UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934 ~~(FEE REQUIRED)~~

For the Quarterly Period Ended September 30, ~~2004~~2006

Commission File Number 0-4690

Financial Industries Corporation

(Exact name of registrant as specified in its charter)

TEXAS State of Incorporation 74-2126975 (I.R.S. Employer Identification number)

	TEXAS		74-2126975
	State of Incorporation		(I.R.S. Employer Identification number)

6500 River Place Boulevard, Building I, Austin, Texas 78730

(Address including Zip Code of Principal Executive Offices)

(512) 404-5000

(Registrant's Telephone Number)

Securities Registered pursuant to Section 12(b) of the Act: None

Securities Registered pursuant to Section 12(g) of the Act:

Common Stock, $.20 par value

(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 o ¨ NO x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o¨ Accelerated ~~filer~~filerx x Non-accelerated filer o¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). ~~YES o NO x~~

~~The number of shares outstanding of Registrant's common stock on September 30, 2006 was 9,869,504.~~YES ¨ NO x

The number of shares outstanding of Registrant's common stock on March 31, 2007, was 10,210,385.

Forward-Looking Statements

Except for historical factual information set forth in this Form 10-Q of Financial Industries Corporation (the “Company” or “FIC”), the statements, analyses, and other information contained in this report relating to trends in ~~our~~the Company’s operations and financial results, the markets for our products, future results, the future development of our business, and the contingencies and uncertainties to which we may be subject, as well as other statements including words such as “anticipate,” “believe,” “plan,” “budget,” “could,” “designed,” “estimate,” “expect,” “intend,” “forecast,” “predict,” “project,” “may,” “might,” “should” 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 financial results and economic conditions and are subject to known and unknown risks, uncertainties and other factors contemplated by the forward-looking statements. These factors include, among other things: (1) general economic conditions and other factors, including prevailing interest rate levels and stock market performance, which may affect the ability of FIC to sell its products, the market value of FIC’s investments and the lapse rate and profitability of policies; (2) FIC’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 that may affect the profitability of FIC’s insurance products; (5) FIC’s ability to develop and maintain effective risk management policies and procedures and to maintain adequate reserves for future policy benefits and claims; (6) changes in the federal income tax laws and regulations that may affect the relative tax advantages of some of FIC’s products; (7) increasing competition in the sale of insurance ~~and annuities~~; (8) the effect of regulation and regulatory changes or actions, including those relating to regulation of insurance products and insurance companies; (9) ratings assigned to FIC’s insurance subsidiaries by independent rating organizations such as A.M. Best Company, which FIC believes are particularly important to the sale of ~~annuity and other~~ accumulation-type products; (10) the performance of our investment portfolios; (11) the effect of changes in standards of accounting; (12) the effects and results of litigation; (13) business risks and factors described elsewhere in this report, including, but not limited to, Item 2 - 2–Management'’s Discussion and Analysis of Financial Condition and Results of Operations and Item 3 - Quantitative and Qualitative Disclosures about Market ~~Risk~~ Risks in Part 1, and Item 1 - Legal Proceedings in Part 2, and (14) other factors discussed in the Company’s other filings with the SEC, which are available free of charge on the SEC’s website at www.sec.gov. You should read carefully the above factors and all of the other information contained in this report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those indicated. All subsequent written and oral forward-looking statements attributable to the Company or to persons acting on our behalf are expressly qualified in their entirety by reference to these risks and uncertainties. There can be no assurance that other factors not currently anticipated by management will not also materially and adversely affect our results of operations. Each forward-looking statement speaks only as of the date of the particular statement and the Company undertakes no obligation to update or revise any forward-looking statement, except as required by federal securities laws.

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

INDEX

Page No.

	Page No.

Part I - Financial Information

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets September 30, 2006 and December 31, 2005	4

Condensed Consolidated Statements of Operations For the three and nine month periods ended September 30, 2006 and September 30, 2005	6

Condensed Consolidated Statements of Cash Flows For the nine month periods ended September 30, 2006 and September 30, 2005	10

Notes to Condensed Consolidated Financial Statements	12

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3. Quantitative and Qualitative Disclosures about Market Risk	25

Item 4. Controls and Procedures	26

Part II – Other Information

Item 1. Legal Proceedings	27

Item 1A. Risk Factors	29

Item 2. Changes in Securities and Use of Proceeds	29

Item 3. Defaults Upon Senior Securities	29

Item 4. Submission of Matters to a Vote of Security Holders	29

Item 5. Other Information	29

Item 6. Exhibits	29

Signatures	30

~~Part I - Financial Information~~Index

Item 1. Financial Statements

Condensed Consolidated Balance Sheets

September 30, 2004 (unaudited) and December 31, 2003 (as restated) 4

Condensed Consolidated Statements of Operations (unaudited)

For the three and nine month periods ended

September 30, 2004 and September 30, 2003 (as restated) 6

Condensed Consolidated Statements of Cash Flows (unaudited)

For the nine month period ended

September 30, 2004 and September 30, 2003 (as restated) 10

Notes to Condensed Consolidated Financial Statements (unaudited) 12

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations 30

Item 3. Quantitative and Qualitative Disclosures

About Market Risk 39

Item 4. Controls and Procedures 40

Part II – Other Information

Item 1. Legal Proceedings 41

Item 2. Changes in Securities and Use of Proceeds 45

Item 3. Defaults Upon Senior Securities 45

Item 4. Submission of Matters to a Vote of Security Holders 45

Item 5. Other Information 45

Item 6. Exhibits and Reports on Form 8-K 45

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in In thousands) (Unaudited)

			September 30,	December 31,
		September 30, 2006			December 31, 2005 (1)
			2004	2003
ASSETS
			(unaudited)	(restated) (1)
Investments:
ASSETS
Fixed maturity securities available for sale, at fair value (amortized cost of $624,838and $605,803 at September 30, 2006 and December 31, 2005, respectively)		$	607,117		$	593,752
Investments:
Equity securities, at fair value (cost of $8,713 and $8,405 at September 30, 2006 and December 31, 2005, respectively)			11,274			10,907
Fixed maturity securities held to maturity, at amortized cost (fair value of
Policy loans			35,412			37,637
	$19 at December 31, 2003)		$ -	$ 17
Real estate held for sale			-			130
Fixed maturity securities available for sale, at fair value (amortized cost of $483,916
Short-term investments			16,847			1,204
	and $557,285 at September 30, 2004 and December 31, 2003, respectively)		482,397	555,801
Total investments			670,650			643,630
Fixed maturity securities held for trading, at fair value			1,741	4,873
Cash and cash equivalents			7,393			63,581
Equity securities, at fair value (cost of $6,334 and $6,393 at
Deferred policy acquisition costs			50,432			50,805
	September 30, 2004 and December 31, 2003, respectively)		7,836	7,941
Present value of future profits of acquired business			14,509			15,865
Policy loans			41,650	42,452
Agency advances and other receivables, net of allowances for doubtful accounts of $3,395 and $3,513 as of September 30, 2006 and December 31, 2005			13,277			8,188
Investment real estate			75,023	76,712
Reinsurance receivables			32,526			38,108
Real estate held for sale			589	968
Accrued investment income			7,420			7,165
Short-term investments			128,565	-
Due premiums			1,555			2,048
	Total investments		737,801	688,764
Property and equipment, net			720			1,033
Cash and cash equivalents			14,008	82,436
Other assets			2,251			2,088
Deferred policy acquisition costs			50,950	54,819
Separate account assets			341,841			342,911
Present value of future profits of acquired business			18,583	21,096
Total assets		$	1,142,574		$	1,175,422
Agency advances and other receivables, net of allowances for doubtful
	accounts of $3,251 and $3,011 as of September 30, 2004 and December 31, 2003		11,895	10,241
Reinsurance receivables			36,070	39,978
Real estate held for use			13,596	13,870
Accrued investment income			6,471	6,695
Due premiums			2,236	2,362
Property and equipment, net			1,374	1,454
Other assets			5,109	6,058
Separate account assets			350,186	358,271
	Total Assets		$ 1,248,279	$ 1,286,044

(1)~~See~~ Derived ~~Note~~from 2audited consolidated financial statements

The accompanying notes are an integral part of these condensed consolidated financial statements.

