completed by September 1, 1999. -14- The Company also faces the risk that one or more of its external suppliers of goods or services ("third party providers") will not be in a position to properly interact with the Company due to the inability of such third party provider to resolve its own Y2K issues. Pursuant to the Plan, the Company has completed an inventory of its third party provider relationships. In order to assess the Y2K readiness of such third party providers, the Company has developed and forwarded a detailed questionnaire to such providers. As the responses to the questionnaires are received, the Company will evaluate the overall Y2K readiness of its third party provider relationships. However, the Company does not have sufficient information at the current time to determine whether the computer systems of its third party providers will be in compliance with the Y2K requirements as the year 2000 approaches. In the event that a major administrative system fails to operate properly due to the Y2K problem, or the Company does not complete the necessary systems conversions prior to January 1, 2000, the Company has developed a plan to respond to such a contingency. FIC Computer Services has assigned certain personnel to be members of an emergency response team to resolve Y2K operations problems. Additionally, insurance policies would be administered manually if the necessary systems conversions were not completed prior to January 1, 2000, or subsequent Y2K operational problems arise. Manual policy administration would require additional personnel. If substantial additional personnel become necessary for manual policy administration, the training and salary expenses of such personnel could materially affect the Company's business and results of operations. The Company is not able to estimate the likelihood that manual administration will be needed or the amount of any expense which it would incur in connection with such manual administration. Competition There are many life and health insurance companies in the United States. A significant number of casualty companies also market health insurance. Agents placing insurance business with ILCO's life insurance subsidiaries are compensated on a commission basis. However, some companies pay higher commissions and charge lower premium rates and many companies have more substantial resources. The principal cost and competitive factors that affect the Company's ability to sell its life insurance and annuity products on a profitable basis are: (1) the general level of premium rates for comparable products; (2) the extent of individual policy holder services required to service each product category; (3) general interest rate levels; (4) competitive commission rates and related marketing costs; (5) legislative and regulatory requirements and restrictions; (6) the impact of competing insurance and other financial products; and (7) the condition of the regional and national economies. Reinsurance and Reserves Reinsurance Ceded: -15- In accordance with general practices in the insurance industry, the Company's insurance subsidiaries limit the maximum net losses that may arise from large risks by reinsuring with other carriers. Such reinsurance provides for a portion of the mortality risk to be retained (the "Retention") with the excess being ceded to a reinsurer at a premium set forth in a schedule based upon the age and risk classification of the insured. The reinsurance treaties provide for allowances that help the Company's insurance subsidiaries offset the expense of writing new business. Investors-IN generally retains the first $60,000 to $100,000 of risk on the life of any individual, depending upon the type of coverage being written. Investors-NA generally retains the first $100,000 to $250,000 of risk on the life of any individual, depending on the type of coverage being issued. Investors-NA maintains a bulk reinsurance treaty, under which it reinsured all of its risks under accidental death benefit policies. The treaty was most recently renegotiated with the current reinsurer in January, 1997. As discussed above (see "Principal Products"), in December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which all of the contractual obligations and risks under individual accident and health insurance policies were assumed by a third party reinsurer. In connection with the transaction, the total amount of net reserves transferred by the subsidiaries was $6,327,504. In addition to the transfer of reserves, the life companies paid the reinsurer $1,037,150 in connection with the transaction, which amount was accounted for as an expense for the year ended December 31, 1997. Although reinsurance does not eliminate the exposure of the Company's insurance subsidiaries to losses from risks insured, the net liability of such subsidiaries will be limited to the portion of the risk retained, provided that the reinsurers meet their contractual obligations. The Company's insurance subsidiaries carry reserves on their books to meet future obligations under their outstanding insurance policies. Such reserves are believed to be sufficient to meet policy obligations as they mature and are calculated using assumptions for interest, mortality, expenses and withdrawals in effect at the time the policies were issued. Reinsurance Assumed: In 1995, Investors-NA entered into a reinsurance agreement with Family Life pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. In 1996, Investors-NA entered into a reinsurance agreement with Family Life, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. These reinsurance arrangements reflect management's plan to develop universal life and annuity business at Investors-NA, with Family Life concentrating on the writing of term life insurance products. -16- FIC's Acquisition of Control of the Company In January 1985, FIC acquired 26.53% of ILCO's common stock. FIC and Family Life subsequently acquired additional shares of ILCO's common stock and as of March 15, 1999, FIC owned, directly and indirectly through Family Life, approximately 45% of the outstanding shares of ILCO's common stock. Prior to October 1, 1998, FIC held options to acquire up to 1,702,155 additional shares of ILCO Common Stock. As a result of the final repayment on ILCO's Senior Loan (see discussion under the caption "Senior Loan") on September 30, 1998, FIC's options to acquire shares of ILCO's Common Stock expired. FIC's Acquisition of Family Life After FIC acquired control of ILCO, FIC's primary involvement in the insurance industry was its indirect investment, through ILCO, in ILCO's insurance subsidiaries. In June 1991, FIC acquired Family Life Insurance Company, ("Family Life"), based in Seattle, Washington, from Merrill Lynch Insurance Group, Inc. Family Life underwrites and sells mortgage protection life insurance to customers who are mortgage borrowers from financial institutions where Family Life has marketing relationships. Family Life distributes its insurance products primarily through a national career sales force in 49 states and the District of Columbia. The $114 million purchase price for Family Life and an additional $5 million for transaction costs, working capital and other related purposes were financed by: (a) a $50 million senior loan provided by a group of banks, (b) $44 million subordinated notes issued to the seller and its affiliates and (c) $25 million senior subordinated notes issued to Investors-CA and Investors-NA. In addition, FIC granted to Investors-CA and Investors-NA nontransferable options to purchase up to a total of 9.9% of FIC's common stock at a price of $10.50 per share, equivalent to the then current market price, subject to adjustment to prevent dilution. As a result of the five-for-one stock split implemented by FIC, effective in November, 1996, the exercise price of the options was changed to $2.10 per share. The initial terms of the option provided for their expiration on June 12, 1998, if not previously exercised. In connection with the 1996 amendments to the subordinated loans held by Investors-NA, the expiration date of the options was extended to September 12, 2006. For a discussion of the 1996 amendments, see Item 13, "Certain Relationships and Related Transactions with Management" . In July 1993, the subordinated notes held by the seller and its affiliates were prepaid. The primary source of the funds used to prepay the subordinated debt was a new subordinated loan of $34.5 million obtained from Investors-NA. See Item 13. Senior Loan The Senior Loan of ILCO was originally arranged in connection with the 1988 acquisition of Investors-NA and Investors-CA. In January, 1993, the Company refinanced its Senior Loan. That -17- transaction was done in connection with the prepayment of the subordinated indebtedness and the purchase of warrants which had been issued as part of the financing of the 1988 acquisitions. The terms of the amended and restated credit facility are substantially the same as the terms and provisions of the 1988 senior loan. The maturity date, which had been December 31, 1996, was extended to July 1, 1998 for the Senior Loan. The average interest rate paid by the Company on its Senior Loan was approximately 7.76% during 1996, 7.68% during 1997 and 7.63% during 1998. In February, 1995, the Company borrowed an additional $15 million under the Senior Loan to help finance the acquisition of Investors-IN, and the maturity date of the Senior Loan was further extended to July 1, 1999. As of December 31, 1995, the outstanding principal balance of ILCO's senior loan obligations was $59.4 million. In January, 1996, the Company made a scheduled payment of $4.5 million under its Senior Loan. In March, 1996, the Company made the scheduled payments for April 1st and July 1st, totaling $9 million. At that same time, the Company made a payment of $941,000, an additional payment under the terms of the loan applied to the principal balance. On April 1, 1996, an optional principal payment in the amount of $15 million was made, which resulted in advancing the scheduled payoff date of the Senior Loan to April 1, 1998. In July, 1996, the Company made the principal payment for October 1st ($4.5 million), plus an optional principal payment of $0.5 million. In connection with the acquisition of State Auto Life Insurance Company in July, 1997, the Senior Loan agreement was modified to extend the maturity date to October 1, 1998. As of December 31, 1997, the outstanding principal balance of ILCO's senior loan obligations was $11.0 million, which reflected the prepayment by the Company of the payment originally scheduled for January 1, 1998. A regular payment, in the amount of $3.7 million, was made on April 1, 1998 and a prepayment of the July 1, 1998 installment, in the amount of $3.7 million, was made on June 30, 1998. The outstanding principal balance of ILCO's senior loan obligations was $3.6 million at June 30, 1998. The final installment on the senior loan obligation scheduled for October 1, 1998, was prepaid on September 30, 1998. As a result, the senior loan obligation of ILCO was fully discharged effective September 30, 1998. Regulation General. The Company's insurance subsidiaries are subject to regulation and supervision by the states in which they are licensed to do business. Such regulation is designed primarily to protect policy owners. Although the extent of regulation varies by state, the respective state insurance departments have broad administrative powers relating to the granting and revocation of licenses to transact business, licensing of agents, the regulation of trade practices and premium rates, the approval of form and content of financial statements and the type and character of investments. These laws and regulations require the Company's insurance subsidiaries to maintain certain minimum surplus levels and to file detailed periodic reports with the supervisory agencies in each of the states in which they do business and their business and accounts are subject to examination -18- by such agencies at any time. The insurance laws and regulations of the domiciliary states of the Company's insurance subsidiaries require that such subsidiaries be examined at specified intervals. Investors-NA and Investors-IN are domiciled in the states of Washington and Indiana, respectively. In December 1992, Investors-NA redomesticated from Pennsylvania to Washington, and Investors-CA merged into Investors-NA. In June, 1993, Standard Life merged into Investors-NA. Prior to December, 1997, Investors-IN was domiciled in the State of New Jersey. In December, 1997, Investors-IN transferred its domicile to the State of Indiana. A number of states regulate the manner and extent to which insurance companies may test for acquired immune deficiency syndrome (AIDS) antibodies in connection with the underwriting of life insurance policies. To the extent permitted by law, the Company's insurance subsidiaries consider AIDS information in underwriting coverage and establishing premium rates. An evaluation of the financial impact of future AIDS claims is extremely difficult, due in part to insufficient and conflicting data regarding the incidence of the disease in the general population and the prognosis for the probable future course of the disease. Risk-Based Capital Requirements. The National Association of Insurance Commissioners ("NAIC") has imposed Risk-Based Capital ("RBC") requirements to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks associated with; (i) asset quality; (ii) mortality and morbidity; (iii) asset and liability matching; and (iv) other business factors. The states will use the RBC formula as an early warning tool to discover potential weakly capitalized companies for the purpose of initiating regulatory action. The RBC requirements are not intended to be a basis for ranking the relative financial strength of insurance companies. In addition, the formula defines a new minimum capital standard which will supplement the prevailing system of low fixed minimum capital and surplus requirements on a state-by-state basis. The RBC requirements provide for four different levels of regulatory attention in those states that adopt the NAIC regulations, depending on the ratio of the company's Total Adjusted Capital (which generally consist of its statutory capital, surplus and asset valuation reserve) to its Authorized Control Level RBC. A "Company Action Level Event" is triggered if a company's Total Adjusted Capital is less than 200% but greater than or equal to 150% of its Authorized Control Level RBC, or if a negative trend has occurred (as defined by the regulations) and Total Adjusted Capital is less than 250% but more than 200% of its Authorized Control Level RBC. When a Company Action Level Event occurs, the company must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve its capital position. A "Regulatory Action Level Event" is triggered if a company's Total Adjusted Capital is less than 150% but greater than or equal to 100% of its Authorized Control Level RBC. When a Regulatory Action Level Event occurs, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. An "Authorized Control Level Event" is triggered if a company's Total Adjusted Capital is less than 100% but greater than or equal to 70% of its Authorized Control Level RBC, and the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. A "Mandatory Control Level -19- Event" is triggered if a company's total adjusted capital is less than 70% of its Authorized Control Level RBC, and the regulatory authority is mandated to place the company under its control. Calculations using the NAIC formula and the statutory financial statements of the Company's insurance subsidiaries as of December 31, 1998 indicate that the Total Adjusted Capital of each of the Company's insurance subsidiaries is above 640% of its respective Authorized Control Level RBC. Solvency Laws Assessments. The solvency or guaranty laws of most states in which the Company's insurance subsidiaries do business may require the Company's insurance subsidiaries to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. Recent insolvencies of insurance companies increase the possibility that such assessments may be required. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. The insurance companies record the expense for guaranty fund assessments in the period assessed. The net amount of such assessment for the Company's insurance subsidiaries was approximately $7,000 in the year ended December 31, 1998. That amount is net of the amounts that can be offset against future premium taxes. The likelihood and amount of any other future assessments cannot be estimated and are beyond the control of the Company. Surplus Debentures and Dividends. The Company receives payments from Investors-NA under the terms of two surplus debentures . The surplus debentures were originally issued by Standard Life. Upon the merger of Standard Life into Investors-NA, the obligations of the surplus debentures were assumed by Investors-NA. Since Investors-NA is domiciled in the State of Washington, the provisions of Washington insurance law apply to the surplus debentures. Under the provisions of the surplus debentures and current law, Investors-NA can pay interest and principal on the surplus debentures without having to obtain the prior approval of the Washington Insurance Commissioner; provided that, after giving effect to such payments, the statutory surplus of Investors-NA is in excess of $10 million. As of December 31, 1998, the statutory surplus of Investors-NA was $68.2 million. Investors-NA does give five-days prior notification to the Washington Insurance Department of each proposed payment on the surplus debentures in accordance with an agreement between Investors-NA and the Department. ILCO does not anticipate that Investors-NA will have any difficulty in making principal and interest payments on the surplus debentures. Pursuant to the surplus debentures, Investors-NA paid to the Company principal and interest on the surplus debentures of $36,288,469 in 1996, $14,093,711 in 1997 and $13,382,361 in 1998. In addition to the payments under the terms of the Surplus Debentures, ILCO has received dividends from its insurance subsidiaries. Washington's insurance code includes the "greater of" standard for payment of dividends to shareholders, but has requirements that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. Under the "greater of" standard, an insurer may pay a dividend in an -20- amount equal to the greater of (i) 10% of policyholder surplus or (ii) the insurer's net gain from operations for the previous year. As of December 31, 1998, Investors-NA had earned surplus of $39.3 million. Since the law applies only to dividend payments, the ability of Investors-NA to make principal and interest payments under the Surplus Debentures is not affected. ILCO does not anticipate that Investors-NA will have any difficulty in making principal and interest payments on the Surplus Debentures . Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance code, a domestic insurer may make dividend distributions upon proper notice to the Department of Insurance, as long as the distribution is reasonable in relation to adequate levels of policyholder surplus and quality of earnings. Under Indiana law the dividend must be paid from earned surplus. Extraordinary dividend approval would be required where a dividend exceeds the greater of 10% of surplus or the net gain from operations for the prior fiscal year. Investors-IN had earned surplus of $18.1 million at December 31, 1998. Valuation Reserves. Commencing in 1992, the Mandatory Securities Valuation Reserve ("MSVR") required by the NAIC for life insurance companies was replaced by a mandatory Asset Valuation Reserve ("AVR") which is expanded to cover mortgage loans, real estate and other investments. During 1997, a change in the NAIC's AVR procedures resulted in a one-time reduction in the amount of the reserves held by ILCO's life insurance subsidiaries, with a corresponding one-time increase in the amount of surplus. For Investors-NA, the amount of the increase in surplus was $2,395,000; for Investors-IN, the amount of the increase in surplus was $590,000. A new mandatory Interest Maintenance Reserve ("IMR"), designed to defer realized capital gains and losses due to interest rate changes on fixed income investments and to amortize those gains and losses into future income, is also effective for 1992. Previously, realized capital gains attributable to interest rate changes were credited to the MSVR and had the effect of reducing the required MSVR contributions of ILCO's insurance subsidiaries. Effective in 1992, such realized capital gains are credited to the IMR. As a result of these changes, management believes that the Company's insurance subsidiaries are required to accrue greater aggregate asset valuation reserves. The combination of the AVR and IMR will affect statutory capital and surplus and may reduce the ability of the Company's insurance subsidiaries to pay dividends and make payments on the surplus debentures. Insurance Holding Company Regulation. Investors-NA and Investors-IN are subject to regulation under the insurance and insurance holding company statutes of Washington and Indiana. The insurance holding company laws and regulations vary from jurisdiction to jurisdiction, but generally require insurance and reinsurance subsidiaries of insurance holding companies to register with the applicable state regulatory authorities and to file with those authorities certain reports describing, among other information, their capital structure, ownership, financial condition, certain intercompany transactions and general business operations. The insurance holding company statutes also require prior regulatory agency approval or, in certain circumstances, prior notice of certain material intercompany transfers of assets as well as certain transactions between insurance companies, their parent companies and affiliates. -21- Under the Washington and Indiana insurance holding company laws, unless (i) certain filings are made with the respective department of insurance, (ii) certain requirements are met, including a public hearing and (iii) approval or exemption is granted by the respective insurance commissioner, no person may acquire any voting security or security convertible into a voting security of an insurance holding company, such as the Company, which controls an insurance company domiciled in that state, or merge with such a holding company, if as a result of such transaction such person would "control" the insurance holding company. "Control" is presumed to exist if a person directly or indirectly owns or controls 10% or more or the voting securities of another person. Potential Federal Regulation. Although the federal government generally does not directly regulate the insurance industry, federal initiatives often have an impact on the business. Congress and certain federal agencies are investigating the current condition of the insurance industry (encompassing both life and health and property and casualty insurance) in the United States in order to decide whether some form of federal role in the regulation of insurance companies would be appropriate. Congress is currently conducting a variety of hearings relating in general to the solvency of insurers. It is not possible to predict the outcome of any such congressional activity nor the potential effects thereof on the Company's insurance subsidiaries. Congressional initiatives directed at repeal of the McCarran-Ferguson Act (which exempts the "business of insurance" from most federal laws, including the antitrust laws, to the extent it is subject to state regulation) and judicial decisions narrowing the definition of "business of insurance" for McCarran-Ferguson Act purposes may limit the ability of insurance companies in general to share information with respect to rate-setting, underwriting and claims management practices. Current and proposed federal measures which may also significantly affect the insurance industry include minimum solvency requirements and removal of barriers preventing banks from engaging in the insurance business. Federal Income Taxation The Revenue Reconciliation Act of 1990 amended the Internal Revenue Code of 1986 to require a portion of the expenses incurred in selling insurance products to be deducted over a period of years, as opposed to an immediate deduction in the year incurred. Since this change only affects the timing of the deductions, it does not affect tax expense as shown on the