10-Q 1 0001.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2000 Commission File Number 2-39310 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 I Austin, Texas 78730 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (512) 404-5000 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 (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO Number of common shares outstanding ($.22 Par Value) at end of period: 8,123,071 - 1 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES INDEX Page No. Part I - Financial Information Item 1. Financial Statements Consolidated Balance Sheets September 30, 2000 and December 31, 1999................................. 3 Consolidated Statements of Income For the three and nine month periods ended September 30, 2000 and September 30, 1999.................................5 Consolidated Statements of Cash Flows For the three and nine month periods ended September 30, 2000 and September 30, 1999.................................7 Notes to Consolidated Financial Statements................................... 11 Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations...........................12 Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................................18 Part II Other Information.............................................................19 Signature Page................................................................21 - 2 - page> INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands of dollars) September 30, December 31, 2000 1999

ASSETS (Unaudited) Investments: Fixed maturities, at amortized cost (market value approximates $1,393 and $2,056) $ 1,406 $ 2,088 Fixed maturities available for sale, at market value (amortized cost $448,885 and $411,532) 445,610 404,217 Equity securities, at market value (cost approximates $338) 1,745 1,943 Policy loans 48,954 50,882 Mortgage loans 6,681 6,844 Invested real estate and other invested assets 42,511 21,145 Short-term investments 125,915 191,695 Total investments 672,822 678,814 Cash and cash equivalents 4,246 3,358 Notes receivable from affiliates 36,886 41,497 Accrued investment income 9,632 7,529 Agent advances and other receivables 24,700 24,230 Reinsurance receivables 17,431 18,769 Property and equipment, net 4,455 4,416 Deferred policy acquisition costs 38,357 35,598 Present value of future profits of acquired businesses 36,919 39,831 Other assets 7,553 9,304 Separate account assets 461,789 457,853 Total Assets $ 1,314,790 $ 1,321,199

The accompanying notes are an integral part of the consolidated financial statements. - 3 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, Continued (in thousands of dollars)

September 30, December 31, 2000 1999 LIABILITIES AND SHAREHOLDERS' EQUITY (Unaudited) Liabilities: Policy liabilities and contractholder deposit funds: Future policy benefits $ 132,019 $ 130,092 Contractholder deposit funds 517,697 533,869 Unearned premiums 1,959 1,977 Other policy claims and benefits payable 9,901 9,893 661,576 675,831 Other policyholders' funds 3,015 3,012 Deferred federal income taxes 23,151 21,741 Other liabilities 12,802 14,635 Separate account liabilities 457,267 454,289 Total Liabilities 1,157,811 1,169,508 Commitments and Contingencies 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; 10,855,478 and 10,855,478 shares issued, 8,123,071 and 8,827,941 shares outstanding in 2000 and 1999, respectively 2,388 2,388 Additional paid-in capital 4,526 4,526 Accumulated other comprehensive income (1,215) (3,712) Retained earnings 161,525 151,932 167,224 155,134 Common treasury stock, at cost, 2,732,407 and 2,027,537 in 2000 and 1999, respectively (10,245) (3,443) Total Shareholders' Equity 156,979 151,691 Total Liabilities and Shareholders' Equity $ 1,314,790 $ 1,321,199

The accompanying notes are an integral part of the consolidated financial statements. - 4 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands of dollars, except for per share data) (unaudited) Three Months Ended Sept. 30, 2000 1999

Revenues: Premium $ 4,081 $ 2,446 Net investment income 13,400 12,209 Earned insurance charges 9,497 10,161 Other 652 483 27,630 25,299 Benefits and expenses: Policyholder benefits and expenses 9,204 7,048 Interest expense on contract holders deposit funds 7,441 7,524 Amortization of present value of future profits of acquired businesses 908 995 Amortization of deferred policy acquisition costs 678 461 Operating expenses 4,289 4,328 22,520 20,356 Income from operations 5,110 4,943 Provision for federal income taxes 1,872 1,808 Net income $ 3,238 $ 3,135 Net income per share: Basic: Weighted average common stock outstanding 8,172 8,791 Basic earnings per share $ 0.40 $ 0.36 Diluted: Common stock and common stock equivalents 8,186 8,817 Diluted earnings per share $ 0.40 $ 0.36

