-----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, JqcEOVE0rgtV32pc5Qf+KZU9CmbLgD/JQYZqQp0Kikbbb6C29UMQec7t7o8nyZD/ u7PIvlg57BOs0ahfPO1PCA== 0000050982-98-000002.txt : 19980331 0000050982-98-000002.hdr.sgml : 19980331 ACCESSION NUMBER: 0000050982-98-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD 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: 98577715 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, 1997 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 The aggregate market value of the voting stock held by non-affiliates of the Registrant on March 16, 1998, based on the closing sales price in The Nasdaq Small-Cap Market ($21.25 per share), was $48,056,663. As of March 16, 1998, Registrant had 4,343,335 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. [ ] 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, credit life and credit disability 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 a 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 45.40% of the Company's outstanding Common Stock. FIC also holds options to acquire additional shares, which, if exercised, would result in FIC's owning approximately 60.80% of the Company's outstanding shares. 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 34% 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, and State Auto Life Insurance Company (via merger of that company into Investors- Indiana in 1997). 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 do 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 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"). Investors-Indiana was licensed in ten states and markets a variety of individual life and annuity products through independent agents. 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. 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. 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, 1997, it had assets of $153.8 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 1997, the general insurance expenses of the Company's insurance subsidiaries on a statutory basis were $15,574,265, as compared to $12,008,163 in 1996 and $13,737,883 in 1995. 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 326 at December 31, 1997. Principal Products The Company's insurance subsidiaries are engaged primarily in administering existing portfolios of life insurance policies and annuity products. Approximately 84.7% of the total collected premiums for 1997 were derived primarily 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 and interest-sensitive whole life insurance. Under a whole life insurance policy, the policyholder pays a level premium over his or her expected lifetime. The policy combines life insurance protection with a savings plan that gradually increases in amount over a period of several years. The universal and interest-sensitive whole life insurance policies of the Company's insurance subsidiaries provide permanent life insurance which credit company-declared current interest rates. 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 $40.6 million in 1997, as compared to $40.6 million in 1996, and $42.3 million in 1995. Investors-NA received reinsurance premiums from Family Life of $1.8 million in 1997, pursuant to the reinsurance agreement for universal life products written by Family Life. In 1997, 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 (9.0%) New Jersey (8.0%). Two of the Company's insurance subsidiaries received premium income from health insurance policies. In 1997, premium income from all health insurance policies was $0.9 million in 1997 and 1996, as compared to $1.1 million in 1995. Premium income from health insurance in 1997 was derived from all of the states in which those two insurance subsidiaries are licensed, with significant amounts derived from New Jersey (15%), Pennsylvania (12%) and Florida (10%). 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 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 $6,327,504. 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, 1997, the assets held in the separate account were $50.8 million. During 1997, the premium income realized in connection with these variable annuity policies was $172,666, which was received from existing contract owners. Investors-NA also maintains a closed variable annuity separate account, with approximately $22.3 million of assets as of December 31, 1997. 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 account 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 $3,499,000 in 1997, as compared to $1,741,000 in 1996, and $2,169,000 in 1995. Investors-NA also received reinsurance premiums from Family Life of $3,259,410 in 1997, pursuant to a reinsurance agreement for annuity products between Investors-NA and Family Life Insurance Company. The following table sets forth, for the three years ended December 31, 1997, the combined premium income and other considerations received by the Company's insurance subsidiaries from sales of their various lines of insurance. Item 6. Selected Financial Data (in thousands, except per share data; certain restatements and adjustments are explained following this table.) Year Ended December 31, Type of Insurance Premium 1997 1996 1995 (in thousands) Individual: Life $25,787 $15,031 $16,426 Accident & Health 792 1,035 1,218 Total Individual Lines 26,579 16,066 17,644 Group: Life 2,639 2,018 2,594 Accident & Health 40 0 6 Total Group Lines 2,679 2,018 2,600 Credit: Life (27) (85) (222) Accident & Health 14 (57) 240 Total Credit Lines (13) (142) 18 Total Premium 29,245 17,942 20,262 Reinsurance premiums ceded (10,439) (7,962) (8,568) Total Net Premium 18,806 9,980 11,694 Amount Received on Investment Type Contracts 43,248 47,135 44,130 Total Premiums and Deposits Received $ 62,054 $57,115 $55,824 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, 1997, only 0.9% 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 0.7% of the Company's total assets at December 31, 1997. The Company had investments in debt securities of affiliated corporations aggregating approximately $53.8 million as of December 31, 1997. Investments in mortgage-backed securities included collateralized mortgage obligations ("CMOs") of $244.8 million and mortgage-backed pass-through securities of $42.9 million at December 31, 1997. Mortgage-backed pass-through securities, sequential CMOs, support bonds, and z-accrual bonds, which comprised approximately 47.6% of the book value of the Company's mortgage-backed securities at December 31, 1997, 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 50.0% and sequential and support classes represented approximately 29.6% of the book value of the Company's mortgage-- backed securities at December 31, 1997. 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 Company does invest in z-accrual bonds, but they constituted only 3.1% of the book value of the Company's mortgage-backed securities at December 31, 1997. 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 1997, and the current investment objectives of the Company do not contemplate additions to the portfolio of CMO investments during 1998. 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, 1997, 0.75% 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 1997, 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 0.49% of the Company's invested assets at December 31, 1997. 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. 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 provides other sales inducements. The Investors sales distribution system is presently concentrating its efforts on the promotion and sale of universal life, interest-sensitive 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 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. Data Processing Pursuant to a data processing agreement with a major service company, the data processing needs of ILCO's and FIC's insurance subsidiaries were provided at a central location until November 30, 1994. Since December, 1994, all of those data processing needs 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 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. Additionally, the Company is developing a strategy for obtaining assurances from its various suppliers and service providers. In furtherance of this strategy, the Company is creating questionnaires which it will forward to its suppliers and service providers regarding the Y2K problem. The questionnaire will request information regarding that particular supplier's or service provider's awareness of the Y2K problem, its impact on their operations, and their plan for addressing any problems as they relate to that supplier's or service provider's performance of their contractual obligations to the Company and its subsidiaries. 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 has budgeted approximately $470,000 for implementation of the Plan. 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, 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 February 1, 1998, FIC Computer Services, Inc. estimated that it had completed the necessary conversions and modifications on the administrative systems which process approximately 35% of the insurance policies for the Company and its subsidiaries. This included the conversion of the ALIS System (administering approximately 49,280 policies) to CK/4 in January of 1998. The TI System (administering approximately 5,244 policies) will be converted to CK/4 in May, 1998, bringing the total to approximately 38%. The conversion of the Life 70 system (administering approximately 17,285 policies for Investors-IN) is scheduled for completion in April, 1999. The modification of the Lifecomm-B system which is responsible for the 19,205 policies assumed after the acquisition of State Auto Life is also scheduled for completion in April, 1999. The conversion of the Lifecomm-A system (administering approximately 65,266 policies for Investors-NA) is scheduled for completion in September of 1999. The modification of three non-material systems which administer 6,806 credit life policies, 2,514 group policies and 15,938 industrial life policies are scheduled for completion in December of 1998, March of 1999 and June of 1999, respectively. 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. will be testing this hardware and software in 1998. The telephone system 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 anticipates that updated software releases will be commercially available well in advance of the year 2000. Accordingly, to the extent that such systems rely on date sensitive information, the Company expects that the effort needed to correct for Y2K problems will be less time intensive than the effort needed to achieve compliance for its centralized systems. 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 and health 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: 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. In 1988, Investors-NA entered into a bulk reinsurance treaty under which it reinsured all of its risks under accidental death benefit policies. Investors-IN had previously obtained similar bulk reinsurance for accidental death benefit policies. The treaty was renegotiated with a different 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. In 1997, the accident and health business generated approximately $791,000 in annualized premiums. 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. 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 16, 1998, FIC owned, directly and indirectly through Family Life, approximately 45.4% of the outstanding shares of ILCO's common stock. FIC holds options to acquire up to 1,702,155 additional shares of ILCO Common Stock. Giving effect to the exercise of those options, FIC would own, directly and indirectly through Family Life, approximately 61% of the outstanding shares of ILCO Common Stock. The exercise price of the options is equal to the average quoted market price of ILCO's common stock over the six month period immediately prior to exercise. In addition, in the event that any other party were to seek to acquire, without the prior approval of ILCO's Board of Directors, securities aggregating five percent or more of ILCO's outstanding common stock, FIC would have the right to acquire, under the same price formula, that number of shares of ILCO's common stock which, when added to the number of shares then owned by FIC, would amount to 51% of ILCO's outstanding common stock. The stock options were granted in 1986 to FIC by the Company principally in consideration for a $1,200,000 unsecured loan from FIC, FIC's agreement to guarantee up to $4,000,000 of Registrant's financial obligations and FIC's agreement to guarantee, upon demand, ILCO's performance under its lease on its headquarters building. In addition, FIC guaranteed a $15,000,000 term loan of ILCO. Under the terms of the option agreement, the options remain in effect so long as FIC guarantees any indebtedness of ILCO. As described under the heading "Senior Loan", the current Senior Loan of ILCO is scheduled to be fully repaid on October 1, 1998. Accordingly, unless ILCO s Senior Loan is extended, or ILCO otherwise incurs indebtedness which is guaranteed by FIC, FIC s rights under the 1986 option agreement would expire on October 1, 1998. 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 non- transferable 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, above. 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, above. Senior Loan The current 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 are 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 8.63% during 1995, 7.76% during 1996 and 7.68% during 1997. 