Company's financial statements prepared in accordance with GAAP. However, the change will increase the tax for statutory accounting purposes in the first few years, which will reduce statutory surplus and, accordingly, may decrease the amount of cash dividends that Investors-NA can pay to the Company. For the years ended December 31, 1996, 1997 and 1998, the decreases in the current income tax provisions of the Company's insurance subsidiaries due to this change were $90,413, $269,633 and $253,411, respectively. The change has a negative tax effect for statutory accounting purposes when the premium income of the Company's insurance subsidiaries increases, but has a positive tax effect when their premium income decreases. -22- Segment Information The principal operations of the Company's insurance subsidiaries are the underwriting of life insurance and annuities. Accordingly, no separate segment information is required to be provided by the Registrant for the three-year period ending December 31, 1998. Item 2. Properties The Registrant's headquarters are currently located at Austin Centre, 701 Brazos, Suite 1400, Austin, Texas. Investors-NA purchased Austin Centre, an office-hotel property in downtown Austin in August 1991 for a purchase price of $31,275,000 from an unrelated seller that had previously acquired the property through foreclosure. In September 1995, Investors-NA entered into a contract to sell Austin Centre to an Austin-based real estate investment firm for a purchase price of $62.675 million, less $1 million to be paid to a capital reserve account for the purchaser. The sale was consummated on March 29, 1996. A portion of the sale proceeds equal to the amount that Investors- NA presently had invested in Austin Centre were retained and reinvested by Investors-NA. The balance of the net proceeds of the sale were used to reduce ILCO's bank indebtedness by approximately $15 million. Following the sale of the Austin Centre, the Company and its affiliates continued to occupy three floors of the office space under a lease arrangement. The current lease, which was entered into in May, 1997, is for a five (5) year term ending in October, 2002, with options to renew for three successive five (5) year terms thereafter. In January, 1995, ILCO, through Investors-NA, purchased, as an investment property, an office building project known as Bridgepoint Office Square in Austin, Texas for a cash purchase price of $9.75 million. The property consists of 20 acres of land with four office building sites and two parking structure sites. The first phase of development of the property was completed in 1986 and consists of a five-story office building with 83,474 square feet of rentable space and a 550-car parking garage. In the fourth quarter of 1995, construction began on the second office building, containing approximately 109,000 rentable square feet, and the other parking garage containing approximately 871 spaces. That phase of the project was completed in September 1996. In March 1996, construction commenced on the third office building, with approximately 79,000 rentable square feet of office space and was completed in December, 1996. Construction began on the fourth building in July 1996, and was completed in July, 1997. The fourth building contains approximately 92,459 rentable square feet. On May 3, 1996, Family Life Insurance Company, an indirect, 100% owned subsidiary of FIC, purchased a tract of land adjoining the Bridgepoint Office Square tract for a cash purchase price of $1.3 million. The property consists of 7.1 acres of land with one office building site and one parking structure site. Family Life began construction of the fifth building (known as "Bridgepoint Five") -23- on the new site in January 1997. Construction of the parking garage and the building shell was completed in October, 1997. On November 24, 1997, Investors-NA and Family Life entered into a contract with Health and Retirement Properties Trust, a Maryland real estate investment trust (the "Purchaser") to sell their respective interests in the Bridgepoint Square Office complex. The aggregate purchase price for the project was $78,000,000. The transaction closed on December 5, 1997. The purchase price was allocated approximately 78.5% to Investors-NA and 21.5% to Family Life. The sale of Bridgepoint Office Square resulted in a net profit to Investors-NA of approximately $14.0 million ($9.1 million after tax) that was included in ILCO's fourth quarter earnings for the period ended December 31, 1997. For Family Life, the sale resulted in a net profit of approximately $4.5 million ($3.2 million after tax) that was included in FIC's fourth quarter earnings for the period ended December 31, 1997. On October 29, 1998, Investors-NA purchased two adjoining tracts of land located in Austin, Texas totaling 47.995 acres. The aggregate purchase price for these tracts was $8.1 million. Prior to the closing, Investors-NA obtained approval of Site Development Permit from the City of Austin for the tracts. The Site Development Permit allows for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. The initial phase of the project ("Phase One") will consist of two office buildings, associated parking and the infrastructure for the entire project, which is known as River Place Pointe. Construction on Phase One commenced during the first quarter of 1999. ILCO leases a building located at 40 Parker Road, Elizabeth, New Jersey. This building, which was formerly the Company's headquarters building, contains approximately 41,000 square feet of office space. The remaining term of the lease is 7 years, and the lease calls for a minimum base rental of $450,000 per annum. The lease provides that all costs including, but not limited to, those for maintenance, repairs, insurance and taxes be borne by ILCO. The Company has sub-leased the space in the property to third parties. Investors-IN owns three buildings which are adjacent to the 40 Parker Road building. One building, which is leased to third parties, contains approximately 3,500 square feet of space. The second building contains approximately 2,500 square feet of space and is leased to persons who perform maintenance services for Investors-IN's and ILCO's properties in Elizabeth, New Jersey. The third building, purchased during 1985, contains approximately 3,500 square feet of space, and is partially leased to third parties . Investors-NA owns an office building, located at 206 West Pearl Street, Jackson, Mississippi. This building is 68 years old and contains approximately 85,000 square feet (65,000 net rentable square feet) of office space. Investors-NA currently occupies a nominal portion of the space in this property and leases space to various commercial tenants. -24- The Company believes that its properties and leased space are adequate to meet its foreseeable requirements. Item 3. Legal Proceedings The Company and Investors-NA are defendants in a lawsuit which was filed in October, 1996, in Travis County, Texas. CIGNA Corporation, an unrelated company, is also a named defendant in the lawsuit. The named plaintiffs in the suit (a husband and wife), allege that the universal life insurance policies sold to them by INA Life Insurance Company (a company which was merged into Investors- NA in 1992) utilized unfair sales practices. The named plaintiffs seek reformation of the life insurance contracts and an unspecified amount of damages. The named plaintiffs also seek a class action as to similarly situated individuals. No certification of a class has been granted as of the date hereof. The Company believes that the suit is without merit and intends to vigorously defend this matter. In August, 1997, another individual filed a similar action in Travis County, Texas against the corporate entities identified above. The lawsuit involves the same type of policy and includes allegations which are substantially identical to the allegations in the first action. The named plaintiff also seeks class certification. The Company believes that the court would consider class certification with respect to only one of these actions. The Company also believes that this action is without merit and intends to vigorously defend this matter. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted during the fourth quarter of the fiscal year ended December 31, 1998 to a vote of security holders. -25- PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters A. Market Information The following table sets forth the quarterly high and low sales prices for the Company's Common Stock in The Nasdaq Small-Cap Market for 1998 and 1997. The quotations set forth below have not been adjusted to give retroactive effective to the stock dividend (one share for each issued and outstanding share) which was paid on March 17, 1999. Prices High Low 1998: 1st Quarter. . . . . . . $ 23.00 $18.75 2nd Quarter. . . . . . . 27.813 22.00 3rd Quarter. . . . . . . 27.00 19.50 4th Quarter. . . . . . . 21.00 17.25 1997: 1st Quarter. . . . . . . $ 15.00 $13.00 2nd Quarter. . . . . . . 15.00 12.25 3rd Quarter. . . . . . . 20.375 14.75 4th Quarter. . . . . . . 24.25 19.00 The Common Stock of the Company is traded in The Nasdaq Small-Cap Market (NASDAQ Symbol: ILCO). Quotations are furnished by the National Association of Securities Dealers Automated Quotation System (NASDAQ). B. Holders The approximate number of record holders of the Common Stock of the Registrant as of March 15, 1999 was 1,456. C. Dividends No dividend was declared or paid by the Company during 1996, 1997 or 1998. Under the terms of its Senior Loan the Company was not permitted to declare or pay any dividends on its Common -26- Stock during the loan term. As discussed above, under the caption "Senior Loan", the Senior Loan of the Company was fully repaid on September 30, 1998. The ability of an insurance holding company, such as ILCO, to pay dividends to its shareholders may be limited by the company's ability to obtain revenue, in the form of dividends and other payments, from its operating insurance subsidiaries. The right of such subsidiaries to pay dividends is generally restricted by the insurance laws of their domiciliary states. See Item 1. Business Regulation - Surplus Debentures and Dividends. Item 6. Selected Financial Data (in thousands, except per share data.) Years Ended December 31, 1998 1997 1996 1995 1994 Revenues ............. $ 109,462 $ 127,683 $ 138,244 $ 122,390 $ 114,842 Benefits & Expenses .. 91,876 96,081 96,801 105,907 99,142 Income from operations 17,586 31,602 41,443 16,483 15,700 Provisions for federal income taxes ......... 6,467 11,062 14,505 5,769 5,783 Net Income ........... $ 11,119 $ 20,540 $ 26,938 $ 10,714 $ 9,917 Common Stock and Common Stock Equivalents .......... 4,462 4,369 4,441 4,342 4,473 Net income per share Basic ................ $ 2.54 $ 4.75 $ 6.36 $ 2.57 $ 2.41 Diluted .............. $ 2.49 $ 4.70 $ 6.07 $ 2.47 $ 2.22 Cash Dividend ........ -0- -0- -0- -0- -0- Long Term Debt ....... -0- $ 10,964 $ 24,944 $ 59,385 $ 66,585 Total Assets ......... $1,350,248 $1,321,653 $1,263,942 $1,315,293 $1,148,994
Net income per share for the years 1994, 1995 and 1996 has been restated to reflect the effect of FAS 128. -27- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations For the year ended December 31, 1998, ILCO's net income was $11,119,000 (basic earnings of $2.54 per common share, or diluted earnings of $2.49 per common share) as compared to $20,540,000 (basic earnings of $4.75 per common share, or diluted earnings of $4.70 per common share) in 1997, and $26,938,000 (basic earnings of $6.36 per common share, or diluted earnings of $6.07 per common share) in 1996. Earnings per share are stated in accordance with the requirements of Financial Accounting Standard (FAS) No. 128, which establishes two measures of earnings per share: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that would occur if securities or other contracts to issue common stock were converted or exercised. For the year 1996, earnings per share have been restated to reflect the effect of FAS No. 128. Earnings per share have not been adjusted to give retroactive effect to the stock dividend (one share of common stock for each outstanding share of common stock) which was paid on March 17, 1999. Results of Operations Net income from continuing operations (excluding the gain resulting from the sale of Bridgepoint Square Offices in 1997 and the sale of the Austin Centre in 1996, as described below) was $11,119,000 (basic earnings of $2.54 per common share, or diluted earnings of $2.49 per common share) for the year ended December 31, 1998, as compared to $11,443,000 (basic earnings of $2.64 per common share, or diluted earnings of $2.62 per common share) for the year ended December 31, 1997 and $11,650,000 (basic earnings of $2.75 per common share, or diluted earnings of $2.62 per common share) for the year ended December 31, 1996. Net income for 1997 includes $9.1 million resulting from the sale of the Bridgepoint Square Offices, an office complex located in Austin, Texas. The selling price was $78 million, which was allocated approximately 78.5% to Investors-NA ($61.3 million). The sale closed on December 5, 1997. As part of the decision to sell the Bridgepoint properties, the Company canceled its plans to move its headquarters to one of the Bridgepoint buildings and entered into a new lease at the Austin Centre. Under the provisions of the lease, Investors-NA received a payment from the owner of the Austin Centre in the amount of $1.7 million. That amount is included in net income for the year ended December 31, 1997. Net income for 1996 includes $15.3 million resulting from the sale of the Austin Centre, a hotel/office complex, located in Austin, Texas. The selling price was $62.67 million, less $1 million paid to a capital reserve account for the purchaser. The sale closed on March 29, 1996. The results for 1998 include, for the period beginning on June 30, 1998, the operations of Grinnell Life Insurance Company. Grinnell Life was acquired on June 30, 1998, through a subsidiary of ILCO, for an adjusted purchase price of $16.6 million. A portion of the purchase price ($12.37 -28- million) was paid by way of a dividend to the seller immediately prior to the closing of the transaction; the balance of the purchase price was paid by ILCO's subsidiary. As part of the transaction, Grinnell Life was immediately merged with and into that subsidiary, with that subsidiary being the surviving entity. The statutory earnings of the Company's insurance subsidiaries, as required to be reported to insurance regulatory authorities, before interest expense, capital gains and losses, and federal income taxes were $17,079,000 at December 31, 1998, as compared to $20,192,000 at December 31, 1997, and $21,965,000 at December 31, 1996. These statutory earnings are the source to provide for the repayment of ILCO's indebtedness. The operating strategy of the Company's management emphasizes several key objectives: expense management; marketing of competitively priced insurance products which are designed to generate an acceptable level of profitability; maintenance of a high quality portfolio of investment grade securities; and the provision of quality customer service. Premium income, net of reinsurance, for the year 1998 was $10.89 million, as compared to $11.03 million in 1997, and $ 9.98 million in 1996. Reinsurance premiums ceded were $2.94 million in 1998, as compared to $2.59 million in 1997 and $1.71 million in 1996. For the year 1997, ceded reinsurance includes the results of the sale of the accident and health and disability income insurance business of the Company's life insurance subsidiaries. In December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which all of the contractual obligations and risks under accident and health and disability income insurance policies were assumed by a third party reinsurer. These risks and contractual obligations were sold pursuant to, first, a coinsurance reinsurance agreement. Following applicable regulatory approvals, the reinsurer will assume the direct obligations of the companies, on an assumption reinsurance basis. The decision to dispose of this book of business was based on management's analysis that the business was not generating targeted profit objectives and that the products were not part of the core business of the subsidiaries. The sale permits the companies to focus on its primary business - life insurance and annuity sales. In connection with the transaction, the total amount of net reserves transferred by the subsidiaries was $6.33 million. In addition to the transfer of reserves, the life companies paid the reinsurer $1.04 million in connection with the transaction, which amount was accounted for as an expense for the year ended December 31, 1997. In 1997, the transferred business generated approximately $791,000 in annualized premiums. Earned insurance charges for the year ended December 31, 1998 were $41.1 million, as compared to $40.9 million for 1997 and $42.24 million for 1996. This source of revenues is related to the universal life insurance and annuity book of business of Investors-NA. In 1995, Investors-NA entered into a reinsurance agreement with Family Life Insurance Company (an insurance company subsidiary of Financial Industries Corporation and an affiliated company of Investors-NA), pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and -29- after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. In 1996, Investors-NA entered into a reinsurance agreement with Family Life, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. These reinsurance arrangements reflect management's plan to develop universal life and annuity business at Investors-NA, with Family Life concentrating on the writing of term life insurance products. Interest expense was $0.7 million for the year 1998, as compared to $1.7 million for the year 1997, and $2.8 million for the year 1996. The decrease is attributable to a reduction in the average principal balance of the Senior Loan from $33.7 million for the year ending December 31, 1996 to $18.5 million for the year ending December 31, 1997 and $5.4 million for the year ending December 31, 1998, as well as a decrease in the average rate of interest paid on the senior loan (7.63% for the year 1998, as compared to 7.68% for the year 1997 and 7.76% for the year 1996). The decline in long-term interest rates during 1998, which was related to general economic conditions, had a positive effect upon the market value of the fixed maturities available for sale segment of the portfolio. As of December 31, 1998, the market value of the fixed maturities available for sale segment was $450.15 million as compared to an amortized cost of $435.13 million, or an unrealized gain of $15.02 million. The net of tax effect of this increase has been recorded as an increase in shareholders' equity. There is no assurance that this unrealized gain will be realized in the future. During 1998, the lapse rate with respect to universal life insurance policies decreased slightly from the lapse rate experienced in 1997. The rate in 1998 was 7.3 %, as compared to 8.9 % in 1997. The lapse rate with respect to traditional (non-universal) life insurance policies also decreased from the levels experienced in 1997. The rate in 1998 was 7.1% as compared to 8.9% in 1997. The lapse rates experienced during the 1998 period were within the ranges anticipated by management. Liquidity and Capital Resources: ILCO is a holding company whose principal assets consist of the common stock of Investors Life Insurance Company of North America and its subsidiary - Investors Life Insurance Company of Indiana (formerly InterContinental Life Insurance Company). ILCO's primary source of funds consists of payments under two Surplus Debentures from Investors-NA. As of December 31, 1997, the outstanding principal balance of ILCO's senior loan obligations was $11.0 million, which reflected the prepayment by the Company of the payment originally scheduled for January 1, 1998. A regular payment, in the amount of $3.7 million, was made on April 1, 1998 and a prepayment of the July 1, 1998 installment, in the amount of $3.7 million, was made on June -30- 30, 1998. The outstanding principal balance of ILCO's senior loan obligations was $3.6 million at June 30, 1998. The final installment on the senior loan obligation scheduled for October 1, 1998, was prepaid on September 30, 1998. As a result, the senior loan obligation of ILCO was fully discharged effective September 30, 1998. ILCO's principal source of liquidity consists of the periodic payment of principal and interest by Investors-NA, pursuant to the terms of the Surplus Debentures. The Surplus Debentures were originally issued by Standard Life Insurance Company and their terms were previously approved by the Mississippi Insurance Commissioner. Upon the merger of Standard Life into Investors-NA, the obligations of the Surplus Debentures were assumed by Investors-NA. As of December 31, 1998, the outstanding principal balance of the Surplus Debentures was $4.5 million and $11.4 million, respectively. Since Investors-NA is domiciled in the State of Washington, the provisions of Washington insurance law apply to the Surplus Debentures. Under the provisions of the Surplus Debentures and current law, no prior approval of the Washington Insurance Commissioner is required for Investors-NA to pay interest or principal on the Surplus Debentures; provided that, after giving effect to such payments, the statutory surplus of Investors-NA is in excess of $10 million (the "surplus floor"). However, Investors-NA has voluntarily agreed with the Washington Insurance Commissioner that it will provide at least five days advance notice of payments which it will make under the surplus debenture. As of December 31, 1998, the statutory surplus of Investors-NA was $68.2 million, an amount substantially in excess of the surplus floor. The funds required by Investors-NA to meet its obligations to the Company under the terms of the Surplus Debentures are generated from operating income generated from insurance and investment operations. In addition to the payments under the terms of the Surplus Debentures, ILCO has received dividends from its life insurance subsidiaries. Washington's insurance code includes the "greater of" standard for payment of dividends to shareholders, but has a requirement that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. As of December 31, 1998, Investors-NA had earned surplus of $39.3 million. Since the law applies only to dividend payments, the ability of Investors-NA to make principal and interest payments under the Surplus Debentures is not affected. ILCO does not anticipate that Investors-NA will have any difficulty in making principal and interest payments on the Surplus Debentures for the foreseeable future. Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance code, a domestic insurer may make dividend distributions upon proper notice to the Department of Insurance, as long as the distribution is reasonable in relation to adequate levels of policyholder surplus and quality of earnings. Under Indiana law the dividend must be paid from earned surplus. Extraordinary dividend approval would be required where a dividend exceeds the greater of 10% of surplus or the net gain from operations for the prior fiscal year. Investors-IN had earned surplus of $18.1 million at December 31, 1998. ILCO's net cash flow provided by (used in) operating activities was ($17.33) million for the year ended December 31, 1998, as compared to $3.96 million for the year ended December 31, 1997 and -31- ($23.46) million for the same period in 1996. The change between the 1997 and 1998 periods is primarily due to the payments made in connection with the reinsurance of the health insurance business and the payment in 1998 of income taxes relating to the gain on the sale of Bridgepoint Square Offices. Management believes that its cash, cash equivalents and short term investments are sufficient to meet the needs of its business and to satisfy debt service. Investments As of December 31, 1998, the book value of the Company's investment assets totaled $702.1 million, as compared to $693.1 million as of December 31, 1997. Total assets as of December 31, 1998 ($1.35 billion) increased from the level as of December 31, 1997 ($1.32 billion). The level of short-term investments at the end of 1998 was $171.8 million, as compared to $164.6 million at the end of 1997. Invested real estate and other invested assets increased from $1.3 million at December 31, 1997 to $10.03 million as of December 31, 1998. This increase is related to the purchase by Investors-NA of the 47.995 acres of land in Austin, Texas for the development of the River Place Pointe project. The land was purchased in October, 1998 by Investors-NA, for an aggregate purchase price of $8.1 million. Prior to the closing of the transaction, Investors-NA obtained a Site Development Permit for the tracts from the City of Austin. The Site Development Permit allows for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. Development of the initial phase of the project commenced during the first quarter of 1999; when completed, the first phase will consist of two office buildings, a parking garage and the infrastructure for the entire project. Investors-NA plans to commence development of the additional stages of the project following completion and leasing of Phase One. The fixed maturities available for sale portion of invested assets at December 31, 1998 was $450.15 million. The amortized cost of the fixed maturities available for sale segment as of December 31, 1998 was $435.13 million, representing a net unrealized gain of $15.02 million. This unrealized gain principally reflects changes in interest rates from the date the respective investments were purchased. To reduce the exposure to interest rate changes, portfolio investments are selected so that diversity, maturity and liquidity factors approximate the duration of associated policyholder liabilities. The assets held by ILCO's life insurance subsidiaries 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 -32- generally does not select new investments which are commonly referred to as "high yield" or "non- investment grade." The Company's fixed maturities portfolio (including short-term investments), as of December 31, 1998, included a non-material amount (0.6% of total fixed maturities and short-term investments) of debt securities which, in the annual statements of the companies as filed with state insurance departments, were designated under the National Association of Insurance Commissioners ("NAIC") rating system as "3" (medium quality) or below. For the year ended December 31, 1997, the comparable percentage was 0.9%. The consolidated balance sheets of the Company as of December 31, 1998 include $47.65 million of "Notes receivable from affiliates", represented by (i) a loan of $22.5 million from Investors-NA to Family Life Corporation and a $2.5 million loan from Investors-CA to Financial Industries Corporation (which is now owned by Investors-NA as a result of the merger of Investors-CA into Investors-NA) and $2.0 million of additions to the $2.5 million note made in accordance with the terms of such note; these loans were granted in connection with the 1991 acquisition of Family Life Insurance Company by a wholly-owned subsidiary of FIC (ii) a loan of $30 million by Investors-NA to Family Life Corporation made in July, 1993, in connection with the prepayment by the FIC subsidiaries of indebtedness which had been previously issued to Merrill Lynch as part of the 1991 acquisition and (iii) a loan of $4.5 million by Investors-NA to Family Life Insurance Investment Company made in July, 1993, in connection with the same transaction described above. As of June 12, 1996, the provisions of the notes from Investors-NA to FIC, FLC and FLIIC were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996; the final quarterly principal payment is due on September 12, 2001; the interest rate on the note remains at 11%, (b) the $30 million note was amended to provide for forty 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%, (c) the $4.5 million note was amended to provide for forty 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%, (d) the $2.5 million note was amended to provide that the principal balance of the note is to be repaid in twenty quarterly installments of $125,000 each, commencing December 12, 1996 with the final payment due on September 12, 2001; the rate of interest remains at 12%, (e) the Master PIK note, which was issued to provide for the payment in kind of interest due under the terms of the $2.5 million note prior to June 12, 1996, was amended to provide that the principal balance of the note ($1,977,119) is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%. -33- In December, 1998, FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder (FIC). Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC. The NAIC continued its rating of "3" to the "Notes receivable from affiliates", as amended. These loans have not been included in the preceding description of NAIC rating percentages. Management believes that the absence of any material amounts of "high-yield" or "non-investment grade" investments (as defined above) in the portfolios of its 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. Year 2000 Compliance The Company and its subsidiaries utilize a centralized computer system to process policyholder records and financial information. In addition, the Company uses non-centralized computer terminals in connection with its operations. The software programs used in connection with these systems will be affected by what is referred to as the "year 2000 problem". This refers to the limitations of the programming code in certain existing software programs to recognize date sensitive information as the year 2000 approaches. Unless modified prior to the year 2000, such systems may not properly recognize such information and could generate erroneous data or cause a system to fail to operate properly. The Company has evaluated its centralized computer systems and has developed a plan to reach year 2000 compliance. A central feature of the Plan is to convert most of the centralized systems to a common system which is already in compliance with year 2000 requirements. The Company is in the process of this systems conversion and anticipates that the project will be completed in advance of the year 2000. The Plan calls for a conversion of certain systems onto the Company's CK/4 System; a system which is designed to be Y2K compliant according to the representations of the vendor. Those systems which are not converted will be upgraded by changing individual lines of computer code in order to modify current operating software such that it will become Y2K compliant. Under the Plan, the Company will utilize its own personnel and personnel of its affiliated company, FIC Computer Services, Inc., acquire Y2K compliant operating software, and engage the assistance of outside consultants to facilitate the systems conversions and modifications. The Company is in the process of this systems conversion and anticipates that the project will be completed in advance of the year 2000. The Company has increased the budget for the implementation and completion of the Plan from the prior years estimate. As of December 31, 1997, the Company had budgeted approximately $470,000 for implementing the Plan. Based on its current analysis, the Company -34- expects that the cost of implementing and completing the Plan will result in an after-tax expense of approximately $587,000 for the three-year (1997 - 1999) conversion period. For the twelve month period ended December 31, 1998, the Company has incurred an after tax expense of approximately $158,000 in connection with the completion of the Plan. Between January 1, 1997 and December 31, 1998, the Company has expended approximately 50.7% of the three-year expected after-tax cost discussed above. In the event that the Plan does not achieve full compliance by the target dates, or if unforeseen matters involving Y2K appear before or after January 1, 2000, the Company will utilize the staff of FIC Computer Services, Inc. to identify and resolve such issues as and if they arise. In order to continuously evaluate the effectiveness of the modifications and conversions made to the various systems, FIC Computer Services has acquired testing software to simulate dates on or after January 1, 2000. Additionally, FIC Computer Services runs the systems through model office cycles and also conducts visual inspections of screen displays to determine whether the systems are functioning in a Y2K compliant manner. As of March 1, 1999, FIC Computer Services, Inc. estimated that it had completed the necessary conversions and modifications on the administrative systems which process approximately 66 % of the insurance policies for the Company and its subsidiaries. This included the conversion of the ALIS System (administering approximately 42,000 active policies) to CK/4 in February, 1998, the System 38 (administering approximately 9,400 active policies) conversion in January, 1997, the TI System (administering approximately 5,240 active policies) conversion to CK/4 in July, 1998 and the conversion of the Lifecomm-B system (which is responsible for approximately 18,000 policies assumed after the acquisition of State Auto Life) in February,1999. The conversion of the Life 70 system (administering approximately 16,120 active policies for Investors-IN) is scheduled for completion in May, 1999. The conversion of the Lifecomm-A system (administering approximately 62,410 active policies for Investors-NA) is scheduled for completion in September of 1999. The modification of one of the Company's smaller systems which administers approximately 3,680 active credit life policies was completed on schedule in December 1998. The modification of a smaller system which administers approximately 15,550 active industrial life policies is scheduled for completion in June of 1999. The various software applications described above are licensed to the Company under agreements which permit the Company's subsidiaries to process business on its computer systems utilizing such software. In 1997, FIC Computer Services, Inc. purchased new mainframe hardware and accompanying operating software, which the vendor has represented to be Y2K compliant. FIC Computer Services, Inc. has completed the installation and testing of such new mainframe hardware and software for compliance with the requirements of the Year 2000 conversion. In addition, FIC Computer Services has purchased certain third-party software which is run on the mainframe. This software has been represented by the vendor as being in compliance with Year 2000 requirements. Testing is currently being done on such third-party software, which testing is expected to be completed by September -35- 1, 1999. The telephone system, which includes both PBX and voice mail systems, has been tested by the maintenance provider for that system and the Company has received assurances that the telephone system is Y2K compliant. With respect to non-centralized systems (i.e., desktop computers), the Company has obtained updated software releases and new hardware designed to be Y2K compliant according to the representations of the vendors. The Company expects that the effort needed to correct for Y2K problems on such systems will be less time intensive than the effort needed to achieve compliance for its centralized systems. The installation of such new PC hardware and software was commenced in early 1999 and is expected to be completed by September 1, 1999. The Company also faces the risk that one or more of its external suppliers of goods or services ("third party providers") will not be in a position to properly interact with the Company due to the inability of such third party provider to resolve its own Y2K issues. Pursuant to the Plan, the Company has completed an inventory of its third party provider relationships. In order to assess the Y2K readiness of such third party providers, the Company has developed and forwarded a detailed questionnaire to such providers. As the responses to the questionnaires are received, the Company will evaluate the overall Y2K readiness of its third party provider relationships. However, the Company does not have sufficient information at the current time to determine whether the computer systems of its third party providers will be in compliance with the Y2K requirements as the year 2000 approaches. In the event that a major administrative system fails to operate properly due to the Y2K problem, or the Company does not complete the necessary systems conversions prior to January 1, 2000, the Company has developed a plan to respond to such a contingency. FIC Computer Services has assigned certain personnel to be members of an emergency response team to resolve Y2K operations problems. Additionally, insurance policies would be administered manually if the necessary systems conversions were not completed prior to January 1, 2000, or subsequent Y2K operational problems arise. Manual policy administration would require additional personnel. If substantial additional personnel become necessary for manual policy administration, the training and salary expenses of such personnel could materially affect the Company's business and results of operations. The Company is not able to estimate the likelihood that manual administration will be needed or the amount of any expense which it would incur in connection with such manual administration. -36- Cautionary Statements for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995 Except for historical factual information set forth in this Management's Discussion and Analysis, certain statements made in this report are forward looking and contain information about financial results, economic conditions, Y2K risks and other risks and known uncertainties. The Company cautions the reader that actual results could differ materially from those anticipated by the Company, depending upon the eventual outcome of certain factors, including: (1) heightened competition for new business, (2) significant changes in interest rates, (3) adverse regulatory changes affecting the business of insurance and (4) adverse changes in the Y2K readiness of the Company or its significant third party providers. Accounting Developments In February 1997, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard (FAS) No. 128, "Earnings Per Share," which revises the standards for computing earnings per share previously prescribed by APB Opinion No. 15, "Earnings Per Share." The Statement establishes two measures of earnings per share: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. The Statement requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with potential dilutive securities outstanding. The Statement also requires a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation. The Statement is effective for interim and annual periods ending after December 15, 1997. Earlier application is not permitted. However, a company may disclose pro forma earnings per share amounts that would have resulted if it had applied the Statement in an earlier period. The Company adopted FAS 128 in its annual financial statements for the year ended December 31, 1997. In June, 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income", which establishes standards for reporting and display of comprehensive income and its components in a financial statement with the same prominence as other financial statements. Comprehensive income is defined as net income adjusted for changes in stockholders' equity resulting from events other than net income or transactions related to an entity's capital instruments. The Company adopted FAS 130 effective January 1, 1998, with reclassification of financial statements for earlier years. In June, 1997, the FASB issued FAS No. 131, "Disclosure About Segments of an Enterprise and Related Information", which establishes standards for reporting information about operating segments. Generally, FAS No. 131 requires that financial information be reported on the basis that -37- it is used internally for evaluating performance. The Company adopted FAS No. 131 effective January 1, 1998 and comparative information for earlier years has been restated. This statement does not need to be applied to interim financial statements in the initial year of application. The adoption of FAS No. 131 did not impact upon the Company's reporting of financial information. In February, 1998, the FASB issued FAS No. 132, "Employers' Disclosures About Pensions and Other Postretirement Benefits", which revises current disclosure requirements for employers' pension and other retiree benefits. FAS No. 132 does not change the measurement or recognition of pension or other postretirement benefit plans. The Company adopted FAS No. 132 effective January 1, 1998, with the effect of such adoption to be reflected in year-end financial statements. The adoption of FAS No. 132 did not have a material impact on the Company's results of operations, liquidity or financial position. In December, 1997, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments", which provides guidance on accounting for insurance-related assessments. The Company is required to adopt SOP 97-3, effective January 1, 1999. Previously issued financial statements should not be restated unless the SOP is adopted prior to the effective date and during an interim period. The adoption of SOP 97-3 is not expected to have a material impact on the Company's results of operations, liquidity or financial position. In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FAS No. 133 is applicable to financial statements for all fiscal quarters of fiscal years beginning after June 15, 1999. As the Company does not have significant investments in derivative financial instruments, the adoption of FAS 133 does not have a material impact on the Company's results of operations, liquidity or financial position. Item 7A. Quantitative and Qualitative Disclosures About Market Risk General: ILCO'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 and prices, principally interest rates 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 section entitled "Investment of Assets" in Item I of this report and the information set forth in "Management's Discussion and Analysis of Financial Condition and Operations - Investments". -38- 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 which 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 which 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: Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in fair market value related to the financial instruments segment of the Company's balance sheet is estimated to be $17.1 million at December 31, 1998 and $25.9 million at December 31, 1997. For purposes of the foregoing estimate, the following categories of the Company's fixed income investments were taken into account: (i) fixed maturities, including fixed maturities available for sale, (ii) short-term investments and (iii) notes receivable from affiliates. The market value of such assets was $672.6 million at December 31, 1998 and $676.3 million at December 31, 1997. The fixed income investments of the Company include certain mortgage-backed securities. The market value of such securities was $250.8 million at December 31, 1998 and $299.7 million at December 31, 1997. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in the fair market value related to such mortgage-backed securities is estimated to be $7.1 million at December 31, 1998 and $14.0 million at December 31, 1997. Separate account assets have not been included, since gains and losses on those assets generally accrue to the policyholders. The hypothetical effect of the interest rate risk on fair values was estimated by applying a commonly used model. The model projects the impact of interest rate changes on a range of factors, including duration and potential prepayment. Item 8. Financial Statements and Supplementary Data The following Financial Statements of ILCO and its consolidated subsidiaries have been filed as part of this report: 1. Report of PricewaterhouseCoopers LLP, Independent Accountants, dated March 26, 1999. 2. Consolidated Balance Sheets, as of December 31, 1998 and December 31, 1997. 3. Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996. -39- 4. Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996. 5. Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996. 6. Notes to Consolidated Financial Statements. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure No independent accountant who audited the Registrant's financial statements has resigned or been dismissed during the two most recent fiscal years. -40- PART III Item 10. Directors and Executive Officers of Registrant (a) Directors of the Registrant The names and ages of the current directors of the Registrant, their principal occupations or employment during the past five years and other data regarding them are set forth below. All of the directors were elected at the 1998 annual shareholders meeting. The data supplied below is based on information provided by the directors, except to the extent that such data is known to the Registrant. Director Name Age Director Principal Occupation Since and Other Information Robert A.Bender 45 1997 Director of ILCO since October, 1997. Vice President of Family Life Insurance Company since January 1997. Vice President of Investors Life Insurance Company of North America since January 1997. Vice President of Investors-IN, formerly known as InterContinental Life Insurance Company since January 1997. Assistant Vice President of Investors Life Insurance Company of North America form February 1994 to January 1997. Assistant Vice President of Investors- Indiana from February 1994 to January 1997. Assistant Vice President of Investors- IN, formerly known as InterContinental Life Insurance Company from February 1994 to January 1997. Assistant Vice President of Family Life Insurance Company from February 1994 to January 1997. Retired from 22 years of service in the U.S. Army in February 1994. -41- Jeffrey H. Demgen 46 1995 Director of FIC since May 1995. Vice President of FIC since August 1996. Vice President and Director of ILCO since August 1996. Director of FIC since May 1995. Executive Vice President and Director of Family Life Insurance Company since August 1996. Senior Vice President and Director of Family Life Insurance Company from October 1992 to August 1996. Executive Vice President and Director of Investors Life Insurance Company of North America since August 1996. Senior Vice President and Director of Investors Life Insurance Company of North America from October 1992 to June 1995. Executive Vice President of Investors-IN, formerly known as InterContinental Life Insurance Company since August 1996. Senior Vice President of Investors-IN, formerly known as InterContinental Life Insurance Company from October 1992 to June 1995. Executive Vice President and Director of Investors-Indiana from August 1996 to December 1997. Senior Vice President of United Insurance Company of America from September 1984 to July 1992 Theodore A. Fleron 59 1991 Vice President and Director of ILCO since May 1991. Assistant Secretary since June 1990. Vice President and Director of FIC since August 1996. Senior Vice President, General Counsel, Assistant Secretary and Director of Investors Life Insurance Company of North America and Investors-IN, formerly known as InterContinental Life Insurance Company since July 1992. General Counsel, Assistant Secretary and Director of Investors Life Insurance Company of North America and Investors- IN, formerly known as InterContinental Life Insurance Company from January 1989 to July 1992.Senior Vice President, General Counsel, Director and Assistant Secretary of Investors-Indiana from June 1995 to December 1997. Senior Vice President, General Counsel Director and Assistant Secretary of Family Life Insurance Company since August 1996. W. Lewis 67 1988 Dentist practicing in San Gilcrease Marcos, Texas. Director of ILCO since 1988. Director of FIC from 1979 to July 6, 1991. -42- James M. Grace 55 1984 Vice President and Treasurer of the Company since January, 1985. Executive Vice President, Treasurer and Director of Investors-IN, formerly known as InterContinental Life Insurance Company since 1989. Vice President,Treasurer and Director of Financial Industries Corporation since July, 1976. Executive Vice President and Treasurer of Investors Life Insurance Company of North America since 1989; Executive Vice President, Treasurer and Director of Family Life Insurance Company (a subsidiary of Financial Industries Corporation) since June 1991. Director, Executive Vice President and Treasurer of Investors-Indiana from February 1995 to December 1997. Richard A. 66 1981 Certified Public Accountant and Kosson a partner in the firm of Manheim, Kosson & Novick in Millburn, New Jersey. Director of ILCO since 