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS, Continued

(in In thousands) (Unaudited)

			September 30,		December 31,
		September 30, 2006				December 31, 2005 (1)
			2004		2003
LIABILITIES AND SHAREHOLDERS’ EQUITY
			(unaudited)		(restated) (1)
Liabilities:
LIABILITIES AND SHAREHOLDERS’ EQUITY
Policy liabilities and contractholder deposit funds:
Liabilities:
Contractholder deposit funds		$	520,363			$	542,181
Policy liabilities and contractholder deposit funds:
Future policy benefits			153,877				155,970
	Contractholder deposit funds		$ 578,294		$ 593,881
Other policy claims and benefits payable			8,312				11,456
	Future policy benefits		161,385		169,244
Notes payable			15,000				15,000
	Other policy claims and benefits payable		12,407		13,693
Deferred federal income taxes			413				687
Notes payable			15,000		15,000
Other liabilities			22,078				25,146
Deferred federal income taxes			7,889		6,333
Separate account liabilities			341,841				342,911
Other liabilities			29,758		25,313
Total liabilities			1,061,884				1,093,351
Separate account liabilities			350,186		358,271
Commitments and contingencies (See Note 8)
Total Liabilities			1,154,919		1,181,735
Shareholders’ equity:
Commitments and Contingencies (See Note 10)
Common stock, $.20 par value, 25,000 shares authorized in 2006 and 2005, 12,517 shares issued in 2006 and 2005; 9,870 and 9,849 shares outstanding in 2006 and 2005			2,504				2,504
Shareholders’ equity:
Additional paid-in capital			70,373				70,377
Common stock, $.20 par value; 25,000 shares authorized in 2004 and
Accumulated other comprehensive loss			(13,144	)			(10,339	)
	2003; 12,517 shares issued in 2004 and 2003; 9,800 and
Retained earnings			43,735				42,485
	9,791 shares outstanding in 2004 and 2003		2,504		2,504
Common treasury stock, at cost, 2,647 and 2,668 shares in 2006 and 2005			(22,778	)			(22,956	)
Additional paid-in capital			69,866		70,391
Total shareholders’ equity			80,690				82,071
Accumulated other comprehensive income (loss)			(2,243)		(2,121)
Total liabilities and shareholders’ equity		$	1,142,574			$	1,175,422
Retained earnings			46,076		56,988
Common treasury stock, at cost; 2,717 and 2,726 shares in 2004 and 2003			(22,843)		(23,453)
Total Shareholders’ Equity			93,360		104,309
Total Liabilities and Shareholders’ Equity			$ 1,248,279		$ 1,286,044

(1)~~See~~ Derived ~~Note~~from 2audited consolidated financial statements

The accompanying notes are an integral part of these condensed consolidated financial statements.

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(~~unaudited and in~~ In thousands except per share data) (Unaudited)

		Three Months Ended September 30,	~~Three Months Ended September 30,~~
				2003
		2006			2005
			2004	(restated) (1)
Revenues:
Revenues:
Premiums, net		$	6,152		$	5,925
	Premiums, net		$ 5,410	$ 7,627
Earned insurance charges			9,617			9,919
	Earned insurance charges		10,559	10,040
Net investment income			8,636			8,108
	Net investment income		7,257	8,782
Real estate income			-			16
	Real estate income		477	554
Net realized investment gains (losses)			1			(703	)
	Net realized investment gains (losses)		454	(946)
Other			1,234			636
	Other		486	635
Total revenues			25,640			23,901
Total revenues			24,643	26,692
Benefits and expenses:
Benefits and expenses:
Policyholder benefits and expenses			8,056			11,923
	Policyholder benefits and expenses		12,083	13,359
Interest expense on contractholders deposit funds			5,090			5,434
	Interest expense on contractholders deposit funds		5,765	6,291
Amortization of deferred policy acquisition costs			2,329			2,078
	Amortization of deferred policy acquisition costs		2,531	2,978
Amortization of present value of future profits of acquired business			544			715
	Amortization of present value of future profits of acquired business		819	957
Operating expenses			7,376			7,228
	Operating expenses		7,947	10,565
Interest expense			364			297
	Interest expense		213	207
Total benefits and expenses			23,759			27,675
Total benefits and expenses			29,358	34,357
Income (loss) before federal income taxes			1,881			(3,774	)
Loss from continuing operations before federal income taxes and
Provision (benefit) for federal income taxes			586			(1,252	)
	discontinued operations		(4,715)	(7,665)
Net income (loss)		$	1,295		$	(2,522	)
Provision (benefit) for federal income taxes			130	(1,267)
Loss from continuing operations before discontinued operations			(4,845)	(6,398)
Discontinued operations			-	29
Net loss			$ (4,845)	$ (6,369)

~~(1)See~~The accompanying ~~Note~~notes 2are an integral part of these condensed consolidated financial statements.

The accompanying notes are an integral part of these condensed consolidated statements.

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, Continued

(~~unaudited and in~~ In thousands except per share data) (Unaudited)

		Three Months Ended September 30,	~~Three Months Ended September 30,~~
				2003
		2006			2005
			2004	(restated) (1)
Net Income (Loss) Per Share:
Net Loss Per Share:
Basic:
Basic:
Weighted average common shares outstanding			9,856			9,823
	Weighted average common shares outstanding		9,798	9,688
Basic income (loss) per share		$	0.13		$	(0.26	)
	Basic earnings per share:
Diluted:
Loss from continuing operations before discontinued operations			$ (0.49)	$ (0.66)
Weighted average common shares and common share equivalents			9,856			9,823
	Discontinued operations		-	-
Diluted income (loss) per share		$	0.13		$	(0.26	)
	Net loss per share		$ (0.49)	$ (0.66)
Diluted:
	Weighted average common shares and common share equivalents		9,798	9,688
	Diluted earnings per share:
Loss from continuing operations before discontinued operations			$ (0.49)	$ (0.66)
	Discontinued operations		-	-
	Net loss per share		$ (0.49)	$ (0.66)

(1)See Note 2

The accompanying notes are an integral part of these condensed consolidated financial statements.

