10-K/A 1 0001.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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) 6500 River Place Blvd., Building One, Austin, Texas 78730 (Address of Principal Executive Offices) (Zip Code) (512) 404-5000 (Registrant's Telephone Number, including area code) 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) -1- 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 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation 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. [ ] The aggregate market value of the voting and non-voting common stock held by non-affiliates of the Registrant on March 6, 2001, based on the closing sales price in the Nasdaq Small-Cap Market ($10.44 per share), was $41,514,023. As of March 6, 2001, Registrant had 8,141,385 shares of its common stock outstanding (excluding shares held in Treasury and not entitled to vote). -2- Note: This Form 10-K/A is being filed in order (i) to correct certain typographical errors which appear in the electronic version of the Form 10-K which was filed by the Registrant on April 2, 2001 and (ii) to include an exhibit - Ex-10(aw) of an agreement which was discussed in the Form 10-K. The non-material corrections do not pertain to entries in the income statements or balance sheets of the Registrant. The following material represents the complete Annual Report of the Registrant on Form 10-K for the year ended December 31, 2000, as so corrected. Other than the exhibit being filed herewith, this Form 10-K/A does not include any discussions or disclosures which were not included in the Form 10-K filed on April 2, 2001. Forward-Looking Statements Except for historical factual information set forth in this Form 10-K, the statements, analyses, and other information contained in this report relating to trends in the Company's operations and financial results, the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "path," "estimate," "expect," "intend" and other similar expressions constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management's current expectations and beliefs concerning the financial results, economic conditions and are subject to known and unknown risks, uncertainties and other factors contemplated by the forward-looking statements. Such factors include, among other things: (1) general economic conditions and other factors, including prevailing interest rate levels and stock market performance, which may effect the ability of ILCO to sell its products, the market value of ILCO's investments and the lapse rate and profitability of policies; (2) ILCO's ability to achieve anticipated levels of operational efficiencies and cost-saving initiatives; (3) customer response to new products, distribution channels and marketing initiatives; (4) mortality, morbidity and other factors which may affect the profitability of ILCO's insurance products; (5) changes in the Federal income tax laws and regulations which may affect the relative tax advantages of some of ILCO's products; (6) increasing competition in the sale of insurance and annuities; (7) regulatory changes or actions, including those relating to regulation of insurance products and insurance companies; (8) ratings assigned to ILCO's insurance subsidiaries by independent rating organizations such as A.M. Best Company, which ILCO believes are particularly important to the sale of annuity and other accumulation products; and (9) unanticipated litigation. There can be no assurance that other factors not currently anticipated by management will not also materially and adversely affect ILCO. 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 6500 River Place Blvd., Building One, Austin, Texas 78730. The Company is principally engaged, through its subsidiaries, in administering existing portfolios of life insurance policies and annuity products. Prior to the end of 1997, the life insurance subsidiaries also administered an in-force book of accident and health insurance business. In December, 1997, the life insurance subsidiaries entered into an agreement, effective as of June 30, 1997, with a third party insurer whereby the obligations under the accident and health insurance and the disability income business of the companies were assumed by the reinsurer. The arrangement provides for an initial period of reinsurance on a coinsurance basis, pending applicable approvals of the assumption arrangement. -3- 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 48.3% of the Company's outstanding common stock. FIC, ILCO and their insurance subsidiaries have substantially identical management, 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. The Roy F. and Joann Cole Mitte Foundation (the "Foundation"), a charitable entity exempt from federal income tax under section 501(a) of the Internal Revenue Code (the "Code") as an organization described in section 501(c)(3) of the Code, owns 30.71% of the outstanding shares of FIC's common stock. The sole members of the Foundation are Roy F. Mitte, Chairman, President and Chief Executive Officer of FIC, the Company and their insurance subsidiaries, and his wife, Joann Cole Mitte. FIC owns Family Life Insurance Company, a Washington domiciled underwriter of mortgage protection life insurance. The Company was organized in 1969 to be the publicly owned holding company for InterContinental Life Insurance Company ("ILIC"). The Company acquired Standard Life Insurance Company ("Standard Life") in 1986, Investors Life Insurance Company of California ("Investors-CA") and Investors Life Insurance Company of North America ("Investors-NA") in 1988, Meridian Life Insurance Company, renamed Investors Life Insurance Company of Indiana ("Investors-Indiana"), in February, 1995, State Auto Life Insurance Company (via merger of that company into Investors-Indiana) in 1997 and Grinnell Life Insurance Company (via merger of that company into Investors-Indiana) in 1998. Acquisitions Strategy. The Company's strategy has been and continues to be to grow internally and through acquisitions, while maintaining an emphasis on cost controls. Management believes that, under appropriate circumstances, it is more advantageous to acquire companies with books of in-force life insurance than to produce new business, because initial underwriting costs have already been incurred and mature business is generally less likely to terminate, making possible more predictable profit analysis. However, the Company's insurance subsidiaries continue to market those products that are profitable, as well as develop new products and streamline distribution channels. See "Agency Operations". It is also management's belief that the continuing consolidation in the life insurance industry presents attractive opportunities for the -4- 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. Completed Acquisitions. a. Standard Life. In November 1986, the Company acquired Standard Life, headquartered in Jackson, Mississippi, for a gross purchase price of $54,500,000. b. 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. c. 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"). d. 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. Under the terms of the transaction, State Auto Life was merged into Investors-Indiana. e. Grinnell Life. On June 30, 1998, ILCO, through a subsidiary, acquired Grinnell Life Insurance Company ("Grinnell Life") for an adjusted purchase price of $16.6 million. A portion of the purchase price ($12.37 million) was paid by way of a dividend to the seller immediately prior to the closing of the transaction; the balance of the purchase price was paid by ILCO's subsidiary. As part of the transaction, Grinnell Life was immediately merged with and into that subsidiary, with that subsidiary being the surviving entity. Merger of Insurance Subsidiaries. Investors-NA redomesticated from Pennsylvania to Washington in December of 1992. Investors-CA merged into Investors-NA on December 31, 1992, and Standard Life merged into Investors-NA on June 29, 1993. The mergers have achieved cost savings, such as reduced auditing expenses involved in auditing one combined company; the savings of expenses and time resulting from the combined company being examined by one state insurance department (Washington), rather than three (California, Pennsylvania and Mississippi); the reduction in the number of tax returns and other annual -5- filings with 45 states; and smaller annual fees to do business and reduced retaliatory premium taxes in most states. In December, 1997, InterContinental Life Insurance Company ("ILIC"), an ILCO subsidiary, 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 47 states and the District of Columbia. As of December 31, 2000, it had assets of $170.0 million and capital and surplus of $26.3 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. As of December 31, 2000, the number of administrative employees within the Company and its subsidiaries (including employees who also perform administrative services for Family Life) was approximately 286 and the number of regional vice presidents employed by the life insurance subsidiaries of the Company and FIC was 40. Principal Products The Company's insurance subsidiaries are engaged primarily in administering existing portfolios of life insurance policies and annuity products. Approximately 79% of the total collected premiums for the year 2000 were derived from renewal premiums on insurance policies and annuity products sold by the insurance subsidiaries prior to their acquisition by the Company. The Company's insurance subsidiaries are actively engaged in marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. These products are marketed through independent, non-exclusive general agents. The products currently being distributed include several versions of universal life insurance, which provide permanent life insurance protection while crediting company-declared current interest rates to the cash value of the policy. The universal life insurance portfolio of the Company's insurance subsidiaries consists primarily of flexible premium universal life insurance policies. Under the flexible premium policies, policyholders may vary the amounts of their coverage (subject to minimum and maximum limits) as well as the dates and frequency of payments. -6- During 1999, a marketing subsidiary of the Company entered into marketing agreement with a third- party life insurance company. The marketing agreement makes available, to appointed agents of the Company's life insurance subsidiaries, a portfolio of term life insurance products not currently being offered by the subsidiaries. The underwriting risk on the products sold under this arrangement is assumed by the third- party insurer. The Company's appointed agents receive commissions on the sales of these products and the Company's marketing subsidiary receives an override commission. This initiative was expanded during the year 2000 to include a substantially similar arrangement with another third-party life insurance company. Direct statutory premiums received from all types of universal life products were $36.3 million in 2000, as compared to $35.6 million in 1999 and $38.9 million in 1998. Investors-NA received reinsurance premiums from Family Life of $3.5 million in 2000, pursuant to the reinsurance agreement for universal life products written by Family Life. In 2000, 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 %), California (8 %), New Jersey (7 %) and Ohio (8 %). The Company's insurance subsidiaries receive some premium income from health insurance policies. In 2000, premium income from all health insurance policies was $0.7 million, as compared to $0.8 million in 1999 and $1.0 million in 1998. The health insurance business of the Company's subsidiaries is 100% reinsured with a third party reinsurer. In December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which most of the contractual obligations and risks under accident and health insurance policies were assumed by a third party reinsurer. The transfer was effective as of July 1, 1997. These risks and contractual obligations were sold pursuant to, first, a coinsurance reinsurance agreement. Following applicable regulatory approvals, the reinsurer will assume the direct obligations of the companies, on an assumption reinsurance basis. The decision to dispose of this book of business was based on management's analysis that the business was not generating targeted profit objectives and that the products were not part of the core business of the subsidiaries. The sale permits the companies to focus on its primary business - life insurance and annuity sales. 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. As of December 31, 2000, the assets held in the separate account were $42.3 million. During 2000, the premium income realized in connection with these variable annuity policies was $85,402, which was received from existing contract owners. Investors-NA also maintains a closed variable annuity separate account, with approximately $16.6 million of assets as of December 31, 2000. The separate account was closed to new purchases in 1981, as a result of an IRS ruling which adversely affected the status of variable annuity separate accounts which invest in publicly-available mutual funds. The ruling did not adversely affect the status of in-force contracts. -7- For the past several years, ILCO's life companies have expanded their marketing efforts in the fixed annuity market. Direct deposits from the sale of fixed annuity products were $10.6 million in 2000, as compared to $ 7.6 million in 1999 and $6.1 million in 1998. Investors-NA also received reinsurance premiums from Family Life of $1.2 million in 2000, pursuant to a reinsurance agreement for annuity products between Investors-NA and Family Life Insurance Company. In 1998, Investors-NA developed a group deposit administration product, designed for use in connection with the funding of deferred compensation plans maintained by government employers under section 457 of the Internal Revenue Code. The company has established a marketing relationship with a third-party administrator based in San Antonio, Texas, which has established relationships with school districts in Texas and Louisiana. Enrollments under the program commenced during 1999, and contributed $0.9 million of the annuity premiums for that year. Annuity premiums from this product for the year 2000 totaled $1.5 million. The following table sets forth, for the three years ended December 31, 2000, the combined premium income and other considerations received by the Company's insurance subsidiaries from sales of their various lines of insurance. Year Ended December 31, Type of Insurance Premium 2000 1999 1998 (in thousands) Individual: Life $ 7,576 $ 10,647 $ 10,528 Accident & Health 694 808 994 Total Individual Lines 8,270 11,455 11,522 Group: Life 4,231 3,164 2,323 Accident & Health 0 0 11 Total Group Lines 4,231 3,164 2,334 Credit: Life 0 (14) (21) Accident & Health 0 (1) (3) Total Credit Lines 0 (15) (24) Total Premium 12,501 14,604 13,832 Reinsurance Premiums Ceded (1,628) (3,472) (2,942) Total Net Premium 10,873 11,132 10,890 Amount Received on Investment Type Contracts 49,924 45,536 48,739 Total Premiums and Deposits Received $ 60,797 $ 56,668 $ 59,629 -8- 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. As of December 31, 2000, only 4.4% 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 only 0.3 % of the Company's total assets at December 31, 2000. The Company had investments in debt securities of affiliated corporations aggregating $35.3 million as of December 31, 2000. -9- Investments in mortgage-backed securities included collateralized mortgage obligations ("CMOs") of $175.7 million and mortgage-backed pass-through securities of $42.9 million at December 31, 2000. Mortgage-backed pass-through securities, sequential CMOs and support bonds, which comprised approximately 54.3% of the book value of the Company's mortgage-backed securities at December 31, 2000, 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") instruments, 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 45.7 % and sequential and support classes represented approximately 34.7 % of the book value of the Company's mortgage- backed securities at December 31, 2000. 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. ILCO did not have any z-accrual bonds as of December 31, 2000. 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 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, 2000, none of the mortgage loans held by the Company had defaulted as to principal or interest for more than 90 days, and none of the Company's mortgage loans were in foreclosure. -10- Another key element of the Company's investment strategy is to avoid large exposure in other investment categories which the Company believes carry higher credit or liquidity risks, including private placements, partnerships and bank participations. These categories accounted for approximately 0.2% of the Company's invested assets at December 31, 2000. The Company's subsidiaries make investments in real property, subject to regulatory limitations. In October, 1998, Investors-NA purchased River Place Pointe, two adjoining tracts of land located in Austin, Texas totaling 47.995 acres. The aggregate purchase price for these tracts was $8.1 million. Prior to the closing of the transaction, Investors-NA obtained a Site Development Permit for the tracts from the City of Austin. The Site Development Permit allows for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. Construction on the first phase of the Project, which consists of two office buildings, an associated parking garage, and related infrastructure was completed during 2000. The second phase of construction, which includes two more office buildings, is in progress and Investors-NA expects completion of this phase by the end of the second quarter of 2001. The Company has established and staffed an investment department, which manages portfolio investments and investment accounting functions for ILCO's life insurance subsidiaries. Agency Operations ILCO's insurance subsidiaries collectively market through the "Investors" distribution system. Independent non-exclusive agents, general agents and brokers are recruited nation-wide to sell the products. Such agents and brokers also sell insurance products for companies in competition with ILCO's insurance subsidiaries. In order to attract agents and enhance the sale of its products, the Company's insurance subsidiaries pay competitive commission rates and provide other sales inducements. The Investors sales distribution system is presently concentrating its efforts on the promotion and sale of universal life, term life and fixed annuity products. Marketing and sales for all of the Company's insurance subsidiaries are directed by the Executive Vice President of Marketing and Sales. The Senior Vice President for Investors Sales directs Regional Vice Presidents who are responsible for the recruitment and maintenance of the general agents and managing general agents for individual insurance sales. During 1999, the Company implemented a plan to restructure -11- the compensation arrangements for Regional Vice Presidents, so as to emphasize the role of personal production by the RVPs. The effect of this plan during the year 2000 was to lower fixed costs for distribution of the Company's products. Data Processing The data processing needs of ILCO's insurance subsidiaries are provided to ILCO's Austin, Texas 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. 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. The Company developed a Year 2000 Plan and began the major work under the Year 2000 Plan in 1997. The work, including extensive testing of the converted systems, was completed during the fourth quarter of 1999. The Company did not experience any material disruptions in the processing of its business as a result of the Year 2000 date change. Under the Year 2000 Plan, FIC Computer Services, Inc. utilized its own personnel, acquired Y2K compliant operating software, and engaged the assistance of outside consultants to facilitate the systems conversions and modifications. For the twelve month period ended December 31, 1999, the Company incurred an after tax cost of approximately $195,000 in connection with the Year 2000 Plan, as compared to an after tax expense of approximately $158,000 for the year ended December 31, 1998. In the year ended December 31, 2000, the Company incurred $90,000 in pre-tax expenses related to the Year 2000 Plan, in connection with bonus payments made to management employees for Year 2000 Plan-related work. Competition There are many life and health insurance companies in the United States. A significant number of casualty companies also market health insurance. Agents placing insurance business with ILCO's life insurance subsidiaries are compensated on a commission basis. However, some companies pay higher commissions and charge lower premium rates and many companies have more substantial resources. The principal cost and competitive factors that affect the Company's ability to sell its life insurance and annuity products on a profitable basis are: (1) the general level of premium rates for comparable products; -12- (2) the extent of individual policyholder 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 $100,000 of risk on the life of any individual, depending upon the type of coverage being issued. Investors-NA generally retains the first $100,000 to $250,000 of risk on the life of any individual, depending on the type of coverage being issued. Investors-NA maintains a bulk reinsurance treaty, under which it reinsures all of its risks under accidental death benefit policies. The treaty was most recently renegotiated with the current reinsurer in January, 1997. As discussed above (see "Principal Products"), in December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which all of the contractual obligations and risks under individual accident and health insurance policies were assumed by a third party reinsurer. 