1981. Roy F. Mitte 67 1984 Chairman of the Board and Chief Executive Officer of the Company and Investors-IN formerly known as InterContinental Life Insurance Company sinceJanuary, 1985. President of the Company since April, 1985. Chairman of the Board, President and Chief Executive Officer of Financial Industries Corporation since 1976. Chairman of the Board, President and Chief Executive Officer of Investors Life Insurance Company of North America since December, 1988. Chairman of the Board, President and Chief Executive Officer of Family Life Insurance Company since June 1991. Chairman of the Board, President and Chief Executive Officer of Investors- Indiana from February 1995 to December 1997. Chairman, ILG Securities Corporation since December 1988. Elizabeth T. Nash 49 1998 Member of the Board of Regents, Texas State University System since 1993, Chairman from 1997 to 1998, Vice-Chairman from 1996 to 1997. Trustee of the Development Foundation of Southwest Texas State University since 1987, Chairman from 1992 to 1997, Vice-Chairman from 1989 to 1992. Director of ILCO since 1998. -43- Eugene E. Payne 56 1989 Vice President of ILCO since December 1988 and Director and Secretary since May 1989. Vice President and Director of Financial Industries Corporation since February 1992. Executive Vice President, Secretary and Director of Investors Life Insurance Company of North America since December 1988. Executive Vice President since December 1988 and Director since May 1989 of Investors- IN, formerly known as InterContinental Life Insurance Company. Executive Vice President, Secretary and Director of Family Life Insurance Company since June 1991. Director, Executive Vice President and Secretary of Investors-Indiana from February 1995 to December 1997. H. Gene Pruner 70 1995 Director of ILCO since August 1996. Director of Investors-IN since February, 1995. President of Market Share, Inc. since April 1985. Steven P. Schmitt 52 1994 Senior Vice President since April 1992 and Director, Vice President and Assistant Secretary since August 1989 of Investors Life Insurance Company of North America and Investors- IN, formerly known as InterContinental Life Insurance Company. Senior Vice President since April 1992 and Director and Vice President since June 1991 of Family Life Insurance Company. Director, Senior Vice President and Assistant Secretary of Investors-Indiana from June 995 to December 1997. The incumbent directors have been nominated for submission to vote of the shareholders for reelection at the 1999 annual shareholders' meeting. -44- (b) Executive Officers of the Registrant The following table sets forth the names and ages of the persons who have served as Registrant's Executive Officers during 1998 together with all positions and offices held by them with the Registrant. Officers are elected to serve at the will of the Board of Directors or until their successors have been elected and qualified. Name Age Positions and Offices Roy F. Mitte 67 Chairman of the Board, President and Chief Executive Officer James M. Grace 55 Vice President and Treasurer Eugene E. Payne 56 Vice President and Secretary Jeffrey H. Demgen 46 Vice President In May 1991, Roy F. Mitte suffered a stroke, resulting in partial paralysis affecting his speech and mobility. Mr. Mitte continues to make the requisite decisions in his capacity as Chief Executive Officer, although his ability to communicate and his mobility are impaired. (c) Identification of certain significant employees Not Applicable. (d) Family relationships Not Applicable. (e) Business experience All of the executive officers of the Company are members of the Board of Directors and their business experience has been outlined in Item 10(a). (f) Compliance with Section 16(a) of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of beneficial ownership on Form 3 and changes in beneficial ownership on Forms 4 and 5 with the Securities and Exchange Commission. Officers, directors and greater than ten-percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) -45- forms they file. Based solely on review of the copies of such forms furnished to the Company, or written representations that no Forms 5 were required, the Company believes that for the period from January 1, 1998 through December 31, 1998 all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were complied with. Item 11. Executive Compensation Summary Compensation Table The following table sets forth information concerning the compensation of the Company's Chief Executive Officer and each of the three other persons who were serving as executive officers of the Company at the end of 1998 and received cash compensation exceeding $100,000 during 1998. Annual Compensation Long Term Compens- Name and ation Awards All Other Principal Stock Options Compensa- Position Year Salary(1) Bonus(7) Other(2) (Shares) tion8 Roy F. Mitte, Chairman, President and 1998 $ 356,679 $1,535,000 -0- -0- -0- Chief Executive 1997 $ 252,253 751,500 -0- -0- -0- Officer 1996 $ 286,643 -0- -0- -0- $2,446,397(3) James M. Grace, Vice 1998 195,000 25,000 2,365 President and 1997 195,000 40,000 -0-(4) -0- 19,024 Treasurer 1996 195,000 15,000 -0- -0- -0- Eugene E. Payne, Vice 1998 195,000 20,000 2,365 President and 1997 195,000 40,000 -0-(5) -0- 17,925 Secretary 1996 195,000 15,000 -0- -0- -0- Jeffrey H. 1998 $ 145,384 $ 15,000 -0- -0- -0- Demgen, Vice 1997 $ 117,884 $ 30,000 -0- -0- -0- President6 1996 $ 102,500 $ 7,500 -0- -0- -0-
(1) The executive officers of the Company have also been executive officers of the Company's insurance subsidiaries and FIC and FIC's insurance subsidiary, Family Life. FIC and/or Family Life reimbursed the Company (or, in the case of Mr. Mitte, authorized payment of) the following amounts as FIC's or Family Life's share of these executive officers' cash compensation and bonus for 1996, 1997 and 1998: (i) Mr. Mitte: $216,857, $999,746, and $1,111,821 respectively, which amounts are -46- not included in the above table; (ii) Mr. Grace: $83,987, $68,150 and $64,152 respectively, which amounts are included in the above table; (iii) Dr. Payne: $83,987, $68,150 and $61,447 respectively, which amounts are included in the above table; and (iv) Mr. Demgen $46,125, $66,548 and $72,173, respectively, which amounts are included in the above table. Dr. Payne elected to defer a portion ($13,000) of his 1998 compensation under the provisions of the Company's Non-Qualified Deferred Compensation Plan. See also, Note 7. (2) Does not include the value of perquisites and other personal benefits because the aggregate amount of any such compensation does not exceed the lesser of $50,000 or 10 percent of the total amount of annual salary and bonus for any named individual. (3) During 1996, the Company paid Mr. Mitte: (i) $1,862,000 for the cancellation in 1996 of options to purchase 121,500 shares of the Company's common stock, plus interest at the rate of 8% per year on such amount for a one year period (for a total of $2,011,737); (ii) $120,700 for the federal income tax reimbursement relating to the cancellation in 1995 of options to purchase 50,000 shares of the Company's common stock; and (iii) $313,960 for the federal income tax reimbursement relating to the 1996 options cancellation described above in this footnote. Each of these payments was made pursuant to a contract entered into between the Company and Mr. Mitte in 1993, pertaining to cancellation of options which had been granted to him in 1989. (4) Mr. Grace exercised stock options in 1998 to purchase 12,000 shares of the Company's Common Stock under the Non-Qualified Option Plan. See "Aggregated Option Exercises in 1998" below. (5) Dr. Payne exercised stock options in 1997 to purchase 6,000 shares of the Company's Common Stock under the Non-Qualified Stock Option Plan . See "Aggregated Option Exercises in 1998" below. (6) Mr. Demgen became an executive officer of the Company in August, 1996. (7) The data in this column represents the amount of annual bonus awarded. The bonuses for Mr. Grace, Dr. Payne and Mr. Demgen for the year 1997 represent amounts paid in 1997, but include the bonuses awarded with respect to the years 1996 and 1997. Dr. Payne elected to defer the amounts shown for 1997 and 1998 into the Company's Non-Qualified Deferred Compensation Plan. The Plan was established in 1997 to permit Mr. Grace and Dr. Payne to defer a portion of their compensation. Under the provisions of the Plan, contributions are invested on a money purchase basis and plan benefits are based on the value of the account at retirement or other distribution. In accordance with applicable tax law requirements, amounts allocated to the Plan are subject to the claims of general creditors of the Company. See also, Note 8. (8) The data in this column represents the amount paid by the Company in 1997 and 1998 to Mr. Grace and Dr. Payne to supplement the benefits under the Company's Pension Plan. The supplement relates to each of the past service years for Mr. Grace and Dr. Payne which were affected by the limitation on compensation which the Pension Plan may take into account for benefit accrual purposes. Under federal pension rules, an employee's benefits under a qualified pension plan, such -47- as the ILCO Pension Plan, are limited to certain maximum amounts. The amount of the payments made in 1997 was determined by comparing the accrued benefit for the listed individuals under the ILCO Pension Plan through December 31, 1996 to the accrued benefit which the individual would have had under the Plan's benefit formula without application of the limitations applicable to tax qualified retirement plans. The value of the difference, representing an amount payable for life commencing at normal retirement age, was then commuted to its present value, which amount is included in this column. In 1998, the Company made a similar payment, with respect to benefit accruals for the year 1997 only. Mr. Grace and Dr. Payne elected to defer their respective amounts into the Company's Non-Qualified Deferred Compensation Plan. The Company intends to make a similar payment with respect to benefit accruals for subsequent years; however, there is no obligation for it to do so. See also, Note 7. Option Grants in 1998 No options were granted to any executive officers of the Company during the year 1998. Aggregated Option Exercises in 1998 The following table sets forth information concerning each exercise of stock options during 1998 by each of the individuals who were executive officers of the Company as of December 31, 1998. Shares Acquired Value Name On Exercise (#) Realized ($) James M. Grace 12,000 $227,040 Eugene E. Payne 6,000 $100,020 Aggregated Stock Option Values The following table sets forth information with respect to the unexercised options held by the executive officers of the Company. Number of Unexercised Value of Unexercised Options Held at In-the-Money Options at December 31, 1998 December 31, 19981 Exercisable Unexercisable Exercisable Unexercisable James M. Grace 12,000 -0- $200,040 $ -0- Eugene E. Payne 6,000 -0- $100,020 $ -0-
-48- (1) Based on the closing price of the Company's Common Stock on NASDAQ on December 31, 1998 ($20.00). Members of Compensation Committee W. Lewis Gilcrease, Richard A. Kosson and Elizabeth T. Nash are the members of the Company's Compensation Committee, which makes recommendations to the Board of Directors with respect to the Chief Executive Officer's compensation. Compensation Committee Interlocks and Insider Participation Roy F. Mitte determines the compensation of all executive officers of the Company, other than the Chief Executive Officer. Mr. Mitte is the Chairman of the Board, President and Chief Executive Officer of the Company and FIC. He also determines the compensation of all executive officers of FIC, other than the Chief Executive Officer. Pension Plan Table The following table sets forth estimated annual pension benefits payable upon retirement at age of 65 under the Company's noncontributory defined benefit plan ("Pension Plan") to an employee in the final pay and years of service classifications indicated, assuming a straight life annuity form of benefit. The amounts shown in the table do not reflect the reduction related to Social Security benefits referred to below. Years of Service 30 or Remuneration 15 20 25 more $125,000 $29,437 $ 39,250 $ 49,062 $ 58,875 150,000 35,325 47,100 58,875 70,650 160,000 37,680 50,240 62,800 75,360 175,000 41,212 54,950 68,687 82,425 200,000 47,100 62,800 78,500 94,200 The normal retirement benefit provided under the Pension Plan is equal to 1.57% of final average eligible earnings less 0.65% of the participant's Social Security covered compensation multiplied by the number of years of credited service (up to 30 years). The compensation used in determining benefits under the Pension Plan is the highest average earnings received in any five consecutive full- calendar years during the last ten full-calendar years before the participant's retirement date. The maximum amount of annual salary and bonus that can be used in determining benefits under the Pension Plan is $200,000 for any year prior to 1994 and is $150,000 for 1994, 1995, and 1996 and is $160,000 for 1997 and each subsequent year. -49- The annual eligible earnings, for 1998 only, covered by the Pension Plan (salary up to $160,000) with respect to the individuals reported in the Summary Compensation Table were as follows, with their respective years of credited service under the Pension Plan at December 31, 1998 being shown in parentheses: Mr. Mitte, $160,000 (11 years), Mr. Grace, $160,000 (11 years), Dr. Payne, $160,000 (10 years), and Mr. Demgen, $145,384 (6 years). Compensation of Directors Directors who are not officers or employees of the Company are paid a $5,000 annual fee, and are compensated $1,000 for each regular or special meeting of the Board of Directors which they attend in person. In the case of telephonic meetings of the Board, non-employee directors who participate in such telephonic meetings are compensated $500 for such meeting. Directors who participate via telephone in a regular or special meeting which is held by other than conference telephone are not entitled to a fee for such a meeting. Non-employee directors serving on committees of the Board are compensated in the amount of $500 for each committee meeting they attend whether such participation is in person or by telephone, provided that the committee meeting is held on a day other than that on which the Board meets. Employment Agreements and Change In Control Arrangements The terms and conditions of employment agreements that the Company would enter into upon the occurrence of certain events that result in the agreements taking effect were approved by the Board of Directors with respect to Messrs. Grace and Payne in 1991. Each agreement would include two independent provisions with respect to the effective date and the term of each agreement. First, the term of the agreement would begin on the earlier of (i) the date of retirement (early, normal or deferred) of Roy F. Mitte from his position as Chairman, President and Chief Executive Officer of the Company or (ii) the date of death or disability of Mr. Mitte, and would terminate on the last day of the twelfth month next following the commencement date of the term of the agreement, unless extended upon mutually acceptable terms. Independently, the term of the agreement would commence upon the date that any person who is not currently a control person with respect to the Company acquires, or enters into an agreement to acquire, control of the Company, directly or indirectly, and would end on the last day of the twelfth month next following the date on which the employee receives notice of the termination of his employment with the Company or the life insurance subsidiaries of the Company. During the term of the agreement, the employee would be entitled to perform all of the duties of the position or positions held by the employee with the Company and all subsidiaries of the Company on the date immediately preceding the commencement date of the agreement. During the term of the agreement, the employee would be entitled to an annual rate of compensation which is not less than the annual rate of compensation in effect as of the date immediately preceding the commencement date of the agreement. During the term of the agreement, the employee would be entitled to participate in and benefit from all employee benefit plans and other fringe benefits on -50- the same basis as such plans and benefits are made available to other executive personnel of the Company. The agreement may be terminated by the Company only in the event that the employee is guilty of theft of property of the Company or commits a wrongful act which has a material adverse effect upon the business of the Company and with respect to which the employee would not be entitled to indemnification under the provisions of the Bylaws of the Company in effect as of the commencement date of the agreement. The employee may terminate the agreement upon thirty days advance written notice to the Company. Item 12. Security Ownership of Certain Beneficial Owners and Management The following table presents information as of March 15, 1999 as to all persons who, to the knowledge of the Company, were beneficial owners of five (5%) percent or more of the Common Stock of the Company. Amount and Nature Name and Address of Beneficial Ownership Percent of Class Financial Industries Corp. 701 Brazos, Suite 1400 Austin, TX 78701 1,966,346 44.74 % (5) Roy F. Mitte 701 Brazos, Suite 1400 Austin, TX 78701 1,993,245 (1, 2) 45.36 % (5) Investors Life Insurance Company of North America 701 Brazos, Suite 1400 Austin, TX 78701 334,960 (3) 7.62% (5) Investors Life Insurance Company of Indiana 701 Brazos, Suite 1400 Austin, TX 78701 281,560 (4) 6.41 % (5) Fidelity Management & Research Company 82 Devonshire Street Boston, MA 02109 433,900 (6) 9.87% (5) -51- Heartland Advisors, Inc. 790 North Milwaukee Street Milwaukee, WI 53202 264,800 (7) 6.03 % (5) 1. As of March 15, 1999, Mr. Mitte, jointly with his wife Joann, owns 1,493,216 common shares of Financial Industries Corporation ("FIC"). The holdings of Mr. Mitte of FIC's common stock constitutes 29.54% of the outstanding common stock of that company. In addition, Mr. Mitte holds the position of Chairman, President and Chief Executive Officer of FIC. Since FIC holds a controlling interest in ILCO, Mr. Mitte's personal holdings in the Company have been combined with the holdings of FIC in determining the amount and percentage of Mr. Mitte's beneficial ownership of the Company. 2. Includes 15,999 shares allocated to Mr. Mitte's account under the Employees Savings and Investment Plan and 10,900 shares owned directly by Mr. Mitte. 3. Represents 281,560 shares owned by Investors-IN (formerly InterContinental Life Insurance Company and 53,400 shares owned directly by Investors-NA. Investors-IN is a life insurance company subsidiary of Investors-NA. All of these shares are treated as treasury shares. 4. All are directly owned by Investors-IN and are treated as treasury shares. 5. Assumes that outstanding stock options available to other persons have not been exercised. 6. As reported to the Company on a Schedule 13(G) and a Schedule 13(G)/A filed by FMR Corporation, the parent company of Fidelity Management & Research Company ("Fidelity"). According to the Schedule 13(G) and the Schedule 13(G)/A, Fidelity acts as investment advisor to the Fidelity Low-Priced Stock Fund, a registered investment company, and the Fund is the owner of 432,700 shares of ILCO common stock, of which 418,300 shares were reported on a Schedule 13(G) filed on February 14, 1997, 14,400 additional shares which were reported on a Schedule 13(G)/A filed on February 14, 1998 and 1,200 additional shares which were reported on a Schedule 13(G)/A filed on February 1, 1999. 7. As reported to the Company on a schedule 13(G) filed by Heartland Advisors, Inc. ("Heartland") on January 21, 1999. According to the Schedule 13(G), Heartland acts as investment advisor with respect to certain investment advisory accounts, with respect to which various persons have the right to receive or the power to direct the receipt of dividends from, or the proceeds from the sale of securities. The Schedule 13(G) identifies that the interests of one such account, the Heartland Value Fund, a series of Heartland Group, Inc., a registered investment company, relates to more than 5% of the common stock of ILCO. The following table contains information as of March 15, 1999 as to the Common Stock of the Company beneficially owned by each director, nominee and executive officer and by all executive -52- officers and directors of the Company as a group. The information contained in the table has been obtained by the Company from each director and executive officer except for information known to the Company. Except as indicated in the notes to the table, each beneficial owner has sole voting power and sole investment power as to the shares listed opposite his name. Amount and Nature of Percent of Name Beneficial Ownership Class Robert A. Bender 1,005 (3) * Jeffrey H. Demgen 4,019 (3) * Theodore A. Fleron 15,730 (3,4) * W. Lewis Gilcrease -0- James M. Grace 1 62,456 (2,3) 1.42 % Richard A. Kosson 200 * Roy F. Mitte 1,993,245 (3) 45.36 % Elizabeth T. Nash 100 * Eugene E. Payne 1 11,146 (3) * H. Gene Pruner -0- Steven P. Schmitt 13,573 (3,4) * All Executive Officers and Directors as a group, all of whom are listed above 2,101,474 (1,2,3,4) 47.82% * Less than 1% (1) As an executive officer and/or director of FIC which as of March 15, 1999 beneficially owned 1,966,346 shares of the Company's Common Stock . In addition to the shareholdings of Mr. Mitte in FIC (see Note 1, above), Mr. Grace owns 5,600 shares of FIC Common Stock. -53- (2) Includes 12,000 shares issuable upon exercise of options granted under the Non-Qualified Stock Option Plan during 1988 to Mr. Grace at a price of $3.33 (as adjusted) per share, which are currently available for exercise. (3) Includes shares beneficially acquired through participation in the Company's ESOP, 401K and/or the Employee Stock Purchase Plan, which are group plans for eligible employees. (4) Includes 6,000 shares issuable upon exercise of options granted under the Non-Qualified Stock Option Plan during 1988 to each of Messrs. Fleron and Schmitt at a price of $3.33 (as adjusted) per share, which are currently exercisable. Item 13. Certain Relationships and Related Transactions with Management a. Prior to the repayment of the ILCO Senior Loan on September 30, 1998, the obligations of ILCO under the Senior Loan were guaranteed by FIC. FIC presently owns 1,966,346 shares of the company's Common Stock, constituting 44.74% of such shares outstanding. b. As part of the financing arrangement for the acquisition of Family Life Insurance Company, Family Life Corporation ("FLC"), a subsidiary of FIC, entered into a Senior Loan agreement under which $50 million was provided by a group of banks. The balance of the financing consisted of a $30 million subordinated note issued by FLC to Merrill Lynch Insurance Group, Ins. ("Merrill Lynch") and $14 million borrowed by another subsidiary of FIC from an affiliate of Merrill Lynch and evidenced by a senior subordinated note in the principal amount of $12 million and a junior subordinated note in the principal amount of $2 million and $25 million lent by two insurance company subsidiaries of ILCO. The latter amount was represented by a $22.5 million loan from Investors-NA to FLC and a $2.5 million loan provided directly to FIC by Investors-CA. In addition to the interest provided under those loans, Investors-NA and Investors-CA were granted by FIC non-transferable options to purchase, in the amounts proportionate to their respective loans, up to a total of 9.9 percent of shares of FIC's common stock at a price of $10.50 per share ($2.10 per share as adjusted for the five-for-one stock split in November, 1996), equivalent to the then current market price, subject to adjustment to prevent dilution. The original provisions of the options provided for their expiration on June 12, 1998 if not previously exercised. In connection with the 1996 amendments to the subordinated notes, as described below, the expiration date of the options were extended to September 12, 2006. On July 30, 1993, the subordinated indebtedness owed to Merrill Lynch and its affiliate was prepaid. The Company paid $38 million plus accrued interest to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the subordinated debt was new subordinated loans totaling $34.5 million that FLC and another subsidiary of FIC obtained from Investors-NA. The principal amount of the new subordinated debt is payable in four equal annual installments in 2000, 2001, 2002 and 2003 and bears interest at an annual rate of 9%. The other terms of -54- the new debt are substantially the same as those of the $22.5 million subordinated loans that Investors-NA had previously made to FLC and that continue to be outstanding. In June, 1996, the provisions of the notes from Investors-NA to FIC, Family Life Corporation ("FLC") and Family Life Insurance Investment Company ("FLIIC") were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996; the final quarterly principal payment is due on September 12, 2001; the interest rate on the note remains at 11%, (b) the $30 million note was amended to provide for forty 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%, (c) the $4.5 million note was amended to provide for forty 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%, (d) the $2.5 million note was amended to provide that the principal balance of the note is to be repaid in twenty quarterly installments of $125,000 each, commencing December 12, 1996 with the final payment due on September 12, 2001; the rate of interest remains at 12%, (e) the Master PIK note, which was issued to provide for the payment in kind of interest due under the terms of the $2.5 million note prior to June 12, 1996, was amended to provide that the principal balance of the note ($1,977,119) is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%. In December, 1998, FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder (FIC). Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC. c. The data processing needs of ILCO's and FIC's insurance subsidiaries are provided by FIC Computer Services, Inc. ("FIC Computer"), a subsidiary of FIC. Under the provisions of the data processing agreement, FIC Computer provides data processing services to each subsidiary for fees equal to such subsidiary's proportionate share of FIC Computer's actual costs of providing those services to all of the subsidiaries. The Company's insurance subsidiaries paid $2.82 million and Family Life paid $1.61 million to FIC Computer for data processing services provided during the year ended December 31, 1998. d. In 1995, Investors-NA entered into a reinsurance agreement with Family Life pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which -55- is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. e. In 1996, Investors-NA entered into a reinsurance agreement with Family Life, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. f. Roy F. Mitte serves as Chairman, President and Chief Executive Officer of both FIC and ILCO. James M. Grace serves as Vice President, Treasurer and Director of both companies and Secretary of FIC. Dr. Payne serves as Vice President, Secretary and Director of both companies. Messrs. Demgen and Fleron serve as Vice Presidents and Directors of both companies. Mr. Roy Mitte holds beneficial ownership of 29.54% of the outstanding shares of FIC (see "Security Ownership of Certain Beneficial Owners and Management"). g. Mr. Joseph F. Crowe retired from active service with the Company in January, 1997 and served on the ILCO Board until October, 1997; he continues to serve on the Board of Directors of FIC. Following Mr. Crowe's retirement, the Company entered into a consulting agreement with him. Under the terms of the agreement, Mr. Crowe is to be available for periodic consultation on actuarial matters related to the operations of the life insurance companies. The agreement provides for a payment of $25,000 per year for a period of five- years. h. In November, 1998, FIC and Family Life Insurance Company purchased 373,304 shares of FIC's common stock from the Roy F. and Joann C. Mitte Foundation, a Texas non-profit corporation (the "Foundation"). These shares had been previously donated to the Foundation by Mr. and Mrs. Mitte. The transaction, which was privately negotiated between FIC, Family Life Insurance Company and the Foundation, involved approximately 6.8% of the outstanding shares of FIC. The purchase price was at the then current market price of FIC's common stock ($18.625 per share). Family Life Insurance Company acquired 272,000 shares for its investment portfolio and FIC acquired 101,304 shares. -56- Part IV Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K (a) The following documents have been filed as part of this Report. 1. Financial Statements as identified in Item 8 above. 2. Financial Statement Schedules Required to be filed by Item 8. a. Schedule I-Summary of Investments other than Investments in Related Parties. b. Schedule II -Condensed Financial Statements of Registrant. c. Schedule IV-Reinsurance. 3. Exhibits filed with this report or incorporated herein by reference are as listed in the Index to Exhibits on page EX-1. (b) Reports on Form 8-K: No reports on Form 8-K were filed during the last quarter of the fiscal year ended December 31, 1998. -57- INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES FORM 10-K--ITEM 14 (a)(1) and (2) LIST OF FINANCIAL STATEMENTS TABLE OF CONTENTS (1) The following consolidated financial statements of InterContinental Life Corporation and Subsidiaries are included in Item 8: Report of Independent Accountants .................................F-2 Consolidated Balance Sheets, December 31, 1998 and 1997........ ................................F-3 Consolidated Statements of Income, for the years ended December 31, 1998, 1997 and 1996.......................F-5 Consolidated Statements of Changes in Shareholders' Equity, for the years ended December 31, 1998, 1997 and 1996...............F-6 Consolidated Statements of Cash Flows, for the years ended December 31, 1998, 1997 and 1996.............................F-9 Notes to Consolidated Financial Statements...................,.....F-12 (2) The following consolidated financial statement schedules of InterContinental Life Corporation and Subsidiaries are included: Schedule I - Summary of Investments Other Than Investments in Related Parties................................F-44 Schedule II - Condensed Financial Statements of Registrant.........................................................F-45 Schedule IV - Reinsurance..........................................F-49 All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, or are not applicable, and therefore have been omitted. F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of InterContinental Life Corporation In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page F-1 present fairly, in all material respects, the financial position of InterContinental Life Corporation and its subsidiaries (the "Company") at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Dallas, Texas March 26, 1999 F-2 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands of dollars) December 31, 1998 1997 ASSETS Investments: Fixed maturities, at amortized cost (market value approximates $3,059 and $3,332) $ 3,005 $ 3,412 Fixed maturities available for sale, at market value (amortized cost $435,130 and $436,836) 450,149 454,462 Equity securities, at market value (cost approximates $338 and $369) 3,121 4,902 Policy loans 53,614 53,499 Mortgage loans 10,332 10,862 Invested real estate and other invested assets 10,025 1,300 Short-term investments 171,840 164,622 Total investments 702,086 693,059 Cash and cash equivalents 12,206 9,041 Notes receivable from affiliates 47,645 53,792 Accrued investment income 7,768 7,781 Agent advances and other receivables 20,753 11,362 Reinsurance receivables 18,847 20,433 Property and equipment, net 3,470 1,902 Deferred policy acquisition costs 31,953 28,621 Present value of future profits of acquired businesses 43,666 47,286 Deferred financing costs 0 111 Other assets 10,643 7,929 Separate account assets 451,211 440,336 Total Assets $ 1,350,248 $ 1,321,653
The accompanying notes are an integral part of the consolidated financial statements. F-3 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, Continued (in thousands of dollars) December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997 Policy liabilities and contractholder deposit funds: Future policy benefits $ 135,463 $ 131,720 Contractholder deposit funds 545,908 525,135 Unearned premiums 2,124 2,507 Other policy claims and benefits payable 10,856 12,272 694,351 671,634 Other policyholders' funds 3,056 3,093 Senior loan - 0 - 10,964 Deferred federal income taxes 30,185 31,811 Other liabilities 20,127 20,299 Separate account liabilities 448,294 438,090 Total Liabilities 1,196,013 1,175,891 Commitments and Contingencies(Note 13) Redeemable preferred stock: Class A Preferred, $1 par value, 5,000,000 shares authorized, issued 5,000 5,000 Class B Preferred, $1 par value, 15,000,000 shares authorized, issued 15,000 15,000 20,000 20,000 Redeemable preferred stock held in treasury (20,000) (20,000) -0- -0- Shareholders' Equity: Common Stock, $.22 par value, 15,000,000 shares authorized; 5,385,739 and 5,343,739 shares issued, and 4,376,706 and 4,331,335 shares outstanding in 1998 and 1997, respectively 1,185 1,176 Additional paid-in capital 4,385 4,253 Accumulated other comprehensive income 11,571 14,403 Retained earnings 140,356 129,237 157,497 149,069 Common treasury stock, at cost, 1,009,033 and 1,012,404 in 1998 and 1997, respectively (3,262) (3,307) Total Shareholders' Equity 154,235 145,762 Total Liabilities and Shareholders' Equity $ 1,350,248 $ 1,321,653
The accompanying notes are an integral part of the consolidated financial statements. F-4 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands of dollars, except for per share data) Year Ended December 31, 1998 1997 1996 Revenues: Premium $ 10,890 $ 11,031 $ 9,980 Net investment income 54,619 57,740 59,836 Earned insurance charges 41,067 40,853 42,238 Gain on sale of real estate -0- 14,630 23,520 Other 2,886 3,429 2,670 109,462 127,683 138,244 Benefits and expenses: Policyholder benefits and expenses 38,367 37,962 40,091 Interest expense on contract holders deposit funds 29,966 30,533 32,068 Amortization of present value of future profits of acquired businesses 5,903 6,311 3,366 Amortization of deferred policy acquisition costs 2,128 2,818 2,574 Operating expenses 14,853 16,798 15,884 Interest expense 659 1,659 2,820 91,876 96,081 96,801 Income from operations 17,586 31,602 41,443 Provision for federal income taxes: Current 6,899 9,005 10,227 Deferred (432) 2,057 4,278 6,467 11,062 14,505 Net income $ 11,119 $ 20,540 $ 26,938 Basic: Weighted average common stock outstanding 4,375 4,328 4,233 Basic earnings per share 2.54 $ 4.75 $ 6.36 Diluted: Common stock and common stock equivalents 4,462 4,369 4,441 Diluted earnings per share $ 2.49 $ 4.70 $ 6.07
The accompanying notes are an integral part of these consolidated financial statements. F-5 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands) Additional Common Stock Paid-in Shares Amount Capital Balance at December 31, 1995 5,166 $ 1,137 $ 3,521 Comprehensive Income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities Change in net unrealized gain on investments in fixed maturities available for sale Total comprehensive income Options exercised 58 13 231 Balance at December 31, 1996 5,224 1,150 3,752 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities Change in net unrealized gain on investments in fixed maturities available for sale Total comprehensive income Treasury stock purchased Options exercised 120 26 501 Balance at December 31, 1997 5,344 1,176 4,253 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities Change in net unrealized gain on investments in fixed maturities available for sale Total comprehensive income Treasury stock reissued Options exercised 42 9 132 Balance at December 31, 1998 5,386 $ 1,185 $ 4,385
The accompanying notes are an integral part of these consolidated financial statements. F-6 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands of dollars) Accumulated Other Comprehensive Income Net Unrealized Gain on Net Investments Total Unrealized In Fixed Accumulated Appreciation Maturities Other of Equity Available Comprehensive Securities For Sale Income Balance at December 31, 1995 $ 748 $ 12,938 $ 13,686 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities 507 507 Change in net unrealized gain on investments in fixed maturities available for sale (11,413) (11,413) Total comprehensive income 507 (11,413) (10,906) Options exercised Balance at December 31, 1996 1,255 1,525 2,780 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities 1,691 1,691 Change in net unrealized gain on investments in fixed maturities available for sale 9,932 9,932 Total comprehensive income 1,691 9,932 11,623 Treasury stock purchased Options exercised Balance at December 31, 1997 2,946 11,457 14,403 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities (1,137) (1,137) Change in net unrealized gain on investments in fixed maturities available for sale (1,695) (1,695) Total comprehensive income (1,137) (1,695) (2,832) Treasury stock reissued Options exercised Balance at December 31, 1998 $ 1,809 $ 9,762 $ 11,571
The accompanying notes are an integral part of these consolidated financial statements. F-7 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands of dollars) Common Total Retained Treasury Shareholders' Earnings Stock Equity Balance at December 31, 1995 $ 81,759 $ (3,018) $ 97,085 Comprehensive income: Net income 26,938 26,938 Other comprehensive income: Change in net unrealized appreciation of equity securities 507 Change in net unrealized loss on investments in fixed maturities available for sale (11,413) Total comprehensive income 26,938 16,032 Options exercised 244 Balance at December 31, 1996 108,697 (3,018) 113,361 Comprehensive income: Net income 20,540 20,540 Other comprehensive income: Change in net unrealized appreciation of equity securities 1,691 Change in net unrealized loss on investments in fixed maturities available for sale 9,932 Total comprehensive income 20,540 32,163 Treasury stock purchased (289) (289) Options exercised 527 Balance at December 31, 1997 129,237 (3,307) 145,762 Comprehensive income: Net income 11,119 11,119 Other comprehensive income: Change in net unrealized appreciation of equity securities (1,137) Change in net unrealized loss on investments in fixed maturities available for sale (1,695) Total comprehensive income 11,119 8,287 Treasury stock reissued 45 45 Options exercised 141 Balance at December 31, 1998 $ 140,356 $ (3,262) $ 154,235
The accompanying notes are an integral part of these consolidated financial statements. F-8 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Year Ended December 31, CASH FLOWS FROM OPERATING 1998 1997 1996 ACTIVITIES Net Income $ 11,119 $ 20,540 $ 26,938 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Amortization of present value of future profits of acquired businesses 5,903 6,311 3,366 Amortization of deferred policy acquisition costs 2,128 2,819 2,572 Depreciation 551 2,398 1,356 Net gain on sales of investments (988) (14,805) (23,394) Financing costs amortized 111 525 961 Amortization of deferred gain on sale of real estate (110) (110) (110) Changes in assets and liabilities: Decrease in accrued investment income 698 362 383 (Increase) decrease in agent advances and other receivables (7,686) 4,170 (2,783) Policy acquisition costs deferred (5,460) (4,502) (4,584) Decrease in policy liabilities and contractholder deposit funds (16,194) (17,585) (16,374) (Decrease) increase in other policyholders' funds (668) (258) 20 (Decrease) increase in other liabilities (1,036) 5,172 (13,270) (Decrease) increase in deferred federal income taxes (2,355) 5,302 (1,770) (Increase) decrease in other assets (2,691) 1,036 (2,106) Other, net (653) (7,416) 5,331 Net cash (used in) provided by operating activities (17,331) 3,959 (23,464)
The accompanying notes are an integral part of these consolidated financial statements. F-9 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Year Ended December 31, CASH FLOWS FROM INVESTING 1998 1997 1996 ACTIVITIES Purchase of insurance subsidiary (1,322) (11,688) -0- Investments purchased (41,915) (24,276) (55,395) Proceeds from sales and maturities of investments 77,700 117,025 112,791 Net change in short-term investments (7,218) (71,415) (5,562) Purchases & retirements of equipment (2,119) (283) 1,319 Decrease in notes receivable from affiliates 6,148 6,148 1,284 Net cash provided by investing activities 31,274 15,511 54,437 CASH FLOWS FROM FINANCING ACTIVITIES Issuance (purchase) of treasury stock 45 (289) -0- Issuance of common stock 141 527 244 Repayment of debt (10,964) (13,980) (34,441) Net cash used in financing activities (10,778) (13,742) (34,197) Net increase (decrease) in cash and cash equivalents 3,165 5,728 (3,224) Cash and cash equivalents, beginning of year 9,041 3,313 6,537 Cash and cash equivalents, end of year $ 12,206 $ 9,041 $ 3,313
The accompanying notes are an integral part of these consolidated financial statements. F-10 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Supplemental Cash Flow Disclosures: Year Ended December 31, 1998 1997 1996 Income taxes paid $ 12,362 $ 2,200 $ 13,567 Interest paid $ 871 $ 1,925 $ 3,377 Supplemental Schedule of Non-Cash Investing Activities: The Company purchased the outstanding capital stock of two life insurers in the second quarter of 1998 and the third quarter of 1997 for cash purchase prices of $16.6 million (including a $12.4 million dividend paid by the acquired company to its former parent) and $11.8 million, respectively, net of post closing adjustments. The consolidated statements of cash flows reflect the impact of these acquisitions. These purchases resulted in the Company receiving tangible assets and assuming liabilities as follows: 1998 1997 Assets $ 57,745 $ 32,420 Liabilities $ 41,135 $ 20,653 The accompanying notes are an integral part of these consolidated financial statements. F-11 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Summary of Significant Accounting Policies Organization InterContinental Life Corporation (ILCO or the "Company") is principally engaged, through its subsidiaries, in administering existing portfolios of individual life insurance and annuity products. The Company's insurance subsidiaries are also engaged in the business of marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. Such products are marketed through independent, non-exclusive general agents. Principles of Consolidation The consolidated financial statements include the accounts of InterContinental Life Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Basis of Presentation The financial statements have been prepared in conformity with generally accepted accounting principles which differ from statutory accounting principles required by regulatory authorities for the Company's insurance subsidiaries. Significant accounting policies followed by the Company are: Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results will differ from those estimates. Investments The Company's general investment philosophy is to hold fixed maturity securities until maturity. However, fixed maturities may be sold prior to the maturity dates in response to changing market conditions, duration of liabilities, liquidity factors, interest rate movements and other investment factors. Accordingly, most fixed maturity investments are classified as available for sale and are carried at market value. All other fixed maturities are carried at the lower of amortized cost or net realizable value as management has the positive intent and the Company has the ability to hold such investments to maturity. Unrealized gains and losses on securities available for sale are not recognized in earnings but are reported as a separate component of equity in accumulated other comprehensive income, net of income tax effect. F-12 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Premiums and discounts on collateralized mortgage obligations (CMOs) are amortized over the estimated redemption period as opposed to the stated maturities. Equity securities are carried at market value. Unrealized gains and losses on equity securities, net of deferred income taxes, if applicable, are reflected directly in shareholders' equity. Mortgage loans and policy loans are recorded at unpaid balances. Short-term investments are carried at cost, which approximates market value, and generally consist of those fixed maturities and other investments that are intended to be held less than one year from the date of purchase. Real estate is carried at cost less accumulated depreciation, which is generally calculated using the straight-line method over 20 to 40 years. Accumulated depreciation on investments in real estate is $5,501,545 and $5,243,720 at December 31, 1998 and 1997, respectively. Interest is capitalized on funds expended for construction of facilities for the Company's own use and for facilities intended for sale or lease. Interest cost capitalized and included as a component of the historical cost of the assets was approximately $-0- and $237,000 in 1998 and 1997, respectively. Realized gains and losses on disposal of investments are included in net income. The cost of investments sold is determined on the specific identification basis, except for equity securities, for which the first-in, first-out method is employed. When an impairment of the value of an investment is considered other than temporary, the decrease in value is reported in net income as a realized investment loss and a new cost basis is established. Cash and Cash Equivalents Short-term investments with maturities of three months or less at the time of purchase are reported as cash equivalents. Sale of Real Estate Net income for 1997 includes $14.0 million (before federal income tax) resulting from the sale during the fourth quarter of 1997 of the Bridgepoint Square office complex. The aggregate selling price was $78 million which was allocated approximately 78.5% to Investors-NA and 21.5% to Family Life. The sale closed on December 5, 1997. Net income for 1996 includes $23.5 million (before federal income tax) resulting from the sale during the first quarter of 1996 of the Austin Centre, a hotel/office complex, located in Austin, Texas, which served as the Company's home office building. The selling price was $62.67 million, less $1 million paid to a capital reserve account for the purchaser. The property was purchased in 1991 for $31.275 million. The book value of the property, $36.8 million, net of improvements and amortization, was retained and reinvested by the Company. The balance of the proceeds of the sale, net of federal income tax, was used to reduce the Company's senior loan obligations by $15 million. The sale closed on March 29, 1996. F-13 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Property and Equipment Property and equipment is stated at cost less accumulated depreciation. Depreciation is calculated using straight-line and accelerated methods over estimated useful lives of 10 to 33 years for buildings and improvements and 10 years for furniture and equipment. Maintenance and repairs are charged to expense when incurred. Accumulated depreciation for property and equipment and home office real estate was $5,091,033 and $4,517,477 at December 31, 1998 and 1997, respectively. Deferred Acquisition Costs The cost of acquiring new and renewal business, principally first year commissions and certain expenses of the policy issuance and underwriting departments, which vary with and are primarily related to the production of new and renewal business, have been deferred to the extent recoverable. Acquisition costs related to universal life products are deferred and amortized in proportion to the ratio of estimated annual gross profits to total estimated gross profits over the expected lives of the contracts. Acquisition costs related to traditional life insurance business are deferred and amortized over the premium paying period of the related policies. Present Value of Future Profits The present value of future profits of acquired traditional life business is amortized over the premium paying period of the related policies in proportion to the ratio of the annual premium revenue to total anticipated premium revenue applicable to such policies. Interest on the unamortized balance is accreted at rates from 7.0% to 8.5%. For interest-sensitive products, these costs are amortized in relation to the present value, using the current credited interest rate, of expected gross profits of the policies over the