The accompanying notes are an integral part of these consolidated financial statements. - 5 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands of dollars, except for per share data) (unaudited)

Nine Months Ended September 30, 2000 1999 Revenues: Premium $ 8,665 $ 7,604 Net investment income 37,914 38,084 Earned insurance charges 29,182 30,308 Other 2,539 2,266 78,300 78,262 Benefits and expenses: Policyholder benefits and expenses 23,641 23,642 Interest expense on contract holders deposit funds 22,035 23,599 Amortization of present value of future profits of acquired businesses 2,912 2,883 Amortization of deferred policy acquisition costs 1,881 1,676 Operating expenses 12,687 12,682 63,156 64,482 Income from operations 15,144 13,780 Provision for federal income taxes 5,551 5,057 Net income $ 9,593 $ 8,723 Net income per share: Basic: Weighted average common stock outstanding 8,408 8,791 Basic earnings per share $ 1.14 $ 0.99 Diluted: Common stock and common stock equivalent 8,415 8,817 Diluted earnings per share $ 1.14 $ 0.99

The accompanying notes are an integral part of these consolidated financial statements. - 6 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) (unaudited)

Three Months Ended September 30, CASH FLOWS FROM OPERATING 2000 1999 ACTIVITIES Net Income $ 3,238 $ 3,135 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Amortization of present value of future profits of acquired businesses 908 995 Amortization of deferred policy acquisition costs 678 461 Net gain on sale of investments 0 73 Depreciation 283 120 Changes in assets and liabilities Increase in accrued investment income (1,499) (394) (Increase) decrease in agent advances and other receivables (1,992) 7,717 Policy acquisition costs deferred (1,503) (1,537) Increase (decrease) in policy liabilities and contractholder deposit funds 898 (3,944) Increase (decrease) in other policyholders' funds 27 (16) Decrease in other liabilities (8,443) (7,048) Increase (decrease) in deferred federal income taxes 1,689 (997) Decrease in other assets 3,239 882 Other, net 80 (4,419) Net cash used in operating activities $ (2,397) $ (4,972)

The accompanying notes are an integral part of these consolidated financial statements. - 7 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) (unaudited)

Three Months Ended September 30, ed CASH FLOWS FROM INVESTING 2000 1999 ACTIVITIES Investments purchased $ (8,982) $ (27,343) Proceeds from sales and maturities of investments 3,624 29,596 Net change in short-term investments 1,387 3,220 Purchases and retirements of equipment (296) (170) Decrease in notes receivable from affiliates 1,537 1,537 Net cash (used in) provided by investing activities (2,730) 6,840 CASH FLOWS FROM FINANCING ACTIVITIES (Purchase) issuance of treasury stock (924) 27 Net cash (used in) provided by financing activities (924) 27 Net (decrease) increase in cash and cash equivalents (6,051) 1,895 Cash and cash equivalents, beginning of period 10,297 9,688 Cash and cash equivalents, end of period $ 4,246 $ 11,583

The accompanying notes are an integral part of these consolidated financial statements. - 8 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars)

Nine Months Ended September 30,ed CASH FLOWS FROM OPERATING 2000 1999 ACTIVITIES (unaudited) Net Income $ 9,593 $ 8,723 Adjustments to reconcile net income to net cash used in operating activities: Amortization of present value of future profits of acquired businesses 2,912 2,883 Amortization of deferred policy acquisition costs 1,881 1,676 Net gain on sale of investments 0 (149) Depreciation 419 347 Changes in assets and liabilities: Increase in accrued investment income (2,103) (312) Decrease in agent advances and other receivables 868 669 Policy acquisition costs deferred (4,640) (4,382) Decrease in policy liabilities and contractholder deposit funds (14,255) (15,055) Increase in other policyholders' funds 3 9 Decrease in other liabilities (1,833) (2,685) Increase (decrease) in deferred federal income taxes 1,410 (5,056) Decrease (increase) in other assets 1,751 (1,068) Other, net (336) (710) Net cash used in operating activities $ (4,330) $ (15,110)