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. The Senior Loan bears interest, at the option of the Company, at a rate per annum equal to (i) the Alternate Base Rate (as defined below) plus the Applicable Margin (as defined below), or (ii) LIBOR (adjusted for reserves) for interest periods of 1, 2, 3 or 6 months plus the Applicable Margin. LIBOR is London Inter-Bank Offered Rates. The Alternate Base Rate for any day is the higher of (a) the agent bank's corporate base rate as announced from time to time and (b) the federal funds rate as published by the Federal Reserve Bank of New York plus 0.5%. The Applicable Margin, depending on the outstanding principal balance of the Senior Loan, ranges from 0.5% to 1.25% for loans that bear interest based upon the Alternate Base Rate and from 1.75% to 2.5% for loans that bear interest based upon LIBOR. The initial Applicable Margin for Alternate Base Rate loans is 1.25% and the initial Applicable Margin for LIBOR loans is 2.5%. The obligations of the Company under the Senior Loan are secured by: (1) all of the outstanding shares of stock of Investors-NA, (2) a $15,000,000 surplus debenture of Investors-NA payable to the Company, which had an outstanding principal balance of $5,206,224 as of December 31, 1997 and (3) a $140,000,000 surplus debenture of Investors-NA payable to the Company, which had an outstanding principal balance of $22,590,000 as of December 31, 1997. The obligations of the Company under the Senior Loan are guaranteed by FIC. The Senior Loan prohibits the payment by the Company of cash dividends on the Common Stock and contains covenants, including restrictive covenants that impose limitations on the Company's and its subsidiaries' ability to, among other things: (i) make investments; (ii) create or incur additional debt; (iii) engage in businesses other than their present and related businesses; (iv) create or incur additional liens; (v) incur contingent obligations; (vi) dispose of assets, (vii) enter into transactions with affiliated companies; and (viii) make capital expenditures; and various financial covenants, including covenants requiring the maintenance of a minimum cash flow coverage ratio, minimum consolidated net worth and minimum statutory surplus of subsidiaries, and a minimum ratio (360%) of (i) the sum of the statutory capital and surplus, the asset valuation reserve and one-half of the dividend liability pertaining to participating policies of each insurance company subsidiary to (ii) its respective Authorized Control Level RBC (see "Regulation"). The Senior Loan specifies events of default, including, but not limited to, failure to pay amounts under the Senior Loan documents when due; defaults or violation of covenants under other indebtedness; defaults under the loans made by Investors-NA to subsidiaries of FIC; the loss of any license of an insurance subsidiary of the Company which would have a material adverse effect on the Company; defaults under the FIC guaranty agreement; changes in ownership or control of FIC or the Company by its controlling person, Roy F. Mitte, or in the Company by FIC; and the occurrence of certain events of bankruptcy. If Mr. Mitte ceases to control the management of the Company solely by reason of (i) his death or (ii) his permanent inability to perform his usual and customary duties on a full-time basis on behalf of the Company and FIC as the result of physical or mental infirmity, a default will occur, and the banks holding in the aggregate at least 66 2/3% of the outstanding balance of the Senior Loan may, on or after 180 days after the date on which such default occurs, declare the Senior Loan immediately due and payable. Mr. Mitte's ability to communicate and his mobility are impaired as a result of a stroke he suffered in May 1991. However, Mr. Mitte continues to control the management of the Company, and Mr. Mitte's impairments did not constitute a default under the Senior Loan. See Item 10(b)-Executive Officers of the Registrant. The outstanding principal balance of the Senior Loan was $10,964,000 as of December 31, 1997. 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 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. Effective for the 1993 calendar year, the National Association of Insurance Commissioners ("NAIC") has adopted 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 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, 1997 indicate that the Total Adjusted Capital of each of the Company's insurance subsidiaries is above 737% 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 $70,253 in the year ended December 31, 1997. 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 principal sources of cash for the Company to make payments of principal and interest on the Senior Loan are payments under the surplus debentures of Investors-NA (a Washington-domiciled corporation). 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, 1997, the statutory surplus of Investors-NA was $71.5 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 in the amounts necessary to enable ILCO to service the Senior Loan for the foreseeable future. Pursuant to the surplus debentures Investors-NA paid to the Company principal and interest on the surplus debentures of $22,749,576 in 1995, $36,288,469 in 1996 and $14,093,711 in 1997. In addition to the payments under the terms of the Surplus Debentures, ILCO has received dividends from Standard Life (now, from Investors-NA). 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 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, 1997, Investors-NA had earned surplus of $32.9 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 in the amounts necessary to enable ILCO to service the Senior Loan 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, 1997. 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. 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 Life-NA can pay to the Company. For the years ended December 31, 1995, 1996 and 1997, the decreases in the current income tax provisions of the Company's insurance subsidiaries due to this change were $118,480, $90,413 and $269,633, 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. 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, 1997. 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. Austin Centre covers a full city block and is a sixteen story mixed use development consisting of 343,664 square feet of office/retail space (predominately office space), a 314 room hotel and 61 luxury apartments, all united by a 200 foot high glass atrium. The project was completed in October 1986. 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. The office space is fully rented. 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, and is 100% leased to a major tenant in the technology business. 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. Investors-NA leased approximately 43,000 square feet of the third office building to the same tenant which leased all of the space in the second building. The remaining space was leased in October, 1996 to a major tenant also in the technology business. 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. In September of 1996, approximately 23,619 rentable square feet were leased to an oil and gas company, which then expanded its premises to 29,631 under an expansion option contained in its Lease. Another 8,368 square feet was leased in March, 1997, to a company involved in the technology field. In June, 1997, approximately 40,611 rentable square feet was leased to a tenant in the technology field. In November, 1997 approximately 2967 rentable square feet was leased to a securities brokerage firm. The remaining 10,882 rentable square feet is reserved for a health club facility and a retail food outlet. 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") on the new site in January 1997. In May, 1997, the entire rentable space (approximately 76,793 rentable square feet) contained in the building was leased to a major tenant in the technology business. 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 is included in ILCO's fourth quarter earnings. For Family Life, the sale resulted in a net profit of approximately $4.5 million ($3.2 million after tax)that is included in FIC's fourth quarter earnings. Pursuant to the terms of the Bridgepoint Sale Agreement, Family Life is obligated to complete the construction of and tenant improvements in Bridgepoint Five. At the date on which the transaction closed, the building and adjacent parking garage had been completed. As of March, 1998, all tenant improvements had been completed subject to final inspection. 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 8 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 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 and the remainder is used to provide accommodations for employees working at the New Jersey office. Investors-NA owns an office building, located at 206 West Pearl Street, Jackson, Mississippi. This building is 67 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. 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, 1997 to a vote of security holders. 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 1997 and 1996. Prices High Low 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 1996: 1st Quarter. . . . . . . $15.50 $12.50 2nd Quarter. . . . . . . 16.25 13.375 3rd Quarter. . . . . . . 15.25 11.50 4th Quarter. . . . . . . 14.25 12.00 The Common Stock of the Company is traded in The Nasdaq Small-Cap Market (NASDAQ Symbol: ILC0). 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 16, 1998 was 1,456. C. Dividends No dividend was declared or paid by the Company during 1995, 1996 or 1997. Under the terms of its Senior Loan the Company is not permitted to declare or pay any dividends on its Common Stock during the loan term. A more detailed discussion of the Senior Loan is set forth in Item 1 hereof. 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, 1997 1996 1995 1994 1993 Revenues $127,683 $ 138,244 $ 122,390 $ 114,842 $ 117,843 Benefits & Expenses 96,081 96,801 105,907 99,142 100,525 Income from operations 31,602 41,443 16,483 15,700 17,318 Provision for federal income taxes 11,062 14,505 5,769 5,783 5,118 Net Income before extra- ordinary item and cumulative effect of change in accounting principle 20,540 26,938 10,714 9,917 12,200 Extraordinary Item -0- -0- -0- -0- (6,253) Net Income before cumulative effect of change in accounting principle 20,540 26,938 10,714 9,917 5,947 Cumulative effect of change in accounting principle -0- -0- -0- -0- (2,600) Net Income $ 20,540 $ 26,938 $ 10,714 $ 9,917 $ 3,347 Common Stock and Common Stock Equivalents 4,369 4,441 4,342 4,473 4,538 Net Income per share before extraordinary item and cumulative effect of change in accounting principle Basic $ 4.75 $ 6.36 $ 2.57 $ 2.41 $ 2.97 Diluted $ 4.70 $ 6.07 $ 2.47 $ 2.22 $ 2.69 Extraordinary Item Basic -0- -0- -0- -0- (1.52) Diluted -0- -0- -0- -0- (1.38) Net income per share before cumulative effect of change in accounting principle Basic 4.75 6.36 2.57 2.41 1.45 Diluted 4.70 6.07 2.47 2.22 1.31 Cumulative effect of change in accounting principle Basic -0- -0- -0- -0- (.63) Diluted -0- -0- -0- -0- (.57) Net income per share Basic $4.75 $6.36 $2.57 $2.41 $0.82 Diluted $4.70 $6.07 $2.47 $2.22 $0.74 Cash Dividend -0- -0- -0- -0- -0- Long Term Debt $ 10,964 $ 24,944 $ 59,385 $ 66,585$ 84,000 Total Assets $1,321,653 $1,263,942 $1,315,293 $1,148,994$1,266,941 Net Income per share for the year 1993 to 1996 has been restated to reflect the effect of FAS 128. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations For the year ended December 31, 1997, ILCO's net income from operations was $20,540,000 ($4.70 per common share) as compared to $26,938,000 ($6.07 per common share) in 1996, and $10,714,000 ($2.47 per common share) in 1995. Earnings per share are stated on a diluted basis, in accordance with the requirements of FAS 128, which requires that 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 years 1996 and 1995, earnings per share have been restated to reflect the effect of FAS No.128. 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 $11,443,000 ($2.62 per common share) for the year ended December 31, 1997, $11,650,000 ($2.62 per common share) for the year ended December 31, 1996 and $10,714,000 ($2.47 per common share) for the year ended December 31, 1995. 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 cancelled 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 1997, 1996 and for that portion of 1995 beginning on February 14th, include the operations of Investors Life Insurance Company of Indiana (formerly known as Meridian Life Insurance Company and referred to herein as "Pre-Merger Investors-IN" for purposes of identifying the entity prior to the December 1997 merger transaction described below). Pre-Merger Investors-IN was purchased by ILCO and Investors Life Insurance Company of North America ("Investors-NA") for an adjusted purchase price of $17.1 million; the transaction was completed on February 14, 1995. The name change was completed in May, 1995. The results for 1997 include, for the period beginning on July 9th, the operations of State Auto Life Insurance Company. That company was acquired 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 ILCO 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 Pre-Merger Investors-IN. The closing of the transaction took place on July 9, 1997. In December, 1997, ILIC, an indirect subsidiary of the Company, transferred its domicile from New Jersey to Indiana. Following completion of the redomestication, ILIC merged with Pre-Merger Investors-IN, 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, 1997, it had assets of $153.8 million and capital and surplus of $23.1 million. 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 $19,681,000 at December 31, 1997, as compared to $21,965,000 at December 31, 1996, and $24,511,342 at December 31, 1995. 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 1997 was $18.8 million, as compared to $9.98 million in 1996, and $11.69 million in 1995. Reinsurance premiums ceded were $10.4 million in 1997, as compared to $8.0 million in 1996 and $8.5 million in 1995. 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 $6,327,504. 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. Earned insurance charges for the year ended December 31, 1997 were $40.9 million, as compared to $42.24 million for 1996 and $42.32 million for 1995. 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 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 $1.7 million for the year 1997, as compared to $2.8 million for the year 1996, and $5.7 million for the year 1995. The decrease is attributable to a reduction in the average principal balance of the Senior Loan from $64.4 million for the year ending December 31, 1995 to $33.7 million for the year ending December 31, 1996 and $18.5 million for the year ending December 31, 1997, as well as a decrease in the average rate of interest paid on the senior loan - 7.68% for the year 1997, as compared to 7.76% for the year 1996 and 8.63% for the year 1995. The decline in long-term interest rates during 1997, 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, 1997, the market value of the fixed maturities available for sale segment was $454.5 million as compared to an amortized cost of $436.8 million, or an unrealized gain of $17.7 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. At the annual meeting of shareholders, which was held on June 17, 1997, the shareholders approved the redomestication of the ILCO from the State of New Jersey to the State of Texas. The redomestication was implemented by a merger of the Company into a Texas-domiciled company (ILCO-Texas) and, following the merger, changing the name of ILCO-Texas to InterContinental Life Corporation. For the year ended December 31, 1997, the Company's income from operation before Federal income taxes was $31,602,000 on revenues of $127,683,000, as compared to $41,443,000 on revenues of $138,244,000 for the year 1996, and $16,483,000 on revenues of $122,390,000 in 1995. During 1997, the lapse rate with respect to universal life insurance policies decreased slightly from the lapse rate experienced in 1996. The rate in 1997 was 8.9%, as compared to 9.0% in 1996. The lapse rate with respect to traditional (non-universal) life insurance policies increased slightly from the levels experienced in 1996. The rate in 1997 was 8.9% as compared to 8.0% in 1996. The lapse rates experienced during the 1997 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, 1996, the outstanding principal balance of ILCO's senior loan obligations was $24.9 million. The Company made scheduled principal payments under its senior loan on January 1, 1997 and July 1, 1997, reducing the principal balance to $11.0 million at December 31, 1997. 