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. -13- 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 6, 2001, FIC owned, directly and indirectly through Family Life, approximately 48.3% of the outstanding shares of ILCO's common stock. 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 specializes in underwriting and selling 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) a$44 million subordinated notes issued to the seller and its affiliates and (c) $25 million senior subordinated notes issued to Investors-CA and Investors-NA. In addition, FIC granted to Investors-CA and Investors-NA nontransferable options to purchase up to a total of 9.9% of FIC's common stock at a price of $10.50 per share, equivalent to the then current market price, subject to adjustment to prevent dilution. As a result of the five-for-one stock split implemented by FIC, effective in November, 1996, the exercise price of the options was changed to $2.10 per share. The initial terms of the option provided for their expiration on June 12, 1998, if not previously exercised. In connection with the 1996 amendments to the subordinated loans held by Investors-NA, the expiration date of the options was extended to September 12, 2006. For a discussion of the 1996 amendments, see Item 13 - "Certain Relationships and Related Transactions with Management." In July, 1993, the subordinated notes held by the seller and its affiliates were prepaid. The primary source of the funds used to prepay the subordinated debt was a new subordinated loan of $34.5 million obtained from Investors-NA. Senior Loan The Senior Loan of ILCO was originally arranged in connection with the 1988 acquisition of Investors-NA and Investors-CA. In January, 1993, the Company refinanced its Senior Loan. That transaction was done in connection with the prepayment of the subordinated indebtedness and the purchase of warrants which -14- had been issued as part of the financing of the 1988 acquisitions. The terms of the amended and restated credit facility are substantially the same as the terms and provisions of the 1988 senior loan. The maturity date, which had been December 31, 1996, was extended to July 1, 1998 for the Senior Loan. The average interest rate paid by the Company on its Senior Loan was approximately 7.63% during 1998. In February, 1995, the Company borrowed an additional $15 million under the Senior Loan to help finance the acquisition of Investors-IN, and the maturity date of the Senior Loan was further extended to July 1, 1999. In connection with the acquisition of State Auto Life Insurance Company in July, 1997, the Senior Loan agreement was modified to extend the maturity date to October 1, 1998. As of December 31, 1997, the outstanding principal balance of ILCO's senior loan obligations was $11.0 million, which reflected the prepayment by the Company of the payment originally scheduled for January 1, 1998. A regular payment, in the amount of $3.7 million, was made on April 1, 1998 and a prepayment of the July 1, 1998 installment, in the amount of $3.7 million, was made on June 30, 1998. The outstanding principal balance of ILCO's senior loan obligations was $3.6 million at June 30, 1998. The final installment on the senior loan obligation scheduled for October 1, 1998, was prepaid on September 30, 1998. As a result, the senior loan obligation of ILCO was fully discharged effective September 30, 1998. Regulation General. The Company and its insurance subsidiaries are subject to regulation and supervision at both the state and Federal level, including regulation under federal and state securities laws and regulation by the states in which they are licensed to do business. The state insurance 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. -15- A number of states regulate the manner and extent to which insurance companies may test for acquired immune deficiency syndrome (AIDS) antibodies in connection with the underwriting of life insurance policies. To the extent permitted by law, the Company's insurance subsidiaries consider AIDS information in underwriting coverage and establishing premium rates. An evaluation of the financial impact of future AIDS claims is extremely difficult, due in part to insufficient and conflicting data regarding the incidence of the disease in the general population and the prognosis for the probable future course of the disease. Risk-Based Capital Requirements. The National Association of Insurance Commissioners ("NAIC") has imposed Risk-Based Capital ("RBC") requirements to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks associated with; (i) asset quality; (ii) mortality and morbidity; (iii) asset and liability matching; and (iv) other business factors. The RBC formula is intended to be used by insurance regulators 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. The formula also 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, 2000 indicate that the Total Adjusted Capital of each of the Company's insurance subsidiaries is above 560% 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 -16- (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. For the year ended December 31, 2000, the Company's insurance subsidiaries received a net credit on their guaranty fund assessment returns of $24,136, as compared to a net credit of $13,478 for the year ended December 31, 1999. The likelihood and amount of any other future assessments cannot be estimated and are beyond the control of the Company, however, we believe that assessments with respect to other pending insurance company impairments and insolvencies will not be material to our business, financial condition or results of operations. Dividends. ILCO is a holding company and as such depends primarily on dividends from its insurance subsidiaries to pay operating expenses. Washington's insurance code, which governs the dividends payable by Investors-NA, 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, 2000, Investors-NA had earned surplus of $69.1 million. 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 $23.8 million at December 31, 2000. Valuation Reserves. Life insurance companies are required to establish an Asset Valuation Reserve ("AVR") consisting of two components: (i) a "default component," which provides for future credit-related losses on fixed maturity investments, and (ii) an "equity component," which provides for losses on all types of equity investments, including equity securities and real estate. Insurers are also required to establish an 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. The IMR is required to be amortized into statutory earnings on a basis reflecting the remaining period to maturity of the fixed maturity securities sold. These reserves are required by state insurance regulatory authorities to be established as a liability on a life insurer's statutory financial statements, but do not affect the financial statements prepared in accordance with GAAP. Management believes that 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 to ILCO. -17- 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. The Financial Services Modernization Act. On November 12, 1999, President Clinton signed into law the Financial Services Modernization Act (referred to in this paragraph as the "Act") of 1999, implementing fundamental changes in the regulation of the financial services industry in the United States. In general, the Act provides that financial institutions have certain obligations with respect to the maintenance of the privacy of customer information, so as to insure the security and confidentiality of customer records and information, to protect against any anticipated threats or hazards to the security or integrity of these records and to protect against unauthorized access or use of these records or information which could result in substantial harm or inconvenience to any customer. In addition, the Act places new restrictions on disclosure of nonpublic personal information to third party institutions seeking to utilize such information in connection with the sale of products or services. A financial institution may disseminate certain types of customer information to nonaffiliated third parties if the institution provides clear and conspicuous disclosure of the institution's privacy policy and the customer authorizes the release of certain information to third parties. Where the customer permits the release of the information, the Act restricts disclosure of information that is non-public in nature but does not prohibit the release of information which can be obtained from public sources. The passage of the Act and regulations pertaining thereto may adversely affect ILCO's insurance subsidiaries from utilizing certain sales methods; however, at this time, ILCO is unable to determine to what extent the final regulations will impact the sales practices of ILCO's insurance subsidiaries. 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. -18- 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. For the years ended December 31, 1998, 1999 and 2000, the decreases in the current income tax provisions of the Company's insurance subsidiaries due to this change were $253,411, $409,193 and $8,368 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, 2000. Item 2. Properties ILCO's home office is located at River Place Pointe, 6500 River Place Blvd., Building One, Austin, Texas. River Place Pointe was purchased by Investors-NA on October 29, 1998. It consists of two adjoining tracts of land located in Austin, Texas totaling 47.995 acres. The aggregate purchase price for these tracts was $8.1 million. Prior to the closing of the purchase transaction, Investors-NA obtained a Site Development Permit for the tracts from the City of Austin. The Site Development Permit allows for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. Construction on the first phase of the Project, which consists of two office buildings, an associated parking garage, and related infrastructure, was completed during 2000. The second phase of construction, which includes two more office buildings, is in progress and Investors-NA expects completion of this phase by the end of the second quarter of 2001. ILCO, FIC and their insurance subsidiaries occupy almost the entire Building One of River Place Pointe, consisting of approximately 74,021 square feet of space. 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 lease was signed in December, 1985 and expires in December, 2005, and 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 sub-leases the space in the property to third parties. -19- Investors-IN owns three residential buildings which are adjacent to the 40 Parker Road building. One residence, which is leased to a third party, contains approximately 3,000 square feet of space. The second building contains approximately 2,000 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 contains approximately 3,000 square feet of space, and is partially leased to third parties. 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. Additionally, ILCO's insurance subsidiaries are regularly involved in litigation, both as a defendant and as plaintiff. The litigation naming the insurance subsidiaries as defendant ordinarily involves our activities as a provider of insurance protection products. Management of the Company does not believe that such litigation, either individually or in the aggregate, will have a material adverse effect on the Company's business, financial condition or results of operations. 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, 2000 to a vote of security holders. -20- PART II Item 5. Market for the Company's Common Stock and Related Stockholder Matters A. Market Information ILCO's common stock is traded in the Nasdaq Small-Cap Market (NASDAQ Symbol: ILCO). The following table sets forth the quarterly high and low sales prices for the Company's common stock for 2000 and 1999. Quotations are furnished by the National Association of Securities Dealers Automated Quotation System (NASDAQ). Prices High Low 2000: 1st Quarter. . . . . . . $10.25 $ 8.6875 2nd Quarter. . . . . . . 10.00 7.9375 3rd Quarter. . . . . . . 9.75 8.875 4th Quarter. . . . . . . 10.625 9.00 1999: 1st Quarter. . . . . . . $10.00 $ 8.250 2nd Quarter. . . . . . . 9.875 7.00 3rd Quarter. . . . . . . 11.50 9.250 4th Quarter. . . . . . . 10.50 9.188 B. Holders The approximate number of record holders of the common stock of the Registrant as of March 15, 2001 was 1,349. C. Dividends No dividend was declared or paid by the Company during 2000. In 1999, the Company paid a stock dividend in the amount of one share of common stock for each share of common stock issued and outstanding. The dividend was paid on March 17, 1999, to holders of record on March 8, 1999. 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 - Dividends." -21- Item 6. Selected Financial Data (in thousands, except per share data.) Years Ended December 31, 2000 1999 1998 1997 1996 Revenues $ 103,756 $ 104,205 $ 109,462 $ 127,683 $ 138,244 Benefits & Expenses 84,669 85,466 91,876 96,081 96,801 Income from operations 19,087 18,739 17,586 31,602 41,443 Provisions for federal income taxes 7,021 5,974 6,467 11,062 14,505 Net Income $ 12,066 $ 12,765 $ 11,119 $ 20,540 $ 26,938 Common Stock and Common Stock Equivalents 1 8,343 8,800 8,924 8,738 8,882 Net income per share 1, 2 Basic $ 1.45 $ 1.45 $ 1.27 $ 2.38 $ 3.18 Diluted $ 1.45 $ 1.45 $ 1.25 $ 2.35 $ 3.04 Cash Dividend -0- -0- -0- -0- -0- Long Term Debt -0- -0- -0- $ 10,964 $ 24,944 Total Assets $1,307,615 $1,321,199 $1,350,248 $1,321,653 $1,263,942 1. Data for the years 1996 to 1998 has been restated to reflect the effect of the stock dividend which was paid on March 17, 1999. 2. Net income per share for the year 1996 has been restated to reflect the effect of FAS 128. -22- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Following is a discussion and analysis of the financial statements and other statistical data that management believes will enhance the understanding of ILCO's financial condition and results of operations. This discussion should be read in conjunction with the financial statements beginning on page F-1. Forward-Looking Statements Except for historical factual information set forth in this Management's Discussion and Analysis, the statements, analyses, and other information contained herein relating to trends in the Company's operations and financial results, the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "path," "estimate," "expect," "intend" and other similar expressions constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management's current expectations and beliefs concerning the financial results, economic conditions and are subject to known and unknown risks, uncertainties and other factors contemplated by the forward-looking statements. Such factors include, among other things: (1) general economic conditions and other factors, including prevailing interest rate levels and stock market performance, which may effect the ability of ILCO to sell its products, the market value of ILCO's investments and the lapse rate and profitability of policies; (2) ILCO's ability to achieve anticipated levels of operational efficiencies and cost-saving initiatives; (3) customer response to new products, distribution channels and marketing initiatives; (4) mortality, morbidity and other factors which may affect the profitability of ILCO's insurance products; (5) changes in the Federal income tax laws and regulations which may affect the relative tax advantages of some of ILCO's products; (6) increasing competition in the sale of insurance and annuities; (7) regulatory changes or actions, including those relating to regulation of insurance products and insurance companies; (8) ratings assigned to ILCO's insurance subsidiaries by independent rating organizations such as A.M. Best Company, which ILCO believes are particularly important to the sale of annuity and other accumulation products; and (9) unanticipated litigation. There can be no assurance that other factors not currently anticipated by management will not also materially and adversely affect ILCO. Results of Operations - Three Years Ended December 31, 2000 Net income from continuing operations was $12,066,000 (basic earnings of $1.45 per common share, or diluted earnings of $1.45 per common share) for the year ended December 31, 2000, as compared to $12,765,000 (basic earnings of $1.45 per common share, or diluted earnings of $1.45 per common share) for the year ended December 31, 1999 and $11,119,000 (basic earnings of $1.27 per common share, or diluted earnings of $1.25 per common share) for the year ended December 31, 1998. Earnings per share are stated in accordance with the requirements of Financial Accounting Standard (FAS) No. 128, which establishes two measures of earnings per share: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that would occur if securities or other contracts to issue common stock were converted or exercised. For the year 1998, earnings per share have been restated to reflect the effect of the stock dividend which was paid on March 17, 1999. -23- 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. Revenues. Premium income, net of reinsurance, for the year 2000 was $10.87 million, as compared to $11.13 million for the year 1999 and $10.89 million for the year 1998. This source of revenues is related to the traditional life insurance and accident & health insurance book of business of ILCO's insurance subsidiaries. The increase in premium income from 1998 to 1999 was due primarily to the acquisition of the book of business from Grinnell Life Insurance Company in 1998. The results for 1998 include, for the period beginning on June 30, 1998, the operations of Grinnell Life. Grinnell Life was acquired on June 30, 1998, through a subsidiary of ILCO, for an adjusted purchase price of $16.6 million. A portion of the purchase price ($12.37 million) was paid by way of a dividend to the seller immediately prior to the closing of the transaction; the balance of the purchase price was paid by ILCO's subsidiary. As part of the transaction, Grinnell Life was immediately merged with and into that subsidiary, with that subsidiary being the surviving entity. The decrease from 1999 to 2000 is attributable to the decrease in the traditional life insurance book of business. Reinsurance premiums ceded were $3.04 million in 2000, as compared to $3.47 million in 1999 and $2.94 million in 1998. Premiums ceded decreased between 1999 and 2000 consistent with the decrease in premium income, and increased from 1998 to 1999 consistent with the increase in premium income. Net investment income for the year ended December 31, 2000 was $50.89 million as compared to $49.91 million for the year ended December 31, 1999 and $54.62 million for the year ended December 31, 1998. The increase from 1999 to 2000 was primarily attributable to the investment income earned from the leases on the buildings at River Place Pointe during the second half of the year 2000. The decrease of $4.7 million from 1998 to 1999 was attributable to the allocation of a portion of the investment portfolio to the development of the River Place Pointe project. The project did not produce rental income during the year 1999. Income from earned insurance charges for the year ended December 31, 2000 was $38.50 million, as compared to $40.45 million for the year 1999 and $41.07 million for the year 1998. This source of revenues is related to the universal life insurance and annuity book of business of Investors-NA. The decrease in income from earned insurance charges over the three year period is consistent with thedecrease in the universal life insurance book of business, as well as the decreased income from surrender charges on universal life policies that have been in force for a number of years. -24- Benefits and Expenses. Policyholder benefits and expenses for the year ended December 31, 2000 were $32.46 million, as compared to $32.00 million for the year ended December 31, 1999 and $38.37 million for the year ended December 31, 1998. The $6.4 million decrease from 1998 to 1999 was due to a lower level of death claims ($2.6 million lower in 1999 than in 1998) and a $4.4 million decrease in reserves related to policyholder surrenders. Interest expense on contract holders deposit funds was $28.79 million for the year ended December 31, 2000, as compared to $30.23 million for the year ended December 31, 1999 and $29.97 million for the year ended December 31, 1998. This expense reflects increases or decreases in the universal life book of business. The increase in 1999 from 1998 is due to the acquisition of the universal life book of business from Grinnell Life. The decrease in 2000 is consistent with the decrease in the total amount of universal life policies in force. The expense related to the amortization of present value of future profits of acquired businesses was $3.81 million for the year ended December 31, 2000, $3.84 million for the year ended December 31, 1999, and $5.90 million for the year ended December 31, 1998. The $2.1 million decrease in expenses from 1998 to 1999 is attributable to the final amortization in 1998 of a portion of the business. The small decrease from 1999 to 2000 is in line with the expected amortization of the remaining book of business. The expense related to the amortization of deferred policy acquisition costs was $2.51 million for the year ended December 31, 2000, $2.37 million for the year ended December 31, 1999, and $2.13 million for the year ended December 31, 1998. The slight increase in amortization of deferred policy acquisition costs over the three year period can be attributed to the continued capitalization of expenses incurred in connection with the writing of new business. The operating expenses of the Company were $17.10 million for the year ended December 31, 2000, as compared to $17.03 million for the year ended December 31, 1999 and $14.85 million for the year ended December 31, 1998. The level of expenses for the year 1999 was affected by expenses incurred in connection with the data processing Year 2000 compliance. The level of expenses in the year 2000 was affected by costs associated with the Company's move to River Place Pointe and the increased