The accompanying notes are an integral part of these consolidated financial statements. - 9 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) (unaudited) Nine Months Ended September 30, CASH FLOWS FROM INVESTING 2000 1999 ACTIVITIES Investments purchased $ (84,945) $ (54,825) Proceeds from sales and maturities of investments 27,044 83,254 Net change in short-term investments 65,768 (18,176) Purchases and retirements of equipment (458) (497) Decrease in notes receivable from affiliates 4,611 4,611 Net cash provided by investing activities 12,020 14,367 CASH FLOWS FROM FINANCING ACTIVITIES (Purchase) Issuance of treasury stock (6,802) 33 Issuance of common stock 0 87 Net cash (used in) provided by financing activities (6,802) 120 Net increase (decrease) in cash and cash equivalents 888 (623) Cash and cash equivalents, beginning of year 3,358 12,206 Cash and cash equivalents, end of period $ 4,246 $ 11,583 The accompanying notes are an integral part of these consolidated financial statements. - 10 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The financial statements included herein reflect all adjustments which are, in the opinion of management, necessary to present a fair statement of the interim results. The statements have been prepared to conform to the requirements of Form 10-Q and do not necessarily include all disclosures required by generally accepted accounting principles (GAAP). The reader should refer to Form 10-K for the year ended December 31, 1999 previously filed with the Securities and Exchange Commission for financial statements prepared in accordance with GAAP. Comprehensive Income The following is a reconciliation of total accumulated other comprehensive income from December 31, 1999 to September 30, 2000 (in thousands):

Net unrealized Net Total gain on appreciation accumulated investments (depreciation) other in fixed of equity comprehensive maturities securities income available for sale Balance at December 31, 1999 $ (4,755) $ 1,043 $ (3,712) Current period change 2,626 (129) 2,497 Balance at September 30, 2000 $ (2,129) $ 914 $ (1,215)