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, 1997, the outstanding principal balance of the Surplus Debentures was $5.2 million and $22.6 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, 1997, the statutory surplus of Investors-NA was $71.5 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 Standard Life (now, from Investors-NA). 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, 1997, Investors-NA had earned surplus of $32.9 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 in the amounts necessary to enable ILCO to service the Senior Loan 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, 1997. ILCO's net cash flow provided by (used in) operating activities was $3.96 million, as compared to ($23.46) million for the year ended December 31, 1996 and $10.3 million for the same period in 1995. This change is primarily due to fluctuations in the amount of deferred federal income tax related to the market value of investment assets that are fixed maturities available for sale and the net gain realized in connection with the sale of the Austin Centre. 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, 1997, the book value of the Company's investment assets totaled $693.1 million, as compared to $661.1 million as of December 31, 1996. Total assets as of December 31, 1997 ($1.32 billion) increased from the level as of December 31, 1996 ($1.26 billion). The level of short-term investments at the end of 1997 was $164.6 million, as compared to $91.6 million at the end of 1996. Invested real estate and other invested assets decreased from $38.7 million at December 31, 1996 to $1.3 million as of December 31, 1997. This decrease is attributable to the sale of the Bridgepoint Square Offices property by Investors-NA. The fixed maturities available for sale portion of invested assets at December 31, 1997 was $454.5 million. The amortized cost of the fixed maturities available for sale segment as of December 31, 1997 was $436.8 million, representing a net unrealized gain of $17.7 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 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, 1997, included a non-material amount (0.9% 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, 1996, the comparable percentage was 1.1%. The majority of these non-investment grade investments are concentrated in the medium quality (or "3") category, with only 0.7% receiving an NAIC rating of "4" (low quality) or below as of December 31, 1997, as compared to 0.7% as of December 31, 1996. The consolidated balance sheets of the Company as of December 31, 1997 include $53.79 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%. 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 has budgeted approximately $470,000 for implementation of the Plan. 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 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 February 1, 1998, the Company estimated that it had completed the necessary conversions and modifications on the administrative systems which process approximately 35% of the insurance policies for the Company and its subsidiaries. This included the conversion of the ALIS System (administering approximately 49,280 policies) to CK/4 in January of 1998. The TI System (administering approximately 5,244 policies) will be converted to CK/4 in May, 1998, bringing the total to approximately 38%. The conversion of the Life 70 system (administering approximately 17,285 policies for Investors-IN) is scheduled for completion in April, 1999. The modification of the Lifecomm-B system which is responsible for the 19,205 policies assumed after the acquisition of State Auto Life is also scheduled for completion in April, 1999. The conversion of the Lifecomm-A system (administering approximately 65,266 policies for Investors-NA) is now scheduled for completion in September of 1999. The modification of three non-material systems which administer 6,806 credit life policies, 2,514 group certificates and 15,938 industrial life policies are scheduled for completion in December of 1998, March of 1999 and June of 1999 respectively. 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 purchased new mainframe hardware and accompanying operating software, which the vendor has represented to be Y2K compliant. This hardware and software will be tested in 1998. The telephone system 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 anticipates that updated software releases will be commercially available well in advance of the year 2000. Accordingly, to the extent that such systems rely on date sensitive information, the Company expects that the effort needed to correct for year 2000 problems will be less time intensive than the effort needed to achieve compliance for its centralized systems. 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 is required to adopt FAS 130 effective January 1, 1998, with reclassification of financial statements for earlier years required. In June, 1997, the FASB issued FAS 131, "Disclosure 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 it is used internally for evaluating performance. The Company is required to adopt FAS 131 effective January 1, 1998 and comparative information for earlier years must be restated. This statement does not need to be applied to interim financial statements in the initial year of application. The Company is currently considering the impact, if any, of FAS 131 on its current reporting structure. In February, 1998, the FASB issued FAS 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 is required to adopt FAS 132 effective January 1, 1998, with restatement of disclosures for earlier years required. 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. 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 Price Waterhouse LLP, Independent Accountants, dated March 27, 1998. 2. Consolidated Balance Sheets, as of December 31, 1997 and December 31, 1996. 3. Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995. 4. Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995. 5. Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995. 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. 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. Except for Mr. Bender, who was appointed by the Board of Directors in October, 1997, to fill a vacancy, all of the directors were elected at the 1997 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. Age Director Principal Occupation Name Since and Other Information Robert A. Bender 44 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 on February 1994. Jeffrey H. Demgen 45 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 58 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 Gilcrease 66 1988 Dentist practicing in San Marcos, Texas. Director of ILCO since 1988. Director of FIC from 1979 to July 6, 1991. James M. Grace 54 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. Kosson 65 1981 Certified Public Accountant and a partner in the firm of Manheim, Kosson & Novick in Millburn, New Jersey. Director of ILCO since 1981. Roy F. Mitte 66 1984 Chairman of the Board and Chief Executive Officer of the Company and Investors-IN formerly known as InterContinental Life Insurance Company since January, 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. Eugene E. Payne 55 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 69 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 51 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 1995 to December 1997. Donald Shuman 72 1980 Real estate specialist, engaged in sales and management of real estate for his own company, Don Shuman Associates, a real estate brokerage and management firm. Mr. Shuman was the general partner of Shuman-Carlisle Mall Associates, a partnership that owned a 400,000 square foot shopping mall located in Carlisle, Pennsylvania. In January 1993, the partnership filed a petition pursuant to Chapter 11 of the Federal Bankruptcy Code, and that bankruptcy proceeding was concluded in early 1995. The incumbent directors, except for Mr. Shuman, have been nominated for submission to vote of the shareholders for reelection at the 1998 annual shareholders' meeting. (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 1997 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 66 Chairman of the Board, President and Chief Executive Officer James M. Grace 54 Vice President and Treasurer Eugene E. Payne 55 Vice President and Secretary Joseph F. Crowe(1) 59 Vice President Jeffrey H. Demgen 45 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. 1. Mr. Crowe retired from active service with the Company as of January 3, 1997. He continued to serve on the Board of Directors until October, 1997, when he resigned from the ILCO Board in order to devote his efforts to the Board activities of FIC. (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) 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, 1997 through December 31, 1997 all Section 16(a) filing requirements applicable to its officers, directors and greater than ten- percent beneficial owners were complied with, except as follows: Robert A. Bender filed a Form 5 in February, 1998, to report his appointment as a Director of the Company as of October 10, 1997. 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 1997 and received cash compensation exceeding $100,000 during 1997. Annual Compensation Long Term Compensa- tion Awards Name and Stock Principal Options All Other Position Year Salary(1) Bonus(8) Other(2) (Shares) Compensation(9) Roy F. Mitte, Chairman, President 1997 $252,253 $751,500 -0- -0- -0- and Chief 1996 $286,643 -0- -0- -0- $2,446,397 (3) Executive 1995 $286,643 -0- -0- -0- $ 713,513 (4) Officer James M. Grace, Vice President 1997 $195,000 $40,000 -0-(5) -0- $19,024 and 1996 195,000 $15,000 -0- -0- -0- Treasurer 1995 195,000 $10,000 -0- -0- -0- Eugene E. Payne, Vice 1997 $195,000 $40,000 -0-(6) -0- $17,925 President 1996 $195,000 $15,000 -0- -0- -0- and 1995 $195,000 $10,000 -0- -0- -0- Secretary Jeffrey H. Demgen 1997 $117,884 $30,000 -0- -0- -0- Vice 1996 $102,500 $ 7,500 -0- -0- -0- Presi- dent(7) (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 1995, 1996 and 1997: (i) Mr. Mitte: $216,857, $216,857, and $999,746 respectively, which amounts are not included in the above table; (ii) Mr. Grace: $88,293, $83,987 and $68,150 respectively; (iii) Dr. Payne: $79,875, $83,987 and $68,150 respectively; and (iv) Mr. Demgen $46,125 and $66,548(1996 and 1997 only). (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 the contract referred to in footnote 4. (4) In 1989, the Board of Directors granted Mr. Mitte options to purchase 600,000 shares (as adjusted for the three-for-one stock split effective February 15, 1990) of the Common Stock of the Company in equal annual installments of 150,000 shares each. Each installment was subject to the approval of the Board of Directors and is exercisable for a period of ten years from the date the options become exercisable at a price of $1.00 per share (as adjusted). The Board of Directors voted to award installments of 150,000 shares in each of 1989, 1990, 1991 and 1992. In October 1992, Mr. Mitte surrendered to the Company for cancellation options to purchase 120,000 shares. The Company and Mr. Mitte entered into a contract in 1993 providing for the cancellation in 1993 of 240,000 options for an aggregate amount of $3,237,120 and the cancellation in subsequent years of the remaining options for an aggregate amount of $3,610,240. In addition, the Company agreed to pay Mr. Mitte the amount necessary to ensure that Mr. Mitte will receive the same amount, after federal income tax, that he would have received if the options had been cancelled in 1992. During 1995, Mr. Mitte was paid $836,582 for the cancellation in 1995 of options to purchase 50,000 shares of ILCO's Common Stock, $156,323 for the federal income tax reimbursement relating to the cancellation in 1994 of options to purchase 68,500 shares and $127,608 as the final payment relating to the cancellation in 1993 of options to purchase 240,000 shares. These option cancellation payments were made pursuant to the contract referred to above. FIC's Compensation Committee made a recommendation to FIC's Board of Directors, which it adopted, that, in lieu of paying Mr. Mitte a bonus as it has in the past, FIC paid $407,000 of these option cancellation payments to Mr. Mitte, with the balance of $713,513 being paid by ILCO. (5) Mr. Grace exercised stock options in 1997 to purchase 12,000 shares of the Company's Common Stock under the Non-Qualified Option Plan and 30,000 shares of the Company s Common Stock under the Incentive Stock Option Plan. See "Aggregated Option Exercises in 1997" below. (6) 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 and 20,000 shares of the Company s Common Stock under the Incentive stock Option Plan. See "Aggregated Option Exercises in 1997" below. (7) Mr. Demgen became an executive officer of the Company in August, 1996. (8) The data in this column represents the annual bonus paid in 1997. The bonuses for Mr. Grace, Dr. Payne and Mr. Demgen represent amounts paid in 1997, but include the bonuses awarded with respect to the years 1996 and 1997. Dr. Payne elected to defer this amount 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 9. (9) The data in this column represents the amount paid by the Company in 1997 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 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. 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 the year 1997 only; however, there is no obligation for it to do so. See Note 8. Option Grants in 1997 No options were granted to any executive officers of the Company during the year 1997. Aggregated Option Exercises in 1997 The following table sets forth information concerning each exercise of stock options during 1997 by each of the individuals who were executive officers of the Company as of December 31, 1997. Shares Acquired Value Name On Exercise (#) Realized ($) James M. Grace 42,000 $437,340 Eugene E. Payne 26,000 $278,920 Aggregated Stock Option Values The following table sets forth information with respect to the unexercised options held by the executive officers of the Company. Value of Number of Unexercised Unexercised Options In-the-Money Held at Options at December 31, 1997 December 31, 19971 Name Exercisable Unexercisable Exercisable Unexercisable James M. Grace 12,000 12,000 $200,040 $200,040 Eugene E. Payne 6,000 6,000 $100,020 $100,020 (1) Based on the closing price of the Company's Common Stock on NASDAQ on December 31, 1997 ($20.00). Members of Compensation Committee W. Lewis Gilcrease, Donald Shuman and Richard A. Kosson 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. The annual eligible earnings, for 1997 only, covered by the Pension Plan (salary and bonus 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, 1997 being shown in parentheses: Mr. Mitte, $160,000 (10 years), Mr. Grace, $160,000 (10 years), Dr. Payne, $160,000 (9 years), and Mr. Demgen (5 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 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 16, 1998 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 of Percent of Name and Address Beneficial Ownership Class Financial Industries Corp. 701 Brazos, Suite 1400 Austin, TX 78701............. 