amount of rent paid by the Company at its new offices. The Company did not incur any interest expense in either the year ended December 31, 2000 or 1999. For the year ended December 31, 1998, the Company incurred $659,000 in interest expense related to the final portion of outside debt, which was completely paid off by the Company in 1998. -25- The provision for federal income taxes was $7.02 million in 2000 as compared to $5.97 million in 1999 and $6.47 million in 1998. The decrease in the year 1999 was due to the tax deduction attributable to the donation of the Standard Life Building. Prior to December, 1999, Investors-NA owned an office building, located at 206 West Pearl Street, Jackson, Mississippi, which was the former headquarters of Standard Life Insurance Company the ("Standard Life Building"). On December 29, 1999, Investors-NA donated the Standard Life Building to the Jackson Redevelopment Authority ("JRA"). Contemporaneously with the donation of the Standard Life Building, Investors-NA and Financial Industries Corporation ("FIC") sold all of the adjacent parcels they owned to the JRA for a total sale price of $2,500,000.00, which has been allocated according to the respective ownership interests of Investors-NA (approximately 59.28%) and FIC (approximately 40.72%). The donation and sale was made pursuant to the terms of the Donation, Purchase and Sale Agreement dated July 17, 1998. Investors-NA claimed an income tax deduction on tax return filed in 2000 in an amount of $864,231. The donation and sale transaction referenced above resulted in a net gain (GAAP basis) of $992,000 for ILCO and $409,000 for FIC (or a combined total of $1.401 million). During 2000, the lapse rate with respect to universal life insurance policies decreased from the lapse rate experienced in 1999. The rate in 2000 was 5.84 %, as compared to 6.30 % in 1999. The lapse rate with respect to traditional (non-universal) life insurance policies also decreased from the levels experienced in 1999. The rate in 2000 was 6.45% compared to 8.15% in 1999. The lapse rates experienced during the 2000 period were within the ranges anticipated by management. Results of Operations - Three Months Ended December 31, 2000 as compared to the Three Months Ended December 31, 1999 For the three-month period ended December 31, 2000, ILCO's net income was $2,474,000 (basic and diluted earnings of $0.30 per common share) on revenues of $25,456,000 as compared to $4,042,000 (basic earnings and diluted earnings of $0.46 per common share) on revenues of $25,943,000 in the last three months of 1999. The decrease in net income was primarily attributable to a $1.6 million increase in death benefits in the fourth quarter of 2000 from the fourth quarter of 1999. Additionally, the Standard Life Building was donated during the fourth quarter of 1999 and the corresponding tax deduction increased the net income for that quarter. Earnings per share are stated in accordance with the requirements of Financial Accounting Standard (FAS) No. 128, which establishes two measures of earnings per share: basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that would occur if securities or other contracts to issue common stock were converted or exercised. -26- Liquidity and Capital Resources Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. Historically, our principal cash flow sources have been from periodic payment of principal and interest by Investors-NA, pursuant to the terms of the Surplus Debentures. In addition to the need for cash flow to meet operating expenses, our liquidity requirements relate principally to the liabilities associated with our various life insurance and annuity products. Our product liabilities include the payment of benefits under life insurance and annuity products, as well as the payment of policy surrenders, withdrawals and policy loans. ILCO is an insurance holding company. The principal assets of ILCO consist of the outstanding capital stock of Investors-NA and its subsidiary, Investors-IN. Prior to June 30, 2000, ILCO's principal source of liquidity consisted 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. In connection with the 1993 merger of Standard Life into Investors-NA, the obligations of the Surplus Debentures were assumed by Investors-NA. As of June 30, 2000, the outstanding principal balance of the Surplus Debentures was completely paid off. For periods subsequent to June 30, 2000, ILCO's available source of liquidity is dividends paid to it from its subsidiaries. Applicable state insurance laws generally restrict the ability of insurance companies to pay cash dividends in excess of prescribed limitations without prior approval. The ability of Investors-NA to pay shareholder dividends is and will continue to be subject to restrictions set forth in the insurance laws and regulations of Washington, its domiciliary state. The Washington insurance law limits how and when Investors-NA can pay shareholder dividends by including the "greater of" standard for payment of dividends to shareholders, and requiring 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 the policyholder surplus or (ii) the insurer's net gain from operations for the previous year. As of December 31, 2000, Investors-NA had earned surplus of $69.1 million. 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 $23.8 million at December 31, 2000. ILCO's cash and cash equivalents at December 31, 2000 was $9.07 million as compared to $3.36 million at December 31, 1999 and $12.21 million at December 31, 1998. The $5.7 million increase in cash and cash equivalents at December 31, 2000 from 1999 was due primarily to a large decrease in cash used in operating activities. The decrease in cash and cash equivalents from 1998 to 1999 was primarily attributable to a decrease of cash flow provided by investing activities due to an increase in investments purchased and a decrease in the value of short-term investments attributable to interest rate fluctuations during 1999. -27- ILCO's net cash flow used in operating activities was $(1.91) million for the year ended December 31, 2000, as compared to $(20.89) million for the year ended December 31, 1999 and $(17.33) million for the year ended December 31, 1998. The $19.0 million increase in cash flow from 1999 to 2000 was primarily attributable to a $4.6 million decrease in agent advances and other receivables, a $5.8 million decrease in policy liabilities and contractholder deposit funds due to fewer surrenders of policies, and a $13.9 million increase in deferred federal income taxes due primarily to the gain on the Company's bond portfolio. The net cash used in financing activities was $(6.66) million for the year ended December 31, 2000, as compared to $(.026) million for the year ended December 31, 1999 and $(10.78) million for the year ended December 31, 1998. The cash used in financing activities for the year 2000 was attributable to ILCO's stock repurchase plan. In 1999, the Board of Directors of ILCO adopted a stock repurchase plan, under which ILCO is authorized to repurchase up to 5% of its outstanding common stock at times deemed appropriate by management. On June 29, 1999, the Company issued a press release describing the plan, and a Form 8-K was been filed with the SEC on June 30, 1999. The plan was subsequently amended to allow ILCO to repurchase up to 10% of its outstanding common stock. In authorizing the repurchases, the Board of Directors intended that the plan will enhance the value of ILCO's common stock and to manage its capital. Cash used in financing activities for the year 1998 was attributable to the final payment on the Senior Loan. Management believes that its cash, cash equivalents and short term investments are sufficient to meet the needs of its business. Investments. As of December 31, 2000, the book value of the Company's investment assets totaled $660.0 million, as compared to $678.8 as of December 31, 1999. Total assets as of December 31, 2000, which were $1.31 billion decreased slightly from the level as of December 31, 1999, which was $1.32 billion. The decrease in investment assets was primarily attributable to a decrease in short-term investments. The level of short- term investments at the end of 2000 was $129.8 million, as compared to $191.7 million at the end of 1999. This decrease was primarily attributable to a reallocation of investments from short-term, fixed income bonds to long-term bonds and the Company's real estate investment in River Place Pointe. The fixed maturities available for sale portion of invested assets at December 31, 2000 was $440.75 million. The amortized cost of the fixed maturities available for sale segment as of December 31, 2000 was $437 million, representing a net unrealized gain of $3.75 million. This unrealized gain principally reflects changes in interest rates from the date the respective investments were purchased. At December 31, 1999, -28- the fixed maturities available for sale portion of invested assets was $404.2 million and the amortized cost was $411.5 million, representing a net unrealized loss of $7.3 million. The overall increase from 1999 to 2000 was attributable to additional purchases of fixed maturities available for sale as well as more favorable interest rates for these investments in 2000. 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. Invested real estate and other invested assets increased from $21.1 million at December 31, 1999 to $33.0 million as of December 31, 2000. This increase is related primarily to the ongoing development by Investors-NA of River Place Pointe. The liquidity of our insurance operations is also related to the overall quality of our investments. 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, 2000, included a non-material amount (0.7 % 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, 1999, the comparable percentage was 0.1%. The increase from 0.1% in 1999 to 0.7% in 2000 was attributable to mortgage bonds which the Company's insurance subsidiaries own in California utilities, which were downgraded to a "5" (lower quality) rating by the NAIC as of December, 2000. Inv-NA owns mortgage bonds in Pacific Gas & Electric which were purchased for $1.031 million and had a market value as of December 31, 2000 of $720,000, and owns bonds in Southern California Edison which were purchased for $1.96 million and had a market value as of December 31, 2000 of $1.48 million. Inv-IN also owns bonds in Southern California Edison which were purchased for $488,085 and had a market value as of December 31, 2000 of $370,000. The consolidated balance sheets of the Company as of December 31, 2000 include $35.3 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. -29- 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% and (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, in the amount of $1,977,119, is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%. In December, 1998, FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder (FIC). Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC. 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. New Accounting Pronouncements In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FAS No. 133, as amended by FAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - An Amendment of FASB Statement No. 133," is applicable to financial statements for all fiscal quarters of fiscal years beginning after June 15, 2000, as amended by FAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No.133." As the Company does not have significant investments in derivative financial instruments, the adoption of FAS No. 133 is not anticipated to have a material impact on the Company's results of operations, liquidity or financial position. -30- Subsequent Events Agreement and Plan of Merger. On January 17, 2001, ILCO entered into an Agreement and Plan of Merger (the "Agreement") with FIC and ILCO Acquisition Company ("ILCO Acquisition"), a Texas corporation and wholly-owned subsidiary of FIC. In general, the Agreement provides that, following the approval of the Agreement by the shareholders of ILCO and the approval of the issuance of shares of FIC common stock and amendment to FIC's articles of incorporation by the shareholders of FIC and the satisfaction or waiver of the other conditions to the merger: (1) ILCO Acquisition will merge with and into ILCO; and (2) ILCO Acquisition will cease to exist and ILCO will continue as the surviving corporation and as a wholly-owned subsidiary of FIC following the merger. Upon the consummation of the merger: (1) each share of ILCO common stock issued and outstanding immediately prior to the merger, other than shares of ILCO common stock held as treasury shares by ILCO (but excluding shares of ILCO common stock held by any of ILCO's subsidiaries, whether or not treated as treasury shares of ILCO on a consolidated basis under generally accepted accounting principles) or shares of ILCO common stock held by FIC, will be converted into the right to receive 1.1 shares of FIC common stock. However, in the event of any change in FIC common stock and/or ILCO common stock prior to the merger, such as a stock split, stock dividend, subdivision, reclassification, recapitalization, combination, exchange of shares or the like, the number and class of shares of FIC common stock to be issued and delivered in the merger in exchange for each outstanding share of ILCO common stock will be adjusted so as to maintain the relative proportionate interests of the holders of ILCO common stock and FIC common stock; (2) each share of ILCO common stock, series A preferred stock and series B preferred stock of ILCO, in each case which is held as treasury shares by ILCO prior to the merger (excluding shares of ILCO common stock held by any of ILCO's subsidiaries, whether or not treated as treasury shares of ILCO on a consolidated basis under generally accepted accounting principles), and each share of ILCO common stock which is held by FIC (excluding any shares of ILCO common stock owned by any of FIC's subsidiaries) prior to the merger, will be cancelled and retired; (3) each share of common stock of ILCO Acquisition issued and outstanding immediately prior to the merger will be converted into one share of common stock of ILCO and such shares will represent all of the issued and outstanding capital stock of ILCO following the merger; and (4) shares of FIC common stock outstanding immediately prior to the merger (including shares of FIC common stock held by any subsidiary of FIC or ILCO) will remain outstanding and will be unaffected by the merger. No fractional shares of FIC common stock will be issued in the merger. A holder of ILCO common stock who would otherwise be entitled to receive fractional shares -31- of FIC common stock as a result of the merger will receive, in lieu of fractional shares, cash in an amount equal to the average closing price per share of FIC common stock for the 30 trading days immediately prior to the merger multiplied by the fraction to which the holder would otherwise be entitled. FIC will make available to First Union National Bank, as exchange agent, from time to time sufficient cash amounts to satisfy payment for fractional shares and First Union will distribute such proceeds, without interest, to the holders of the fractional interests. The consummation of the merger remains subject to regulatory approval, as well as to the various conditions precedent set forth in the Agreement, including the approval of certain matters by the shareholders of FIC and ILCO. For a more detailed description of the Agreement, see the complete copy of the Agreement, attached as an annex to the S-4 filed by FIC with the Securities and Exchange Commission on February 1, 2001, as amended by the S-4/A filed on March 13, 2001. Unsolicited Verbal Inquiries Concerning Possible Purchase of Post-Merger Company On March 8, 2001, FIC announced that it has received unsolicited verbal indications of interest from a few companies that may be interested in acquiring FIC after completion of the merger with ILCO. The press release did not state any price ranges or other material terms. In conjunction with such indications of interest, FIC has retained Philo Smith Capital Corporation as its financial advisor to explore the possibility of a post-merger sale of FIC with these companies and to further solicit indications of interest from other companies that may have similar interests. No formal indications of interest have been received by FIC to date and FIC has not determined to sell the post-merger company. Litigation Relating to the Merger On the day that ILCO publicly announced the formation of a special committee to evaluate a potential merger with FIC, two class action lawsuits were filed against ILCO, FIC and the officers and directors of ILCO. The actions allege that a cash consideration in the proposed merger is unfair to the shareholders of ILCO, that it would prevent the ILCO shareholders from realizing the true value of ILCO, and that FIC and the named officers and directors had material conflicts of interest in approving the transaction. In their initial pleadings, the plaintiffs sought certification of the cases as class actions and the named plaintiffs as class representatives, and among other relief, requested that the merger be enjoined (or, if consummated, rescinded and set aside) and that the defendants account to the class members for their damages. As of March 16, 2001, the plaintiffs have not taken any further action with respect to the litigation. The defendants believe that the lawsuits are without merit and intend to vigorously contest the lawsuits. Management is unable to determine the impact, if any, that the lawsuits will have on the results of operations of ILCO. -32- Dividend In March, 2001, ILCO announced that its board of directors approved the payment of an annual cash dividend in the amount of $0.41 per share. The dividend is payable on April 12, 2001, to record holders as of the close of business on March 19, 2001. Item 7A. Quantitative and Qualitative Disclosures About Market Risk General. ILCO's principal assets are financial instruments, which are subject to market risks. Market risk is the risk of loss arising from adverse changes in market rates and prices, principally interest rates on fixed rate investments. For a discussion of the Company's investment portfolio and the management of that portfolio to reflect the nature of the underlying insurance obligations of the Company's insurance subsidiaries, please refer to the section entitled "Investment of Assets" in Item 1 of this report and the information set forth in Item 7, "Management's Discussion and Analysis of Financial Condition and Operations - Liquidity and Capital Resources - Investments." The following is a discussion of the Company's primary market risk sensitive instruments. It should be noted that this discussion has been developed using estimates and assumptions. Actual results may differ materially from those described below. Further, the following discussion does not take into account actions which could be taken by management in response to the assumed changes in market rates. In addition, the discussion does not take into account other types of risks which may be involved in the business operations of the Company, such as the reinsurance recoveries on reinsurance treaties with third party insurers. The primary market risk to the Company's investment portfolio is interest rate risk. Interest rate risk is the risk that the Company will incur economic losses due to adverse changes in interest rates. Interest Rate Risk. The Company manages the interest rate risk inherent in our assets relative to the interest rate risk inherent in our liabilities. Generally, we manage interest rate risk based on the application of a commonly used model. The model projects the impact of interest rate changes on a range of factors, including duration and potential prepayment. For example, assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in fair market value related to the financial instruments segment of the Company's balance sheet is estimated to be $21.1 million at December 31, 2000 and $23.3 million at December 31, 1999. For purposes of the foregoing estimate, the following categories of the Company's fixed income investments were taken into account: (i) fixed maturities, including fixed maturities available for sale, (ii) short-term investments and (iii) notes receivable from affiliates. The market value of such assets was $607.3 million at December 31, 2000 and $639.5 million at December 31, 1999. The fixed income investments of the Company include certain mortgage-backed securities. The market value of such securities was $223.6 million at December 31, 2000 and $208 million at December 31, 1999. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in the fair market value related to such mortgage-backed securities is estimated to be $11.1 million at December 31, 2000 and $12.0 million at December 31, 1999. -33- Separate account assets have not been included, since gains and losses on those assets generally accrue to the policyholders. The Company does not use derivative financial instruments to manage our exposure to fluctuations in interest rates. Item 8. Financial Statements and Supplementary Data The following Financial Statements of ILCO and its consolidated subsidiaries have been filed as part of this report: 1. Report of PricewaterhouseCoopers LLP, Independent Accountants, dated April 2, 2001. 2. Consolidated Balance Sheets, as of December 31, 2000 and December 31, 1999. 3. Consolidated Statements of Income for the years ended December 31, 2000, 1999 and 1998. 4. Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2000, 1999 and 1998. 5. Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998. 