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, Continued

(~~unaudited and in~~ In thousands except per share data) (Unaudited)

		Nine Months Ended September 30,	~~Nine Months Ended September 30,~~
				2003
		2006			2005
			2004	(restated) (1)
Revenues:
Revenues:
Premiums, net		$	17,508		$	17,906
	Premiums, net		$ 17,845	$ 23,690
Earned insurance charges			29,061			30,253
	Earned insurance charges		31,455	30,579
Net investment income			25,872			22,856
	Net investment income		23,890	27,880
Real estate income			-			563
	Real estate income		1,319	1,734
Net realized investment gains			502			8,567
	Net realized investment gains		2,308	308
Other			3,308			1,882
	Other		1,622	1,952
Total revenues			76,251			82,027
Total revenues			78,439	86,143
Benefits and expenses:
Benefits and expenses:
Policyholder benefits and expenses			28,743			31,859
	Policyholder benefits and expenses		36,432	34,838
Interest expense on contractholders deposit funds			15,396			16,581
	Interest expense on contractholders deposit funds		17,511	19,871
Amortization of deferred policy acquisition costs			6,453			7,745
	Amortization of deferred policy acquisition costs		8,678	9,402
Amortization of present value of future profits of acquired business			1,717			2,038
	Amortization of present value of future profits of acquired business		2,517	2,940
Operating expenses			20,791			21,815
	Operating expenses		25,096	29,922
Interest expense			1,042			829
	Litigation settlement (Note 10)		-	2,915
Total benefits and expenses			74,142			80,867
	Interest expense		624	286
Income before federal income taxes			2,109			1,160
Total benefits and expenses			90,858	100,174
Provision for federal income taxes			859			143
Loss from continuing operations before federal income taxes,
Net income		$	1,250		$	1,017
	discontinued operations, and cumulative effect of change in
	accounting principle		(12,419)	(14,031)
Benefit for federal income taxes			(1,278)	(2,350)
Loss from continuing operations before discontinued operations
	and cumulative effect of change in accounting principle		(11,141)	(11,681)
Discontinued operations			-	(101)
Loss before cumulative effect of change in accounting principle			(11,141)	(11,782)
Cumulative effect of change in accounting principle			229	-
Net loss			$ (10,912)	$ (11,782)

(1)See Note 2

The accompanying notes are an integral part of these condensed consolidated financial statements.

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, Continued

(~~unaudited and in~~ In thousands except per share data) (Unaudited)

		Nine Months Ended September 30,	~~Nine Months Ended September 30,~~
				2003
		2006			2005
			2004	(restated) (1)
Net Income Per Share:
Net Loss Per Share:
Basic:
Basic:
Weighted average common shares outstanding			9,856			9,813
	Weighted average common shares outstanding		9,795	9,626
Net income per share		$	0.13		$	0.10
	Basic earnings per share:
Diluted:
	Loss from continuing operations before discontinued operations
Weighted average common shares and common share equivalents			9,856			9,813
	and cumulative effective of change in accounting principle		$ (1.13)	$ (1.21)
Net income per share		$	0.13		$	0.10
	Discontinued operations		-	(0.01)
	Loss before cumulative effect
	of change in accounting principle		(1.13)	(1.22)
	Cumulative effect of change in accounting principle		0.02	-
	Net loss per share		$ (1.11)	$ (1.22)
Diluted:
	Weighted average common shares and common share equivalents		9,795	9,626
	Diluted earnings per share:
	Loss from continuing operations before discontinued operations
	and cumulative effective of change in accounting principle		(1.13)	(1.21)
	Discontinued operations		-	(0.01)
	Loss before cumulative effect
	of change in accounting principle		(1.13)	(1.22)
	Cumulative effect of change in accounting principle		0.02	-
	Net loss per share		$ (1.11)	$ (1.22)

(1)See Note 2

The accompanying notes are an integral part of these condensed consolidated financial statements.

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(~~unaudited and in~~ In thousands) (Unaudited)

		Nine Months Ended September 30,	~~Nine Months Ended September 30,~~
					2003
		2006				2005
			2004		(restated) (1)
CASH FLOWS FROM OPERATING ACTIVITIES:
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	1,250			$	1,017
	Net loss		$ (10,912)		$ (11,782)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
	Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Amortization of deferred policy acquisition costs			6,453				7,745
	Amortization of deferred policy acquisition costs		8,678		9,402
Amortization of present value of future profits of acquired business			1,717				2,038
	Amortization of present value of future profits of acquired business		2,517		2,940
Net realized gains on investments			(502	)			(9,606	)
	Net realized gain on investments		(2,308)		(308)
Depreciation			341				1,763
	Depreciation		2,374		2,414
Increase in accrued investment income			(255	)			(1,158	)
	Changes in assets and liabilities:
Decrease (increase) in agent advances and other receivables			493				1,520
	Decrease (increase) in accrued investment income		224		(986)
Decrease (increase) in due premiums			493				(114	)
	Decrease in agent advances and other receivables		2,254		5,519
Increase in deferred policy acquisition costs			(5,082	)			(5,802	)
	Decrease in due premiums		126		692
Decrease (increase) in other assets			(163	)			37
	Increase in deferred policy acquisition costs		(4,800)		(6,517)
Increase (decrease) in policy liabilities and accruals			(7,396	)			779
	Decrease (increase) in other assets		949		2,192
Decrease in other liabilities			(3,068	)			(3,567	)
	(Decrease) increase in policy liabilities and accruals		(2,322)		2,256
Increase in deferred federal income taxes			1,172				1,258
	Increase in other liabilities		4,445		4,614
Net activity from trading securities			-				(759	)
	Increase (decrease) in deferred federal income taxes		1,502		(3,280)
Other, net			22				(1,218	)
	Net activity from trading securities		3,164		(6,101)
Net cash used in operating activities			(4,525	)			(6,067	)
	Other, net		301		435
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash provided by (used in) operating activities			6,192		1,490
Fixed maturities purchased			(59,840	)			(151,494	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Real estate capital expenditures			-				(544	)
	Fixed maturities purchased		(114,481)		(428,024)
Proceeds from sales and maturities of fixed maturities			40,641				59,880
	Real estate capital expenditures		(114)		(790)
Proceeds from sales of invested real estate			646				101,067
	Proceeds from sales and maturities of fixed maturities		188,471		323,107
Net (increase) decrease in short-term investments			(15,643	)			58,312
	Proceeds from sales of invested real estate		2,022		-
Net decrease in policy loans			2,225				1,648
	Proceeds from payments received on mortgage loans		-		17
Purchase of property and equipment			(33	)			(307	)
	Net (increase) decrease in short-term investments		(128,565)		75,644
Net cash provided by (used in) investing activities			(32,004	)			68,562
	Net decrease in policy loans		802		2,213
	Acquisition of subsidiary companies		-		(4,124)
	Purchase of property and equipment		(346)		(716)
Net cash used in investing activities			(52,211)		(32,673)

(1continued)~~See Note 2~~

The accompanying notes are an integral part of these condensed consolidated financial statements.

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued

(~~unaudited and in~~ In thousands) (Unaudited)

		Nine Months Ended September 30,	~~Nine Months Ended September 30,~~
					2003
		2006				2005
			2004		(restated) (1)
CASH FLOWS FROM FINANCING ACTIVITIES:
CASH FLOWS FROM FINANCING ACTIVITIES:
Contractholder fund deposits		$	24,273			$	25,376
	Cash dividends to shareholders		$ -		$ (480)
Contractholder fund withdrawals			(43,932	)			(52,962	)
	Issuance of capital stock		-		944
Net cash used in financing activities			(19,659	)			(27,586	)
	Contractholder fund deposits		31,727		44,503
Net increase (decrease) in cash			(56,188	)			34,909
	Contractholder fund withdrawals		(54,136)		(47,389)
Cash and cash equivalents, beginning of year			63,581				52,044
	Proceeds from bank borrowings		-		15,000
Cash and cash equivalents, end of period		$	7,393			$	86,953
	Purchase of treasury stock		-		656
Supplemental Cash Flow Disclosures:
	Sales of treasury stock		-		(1,812)
Income taxes refunded		$	4,341			$	-
Net cash (used in) provided by financing activities			(22,409)		11,422
Interest paid		$	1,026			$	805
Net decrease in cash			(68,428)		(19,761)
Treasury stock distributions		$	174			$	316
Cash and cash equivalents, beginning of year			82,436		163,053
Cash and cash equivalents, end of period			$ 14,008		$ 143,292
Supplemental Cash Flow Disclosures:
	Income taxes refunded		$ (1,093)		$ (5,163)
	Interest paid		$ 627		$ 205

Supplemental Schedule of Non-Cash Investing Activities:

In June 2003, the Company purchased all of the capital stock of the New Era companies (as described in Note 8) for $4.2 million in cash and consideration in the form of restricted FIC common stock of $646,000. In conjunction with the acquisition, assets were acquired and liabilities were assumed as follows:

Estimated fair value of assets acquired $5.1 million

Estimated fair value of liabilities assumed $0.2 million

(1)See Note 2

The accompanying notes are an integral part of these condensed consolidated financial statements.