3,668,501 (1) 60.68% (6) Roy F. Mitte 701 Brazos, Suite 1400 Austin, TX 78701.............. 3,684,361 (2,3) 60.94% (6) Investors Life Insurance Company of North America 701 Brazos, Suite 1400 Austin, TX 78701................ 334,960 (4) 7.71% (6) Investors Life Insurance Company of Indiana 701 Brazos, Suite 1400 Austin, TX 78701................. 281,560 (5) 6.48% (6) Fidelity Management & Research Company 82 Devonshire Street Boston, MA 02109................... 432,700 (7) 9.96% (6) 1 Includes 1,966,346 shares of the Company's stock presently owned and an option to purchase up to 1,702,155 shares of the Company's authorized but unissued Common Stock which is the balance of the option granted to Financial Industries Corporation ("FIC") by the Company in December, 1985. This option may be exercised by FIC at any time at an exercise price equal to the average bid prices of the Company's Common Stock over the six-month period immediately preceding such exercise. 2 As of March 16, 1998, Mr. Mitte, jointly with his wife Joann, currently owns 1,493,216 common shares of Financial Industries Corporation ("FIC"). Mr. Mitte and his wife also control the Roy F. and Joanne Cole Mitte Foundation, a Texas non-profit corporation (the "Foundation"), which owns 373,304 common shares of FIC stock as a result of a donation made by Mr. Mitte and his wife from their personal holdings. The holdings of the Foundation combined with Mr. and Mrs. Mitte's remaining personal holdings in FIC stock constitutes 34.39 percent of the outstanding common stock of that company. Mr. Mitte holds the position of Chairman, President and Chief Executive Officer of FIC. Since FIC holds a controlling interest in the Company, 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. 3 Includes 15,860 shares allocated to Mr. Mitte's account under the Employee Stock Ownership Plan. 4 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. 5 All are directly owned by Investors-IN and are treated as treasury shares. 6 Assumes that outstanding stock options or warrants available to other persons have not been exercised. 7. As reported to the Company on a Schedule 13(G) filed by FMR Corporation, the parent company of Fidelity Management & Research Company ("Fidelity"). According to the Schedule 13(G), 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 and 14,400 additional shares which were reported on a schedule 13(g)filed on February 14, 1998. The following table contains information as of March 16, 1998 as to the Common Stock of the Company beneficially owned by each director, nominee and executive officer and by all executive 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 854 (3) * Jeffrey H. Demgen 4,067 (3) * Theodore A. Fleron 15,689 (3,4) * W. Lewis Gilcrease -0- James M. Grace (1) 61,346 (2,3) 1.4% Richard A. Kosson 200 * Roy F. Mitte (1) 3,684,361 (3) 60.94% Eugene E. Payne (1) 32,286 (3) * H. Gene Pruner -0- Donald Shuman 450 * Steven P. Schmitt 14,347 (3,4) * All Executive Officers and Directors as a group, all of whom are listed above 3,813,600 (1,2,3,4) 62.83% * Less than 1% (1) As an executive officer and/or director of FIC which as of March 16, 1998 beneficially owned 3,668,501 shares of the Company's Common Stock (including option rights to purchase 1,702,155 shares of the Company). In addition to the shareholdings of Mr. Mitte in FIC (see Note 2, above), Mr. Grace owns 5,600 shares of FIC Common Stock. (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. The obligations of the Company under the Senior Loan are guaranteed by FIC. FIC presently owns 1,966,346 shares of the company's Common Stock, constituting 45.40% of such shares outstanding, and holds 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. In the event that such options were to be fully exercised, the total number of the Company's shares owned by FIC would constitute 60.80% of the outstanding shares of the Company's Common Stock. As described under the heading Senior Loan , the current Senior Loan of ILCO is scheduled to be fully repaid on October 1, 1998. Accordingly, unless ILCO s Senior Loan is extended, or ILCO otherwise incurs indebtedness which is guaranteed by FIC, FIC s rights under the 1986 option agreement would expire on October 1, 1998. b. In connection with the December, 1997 sale of Bridgepoint Square Offices by Investors-NA and Family Life Insurance Company, FIC Realty received a commission in the amount of $156,000, of which $122,538 was paid by Investors-NA and $33,462 by Family Life. c. 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 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%. d. The Company reimbursed FIC for rental expenses and certain other operating expenses incurred during 1997 on behalf of the Company. The amount of such reimbursement was approximately $822,000. e. Pursuant to a data processing agreement with a major service company, the data processing needs of ILCO's and FIC's insurance subsidiaries were provided at a central location until November 30, 1994. Commencing December 1, 1994, all of those data processing needs are provided to ILCO's and FIC's Austin, Texas and Seattle, Washington facilities by FIC Computer Services, Inc. ("FIC Computer"), a new 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 $3,010,110 and Family Life paid $824,425 to FIC Computer for data processing services provided during the year ended December 31, 1997. f. 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. g. 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. h. 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; and Mr. Crowe served as a Director of ILCO until October, 1997; he serves as a Director of FIC and, until his retirement in January, 1997, served as a Vice President of both companies. Mr. Roy Mitte holds beneficial ownership of 34.39% of the outstanding shares of FIC (see "Security Ownership of Certain Beneficial Owners and Management"). i. Mr. 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 provide of a payment of $25,000 per year for a period of five-years. 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-Amounts Receivable from Related Parties, Underwriters, Promoters and Employees other than Related Parties. c. Schedule III-Condensed Financial Statements of Registrant. d. Schedule VI-Reinsurance Ceded and Assumed. 3. Exhibits filed with this report or incorporated herein by reference are as listed in the Index to Exhibits on page E-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, 1997. 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 , 1998. /s/ Roy F. Mitte Roy F. Mitte, Director /s/ James M. Grace James M. Grace, Director /s/ Jeffrey H. Demgen Jeffrey H. Demgen, Director /s/ Eugene E. Payne Eugene E. Payne, Director /s/ Robert A. Bender Robert A. Bender, Director /s/ Theodore A. Fleron Theodore A. Fleron, Director /s/ H. Gene Pruner H. Gene Pruner, Director /s/ Steven P. Schmitt Steven P. Schmitt, Director /s/ W. Lewis Gilcrease W. Lewis Gilcrease, Director /s/ Richard A. Kosson Richard A. Kosson, Director /s/ Donald Shuman Donald Shuman, Director INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES FORM 10-K--ITEM 14 (a)(1) and (2) LIST OF FINANCIAL STATEMENTS TABLE OF CONTENTS 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, 1997 and 1996.......F-3 Consolidated Statements of Income, for the years ended December 31, 1997, 1996 and 1995.............................F-5 Consolidated Statements of Changes in Shareholders' Equity, for the years ended December 31, 1997, 1996 and 1995.........F-6 Consolidated Statements of Cash Flows, for the years ended December 31, 1997, 1996 and 1995.............................F-9 Notes to Consolidated Financial Statements...................................................F-12 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-43 Schedule II - Condensed Financial Statements of Registrant................................................... F-44 Schedule IV - Reinsurance....................................F-48 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. 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, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, 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. Price Waterhouse LLP Dallas, Texas March 27, 1998 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands of dollars) December 31, ASSETS 1997 1996 Investments: Fixed maturities, at amortized cost (market value approximates $3,332 and $8,374) $ 3,412 $ 8,165 Fixed maturities available for sale, at market value (amortized cost $436,836 and $451,550) 454,462 453,896 Equity securities, at market value (cost approximates $369 and $373) 4,902 2,304 Policy loans 53,499 53,030 Mortgage loans 10,862 13,494 Invested real estate and other invested assets 1,300 38,696 Short-term investments 164,622 91,556 Total investments 693,059 661,141 Cash and cash equivalents 9,041 3,313 Notes receivable from affiliates 53,792 59,940 Accrued investment income 7,781 7,807 Agent advances and other receivables 11,362 21,725 Reinsurance receivables 20,433 12,123 Property and equipment, net 1,902 1,785 Deferred policy acquisition costs 28,621 26,938 Present value of future profits of acquired businesses 47,286 45,240 Deferred financing costs 111 636 Other assets 7,929 8,965 Separate account assets 440,336 414,329 Total Assets $1,321,653 $1,263,942 The accompanying notes are an integral part of the consolidated financial statements. INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, Continued (in thousands of dollars) December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996 Liabilities: Policy liabilities and contractholder deposit funds: Future policy benefits $ 131,720 $ 119,744 Contractholder deposit funds 525,135 538,505 Unearned premiums 7,701 9,069 Other policy claims and benefits payable 7,078 5,988 671,634 673,306 Other policyholders' funds 3,093 2,720 Senior loans 10,964 24,944 Deferred federal income taxes 31,811 23,692 Other liabilities 20,299 13,835 Separate account liabilities 438,090 412,084 Total Liabilities 1,175,891 1,150,581 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, 10,000,000 shares authorized; 5,343,739 and 5,223,739 shares issued, 4,331,335 and 4,232,829 shares out- standing in 1997 and 1996, respectively 1,176 1,150 Additional paid-in capital 4,253 3,752 Net unrealized appreciation of equity securities 2,946 1,255 Net unrealized gain on investments in fixed maturities available for sale 11,457 1,525 Retained earnings 129,237 108,697 149,069 116,379 Common treasury stock, at cost, 1,012,404 and 990,910 shares in 1997 and 1996, respectively (3,307) (3,018) Total Shareholders' Equity 145,762 113,361 Total Liabilities and Shareholders' Equity $ 1,321,653 $ 1,263,942 The accompanying notes are an integral part of the consolidated financial statements. INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands of dollars, except for per share data) Year Ended December 31, 1997 1996 1995 Revenues: Premiums $ 11,031 $ 9,980 $ 11,694 Net investment income 57,740 59,836 64,781 Earned insurance charges 40,853 42,238 42,324 Gain on sale of real estate 14,630 23,520 -0- Other 3,429 2,670 3,591 127,683 138,244 122,390 Benefits and expenses: Policyholder benefits and expenses 37,962 40,091 42,639 Interest expense on contractholder deposit funds 30,533 32,068 32,375 Amortization of present value of future profits of acquired businesses 6,311 3,366 6,211 Amortization of deferred policy acquisition costs 2,818 2,574 3,929 Operating expenses 16,798 15,884 15,016 Interest expense 1,659 2,820 5,737 96,081 96,801 105,907 Income from operations 31,602 41,443 16,483 Provision for federal income taxes: Current 9,005 10,227 945 Deferred 2,057 4,278 4,824 11,062 14,505 5,769 Net income $ 20,540 $ 26,938 $ 10,714 Net income per share (Note 14): Basic: Weighted average common stock outstanding 4,328 4,233 4,175 Basic earnings per share $ 4.75 $ 6.36 $ 2.57 Diluted: Common stock and common stock equivalents 4,369 4,441 4,342 Diluted earnings per share $ 4.70 $ 6.07 $ 2.47 The accompanying notes are an integral part of the consolidated financial statements. 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, 1994 5,107 $ 1,124 $ 2,854 Net income Change in net unrealized appreciation of equity securities Change in net unrealized loss on investments in fixed maturities available for sale Options exercised 59 13 667 Balance at December 31, 1995 5,166 1,137 3,521 Net income Change in net unrealized appreciation of equity securities Change in net unrealized loss on investments in fixed maturities available for sale Options exercised 58 13 231 Balance at December 31, 1996 5,224 1,150 3,752 Net income Change in net unrealized appreciation of equity securities Change in net unrealized gain on investments in fixed maturities available for sale Treasury stock purchased Options exercised 120 26 501 Balance at December 31, 1997 5,344 $ 1,176 $ 4,253 The accompanying notes are an integral part of these consolidated financial statements. INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands of dollars) Net Unrealized Gain (Loss) on Invest- Net ments in Unrealized Fixed Appreciation Maturities of Equity Available Retained Balance at December 31, Securities For Sale Earnings 1994 $ 568 $(20,266) $ 71,045 Net income 10,714 Change in net unrealized appreciation of equity securities 180 Change in net unrealized loss on investments in fixed maturities available for sale 33,204 Options exercised Balance at December 31, 1995 748 12,938 81,759 Net income 26,938 Change in net unrealized appreciation of equity securities 507 Change in net unrealized gain on investments in fixed maturities available for sale (11,413) Options exercised Balance at December 31, 1996 1,255 1,525 108,697 Net income 20,540 Change in net unrealized appreciation of equity securities 1,691 Change in net unrealized gain on investments in fixed maturities available for sale 9,932 Treasury stock purchased Options exercised Balance at December 31, 1997 $ 2,946 $ 11,457 $ 129,237 The accompanying notes are an integral part of the consolidated financial statements. INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands of dollars) Common Total Treasury Shareholders' Stock Equity Balance at December 31, 1994 $(3,018) $ 52,307 Net income 10,714 Change in net unrealized appreciation of equity securities 180 Change in net unrealized loss on investments in fixed maturities available for sale 33,204 Options exercised 680 Balance at December 31, 1995 (3,018) 97,085 Net income 26,938 Change in net unrealized appreciation of equity securities 507 Change in net unrealized loss on investments in fixed maturities available for sale (11,413) Options exercised 244 Balance at December 31, 1996 (3,018) 113,361 Net income 20,540 Change in net unrealized appreciation of equity securities 