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. -34- PART III Item 10. Directors and Executive Officers of Registrant (a) Identification of Directors Set forth below are the names and ages of the current directors of the Registrant, the positions and offices with the Registrant held by each such person, the period which each such person has served as a director of the Registrant, and other data regarding each director. All of the directors other than M. Scott Mitte, were elected at the 2000 annual shareholders meeting. Scott Mitte was appointed as a director in October, 2000, to fill a vacancy created by the resignation of Charles K. Chacosky in October, 2000. The data supplied below is based on information provided by the directors, except to the extent that such data is known to the Registrant. Director Name Age Since Principal Occupation and Other Information Robert A. Bender 47 1997 Director of ILCO since October, 1997. Vice President 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 since January, 1997. Assistant Vice President of Investors Life Insurance Company of North America from February, 1994 to January, 1997. Assistant Vice President of Investors-Indiana from February, 1994 to January, 1997. Assistant Vice President of Investors-IN from February, 1994 to January, 1997. Assistant Vice President of Family Life Insurance Company from February, 1994 to January, 1997. -35- Jeffrey H. Demgen 48 1995 Director of FIC since May, 1995. Vice President of FIC since August, 1996. Director and Vice President of ILCO since August, 1996. 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-NA and Investors-IN since August, 1996. Senior Vice President and Director of Investors Life Insurance Company of North America from October, 1992 to June, 1995. 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. Theodore A. Fleron 61 1991 Vice President and Director of ILCO since May, 1991. Assistant Secretary of ILCO since June, 1990. Vice President and Director of FIC since August, 1996. Senior Vice President, General Counsel, Assistant Secretary and Director of Investors-NA and Investors-IN since July, 1992. General Counsel, Assistant Secretary and Director of Investors-NA and Investors-IN 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 69 1988 Director of ILCO since 1988. Director of FIC from 1979 to July, 1991. Dentist practicing in San Marcos, Texas. -36- James M. Grace 57 1984 Vice President and Treasurer of ILCO since January, 1985. Executive Vice President, Treasurer and Director of Investors-IN since 1989. Vice President, Treasurer and Director of FIC since July, 1976. Executive Vice President and Treasurer of Investors-NA since 1989. Executive Vice President, Treasurer and Director of Family Life Insurance Company since June, 1991. Director, Executive Vice President and Treasurer of Investors-Indiana from February, 1995 to December, 1997. Richard A. Kosson 69 1981 Director of ILCO since 1981. Certified Public Accountant and a partner in the firm of Manheim, Kosson & Novick in Millburn, New Jersey. M. Scott Mitte 44 2000 Director of FIC since October, 2000. Director of ILCO since October, 2000. Executive Director and Vice-President of the Roy F. and Joann Cole Mitte Foundation since 1999. Roy F. Mitte 69 1984 Chairman of the Board and Chief Executive Officer of ILCO and Investors-IN since January, 1985. President of ILCO since April, 1985. Chairman of the Board, President and Chief Executive Officer of FIC since 1976. Chairman of the Board, President and Chief Executive Officer of Investors -NA since December, 1988. Chairman of the Board, President and Chief Executive Officer of Family Life Insurance Company since June, 1991. Chairman of the Board, President and Chief Executive Officer of Investors-Indiana from February 1995 to December, 1997. Chairman, ILG Securities Corporation since December, 1988. Elizabeth T. Nash 51 1998 Director of ILCO since 1998. Member of the Board of Regents, Texas State University System from 1993 through 1999, Chairman from 1997 to 1998, Vice-Chairman from 1996 to 1997. Board member of the Development Foundation of Southwest Texas State University since 1987, Chairman from 1992 to 1997, Vice-Chairman from 1989 to 1992. -37- Eugene E. Payne 58 1989 Director of ILCO since December, 1988. Chairman of the Department of Management at Southwest Texas State University in San Marcos, Texas, from 2000 to present. Vice President of ILCO from December, 1988 through July, 2000 and Secretary from May, 1989 through July, 2000. Vice President and Director of FIC from February, 1992 through July, 2000. 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. Steven P. Schmitt 54 1994 Director of ILCO since 1994. Director of FIC since October, 2000. Vice President of ILCO and FIC since October, 2000. Executive Vice President of Family Life Insurance Company since October, 2000. Executive Vice President of Investors-NA and Investors-IN since October, 2000. Senior Vice President of Investors-NA and Investors-IN from April, 1992 through October, 2000 and Director and Assistant Secretary of Investors-NA and Investors-IN since August, 1989. Senior Vice President of Family Life Insurance Company from April, 1992 through October, 2000 and Director of FLIC since June, 1991. (b) Identification of Executive Officers The following table sets forth the names and ages of the persons who have served as Registrant's Executive Officers during 2000 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. -38- Name Age Positions and Offices Roy F. Mitte 69 Chairman of the Board, President and Chief Executive Officer James M. Grace 57 Vice President and Treasurer Steven P. Schmitt 54 Vice President and Secretary Jeffrey H. Demgen 48 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. Steven P. Schmitt was appointed Vice President and Secretary of the Company in October, 2000, upon the resignation of Charles K. Chacosky. (c) Identification of certain significant employees Not Applicable. (d) Family relationships M. Scott Mitte is the son of Roy F. Mitte. (e) Business experience All of the executive officers of the Company are members of the Board of Directors and the business experience of each director has been outlined in Item 10(a). (f) Involvement in certain legal proceedings Not Applicable (g) Beneficial Ownership Reporting Compliance 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. -39- Based solely on review of the copies of such forms furnished to the Company, or written representations that no Form 5s were required, the Company believes that during the period from January 1, 2000 through December 31, 2000, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were complied with, other than with respect to (i) Mr. Michael Scott Mitte, who filed a Form 5 in February, 2001, to report his election as a director on October 13, 2000; (ii) Jefrey H. Demgen, who filed a Form 5 in February, 2001, to report his voluntary disposition in April, 2000, of 318 shares held in his account under the ILCO ESOP Plan; (iii) James M. Grace, who filed a Form 5 in February, 2001, to report his voluntary disposition, in April, 2000, of 1,302 shares held in his account under the ILCO ESOP Plan; (iv) Eugene E. Payne, who filed a Form 5 in February, 2001, to report his voluntary disposition in January, 2000, of 1,053 shares held in his account under the ILCO ESOP Plan, his exercise in October, 2000 of options to acquire 2,000 shares of the common stock of the Company pursuant to the provisions of the ILCO 1999 Stock Option Plan and the subsequent sale in October, 2000 of the shares so acquired upon exercise of the options; and (v) Steven P. Schmitt, who filed a Form 5 in February, 2001, to report his voluntary disposition in January, 2000 of 649 shares held in his account under the ILCO ESOP Plan and his voluntary disposition, in April, 2000, of 616 shares held in his account under the ILCO ESOP Plan. Item 11. Executive Compensation Composition of Board The business of ILCO is managed under the direction of its board of directors. The board of directors currently consists of 11 directors, 3 of whom are independent directors. Compensation Committee The compensation committee of ILCO is chosen by the board of directors. The compensation committee makes recommendations to the Board of Directors with respect to the Chief Executive Officer's compensation. The compensation committee met once to determine Mr. Mitte's compensation for the year 2000. The members of the committee are: W. Lewis Gilcrease, Richard A. Kosson and Elizabeth T. Nash. 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. -40- 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 2000 for services rendered during the fiscal years ended December 31, 2000, 1999 and 1998. Annual Compensation Long Term Compensation Name and Other Annual Stock Options All Other Principal Position Year Salary(1) Bonus Compensation (Shares)(4) Long Term (2, 3) Compensation (5) Roy F. Mitte, Chairman, President and 2000 $356,679 $ 1,535,000 $0- -0- $ -0- Chief Executive 1999 356,679 1,535,000 -0- 10,000 -0- Officer 1998 356,679 1,535,000 -0- -0- -0- James M. Grace, 2000 195,000 25,000 -0- -0- 6,337 Vice President 1999 195,000 20,000 191,215 10,000 1,600 and Treasurer 1998 195,000 25,000 227,040 -0- 1,350 Steven P.Schmitt, 2000(6) 108,846 16,000 -0- -0- 2,004 Vice President and Secretary Jeffrey Demgen, 2000 160,000 20,000 -0- 0- 2,021 Vice President 1999 150,000 20,000 -0- 10,000 1,600 1998 145,384 15,000 -0- -0- 1,615 (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 1998, 1999 and 2000: (i) Mr. Mitte: $1,111,821, $1,111,821 and $1,111,821 respectively, which amounts are not included in the above table; (ii) Mr. Grace: $64,152, $62,694, and $64,152, respectively, which amounts are included in the above table; (iii) Mr. Demgen: $72,173, $76,500, and $81,000 respectively, which amounts are included in the above table; and (iv) for the year 2000 only, $38,888 for Mr. Schmitt, which amount is included in the above table. (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. -41- (3) Includes the value realized by Mr. Grace in connection with the exercise of stock options. In 1999, Mr. Grace exercised options to purchase 24,000 shares of the Company's common stock under the Non-Qualified Option Plan. See "Aggregated Option Exercises in 1999 and 2000" below. (4) The data in this column represents the number of shares available for exercise under options granted in 1999 under the 1999 ILCO Non-Qualified Stock Option Plan. See also, "Option Grants in 1999", below. (5) All Other Compensation includes: (i) Company contributions to the InterContinental Life Corporation Employees Savings and Investment Plan. The amount of each such contribution for the years 1998, 1999, and 2000 respectively, was as follows: (a) Mr. Grace:$1,350, $1,600, and $2,021 respectively, (b) Mr. Demgen:$1,615, $ 1,600, and $2,021 respectively, and (c) for Mr. Schmitt: $2,004 in the year 2000 only. (ii) amounts paid by the Company to Mr. Grace to supplement his benefits under the Company's Pension Plan. The Pension Plan supplement relates to each of the past service years for Mr. Grace 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 benefit under a qualified pension plan, such as the ILCO Pension Plan, is limited to certain maximum amounts. The amount of the payment made in 1998 was determined by comparing the accrued benefit for Mr. Grace under the ILCO Pension Plan through December 31, 1997 to the accrued benefit which he 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 elected to defer his amounts into the Company's Non-Qualified Deferred Compensation Plan. In 1999, the actuarial consulting firm which provides the Company with the calculations of the amounts of the supplements advised the Company that certain errors had been made with respect to prior years. As a result, the Company adjusted the amount of the supplement for Mr. Grace. The adjustment resulted in a credit to the Company in the amount of $6,574. This amount was deducted from the Non-Qualified Deferred Compensation Plan maintained by the Company for Mr. Grace. For the year 2000, the Company contribution to the Non-Qualified Deferred Compensation Plan for Mr. Grace to supplement his benefits under the Company's Pension Plan was $4,316. The Company intends to make a similar payment with respect to benefit accruals for subsequent years; however, there is no obligation for it to do so. (6) Steven P. Schmitt was appointed as an executive officer in the year 2000, thus only his compensation for the year 2000 is disclosed. Option Grants in 1999 The following table sets forth certain information regarding stock options granted during calendar year 1999 to the persons named in the Summary Compensation Table, above. The options were granted under the InterContinental Life Corporation 1999 Stock Option Plan. The plan was approved at the Annual Meeting of -42- Stockholders held on May 18, 1999. During 1999, options to purchase 10,000 shares of the common stock of the Company were granted to each of 46 employees of the Company, its subsidiaries and affiliates, for a total of 460,000 options. As of December 31, 2000, options to purchase a total of 88,000 shares had terminated as a result of employee turnover and 70,000 additional options were granted during the year ended December 31, 2000 to employees of the Company, its subsidiaries and affiliates. The potential realizable values on date of grant of stock options granted in 1999 shown below are presented pursuant to SEC rule and are calculated using assumed annual rates of stock price appreciation for the option term. The theoretical values of options do not necessarily bear a relationship to the compensation cost to the Company or potential gain realized by an executive. The actual amount, if any, realized upon exercise of stock options will depend upon the market price of the common stock of the Company relative to the exercise price of the stock option at the time the stock option is exercised. There is no assurance that the theoretical values of stock options reflected in this table actually will be realized. % of Total Potential Realizable Options Value at Assumed Granted to Annual Rates of Stock Options Employees Exercise Expiration Price Appreciation for Name Granted (1) During 1999 Price Date Option Term (2) 5% 10% Roy F. Mitte 10,000 2.27% $9.00 5/18/05 $14,434 $30,880 James M. Grace 10,000 2.27% 9.00 5/18/05 14,434 30,880 Steven P. Schmitt 10,000 2.27% 9.00 5/18/05 14,434 30,880 Jeffrey H. Demgen 10,000 2.27% 9.00 5/18/05 14,434 30,880 (1) The options shown in the preceding table were each granted on May 18, 1999. Options vest in 20% increments with the first 20% vesting on the first anniversary of the date of grant and an additional 20% vesting on each subsequent anniversary. The option period for each sequentially vested portion of an option is one year from the respective Anniversary Date on which said portion of the option becomes partially exercisable. (2) The potential realizable values on date of grant are calculated assuming that the market price of the underlying security appreciates in value from the date of the grant to the last date on which the options may be exercised at an assumed annualized rate of 5% and, alternatively, 10%. The calculations assume that each vested option is exercised as of the initial date on which such vested percentage may be exercised. -43- Aggregated Option Exercises in 1999 and 2000 The following table sets forth information concerning each exercise of stock options during 1999 by each of the individuals who were executive officers of the Company as of December 31, 2000. Shares Acquired Value Name On Exercise (#)(1) Realized ($) James M. Grace 24,000 $191,215 Steven P. Schmitt(2) (1) The number of shares acquired upon exercise of options reflects the stock dividend which was paid on March 17, 1999. (2) Steven P. Schmitt was appointed as an executive officer in the year 2000 and did not exercise any stock options during the year ended December 31, 2000. No additional options were exercised by executive officers of the Company under the InterContinental Life Corporation 1999 Stock Option Plan during the year 2000. Aggregated Stock Option Values The following table sets forth information with respect to the unexercised options held by the executive officers of the Company. The value of unexercised in-the-money stock options at December 31, 2000 shown below are presented in accordance with SEC rules. The actual amount, if any, realized upon exercise of stock options will depend upon the market price of the common stock of the Company relative to the exercise price per share of the stock option at the time the stock option is exercised. There is no assurance that the values of unexercised in-the-money stock options reflected in the following table will be realized. -44- Number of Unexercised Value of Unexercised Options Held at In-the-Money Options at December 31, 2000 December 31, 20001 Exercisable Unexercisable Exercisable Unexercisable Roy F. Mitte 2,000 8,000 $1,000 $4,000 Jeffrey H. Demgen 2,000 8,000 1,000 4,000 James M. Grace 2,000 8,000 1,000 4,000 Steven P. Schmitt 2,000 8,000 1,000 4,000 (1)Based on the closing price of the Company's common stock on NASDAQ on December 31, 2000 ($9.50). 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. -45- The annual eligible earnings, for 2000 only, covered by the Pension Plan (salary up to $160,000) with respect to the individuals reported in the Summary Compensation Table were as follows, with their respective years of credited service under the Pension Plan at December 31, 2000 being shown in parentheses: Mr. Mitte, $160,000 (13 years), Mr. Grace, $160,000 (13 years), Mr. Demgen, $160,000 (8 years), and Mr. Schmitt, $108,846 (29 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 From 1991 to January, 2001, James Grace had an employment agreement with ILCO, which would become effective upon the occurrence of certain events related to (i) the retirement or date of death or disability of Roy F. Mitte or (ii) the date that any person who is not currently a control person with respect to the Company acquired, or entered into an agreement to acquire, control of the Company, directly or indirectly. This agreement provided that Mr. Grace would be entitled to perform all of the duties of the position or positions held by him with the Company and all subsidiaries of the Company on the date immediately preceding the commencement date of the agreement and he 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. This agreement was superseded by an employment agreement between ILCO and Mr. Grace which became effective on January 8, 2001. The new agreement provides for the employment of Mr. Grace through August 12, 2005 at a salary of $195,000 per year. Mr. Grace shall perform the duties he performed at the time of the effective date of the agreement, or other similar duties as may be assigned from time to time. The agreement may be terminated by the Company only in limited circumstances. In the event of a change of control of the Company, the remaining amounts payable under this agreement shall become immediately due and payable in one lump sum and the agreement shall terminate. Item 12. Security Ownership of Certain Beneficial Owners and Management The following table presents information as of March 6, 2001 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. -46- Amount and Nature Name and Address of Beneficial Ownership Percent of Class(7) Financial Industries Corp. 6500 River Place Blvd. Austin, TX 78730 3,932,692 (1) 48.3 % Roy F. and Joann Cole Mitte Foundation 6500 River Place Blvd. Austin, Texas 78730 3,932,692 (1, 2) 48.3% Roy F. Mitte 6500 River Place Blvd. Austin, TX 78730 3,998,983 (3, 4) 49.1 % Investors Life Insurance Company of North America 6500 River Place Blvd. Austin, TX 78730 669,920 (5) 8.2 % Investors Life Insurance Company of Indiana 6500 River Place Blvd. Austin, TX 78730 563,120 (6) 6.9 % Fidelity Management & Research Company 82 Devonshire Street Boston, MA 02109 878,200 (8) 10.8 % Wellington Management Company, LLP 75 State Street Boston, MA 02109 425,000 (9) 5.2 % 1. Includes 3,590,292 shares owned by Financial Industries Corporation and 342,400 shares owned by Family Life Insurance Company, a wholly-owned subsidiary of FIC. 2. The Roy F. and Joann Cole Mitte Foundation owns 1,552,206 common shares of Financial Industries Corporation ("FIC"). The holdings by the Foundation of FIC's common stock constitutes 30.71 % of the outstanding common stock of that company. The Roy F. and Joann Cole Mitte Foundation is a non-profit corporation/membership organization and its two members are Roy F. Mitte and Joann -47- Cole Mitte. The Internal Revenue Service has determined that the Foundation is exempt from federal income tax under section 501(a) of the Internal Revenue Code (the "Code") as an organization described in section 501(c)(3) of the Code. 3. Mr. Mitte is President, Director and a Member of the Roy F. and Joann Cole Mitte Foundation. In addition, Mr. Mitte holds the positions of Chairman, President and Chief Executive Officer of both ILCO and FIC. For purposes of this table, 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. 4. Includes 32,091 shares allocated to Mr. Mitte's account under the Employees Stock Ownership Plan, 32,200 shares owned directly by Mr. Mitte and 2,000 shares which may be acquired pursuant to options which are exercisable within 60 days. 5. Represents 563,120 shares owned by Investors-IN and 106,800 shares owned directly by Investors- NA. Investors-IN is a life insurance company subsidiary of Investors-NA. 6. All are directly owned by Investors-IN. 7. Assumes that outstanding stock options available to other persons have not been exercised. 8. As reported to the Company on a Schedule 13(G), as amended, filed by FMR Corporation, the parent company of Fidelity Management & Research Company ("Fidelity"). According to the Schedule 13(G) filings, Fidelity acts as investment advisor to the Fidelity Low-Priced Stock Fund, a registered investment company, and the Fund is the owner of 878,200 shares of ILCO common stock. 