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 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. - 11 - Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations For the nine-month period ended September 30, 2000, InterContinental Life Corporation's ("ILCO") net income was $9,593,000 (basic and diluted earnings of $1.14 per common share) as compared to $8,723,000 (basic earnings and diluted earnings of $0.99 per common share) in the first nine months of 1999. Earnings per share are stated in accordance with the requirements of 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. Results of Operations For the nine-month period ended September 30, 2000, the Company's income before federal income taxes was $15,144,000 on revenues of $78,300,000 as compared to income of $13,780,000 on revenues of $78,262,000 for the first nine months of 1999. 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 quality customer service. Premium income, net of reinsurance, for the first nine months of 2000 was $8.67 million, as compared to $7.60 million for the first nine months of 1999. Reinsurance premiums ceded were $1.21 million for the first nine months of 2000, as compared to $1.59 million in the first nine months of 1999. Earned insurance charges for the nine-month period ended September 30, 2000 were $29.2 million, as compared to $30.3 million for the same period in 1999. This source of revenues is related to the universal life insurance and annuity book of business of the insurance subsidiaries of the Company. As of September 30, 2000, the market value of the fixed maturities available for sale segment was $445.6 million as compared to an amortized cost of $448.9 million, or an unrealized loss of $3.3 million. The decrease reflects unrealized losses on such investments related to changes in interest rates subsequent to the purchase of such investments. The net of tax effect of this decrease ($2.14 million at September 30, 2000) is included in "Accumulated other comprehensive loss" on the Consolidated Balance Sheets and has been recorded as a decrease in shareholders' equity. As required under the provisions of FAS No. 130, the determination of "Accumulated other comprehensive income" includes separate identification of the change in values which occurred during the current period. - 12 - For the three-month period ended September 30, 2000, the lapse rate with respect to universal life insurance policies decreased from the lapse rate experienced in the similar period in 1999. The rate for the 2000 period was 5.60 %, as compared to 5.89 % in the 1999 period. The lapse rate with respect to traditional (non-universal) life insurance policies decreased significantly from the levels experienced in the third quarter of 1999. The rate for the three-month period ended September 30, 2000 was 5.31 %, as compared to 8.56 % in the similar period in 1999. The lapse rates experienced during these periods were within the ranges anticipated by management. Liquidity and Capital Resources ILCO is a holding company whose principal assets consist of the common stock of Investors Life Insurance Company of North America ("Investors-NA") and its subsidiary - Investors Life Insurance Company of Indiana ("Investors-IN"). Financial Industries Corporation ("FIC") currently owns, directly and indirectly through its subsidiary Family Life Insurance Company, 3,932,692 shares (approximately 48 %) of ILCO's common stock. 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 would be from dividends paid to it from its subsidiaries. Applicable state insurance laws may limit the ability of such subsidiaries to pay dividends to ILCO. Investors-NA is domiciled in the State of Washington. The Washington insurance law includes the "greater of" standard for payment of dividends to shareholders, but has a requirement that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. 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 September 30, 2000, Investors-NA had earned surplus of $52.9 million. Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance law, 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 $20.86 million at September 30, 2000. In June, 1999, Investors-IN paid a dividend in the amount of $3 million to its sole shareholder, Investors-NA. The amount of the dividend was less than the net gain from operations for the prior fiscal year; accordingly, no prior approval was required for the payment of the dividend. Advance notice of the payment was provided to the Indiana Department of Insurance, in accordance with the provisions of the Indiana Insurance Code. - 13 - ILCO's net cash flow used in operating activities was $4.33 million for the nine-month period ended September 30, 2000, as compared to $15.11 million for the first nine months of 1999. The change is primarily related to a decrease in other receivables and deferred federal income taxes. Management believes that its cash, cash equivalents and short term investments are sufficient to meet the needs of its business and to satisfy debt service. Investments As of September 30, 2000, the Company's investment assets totaled $672.8 million, as compared to $678.8 million as of December 31, 1999. Total assets as of September 30, 2000 ($1.315 billion) decreased slightly from the level as of December 31, 1999 ($1.321 billion). The level of short-term investments at September 30, 2000 was $125.9 million, as compared to $191.7 million at December 31, 1999. Invested real estate and other invested assets increased from $21.1 million at December 31, 1999 to $42.5 million as of September 30, 2000. This increase is related to the development of the River Place Pointe project (the "Project") by Investors-NA. The Project consists of 47.995 acres of land in Austin, Texas, which was purchased in October, 1998 by Investors-NA, for an aggregate purchase price of $8.1 million. Prior to the closing of the transaction, Investors-NA obtained a Site Development