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (~~unaudited~~Unaudited)

~~The financial statements included herein have been presented to conform to the requirements of Form 10-Q~~1. ~~The~~Basis ~~Company has restated the consolidated financial statements for the year ended December 31, 2003, and the unaudited condensed consolidated financial statements for the four quarters~~ of ~~2003,~~Presentation of which summary quarterly financial data was previously reported in its 2003 Annual Report on Form 10-K. The Company has not amended its Annual Report on Form 10-K for the year 2003. The Company’s restatement of its consolidated financial statements for 2003 has been included in its Annual Report on Form 10-K for the year ended December 31, 2004, which has been filed with the Securities and ~~Exchange Commission (“SEC”), contemporaneously with this Form 10-Q filing.~~ Consolidation

The financial ~~information~~statements ~~that~~included ~~has~~herein have been ~~previously~~presented ~~filed~~to ~~for~~conform ~~2003~~to ~~or its interim quarterly periods is superseded by~~ the requirements ~~information~~of ~~in this~~ Form 10-Q~~, and the consolidated financial statements and related financial information for 2003 contained in other such reports should no longer be relied upon~~.

~~Accordingly,~~The accompanying ~~this~~unaudited ~~Form~~condensed ~~10-Q~~consolidated ~~reflects~~financial statements reflect all adjustments (including normal recurring adjustments) necessary to present fairly the ~~restatement~~consolidated financial position of the Company’s ~~financial~~at ~~statements~~September 30, 2006, its consolidated results of operations for the three months and nine months ended September 30, ~~2003~~2006 asand ~~presented~~2005, inand its consolidated cash flows for the ~~Company’s~~nine ~~Annual~~months ended ~~Report~~September on30, ~~Form~~2006 ~~10-K~~and ~~for~~2005 in conformity with accounting principles generally accepted in the ~~year~~United ~~ended~~States ~~December~~of ~~31,~~America ~~2004~~(“GAAP”). ~~For~~Interim ~~further~~results ~~information~~are not ~~about~~necessarily ~~the~~indicative ~~restatement,~~of ~~see~~full ~~Note~~year 2performance. toThe ~~the~~December 31, 2005 condensed consolidated balance sheet data was derived from the audited consolidated financial statements ~~below~~included ~~and~~in the Company’s ~~2004~~2005 Annual Report on Form 10-K filed ~~contemporaneously~~with the SEC (“2005 Annual Report”), which includes all disclosures required by GAAP. Therefore, these unaudited condensed consolidated financial statements should be read in conjunction with ~~this~~the ~~Form~~consolidated financial ~~10-Q~~statements ~~filing~~of the Company included in the 2005 Annual Report.

~~Because~~The condensed ofconsolidated ~~the~~financial ~~gap~~statements ininclude ~~our public reporting and~~ the ~~significant~~accounts ~~changes~~of weFinancial Industries ~~have~~Corporation ~~made~~(“FIC”) toand ~~our~~its ~~business~~wholly inowned ~~the~~subsidiaries. ~~interim,~~Intercompany items ~~we have included certain information relating to our business, current directors, current officers,~~ and ~~related~~transactions ~~matters which~~ have ~~occurred~~been ~~subsequent to September 30, 2004~~eliminated.

~~The~~2. ~~accompanying~~Accumulated ~~unaudited~~Other ~~condensed~~Comprehensive ~~consolidated~~Income ~~financial statements reflect all adjustments~~ (~~including normal recurring adjustments~~Loss) ~~necessary to present fairly the consolidated financial position of the Company at September 30, 2004, its consolidated results of operations for the three months~~ and ~~nine~~Comprehensive ~~months~~Income ~~ended September 30, 2004 and 2003~~ (~~as restated~~Loss), and its consolidated cash flows for the nine months ended September 30, 2004 and 2003 (as restated) in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Interim results are not necessarily indicative of full year performance. The December 31, 2003 condensed consolidated balance sheet data (as restated) was derived from the audited financial statements included in the Company’s 2004 Annual Report on Form 10-K filed with the SEC (“2004 Annual Report”) contemporaneously with this Form 10-Q filing, which includes all disclosures required by GAAP. Therefore, these unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company included in the 2004 Annual Report.

~~1. Accumulated~~The following ~~Other~~is ~~Comprehensive~~a ~~Income~~reconciliation of accumulated other comprehensive income (~~Loss~~loss) from December 31, 2005 to September 30, 2006 (in thousands):

The following is a reconciliation of accumulated other comprehensive income from December 31, 2003 to September 30, 2004 (in thousands):

	Net Unrealized Appreciation (Depreciation) of Equity Securities		Net Unrealized Gain (Loss) on Fixed Maturities Available for Sale			Other			Total Accumulated Other Comprehensive Income (Loss)

Balance at December 31, 2005	$	1,651	$	(5,914	)	$	(6,076	)	$	(10,339	)
Current Period Change		40		(2,845	)		-			(2,805	)
Balance at September 30, 2006	$	1,691	$	(8,759	)	$	(6,076	)	$	(13,144	)

	Net Unrealized	Net Unrealized		Total
	Appreciation	Gain (Loss) on		Accumulated
	(Depreciation)	Fixed Maturities		Other
	of Equity	Available for		Comprehensive
	Securities	Sale	Other	Income (Loss)
Balance at December 31, 2003	$ 1,023	$ (1,253)	$ (1,891)	$ (2,121)
Current Period Change	(31)	(91)	-	(122)
Balance at September 30, 2004	$ 992	$ (1,344)	$ (1,891)	$ (2,243)

The comprehensive income (loss) for the three and nine months ending September 30, 2006 and 2005 is summarized as follows (in thousands):

2. Restatement of Previously Issued Financial Statements

	Three Months Ended September 30,					Nine Months Ended September 30,
	2006		2005			2006			2005

Net income (loss)	$	1,295	$	(2,522	)	$	1,250		$	1,017
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holdings gains (losses) arising during the period		7,995		(4,332	)		(2,796	)		(2,401	)
Reclassification adjustments for gains (losses) included in net loss		1		(683	)		(9	)		(311	)
Total other comprehensive income (loss)		7,996		(5,015	)		(2,805	)		(2,712	)

Comprehensive income (loss)	$	9,291	$	(7,537	)	$	(1,555	)	$	(1,695	)

In the course of the Company’s work on its insurance company subsidiaries’ 2004 statutory financial statements, the Company identified significant adjustments relating to 2003 and other prior periods. The Company determined that the accounting errors also affected its consolidated financial statements prepared in accordance with generally accepted accounting principles as included in its previously filed 2003 annual and quarterly filings. Subsequent to this determination, the Company continued to work on the completion of its consolidated financial statements for 2004. This work resulted in the identification of additional adjustments affecting 2003 and prior years.