anticipated coverage period. Retrospective adjustments of these amounts are made periodically upon the revision of estimates of current or future gross profits on universal life-type products to be realized from a group of policies. Recoverability of present value of future profits is evaluated periodically by comparing the current estimate of future profits to the unamortized asset balances. Anticipated investment returns, including realized gains and losses, from the investment of policyholder balances are considered in determining the amortization of present value of future profits acquired. F-14 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred Financing Costs Financing costs associated with the Company's Senior Loan were deferred and were amortized over the borrowing periods using the interest method. Separate Accounts Separate account assets, carried at market value, and liabilities represent policyholder funds maintained in accounts having specific investment objectives. The net investment income, gains and losses of these accounts, less applicable contract charges, generally accrue directly to the policyholders and are not included in the Company's statement of income. Solvency Laws Assessments The solvency or guaranty laws of most states in which the Company's insurance subsidiaries do business may require the Company's insurance subsidiaries to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. The Company's insurance subsidiaries' expense for guaranty fund assessment from states which do not allow premium tax offsets is not material. Policy Liabilities and Contractholder Deposit Funds Liabilities for future policy benefits related to traditional life products are computed using the net level premium method or an equivalent actuarial method. Assumptions for future investment yields are incorporated in these liabilities (principally 8% for guaranteed premium products). Assumptions for mortality and withdrawal, based on industry and Company experience for all products, include provisions for possible unfavorable deviations. The liability for future policy benefits for traditional life policies is graded to reserves stipulated by regulatory authorities over a 30-year period or the end of the premium paying period, if less. Contractholder deposit funds are liabilities for universal life and annuity products. These liabilities consist of deposits received from customers and accumulated net investment income on their fund balances, less administrative charges. Universal life fund balances are also assessed mortality charges. The cash value benefit for these products is based on actual crediting rates, which are lower than assumed investment yields. Liabilities for future policy benefits related to non-cancelable and guaranteed renewable accident and health contracts are computed based on industry and Company experience and estimated future investment yields ranging from 4 1/2% to 6%. Unearned premium reserves for credit life and accident and health contracts are computed on either the sum-of-the-year's digits or pro rata methods F-15 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS depending upon the type of coverage. In December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which all of the contractual obligations and risks under accident and health insurance policies were assumed by a third party reinsurer. (See Note 8.) Other Policy Claims and Benefits Payable The liability for other policy claims and benefits payable represents management's estimate of unpaid losses on claims and other miscellaneous liabilities to policyholders. Estimated unpaid losses on claims are comprised of losses on claims that have been reported but not yet paid, including estimates of additional development of initial claims estimates, and claims that have been incurred but not yet reported (IBNR) to the Company. The liability for other policy claims and benefits payable is subject to the impact of changes in claim severity, frequency and other factors. Although there is considerable variability inherent in such estimates, management believes that the liability recorded is adequate. Revenue Recognition Premiums on traditional life and health products are recognized as revenue over the premium paying period when due. Credit life and credit health insurance premiums are recognized over the contract period on a pro rata basis, or the sum of years digits basis. Benefits and expenses are associated with earned premiums, so as to result in recognition of profits over the lives of the contracts. Proceeds from investment-related products and universal life products are recorded as liabilities when received. Revenues for investment-related products consist of contract charges assessed against the deposit fund values and net investment income. Related benefit expenses primarily consist of interest credited to the fund values after deductions for investment and policy charges. Revenues for universal life products consist of net investment income, mortality and administration charges against deposits and fund values and surrender charges assessed against the fund values. Related benefit expenses include universal life benefit claims in excess of fund values and interest credited to universal life fund values. Net Income Per Share Net income per share is calculated based on two methods, basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. Both methods are presented on the face of the income statement. F-16 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Federal Income Taxes In February, 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109). The Company adopted FAS 109 on a prospective basis effective January 1, 1993. FAS 109 mandates the asset and liability method for computing deferred income taxes. Under this method, balance sheet amounts for deferred income taxes are computed based on the tax effect of the differences between the financial reporting and federal income tax basis of assets and liabilities using the tax rates which are expected be in effect when these differences are anticipated to reverse. New Accounting Pronouncements In February 1997, the Financial Standards Board ("FASB") issued FAS No. 128, "Earnings Per Share", which revises the standards for computing earnings per share previously prescribed by APB Opinion No. 15, "Earnings Per Share". The Statement establishes two measures of earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were converted or exercised. The Statement requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with potentially dilutive securities outstanding. The Statement also requires a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation. The Statement is effective for interim and annual periods ending after December 15, 1997. The Company adopted SFAS No. 128 for the year ended December 31, 1997 and has restated the earnings per share computations for 1996 to conform to this pronouncement. In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income and its components. Comprehensive income is defined as net income adjusted for changes in stockholders' equity resulting from events other than net income or transactions related to an entity's capital instruments. The Company has adopted FAS 130 for the year ended December 31, 1998 and has restated the financial statement presentation for 1997 and 1996 as required by this pronouncement. In June 1997, the FASB issued FAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for reporting information about operating segments. Generally, FAS 131 requires that financial information be reported on the basis that is used internally for evaluating performance. The Company adopted SFAS 131 for the year ended December 31, 1998. As described in Note 1, the Company is principally engaged, through its F-17 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS subsidiaries, in administering existing portfolios of individual life insurance and annuity products. The Company's insurance subsidiaries are also engaged in the business of marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. Such products are marketed through independent, non-exclusive general agents. Management considers the Company's insurance operations to constitute one reportable segment. Premium revenues for traditional insurance products and earned insurance charges on universal life and annuity products are presented in the accompanying consolidated statements of income. No single customer accounts for 10 percent or more of the Company's revenue. The Company has no foreign operations. In February 1998, the FASB issued FAS No. 132, "Employers Disclosures about Pensions and Other Postretirement Benefits," which revises current disclosure requirements for employers' pension and other retiree benefits. FAS 132 does not change the measurement or recognition of pension or other postretirement benefit plans. The Company adopted FAS 132 for the year ended December 31, 1998, and restated disclosures for 1997 and 1996 as required by this pronouncement. In December 1997, the Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," which provides guidance on accounting for insurance-related assessments. The Company is required to adopt SOP 97-3 effective January 1, 1999. Previously issued financial statements should not be restated unless the SOP is adopted prior to the effective date and during an interim period. The adoption of this SOP is not expected to have a material impact on the Company's financial statements. In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FAS No. 133 is applicable to financial statements for all fiscal quarters of fiscal years beginning after June 15, 1999. As the Company does not have significant investments in derivative financial instruments, the adoption of FAS 133 does not have a material impact on the Company's results of operations, liquidity or financial position. Reclassification Certain prior years' amounts have been reclassified to conform with the 1998 presentation. F-18 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. Investments Fixed Maturities The amortized cost, gross unrealized gains and losses and market values of fixed maturities available for sale and fixed maturities held to maturity at December 31, 1998 and 1997, respectively were as follows (in thousands): Amortized Gross Unreal- Gross Unreal- Market Cost ized Gains ized Losses Value Fixed Maturities Available for Sale as of December 31, 1998: U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 37,360 $ 3,293 $ 1 $ 40,652 Obligations of states and political subdivisions 4,690 383 -0- 5,073 Corporate securities 148,989 4,755 110 153,634 Mortgage-backed securities 244,091 7,067 368 250,790 Total fixed Maturities Available For Sale 435,130 15,498 479 450,149 Fixed Maturities Held to Maturity: Private placements-corporate 3,005 54 0 3,059 Total Fixed Maturities $ 438,135 $ 15,552 $ 479 $453,208 Fixed Maturities Available For Sale as of December 31, 1997 U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 24,556 $ 1,334 $ 65 $ 25,825 Obligations of states and political subdivisions 4,686 349 -0- 5,035 Corporate securities 119,847 4,696 630 123,913 Mortgage-backed securities 287,747 12,458 516 299,689 Total Fixed Maturities Available For Sale 436,836 18,837 1,211 454,462 Fixed Maturities Held to Maturity: Private placements-corporate 3,412 20 100 3,332 Total Fixed Maturities $ 440,248 $ 18,857 $ 1,311 $ 457,794
F-19 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amounts of unrealized gains and losses on fixed maturities available for sale included in accumulated other comprehensive income reflected in the balance sheet have been reduced by estimated deferred taxes in the amount of $5,257,000 and $6,169,000 in 1998 and 1997, respectively. The amortized cost and market value of fixed maturities available for sale and fixed maturities held to maturity at December 31, 1998 is shown below by contractual maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fixed Maturities Available for Sale Amortized Market Cost Value (in thousands) Due in one year or less $ 23,437 $ 23,578 Due after one through five years 47,730 49,263 Due after five through ten years 27,610 29,215 Due after ten years 92,263 97,303 Mortgage backed securities 244,090 250,790 Total Fixed Maturities Available for Sale $435,130 $ 450,149 Fixed Maturities Held to Maturity Amortized Market Cost Value (in thousands) Due in one year or less $ -0- $ -0- Due after one through five years 2,148 2,171 Due after five through ten years 760 777 Due after ten years 97 111 Mortgage backed securities -0- -0- Total Fixed Maturities Held to Maturity $ 3,005 $ 3,059 Proceeds from sales and maturities of investments in fixed maturities during 1998, 1997 and 1996 were approximately $77,700,000, $57,840,000, and $53,888,000. Gross gains of approximately $178,000, $293,000, and $322,000 and gross losses of approximately $16,000 $123,000, and $100,000 were realized on those sales and maturities in 1998, 1997 and 1996, respectively. F-20 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity Securities The change in net unrealized appreciation for equity securities was $(1,749,000) and $2,601,000 for the years ended December 31, 1998 and 1997, respectively. Amounts as of December 31 were as follows (in thousands): 1998 1997 Unrealized appreciation $ 2,796 $ 4,543 Unrealized depreciation (13) (11) Net unrealized appreciation before tax 2,783 4,532 Less: Federal income tax (974) (1,586) Net unrealized appreciation $ 1,809 $ 2,946 Equity securities included a $3,083,438 investment, ($318,390 at cost), in 189,750 shares of common stock of Financial Industries Corporation (FIC) (See note 9). This represents 3.5% of FIC's outstanding common stock at December 31, 1998. The net change in unrealized investment gains (losses) represents the only component of other comprehensive income for the years ended December 31, 1998, 1997 and 1996. The following is a summary of the change in unrealized investment gains (losses) net of related deferred income taxes which are reflected in accumulated other comprehensive income for the periods presented: Change in Unrealized Gains (Losses) on Investments 1998 1997 1996 (in thousands) Fixed maturities $ (2,607) $ 15,280 $ (17,558) Equity securities (1,749) 2,602 780 (4,356) 17,882 (16,778) Deferred federal income taxes (1,524) 6,259 (5,872) Net change in unrealized gains (losses) on investments $ (2,832) $ 11,623 $ (10,906) F-21 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table sets forth the reclassification adjustments required for the years ended December 31, 1998, 1997 and 1996: Reclassification Adjustments 1998 1997 1996 (in thousands) Unrealized holding gains (losses) on investments arising during the period $ (2,621) $ 11,733 $ (10,761) Reclassification adjustments for gains included in net income 211 110 145 Unrealized gains (losses) on investments, net of reclassification adjustment $ (2,832) $ 11,623 $ (10,906) Net Investment Income The components of net investment income are summarized as follows (in thousands): Year Ended December 31, 1998 1997 1996 Fixed maturities $ 47,322 $ 46,570 $ 47,448 Equity securities 7 10 12 Other, including policy loans, real estate and mortgage loans 8,275 14,826 15,708 55,604 61,406 63,168 Investment expenses (985) (3,666) (3,332) Net Investment Income $ 54,619 $ 57,740 $ 59,836 Realized Gains and Losses Net realized gains (losses) included in net investment income are summarized below (in thousands): Year Ended December 31, 1998 1997 1996 Fixed maturities available for sale $ 161 $ 171 $ 222 Equity securities 164 (2) 1 Other investments 663 6 (256) 988 175 33 Income taxes 346 61 12 Net realized gains $ 642 $ 114 $ 21 F-22 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Mortgage loans and invested real estate The Company's mortgage loans and invested real estate are diversified by property type, location and issuer. Mortgage loans are collateralized by the related properties and such loans generally range from 15% to 80% of the property's value at the time the loan is made. No new mortgage loans were made during the three year period ended December 31, 1998. Non-income producing investments The carrying value of non-income producing investments were as follows as of December 31: 1998 1997 (in thousands) Fixed Maturities $ -0- $ -0- Mortgage loans 81 81 Total $ 81 $ 81 3. Disclosures about Fair Value of Financial Instruments The estimated fair value of the Company's financial instruments at December 31, 1998 are as follows: Carrying Fair Amount Value (in thousands) Financial assets: Fixed maturities $ 453,154 $ 453,208 Policy loans 53,614 53,614 Mortgage loans 10,332 10,883 Short-term investments 171,840 171,840 Cash and cash equivalents 12,206 12,206 Notes receivable from affiliates 47,645 47,645 Carrying Fair Amount Value (in thousands) Financial liabilities: Deferred annuities $ 134,062 $ 132,208 Supplemental contracts 14,859 14,228 F-23 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following methods and assumptions were used to estimate the fair value of each class of financial investments: Fixed maturities Fair values are based on quoted market prices or dealer quotes. Policy loans Policy loans are, generally, issued with coupon rates below market rates and are considered early payment of the life benefit. As such, the carrying amount of these financial instruments is a reasonable estimate of their fair value. Mortgage loans The fair value of mortgage loans is estimated using a discounted cash flow analysis using rates for BBB- rated bonds with similar coupon rates and maturities. Cash and cash equivalents and short-term investments The carrying amount of these instruments approximates market value. Notes receivable from affiliates The fair value is based on redemption value. Senior loans The fair value has been set at the price to call the debt. Deferred annuities and supplemental contracts The fair value of deferred annuities is estimated using cash surrender values. Fair values for supplemental contracts is estimated using a discounted cash flow analysis, based on interest rates currently offered on similar products. F-24 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. Present Value of Future Profits of Acquired Business An analysis of the present value of future profits of acquired businesses is as follows: 1998 1997 (in thousands) Beginning balance $ 47,286 $ 45,240 Acquisition of insurance subsidiary 1,981 8,357 Accretion of interest 3,559 3,786 Amortization (9,160) (10,097) Ending Balance $ 43,666 $ 47,286 Amortization of the present value of future profits included in the consolidated statements of income is presented net of the accretion of interest. The estimated amount of present value of future profits to be amortized net of interest accretion during each of the next five years is as follows: (in thousands) 1999 $ 3,800 2000 $ 3,506 2001 $ 3,142 2002 $ 2,912 2003 $ 2,668 5. Acquisition of Business On June 30, 1998, ILCO, through its subsidiary, Investors-Indiana, acquired Grinnell Life Insurance Company ("Grinnell Life") an Iowa-domiciled life insurer, from Grinnell Mutual Life Insurance Company for an adjusted purchase price of $16.6 million. As part of the transaction, Grinnell Life was immediately merged with and into Investors-Indiana, with Investors-Indiana being the surviving entity. On July 9, 1997, ILCO and Investors-Indiana acquired State Auto Life Insurance Company, an Ohio domiciled life insurer, from State Automobile Mutual Insurance Company, for an adjusted cash purchase price of $11.8 million. The transaction was accounted for as a purchase business combination. Accordingly, the results of State Auto Life's operations are included in income from the date of the acquisition. The purchase price was allocated to the fair values of the assets and liabilities acquired including the present value of future profits disclosed in Note 4. Under the terms of the transaction, State Auto Life was merged into Investors-Indiana. On February 14, 1995, the Company and Investors-NA completed the purchase of Meridian Life Insurance Company (MLIC), a life insurer domiciled in Indiana, from Meridian Mutual Insurance Company. Under the terms of the agreement, the Company acquired approximately 82% of the outstanding common stock of MLIC for F-25 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS $14 million. Investors-NA acquired the remaining 18% for $3 million. Immediately after finalizing the transaction, ILCO contributed its acquired shares to unassigned surplus of Investors-NA, resulting in MLIC being a wholly owned subsidiary of Investors-NA. ILCO's senior loans were increased by $15 million (through an amendment to the loan agreement) to fund its portion of the purchase price. Subsequent to the purchase, MLIC's name was officially changed to Investors Life Insurance Company of Indiana (Investors-Indiana). The transaction was accounted for as a purchase business combination. Accordingly, the results of Investors-Indiana's operations are included in income from the date of the acquisition. The purchase price was allocated to the fair values of the assets and liabilities acquired, including the present value of future profits disclosed in Note 4. 6. Senior Loans The Senior Loan of ILCO was originally arranged in connection with the 1988 acquisition of Investors-NA and Investors-CA. In January, 1993, the Company refinanced its Senior Loan. That transaction was done in connection with the prepayment of the subordinated indebtedness and the purchase of warrants which had been issued as part of the financing of the 1988 acquisitions. The terms of the amended and restated credit facility were substantially the same as the terms and provisions of the 1988 senior loan. The average interest rate paid by the Company on its Senior Loan was approximately 7.76% during 1996, 7.68% during 1997 and 7.63% during 1998. The maturity date, which had been December 31, 1996, was extended to July 1, 1998 for the Senior Loan. In February, 1995, the Company borrowed an additional $15 million under the Senior Loan to help finance the acquisition of Investors-IN, and the maturity date of the Senior Loan was further extended to July 1, 1999. As of December 31, 1995, the outstanding principal balance of ILCO's senior loan obligations was $59.4 million. In January, 1996, the Company made a scheduled payment of $4.5 million under its Senior Loan. In March, 1996, the Company made the scheduled payments for April 1st and July 1st, totaling $9 million. At that same time, the Company made a payment of $941,000, an additional payment under the terms of the loan applied to the principal balance. On April 1, 1996, an optional principal payment in the amount of $15 million was made, which resulted in advancing the scheduled payoff date of the Senior Loan to April 1, 1998. In July, 1996, the Company made the principal payment for October 1st ($4.5 million), plus an optional principal payment of $0.5 million. In connection with the acquisition of State Auto Life Insurance Company in July, 1997, the Senior Loan agreement was modified to extend the maturity date to October 1, 1998. As of December 31, 1997, the outstanding principal balance of ILCO's senior loan obligations was $11.0 million, which reflected the prepayment by the Company of the payment originally scheduled for January 1, 1998. A regular payment, in the amount of $3.7 million, was made on April 1, 1998 and a prepayment of the July 1, 1998 installment, in the amount of $3.7 million, was made on June 30, 1998. The outstanding principal balance of ILCO's senior loan obligations was $3.6 million at June 30, 1998. The final installment on the senior loan obligation scheduled for October 1, 1998, was prepaid on September 30, 1998. As a result, the senior loan obligation of ILCO was fully discharged effective September 30, 1998. F-26 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. Income Taxes The Company files consolidated federal income tax returns with its non-life subsidiaries. The Company's life insurance subsidiaries file a separate life consolidated federal income tax return. In accordance with the Company's tax allocation agreement, federal income tax expense or benefit is allocated to each member of the consolidated group as if each member were filing a separate return. The U.S. federal income tax provision (benefit) charged to continuing operations for the years ended December 31, was as follows: 1998 1997 1996 (in thousands) Current tax provision $ 6,899 $ 9,005 $ 10,227 Deferred tax provision (432) 2,057 4,278 Total provision for income taxes $ 6,467 $ 11,062 $ 14,505 Provision has not been made for state and foreign income tax expense since expense is minimal. Premium taxes are paid to various states where premium revenues are earned. Premium taxes are included in the statement of income as operating expenses. The provision for income taxes differs from the amount of income tax determined by applying the U.S. statutory federal income tax rate of 35% to pre-tax income from continuing operations as a result of the following differences: 1998 1997 1996 (in thousands) Income taxes at the U.S. Statutory rate $ 6,155 $ 11,062 $ 14,505 Increase (decrease in taxes resulting from: Non-deductible compensation 312 -0- -0- Total provision for income taxes $ 6,467 $ 11,062 $ 14,505 F-27 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred taxes are recorded for temporary differences between the financial reporting bases and the federal income tax bases of the Company's assets and liabilities. The sources of these differences and the estimated tax effect of each are as follows: December 31, 1998 1997 Deferred Tax Liability: (in thousands) Deferred policy acquisition costs $ 6,897 $ 5,773 Present value of future profits 12,718 13,689 Net unrealized appreciation on marketable securities 6,231 7,755 Acquisition discounts on mortgages/ policy loans 1,213 1,458 Reinsurance recoverable 5,607 6,212 Other taxable temporary differences 2,782 1,960 Total deferred tax liability 35,448 36,847 Deferred Tax Asset: Policy reserves 1,896 2,858 Invested assets 1,759 413 Net operating loss carry forward 1,298 1,465 Minimum tax credit 310 300 Total deferred tax asset 5,263 5,036 Net deferred tax liability $ 30,185 $ 31,811