Permit for the tracts from the City of Austin. The Site Development Permit allows for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. Construction on the first phase of the Project, which consists of two office buildings and an associated parking garage, commenced during the first quarter of 1999 and has been completed. ILCO began moving its corporate headquarters to Building I of the Project in June, 2000 and completed the move in July, 2000. The cost of the move, approximately $375,713, was treated as a period cost in the third quarter of 2000. In connection with the move, Investors-NA (the tenant under the lease of the former Austin Centre space), entered into a termination agreement with the owner of the Austin Centre to terminate its lease at the Austin Centre as of July 30, 2000. As part of the termination agreement, Investors-NA agreed to pay rent for the month of August, 2000 in the amount of $113, 258 and the landlord agreed to pay Investors-NA $7,252.30 per month for a period of seven years, which latter amount includes a reimbursement to Investors-NA over the seven-year period of the amount of the rental for the month of August. The present value of the series of payments to be received by Investors-NA is $480,518, which amount was recorded as income in the third quarter of 2000. - 14 - As of September 30, 2000, approximately 75,000 rentable square feet was leased in Building II of the Project to two tenants, both of whom moved into the building in July, 2000. During the second quarter of 2000, construction began on the third office building of the Project. The third building will contain approximately 116,000 square feet. In July, Investors-NA completed negotiations to lease all of the space in Building III to a single tenant. The lease is for a seven-year term, with its commencement date in the first quarter of 2001, upon completion of the construction of Building III. The fixed maturities available for sale portion of invested assets at September 30, 2000 was $445.6 million. The amortized cost of the fixed maturities available for sale segment as of September 30, 2000 was $448.9 million, representing a net unrealized loss of $3.3 million. This unrealized loss principally reflects changes in interest rates from the date the respective investments were purchased. To reduce the exposure to interest rate changes, portfolio investments are selected so that diversity, maturity and liquidity factors approximate the duration of associated policyholder liabilities. The assets held by ILCO's life insurance subsidiaries must comply with applicable state insurance laws and regulations. In selecting investments for the portfolios of its life insurance subsidiaries, the Company's emphasis is to obtain targeted profit margins, while minimizing the exposure to changing interest rates. This objective is implemented by selecting primarily short-to-medium term, investment grade fixed income securities. In making such portfolio selections, the Company generally does not select new investments which are commonly referred to as "high yield" or "non-investment grade." The portfolio includes investments in mortgage-backed securities which includes collateralized mortgage obligations ("CMOs") of $176.2 million and mortgage-backed pass-through securities of $44.4 million at September 30, 2000. Mortgage-backed pass-through securities, sequential CMOs and support bonds, which comprised approximately 55.5% of the book value of the Company's mortgage-backed securities at September 30, 2000, are sensitive to prepayment and extension risks. The Company has reduced the risk of prepayment associated with this portion of the investment portfolio by investing in planned amortization class ("PAC"), target amortization class ("TAC") instruments, and scheduled bonds. These investments are designed to amortize in a predictable manner by shifting the risk of prepayment of the underlying collateral to other investors in other tranches ("support classes") of the CMO. PAC and TAC instruments and scheduled bonds represented approximately 44.5 % and sequential and support classes represented approximately 35.3 % of the book value of the Company's mortgage-backed securities at September 30, 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. The prepayment risk that certain mortgage-backed securities are subject to is prevalent in periods of declining interest rates, when mortgages may be repaid more rapidly than scheduled as individuals refinance higher rate mortgages to take advantage of the lower current rates. As a result, holders of mortgage-backed securities may receive large prepayments on their investments which cannot be reinvested at an interest rate comparable to the rate on the prepaying mortgages. The Company did not make additional - 15 - investments in CMOs during 1999. For the year 2000, the Company's investment objectives include the making of selected investments in CMOs. The Company's fixed maturities portfolio (including short-term investments), as of September 30, 2000 and December 31, 1999, included a non-material amount (0.1 % 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. Of these non-investment grade investments, all received an NAIC rating of "5" (lowest quality). The consolidated balance sheets of the Company as of September 30, 2000 include $ 36.89 million of "Notes receivable from affiliates", represented by (i) a loan of $22.5 million from Investors- NA to Family Life Corporation ("FLC") and a $2.5 million loan from Investors Life Insurance Company of California ("Investors-CA") to Financial Industries Corporation ("FIC") - which loan 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 ("FLIIC") made in July, 1993, in connection with the same transaction described above. As of June 12, 1996, the provisions of the notes from Investors-NA to FIC, FLC and 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 - 16 - ($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. Cautionary