As a result, the Company has restated the accompanying condensed consolidated financial statements for 2003. These restatement

~~adjustments have been classified into the following areas:~~Index

Policy liabilities and Contractholder Deposit Funds – Following the filing of its 2003 Form 10-K, the Company engaged a new actuarial consulting firm to assist with the Company’s actuarial functions and the actuarial processes affecting financial statement preparation3. ~~The~~Earnings ~~Company,~~Per along with the new firm, performed various reviews of the actuarial policy reserving process. Through this review, errors in to the Company’s 2003 and prior year consolidated financial statements were identified relating to policy liabilities and contractholder deposit funds as described below.Share

The following ~~most~~table ~~significant~~reflects of the ~~errors~~calculation ~~related to a unique block~~ of ~~life~~basic ~~insurance policies. This block of policies consisted of several different policy types including hybrid fixed premium universal life policies~~ and ~~fixed~~diluted ~~premium~~earnings ~~interest~~(loss) per sensitive whole life policies. These are relatively complex products that were not properly administered in some cases and, therefore, reserves were not recorded to cover all of the policy options. This block also required manual policy reserve calculations in many instances. Upon additional review of this block of business, errors in the reserving calculations were identified along with the determination that a significant number of policies had not been included in the reserving process. share:

Another significant adjustment related to contractholder deposit funds for annuity policies. Several annuity policies were misidentified in prior years as variable annuities and excluded from policy liabilities. Upon additional review, these policies have been appropriately identified as general account policies and included in the Company’s contractholder deposit fund liabilities.

	Three Months Ended September 30,					Nine Months Ended September 30,
	2006		2005			2006		2005
	(in thousands except per share data)

BASIC:
Net income (loss)	$	1,295	$	(2,522	)	$	1,250	$	1,017
Weighted average common shares outstanding		9,856		9,823			9,856		9,813
Basic income (loss) per share	$	0.13	$	(0.26	)	$	0.13	$	0.10
DILUTED:
Net income (loss)	$	1,295	$	(2,522	)	$	1,250	$	1,017
Weighted average common shares outstanding		9,856		9,823			9,856		9,813
Diluted income (loss) per share	$	0.13	$	(0.26	)	$	0.13	$	0.10

AsOptions to apurchase ~~result,~~shares ~~corrected~~of ~~calculations~~common ~~and~~stock ~~reserving processes for these policies~~ were ~~performed~~not ~~and~~included in the ~~liability~~computation ~~balances~~of diluted ~~were~~earnings ~~increased~~per ~~for~~share ~~these~~because ~~corrections~~the ~~totaling~~inclusion ~~$6.5~~would ~~million,~~result ~~specifically,~~in ~~contractholder~~an anti-dilutive ~~deposit~~effect ~~funds~~in ~~totaling~~periods ~~$4.8~~in ~~million~~which ~~and~~a ~~future~~net ~~policy~~loss ~~benefits~~was ~~totaling $1~~incurred.~~7 million.~~

The Company also determined that there were errors in its process for calculating the liability for premiums received in advance related to policies processed on one of its policy administration systems4. As aNet ~~result,~~Realized ~~the~~Investment ~~Company developed a new program to correct the advance premium calculation process resulting in an increase to this liability of $365,000.~~Gains

~~Various~~On June 1, ~~other~~2005, ~~errors~~the ~~were~~Company ~~identified~~sold ~~resulting~~the inRiver ~~corrections~~Place ~~primarily~~Pointe ~~related~~office complex to ~~paid~~a non-upaffiliated ~~insurance~~party ~~coverages~~in an all-cash transaction for a gross sales price of $103 million. The office complex is located in Austin, ~~manual~~Texas. ~~policy~~Under ~~processing~~the terms of the sale agreement, ~~and~~the ~~accumulation~~Company entered into a lease with the purchaser with respect to all of ~~GAAP~~the ~~policy~~space ~~reserves~~in ~~and~~Building ~~related~~One ~~reinsurance~~(approximately ~~reserve~~76,000 ~~credits~~square feet) for a five-year term at a rate of $28. ~~These~~00 ~~resulted~~per square foot, which was the prevailing rental rate at the time that FIC and its subsidiaries occupied the building in July an2000. ~~increase~~The tolease ~~reinsurance~~provides ~~receivables~~the Company with a right of cancellation of the lease at March 31, 2008. The Company will realize a gain of $~~291~~10.6 million on the sale,~~000,~~ ~~with~~which includes both a ~~reduction~~realized gain of $8.5 million in the quarter ~~future~~ended ~~policy~~June ~~benefits~~30, 2005 and a deferred gain of $172.1 million to be recognized as a reduction of office lease expenses over the period from the sale date through March 31,~~000~~ 2008. The deferred gain represents an amount equal to the estimated excess rent to be paid under the lease agreement through March 31, 2008 over the prevailing rate at the time of sale.

~~Reinsurance~~During the –third Asquarter ~~a result~~ of ~~the findings by a significant reinsurer and issues identified by the Company~~2005, the Company ~~completed~~identified a ~~comprehensive~~fixed ~~review~~maturity of its reinsurance administrative systems. These systems generally rely on manual interface with the Company’s policy administration systems and general ledger. This manual interface, along with changes in retention policies security which ~~are~~was ~~based~~considered onimpaired ~~covered individuals, resulted in errors in premiums ceded. As a result, restatement adjustments totaling $668,000 were made to appropriately cede premiums~~ and ~~reduce~~reduced ~~reinsurance~~its ~~receivables~~carrying invalue ~~accordance~~by ~~with the reinsurance agreements with various reinsurers~~$1 million.

Present Value of Future Profits of Acquired Businesses (PVFP) – The Company recorded a restatement adjustment totaling $56,000 for the amortization of PVFP in 2003 related to the correction of certain policy in-force data.

Excess of Net Assets Acquired Over Cost – In connection with the 2001 acquisition of ILCO, the Company allocated the purchase price to the fair value of the assets acquired and liabilities assumed in accordance with the purchase method of accounting resulting in the recognition of an excess of net assets acquired over cost, also referred to as negative goodwill. Prior to its acquisition of ILCO’s remaining outstanding common shares on May 18, 2001, the Company accounted for ILCO under the equity method of accounting. The Company owned approximately 48% of ILCO’s common shares prior to May 18, 2001. The restatement adjustments to the Company’s equity in earnings of affiliate are therefore equal to approximately 48% of the related adjustments to ILCO’s retained earnings and total shareholders’ equity prior to May 18, 2001. Certain restatement adjustments as described in this Note, therefore, affected the fair value of the net assets acquired from ILCO and the cost of the investment in ILCO resulting in a decrease of $2.7 million in the remaining unamortized negative goodwill, which was recognized as a cumulative effect of a change in accounting principle in 2002 in accordance with SFAS No. 141 “Business Combinations”.

Income Taxes – Current and deferred Federal income tax provisions were recalculated to include the impact of the restatement adjustments as described herein, and to reflect the amount of taxes receivable from the IRS and the amount of deferred Federal income tax liability resulting from the utilization of the asset and liability method after consideration of the portion of the deferred tax asset that may not be realized pursuant to the requirements of SFAS

No. 109, “Accounting for Income Taxes.” The Company also determined that deferred taxes had not been established related to ILCO’s pension assets. Adjustments made to decrease the income tax receivable and reduce the deferred tax liability totaled $1.9 million, including an increase to accumulated other comprehensive income of $280,000 primarily as a result of changes to the deferred tax valuation allowance applied to other comprehensive income and the recalculation of deferred income taxes applied to the Company’s minimum pension liability.