1,691 Change in net unrealized gain on investments in fixed maturities available for sale 9,932 Treasury stock purchased (289) (289) Options exercised 527 Balance at December 31, 1997 $(3,307) $145,762 The accompanying notes are an integral part of the consolidated financial statements. INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Year Ended December 31, CASH FLOWS FROM OPERATING 1997 1996 1995 ACTIVITIES Net income $ 20,540 $ 26,938 $10,714 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization of present value of future profits of acquired businesses 6,311 3,366 6,211 Amortization of deferred policy acquisition costs 2,819 2,572 5,393 Depreciation 2,398 1,356 2,610 Net gain on sales of investments (14,805) (23,394) (418) Financing costs amortized 525 961 865 Amortization of deferred gain on sale of real estate (110) (110) (110) Changes in assets and liabilities: Decrease in accrued investment income 362 383 1,759 Decrease (increase) in agent advances and other receivables 4,170 (2,783) 4,656 Policy acquisition costs deferred (4,502) (4,584) (3,573) Decrease in policy liabilities and contractholder deposit funds (17,585) (16,374) (27,753) (Decrease) increase in other policy holders' funds (258) 20 (349) Increase (decrease) in other liabilities 5,172 (13,270) 911 Increase (decrease) in deferred federal income taxes 5,302 (1,770) 4,696 Decrease (increase) in other assets 1,036 (2,106) 7,527 Other, net (7,416) 5,331 (1,388) Net cash provided by (used in) operating activities 3,959 (23,464) 10,287 The accompanying notes are an integral part of the consolidated financial statements. INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Year Ended December 31, CASH FLOWS FROM INVESTING 1997 1996 1995 ACTIVITIES Purchase of insurance subsidiary (11,688) -0- (17,492) Investments purchased (24,276) (55,395) (38,781) Proceeds from sales and maturities of investments 117,025 112,791 50,181 Net change in short-term investments (71,415) (5,562) 8,847 Purchases & retirements of equipment (283) 1,319 (4,403) Decrease (increase)in notes receivable from affiliates 6,148 1,284 (465) Net cash provided by (used in) investing activities 15,511 54,437 (2,113) CASH FLOWS FROM FINANCING ACTIVITIES Purchase of treasury stock (289) -0- -0- Issuance of common stock 527 244 -0- Issuance of senior loan -0- -0- 15,000 Repayment of debt (13,980) (34,441) (22,200) Net cash used in financing activities (13,742) (34,197) (7,200) Net increase (decrease) in cash and cash equivalents 5,728 (3,224) 974 Cash and cash equivalents, beginning of year 3,313 6,537 5,563 Cash and cash equivalents, end of year $ 9,041 $ 3,313 $ 6,537 The accompanying notes are an integral part of the consolidated financial statements. INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Supplemental Cash Flow Disclosures: Year Ended December 31, 1997 1996 1995 Income taxes paid $2,200 $ 13,567 $ 560 Interest paid $1,925 $ 3,377 $ 5,905 Supplemental Schedule of Non-Cash Investing Activities: The Company purchased the outstanding capital stock of life insurers in the third quarter of 1997 and the first quarter of 1995 for cash purchase prices of $11.8 million and $17.1 million 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: 1997 1995 Assets $32,420 $99,642 Liabilities $20,653 $90,816 The accompanying notes are an integral part of the consolidated financial statements. 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, credit life and credit disability insurance policies 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 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS as a separate component of equity, net of the income tax effect. 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 $5,243,720 and $5,788,424 at December 31, 1997 and 1996, 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 $237,000 and $620,000 in 1997 and 1996, respectively. No interest cost was capitalized in 1995. 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. 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 $4,517,477 and $4,364,064 at December 31, 1997 and 1996, 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 8.5% to 9%. 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. Deferred Financing Costs Financing costs associated with the Company's Senior Loan have been deferred and are being 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 record the expense for guaranty fund assessment from states which do not allow premium tax offsets in the period assessed. The Company's insurance subsidiaries recorded expenses of $70,253, $100,165, and $241,692 in the years ended December 31, 1997, 1996 and 1995, respectively, as a result of such assessments. 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 depending upon the type of coverage. 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. 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 and 1995 to conform to this pronouncement. 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 is required to adopt FAS 130 effective January 1, 1998, with reclassification of financial statements for earlier years required. 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 is required to adopt FAS 131 effective January 1, 1998, and comparative information for earlier years must be restated. This statement does not need to be applied to interim financial statements in the initial year of application. 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 is required to adopt FAS 132 effective January 1, 1998, with restatement of disclosures for earlier years required. 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. 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, 1997 and 1996, respectively were as follows (in thousands): Gross Gross Amort- Unreal- Unreal- ized ized ized Market Cost Gains Losses Value 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 Fixed Maturities Available For Sale as of December 31, 1996: U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 13,817 $ 902 $ 18 $ 14,701 Obligations of states and 4,727 163 -0- 4,890 political subdivisions Foreign government debt securities 5 -0- -0- 5 Corporate securities 120,263 2,582 3,625 119,220 Mortgage-backed securities 312,738 7,473 5,131 315,080 Total Fixed Maturities Available For Sale 451,550 11,120 8,774 453,896 Fixed Maturities held to Maturity: Private placements-corporate 8,165 320 111 8,374 Total Fixed Maturities $459,715 $11,440 $ 8,885 $462,270 In determining the amounts reflected in the balance sheet, the Company has reduced its gross unrealized gains and losses on investments in fixed maturities available for sale as reflected above by $6,169,000 and $821,000 in 1997 and 1996, respectively, in determining the net unrealized gain on investments in fixed maturities available for sale recorded as a component of shareholders' equity. The adjustment is made to recognize deferred taxes on the net unrealized gain. The amortized cost and market value of fixed maturities carried at amortized cost at December 31, 1997 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...... $ 5,475 $ 5,491 Due after one through five years................. 21,727 22,612 Due after five through ten years...................... 25,237 26,213 Due after ten years.......... 96,650 100,457 Mortgage backed securities... 287,747 299,689 Total Fixed Maturities Available for Sale $436,836 $454,462 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................ 2,503 2,425 Due after five through ten years..................... 830 807 Due after ten years......... Mortgage backed securities.. 79 99 Total Fixed Maturities Held to Maturity $ 3,412 $ 3,332 Proceeds from sales and maturities of investments in fixed maturities during 1997, 1996 and 1995 were approximately $57,840,000, $53,888,000, and $47,316,000. Gross gains of approximately $293,000, $322,000, and $578,000 and gross losses of approximately $ 123,000, $100,000, and $22,000 were realized on those sales and maturities in 1997, 1996 and 1995, respectively. Equity Securities The change in net unrealized appreciation for equity securities was $2,601,000 and $780,000 for the years ended December 31, 1997 and 1996, respectively. Amounts as of December 31 were as follows: 1997 1996 (in thousands) Unrealized appreciation $ 4,543 $ 1,946 Unrealized depreciation (11) (15) Net unrealized appreciation before tax 4,532 1,931 Less: Federal income tax (1,586) (676) Net unrealized appreciation $ 2,946 $ 1,255 Net Investment Income The components of net investment income are summarized as follows: Year Ended December 31, 1997 1996 1995 (in thousands) Fixed maturities $46,570 $47,448 $49,329 Equity securities 10 12 65 Other, including policy loans, real estate and mortgage loans 14,826 15,708 19,392 61,406 63,168 68,786 Investment expenses (3,666) (3,332) (4,005) Net investment income $57,740 $59,836 $64,781 Realized Gains and Losses Net realized gains (losses) included in net investment income are summarized below: Year Ended December 31, 1997 1996 1995 (in thousands) Fixed maturities available for sale $ 171 $ 222 $ 556 Equity securities (2) 1 (26) Other investments 6 (256) (97) 175 33 433 Income taxes 61 12 152 Net realized gains $ 114 $ 21 $ 281 Non-income producing investments The carrying value of non-income producing investments were as follows as of December 31: 1997 1996 (in thousands) Fixed maturities $ -0- $ 100 Mortgage loans 81 81 Total $ 81 $ 181 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, 1997. Financial Industries Corporation Equity securities includes a $4,709,251 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, 1997. 3. Disclosures about Fair Value of Financial Instruments The estimated fair values of the Company's financial instruments at December 31, 1997 are as follows: Carrying Fair Amount Value (in thousands) Financial assets: Fixed maturities $457,849 $457,794 Policy loans 53,499 53,499 Mortgage loans 10,862 11,307 Short-term investments 164,622 164,622 Cash and cash equivalents 9,041 9,041 Notes receivable from affiliates 53,792 53,792 Carrying Fair Amount Value (in thousands) Financial liabilities: Deferred annuities $107,147 $106,420 Supplemental contracts 11,826 11,317 Senior loans 10,964 10,964 The following methods and assumptions were used to estimate the fair value of each class of financial instrument: 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. 4. Present Value of Future Profits of Acquired Business An analysis of the present value of future profits of acquired businesses is as follows: 1997 1996 (in thousands) Beginning balance $ 45,240 $ 48,606 Acquisition of insurance subsidiary 8,357 -0- Accretion of interest 3,786 4,401 Amortization (10,097) (7,767) Ending balance $ 47,286 $ 45,240 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) 1998 $ 5,366 1999 $ 3,472 2000 $ 3,063 2001 $ 2,755 2002 $ 2,403 5. Acquisition of Business 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 $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 loan was 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. The pro forma unaudited results of operations for the year ended December 31, 1995, assuming the acquisition of MLIC had been consummated as of the beginning of 1994, is as follows: Unaudited 1995 (in thousands, except per share data) Total revenues $123,905 Net income $ 10,391 Net income per share available to common shareholders: Basic $ 2.49 Dilutive $ 2.39 6. Senior Loans The Company's outstanding debt at December 31, 1997 and 1996 consists of a series of separate notes, each of which is payable to a member bank of a lending syndicate with principal payments beginning April 1, 1993 and a final payment on or before October 1, 1998. The balance of the notes was $10,964,000 and $24,944,000 at December 31, 1997 and 1996, respectively. Interest is payable at the Company's option based on (1) the managing bank's corporate base rate plus 1.25% declining to .5% as principal declines, or (2) LIBOR plus 2.5% declining to 1.75%. The rate in effect at December 31, 1997 and 1996 was 7.68% and 7.56%, respectively. The obligations of the Company under the Senior Loans are secured by: (1) all of the outstanding shares of stock of Investors-NA, (2) a $15,000,000 surplus debenture of Investors-NA payable to the Company, which had an outstanding principal balance of $5,206,224 as of December 31, 1997 and (3) a $140,000,000 surplus debenture of Investors-NA payable to the Company, which had an outstanding principal balance of $22,590,000 as of December 31, 1997. The obligations of the Company under the Senior Loans are guaranteed by FIC. 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. 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 charged to continuing operations for the years ended December 31, was as follows: 1997 1996 1995 (in thousands) Current tax provision $ 9,005 $10,227 $ 945 Deferred tax provision 2,057 4,278 4,824 Total provision for income taxes $11,062 $14,505 $ 5,769 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 does not differ 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. 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, 1997 1996 Deferred Tax Liability: (in thousands) Deferred policy acquisition costs $ 5,773 $ 4,989 Present value of future profits 13,689 11,715 Invested assets -0- 769 Net unrealized appreciation on marketable securities 7,755 1,497 Acquisition discounts on mortgages/policy loans 1,458 1,984 Reinsurance recoverable 6,212 3,268 Other taxable temporary differences 1,547 2,876 Total deferred tax liability 36,434 27,098 Deferred Tax Asset: Policy Reserves 2,858 1,594 Net operating loss carry forward 1,465 1,512 Minimum tax credit 300 300 Total deferred tax asset 4,623 3,406 Net deferred tax liability $ 31,811 $ 23,692 Deferred federal income tax expense (benefit) of $6,258,000 and ($5,872,000) for 1997 and 1996, 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 company. The accumulation in these accounts for Investors-NA and Investors-IN at December 31, 1997 and 1996 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, 1997, Investors-NA and Investors-IN have approximately $120,000,000 and $12,200,000, respectively, in the aggregate in their shareholders' surplus accounts from which distributions could be made without incurring any federal tax liability. At December 31, 1997, the Company and its non-life wholly-owned subsidiaries have net operating loss carryforwards of approximately $4.2 million. At December 31, 1997, 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 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 $6,327,504. 