Deferred federal income tax expense (benefit) of $(1,524,000) and $6,258,000 for 1998 and 1997, respectively, have been provided on the unrealized appreciation (depreciation) of marketable securities and included in the balance of the deferred tax liability account. This increase or decrease in deferred tax liability has been recorded as a reduction or increase to the equity adjustment due to the net change in unrealized appreciation or depreciation and has not been reflected in the deferred income tax expense included in net income from operations. Under the provisions of pre-1984 life insurance company income tax regulations, a portion of "gain from operations" of Investors-IN and Investors-NA was not subject to current taxation but was accumulated, for tax purposes, in special tax memorandum accounts designated as "policyholders' surplus accounts". Subject to certain limitations,"policyholders' surplus" is not taxed until distributed or the insurance company no longer qualifies to be taxed as a life insurance F-28 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS company. The accumulation in these accounts for Investors-NA and Investors-IN at December 31, 1998 was $8,225,000 and $4,357,000, respectively. Federal income tax of $2,879,000 and $1,525,000 would be due if the entire balance is distributed at a tax rate of 35%. The Company does not anticipate any transactions that would cause any part of the policyholders' surplus accounts to become taxable and, accordingly, deferred taxes have not been provided on such amounts. At December 31, 1998, Investors-NA and Investors-IN have approximately $131,000,000 and $15,500,000, respectively, in the aggregate in their shareholders' surplus accounts from which distributions could be made without incurring any federal tax liability. At December 31, 1998, the Company and its non-life wholly-owned subsidiaries have net operating loss carry forwards of approximately $3.7 million. At December 31, 1998, there were no IRS examinations in progress for the Company or its subsidiaries. 8. Reinsurance The Company reinsures portions of certain policies thereby providing greater diversification of risk and minimizing exposure on larger policies. The Company's retention on any one individual ranges from $60,000 to $250,000 depending on the risk. The Company remains liable to the extent the reinsurance companies are unable to meet their obligations under the reinsurance agreements. In December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which all of the contractual obligations and risks under accident and health insurance policies were assumed by a third party reinsurer. The transfer is effective as of July 1, 1997. These risks and contractual obligations were sold pursuant to, first, a coinsurance reinsurance agreement. Following applicable regulatory approvals, the reinsurer will assume the direct obligations of the companies, on an assumption reinsurance basis. The decision to dispose of this block of business was based on management's analysis that the business was not generating targeted profit objectives and that the products were not part of the core business of the subsidiaries. The sale permits the company to focus on its primary business: life insurance and annuity sales. In connection with the transaction, the total amount of net reserves transferred by the subsidiaries was $6,327,504. In addition to the transfer of reserves, the life companies paid the reinsurer $1,037,150 in connection with the transaction, which amount was accounted for as an expense for the year ended December 31, 1997. In 1997, the transferred business generated approximately $791,000 in annualized premiums. F-29 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amounts reported in the consolidated financial statements for reinsurance ceded are as follows: December 31, 1998 1997 (in thousands) Future policy benefits $ 10,178 $ 10,008 Unearned premiums 1,878 2,307 Other policy claims and benefits payable 4,225 5,434 Amounts recoverable on paid claims 2,566 2,684 Reinsurance receivables 18,847 $ 20,433 Year ended December 31, 1998 1997 1996 (in thousands) Premiums $ 11,511 $ 10,438 $ 7,962 Policyholder benefits and expenses $ 20,311 $ 15,286 $ 14,712 9. Shareholders' Equity Financial Industries Corporation ("FIC"), a life insurance holding company, retains ownership of approximately 45% of the Company's outstanding common stock. FIC held options to purchase up to an additional 1,702,155 shares of the Company's authorized but unissued common stock at a price equal to the average market value during the six months preceding the exercise date. These options expired on September 30, 1998. The Company's ability to pay dividends to its shareholders is affected, in part, by the receipt of dividends from Investors-NA, which is organized under the laws of the state of Washington. Under current Washington law, any proposed payment of a dividend or distribution which, together with dividends or distributions paid during the preceding twelve months, exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31 or (ii) statutory net gain from operations for the preceding calendar year is called an "extraordinary dividend" and may not be paid until either it has been approved, or a waiting period shall have passed during which it has not been disapproved, by the insurance commissioner. In addition, Washington laws require that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that dividends may be paid only from earned surplus. F-30 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Net income (before surplus debenture interest expense) and capital and surplus of Investors-NA as reported to insurance regulators and as determined in accordance with statutory accounting practices are as follows: Year Ended December 31, 1998 1997 1996 Net Income $ 14,246 $ 25,925 $ 33,068 Capital and Surplus $ 70,627 $ 73,932 $ 56,174 The insurance regulations of the state of Washington limit the amount an insurer may invest in the obligations of any one corporation to four percent of the insurer's statutory admitted assets. Investors-NA held $40,903,140 and $46,057,300 in subordinated notes issued by Family Life Corporation, a wholly-owned subsidiary of FIC, at December 31, 1998 and 1997, respectively. This investment exceeds the limit on investments prescribed by the state of Washington by $-0- and $2,606,560 at December 31, 1998 and 1997, respectively. Prior to the acquisition of these notes, Investors-NA received written approval from the Washington State Insurance Department for the inclusion of the full amount of these notes in its statutory admitted assets. At December 31, 1998 and 1997, this permitted practice increased statutory surplus by $-0- and $2,606,560 over what it would have been under prescribed statutory accounting practices. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The NAIC is now considering amendments to the Codification guidance that would also be effective upon implementation. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, e.g. deferred income taxes are recorded. It is not known whether the Company's insurance subsidiaries states of domicile Insurance Departments will adopt the Codification, and whether the Departments will make any changes to that guidance. The Company has not estimated the potential effect of the Codification guidance on statutory net income and statutory capital and surplus if adopted by the Department. However, the actual effect of adoption could differ as changes are made to the Codification guidance, prior to its recommended effective date of January 1, 2001. In 1988, the Company authorized the issuance of 10 million shares of Class C Preferred Stock, $1.00 par value. The Company was not permitted, under the provisions of the Senior Loan Agreements (See Note 6), to issue any preferred stock except Class A and Class B issued in connection with the acquisition of the Investors Life Companies. The Company has reacquired the Class A and Class B Preferred Stock and holds the shares in treasury. F-31 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. Retirement Plans and Employee Stock Plans Retirement Plan The Company maintains a retirement plan, ("ILCO Pension Plan"), covering substantially all employees of the Company. The 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 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 plan maintained by the Company 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 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. The pension costs for the plan includes the following components: 1998 1997 1996 (in thousands) Service cost for benefits earned during the period $ 460 $ 390 $ 502 Interest cost on projected benefit obligation 793 693 686 Expected return on plan assets (1,235) (1,226) (1,128) Amortization of unrecognized prior service cost (229) (229) (229) Pension benefit $ (211) $ (372) $ (169) F-32 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following summarizes the funded status of the plan at December 31: 1998 1997 (in thousands) Change in benefit obligation: Benefit obligation at beginning of period $ 11,162 $ 8,936 Service cost 460 390 Interest cost 793 693 Benefits paid (443) (399) (Gain)/Loss due to change in assumptions 804 -0- (Gain)/Loss due to experience (50) 1,542 Benefit Obligation at end of year $ 12,726 $ 11,162 Change in plan assets: Fair value of plan assets at beginning of year $ 15,681 $15,322 Actual return on plan assets 1,000 758 Benefits paid (443) (399) Fair value of plan assets at end of year $ 16,238 $ 15,681 Funded Status: Funded status at end of year $ 3,512 $ 4,519 Unrecognized prior service cost (469) (698) Unrecognized actuarial net (gain) loss 1,683 693 Prepaid pension expense at end of year $ 4,726 $ 4,514 The significant assumptions for the plans are as follows: The discount rate for projected benefit obligations was 7.25%, 7.75% and 7.75% F-33 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS in 1998, 1997 and 1996. The assumed long-term rate of compensation increases was 5.0%, 6.0% and 6.0% for 1998, 1997 and 1996. The assumed long-term rate of return on plan assets was 8.0% for 1998, 1997 and 1996. Assumed expenses as a percentage of plan assets were 0%, 0% and .5% for 1998, 1997 and 1996, respectively. Savings and Investment Plan The Company maintains a Savings and Investment (401(k)) Plan that allows eligible employees who have met a one-year service requirement to make contributions to the Plan on a tax-deferred basis. A Plan participant may elect to contribute up to 16% of eligible earnings on a tax deferred basis, subject to certain limitations applicable to "highly compensated employees" as defined in the Internal Revenue Code. Plan participants may allocate contributions, and earnings thereon, between investment options selected by participants. The Account Balance of each Participant attributable to employee contributions is 100% vested at all times. Prior to January 1, 1990, the Company made matching contributions of up to 50% of the first 6% of eligible compensation contributed by the plan participants. Vesting of such Company contributions is based on number of years of service. The employer contributions were discontinued effective January 1, 1990. During 1995, the Plan was amended to allow for the addition of Family Life Insurance Company (FLIC), a wholly-owned subsidiary of FIC, as a participating employer, thus allowing FLIC employees to participate in the Plan. The amendment did not affect the Plan's tax-qualified status. In 1997, the Plan was amended to provide for a matching contribution by the Company. The match, which is in the form of shares of ILCO common stock, is equal to 100% of an eligible participant's elective deferral contributions, as defined in the Plan, not to exceed 1% of the participant's plan compensation. Allocations are made on a quarterly basis to the account of participants who have at least 250 hours of service in that quarter. Employee Stock Ownership Plan During 1979, the Company established an Employee Stock Ownership Plan and a related trust for the benefit of its employees. The Plan generally covers employees who have attained the age of 21 and have completed one year of service. Vesting of benefits to employees is based on number of years of service. No contributions were made to the Plan in 1998, 1997 or 1996. At December 31, 1998, the Plan had a total of 319,488 shares which are allocated to participants. During 1995, the Plan was amended to allow for the addition of FLIC as a participating employer, thus allowing FLIC employees to participate in the Plan. The amendment did not affect the Plan's tax-qualified status. F-34 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Stock Option Plans The Company applies APB Opinion No. 25 and related Interpretations in accounting for its stock option plans, which are described below accordingly. No compensation cost has been recognized by the Company in the accompanying income statement for its stock option plans. Had compensation cost for the Company's stock option plans been determined based on the fair market value at the grant dates for awards under those plans consistent with the method provided by FAS No. 123, the impact to the Company's net income would have been immaterial. Under the Company's Incentive Stock Option Plan, options to purchase shares of the Company's common stock, at 100% of fair market value on the date of grant, have been granted to key employees. A total of 315,000 shares of the Company's common stock are currently reserved for issuance under this plan. As of December 31, 1998, options to purchase 327,850 shares have been granted since the plan's inception. As of December 31, 1998, 241,750 options have been exercised and 86,100 options have been terminated. At December 31, 1998 there were no options remaining under the ISO Plan to purchase shares of the Company's common stock. The number of options exercised in 1998, 1997 and 1996 were -0-, 72,000 and 9,500, respectively. Under the Non-Qualified Stock Option Plan for certain officers, directors, agents and others, the Board of Directors is authorized to issue options to purchase up to 600,000 shares of the Company's common stock at 100% of the fair market value on the date of grant but in no case less than $3.33 per share. In 1988, options to purchase 330,000 shares were granted at a price of $3.33 per share. In 1990, options to purchase 30,000 shares expired. In 1991, options to purchase 50,000 shares were granted at prices ranging from $8.75 to $9.25. In 1992 options to purchase 60,000 shares expired. In 1995, options to purchase 60,000 shares were granted at a price of $11.12 per share. These same options, along with 20,000 other options, were terminated in 1996. In 1997 42,000 options were canceled. There were no options granted in 1998, 1997 and 1996. The number of options exercised in 1998, 1997 and 1996 were 42,000, 48,000, and 48,000, respectively. F-35 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarized activity under all Plans for each of the three years ended December 31, 1998: 1996 Weighted Average Shares Exercise Price (000's) Outstanding at the beginning of the year 384 $ 5.75 Granted 0 0 Exercised (58) 4.24 Canceled (80) 10.65 Outstanding at the end of the year 246 $ 4.50 Options exercisable at year end 120 $ 4.38 Weighted average fair value of options granted during the year $ -0- 1997 Weighted Average Shares Exercise Price (000's) Outstanding at the beginning of the year 246 $ 4.50 Granted 0 0.00 Exercised (120) 4.38 Canceled (42) 7.20 Outstanding at the end of the year 84 $ 3.33 Options exercisable at year end -0- $ -0- Weighted average fair value of options granted during the year $ -0- 1998 Weighted Average Shares Exercise Price (000's) Outstanding at the beginning of the year 84 $ 3.33 Granted -0- 0.00 Exercised (42) 3.33 Canceled -0- 0.00 Outstanding at the end of the year 42 $ 3.33 Options exercisable at year end -0- $ -0- Weighted average fair value of options granted during the year $ -0- F-36 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 1998: Options Outstanding Number Outstanding weighted-average remaining Range of exercise prices December 31, 1998 contractual Life (years) $3.33 42,000 1 year Weighted Average Range of exercise prices Exercise prices $3.33 $3.33 Number exercisable Weighted average Range of Exercise prices December 31, 1998 exercise price $3.33 -0- $3.33 11. Leases The Company and its subsidiaries occupy office facilities under lease agreements which expire at various dates through 2005. Certain office space leases may be renewed at the option of the Company. Rent expense in 1998, 1997, and 1996 was $2,283,198, $3,147,037, and $2,466,679, respectively, under these lease agreements. Minimum annual future rentals are as follows: (in thousands) 1999 1,783 2000 1,783 2001 1,766 2002 1,400 2003 671 Thereafter 1,273 $ 8,676 12. Related Party Transactions The obligations of the Company under the Senior Loan were guaranteed by FIC. FIC presently owns 1,966,346 shares of the company's Common Stock, constituting 44.93% of such shares outstanding. FIC held options to acquire an additional 1,702,155 shares at the average bid price of such shares during the six-month period preceding the date of any such purchase as long as ILCO's debt guaranteed by FIC (the Senor Loans) remained outstanding.. As described in Note 6, the current Senior Loan of ILCO was fully repaid on September 30, 1998. Accordingly, FIC's rights under the 1986 option agreement expired on September 30, 1998. F-37 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FIC Property Management, Inc., ("FIC Property"), a subsidiary of FIC, conducted the leasing activities for the Bridgepoint Square properties previously owned by Investors-NA. As described in Note 1, these properties were sold in 1997. In connection with the December, 1997 sale of Bridgepoint Square Offices by Investors-NA and Family Life Insurance Company, FIC Realty Services, Inc., ("FIC Realty"), a subsidiary of FIC, received a commission in the amount of $156,000, of which $122,538 was paid by Investors-NA and $33,462 by Family Life. In connection with the 1996 sale of Austin Centre by Investors-NA, FIC Realty received a commission in the amount of $123,350 from Investors-NA. As part of the financing arrangement for the acquisition of Family Life Insurance Company, Family Life Corporation ("FLC"), a subsidiary of FIC, entered into a senior loan agreement under which $50 million was provided by a group of banks. The balance of the financing consisted of a $30 million subordinated note issued by FLC to Merrill Lynch Insurance Group, Ins. ("Merrill Lynch") and $14 million borrowed by another subsidiary of FIC from an affiliate of Merrill Lynch and evidenced by a senior subordinated note in the principal amount of $12 million and a junior subordinated note in the principal amount of $2 million and $25 million lent by two insurance company subsidiaries of ILCO. The latter amount was represented by a $22.5 million loan from Investors-NA to FLC and a $2.5 million loan provided directly to FIC by Investors-CA. In addition to the interest provided under those loans, Investors-NA and Investors-CA were granted by FIC non-transferable options to purchase, in the amounts proportionate to their respective loans, up to a total of 9.9 percent of shares of FIC's common stock at a price of $10.50 per share ($2.10 per share as adjusted for the five-for-one stock split in November, 1996), equivalent to the then current market price, subject to adjustment to prevent dilution. The original provisions of the options provided for their expiration on June 12, 1998 if not previously exercised. In connection with the 1996 amendments to the subordinated notes, as described below, the expiration date of the options was extended to September 12, 2006. On July 30, 1993, the subordinated indebtedness owed to Merrill Lynch and its affiliate was prepaid. The Company paid $38 million plus accrued interest to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the subordinated debt was new subordinated loans totaling $34.5 million that FLC and Family Life Insurance Investment Company ("FLIIC"), another subsidiary of FIC, obtained from Investors-NA. The principal amount of the new subordinated debt was payable in four equal annual installments in 2000, 2001, 2002 and 2003 and bears interest at an annual rate of 9%. The other terms of the new debt are substantially the same as those of the $22.5 million subordinated loans that Investors-NA had previously made to FLC and that continue to be outstanding. In June, 1996, the provisions of the notes from Investors-NA to FIC, FLC and FLIIC were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996; the final quarterly principal payment is due on September 12, 2001; the interest rate on the note remains at 11%, (b) the $30 million note was amended to provide for forty 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 F-38 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9%, (c) the $4.5 million note was amended to provide for forty 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%, (d) the $2.5 million note was amended to provide that the principal balance of the note is to be repaid in twenty quarterly installments of $125,000 each, commencing December 12, 1996 with the final payment due on September 12, 2001; the rate of interest remains at 12%, (e) the Master PIK note, which was issued to provide for the payment in kind of interest due under the terms of the $2.5 million note prior to June 12, 1996, was amended to provide that the $1,977,119 principal balance of the note is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%. In December 1998 FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder, FIC. Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC. The Company reimbursed FIC for rental expenses and certain other operating expenses incurred during 1998, 1997 and 1996 on behalf of the Company. The amount of such reimbursement was approximately $-0-, $822,000 and $305,000, respectively. Data processing services for ILCO's and FIC's insurance subsidiaries are provided by FIC Computer Service, Inc. ("FIC Computer"), a subsidiary of FIC. Each of FIC's and ILCO's insurance subsidiaries has entered into a data processing agreement with FIC Computer whereby FIC Computer provides data processing services to each subsidiary for fees equal to such subsidiary's proportionate share of FIC Computer's actual costs of providing those services to all of the subsidiaries. The Company's insurance subsidiaries paid $2,818,095, $3,010,110 and $2,243,234 and Family Life paid $1,610,397, $824,425 and $1,055,639 to FIC Computer for data processing services provided during the years ended December 31, 1998, 1997 and 1996, respectively. In 1995, Investors-NA entered into a reinsurance agreement with Family Life pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. In 1996, Investors-NA entered into a reinsurance agreement with Family Life, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. ILCO received $11 million, $14 million, and $14 million from Family Life for direct costs incurred by ILCO on behalf of Family Life's operations in 1998, 1997 and 1996, respectively. Under an agreement between ILCO and Family Life all direct costs incurred on behalf of the other are to be reimbursed. F-39 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. Commitments and Contingencies 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 matters will not have a material impact on the financial statements. 14. Net Income Per Share The following table reflects the calculation of basic and diluted earnings per share: Year Ended December 31, 1998 1997 1996 (in thousands except per share amounts) Basic: Net income available to common shareholders $ 11,119 $ 20,540 $26,938 Weighted average common stock outstanding 4,375 4,328 4,233 Basic earnings per share $ 2.54 $ 4.75 $ 6.36 Diluted: Net income available to common shareholders $ 11,119 $ 20,540 $26,938 Weighted average common stock outstanding 4,375 4,328 4,233 Common stock options 1,319 88 1,993 Repurchase of treasury stock (1,232) (47) (1,785) Common stock and common stock equivalents 4,462 4,369 4,441 Diluted earnings per share $ 2.49 $ 4.70 $ 6.07