9. As reported on a Schedule 13(G) filed by Wellington Management Company, LLP ("WMC") on February 14, 2001. According to the Schedule 13(G) filing, WMC acts as investment advisor to certain clients of WMC and such clients have the right to receive, or the power to direct the receipt of, dividends from, or the proceeds from the sale of, such securities. The filing further states that no such client is known to have such right or power with respect to more than five percent of the common stock of the Company. The following table contains information as of March 6, 2001 as to the common stock of the Company beneficially owned by each director 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. -48- Amount and Nature of Percent of Name Beneficial Ownership (2, 3) Class Robert A. Bender 4,739 * Jeffrey H. Demgen 10,433 * Theodore A. Fleron 21,240 * W. Lewis Gilcrease -0- James M. Grace 99,924 1.2 % Richard A. Kosson 200 * Roy F. Mitte (1) 3,998,983 49.1% Michael Scott Mitte 30 * Elizabeth T. Nash 200 * Eugene E. Payne 20,822 * Steven P. Schmitt 14,375 * All Executive Officers and Directors as a group, all of whom are listed above 4,170,946 51.2 % * Less than 1% (1) As an executive officer and director of FIC, which as of March 6, 2001 beneficially owned 3,932,692 shares of the Company's common stock . (2) Includes shares beneficially acquired through participation in the Company's Employees Stock Ownership Plan, 401K Plan and/or the Employee Stock Purchase Plan, which are group plans for eligible employees. -49- (3) Include shares issuable upon exercise of options granted under the 1999 Non-Qualified Stock Option Plan to executive officers and directors who are also employees of the Company or its subsidiaries, to the extent that such options are exercisable within 60 days of March 6, 2001. Item 13. Certain Relationships and Related Transactions with Management 1. 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% and (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%. -50- In December, 1998, FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder (FIC). Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC. 2. The data processing needs of ILCO's and FIC's insurance subsidiaries are provided by FIC Computer Services, Inc. ("FIC Computer"), a subsidiary of FIC. Under the provisions of the data processing agreement, FIC Computer provides data processing services to each subsidiary for fees equal to such subsidiary's proportionate share of FIC Computer's actual costs of providing those services to all of the subsidiaries. The Company's insurance subsidiaries paid $2,427,000 million and Family Life paid $1,758,000 million to FIC Computer for data processing services provided during the year ended December 31, 2000. 3. 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. 4. 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. 5. 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. Steven P. Schmitt serves as Vice President, Secretary and Director of both companies. Messrs. Demgen and Fleron serve as Vice Presidents and Directors of both companies. Mr. Roy Mitte, through the Roy F. and Joann Cole Mitte Foundation, holds beneficial ownership of 30.71% of the outstanding shares of FIC (see "Security Ownership of Certain Beneficial Owners and Management"). -51- 6. On January 8, 2001, the Compensation Committee of the Company recommended that the Company make a donation of $375,000 to the Roy F. and Joann Cole Mitte Foundation (the "Foundation"). At the Company's board meeting held on January 17, 2001, the Board of Directors approved the donation to the Foundation. The Foundation is a charitable entity exempt from federal income tax under section 501(a) of the Code as an organization described in section 501(c)(3) of the Code, and owns 30.71% of the outstanding shares of FIC's common stock. The sole members of the Foundation are Roy F. Mitte, Chairman, President and Chief Executive Officer of FIC, the Company and their insurance subsidiaries, and his wife, Joann Cole Mitte. Part IV Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K (a) The following documents have been filed as part of this Report: 1. Financial Statements as identified in Item 8 above. 2. Financial Statement Schedules Required to be filed by Item 8. a. Schedule I-Summary of Investments other than Investments in Related Parties. b. Schedule II -Condensed Financial Statements of Registrant. c. Schedule IV-Reinsurance. 3. Exhibits filed with this report or incorporated herein by reference are as listed in the Index to Exhibits on page EX-1. (b) Reports on Form 8-K: No reports on Form 8-K were filed during the last quarter of the fiscal year ended December 31, 2000. -52- 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 30, 2001. /s/ Roy F. Mitte /s/ James M. Grace Roy F. Mitte, Director James M. Grace, Director /s/ Eugene E. Payne /s/ Jeffrey H. Demgen Eugene E. Payne, Director Jeffrey H. Demgen, Director /s/ Robert A. Bender /s/ Theodore A. Fleron Robert A. Bender, Director Theodore A. Fleron, Director /s/ W. Lewis Gilcrease /s/ Richard A. Kosson W. Lewis Gilcrease, Director Richard A. Kosson, Director /s/ Elizabeth T. Nash /s/ M. Scott Mitte Elizabeth T. Nash, Director M. Scott Mitte, Director /s/ Steven P. Schmitt Steven P. Schmitt, Director -53- INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES FORM 10-K--ITEM 14 (a)(1) and (2) LIST OF FINANCIAL STATEMENTS TABLE OF CONTENTS (1) The following consolidated financial statements of InterContinental Life Corporation and Subsidiaries are included in Item 8: Report of Independent Accountants..................................F-2 Consolidated Balance Sheets, December 31, 2000 and 1999.........................................F-3 Consolidated Statements of Income, for the years ended December 31, 2000, 1999 and 1998.......................F-5 Consolidated Statements of Changes in Shareholders' Equity, for the years ended December 31, 2000, 1999 and 1998...............F-6 Consolidated Statements of Cash Flows, for the years ended December 31, 2000, 1999 and 1998.............................F-9 Notes to Consolidated Financial Statements................. .......F-12 (2) The following consolidated financial statement schedules of InterContinental Life Corporation and Subsidiaries are included: Schedule I - Summary of Investments Other Than Investments in Related Parties......................... ......F-44 Schedule II - Condensed Financial Statements of Registrant.........................................................F-45 Schedule IV - Reinsurance..........................................F-49 All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, or are not applicable, and therefore have been omitted. F-1 REPORT OF INDEPENDENT ACCOUNTANTS To The Board of Directors and Shareholders of InterContinental Life Corporation In our opinion, the accompanying 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, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14 (a) (1) on page F-1 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, 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 our opinion. PricewaterhouseCoopers LLP Dallas, Texas April 2, 2001 F-2 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands of dollars) December 31, 2000 1999 ASSETS Investments: Fixed maturities held to maturity, at amortized cost (market value approximates $1,386 and $2,056) $ 1,386 $ 2,088 Fixed maturities available for sale, at market value (amortized cost $436,997 and $411,532) 440,749 404,217 Equity securities, at market value (cost approximates $338 and $338) 1,764 1,943 Policy loans 48,449 50,882 Mortgage loans 4,858 6,844 Invested real estate and other invested assets 32,969 21,145 Short-term investments 129,807 191,695 Total investments 659,982 678,814 Cash and cash equivalents 9,066 3,358 Notes receivable from affiliates 35,349 41,497 Accrued investment income 8,304 7,529 Accounts receivable and other receivables 24,340 24,230 Reinsurance receivables 17,448 18,769 Real estate occupied by the Company 19,938 -0- Property and equipment, net 5,005 4,416 Deferred policy acquisition costs 39,395 35,598 Present value of future profits of acquired business 36,024 39,831 Other assets 7,866 9,304 Separate account assets 444,898 457,853 Total Assets $1,307,615 $ 1,321,199 The accompanying notes are an integral part of the consolidated financial statements. F-3 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, Continued (in thousands of dollars, except share data) December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 2000 1999 Liabilities: Policy liabilities and contractholder deposit funds: Future policy benefits $ 130,325 $ 130,092 Contractholder deposit funds 520,349 533,869 Unearned premiums 1,589 1,977 Other policy claims and benefits payable 10,801 9,893 663,064 675,831 Other policyholders' funds 3,015 3,012 Deferred federal income taxes 27,188 21,741 Other liabilities 10,045 14,635 Separate account liabilities 440,127 454,289 Total Liabilities 1,143,439 1,169,508 Commitments and Contingencies (Note 6, 8, 11, 13 and 16) Redeemable preferred stock: Class A Preferred, $1 par value, 5,000,000 shares authorized, issued 5,000 5,000 Class B Preferred, $1 par value, 15,000,000 shares authorized, issued 15,000 15,000 20,000 20,000 Redeemable preferred stock held in treasury (20,000) (20,000) -0- -0- Shareholders' Equity: Common Stock, $.22 par value, 15,000,000 shares authorized; 10,859,478 and 10,855,478 shares issued, and 8,129,385 and 8,827,941 shares outstanding in 2000 and 1999, respectively 2,389 2,388 Additional paid-in capital 4,561 4,526 Accumulated other comprehensive income (loss) 3,365 (3,712) Retained earnings 163,998 151,932 174,313 155,134 Common treasury stock, at cost, 2,730,093 and 2,027,537 shares in 2000 and 1999, respectively (10,137) (3,443) Total Shareholders' Equity 164,176 151,691 Total Liabilities and Shareholders' Equity $ 1,307,615 $ 1,321,199 The accompanying notes are an integral part of the consolidated financial statements. F-4 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands of dollars, except for per share data) Year Ended December 31, 2000 1999 1998 Revenues: Premium $ 10,873 $ 11,132 $ 10,890 Net investment income 50,893 49,913 54,619 Earned insurance charges 38,500 40,447 41,067 Gain on sale of real estate -0- 112 -0- Other 3,490 2,601 2,886 103,756 104,205 109,462 Benefits and expenses: Policyholder benefits and expenses 32,460 32,001 38,367 Interest expense on contract holders deposit funds 28,794 30,229 29,966 Amortization of present value of future profits of acquired businesses 3,807 3,835 5,903 Amortization of deferred policy acquisition costs 2,505 2,372 2,128 Operating expenses 17,103 17,029 14,853 Interest expense -0- -0- 659 84,669 85,466 91,876 Income from operations 19,087 18,739 17,586 Provision for federal income taxes: Current 5,385 5,955 6,899 Deferred 1,636 19 (432) 7,021 5,974 6,467 Net income $ 12,066 $ 12,765 $ 11,119 Net income per share (Note 14): Basic: Weighted average common stock outstanding 8,333 8,796 8,750 Basic earnings per share $ 1.45 $ 1.45 $ 1.27 Diluted: Common stock and common stock equivalents 8,343 8,800 8,924 Diluted earnings per share $ 1.45 $ 1.45 $ 1.25 The accompanying notes are an integral part of these consolidated financial statements. F-5 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands) Additional Common Stock Paid-in Shares Amount Capital Balance at December 31, 1997 5,344 $ 1,176 $ 4,253 Comprehensive Income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities Change in net unrealized gain on investments in fixed maturities available for sale Total comprehensive income Options exercised 42 9 132 Balance at December 31, 1998 5,386 1,185 4,385 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities Change in net unrealized gain on investments in fixed maturities available for sale Total comprehensive income Stock dividend paid 5,405 1,189 Treasury stock purchased and reissued Options exercised 64 14 141 Balance at December 31, 1999 10,855 2,388 4,526 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities Change in net unrealized gain on investments in fixed maturities available for sale Total comprehensive income Treasury stock purchased and reissued Options exercised 4 1 35 Balance at December 31, 2000 10,859 $ 2,389 $ 4,561 The accompanying notes are an integral part of these consolidated financial statements. F-6 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands of dollars) Accumulated Other Comprehensive Income Net Unrealized Net Gain (Loss) on Unrealized Investments Total Appreciation In Fixed Accumulated (Depreciation) Maturities Other of Equity Available Comprehensive Securities For Sale Income (Loss) Balance at December 31, 1997 $ 2,946 $ 11,457 $ 14,403 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities (1,137) (1,137) Change in net unrealized gain on investments in fixed maturities available for sale (1,695) (1,695) Total comprehensive income (1,137) (1,695) (2,832) Options exercised Balance at December 31, 1998 1,809 9,762 11,571 Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities (766) (766) Change in net unrealized gain on investments in fixed maturities available for sale (14,517) (14,517) Total comprehensive income (766) (14,517) (15,283) Stock dividend paid Treasury stock purchased Options exercised Balance at December 31, 1999 1,043 (4,755) (3,712) Comprehensive income: Net income Other comprehensive income: Change in net unrealized appreciation of equity securities (117) (117) Change in net unrealized loss on investments in fixed maturities available for sale 7,194 7,194 Total comprehensive income (117) 7,194 7,077 Treasury stock purchased and reissued Options exercised Balance at December 31, 2000 $ 926 $ 2,439 $ 3,365 The accompanying notes are an integral part of these consolidated financial statements. F-7 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands of dollars) Common Total Retained Treasury Shareholders' Earnings Stock Equity Balance at December 31, 1997 $ 129,237 $ (3,307) $ 145,762 Comprehensive income: Net income 11,119 11,119 Other comprehensive income: Change in net unrealized appreciation of equity securities (1,137) Change in net unrealized gain on investments in fixed maturities available for sale (1,695) Total comprehensive income 11,119 8,287 Treasury stock purc hased 45 45 Options exercised 141 Balance at December 31, 1998 140,356 (3,262) 154,235 Comprehensive income: Net income 12,765 12,765 Other comprehensive income Change in net unrealized appreciation of equity securities (766) Change in net unrealized gain on investments in fixed maturities available or sale (14,517) Total comprehensive income 12,765 (2,518) Stock dividend paid (1,189) Treasury stock purchased and reissued (181) (181) Options exercised 155 Balance at December 31, 1999 151,932 (3,443) 151,691 Comprehensive income: Net income 12,066 12,066 Other comprehensive income: Change in net unrealized appreciation of equity securities (117) Change in net unrealized loss on investments in fixed maturities available for sale 7,194 Total comprehensive income 12,066 19,143 Treasury stock purchased and reissued (6,694) (6,694) Options exercised 36 Balance at December 31, 2000 $ 163,998 $ (10,137) $ 164,176 The accompanying notes are an integral part of these consolidated financial statements. F-8 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Year Ended December 31, CASH FLOWS FROM OPERATING 2000 1999 1998 ACTIVITIES Net Income $ 12,066 $ 12,765 $ 11,119 Adjustments to reconcile net income to net cash used in operating activities: Amortization of present value of future profits of acquired businesses 3,807 3,835 5,903 Amortization of deferred policy acquisition costs 2,505 2,372 2,128 Depreciation 848 488 551 Net gain on sales of investments -0- (112) (988) Financing costs amortized -0- -0- 111 Amortization of deferred gain on sale of real estate (110) (110) (110) Changes in assets and liabilities: (Increase) decrease in accrued investment income (775) 239 698 Decrease (increase) in agent advances and other receivables 1,211 (3,399) (7,686) Policy acquisition costs deferred (6,302) (6,017) (5,460) Decrease in policy liabilities and contractholder deposit funds (12,767) (18,520) (16,194) Increase (decrease) in other policyholders' funds 3 (44) (668) Decrease in other liabilities (4,480) (5,382) (1,036) Increase (decrease) in deferred federal income taxes 5,447 (8,444) (2,355) Decrease (increase) in other assets 1,438 1,339 (2,691) Other, net (4,804) 100 (653) Net cash used in operating activities (1,913) (20,890) (17,331) The accompanying notes are an integral part of these consolidated financial statements. F-9 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Year Ended December 31, CASH FLOWS FROM INVESTING 2000 1999 1998 ACTIVITIES Purchase of insurance subsidiary -0- -0- (1,322) Investments purchased (100,710) (79,308) (41,915) Proceeds from sales and maturities of investments 47,761 106,517 77,700 Net change in short-term investments 61,888 (19,855) (7,218) Purchases and retirements of equipment, net (808) (1,434) (2,119) Decrease in notes receivable from affiliates 6,148 6,148 6,148 Net cash provided by investing activities 14,279 12,068 31,274 CASH FLOWS FROM FINANCING ACTIVITIES (Purchase) re-issuance of treasury stock (6,694) (181) 45 Issuance of common stock 36 155 141 Repayment of debt -0- -0- (10,964) Net cash used in financing activities (6,658) (26) (10,778) Net increase (decrease) in cash and cash equivalents 5,708 (8,848) 3,165 Cash and cash equivalents, beginning of year 3,358 12,206 9,041 Cash and cash equivalents, end of year $ 9,066 $ 3,358 $ 12,206 The accompanying notes are an integral part of these consolidated financial statements. F-10 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Supplemental Cash Flow Disclosures: Year Ended December 31, 2000 1999 1998 Income taxes paid $ 4,700 $ 9,050 $ 11,700 Interest paid $ 272 $ 461 $ 871 Supplemental Schedule of Non-Cash Investing Activities: The Company purchased the outstanding capital stock of a life insurer in the second quarter of 1998 for cash purchase price of $16.6 million (including a $12.4 million dividend paid by the acquired company to its former parent), net of post closing adjustments. The consolidated statements of cash flows reflect the impact of this acquisition. This purchase resulted in the Company receiving tangible assets and assuming liabilities as follows: 1998 Assets $57,745 Liabilities $41,135 The accompanying notes are an integral part of these consolidated financial statements. F-11 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Summary of Significant Accounting Policies Organization InterContinental Life Corporation (ILCO or the "Company") is principally engaged, through its subsidiaries, in administering existing portfolios of individual life insurance and annuity products. The Company's insurance subsidiaries are also engaged in the business of marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. Such products are marketed through independent, non-exclusive general agents. Principles of Consolidation The consolidated financial statements include the accounts of InterContinental Life Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Basis of Presentation The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results will differ from those estimates. Investments The Company's general investment philosophy is to hold fixed maturity securities until maturity. However, fixed maturities may be sold prior to the maturity dates in response to changing market conditions, duration of liabilities, liquidity factors, interest rate movements and other investment factors. Accordingly, most fixed maturity investments are classified as available for sale and are carried at market value. All other fixed maturities are carried at the lower of amortized cost or net realizable value as management has the positive intent and the Company has the ability to hold such investments to maturity. Unrealized gains and losses on securities available for sale are not recognized in earnings but are reported as a separate component of equity in accumulated other comprehensive income, net of income tax effect. F-12 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS While collateralized mortgage obligations (CMOs) are carried at market value, premiums and discounts on CMOs are amortized over the stated maturity of the CMOs, with consideration given to estimates of prepayments in the amortization of those premiums and discounts. The Company endeavors to minimize the portfolio's exposure to interest rate changes inherent in interest-sensitive products by selecting and selling investments so that diversity, maturity and liquidity factors approximate the duration of related policyholder liabilities. 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 as a component of accumulated other comprehensive income. 