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. The amounts reported in the consolidated financial statements for reinsurance ceded are as follows: December 31, 1997 1996 (in thousands) Future policy benefits $10,008 $ 7,314 Unearned premiums 7,501 1,946 Other policy claims and benefits payable 240 76 Amounts recoverable on paid claims 2,684 2,787 Reinsurance receivables $20,433 $12,123 Year ended December 31, 1997 1996 1995 (in thousands) Premiums $ 10,438 $ 7,962 $ 8,568 Policyholder benefits and expenses $ 15,286 $ 14,712 $ 14,404 9. Shareholders' Equity 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 also holds 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. If all of these options were exercised at December 31, 1997, FIC would own approximately 60.84% of the issued and outstanding shares of the Company's common stock, assuming no other options or warrants held by other parties were exercised. These options will expire in October, 1998. In the event that any other party seeks to acquire the Company's outstanding shares, FIC has the right to acquire, without prior approval and under the same pricing formula, the number of shares of common stock which when added to the number of shares then owned by FIC, amount to 51% of the outstanding shares of the Company. These options will remain in effect as long as any indebtedness guaranteed by FIC remains outstanding (See Note 6). 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. The Senior Loans described in Note 6 restrict the Company from paying any dividends on its common stock during their term. 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 1997 1996 1995 (in thousands) Net Income $ 25,925 $ 33,068 $ 23,810 Capital and Surplus $ 73,932 $ 56,174 $ 61,896 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 $46,057,300 and $51,211,460 in subordinated notes issued by Family Life Corporation, a wholly-owned subsidiary of FIC, at December 31, 1997 and 1996, respectively. This investment exceeds the limit on investments prescribed by the state of Washington by $2,606,560 and $8,787,303 at December 31, 1997 and 1996, 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, 1997 and 1996, this permitted practice increased statutory surplus by $2,606,560 and $8,787,303 over what it would have been under prescribed statutory accounting practices. In 1988, the Company authorized the issuance of 10 million shares of Class C Preferred Stock, $1.00 par value. The Company is 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. 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 all plans include the following components: 1997 1996 (in thousands) Service cost-benefits earned during the period $ 390 $ 502 Interest cost on projected benefit obligation 693 686 Return on plan assets (1,226) (1,128) Amortization (229) (229) Pension benefit $ (372) $ (169) The following summarizes the funded status of the plans at December 31: 1997 1996 (in thousands) Actuarial present value of: Vested benefit obligation $ (9,778) $ (7,726) Accumulated benefit obligation $ (9,968) $ (7,914) Projected benefit obligation $ (11,162) $ (8,936) Plan assets at market value 15,681 15,322 Plan assets in excess of projected benefit obligations $ 4,519 $ 6,386 Unrecognized prior service cost $ (698) $ (926) Unrecognized net loss (gain) $ 693 $ (1,317) Prepaid pension expense $ 4,514 $ 4,143 The significant assumptions for the plans are as follows: The discount rate for projected benefit obligations was 7.75% in 1997 and 1996. The assumed long-term rate of compensation increases was 6.0% for 1997 and 1996. The long-term rate of return on plan assets was 8.0% for 1997 and 1996. Assumed expenses as a percentage of plan assets were 0% and 0.5% for 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 1997, 1996 or 1995. At December 31, 1997, the Plan had a total of 350,296 shares which are allocated to participants and no shares remain unallocated. 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. 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, 1997, options to purchase 327,850 shares have been granted since the plan's inception. As of December 31, 1997, 233,750 options have been exercised and 86,100 options have been terminated. At December 31, 1997 there were no options remaining under the ISO Plan to purchase shares of the Company's common stock. The number of options exercised in 1997, 1996 and 1995 were 72,000, 9,500 and 11,000, 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 1991, options to purchase 50,000 shares were granted at prices ranging from $8.75 to $9.25. In 1992 and 1990 options to purchase 60,000 and 30,000 shares respectively, 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 shares were cancelled. There were no options granted in 1997 and 1996. The number of options exercised in 1997, 1996 and 1995 were 48,000, 48,000 and 48,000, respectively. The following table summarizes activity under all Plans for each of the three years ended December 31, 1997: 1995 Weighted Average Shares Exercise (000's) Price Outstanding at the beginning of the year 383 $ 4.58 Granted 60 11.12 Exercised (59) 3.67 Canceled 0 0.00 Outstanding at the end of the year 384 $ 5.75 Options exercisable at year end 130 $ 4.70 Weighted average fair value of options granted during the year 60 $ 11.12 1996 Weighted Average Shares Exercise (000's) Price Outstanding at the beginning of the year 384 $ 5.75 Granted 0 0.00 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 (000's) Price 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- As of December 31, 1997: Options Outstanding weighted-average Number remaining Range of Outstanding contractual exercise prices December 31, 1997 Life (years) $ 3.33 84,000 1 year $13.09 1,702,155 1 year Range of Weighted Average exercise prices Exercise price $ 3.33 $ 3.33 $13.09 $13.09 Range of Number exercisable Weighted average Exercise prices December 31, 1997 exercise price $ 3.33 -0- -0- $13.09 -0- -0- In 1989 options to purchase 600,000 shares of the Company's common stock at $1.00 per share (as adjusted for the three for one stock split effective February 15, 1990) were granted by the Board of Directors to the Company's Chairman of the Board. These options became exercisable upon approval of the Board of Directors in annual installments of 150,000 shares each. The last installment was granted in 1992. In 1992, the chairman surrendered for cancellation 120,000 of these options. In October of 1993, the Company entered into an agreement with the Chairman, whereby the Chairman agreed to surrender all of his remaining common stock options between 1993 and 1996. Pursuant to this agreement, all remaining options were surrendered through December 31, 1996, (see Note 12). 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 1997, 1996, and 1995 was $3,147,037, $2,466,679, $2,531,085, respectively, under these lease agreements. Minimum annual future rentals are as follows: (in thousands) 1998 1,758 1999 1,670 2000 1,670 2001 1,670 2002 1,424 Thereafter 1,944 $ 10,136 12. Related Party Transactions The obligations of the Company under the Senior Loan are guaranteed by FIC. FIC presently owns 1,966,346 shares of the company's Common Stock, constituting 45.43% of such shares outstanding, and holds 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. In the event that such options were to be fully exercised, the total number of the Company's shares owned by FIC would constitute 60.84% of the outstanding shares of the Company's Common Stock. As described in Note 6, the current Senior Loan of ILCO is scheduled to be fully repaid on October 1, 1998. Accordingly, unless ILCO s Senior Loan is extended, or ILCO otherwise incurs indebtedness which is guaranteed by FIC, FIC s rights under the 1986 option agreement would expire on October 1, 1998. FIC Property Management, Inc., ("FIC Property"), a subsidiary of FIC, conducted the leasing activities for the Bridgepoint Square properties previously owned by Investors-NA. 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 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 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, 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 $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%. The Company reimbursed FIC for rental expenses and certain other operating expenses incurred during 1997, 1996 and 1995 on behalf of the Company. The amount of such reimbursement was approximately $822,000, $305,000 and $830,000, respectively. All of the data processing needs of ILCO's and FIC's insurance subsidiaries are provided to ILCO's and FIC's Austin, Texas and Seattle, Washington facilities by FIC Computer Services, 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 $3,010,110 and Family Life paid $824,425 to FIC Computer for data processing services provided during the year ended December 31, 1997. 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 $14 million, $14 million, and $15 million from Family Life Insurance Company for direct costs incurred by ILCO on behalf of Family Life Insurance Company's operations in 1997, 1996 and 1995, respectively. Under an agreement between ILCO and Family Life all direct costs incurred on behalf of the other are to be reimbursed. In October of 1993, the Company entered into an agreement with the Chairman, whereby the Chairman agreed to surrender all of his remaining common stock options for consideration of $6,847,000 (See Note 10). Prior to entering into this agreement, the Company had accrued compensation expense related to these options of $4,225,000. Upon entering into the agreement, additional compensation was recorded totaling $2,622,000 for the year ended December 31, 1993 to increase total compensation to the surrender price. Accordingly, a liability was recorded for the unpaid portion of the agreement. Pursuant to this agreement, during 1993 the Chairman was paid $3,237,120 for cancellation of 240,000 of these options and during 1994 he was paid $997,520 for cancellation of 68,500 options and $379,143 for federal income tax reimbursement relating to the cancellation of options in 1993. During 1995, the Chairman was paid $836,582 for the cancellation in 1995 of options to purchase 50,000 shares of ILCO's Common Stock, $156,323 for the federal income tax reimbursement relating to the cancellation in 1994 of options to purchase 68,500 shares and $127,608 as the final payment relating to the cancellation in 1993 of options to purchase 240,000 shares. During 1996, the Company paid the Chairman: (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. The federal income tax reimbursements are expensed in the period when they are incurred. 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: December 31, 1997 1996 1995 (amounts in thousands, except per share amounts) Basic: Net income available to common shareholders $20,540 $26,938 $10,714 Weighted average common stock outstanding 4,328 4,233 4,175 Basic earnings per share $ 4.75 $ 6.36 $ 2.57 Diluted: Net income available to common shareholders $20,540 $26,938 $10,714 Weighted average common stock outstanding 4,328 4,233 4,175 Common stock options 88 1,993 2,049 Repurchase of treasury stock (47) (1,785) (1,882) Common stock and common stock equivalents 4,369 4,441 4,342 Diluted earnings per share $4.70 $6.07 $2.47 The options held by FIC to purchase ILCO stock were excluded from the 1997 diluted EPS calculation as they were antidilutive. 15. Quarterly Financial Data (unaudited) (in thousands, except per share amounts) Three Months Three Months Ended Ended March 31, June 30, 1997 1996 1997 1996 Net Operating Revenue $27,401 $53,581 $28,555 $27,836 Net Income $ 2,700 $18,042 $ 2,942 $ 2,936 Basic earnings per share $ 0.64 $ 4.31 $ 0.68 $ 0.70 Diluted earnings per share $ 0.61 $ 3.89 $ 0.67 $ 0.66 Three Months Three Months Ended Ended September 30, December 31, 1997 1996 1997 1996 Net Operating Revenue $ 29,306 $29,474 $42,421 $27,353 Net Income $ 2,837 $ 2,973 $12,061 $ 2,987 Basic earnings per share $ 0.66 $ 0.71 $ 2.79 $ 0.70 Diluted earnings per share $ 0.62 $ 0.70 $ 2.69 $ 0.68 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1997 (in thousands of dollars) Column A Column B Column C Column D Amount at Which Shown in the Balance Type of Investment Costs Value Sheet Fixed maturities available for sale: United States Government and government agencies and authorities $ 24,556 $ 25,825 $ 25,825 States, municipalities and political subdivisions 4,686 5,035 5,035 Corporate securities 119,847 123,913 123,913 Mortgage-backed securities 287,747 299,689 299,689 Total fixed maturities available for sale 436,836 454,462 454,462 Fixed maturities held to maturity 3,412 3,332 3,412 Total fixed maturities 440,248 457,794 457,874 Equity securities: Public utilities 2 2 2 Banks, trust and financial institutions 31 161 161 Industrial, miscellaneous and all other 18 30 30 Total equity securities 51 193 193 Policy loans 53,499 53,499 53,499 Mortgage loans 10,862 11,307 10,862 Real estate 1,300 1,300 1,300 Short term investments 164,622 164,622 164,622 Total investments $670,582 $688,715 $688,350 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT BALANCE SHEETS December 31, 1997 and 1996 (in thousands of dollars) ASSETS 1997 1996 Short-term investments $ 692 $ 6,252 Cash and cash equivalents 99 126 Subordinated debenture receivables from Investors Life Insurance Company of North America, due September 30, 1999 27,796 38,546 Investments in and advances to subsidiaries 128,305 91,601 Accounts receivable 4,940 6,117 Property, plant and equipment, net 271 277 Other assets 493 1,022 Total Assets $ 162,596 $ 143,941 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANTS BALANCE SHEETS, continued December 31, 1997 and 1996 (in thousands of dollars) LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996 Liabilities: Accounts payable and accrued expenses $ 2,570 $ 2,226 Senior loans 10,964 24,944 Deferred gain on sale of real estate 847 956 14,381 28,126 Redeemable preferred stock: Class A preferred stock, $1 par value, shares authorized and issued 5,000 5,000 Class B preferred stock, $1 par value, shares authorized, and issued 15,000 15,000 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, 10,000,000 shares authorized; 5,343,739 and 5,223,739 shares issued, 4,331,335 and 4,232,829 shares outstanding in 1997 and 1996, respectively 1,176 1,150 Additional paid-in capital 4,253 3,752 Net unrealized appreciation of securities held by insurance subsidiaries 2,946 1,255 Net unrealized gain (loss) on investments in fixed maturities available for sale held by insurance subsidiaries 11,457 1,525 Retained earnings (including $125,452 and $105,628 of undistributed earnings of subsidiaries at December 31, 1997 and 1996, respectively) 129,237 108,697 149,069 116,379 Common treasury stock, at cost, 687,644 and 665,950 shares in 1997 and 1996 (854) (564) Total Shareholders' Equity 148,215 115,815 Total Liabilities and Shareholders' Equity $ 162,596 $143,941 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT, STATEMENTS OF INCOME, continued Years Ended December 31, 1997, 1996 and 1995 (in thousands of dollars) 1997 1996 1995 Revenues charged to subsidiaries: Interest income $ 3,345 $ 4,915 $ 8,236 Other income 131 133 134 3,476 5,048 8,370 Operating expenses 958 2,513 1,779 Interest expense 1,417 2,613 5,469 2,375 5,126 7,248 Income (loss) from operations 1,101 (78) 1,122 Federal income tax provision (benefit) 385 (27) 393 Net income (loss) before equity in undistributed earnings from subsidiaries extraordinary item and change in accounting principle 716 (51) 729 Equity in undistributed earnings from subsidiaries 19,824 26,989 9,985 Net Income $ 20,540 $ 26,938 $ 10,714 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED STATEMENTS OF REGISTRANT STATEMENT OF CASH FLOWS, continued (in