The options held by FIC to purchase ILCO stock were excluded from the 1997 diluted EPS calculation as they were anti dilutive. F-40 INTERCONTENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENT 15. Quarterly Financial Data (unaudited) ( in thousands, except per share amounts) Three Months Three Months Ended Ended March 31, June 30, 1998 1997 1998 1997 Net Operating Revenue $ 27,872 $ 27,401 $ 27,527 $ 28,555 Net Income $ 2,719 $ 2,700 $ 2,808 $ 2,942 Basic earnings per share $ 0.63 $ 0.64 $ 0.64 $ 0.68 Diluted earnings per share $ 0.62 $ 0.61 $ 0.62 $ 0.67 Three Months Three Months Ended Ended September 30, December 31, 1998 1997 1998 1997 Net Operating Revenue $ 27,269 $ 29,306 $ 26,793 $ 42,421 Net Income $ 2,829 $ 2,837 $ 2,763 $ 12,061 Basic earnings per share $ 0.65 $ 0.66 $ 0.63 $ 2.79 Diluted earnings per share $ 0.64 $ 0.62 $ 0.63 $ 2.69 16. Subsequent Events On March 6, 1999, the Company's Board of Directors approved a stock dividend in the amount of one share of ILCO common stock for each share issued and outstanding. The stock dividend was paid on March 17, 1999, to holders of record on March 8, 1999. F-41 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998 (in thousands of dollars) Column A Column B Column C Column D Amount at which Shown in the Balance Sheet Type of Investment Costs Value Fixed maturities available for sale: United States Government and government agencies and authorities $ 37,360 $ 40,652 $ 40,652 States, municipalities and political subdivisions 4,690 5,073 5,073 Corporate securities 148,989 153,634 153,634 Mortgage-backed securities 244,091 250,790 250,790 Total fixed maturities available for sale 435,130 450,149 450,149 Fixed maturities held to maturity 3,005 3,059 3,005 Total fixed maturities 438,135 453,208 453,154 Equity securities: Public utilities 2 2 2 Industrial, miscellaneous and all other 18 36 36 Total equity securities 20 38 38 Policy loans 53,614 53,614 53,614 Mortgage loans 10,332 10,883 10,332 Real estate 10,025 10,025 10,025 Short term investments 171,840 171,840 171,840 Total investments $ 683,966 $ 699,608 $ 699,003
F-42 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT BALANCE SHEETS December 31, 1998 and 1997 (in thousands of dollars) ASSETS 1998 1997 Short-term investments $ 3,732 $ 692 Cash and cash equivalents 157 99 Subordinated debenture receivables from Investors Life Insurance Company of North America, due September 30, 1999 15,896 27,796 Investments in and advances to subsidiaries 134,437 128,305 Accounts receivable 4,960 4,940 Property, plant and equipment, net 265 271 Other assets 388 493 Total Assets $ 159,835 $ 162,596 F-43 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT BALANCE SHEETS, continued December 31, 1998 and 1997 (in thousands of dollars) LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: 1998 1997 Accounts payable and accrued expenses $ 2,409 $ 2,570 Senior loan -0- 10,964 Deferred gain on sale of real estate 738 847 Total Liabilities 3,147 14,381 Redeemable preferred stock: Class A preferred stock, $1 par value, shares authorized and issued 5,000 5,000 Redeemable preferred stock: Class B preferred stock, $1 par value, 15,000 15,000 shares authorized and issued 20,000 20,000 Redeemable preferred stock, repurchased and held as treasury stock (20,000) (20,000) -0- -0- Shareholders' Equity: Common stock, $.22 par value, 15,000,000 shares authorized; 5,385,739 and 5,343,739 shares issued, 4,376,706 and 4,331,335 shares outstanding in 1998 and 1997, respectively 1,185 1,176 Additional paid-in capital 4,385 4,253 Accumulated other comprehensive income 11,571 14,403 Retained earnings (including $135,423 and $125,452 of undistributed earnings of subsidiaries at December 31, 1998 and 1997, respectively) 140,356 129,237 157,497 149,069 Common treasury stock, at cost, 684,273 and 687,644 shares in 1998 and 1997 (809) (854) Total Shareholders' Equity 156,688 148,215 Total Liabilities and Shareholders' Equity $ 159,835 $ 162,596
F-44 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT, STATEMENTS OF INCOME Years Ended December 31, 1998, 1997 and 1996 (in thousands of dollars) 1998 1997 1996 Revenues charged to subsidiaries: Interest income $ 2,391 $ 3,345 $ 4,915 Other income 138 131 133 2,529 3,476 5,048 Operating expenses 348 958 2,513 Interest expense 415 1,417 2,613 763 2,375 5,126 Income (loss) from operations 1,766 1,101 (78) Federal income tax provision (benefit) 618 385 (27) undistributed earnings from subsidiaries 1,148 716 (51) Equity in undistributed earnings from subsidiaries 9,971 19,824 26,989 Net income $ 11,119 $ 20,540 $ 26,938
F-45 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED STATEMENTS OF REGISTRANT STATEMENTS OF CASH FLOWS (in thousands of dollars) Year ended December 31, CASH FLOWS FROM OPERATING 1998 1997 1996 ACTIVITIES: Net income $ 11,119 $ 20,540 $ 26,938 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization of deferred gain on sale of real estate (110) (109) (110) Unrealized appreciation of equity securities held by insurance subsidiaries (1,137) 1,691 507 Decrease in accounts receivable (20) 1,023 -0- Increase in investment in and advances to subsidiaries (7,820) (26,618) (26,284) (Decrease) increase in accounts payable and accrued expenses (161) 344 (3,067) Decrease in other assets 105 1,215 Other -0- 6 2 Net cash provided by (used in) operating activities 1,976 (2,594) (799) CASH FLOWS FROM INVESTING ACTIVITIES: Change in short term investments (3,040) 5,560 770 Net cash (used in) provided by investing activities (3,040) 5,560 770 CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of debt (10,964) (13,980) (34,441) Stock options exercised 141 527 244 Purchase of treasury stock 45 (290) -0- Payment received on subordinated debenture receivable 11,900 10,750 34,289 Net cash provided by (used in) financing activities 1,122 (2,993) 92 Net increase (decrease) in cash 58 (27) 63 Cash, beginning of year 99 126 63 Cash, end of year $ 157 $ 99 $ 126
F-46 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE IV - REINSURANCE (in thousands of dollars) Ceded to Assumed Direct Other From Other 1998 Amount Companies Companies Life insurance in -force $ 7,258,662 $ 1,531,981 $ 331,133 Life insurance $ 12,782 $ 2,112 $ 48 Accident-health insurance 1,001 830 1 Total $ 13,783 $ 2,942 $ 49 1997 Life insurance in-force $ 7,788,147 $ 1,636,371 $ 174,777 Life insurance $ 12,661 $ 2,186 $ 114 Accident-health insurance 809 404 37 Total $ 13,470 $ 2,590 $ 151 1996 Life insurance in -force $ 6,934,547 $ 1,112,318 $ 93,927 Life insurance $ 10,611 $ 1,913 $ 101 Accident-health insurance 947 (202) 32 Total $ 11,588 $ 1,711 $ 133 F-47 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE IV - REINSURANCE, continued (in thousands of dollars) Percentage Net Of Amount Amount Assumed 1998 Life insurance in-force $ 6,057,814 5.47% Premium: Life insurance $ 10,718 0.45% Accident-health insurance 172 0.58% Total $ 10,890 0.45% 1997 Life insurance in-force $ 6,326,553 2.76% Premium: Life insurance $ 10,589 1.08% Accident-health insurance 442 8.37% Total $ 11,031 1.37% 1996 Life insurance in-force $ 5,916,156 1.59% Life insurance $ 8,799 1.15% Accident-health insurance 1,181 2.71% Total $ 9,980 1.33% F-48 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) 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. InterContinental Life Corporation (Registrant) By: /s/ Roy F. Mitte By: /s/ James M. Grace -------------------------- --------------------------- Roy F. Mitte, Chairman of James M. Grace, Treasurer, the Board, President and Principal Accounting Chief Executive Officer and Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 29, 1999. /s/ Roy F. Mitte /s/ James M. Grace Roy F. Mitte, Director James M. Grace, Director /s/ Eugene E. Payne /s/ Jeffrey H. Demgen Eugene E. Payne, Director Jeffrey H. Demgen, Director /s/ Robert A. Bender /s/ Theodore A. Fleron Robert A. Bender, Director Theodore A. Fleron, Director /s/ W. Lewis Gilcrease /s/ Richard A. Kosson W. Lewis Gilcrease, Director Richard A. Kosson, Director /s/ Elizabeth T. Nash /s/ H. Gene Pruner Elizabeth T. Nash, Director H. Gene Pruner, Director /s/ Steven P. Schmitt Steven P. Schmitt, Director -58- Exhibit Index Exhibit Page Description Number Number 3(a) Certificate of Incorporation of InterContinental Life Corporation filed May 22, 1969 and Amendments thereto (2) (i) Amendment filed July 16, 1973 (ii) Amendment filed August 4, 1977 (iii) Amendment filed February 10, 1983 (iv) Amendment filed December 14, 1988 (v) Amendment filed February 9, 1990 3(b) By-laws of InterContinental Life Corporation. (3) 3(c) Articles of Incorporation of InterContinental Life Corporation of Texas. (15) 3(d) Amendment to Articles of Incorporation of InterContinental Life Corporation of Texas. (15) 3(e) By-Laws of InterContinental Life Corporation of Texas. (15) 3(f) Articles of Merger of InterContinental Life Corporation and InterContinental Life Corporation of Texas. (15) 3(g) Plan and Agreement of Merger Between InterContinental Life Corporation and InterContinental Life Corporation of Texas. (15) 10(a) Registrant's Incentive Stock Option Plan. (1) 10(m) Lease dated December 20, 1985 between Registrant and Parker Road Associates for the rental of 40 Parker Road, Elizabeth, New Jersey. (4) Ex - 1 10(o) (i) Grid Note dated December 18, 1985 in the amount of $800,000 made by the Registrant and payable to Midlantic National Bank. (4) (ii) Demand Note dated December 18, 1985 in the amount of $491,165.03 made by Registrant and payable to Midlantic National Bank. (4) 10(ah) Credit Agreement for $125,000,000 dated as of December 28, 1988 among Registrant and certain banks identified therein. (5) 10(ai) Note Purchase Agreement dated as of December 31, 1988 between Registrant and a Rhode Island based insurance/financial services company. A Note Purchase Agreement in substantially identical form was executed with seven other entities identified in these exhibit. (5) 10(aj) Class A Preferred Stock Purchase Agreement dated as of December 1, 1988 between Registrant and Insurance Company of North America. (5) 10(ak) Class B Preferred Stock Purchase Agreement dated as of December 1, 1988 between Registrant and a Rhode Island based insurance/financial services company. A Class B Preferred Stock Purchase Agreement in substantially identical form was executed with seven other entities identified in this exhibit. (5) 10(al) Pledge Agreement dated as of December 28, 1988 between Registrant and The First National Bank of Chicago, as Agent. (5) 10(am) Surplus Debenture dated as of December 28, 1988 in the amount of $140,000,000 made by Standard to Registrant. (5) 10(an) Warrant Agreement dated as of December 29, 1988 between Registrant and a Connecticut based insurance/ financial services company. A Warrant Agreement in substantially identical form was executed with seven other entities. (5) 10(aq) Registrant's Defined Benefit Pension Plan, effective as of January 1, 1988. Ex - 2 10(ar) Registrant's Employee Stock Purchase Plan, effective as of August 25, 1989. (6) 10(as) Registrant's Non-Qualified Stock Option Plan. (6) 10(at) Exchange and Amendment Agreement dated July 30, 1990 between Registrant and the holders of its Class A Preferred Stock and its Class B Preferred Stock. (7) 10(au) Amendment dated July 30, 1990 to Senior Loan Agreement among the Registrant and certain banks identified therein. (7) 10(av) InterCreditor Agreement dated June 12, 1991, among Investors Life Insurance Company of North America, Investors Life Insurance Company of California, Merrill Lynch Insurance Group, Inc. and Merrill Lynch & Co., Inc. (8) 10(aw) Note dated June 12, 1991 in the amount of $22.5 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America. (8) 10(ax) Note dated June 12, 1991 in the amount of $2.5 million made by Financial Industries Corporation in favor of Investors Life Insurance Company of California. (8) 10(ay) InterCreditor Agreement among Investors Life Insurance Company of North America, Investors Life Insurance Company of California and the Agent under the Credit Agreement dated as of June 12, 1991. (8) 10(az) Option Agreement by Financial Industries Corporation in favor of Investors Life Insurance Company of North America and Investors Life Insurance Company of California. (8) 10(aaa) Hotel Lease Agreement dated as of August 22, 1991 between Investors Life Insurance Company of North America and FIC Realty Services, Inc. (9) 10(aab) Management Agreement dated as of September 4, 1991 between Investors Life Insurance Company of North America and FIC Property Management, Inc. (9) Ex - 3 10(aac) Amended and Restated Credit Agreement dated January 29, 1993 among the Registrant and certain banks identified therein. (10) 10(aad) Amended and Restated Pledge Agreement dated January 29, 1993 between the Registrant and the agent bank named therein. (10) 10(aae) Stock Option Agreement dated March 8, 1986 between Registrant and Financial Industries Corporation. (10) 10(aaf) Surplus Debenture dated as of November 13, 1986 in the amount of $15,000,000 made by New Standard to Registrant. (10) 10(aag) Terms and Conditions of Employment Contracts of James M Grace, Eugene E. Payne and Joseph F. Crowe approved by Registrant's Board of Directors on May 16, 1991, ((10) 10(aah) Letter agreement and addendum dated July 23, 1992 between Investors Life Insurance Company of North America and Mr. and Mrs. Theodore A. Fleron. (10) 10(aai) Letter agreement dated October 15, 1992 between Roy F. Mitte and Registrant evidencing surrender and cancellation of stock options. (10) 10(aaj) Note dated July 30, 1993 in the amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America. (11) 10(aak) Note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America. (11) 10(aal) Amendment No. 1 dated July 30, 1993 between Family Life Corporation and Investors Life Insurance Company of North America amending $22.5 million note. (11) 10(aam) Cancellation of Stock Option Agreement dated October 21 1993 between Registrant and Roy F. Mitte. (11) 10(aan) Waiver and Amendment Agreement dated as of July 23, 1993 among the Registrant and certain banks identified therein. (12) Ex - 4 10(aao) Amendment Agreement dated as of December 20, 1993 among the Registrant and certain banks identified therein. (12) 10(aap) Amendment Agreement dated as of March 12, 1994 among the Registrant and certain banks identified therein. (12) 10(aaq) Amendment Agreement dated as of December 22, 1994 among the Registrant and certain banks identified therein. (12) 10(aar) Amendment Agreement dated as of February 10, 1995 among the Registrant and certain banks identified therein. (12) 10(aas) Data Processing Agreement dated as of November 30, 1994 between InterContinental Life Insurance Company and FIC Computer Services, Inc. (12) 10(aat) Data Processing Agreement dated as of November 30, 1994 between Investors Life Insurance Company of North America and FIC Computer Services, Inc. (12) 10(aau) Data Processing Agreement dated as of November 30, 1994 between Family Life Insurance Company and FIC Computer Services, Inc. (12) 10(aav) Lease Agreement dated as of September 30, 1994 between FIC Realty Services, Inc. and Atrium Beverage Corporation. (12) 10(aaw) Management Agreement dated as of September 30, 1994 between HCD Austin Corporation as agent for FIC Realty Services, Inc. and Atrium Beverage Corporation. (12) 10(aax) Amendment Agreement dated as of August 8, 1995 among the Registrant and certain banks identified therein.(13) 10(aay) Amendment Agreement dated as of December 15, 1995 among the Registrant and certain banks identified therein. (13) 10(aaz) Agreement of Sale dated as of September 5, 1995 between Omni Congress Joint venture as Buyer and Investors Life Ex - 5 Insurance Company of North America as Seller, with exhibits, amendments and assignment. (13) 10(aaaa) Amendment No. 2 dated December 12, 1996, effective June 12, 1996 to the note dated June 12, 1991 in the amount of $22.5 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America. (14) 10(aaab) (i) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated June 12, 1991 in the amount of $2.5 million made by Financial Industries Corporation in favor of Investors Life Insurance Company of California. (14) (ii) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the "payment in kind" provisions of the note dated June 12, 1991 in the amount of $2.5 million made by Financial Industries Corporation in favor of Investors Life Insurance Company of North America. (14) 10(aaac) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated July 30, 1993 in the amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America.(14) 10(aaad) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America. (14) 10(aaae) Amendment Agreement dated as of April 24, 1996 between Registrant and certain banks identified therein.(14) 10(aaaf) Waiver Agreement dated as of December 12, 1996 between Registrant and certain banks identified therein.(14) 10(aaag) Amendment Agreement dated December 12, 1996 to the Option Agreement by Financial Industries Corporation in favor of Investors Life Insurance Company of North America and Investors Life Insurance Company of California. (14) Ex - 6 10(aaah) Amendment and Waiver Agreement dated as of March 31, 1997 among the Registrant and certain banks identified therein. (16). 10(aaai) Amendment and Waiver Agreement dated as of December 9, 1997 among the Registrant and certain banks identified therein. (16). 10(aaaj) Ex-9 Assignment Agreement dated December 23, 1998, from Family Life Insurance Investment Company to Financial Industries Corporation, assigning the 9% Senior Subordinated Note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America. 21 Ex-11 Subsidiaries of the Registrant. 23 Ex-12 Consent of PricewaterhouseCoopers, LLP. (1) Filed with the Registrant's Annual Report of Form 10-K for the fiscal year ended December 31, 1983, Commission File No. 0-7290, and incorporated herein by reference. (2) Filed with the Registrant's Registration Statement on Form S-8 (Registration No. 2085333) and incorporated herein by reference; except Amendment filed December 14, 1988 (item (iv)), which was filed with Registrant's Current Report of Form 8-K dated January 12, 1989, and incorporated herein by reference; and Amendment filed February 9, 1990, which was filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, and incorporated herein by reference. (3) Filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1984 and incorporated herein by reference. (4) Filed with the Registrant's Annual Report of Form 10-K for the fiscal year ended December 31, 1985 and incorporated herein by reference. (5) Filed with Registrant's Annual Report of Form 10-K for the fiscal year ended December 31, 1988, and incorporated herein by reference, (6) Filed with Registrants Annual Report on Form 10-K for the fiscal year ended December 31, 1989, and incorporated herein by reference. (7) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, and incorporated herein by reference. Ex - 7 (8) Filed with Financial Industries Corporation's Current Report on Form 8-K dated June 25, 1991, and incorporated herein by reference. (9) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, and incorporated herein by reference. (10) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and incorporated herein by reference. (11) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, and incorporated herein by reference. (12) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and incorporated herein by reference. (13) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, and incorporated herein by reference. (14) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, and incorporated herein by reference. (15) Filed with Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1997, and incorporated herein by reference. (16) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, and incorporated herein by reference. Ex - 8 Exhibit 10(aaaj) Assignment of 9% Senior Subordinated Note Dated July 30, 1993 This Assignment Agreement ("Assignment") is entered into effective December 23, 1998 , 1998 by and between Family Life Insurance Investment Corporation ("Assignor"), Financial Industries Corporation ("Assignee") and Investors Life Insurance Company of North America ("Payee"). WHEREAS, Assignor is the obligor and Payor under that certain 9% Subordinated Senior Note dated July 30, 1993 in the principal amount of $4,500,000, as amended by Amendment No. 1 dated December 12, 1996, with a current principal balance of $4,279,221 (as amended, the "Note"), and WHEREAS, Investors Life Insurance Company of North America is the Payee under the Note, and WHEREAS, Assignor will dissolve pursuant to a Plan of Dissolution and Articles of Dissolution dated November 30, 1998 which were prepared by the Board of Directors of Assignor and approved by the shareholders of Assignor, and WHEREAS, Assignee has agreed to assume all of the rights, duties and obligations of Assignor under the Note, and WHEREAS, Payee has agreed to release Assignor from Assignor's duties and obligations under the Note once the Note is assumed by Assignee, NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. Capitalized terms used herein and not otherwise defined in this Assignment shall have the meanings attributed to such terms in the Note. 2. Assignor hereby assigns and sets over to Assignee all of Assignor's rights, duties and obligations under the Note. 3. Assignee hereby accepts all of Assignor's rights, duties and obligations under the Note and agrees to perform all of the duties and obligations contained in the Note. 4. By consenting to this Assignment, Payee agrees that Assignee shall assume all of Assignor's rights, duties and obligations under the Note. Ex - 9 IN WITNESS WHEREOF, Family Life Insurance Investment Company, Financial Industries Corporation and Investors Life Insurance Company of North America have executed this Assignment as of December 23 , 1998 Assignor: FAMILY LIFE INSURANCE INVESTMENT CORPORATION By: /s/ James M. Grace Name: James M. Grace Title: Executive Vice President Assignee: FINANCIAL INDUSTRIES CORPORATION By: /s/ Roy F. Mitte Name: Roy F. Mitte Title: President Approved and Agreed to by Payee: INVESTORS LIFE INSURANCE COMPANY OF NORTH AMERICA By: /s/ Roy F. Mitte Name: Roy F. Mitte Title: President Ex - 10 EXHIBIT 21 SUBSIDIARIES OF REGISTRANT Investors Life Insurance Company of North America Investors Life Insurance Company of Indiana ILG Securities Corporation ILG Sales Corporation InterContinental Growth Plans, Inc. InterContinental Life Agency, Inc. * *Wholly-owned subsidiary of InterContinental Growth Plans, Inc. Ex - 11 EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-71074) of InterContinental Life Corporation of our report dated March 26, 1999 appearing on page F-2 of this Form 10-K. PricewaterhouseCoopers LLP Dallas, Texas March 26, 1999 Ex - 12 EX-27 2
7 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1,000 YEAR DEC-31-1998 DEC-31-1998 450,149 3,005 3,059 3,121 10,332 10,025 702,086 12,206 18,847 31,953 1,305,248 135,463 2,124 545,908 10,856 0 0 0 1,185 153,050 1,350,248 10,890 54,619 0 2,886 38,367 2,128 14,853 17,586 6,467 11,119 0 0 0 11,119 2.54 2.49 0 0 0 0 0 0 0
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