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 $2,554,962 and $2,126,231 at December 31, 2000 and 1999, respectively. Realized gains and losses on disposal of investments are included in net income. The cost of investments sold is determined on the specific identification basis, except for equity securities, for which the first-in, first-out method is employed. When an impairment of the value of an investment is considered other than temporary, the decrease in value is reported in net income as a realized investment loss and a new cost basis is established. Cash and Cash Equivalents Short-term investments with maturities of three months or less at the time of purchase are reported as cash equivalents. Sale of Real Estate Prior to December, 1999, Investors-NA owned an office building, located at 206 West Pearl Street, Jackson, Mississippi, which was the former headquarters of Standard Life Insurance Company the ("Standard Life Building"). On December 29, 1999, Investors-NA donated the Standard Life Building to the Jackson Redevelopment Authority ("JRA"). Contemporaneously with the donation of the Standard Life Building, Investors-NA and Financial Industries Corporation ("FIC") sold all of the adjacent parcels they owned to the JRA for a total sale price of $2,500,000.00, which has been allocated according to the respective ownership interests of Investors-NA (approximately 59.28%) and FIC (approximately 40.72%). The donation and sale was made pursuant to the terms of the Donation, Purchase and Sale Agreement dated July 17, 1998. Investors-NA claimed an income tax deduction on tax return filed in 2000 in an amount of $864,231. The donation and sale transaction referenced above resulted in a net gain (GAAP basis) of $0.992 million for ILCO and $0.409 million for FIC (or a combined total of $1.401 million). F-13 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Property and Equipment Property and equipment is stated at cost less accumulated depreciation. Depreciation is calculated using straight-line and accelerated methods over estimated useful lives of 10 to 33 years for buildings and improvements and 10 years for furniture and equipment. Maintenance and repairs are charged to expense when incurred. Accumulated depreciation for property and equipment and home office real estate was $5,124,279 and $4,630,102 at December 31, 2000 and 1999, 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 to expense using actuarial methods that include the same assumptions used to estimate future policy benefits in proportion to the ratio of estimated annual gross profits to total estimated gross profits over the expected lives of the contracts. Acquisition costs related to traditional life insurance business are deferred and amortized over the premium paying period of the related policies. Present Value of Future Profits The present value of future profits of acquired traditional life business is amortized over the premium paying period of the related policies in proportion to the ratio of the annual premium revenue to total anticipated premium revenue applicable to such policies. Interest on the unamortized balance is accreted at rates from 7.0% to 8.5%. For interest-sensitive products, these costs are amortized in relation to the present value, using the current credited interest rate, of expected gross profits of the policies over the anticipated coverage period. Retrospective adjustments of these amounts are made periodically upon the revision of estimates of current or future gross profits on universal life-type products to be realized from a group of policies. Recoverability of present value of future profits is evaluated periodically by comparing the current estimate of future profits to the unamortized asset balances. Anticipated investment returns, including realized gains and losses, from the investment of policyholder balances are considered in determining the amortization of present value of future profits acquired. Deferred Financing Costs Financing costs associated with the Company's Senior Loan were deferred and were amortized over the borrowing periods using the interest method. F-14 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, with the exception for the gains and losses in the Company's seed money in the separate accounts. Solvency Laws Assessments The solvency or guaranty laws of most states in which the Company's insurance subsidiaries do business may require the Company's insurance subsidiaries to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. The Company's insurance subsidiaries' expense for guaranty fund assessment from states which do not allow premium tax offsets is not material. Policy Liabilities and Contractholder Deposit Funds Liabilities for future policy benefits related to traditional life products are accrued as premium revenue is recognized. The liabilities are computed using the net level premium method, or an equivalent actuarial method, based upon industry and Company experience of investment yields, mortality and withdrawals, including provisions for possible adverse deviation. 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. In December, 1997, ILCO's life insurance subsidiaries entered into a reinsurance treaty under which all of the contractual obligations and risks under accident and health insurance policies were assumed by a third party reinsurer. (See Note 8.) F-15 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 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 and universal life products consist of net investment income, mortality, administration charges and surrender charges. 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. F-16 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS New Accounting Pronouncements In June 1997, the FASB issued FAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for reporting information about operating segments. Generally, FAS 131 requires that financial information be reported on the basis that is used internally for evaluating performance. The Company adopted SFAS 131 for the year ended December 31, 1998. As described in Note 1, the Company is principally engaged, through its subsidiaries, in administering existing portfolios of individual life insurance and annuity products. The Company's insurance subsidiaries are also engaged in the business of marketing and underwriting individual life insurance and annuity products in 49 states and the District of Columbia. Such products are marketed through independent, non-exclusive general agents. Management considers the Company's insurance operations to constitute one reportable segment. Premium revenues for traditional insurance products and earned insurance charges on universal life and annuity products are presented in the accompanying consolidated statements of income. No single customer accounts for 10 percent or more of the Company's revenue. The Company has no foreign operations. In February 1998, the FASB issued FAS No. 132, "Employers Disclosures about Pensions and Other Postretirement Benefits," which revises current disclosure requirements for employers' pension and other retiree benefits. FAS 132 does not change the measurement or recognition of pension or other postretirement benefit plans. The Company adopted FAS 132 for the year ended December 31, 1998. 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 adopted SOP 97-3 January 1, 1999. The adoption of this SOP did not have a material impact on the Company's financial statements. In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FAS No. 133, as amended by FAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - An Amendment of FASB Statement No. 133", is applicable to financial statements for all fiscal quarters of fiscal years beginning after June 15, 2000, as amended by FAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FAS No. 133". As the Company does not have significant investments in derivative financial instruments, the adoption of FAS 133 did not have a material impact on the Company's results of operations, liquidity or financial position. Reclassification Certain prior years' amounts have been reclassified to conform with the 2000 presentation. F-17 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. Investments Fixed Maturities The amortized cost, gross unrealized gains and losses and market values of fixed maturities available for sale and fixed maturities held to maturity at December 31, 2000 and 1999, respectively were as follows (in thousands): Amortized Gross Unreal- Gross Unreal- Market Cost ized Gains ized Losses Value Fixed Maturities Available for Sale as of December 31, 2000: U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 25,785 $ 2,040 $ -0- $ 27,825 Obligations of states and political subdivisions 4,527 278 -0- 4,805 Corporate securities 188,056 2,025 5,570 184,511 Mortgage-backed securities 218,629 5,327 348 223,608 Total Fixed Maturities Available For Sale Fixed Maturities Held to Maturity: 436,997 9,670 5,918 440,749 Private placements-corporate 1,386 10 10 1,386 Total Fixed Maturities $ 438,383 $ 9,680 $ 5,928 $ 442,135 Fixed Maturities Available For Sale as of December 31, 1999: U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 26,191 $ 745 $ 30 $ 26,906 Obligations of states and political subdivisions 4,680 91 -0- 4,771 Corporate securities 172,686 334 8,306 164,714 Mortgage-backed securities 207,975 3,273 3,422 207,826 Total Fixed Maturities Available For Sale 411,532 4,443 11,758 404,217 Fixed Maturities Held to Maturity: Private placements-corporate 2,088 11 43 2,056 Total Fixed Maturities $ 413,620 $ 4,454 $ 11,801 $ 406,273 The amounts of unrealized gains and losses on fixed maturities available for sale included in accumulated other comprehensive income reflected in the balance sheet have been reduced by estimated deferred taxes in the amount of $1,313,000 and $(2,560,000) in 2000 and 1999, respectively. F-18 The amortized cost and market value of fixed maturities available for sale and fixed maturities held to maturity at December 31, 2000 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 $ 39,841 $ 39,939 Due after one through five years 50,751 51,653 Due after five through ten years 34,789 35,231 Due after ten years 92,987 90,318 Mortgage backed securities 218,629 223,608 Total Fixed Maturities Available for Sale $436,997 $440,749 Fixed Maturities Held to Maturity Amortized Market Cost Value (in thousands) Due in one year or less $ 879 $ 878 Due after one through five year 440 432 Due after five through ten years -0- -0- Due after ten years 67 76 Mortgage backed securities -0- -0- Total Fixed Maturities Held to Maturity $ 1,386 $ 1,386 Proceeds from sales and maturities of investments in fixed maturities during 2000, 1999 and 1998 were approximately $47,761,000, $106,517,000 and $77,700,000. Gross gains of approximately $6,000, $443,000 and $178,000 and gross losses of approximately $11,000, $61,000 and $16,000 were realized on those sales and maturities in 2000, 1999 and 1998, respectively. F-19 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity Securities The change in net unrealized appreciation for equity securities was $(117,000) and $(766,000) for the years ended December 31, 2000 and 1999, respectively. Amounts as of December 31 were as follows (in thousands): 2000 1999 Unrealized appreciation $ 1,437 $ 1,617 Unrealized depreciation (12) (12) Net unrealized appreciation before tax 1,425 1,605 Less: Federal income tax (499) (562) Net unrealized appreciation $ 926 $ 1,043 Equity securities included a $1,719,704 investment, ($318,390 at cost), in 189,750 shares of common stock of Financial Industries Corporation (FIC) (See note 9). This represents 3.8% of FIC's outstanding common stock at December 31, 2000. The net change in unrealized investment gains (losses) represents the only component of other comprehensive income for the years ended December 31, 2000, 1999 and 1998. The following is a summary of the change in unrealized investment gains (losses) net of related deferred income taxes which are reflected in accumulated other comprehensive income for the periods presented: Change in Unrealized Gains (Losses) on Investments 2000 1999 1998 (in thousands) Fixed maturities $ 11,067 $ (22,334) $ (2,607) Equity securities (180) (1,178) (1,749) 10,887 (23,512) (4,356) Deferred federal income taxes (3,810) 8,229 1,524 Net change in unrealized gains (losses) on investments $ 7,077 $ (15,283) $ (2,832) F-20 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table sets forth the reclassification adjustments required for the years ended December 31, 2000, 1999 and 1998: Reclassification Adjustments 2000 1999 1998 (in thousands) Unrealized holding gains (losses) on investments arising during the period $ 7,080 $ (15,034) $ (2,621) Reclassification adjustments for gains included in net income (3) 249 211 Unrealized gains (losses) on investments, net of reclassification adjustment $ 7,077 $ (15,283) $ (2,832) Net Investment Income The components of net investment income are summarized as follows (in thousands): Year Ended December 31, 2000 1999 1998 Fixed maturities $ 43,797 $ 43,755 $ 47,322 Other, including policy loans, real estate, mortgage loans and equity securities 8,153 6,881 8,282 51,950 50,636 55,604 Investment expenses (1,057) (723) (985) Net Investment Income $ 50,893 $ 49,913 $ 54,619 Realized Gains and Losses Net realized (losses) gains included in net investment income are summarized below (in thousands): Year Ended December 31, 2000 1999 1998 Fixed maturities available for sale $ (5) $ 382 $ 162 Equity securities -0- 1 164 Other investments -0- 74 662 (5) 457 988 Income taxes (2) 160 346 Net realized gains $ (3) $ 297 $ 642 F-21 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Mortgage loans and invested real estate The Company's mortgage loans and invested real estate are diversified by property type, location and issuer. Mortgage loans are collateralized by the related properties and such loans generally range from 15% to 80% of the property's value at the time the loan is made. No new mortgage loans were made during the three year period ended December 31, 2000. Non-income producing investments The Company has no non-income producing investments as of December 31, 2000. 3. Disclosures about Fair Value of Financial Instruments The estimated fair value of the Company's financial instruments at December 31, 2000 are as follows: Carrying Fair Amount Value (in thousands) Financial assets: Fixed maturities $ 442,135 $ 442,135 Policy loans 48,449 48,449 Mortgage loans 4,858 4,858 Short-term investments 129,807 129,807 Cash and cash equivalents 9,066 9,066 Notes receivable from affiliates 35,349 35,349 Financial liabilities: Deferred annuities 114,271 112,648 Supplemental Contracts 13,659 13,263 The following methods and assumptions were used to estimate the fair value of each class of financial investments: Fixed maturities Fair values are based on quoted market prices or dealer quotes. Policy loans F-22 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. 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: 2000 1999 (in thousands) Beginning balance $ 39,831 $ 43,666 Accretion of interest 3,121 3,382 Amortization (6,928) (7,217) Ending Balance $ 36,024 $ 39,831 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) 2001 $ 3,431 2002 $ 3,083 2003 $ 2,875 2004 $ 2,576 2005 $ 2,456 F-23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. Acquisition of Business On June 30, 1998, ILCO, through a subsidiary, Investors-Indiana, acquired Grinnell Life Insurance Company ("Grinnell Life") an Iowa-domiciled life insurer, from Grinnell Mutual Life Insurance Company for an adjusted purchase price of $16.6 million. As part of the transaction, Grinnell Life was immediately merged with and into Investors-Indiana, with Investors-Indiana being the surviving entity. 6. Senior Loans The Senior Loan of ILCO was originally arranged in connection with the 1988 acquisition of Investors- NA and Investors-CA. In January, 1993, the Company refinanced its Senior Loan. That transaction was done in connection with the prepayment of the subordinated indebtedness and the purchase of warrants which had been issued as part of the financing of the 1988 acquisitions. The terms of the amended and restated credit facility are substantially the same as the terms and provisions of the 1988 senior loan. The maturity date, which had been December 31, 1996, was extended to July 1, 1998 for the Senior Loan. The average interest rate paid by the Company on its Senior Loan was approximately 7.63% during 1998. In February, 1995, the Company borrowed an additional $15 million under the Senior Loan to help finance the acquisition of Investors-IN, and the maturity date of the Senior Loan was further extended to July 1, 1999. In connection with the acquisition of State Auto Life Insurance Company in July, 1997, the Senior Loan agreement was modified to extend the maturity date to October 1, 1998. As of December 31, 1997, the outstanding principal balance of ILCO's senior loan obligations was $11.0 million, which reflected the prepayment by the Company of the payment originally scheduled for January 1, 1998. A regular payment, in the amount of $3.7 million, was made on April 1, 1998 and a prepayment of the July 1, 1998 installment, in the amount of $3.7 million, was made on June 30, 1998. The outstanding principal balance of ILCO's senior loan obligations was $3.6 million at June 30, 1998. The final installment on the senior loan obligation scheduled for October 1, 1998, was prepaid on September 30, 1998. As a result, the senior loan obligation of ILCO was fully discharged effective September 30, 1998. 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. F-24 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The U.S. federal income tax provision (benefit) charged to continuing operations for the years ended December 31, was as follows: 2000 1999 1998 (in thousands) Current tax provision $ 5,385 $ 5,955 $ 6,899 Deferred tax provision 1,636 19 (432) Total provision for income taxes $ 7,021 $ 5,974 $ 6,467 Provision has not been made for state income tax expense since expense is minimal. Premium taxes are paid to various states where premium revenues are earned. Premium taxes are included in the statement of income as operating expenses. The provision for income taxes differs from the amount of income tax determined by applying the U.S. statutory federal income tax rate of 35% to pre-tax income from continuing operations as a result of the following differences: 2000 1999 1998 (in thousands) Income taxes at the U.S. statutory rate $ 6,680 $ 6,559 $ 6,155 Charitable contribution -0- (920) -0- Increase (decrease) in taxes resulting from: Non-deductible compensation 335 335 312 Other 6 -0- -0- Total provision for income taxes $ 7,021 $ 5,974 $ 6,467 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, 2000 1999 Deferred Tax Liability: (in thousands) Deferred policy acquisition costs $ 10,025 $ 8,340 Present value of future profits 10,571 11,597 Net unrealized (depreciation) appreciation on 1,813 (1,998) marketable securities Acquisition discounts on mortgages/policy loans 969 1,210 Reinsurance recoverable 5,000 5,571 Other taxable temporary differences 2,910 2,965 Total deferred tax liability 31,288 27,685 F-25 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTSRIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000 1999 (in thousands) Deferred policy acquisition costs $ 10,025 $ 8,340 Deferred Tax Asset: Policy reserves 1,284 2,771 Invested assets 1,708 1,655 Net operating loss carry forward 764 1,195 Minimum tax credit 344 323 Total deferred tax asset 4,100 5,944 Net deferred tax liability $ 27,188 $ 21,741 Deferred federal income tax (expense) benefit of $(3,810,00) and $8,229,000 for 2000 and 1999, 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, 2000 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, 2000, Investors-NA and Investors-IN have approximately $146,000,000 and $17,500,000, respectively, in the aggregate in their shareholders' surplus accounts from which distributions could be made without incurring any federal tax liability. At December 31, 2000, the Company and its non-life wholly-owned subsidiaries have net operating loss carry forwards of approximately $2.1 million. 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 $100,000 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. F-26 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amounts reported in the consolidated financial statements for reinsurance ceded are as follows: December 31, 2000 1999 (in thousands) Future policy benefits $ 9,017 $ 10,010 Unearned premiums 1,456 1,605 Other policy claims and benefits payable 3,812 4,103 Amounts recoverable on paid claims 3,163 3,051 Reinsurance receivables $ 17,448 $ 18,769 Year ended December 31, 2000 1999 1998 (in thousands) Premiums $ 1,641 $ 3,472 $ 2,942 Policyholder benefits and expenses $ 2,300 $ 3,780 $ 4,492 9. Shareholders' Equity Financial Industries Corporation ("FIC"), a life insurance holding company, retains ownership of approximately 48.3% of the Company's outstanding common stock. FIC held options to purchase up to an additional 1,702,155 shares, (which number does not reflect the stock dividend paid by ILCO on March 7, 1999) of the Company's authorized but unissued common stock at a price equal to the average market value during the six months preceding the exercise date. These options expired on September 30, 1998. The Company's ability to pay dividends to its shareholders is affected, in part, by the receipt of dividends from Investors-NA, which is organized under the laws of the state of Washington. Under current Washington law, any proposed payment of a dividend or distribution which, together with dividends or distributions paid during the preceding twelve months, exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31 or (ii) statutory net gain from operations for the preceding calendar year is called an "extraordinary dividend" and may not be paid until either it has been approved, or a waiting period shall have passed during which it has not been disapproved, by the insurance commissioner. In addition, Washington laws require that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that dividends may be paid only from earned surplus. F-27 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIAIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Net income (before surplus debenture interest expense) and capital and surplus of Investors-NA as reported to insurance regulators and as determined in accordance with statutory accounting practices are as follows: Year Ended December 31, 2000 1999 1998 Net Income $11,201 $ 12,549 $ 14,246 Capital and Surplus $71,661 $ 75,169 $ 70,627 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 $35,349,000 and $41,497,000 in subordinated notes issued by FIC and Family Life Corporation, a wholly-owned subsidiary of FIC, at December 31, 2000 and 1999, 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, 2000, this permitted practice did not increase statutory surplus over what it would have been under prescribed statutory accounting practices. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The NAIC is now considering amendments to the Codification guidance that would also be effective upon implementation. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, e.g. deferred income taxes are recorded. While management has not yet determined the impact of Codification, it is possible that certain changes in statutory accounting principles arising from Codification would be material to the Company's insurance subsidiaries. In 1988, the Company authorized the issuance of 10 million shares of Class C Preferred Stock, $1.00 par value. The Company was not permitted, under the provisions of the Senior Loan Agreements (See Note 6), to issue any preferred stock except Class A and Class B issued in connection with the acquisition of the Investors Life Companies. The Company has reacquired the Class A and Class B Preferred Stock and holds the shares in treasury. 