Other Miscellaneous – The Company recorded the following additional restatement adjustments:

• Correct agent advances for calculation errors in amounts collected by the Company, increasing accounts receivable $33,000

• Correct the accounting of certain manually administered policy loans, decreasing policy loans $163,000

• Establish sales tax accrual on actuarial consulting fees, increasing other liabilities $79,000

• Adjustment of duplicate claims checks included in escheat liability and vacation benefits liability, reducing other liabilities by $95,000

• Reduction of accrued interest on bond for which interest received was held in suspense totaling $52,000

• Increase in a tax withholding liability totaling $54,000

• Increase in agency receivables of $183,000

• Reduction of accounts receivable for straight-line treatment of rental income totaling $86,000

• Correction of agent commission liability of $255,000 and allowance for agents’ balances of $157,000 due to errors in programming of the Company’s commission rate structure totaling $98,000

• Correction of treasury stock, increasing additional paid-in capital by $524,000 and common treasury stock by $122,000 and reducing other liabilities by $646,000, as a result of treasury shares distributed in 2003 in conjunction with the acquisition of the New Era companies. See Note 8 for additional details regarding the acquisition and subsequent sale of the New Era companies.

• Establishment of cash account and liability for a unrecorded premium depository account totaling $249,000

• Reclassifications of certain balance sheet and statement of operations items which were improperly classified, including amortization of DAC and PVFP of $121,000, premium revenue and policyholder benefits and expenses of $202,000, accrued investment income and accounts receivable of $395,000, reinsurance receivables and contractholder deposit funds of $303,000, and policyholder benefits and expenses and interest on contractholder deposit funds totaling $1.1 million and $2.4 million for the three months and nine months ended September 30, 2003, respectively.

• Reclassification of quarterly other revenue of $1.0 million and quarterly operating expenses of approximately $971,000 related to the New Era companies from continuing operations to discontinued operations. For the nine months ended September 30, 2003, other revenue reclassified totaled $1.0 million and operating expenses totaled $1.1 million.

In addition to the above restatements, the statement of cash flows for the nine months ended September 30, 2003, was also affected by the following items:

• Acquisition of subsidiary companies was adjusted to eliminate the net effects of changes in other assets and liabilities. Acquisition of subsidiary companies increased by $941,000, offset by reductions in other of $1,587,000, issuance of treasury stock of $646,000, and increases in change in other assets of $647,000 and change in other liabilities of $2,527,000

• Adjustment to issuance of treasury stock of $90,000 due to issuance of treasury stock to 401 (k) participants, reclassifying change to other.

• Adjustment of proceeds from sales or maturities of fixed maturities of $651,000, with offset to other, for accretion and amortization of bond discount and premium, respectively, previously included.

In the aggregate, the correction of these errors impacted the consolidated balance sheet as of December 31, 2003, and consolidated statements of operations for the three and nine months ended September 30, 2003, respectively, as follows (in thousands):

As of December 31, 2003	Policy Liabilities and Contract-holder Deposits	Reinsurance	Present Value of Future Profits	Other Miscellaneous and Reclassifications	Income Taxes	Total
Investments:
Policy loans	$ -	$ -	$ -	$ (163)	$ -	$ (163)
Total investments	-	-	-	(163)	-	(163)
Cash and cash equivalents	-	-	-	249	-	249
Deferred policy acquisition costs	-	-	-	(121)	-	(121)
Present value of future profits of acquired businesses	-	-	56	121	-	177
Agency advances and other receivables	-	-	-	427	(117)	310
Reinsurance receivables	291	(650)	-	303	-	(56)
Accrued investment income	-	-	-	(447)	-	(447)
Total assets	$ 291	$ (650)	$ 56	$ 369	$(117)	$ (51)
Policy liabilities and contractholder deposit funds:
Contractholder deposit funds	$ 4,768	$ -	$ -	$ 303	$ -	$ 5,071
Future policy benefits	2,063	-	-	-	-	2,063
Deferred federal income taxes	-	-	-	-	(2,036)	(2,036)
Other liabilities	-	18	-	(360)	-	(342)
Total liabilities	6,831	18	-	(57)	(2,036)	4,756
Shareholders’ equity:
Additional paid-in capital	-	-	-	524	-	524
Accumulated other comprehensive income	-	-	-	-	280	280
Retained earnings	(6,540)	(668)	56	(220)	1,639	(5,733)
Common treasury stock, at cost	-	-	-	122	-	122
Total shareholders’ equity	(6,540)	(668)	56	426	1,919	(4,807)
Total liabilities and shareholders’ equity	$ 291	$ (650)	$ 56	$ 369	$ (117)	$ (51)

For the three months ended September 30, 2003	Policy Liabilities and Contract-holder Deposits	Reinsurance	Present Value of Future Profits	Other Miscellaneous and Reclassifications	Income Taxes	Total
Revenues:
Premiums, net	$ 11	$ -	$ -	$ (61)	$ -	$ (50)
Net investment income	-	-	-	(21)	-	(21)
Real estate income, net	-	-	-	(5)	-	(5)
Other revenue	-	-	-	(999)		(999)
Total revenues	11	-	-	(1,086)	-	(1,075)
Benefits and expenses:
Policyholder benefits and expenses	84	63	-	1,050	-	1,197
Interest expense on contractholder deposit funds	671	-	-	(1,112)	-	(441)
Amortization of deferred policy acquisition costs	-	-	-	30	-	30
Amortization of present value of future profits
of acquired business	-	-	-	(30)	-	(30)
Operating expenses	-	-	-	(930)	-	(930)
Total benefits and expenses	755	63	-	(992)	-	(174)
(Loss) income from continuing operations before
federal income taxes and discontinued operations	(744)	(63)	-	(94)	-	(901)
Provision (benefit) for federal income taxes	-	-	-	-	(255)	(255)
(Loss) income from continuing operations before
discontinued operations	(744)	(63)	-	(94)	255	(646)
Discontinued operations	-	-	-	29	-	29
Net (loss) income	$ (744)	$ (63)	$ -	$ (65)	$ 255	$ (617)

For the nine months ended September 30, 2003	Policy Liabilities and Contract-holder Deposits	Reinsurance	Present Value of Future Profits	Other Miscellaneous and Reclassifications	Income Taxes	Total
Revenues:
Premiums, net	$ 33	$ -	$ -	$ (155)	$ -	$ (122)
Earned insurance charges	-	-	-	(190)	-	(190)
Net investment income	-	-	-	(61)	-	(61)
Real estate income, net	-	-	-	(15)	-	(15)
Other revenue	-	-	-	(1,244)	-	(1,244)
Total revenues	33	-	-	(1,665)	-	(1,632)
Benefits and expenses:
Policyholder benefits and expenses	36	189	-	2,064	-	2,289
Interest expense on contractholder deposit funds	917	-	-	(2,410)	-	(1,493)
Amortization of deferred policy acquisition costs	-	-	-	90	-	90
Amortization of present value of future profits
of acquired business	-	-	-	(90)	-	(90)
Operating expenses	-	-	-	(1,253)	-	(1,253)
Total benefits and expenses	953	189	-	(1,599)	-	(457)
(Loss) income from continuing operations before
federal income taxes and discontinued operations	(920)	(189)	-	(66)	-	(1,175)
Provision (benefit) for federal income taxes	-	-	-	25	(453)	(428)
(Loss) income from continuing operations before
discontinued operations	(920)	(189)	-	(91)	453	(747)
Discontinued operations	-	-	-	(101)	-	(101)
Net (loss) income	$ (920)	$ (189)	$ -	$ (192)	$ 453	$ (848)