thousands of dollars) Year ended December 31, CASH FLOWS FROM OPERATING 1997 1996 1995 ACTIVITIES: Net income $ 20,540 $ 26,938 $ 10,714 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization of deferred gain on sale of real estate (109) (110) (109) Unrealized appreciation of equity securities held by insurance subsidiaries 1,691 507 180 Decrease in accounts receivable 1,023 -0- 32 Increase in investment in and advances to subsidiaries (26,618) (26,284) (21,748) Increase (decrease) in accounts payable and accrued expenses 344 (3,067) 723 Decrease in other assets 529 1,215 640 Other 6 2 (87) Net Cash used in operating activities (2,594) (799) (9,655) CASH FLOWS FROM INVESTING ACTIVITIES: Investments sold 5,560 770 1,283 Net cash provided by investing activities 5,560 770 1,283 CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of debt (13,980) (34,441) (7,200) Payment on subordinated debenture payable -0- -0- (200) Stock options exercised 527 244 680 Purchase of treasury stock (290) -0- -0- Payment received on subordinated debenture receivable 10,750 34,289 14,960 Net cash (used in) provided by financing activities (2,993) 92 8,240 Net (decrease)increase in cash (27) 63 (132) Cash, beginning of year 126 63 195 Cash, end of year $ 99 $ 126 $ 63 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES SCHEDULE IV - REINSURANCE For the years ended December 31, 1997, 1996 and 1995 (in thousands of dollars) Ceded To Assumed Direct Other From Other 1997 Amount Companies Companies Life insurance in-force $ 7,903,915 $1,636,371 $ 59,009 Premium: Life insurance $ 23,670 $ 10,035 $ 114 Accident-health insurance 809 403 37 Total $ 24,479 $ 10,438 $ 151 1996 Life insurance in-force $ 7,009,993 $1,112,318 $ 18,481 Premium: Life insurance $ 16,863 $ 8,164 $ 100 Accident-health insurance 948 (202) 31 Total $ 17,811 $ 7,962 $ 131 1995 Life insurance in-force $ 7,693,274 $ 864,512 $ 8,124 Premium: Life insurance $ 18,561 $ 8,773 $ 127 Accident-health insurance 2,260 (205) 38 Total $ 20,821 $ 8,568 $ 165 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES SCHEDULE IV - REINSURANCE For the years ended December 31, 1997, 1996 and 1995 (in thousands of dollars) Percentage Net Of Amount 1997 Amount Assumed Life insurance in-force $6,326,553 .93% Premium: Life insurance $ 13,749 0.83% Accident-health insurance 443 8.34% Total $ 14,192 1.07% 1996 Life insurance in-force $5,916,156 .31% Premium: Life insurance $ 8,799 1.15% Accident-health insurance 1,181 2.71% Total $ 9,980 1.33% 1995 Life insurance in-force $6,836,886 .12% Premium: Life insurance $ 9,915 1.24% Accident-health insurance 1,179 3.22% Total $ 11,694 6.84% 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, 1085 between Registrant and Parker Road Associates for the rental of 40 Parker Road, Elizabeth, New Jersey. (4) 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. 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) 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) 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 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, 1003 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) 10(aaah) Ex-9 Amendment and Waiver Agreement dated as of March 31, 1997 among the Registrant and certain banks identified therein. 10(aaai) Ex-19 Amendment and Waiver Agreement dated as of December 9, 1997 among the Registrant and certain banks identified therein. 21 Ex-25 Subsidiaries of the Registrant. 23 Ex-26 Consent of Price Waterhouse, 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 Registrant;s 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. (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. Exhibit 10(aaah) INTERCONTINENTAL LIFE CORPORATION AMENDMENT AND WAIVER AGREEMENT This Amendment and Waiver Agreement (the "Agreement") is entered into as of March 31, 1997 by and among InterContinental Life Corporation (the "Company"), the undersigned lenders (the "Lenders") and The First National Bank of Chicago, as agent for the Lenders (the "Agent"). W I T N E S S E T H : WHEREAS, the Company, the Lenders and the Agent are parties to that certain Amended and Restated Credit Agreement dated as of January 29, 1993 (as amended, the "Credit Agreement"); WHEREAS, the Company, the Lenders and the Agent desire to amend the Credit Agreement in connection with the acquisition (the "State Auto Acquisition") by Investors Life'Insurance Company of Indiana ("Investors-NA") of State Auto Life Insurance Company ("State Auto"), as hereinafter set forth; WHEREAS, the Company has requested that the Lenders and Agent amend the Credit Agreement and waive compliance with certain provisions of the Credit Agreement in connection with (i) the State Auto Acquisition and (ii) the purchase in cash by the Company of 25,000 shares of its common stock for an amount per share equal to the existing market price (as quoted on the NASDAQ National Market System) at the time of such purchase, which shares of common stock, when acquired by the Company, shall be used solely by the Company to make a contribution to the InterContinental Life Corporation Employees Savings and Investment Plan (the "Plan") for allocation of matching contributions to participants under the Plan, all as hereinafter set forth; NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not otherwise defined herein shall have the meanings attributed to such terms in the Credit Agreement. 2. Amendment to Credit Agreement. The Credit Agreement is amended as follows: (a) All references to "Meridian" contained in the Credit Agreement and the Loan Documents (as defined in Section 7(a) below) shall be deleted and the term "Investors-IN" shall be inserted in lieu thereof; (b) Article I of the Credit Agreement is amended by deleting the definition of "Meridian" contained therein; (c) Article I of the Credit Agreement is amended by inserting immediately before the definition of "Investors-NA" the following new definition: "Investors-IN" means Investors Life Insurance Company of Indiana (formerly known as Meridian Life Insurance Company prior to its name change to Investors Life Insurance Company of Indiana) , an Indiana corporation which became upon consummation of the Meridian Acquisition, and continues to be, a direct Wholly-owned Subsidiary of Investors-North America." (d) Article I of the Credit Agreement is amended by inserting immediately after the definition of "Modified IRIS Tests" the following new definition: "Modified IRIS (Investors-IN) Tests" means the Modified IRIS Tests other than (i) the net change in capital and surplus test, (ii) the gross change in capital and surplus test, (iii) the change in premium test and (iv) the change in reserving ratio test." (e) Article I of the Credit Agreement is amended by inserting immediately before the definition of "Statutory Capital" the following new definitions: "State Auto" means State Auto Life Insurance Company, an Ohio corporation which, upon consummation of the State Auto Acquisition, shall be merged with and into Investors-IN pursuant to which Investors-IN shall be the surviving corporation." "State Auto Acquisition" means the acquisition by Investors-IN of all of the capital stock of State Auto for an aggregate purchase price not to exceed $14 million." (f) Section 2.3 (c) of the Credit Agreement is hereby amended to delete the reference to "July 1, 1999" contained in Section 2.3(c) and to insert "October 1, 1998" in lieu thereof. (g) Section 2.4 of the Credit Agreement is hereby amended to delete the entire paragraph (a) of Section 2.4 and to insert the following in lieu thereof: "(a) Intentionally omitted." (h) Section 2.4(c) of the Credit Agreement is hereby deleted in its entirety and the following is inserted in lieu thereof: -2- "(c) On April 1, 1993, the Company shall make a mandatory payment on the Advances outstanding equal to $26,000,000. In addition, the Company shall make quarterly installments of principal set forth below payable on the first day of each calendar quarter beginning April 1, 1994: Aggregate Quarterly Payments Period Payments in Period 4/l/94-3/31/95 $4,500,000 $18,000,000 4/l/95-3/31/96 $4,500,000 $18,000,000 4/l/96-3/31/97 $4,500,000 $18,000,000 4/1/97 $0 $0 7/l/97 $2,000,000 $ 2,000,000 10/l/97-9/30/98 $3,700,000 $14,800,000 10/1/98 $3,644,000 $ 3,644,000" (i) Section 2.11 of the Credit Agreement is hereby amended to delete the reference to "July 1, 1999" contained in Section 2.11 and to insert "October 1, 1998" in lieu thereof. (j) Section 6.4.1 of the Credit Agreement is hereby deleted in its entirety and the following is inserted in lieu thereof: "6.4.1. Adiusted Capital and Surplus. The Company will not permit at any time the total Adjusted Capital and Surplus of each of the Insurance Subsidiaries set forth below to be less than the amount(s) set forth below opposite the name of each such insurance Subsidiary: -3- Amount of Adjusted Insurance Subsidiary Capital and Surplus Investors-North America $56,500,000 ILIC $ 8,500,000 Investors-IN $ 7,000,000 provided, however, that if any of the mergers set forth below are consummated, the surviving entity shall maintain at all times total Adjusted Capital and Surplus at least equal to: Amount of Adjusted Merger Capital and Surplus ILIC and Investors-North America $56,500,000 (1) Section 6.4.6 of the Credit Agreement is hereby deleted in its entirety and the following is inserted in lieu thereof: "6.4.6. IRIS Tests. Subject to the last sentence of this Section 6.4.6, the Company will cause its Insurance Subsidiaries to maintain at all times the NAIC ratios in respect of net gain to total income, investment yield, real estate to capital and surplus and surplus relief within the acceptable range prescribed by NAIC for at least 7 of the 10 Modified IRIS Tests in the case of ILIC and Investors-North America. Subject to the last sentence of this Section 6.4.6, the Company will cause Investors-IN to maintain the NAIC ratios in respect of net gain to total income, investment yield, real estate to capital and surplus and surplus relief within the acceptable range prescribed by NAIC (i) for at least 7 of the 10 Modified IRIS Tests at all times prior to the consummation of the State Auto Acquisition and at all times after March 31, 1998 and (ii) at all times during the period commencing on the date of consummation of the State Auto Acquisition and ending on March 31, 1998, for at least 4 of the 6 Modified IRIS (Investors-IN) Tests. Solely for purposes of computations under this Section, if any merger of Insurance Subsidiaries (including the merger of Investors-North America and Investors Life Insurance Company of California) occurs during the twelve month period preceding -4- any date as of which compliance with this Section 6.4.6 is determined, such merger shall be deemed to have occurred immediately prior to the first day of such twelve month period." 3. Waiver re State Auto Acquisition. The Lenders hereby waive any violation of the Credit Agreement and any default created thereby attributable solely to the Company's breach of Section 2.4(c) of the Credit Agreement as in effect prior to the effectiveness of Section 2 hereunder by reason of the Company's failure to make the payment required by Section 2.4(c) of the Credit Agreement as in effect on the date hereof, such waiver to be effective only for the period commencing on March 31, 1997 and ending on the earlier of (x) the date on which all conditions precedent set forth in Section 5(a) hereof shall have been met (at which point Section 2 hereof shall be effective), and (y) either (1) April 30, 1997 if a definitive purchase agreement in connection with the State Auto Acquisition is not executed by Investors-IN prior to April 30, 1997 or (2) if it is ultimately determined that the State Auto Acquisition will not be consummated for any reason, then on the date of such determination (at which point for the purposes of this clause (y) the Company shall be required to make the payment set forth in Section 5(b) hereof); provided, however, the waiver set forth in this sentence shall only be effective if beginning on the date hereof the Company makes prepayments on the Advances in the amounts and on the dates called for by Section 2(h) of this Agreement prior to the occurrence of an event described by subclause (1) or (2) of this Section 3. The Lenders hereby further waive any violation of the Credit Agreement and any default created thereby attributable solely to the Company's breach of Section 6.13 of the Credit Agreement by reason of the merger of State Auto into Investors-IN. The Lenders further hereby waive any violation of the Credit Agreement and any Default created thereby attributable solely to the Company's breach of Section 6.16(b) of the Credit Agreement by reason of the State Auto Acquisition. The Lenders further hereby waive any violation of the Credit Agreement and any Default created thereby attributable solely to the Company's breach of Section 7.24 of the Credit Agreement by reason of the failure of Investors-NA (as successor To Standard) to make a prepayment of the Standard Surplus Debenture in the amount of $4,700,000 anticipated to be made on or before December 31, 1997, which amount and date were specified on the Compliance Certificate for the period ending December 31, 1996 pursuant to Section 6.4.2. The waivers set forth in this Section 3 are only applicable and shall only be effective in this specific instance and for the specific purpose for which made or given. -5- 4. Waiver re Purchase by the Company of its Common Stock. The Lenders hereby waive any violation of the Credit Agreement and any Default created thereby attributable solely to the Company's breach of Section 6. 11 of the Credit Agreement by reason of the purchase in cash by the Company of 25,000 shares of its common stock for an amount per share equal to the existing market price (as quoted on the NASDAQ National Market System) at the time of such purchase, so long as such shares of common stock, when acquired by the Company, shall be used solely by the Company to make a contribution to the Plan for allocation of matching contributions to participants under the Plan. The waiver set forth in this Section 4 is only applicable and shall only be effective in this specific instance and for the specific purpose for which made or given. 