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. F-28 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 benefit (costs) for the plan includes the following components: 2000 1999 1998 (in thousands) Service cost for benefits earned during the period $ 434 $ 446 $ 460 Interest cost on projected benefit obligation 987 905 793 Expected return on plan assets (1,174) (1,277) (1,235) Amortization of unrecognized prior service cost (229) (229) (229) Pension benefit (costs) $ 18 $ (155) $ (211) The following summarizes the funded status of the plan at December 31: 2000 1999 (in thousands) Change in benefit obligation: Benefit obligation at beginning of period $ 13,868 $ 12,726 Service cost 434 446 Interest cost 987 905 Benefits paid (505) (483) (Gain)/Loss due to change in assumptions -0- -0- (Gain)/Loss due to experience (1,232) 274 Benefit Obligation at end of year $ 13,552 $ 13,868 Change in plan assets: 2000 1999 Fair value of plan assets at beginning of year $ 16,325 $ 16,238 Actual return on plan assets 1,015 570 Benefits paid (505) (483) Fair value of plan assets at end of year $ 16,835 $ 16,325 Funded Status: Funded status at end of year $ 3,282 $ 2,457 Unrecognized prior service cost (11) (240) Unrecognized actuarial net loss 1,592 2,665 Prepaid pension expense at end of year $ 4,863 $ 4,882 The significant assumptions for the plans are as follows: The discount rate for projected benefit obligations was 7.25% in 2000, 1999 and 1998. The assumed long-term rate of compensation increases was 5.0% for 2000, 1999 and 1998. The assumed long-term rate of return on plan assets was 8.0% for 2000, 1999 and 1998. Assumed expenses as a percentage of plan assets were 0% for 2000, 1999 and 1998. F-29 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. 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. F-30 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 a maximum percentage of the participant's plan compensation. Initially, the maximum percentage was 1%. Effective, January 1, 2000, the plan was amended to increase the maximum percentage to 2%. 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 The Company has an Employee Stock Ownership Plan and a related trust for the benefit of its employees and FLIC 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 2000, 1999 or 1998. At December 31, 2000, the Plan had a total of 530,562 shares which are allocated to participants. Effective May 1, 1998, the 401(k) Plan was amended to provide for the merger of the ESOP into the 401(k) Plan. In connection with the merger, certain features under the ESOP were preserved for the benefit of employees previously participating in the ESOP with regard to all benefits accrued under the ESOP through the date of merger. 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. In 1999, the Company paid a stock dividend in the amount of one share of common stock for each share of common stock issued and outstanding. The dividend was paid on March 17, 1999 to holders of record on March 8, 1999. The data in this note has been restated to reflect the effect of the stock dividend. 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 1,200,000 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 $1.67 per share. In 1988, options to purchase 660,000 shares were granted at a price of $1.67 per share. In 1990, options to purchase 60,000 shares expired. In 1991, options to purchase 100,000 shares were granted at prices ranging from $4.38 to $4.63. In 1992 options to purchase 120,000 shares expired. In 1995, options to purchase 120,000 shares were granted at a price of $5.56 per share. These same options, along with 40,000 other options, were terminated in 1996. In 1997 84,000 options were canceled. There were no options granted in 1998, 1997 and 1996. The number of options exercised in 2000, 1999 and 1998 were 0, 84,000, and 84,000, respectively. Under the Company's 1999 Non-Qualified Stock Option Plan options to purchase 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 $7.50 per share, were granted to certain employees of the Company, its subsidiaries and affiliates. In 1999 options to purchase 460,000 shares were granted at prices ranging from $9.00 to $9.75. During 1999, 20,000 options were canceled and no options were exercised. During 2000, 70,000 shares were granted at prices ranging from $9.00 to $9.75. During 2000, 68,000 options were canceled and 4,000 options were exercised. F-31 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarized activity under all Plans for each of the three years ended December 31, 2000: 1998 Weighted Shares Average (000's) Exercise Price Outstanding at the beginning of the year 168 $ 1.67 Granted -0- 0.00 Exercised (84) 1.67 Canceled -0- 0.00 Outstanding at the end of the year 84 $ 1.67 Options exercisable at year end -0- $ -0- Weighted average fair value of options granted during the year $ -0- 1999 Weighted Shares Average (000's) Exercise Price Outstanding at the beginning of the year 84 $ 1.67 Granted 460 9.03 Exercised (84) 1.67 Canceled (20) 9.00 Outstanding at the end of the year 440 $ 9.03 Options exercisable at year end -0- $ -0- Weighted average fair value of options granted during the $ -0- year 2000 Weighted Shares Average (000's) Exercise Price Outstanding at the beginning of the year 440 $ 9.03 Granted 70 9.30 Exercised (4) 9.00 Canceled (68) 9.00 Outstanding at the end of the year 438 $ 9.08 Options exercisable at year end 76 F-32 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Weighted average fair value of options granted during the year As of December 31, 2000: Options Outstanding weighted- Number Outstanding average remaining Range of exercise prices December 31, 2000 Contractual Life (years) $9.00 to $9.75 438,000 2.45 Weighted Average Range of exercise prices Exercise prices $9.00 to $9.75 $9.08 Number exercisable Weighted average Range of Exercise prices December 31, 2000 exercise price $9.00 to $9.75 76,000 $9.03 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 2000, 1999, and 1998 was $2,436,159, $2,320,185, and $2,283,198, respectively, under these lease agreements. Minimum annual future rentals are as follows: (in thousands) 2001 $ 2,281 2002 2,155 2003 2,133 2004 2,099 2005 2,041 Thereafter 6,347 $ 17,057 F-33 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. Related Party Transactions The obligations of the Company under the Senior Loan were guaranteed by FIC. FIC presently owns 3,932,692 shares of the company's Common Stock, constituting 48.3% of such shares outstanding. FIC held options to acquire an additional 1,702,155 shares, (which does not reflect the stock dividend paid by ILCO on March 7, 1999) at the average bid price of such shares during the six-month period preceding the date of any such purchase as long as ILCO's debt guaranteed by FIC (the Senor Loans) remained outstanding. As described in Note 6, the current Senior Loan of ILCO was fully repaid on September 30, 1998. Accordingly, FIC's rights under the 1986 option agreement expired on September 30, 1998. 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, Inc. ("Merrill Lynch") and $14 million borrowed by another subsidiary of FIC from an affiliate of Merrill Lynch and evidenced by a senior subordinated note in the principal amount of $12 million and a junior subordinated note in the principal amount of $2 million and $25 million lent by two insurance company subsidiaries of ILCO. The latter amount was represented by a $22.5 million loan from Investors-NA to FLC and a $2.5 million loan provided directly to FIC by Investors-CA. In addition to the interest provided under those loans, Investors-NA and Investors-CA were granted by FIC non-transferable options to purchase, in the amounts proportionate to their respective loans, up to a total of 9.9 percent of shares of FIC's common stock at a price of $10.50 per share ($2.10 per share as adjusted for the five-for-one stock split in November, 1996), equivalent to the then current market price, subject to adjustment to prevent dilution. The original provisions of the options provided for their expiration on June 12, 1998 if not previously exercised. In connection with the 1996 amendments to the subordinated notes, as described below, the expiration date of the options was extended to September 12, 2006. F-34 On July 30, 1993, the subordinated indebtedness owed to Merrill Lynch and its affiliate was prepaid. The Company paid $38 million plus accrued interest to retire the indebtedness, which had a principal balance of approximately $50 million on July 30, 1993. The primary source of the funds used to prepay the subordinated debt was new subordinated loans totaling $34.5 million that FLC and Family Life Insurance Investment Company ("FLIIC"), another subsidiary of FIC, obtained from Investors-NA. The principal amount of the new subordinated debt was payable in four equal annual installments in 2000, 2001, 2002 and 2003 and bears interest at an annual rate of 9%. The other terms of the new debt are substantially the same as those of the $22.5 million subordinated loans that Investors-NA had previously made to FLC and that continue to be outstanding. In June, 1996, the provisions of the notes from Investors-NA to FIC, FLC and FLIIC were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996; the final quarterly principal payment is due on September 12, 2001; the interest rate on the note remains at 11%, (b) the $30 million note was amended to provide for forty quarterly principal payments, in the amount of $163,540 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $1,336,458; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 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%. F-35 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In December, 1998 FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder, FIC. Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC. Data processing services for ILCO's and FIC's insurance subsidiaries are provided by FIC Computer Service, Inc. ("FIC Computer"), a subsidiary of FIC. Each of FIC's and ILCO's insurance subsidiaries has entered into a data processing agreement with FIC Computer whereby FIC Computer provides data processing services to each subsidiary for fees equal to such subsidiary's proportionate share of FIC Computer's actual costs of providing those services to all of the subsidiaries. The Company's insurance subsidiaries paid $2,426,793, $2,730,189 and $2,818,095 and Family Life paid $1,757,904, $1,916,350 and $1,610,397 to FIC Computer for data processing services provided during the years ended December 31, 2000, 1999 and 1998, respectively. In 1995, Investors-NA entered into a reinsurance agreement with Family Life Insurance Company ("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 $12 million, $13 million, and $11 million from Family Life for direct costs incurred by ILCO on behalf of Family Life's operations in 2000, 1999 and 1998, respectively. Under an agreement between ILCO and Family Life all direct costs incurred on behalf of the other are to be reimbursed. 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. F-36 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. Net Income Per Share The following table reflects the calculation of basic and diluted earnings per share: Year Ended December 31, 2000 1999 1998 (in thousands except per share amounts) Basic: Net income available to common shareholders $ 12,066 $ 12,765 $ 11,119 Weighted average common stock outstanding 8,333 8,796 8,750 Basic earnings per share $ 1.45 $ 1.45 $ 1.27 Diluted: Net income available to common shareholders $ 12,066 $ 12,765 $ 11,119 Weighted average common stock outstanding 8,333 8,796 8,750 Common stock options 423 273 2,638 Repurchase of treasury stock (413) (269) (2,464) Common stock and common stock equivalents 8,343 8,800 8,924 Diluted earnings per share $ 1.45 $ 1.45 $ 1.25 F-37 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. Quarterly Financial Data (unaudited) (in thousands, except per share amounts) Three Months Three Months Ended Ended March 31, June 30, 2000 1999 2000 1999 Net Operating Revenue $ 25,399 $ 26,270 $ 25,270 $ 26,693 Net Income $ 3,231 $ 2,961 $ 3,123 $ 2,627 Basic earnings per share $ 0.37 $ 0.34 $ 0.38 $ 0.30 Diluted earnings per share $ 0.37 $ 0.34 $ 0.38 $ 0.30 Three Months Three Months Ended Ended September 30, December 31, 2000 1999 2000 1999 Net Operating Revenue $ 27,631 $ 25,299 $ 25,456 $ 25,943 Net Income $ 3,238 $ 3,135 $ 2,474 $ 4,042 Basic earnings per share $ 0.40 $ 0.36 $ 0.30 $ 0.46 Diluted earnings per share $ 0.40 $ 0.36 $ 0.30 $ 0.46 16. Subsequent Events Agreement and Plan of Merger. On January 17, 2001, ILCO entered into an Agreement and Plan of Merger (the "Agreement") with FIC and ILCO Acquisition Company ("ILCO Acquisition"), a Texas corporation and wholly-owned subsidiary of FIC. In general, the Agreement provides that, following the approval of the Agreement by the shareholders of ILCO and the approval of the issuance of shares of FIC common stock and amendment to FIC's articles of incorporation by the shareholders of FIC and the satisfaction or waiver of the other conditions to the merger: (1) ILCO Acquisition will merge with and into ILCO; and (2) ILCO Acquisition will cease to exist and ILCO will continue as the surviving corporation and as a wholly-owned subsidiary of FIC following the merger. F-38 Upon the consummation of the merger: (1) each share of ILCO common stock issued and outstanding immediately prior to the merger, other than shares of ILCO common stock held as treasury shares by ILCO (but excluding shares of ILCO common stock held by any of ILCO's subsidiaries, whether or not treated as treasury shares of ILCO on a consolidated basis under generally accepted accounting principles) or shares of ILCO common stock held by FIC, will be converted into the right to receive 1.1 shares of FIC common stock. However, in the event of any change in FIC common stock and/or ILCO common stock prior to the merger, such as a stock split, stock dividend, subdivision, reclassification, recapitalization, combination, exchange of shares or the like, the number and class of shares of FIC common stock to be issued and delivered in the merger in exchange for each outstanding share of ILCO common stock will be adjusted so as to maintain the relative proportionate interests of the holders of ILCO common stock and FIC common stock; (2) each share of ILCO common stock, series A preferred stock and series B preferred stock of ILCO, in each case which is held as treasury shares by ILCO prior to the merger (excluding shares of ILCO common stock held by any of ILCO's subsidiaries, whether or not treated as treasury shares of ILCO on a consolidated basis under generally accepted accounting principles), and each share of ILCO common stock which is held by FIC (excluding any shares of ILCO common stock owned by any of FIC's subsidiaries) prior to the merger, will be cancelled and retired; (3) each share of common stock of ILCO Acquisition issued and outstanding immediately prior to the merger will be converted into one share of common stock of ILCO and such shares will represent all of the issued and outstanding capital stock of ILCO following the merger; and (4) shares of FIC common stock outstanding immediately prior to the merger (including shares of FIC common stock held by any subsidiary of FIC or ILCO) will remain outstanding and will be unaffected by the merger. No fractional shares of FIC common stock will be issued in the merger. A holder of ILCO common stock who would otherwise be entitled to receive fractional shares of FIC common stock as a result of the merger will receive, in lieu of fractional shares, cash in an amount equal to the average closing price per share of FIC common stock for the 30 trading days immediately prior to the merger multiplied by the fraction to which the holder would otherwise be entitled. FIC will make available to First Union National Bank, as exchange agent, from time to time sufficient cash amounts to satisfy payment for fractional shares and First Union will distribute such proceeds, without interest, to the holders of the fractional interests. F-39 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The consummation of the merger remains subject to regulatory approval, as well as to the various conditions precedent set forth in the Agreement, including the approval of certain matters by the shareholders of FIC and ILCO. For a more detailed description of the Agreement, see the complete copy of the Agreement, attached as an annex to the S-4 filed by FIC with the Securities and Exchange Commission on February 1, 2001, as amended by the S-4/A filed on March 13, 2001. Unsolicited Verbal Inquiries Concerning Possible Purchase of Post-Merger Company On March 8, 2001, FIC announced that it has received unsolicited verbal indications of interest from a few companies that may be interested in acquiring FIC after completion of the merger with ILCO. The press release did not state any price ranges or other material terms. In conjunction with such indications of interest, FIC has retained Philo Smith Capital Corporation as its financial advisor to explore the possibility of a post-merger sale of FIC with these companies and to further solicit indications of interest from other companies that may have similar interests. No formal indications of interest have been received by FIC to date and FIC has not determined to sell the post-merger company. Litigation Relating to the Merger On the day that ILCO publicly announced the formation of a special committee to evaluate a potential merger with FIC, two class action lawsuits were filed against ILCO, FIC and the officers and directors of ILCO. The actions allege that a cash consideration in the proposed merger is unfair to the shareholders of ILCO, that it would prevent the ILCO shareholders from realizing the true value of ILCO, and that FIC and the named officers and directors had material conflicts of interest in approving the transaction. In their initial pleadings, the plaintiffs sought certification of the cases as class actions and the named plaintiffs as class representatives, and among other relief, requested that the merger be enjoined (or, if consummated, rescinded and set aside) and that the defendants account to the class members for their damages. F-40 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of March 16, 2001, the plaintiffs have not taken any further action with respect to the litigation. The defendants believe that the lawsuits are without merit and intend to vigorously contest the lawsuits. Management is unable to determine the impact, if any, that the lawsuits will have on the results of operations of ILCO. Dividend In March, 2001, the Company announced that its board of directors approved the payment of an annual cash dividend in the amount of $0.41 per share. The dividend is payable on April 12, 2001 to record holders as of the close of business on March 20, 2001. F-41 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT BALANCE SHEETS December 31, 2000 and 1999 ( in thousands of dollars ) Column A Column B Column C Column D Amount at which Shown in the Type of Investment Costs Value Balance Sheet Fixed maturities available for sale: United States Government and government agencies and authorities $ 25,785 $ 27,825 $ 27,825 States, municipalities and political subdivisions 4,527 4,805 4,805 Corporate securities 188,056 184,511 184,511 Mortgage-backed securities 218,629 223,608 223,608 Total fixed maturities available for sale 436,997 440,749 440,749 Fixed maturities held to maturity 1,386 1,386 1,386 Total fixed maturities $438,383 $442,135 $442,135 Equity securities: Public utilities 2 4 4 Industrial, miscellaneous and all other 18 40 40 Total equity securities 20 44 44 Policy loans 48,449 48,449 48,449 Mortgage loans 4,858 4,858 4,858 Real estate 32,969 32,969 32,969 Short term investments 129,807 129,807 129,807 Total investments $654,486 $658,262 $658,262 F-42 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT BALANCE SHEETS December 31, 2000 and 1999 (in thousands of dollars) ASSETS 2000 1999 Short-term investments $ 12,404 $ 15,505 Cash and cash equivalents 179 48 Subordinated debenture receivables from Investors Life Insurance Company of North America -0- 5,896 Investments in and advances to subsidiaries 150,609 129,345 Accounts receivable 5,055 5,144 Property and equipment, net 254 260 Other assets 446 382 Total Assets $ 168,947 $ 156,580 F-43 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT BALANCE SHEETS, continued December 31, 2000 and 1999 (in thousands of dollars) LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: 2000 1999 Accounts payable and accrued expenses $ 1,799 $ 1,808 Deferred gain on sale of real estate 519 628 Total Liabilities 2,318 2,436 Redeemable preferred stock: Class A preferred stock, $1 par value, shares authorized and issued 5,000 5,000 Redeemable preferred stock: Class B preferred stock, $1 par value, 15,000 15,000 shares authorized and issued 20,000 20,000 Redeemable preferred stock, repurchased and held as treasury stock (20,000) (20,000) -0- -0- Shareholders' Equity: Common stock, $.22 par value, 15,000,000 shares authorized; 10,859,478 and 10,855,478 shares issued, 8,798,905 and 8,827,941 shares outstanding in 2000 and 1999, respectively 2,389 2,388 Additional paid-in capital 4,561 4,526 Accumulated other comprehensive income 3,365 (3,712) Retained earnings (including $158,544 and $147,259 of undistributed earnings of subsidiaries at December 31, 2000 and 1999, respectively) 163,998 151,932 174,313 155,134 Common treasury stock, at cost, 2,080,573 and 1,378,017 shares in 2000 and 1999 (7,684) (990) Total Shareholders' Equity 166,629 154,144 Total Liabilities and Shareholders' Equity $168,947 $ 156,580 F-44 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT STATEMENTS OF INCOME Years Ended December 31, 2000, 1999 and 1998 (in thousands of dollars) 2000 1999 1998 Revenues charged to subsidiaries: Interest income $ 1,192 $ 1,418 $ 2,391 Other income 130 134 138 1,322 1,552 2,529 Operating expenses 