The effect of the above restatement adjustments on the results of operations for the three months and nine months ended September 30, 2003, respectively, cash flows for the nine months ended September 30, 2003, and financial position as of December 31, 2003, are as follows (in thousands):

	2003
	As Previously
	Reported	As Restated
Consolidated Balance Sheet as of December 31, 2003:
Investments:
Policy loans	$ 42,615	$ 42,452
Total investments	688,927	688,764
Cash and cash equivalents	82,187	82,436
Deferred policy acquisition costs	54,940	54,819
Present value of future profits of acquired businesses	20,919	21,096
Agency advances and other receivables	9,931	10,241
Reinsurance receivables	40,034	39,978
Accrued investment income	7,142	6,695
Total assets	$ 1,286,095	$ 1,286,044
Policy liabilities and contractholder deposit funds:
Contractholder deposit funds	$ 588,810	$ 593,881
Future policy benefits	167,181	169,244
Deferred federal income taxes	8,369	6,333
Other liabilities	25,655	25,313
Total liabilities	1,176,979	1,181,735
Shareholders’ equity:
Additional paid-in capital	69,867	70,391
Accumulated other comprehensive income	(2,401)	(2,121)
Retained earnings	62,721	56,988
Common treasury stock, at cost	(23,575)	(23,453)
Total shareholders’ equity	109,116	104,309
Total liabilities and shareholders’ equity	$ 1,286,095	$ 1,286,044

	2003
	As Previously
	Reported	As Restated
Consolidated Statements of Operations for the three months ended
September 30, 2003:
Revenues:
Premiums, net	$ 7,677	$ 7,627
Net investment income	8,803	8,782
Real estate income, net	559	554
Other revenue	1,634	635
Total revenues	27,767	26,692
Benefits and expenses:
Policyholder benefits and expenses	12,161	13,359
Interest expense on contractholder deposit funds	6,733	6,291
Amortization of deferred policy acquisition costs	2,948	2,978
Amortization of present value of future profits of acquired business	987	957
Operating expenses	11,495	10,565
Total benefits and expenses	34,531	34,357
(Loss) income from continuing operations before
federal income taxes	(6,764)	(7,665)
Provision (benefit) for federal income taxes	(1,012)	(1,267)
(Loss) income from continuing operations before discontinued operations	(5,752)	(6,398)
Discontinued operations	-	29
Net (loss) income	$ (5,752)	$ (6,369)
Net loss per share (basic and diluted)	$ (0.60)	$ (0.66)

	2003
	As Previously
	Reported	As Restated
Consolidated Statements of Operations for the nine months ended
September 30, 2003:
Revenues:
Premiums, net	$ 23,812	$ 23,690
Earned insurance charges	30,769	30,579
Net investment income	27,941	27,880
Real estate income, net	1,749	1,734
Other revenue	3,195	1,952
Total revenues	87,775	86,143
Benefits and expenses:
Policyholder benefits and expenses	32,548	34,838
Interest expense on contractholder deposit funds	21,364	19,871
Amortization of deferred policy acquisition costs	9,312	9,402
Amortization of present value of future profits of acquired business	3,030	2,940
Operating expenses	31,175	29,922
Total benefits and expenses	100,630	100,174
(Loss) income from continuing operations before
federal income taxes	(12,855)	(14,031)
Provision (benefit) for federal income taxes	(1,922)	(2,350)
(Loss) income from continuing operations before discontinued operations	(10,933)	(11,681)
Discontinued operations	-	(101)
Net (loss) income	$ (10,933)	$ (11,782)
Net loss per share (basic and diluted)	$ (1.13)	$ (1.22)

	2003
	As Previously
	Reported	As Restated
Consolidated Statements of Cash Flows for the
nine months ended September 30, 2003:
Cash flows from operating activities:
Net loss	$ (10,932)	$ (11,782)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Amortization of deferred policy acquisition costs	9,311	9,402
Amortization of present value of future profits of acquired business	3,030	2,940
Changes in assets and liabilities:
Increase in accrued investment income	(1,019)	(986)
Decrease in agency advances and other receivables	5,360	5,519
Decrease (increase) in other assets	1,545	2,192
Increase in policy liabilities and accruals	2,217	2,256
Increase in other liabilities	2,374	4,614
Decrease in deferred federal income taxes	(3,072)	(3,280)
Other, net	1,308	435
Net cash provided by (used in) operating activities	302	1,490
Cash flows from investing activities:
Proceeds from sales and maturities of fixed maturities	323,758	323,107
Net decrease in policy loans	2,231	2,213
Acquisition of subsidiary companies	(3,183)	(4,124)
Net cash used in investing activities	(31,063)	(32,673)
Cash flows from financing activities:
Sales of treasury stock	(1,103)	(1,812)
Net cash provided by financing activities	12,131	11,422
Net decrease in cash	$ (18,633)	$ (19,761)

3. Change in Accounting Principles

In July 2003, the Accounting Standards Executive Committee (“AcSEC”) of the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-01, “Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-Duration Contracts and for Separate Accounts.” AcSEC developed the SOP to address the evolution of product designs since the issuance of SFAS No. 60, “Accounting and Reporting by Insurance Enterprises,” and SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” and the need for interpretive guidance to be developed in three areas: separate account presentation and valuation; the accounting recognition given sales inducements (bonus interest, bonus credits, persistency bonuses); and the classification and valuation of certain long-duration contract liabilities.

The Company adopted the provisions of SOP 03-01 at January 1, 2004, resulting in an increase to income as a cumulative effect of a change in accounting principle totaling $229,000, net of taxes, as reflected in the accompanying 2004 condensed consolidated statement of operations for the nine months ended September 30, 2004. The Company has certain universal life insurance products that are credited with bonus interest after applicable qualifying periods. The adoption of the new accounting principle resulted in a change in the pattern of recognition of the bonus interest expense.

4. Earnings Per Share

The following table reflects the calculation of basic and diluted earnings per share (amounts in thousands, except per share amounts):

		Three Months Ended September 30,		Nine Months Ended September 30,
			2003		2003
		2004	(restated) (1)	2004	(restated) (1)
BASIC:
	Loss from continuing operations before cumulative effect of change
	in accounting principle	$ (4,845)	$ (6,398)	$ (11,141)	$ (11,681)
	Weighted average common shares
	outstanding	9,798	9,688	9,795	9,626
Basic loss per share		$ (0.49)	$ (0.66)	$ (1.13)	$ (1.21)
DILUTED:
	Loss from continuing operations before cumulative effect of change
	in accounting principle	$ (4,845)	$ (6,398)	$ (11,141)	$ (11,681)
	Weighted average common shares
	outstanding	9,798	9,688	9,795	9,626
	Common stock options	-	-	-	-
	Common stock and common stock
	equivalents	9,798	9,688	9,795	9,626
Diluted loss per share		$ (0.49)	$ (0.66)	$ (1.13)	$ (1.21)

(1) See Note 2

Options to purchase 650,000 shares of common stock at $16.42 were outstanding at September 30, 2004, but were not included in the computation of diluted earnings per share because the inclusion would result in an antidilutive effect in periods in which a loss from continuing operations was incurred. Options to purchase 873,020 shares of common stock at prices ranging from $8.18 to $16.42 were outstanding at September 30, 2003, but were not included in the computation of diluted earnings per share because the inclusion would result in an antidilutive effect in periods in which a loss from operations was incurred.