5. Conditions Precedent to Sections 2 and 3; Repayment if State Auto Acquisition not Consummated. (a) Sections 2 and 3 of this Agreement shall not become effective unless and until the Company has furnished, or caused to be furnished, to the Agent, with sufficient copies for each Lender, the following: (i) A consent from FIC, in the form of Exhibit A attached hereto. (ii) Copies, certified by the Secretary or Assistant Secretary of the Company, of its Board of Directors resolutions authorizing the execution of this Agreement. (iii) An incumbency certificate, executed by the Secretary or Assistant Secretary of the Company, which shall identify by name and title and bear the signature of the officers of the Company authorized to sign this Agreement, upon which certificate each Lender shall be entitled to rely until informed of any change in writing by the Company. (iv) Evidence satisfactory to the Agent and its counsel that the State Auto Acquisition has been consummated. (b) In the event that a definitive purchase agreement in connection with the State Auto Acquisition is not executed by Investors-In prior to April 30, 1997 or in the event it ultimately determined that the State Auto Acquisition will not be consummated for any reason, then Sections 2 and 3 of this Agreement shall not become effective, and the Company shall promptly make a mandatory prepayment on the Advances in an amount equal to the difference of (i) prepayments that would have been required to have been paid by Section 2.4(c) of the Credit Agreement as in effect on the date hereof for -6- the period commencing on the date hereof and ending on either April 30, 1997 or such determination date, whichever is applicable, minus (ii) prepayments paid by the Company pursuant to the proviso contained in the first sentence of Section 3 hereof, together with all accrued interest thereon. 6. Conditions Precedent to Section 4. Section 4 of this Agreement shall not become effective unless and until the Company has furnished, or caused to be furnished, to the Agent, with sufficient copies for each Lender, the items required by clauses (i), (ii) and (iii) of Section 5(a) hereof. 7. Representation and Warranty. The Company hereby represents and warrants to the Lenders that after giving effect to the amendment and waivers herein contained (i) all of the representations and warranties contained in the Credit Agreement are true and correct as of the date hereof, (ii) no Default or Unmatured Default exists or is continuing and (iii) the Company has performed all the agreements on its part to be performed prior to the date hereof as set forth in the Credit Agreement. 8. Effectiveness of Amendment and Waivers. This Agreement shall become effective as of the date first above written upon receipt by the Agent of counterparts of this Agreement duly executed by the Company and the Required Lenders. 9. Reference to and Effect on the Credit Agreement (a) Upon the effectiveness of Sections 2, 3 and 4 hereof, on or after the date hereof each reference in the Credit Agreement to "this Agreement," "hereunder," "hereof," "herein" or words of like import and each reference to the Credit Agreement in the Notes and all other documents (the "Loan Documents") delivered in connection with the Credit Agreement shall mean and be a reference to the Credit Agreement as amended hereby. (b) Except as specifically amended above, all of the terms, conditions and covenants of the Credit Agreement and all other Loan Documents shall remain unaltered and in full force and effect and shall continue to be binding upon the Company in all respects and are hereby ratified and confirmed. (c) The execution, delivery and effectiveness of this Agreement shall not, except as expressly provided herein, operate as a waiver of (i) any right, power or remedy of the Lenders or the Agent under the Credit Agreement or any of the Loan Documents, or (ii) any -7- Default or Unmatured Default under the Credit Agreement. 10. Costs, Expenses and Taxes. The Company agrees to pay on demand all costs and expenses of the Agent in connection with the preparation, execution and delivery of this Agreement, including the reasonable fees and out-of-pocket expenses of counsel for the Agent with respect thereto. 11. CHOICE OF LAW. THIS AGREEMENT SHALL BE CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AND NOT THE LAW OF CONFLICTS) OF THE STATE OF ILLINOIS, BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS. 12. Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. -8- IN WITNESS WHEREOF, the Company, the undersigned Lenders and the Agent have executed this Agreement as of the date first above written. INTERCONTINENTAL LIFE CORPORATION By: /s/ Roy F. Mitte Title:President THE FIRST NATIONAL BANK OF CHICAGO, Individually and as Agent By: /s/ Title: BARCLAYS BANK, PLC By: /s/ Title: FIRST UNION NATIONAL BANK OF NORTH CAROLINA By: /s/ Title: FLEET NATIONAL BANK OF CONNECTICUT By: /s/ Title: CORESTATES PHILADELPHIA NATIONAL BANK N.A. By: /s/ Title: -9- CONSENT OF GUARANTOR Financial Industries Corporation, as guarantor under the Amended and Restated Guaranty dated January 29, 1993 (the "Guaranty") in favor of the Lenders party to the Amended and Restated Credit Agreement dated as of January 29, 1993 (as amended, the "Credit Agreement") hereby consents to the Amendment Agreement dated as of March 31, 1997 and hereby confirms and agrees that the Guaranty is, and shall continue to be, in full force and effect and is hereby confirmed and ratified in all respects. This Consent is executed and delivered as of March 31, 1997. FINANCIAL INDUSTRIES CORPORATION By: /s/ Roy F. Mitte Title: Chairman, President and Chief Executive Officer -10- Exhibit 10(aaai) INTERCONTINENTAL LIFE CORPORATION WAIVER AGREEMENT This Waiver Agreement (the "Agreement") is entered into as of December 9, 1997 by and among InterContinental Life Corporation (the "Company"), the undersigned lenders (the "Lenders") and The First National Bank of Chicago, as agent for the Lenders (the "Agent"). W I T N E S S E T H : WHEREAS, the Company, the Lenders and the Agent are parties to that certain Amended and Restated Credit Agreement dated as of January 29, 1993 (as amended, the "Credit Agreement"); WHEREAS, the Company, the Lenders and the Agent desire to waive compliance with certain provisions of the Credit Agreement specified herein in connection with the sale and transfer by ILIC and Investors - - North America of their respective accident, health and disability insurance policies issued in connection therewith (the "Transferred Policies") to United Teacher Associates Insurance Company ("United") pursuant to which, among other things, the Company shall make a cash payment of $1,050,000 to United, and United shall purchase, acquire, assume and reinsure the contractual obligations and risks under the Transferred Policies, all as set forth in (i) that certain Agreement for Insurance to be entered into by and among United, on the one hand, and Investors - North America, ILIC, and Family Life Insurance Company ("FLIC", and together with Investors - North America and ILIC, the "Transferee Companies"), on the other hand, the form of which is attached hereto as Exhibit A (the "Agreement for Reinsurance"), (ii) that certain Coinsurance Reinsurance Agreements to be entered into by and between United and each of the Transferee Companies, the form of which is attached hereto as Exhibit B (the "Coinsurance Agreement"), and (iii) that certain Assumption Reinsurance Agreement to be entered into by and among United and the Transferee Companies, the form of which is attached hereto as Exhibit C (the "Assumption Agreement", and together with the Agreement for Reinsurance and the Coinsurance Agreement, the "Transfer Agreements"), all as hereinafter set forth; WHEREAS, the Company, the Lenders and Agent desire to waive compliance with certain provisions of the Credit Agreement in connection with (i) the redomestication of ILIC from the State of New Jersey to State of Indiana, (ii) immediately after such redomestication, the merger of Investors-Indiana with and into ILIC, pursuant to which ILIC shall be the surviving entity, all of hereinafter set forth; and (iii) the cancellation by the Company of that certain loan in the amount of approximately $300,000 made by the Company in 1988 to the InterContinental Life Corporation Employee Stock Ownership Plan. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not otherwise defined herein shall have the meanings attributed to such terms in the Credit Agreement. 2. Waiver. The Lenders hereby waive any violation of the Credit Agreement and any default created thereby attributable solely to the Company's breach of Section 6.4.7 of the Credit Agreement by reason of the fact United will undertake reinsurance obligations under the Transfer Agreements with respect to the Transferred Agreements at a time in which United is rated B+ by A.M. Best & Co.(and not A or better). The Lenders hereby further waive any violation of the Credit Agreement and any default created thereby attributable solely to the Company's breach of Section 6.5 of the Credit Agreement by reason of the fact that upon effectiveness of the transactions contemplated under the Transfer Agreements, Investors - North America and ILIC will no longer conduct business in the accident, health and disability insurance businesses. The Lenders hereby further waive any violation so and so forth of the Credit Agreement and any default created thereby attributable solely to the breach of Section 6.5 of the Credit Agreement by reason of the redomestication of ILIC from the State of New Jersey to the State of Indiana. The Lenders hereby further waive any violation of the Credit Agreement and any default created thereby attributable solely to the breach of Section 6.13 of the Credit Agreement by reason of the merger of Investors-Indiana with and into ILIC, pursuant to which ILIC shall be the surviving entity. The waivers set forth in this Section 2 are only applicable and shall only be effective in this specific instance and for the specific purpose for which made or given. The Lenders hereby further waive any violation of the Credit Agreement and any default created thereby attributable solely to the breach of Section 6.21 of the Credit Agreement by reason of the cancellation by the Company of that certain loan in the amount of approximately $300,000 made by the Company in 1988 to the InterContinental Life Corporation Employee Stock Ownership Plan. 3. Conditions Precedent to Section 2. Section 2 of this Agreement shall not become effective unless and until the Company has furnished, or caused to be furnished, to the Agent, with sufficient copies for each Lender, the following: (a) Fully executed copies of each of the Transfer Agreements, providing for the sale and transfer of the Transferred Policies to United and for the Cash Payment and containing substantially all of the other terms set forth in, and each substantially in the respective form of, Exhibit A, B and C attached hereto (except for those changes which, in the reasonable discretion of the Agent, do not adversely affect -2- (i) the ability of the Company to perform its obligations under the Credit Agreement and (ii) the rights of the Agent and the Lenders under the Credit Agreement). (b) A consent from FIC, in the form of Exhibit D attached hereto. (b) Copies, certified by the Secretary or Assistant Secretary of the Company, of its Board of Directors resolutions authorizing the execution of this Agreement. (c) An incumbency certificate, executed by the Secretary or Assistant Secretary of the Company, which shall identify by name and title and bear the signature of the officers of the Company authorized to sign this Agreement, upon which certificate each Lender shall be entitled to rely until informed of any change in writing by the Company. 4. Representation and Warrantv. The Company hereby represents and warrants to the Lenders that after giving effect to the waivers herein contained (i) all of the representations and warranties contained in the Credit Agreement are true and correct as of the date hereof, (ii) no Default or Unmatured Default exists or is continuing-and (iii) the Company has performed all the agreements on its part to be performed prior to the date hereof as set forth in the Credit Agreement. 5. Effectiveness of Waivers. This Agreement shall become effective as of the date first above written upon receipt by the Agent of counterparts of this Agreement duly executed by the Company and the Required Lenders. 6. Reference to and Effect on the Credit Agreement. (a) Upon the effectiveness of Sections 2 hereof, on or after the date hereof each ref erence in the Credit Agreement to "this Agreement," "hereunder," "hereof," "herein" or words of like import and each reference to the Credit Agreement in the Notes and all other documents (the "Loan Documents") delivered in connection with the Credit Agreement shall mean and be a reference to the Credit Agreement after giving effect to the waivers effected hereby. (b) Except as specifically waived above, all of the terms, conditions and covenants of the Credit Agreement and all other Loan Documents shall remain unaltered and in full force and effect and shall continue to be binding upon the Company in all respects and are hereby ratified and confirmed. (c) The execution, delivery and effectiveness of this Agreement shall not, except as expressly provided herein, operate as a waiver of (i) any right, power or remedy of the -3- Lenders or the Agent under the Credit Agreement or any of the Loan Documents, or (ii) any Default or Unmatured Default under the Credit Agreement. 7. Costs, Expenses and Taxes. The Company agrees to pay on demand all costs and expenses of the Agent in connection with the preparation, execution and delivery of this Agreement, including the reasonable fees and out-of-pocket expenses of counsel for the Agent with respect thereto. 8. CHOICE OF LAW. THIS AGREEMENT SHALL BE CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AND NOT THE LAW OF CONFLICTS) OF THE STATE OF ILLINOIS, BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS. 9. Execution in Counterparts. This Agreement may be executed in any number of counterparts and by dif f erent parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. -4 - IN WITNESS WHEREOF, the Company, the undersigned Lenders and the Agent have executed this Agreement as of the date first above written. INTERCONTINENTAL LIFE CORPORATION By:/s/ Roy F. Mitte Title: President THE FIRST NATIONAL BANK OFCHICAGO, Individually and as Agent By:/s/ Title: BARCLAYS BANK, PLC By:/s/ Title: FIRST UNION NATIONAL BANK By:/s/ Title: FLEET NATIONAL BANK OF CONNECTICUT By:/s/ Title: CORESTATES PHILADELPHIA NATIONAL BANK N.A. By:/s/ Title: -5- CONSENT OF GUARANTOR Financial Industries Corporation, as guarantor under the Amended and Restated Guaranty dated January 29, 1993 (the "Guaranty") in favor of the Lenders party to the Amended and Restated Credit Agreement dated as of January 29, 1993 (as amended, the "Credit Agreement") hereby consents to the Amendment Agreement dated as of December 9, 1997 and hereby confirms and agrees that the Guaranty is, and shall continue to be, in full force and effect and is hereby confirmed and ratified in all respects. This Consent is executed and delivered as of December 9, 1997. FINANCIAL INDUSTRIES CORPORATION By: /s/ Roy F. Mitte Title: Chairman, President and Chief Executive Officer 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. 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 27, 1998 appearing on page F-2 of this Form 10-K. PRICE WATERHOUSE LLP Dallas, Texas March 27, 1998 EX-27 2
7 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1997 DEC-31-1997 454,462 3,412 3,332 4,902 10,862 1,300 693,059 9,041 20,433 28,621 1,321,653 131,720 7,701 525,135 7,078 10,964 0 0 1,176 144,586 1,321,653 11,031 57,740 14,630 3,429 37,962 2,818 16,798 31,602 11,062 20,540 0 0 0 20,540 4.75 4.70 0 0 0 0 0 0 0
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