121 122 348 Interest expense -0- -0- 415 121 122 763 Income from operations 1,201 1,430 1,766 Federal income tax provision 420 501 618 Net income before equity in undistributed earnings from subsidiaries 781 929 1,148 Equity in undistributed earnings from subsidiaries 11,285 11,836 9,971 Net income $ 12,066 $ 12,765 $ 11,119 F-45 INTERCONTINENTAL LIFE CORPORATION (PARENT COMPANY) SCHEDULE II - CONDENSED FINANCIAL STATEMENTS OF REGISTRANT STATEMENTS OF CASH FLOWS (in thousands of dollars) Year ended December 31, CASH FLOWS FROM OPERATING 2000 1999 1998 ACTIVITIES: Net income $ 12,066 $ 12,765 $ 11,119 Adjustments to reconcile net income to net cash (used in ) provided by operating activities: Amortization of deferred gain on sale of real estate (110) (110) (110) Decrease (increase) in accounts receivable 89 (184) (20) Increase in investment in and advances to subsidiaries (14,185) (10,191) (8,957) (Decrease) increase in accounts payable and accrued expenses (9) (601) (161) (Increase) decrease in other assets (64) 6 105 Other 5 5 -0- Net cash (used in) provided by operating activities (2,208) 1,690 1,976 CASH FLOWS FROM INVESTING ACTIVITIES: Change in short term investments 3,101 (11,773) (3,040) Net cash provided by (used in) investing activities 3,101 (11,773) (3,040) CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of debt -0- -0- (10,964) Stock options exercised 36 155 141 Purchase and reissuance of treasury stock (6,694) (181) 45 Payment received on subordinated debenture receivable 5,896 10,000 11,900 Net cash (used in) provided by financing activities (762) 9,974 1,122 Net increase (decrease) in cash and cash 131 (109) 58 equivalents Cash and cash equivalents, beginning of year 48 157 99 Cash and cash equivalents, end of year $ 179 $ 48 $ 157 F-46 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES SCHEDULE IV - REINSURANCE (in thousands of dollars) Ceded To Assumed Direct Other From Amount Companies Companies 2000 Life insurance in-force $6,383,740 $1,160,358 $492,891 Premium Life insurance 11,819 1,008 -0- Accident-health insurance 694 633 -0- Total $ 12,513 $ 1,641 $ -0- 1999 Life insurance in-force $6,612,022 $1,294,265 $438,833 Premium: Life insurance $ 13,776 $ 2,741 $ 21 Accident-health insurance 808 731 (1) Total $ 14,584 $ 3,472 $ 20 1998 Life insurance in-force $7,258,662 $1,531,981 $331,133 Premium: Life insurance $ 12,782 $ 2,112 $ 48 Accident-health insurance 1,001 830 1 Total $ 13,783 $ 2,942 $ 49 F-47 INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES SCHEDULE IV - REINSURANCE, continued (in thousands of dollars) Percentage Net Of Amount 2000 Amount Assumed Life insurance in-force $ 5,716,273 8.62% Premium: Life insurance 10,811 0.00% Accident-health insurance 61 0.00% Total $ 10,872 0.00% 1999 Life insurance in-force $ 5,756,590 7.62% Premium: Life insurance $ 11,056 0.19% Accident-health insurance 76 1.03% Total $ 11,132 0.18% 1998 Life insurance in-force $ 6,057,814 5.47% Premium: Life insurance $ 10,718 0.45% Accident-health insurance 172 0.58% Total $ 10,890 0.45% F-48 Exhibit Index Exhibit Page Number Number Description 3(a) Certificate of Incorporation of InterContinental Life Corporation filed May 22, 1969 and Amendments thereto (1) (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 (2) 3(c) Articles of Incorporation of InterContinental Life Corporation of Texas (10) 3(d) Amendment to Articles of Incorporation of InterContinental Life Corporation of Texas (10) 3(e) By-Laws of InterContinental Life Corporation of Texas (10) 3(f) Articles of Merger of InterContinental Life Corporation and InterContinental Life Corporation of Texas (10) 3(g) Plan and Agreement of Merger Between InterContinental Life Corporation and InterContinental Life Corporation of Texas (10) 10(aa) Lease dated December 20, 1985 between Registrant and Parker Road Associates for the rental of 40 Parker Road, Elizabeth, New Jersey (3) 10(ab) Registrant's Defined Benefit Pension Plan, effective as of January 1, 1988 (4) 10(ac) Registrant's Employee Stock Purchase Plan, effective as of August 25, 1989(5) Ex - 1 10(ad) 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(6) 10(ae) 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 (6) 10(af) 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 (6) 10(ag) Option Agreement by Financial Industries Corporation in favor of Investors Life Insurance Company of North America and Investors Life Insurance Company of California (6) 10(ah) Terms and Conditions of Employment Contract of James M. Grace approved by Registrant's Board of Directors on May 16, 1991 (10) 10(ai) 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(7) 10(aj) 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 (7) 10(ak) Amendment No. 1 dated July 30, 1993 between Family Life Corporation and Investors Life Insurance Company of North America amending $22.5 million note (7) 10(al) Data Processing Agreement dated as of November 30, 1994 between InterContinental Life Insurance Company and FIC Computer Services, Inc.(8) 10(am) Data Processing Agreement dated as of November 30, 1994 between Investors Life Insurance Company of North America and FIC Computer Services, Inc. (8) 10(an) Data Processing Agreement dated as of November 30, 1994 between Family Life Insurance Company and FIC Computer Services, Inc. (8) 10(ao) 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(9) Ex - 2 10(ap) (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 (9) (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.(9) 10(aq) Amendment No. 1 dated December 12, 1996, effective June 12, 1996 to the note dated July 30, 1993 in the amount of $30 million made by Family Life Corporation in favor of Investors Life Insurance Company of North America(9) 10(ar) 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 (9) 10(as) 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 (9) 10(at) Assignment Agreement dated December 23, 1998, from Family Life Insurance Investment Company to Financial Industries Corporation, assigning the 9% Senior Subordinated Note dated July 30, 1993 in the amount of $4.5 million made by Family Life Insurance Investment Company in favor of Investors Life Insurance Company of North America (11) 10(au) InterContinental Life Corporation 1999 Stock Option Plan. Filed on April 20, 1999 with Registrant's Form DEF 14A, and incorporated herein by reference. 10(av) Amendment to Surplus Debenture dated September 28, 1999 between Investors Life Insurance Company of North America and the Registrant. Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1999 and incorporated herein by reference. 10(aw) Ex-5 Employment Agreement of James M. Grace dated January 8, 2001. 21 Ex-11 Subsidiaries of the Registrant. 23 Ex-12 Consent of PricewaterhouseCoopers LLP. Ex - 3 (1) 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. (2) Filed with the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1984 and incorporated herein by reference. (3) Filed with the Registrant's Annual Report of Form 10-K for the fiscal year ended December 31, 1985 and incorporated herein by reference. (4) Filed with Registrant's Annual Report of Form 10-K for the fiscal year ended December 31, 1988, and incorporated herein by reference. (5) Filed with Registrants Annual Report on Form 10-K for the fiscal year ended December 31, 1989, and incorporated herein by reference. (6) Filed with Financial Industries Corporation's Current Report on Form 8-K dated June 25, 1991, and incorporated herein by reference. (7) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, and incorporated herein by reference. (8) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and incorporated herein by reference. (9) Filed with Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, and incorporated herein by reference. (10) Filed with Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1997, and incorporated herein by reference. (11) Filed with Registrant's Annual Report on form 10-K for the fiscal year ended December 31, 1998, and incorporated herein by reference. Ex - 4 EXHIBIT 10(aw) EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this "Agreement") is entered into as of January 8, 2001, between InterContinental Life Corporation, a Texas corporation with its principal place of business located at 6500 River Place Blvd., Building One, Austin, Texas 78730 (the "Company"), and James M. Grace, of PO Box 7981, Horseshoe Bay, Texas 78657-7981 (the "Employee"). RECITALS The Company is primarily engaged in the business of insurance and financial services. The Company desires to employ the Employee, and the Employee desires to be so employed by the Company, on the terms and subject to the conditions set forth in this Agreement. AGREEMENT NOW, THEREFORE, in consideration of the premises and the mutual promises set forth in this Agreement, the Company and the Employee hereby agree as follows: 1. Employment. (a) Subject to the terms and conditions contained herein, the Company hereby agrees to employ the Employee, and the Employee accepts such employment, from the date hereof until August 12, 2005. During the Employee's employment under this Agreement, the Employee shall perform such duties for the Company as are customarily performed by an employee in a similar position or as may from time to time be assigned to the Employee by the Board of Directors of the Company (the "Board") or by the President of the Company; provided, however, the Employee shall only be assigned duties which are the same or substantially similar to the duties that Employee performed at the time that this Agreement was executed. The Employee shall have the title of Vice President and Treasurer or such other title or titles, if any, as from time to time may be assigned to the Employee by the Board. (b) The Employee agrees to perform faithfully, industriously, and to the best of the Employee's ability, experience, and talents, all of the duties as assigned to him as needed from time to time pertaining to consultation on pertinent financial reporting and acquisition activities. So long as the Employee is employed by the Company, the Employee shall not, without the written consent of the Company: (i) engage in any other activity for compensation, profit or other pecuniary advantage, during the term of this Agreement; Ex - 5 (ii) render or perform services of a business, professional, or commercial nature (which shall specifically not include services performed for a charitable entity or a homeowners' or condominium association), either alone or as an employee, consultant, director, officer, or partner of another business entity, whether or not for compensation, which services are competitive with or adverse to the business of the Company or its affiliates or subsidiaries; or (iii) invest in or become a shareholder of another corporation or other entity (other than an affiliate of the Company) which business is competitive with or adverse to the business of the Company or its affiliates or subsidiaries, if such investment requires active involvement of the Employee in the operation of said corporation or other entity. 2. Location of Employment. The Employee's principal place of employment shall be at the principal executive offices of the Company located at 6500 River Place Blvd., Building One, Austin, Texas 78730, or the Austin area. Employee shall not be required to perform services for the Company or its affiliates outside of the Austin area. 3. Compensation. (a) In exchange for full performance of the Employee's obligations and duties under this Agreement, the Company shall pay the Employee as follows: From To Amount January 1, 2001 August 12, 2001 $ 121,875 August 13, 2001 August 12, 2002 $ 195,000 August 13, 2002 August 12, 2003 $ 195,000 August 13, 2003 August 12, 2004 $ 195,000 August 13, 2004 August 12, 2005 $ 195,000 Such payments shall be payable in installments in accordance with the Company's regular payroll schedule. (b) The base salary described in subsection (a) hereof is a gross amount, and the Company shall be required to withhold from such amount deductions with respect to Federal, state and local taxes, FICA, unemployment compensation taxes and similar taxes, assessments or withholding requirements. (c) During the Employee's employment under this Agreement, the Employee shall also be reimbursed by the Company for reasonable business expenses actually incurred or paid by the Employee, consistent with the policies established by the Board, in rendering to the Company or its affiliates the services provided for in this Agreement, upon presentation of expense statements or such other supporting information as is consistent with the policies of the Company. Ex - 6 (d) The Employee shall be entitled to participate in all benefit plans (including but not limited to, deferred compensation plans, medical, dental, life insurance plans, or stock option plans) which shall be available from time to time to the domestic management employees of the Company (including the management employees of an affiliate of the Company) generally. If, for any reason, the Company is unable to make available to Employee coverage under the life insurance or the group medical insurance plans generally available to employees of the Company, the Company shall obtain substantially similar individual life insurance and medical insurance benefits for Employee and his spouse. The dollar amount of the Employee's contribution to the premiums for such individual life insurance and medical insurance benefits shall not exceed the dollar amount of the contribution which would otherwise have been made by Employee under the group life and medical plans generally available to employees of the Company. 4. Term. (a) This Agreement shall be effective as of January 1, 2001, and shall terminate on August 12, 2005. The Agreement may not be terminated by the Company prior to such date, other than as set forth in Section 4. If Employee is terminated in a manner other than as provided herein, the Company shall pay the Employee the remaining salary through the end of the term of this Agreement. (b) The employment of the Employee under this Agreement shall terminate on the date of the Employee's death; provided however, if Employee dies prior to August 12, 2002, Employee's spouse, Letitia Grace, shall be entitled to receive the salary due hereunder to Employee through August 12, 2002, in installments as if Employee were still on the Company's payroll. If Employee dies after August 12, 2002, Letitia Grace shall not be entitled to any further salary payments and this Agreement shall immediately terminate. (c) The employment of the Employee under this Agreement may be terminated by the Company upon written notice from the Board that, in the opinion of the Board, the Employee has (i) demonstrated willful and continued misconduct in the execution of the Employee's duties which have been appropriately assigned in accordance with the terms and provisions of this Agreement, (ii) been convicted of or pleaded nolo contendere to a felony or other serious crime involving the theft or misappropriation of money, or (iii) misappropriated assets of the Company. (d) The employment of the Employee under this Agreement shall terminate upon receipt by the Board of a written notice of resignation signed by the Employee or, if no notice is given, on the date on which the Employee voluntarily terminates his employment relationship with the Company. In such event, Employee shall not be entitled to any further compensation hereunder. (e) If the Employee's employment is terminated pursuant to this Section 4(c) or (d), the Employee shall not be entitled to any compensation or benefits from the Company, under Section 3 of this Agreement or otherwise, except for the following: (i) base salary accrued, and reasonable business expenses incurred, under Section 3 of this Agreement through the date of such termination; and Ex - 7 (ii) such benefits, if any, as may be required to be provided by the Company under the Comprehensive Omnibus Budget Reconciliation Act (COBRA), or any successor or similar legislation. (f) In the event of a Change in Control of the Company, the remaining amounts payable under this Agreement shall become immediately due and payable in one lump sum. Following such payment, this Agreement shall terminate. For the purposes of this Agreement, a "Change in Control" shall be deemed to have taken place upon the occurrence of any one or more of the following: (i) Roy F. Mitte is no longer the Chairman, President and Chief Executive Officer of the Company, (ii) a majority of the members of the Board of Directors of the Company are not individuals who were selected to serve as Directors by Roy F. Mitte. (g) In no event shall the amount of the payment to be made to Employee under the provisions of Section 4(f), above, exceed an amount which would cause all amounts to be received by Employee which are treated as "parachute payments" (within the meaning of section 280G(b)(2) of the Internal Revenue Code) to exceed 2.99 times the "base amount" applicable to Employee for purposes of section 280G(b)(3) of the Internal Revenue Code. 5. Employee's Representations. (a) The Employee represents that he has full authority to enter into this Agreement and that he is free to enter into this Agreement and not under any contractual restraint which would prohibit the Employee from satisfactorily performing his duties to the Company under this Agreement. (b) The Employee acknowledges that he is free to seek advice from independent counsel with respect to this Agreement. The Employee has either obtained such advice or, after carefully reviewing this Agreement, has decided to forego such advice. The Employee is not relying on any representation or advice from the Company or any of its officers, directors, attorneys or other representatives regarding this Agreement, its content or effect. 6. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Texas. 7. Entire Agreement. This Agreement constitutes the whole agreement of the parties hereto in reference to any employment of the Employee by the Company and in reference to any of the matters or things herein provided for or hereinabove discussed or mentioned in reference to such employment; all prior agreements, promises, representations and understandings relative thereto being herein merged. 8. Assignability. (a) In the event the Company shall merge or consolidate with any other corporation, partnership or business entity, or all or substantially all of the Company's business or assets shall be transferred in any manner to any other corporation, partnership or business entity, then such successor to the Company shall thereupon Ex - 8 succeed to, and be subject to, all rights, interests, duties and obligations of, and shall thereafter be deemed for all purposes hereof to be, the "Company" under this Agreement. (b) This Agreement is personal in nature and the Employee shall not, without the written consent of the Company, assign or transfer this Agreement or any rights or obligations hereunder. (c) Except as set forth in subsection (a) above, nothing expressed or implied in this Agreement is intended or shall be construed to confer upon or give to any person, other than the parties to this Agreement, any right, remedy or claim under or by reason of this Agreement or of any term, covenant or condition of this Agreement. 9. Amendments; Waivers. This Agreement may be amended, modified, superseded, canceled, renewed or extended and the terms or covenants of this Agreement may be waived only by a written instrument executed by the parties to this Agreement or, in the case of a waiver, by the party waiving compliance. Any such written instrument must be approved by the Board to be effective as against the Company. The failure of any party at any time or times to require performance of any provision of this Agreement shall in no manner affect the right at a later time to enforce the same. No waiver by any party of the breach of any term or provision contained in this Agreement, whether by conduct or otherwise, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such breach, or a waiver of the breach of any other term or covenant contained in this Agreement. 10. Notice. All notices, requests or consents required or permitted under this Agreement shall be made in writing and shall be given to the other party by personal delivery, overnight air courier (with receipt signature) or facsimile transmission (with "answerback" confirmation of transmission), if to the Company, sent as follows: Attention: Theodore A. Fleron, 6500 River Place Blvd., Building One, Austin, Texas 78730, and if to the Employee: James M Grace, P.O. Box 7981, Horseshoe Bay, Texas 78657-7981, or such other addresses or telecopy numbers of which the parties have given notice pursuant to this Section 12. Each such notice, request or consent shall be deemed effective upon the date of mailing of such notice, provided the mailing party retains a receipt signature or confirmation of transmission, as applicable. 11. Severability. Any provision of this Agreement that is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. Ex - 9 IN WITNESS WHEREOF, the parties to this Agreement have executed this Employment Agreement as of the date first above written. InterContinental Life Corporation a Texas corporation By -------------------------------------- Roy F. Mitte Chairman, President and Chief Executive Officer Address for Notices: 6500 River Place Blvd., Building One Austin, Texas 78730 Telephone: (512) 404-5000 Employee: By: ----------------------------------------- James M. Grace Address for Notices: P.O. Box 7981 Horseshoe Bay, Texas 78657-7981 Ex - 10 EXHIBIT 21 SUBSIDIARIES OF REGISTRANT Investors Life Insurance Company of North America Investors Life Insurance Company of Indiana ILG Securities Corporation ILG Sales Corporation InterContinental Growth Plans, Inc. InterContinental Life Agency, Inc. * *Wholly-owned subsidiary of InterContinental Growth Plans, Inc. Ex - 11 EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33- 71074) of InterContinental Life Corporation of our report dated April 2, 2001 appearing on page F-2 of this Form 10-K. PricewaterhouseCoopers LLP Dallas, Texas April 2, 2001 Ex - 12