Statements for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995 Except for historical factual information set forth in this Management's Discussion and Analysis, certain statements made in this report are forward looking and contain information about financial results, economic conditions and other risks and known uncertainties. The Company cautions the reader that actual results could differ materially from those anticipated by the Company, depending upon the eventual outcome of certain factors, including: (1) heightened competition for new business, (2) significant changes in interest rates and (3) adverse regulatory changes affecting the business of insurance. Accounting Developments In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FAS No. 133 is applicable to financial statements for all fiscal quarters of fiscal years beginning after June 15, 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 No. 133 is not anticipated to have a material impact on the Company's results of operations, liquidity or financial position. - 17 - Item 3. 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 information set forth in Item 2, "Management's Discussion and Analysis of Financial Conditions and Results of Operations - Investments" of this report. The following is a discussion of the Company's primary market risk sensitive instruments. It should be noted that this discussion has been developed using estimates and assumptions. Actual results may differ materially from those described below. Further, the following discussion does not take into account actions which could be taken by management in response to the assumed changes in market rates. In addition, the discussion does not take into account other types of risks which may be involved in the business operations of the Company, such as the reinsurance recoveries on reinsurance treaties with third party insurers. The primary market risk to the Company's investment portfolio is interest rate risk. The Company does not use derivative financial instruments. Interest Rate Risk Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in fair market value related to the financial instruments segment of the Company's balance sheet is estimated to be $22.5 million at September 30, 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 approximate market value of such assets was $610.8 million at September 30, 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 $220.5 million at September 30, 2000 and $ 208.0 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 $11.2 million at September 30, 2000 and $12.0 million at December 31, 1999. Fixed income investments held in separate accounts have not been included, since gains and losses on those assets generally accrue to the policyholders. The hypothetical effect of the interest rate risk on fair values was estimated by applying a commonly used model. The model projects the impact of interest rate - 18 - changes on a range of factors, including duration and potential prepayment. Part II. Other Information Item 1. Legal Proceedings The Company and Investors-NA are defendants in a lawsuit which was filed in October, 1996, in Travis County, Texas. CIGNA Corporation, an unrelated Company, is also a named defendant in the lawsuit. The named plaintiffs in the suit (a husband and wife), allege that the universal life insurance policies sold to them by INA Life Insurance Company (a company which was merged into Investors- NA in 1992) utilized unfair sales practices. The named plaintiffs seek reformation of the life insurance contracts and an unspecified amount of damages. The named plaintiffs also seek a class action as to similarly situated individuals. No certification of a class has been granted as of the date hereof. The Company believes that the suit is without merit and intends to vigorously defend this matter. In August, 1997, another individual filed a similar action in Travis County, Texas against the corporate entities identified above. The lawsuit involved the same type of policy and includes allegations which are substantially identical to the allegations in the first action. In July, 2000, the court, on its own motion, moved to dismiss the action for failure on the part of the plaintiff to prosecute the matter. The plaintiff did not file a motion to retain the case and the matter has been removed from the court's docket. Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information a. As previously reported in a press release dated October 13, 2000, the Board of Directors of the Company has established a Special Committee of outside directors of the Board to explore a merger with Financial Industries Corporation ("FIC"). FIC owns approximately 48% of the common stock of ILCO. The Board and the Special Committee have received a report on an actuarial evaluation of the Company and FIC, - 19 - which was performed by an independent actuarial consulting firm. The special committee will review the actuarial evaluation and other pertinent information, and furnish a recommendation on the merger proposal to the Board. As of the date of this report on Form 10-Q, no date has been set for the next meeting of the Board of Directors of the Company. b. On October 13, 2000, Charles K. Chacosky submitted his resignation as a director and officer of the Company and its life insurance company subsidiaries. Mr. Chacosky advised the Board that his resignation was for personal reasons. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Form 10-K Annual Report of Registrant for the year ended December 31, 1999 heretofore filed by Registrant with the Securities and Exchange Commission, which is hereby incorporated by reference. (b) Reports on Form 8-K None - 20 - INTERCONTINENTAL LIFE CORPORATION AND SUBSIDIARIES SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. INTERCONTINENTAL LIFE CORPORATION /s/ James M. Grace James M. Grace, Treasurer Date: November 14, 2000