5.	Retirement Plans

A. Family Life

Family Life Insurance Company (“Family Life”) has a non-contributory defined benefit pension plan (“Family Life Pension Plan”), which covers employees who have completed one year or more of service. Under the Family Life Pension Plan, benefits are payable upon retirement based on earnings and years of credited service.

The Normal Retirement Date for all employees is the first day of the month coinciding with or next following the later of attainment of age 65 or the fifth anniversary of employment.

The Normal Retirement Benefit is the actuarial equivalent of a life annuity, payable monthly, with the first payment commencing on the Normal Retirement Date. The life annuity is equal to the sum of (1) plus (2):

(1)

Annual Past Service Benefit: 1.17% of the first $10,000 of Average Final Earnings plus 1 1/2% of the excess of Average Final Earnings over $10,000, all multiplied by the participant’s Credited Past Service. For these purposes, “credited past service” is service prior to April 1, 1967, with respect to employees who were plan participants on December 31, 1975.

Index

(2)

Annual Future Service Benefit: 1.5578% of the first $10,000 of Average Final Earnings plus 2% of the excess of Average Final Earnings over $10,000, all multiplied by the participant’s Credited Future Service.

c. Effective April 1, 1997, the Family Life Pension Plan was amended to provide that the accrual rate for future service is 1.57% of Final Average Earnings multiplied by Credited Service after March 31, 1997, less 0.65% of Final Average Earnings up to Covered Compensation. With respect to service prior to April 1, 1997, the accrual rate described in paragraph (b), above, is applicable, with Average Final Earnings taking into account a participant’s earnings subsequent to April 1, 1997.

21d. Effective March 31, 2004, all employees covered under the plan were terminated. No new or rehired employees are permitted to enter or re-enter the plan. Thus, the plan is frozen.

of Final Average Earnings up to Covered Compensation. With respect to service prior to April 1, 1997, the accrual rate described in paragraph (b), above, is applicable, with Average Final Earnings taking into account a participant's earnings subsequent to April 1, 1997.

d. Effective March 31, 2004, all employees covered under the plan were terminated. No new employees are permitted to enter or re-enter the plan.

Average Final Earnings are the highest average Considered Earnings during any five consecutive years while an active participant. Total Credited Past Service plus Credited Future Service is limited to 30 years.

A settlement ~~curtailment~~ occurred on ~~January~~September 130, ~~2004~~2006 ~~when~~due ~~the decision was made~~ to ~~terminate~~ the ~~employment~~settlement of ~~all~~several former ~~active~~employees’ ~~participants in the~~ plan asobligations ~~discussed~~through inthe ~~item~~payment ~~(d)~~of ~~above~~lump sums. ~~Because~~ A ~~the~~settlement ~~plan’s~~occurs ~~unrecognized~~whenever ~~losses exceeded~~ the ~~decrease~~lump insums ~~projected~~paid ~~benefit~~during ~~obligation~~the ~~(“PBO”)~~year exceed ~~caused by~~ the ~~curtailment~~sum as of ~~January 1, 2004,~~ the ~~SFAS~~plans ~~No.~~Service 88Cost ~~curtailment~~and ~~charge~~Interest ~~recognized~~Cost incomponents ~~the~~of ~~2004~~ expense for ~~was~~that ~~zero~~year. ( The ~~plan~~settlement ~~was~~resulted ~~subsequently~~in ~~amended to prevent any new or rehired employee from entering or reentering~~ the ~~plan~~recognition inof ~~the future. Thus~~a $295,736 ~~the~~charge ~~plan~~to isexpense ~~now~~for ~~frozen~~2006.)

AThe pension ~~settlement~~costs ~~occurred~~for ~~on December 31, 2004 of several former employees’ plan obligations through~~ the ~~payment~~Family ofLife ~~lump~~Pension ~~sums. A~~Plan ~~settlement~~include ~~occurs whenever~~ the ~~lump~~following ~~sums paid during the year exceed the sum of the plan's Service Cost and Interest Cost~~ components at ofSeptember ~~expense for that year. The settlement resulted in the recognition of a $399~~30,~~000~~ ~~charge~~2006 toand ~~expense in the 4th quarter of 2004.~~ 2005:

The pension costs for the Family Life Pension Plan include the following components at September 30, 2004:

	Three Months Ended Sept. 30,						Nine Months Ended Sept. 30,
	2006			2005			2006			2005

Service cost for benefits earned during the year	$	-		$	-		$	-		$	-
Interest cost on projected benefit obligation		109,482			116,054			328,446			348,162
Expected return on plan assets		(101,994	)		(101,268	)		(305,982	)		(303,805	)
Amortization of unrecognized prior service cost		-			-			-			-
Amortization of unrecognized losses		23,460			26,225			70,380			78,677
Recognition of net loss due to settlement		295,736			-			295,736			-

Net periodic benefit cost	$	326,684		$	41,011		$	388,580		$	123,034

	Three months ended September 30,	Nine months ended September 30,
Service cost for benefits earned during the year	$ -	$ -
Interest cost on projected benefit obligation	126,983	380,949
Expected return on plan assets	(108,056)	(324,168)
Amortization of unrecognized prior service cost	-	-
Amortization of unrecognized (gains)/losses	19,276	57,828
Recognition of net loss due to settlement	-	-
Net periodic benefit cost	$ 38,203	$ 114,609

B. ILCO

InterContinental Life Corporation (“ILCO”) maintains a retirement plan (“ILCO Pension Plan”) covering substantially all employees of the Company and its subsidiaries. The ILCO Pension Plan is a non-contributory, defined benefit pension plan, which covers each eligible employee who has attained 21 years of age and has completed one year or more of service. Each participating subsidiary company contributes an amount necessary (as actuarially determined) to fund the benefits provided for its participating employees.

The ILCO Pension 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 ILCO Pension Plan maintained by ILCO 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 ILCO Pension 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.

A curtailment occurred on December 31, 2004 when the plan was amended to freeze accrued benefits for all participants except for Rule of 68 Non-Highly Compensated Employees (“NHCEs”). ( A subsequent curtailment occurred on December 31, 2005 when the decision was made to amend the plan to freeze accrued benefits for Rule of 68 ~~Participant~~NHCEs iseffective aMarch ~~Participant~~31, ~~who~~2006. All ~~was~~plan participants accrued benefits are now frozen.

2214

an Employee on December 31, 2004 and for whom the sum of the Participant’s age in years and fractions thereof and service in years and fractions thereof was greater than or equal to 68 years as of December 31, 2004. A Rule of 68 NHCE is a Rule of 68 Participant who was not a Highly Compensated Employee, as defined under IRC Section 414(q), as of December 31, 2004.) Because the plan’s unrecognized losses exceeded the decrease in the projected benefit obligation caused by the curtailment as of December 31, 2004, the SFAS No. 88 curtailment charge recognized in the 2004 expense was zero.Index

The pension costs for the ILCO Pension Plan include the following components at September 30, ~~2004~~2006 and 2005:

	Three months ended September 30,		Nine months ended September 30,
	Three Months Ended Sept. 30,						Nine Months Ended Sept. 30,
Service cost for benefits earned during the year	$ 145,556		$ 436,668
	2006			2005			2006			2005
Interest cost on projected benefit obligation	283,352		850,056
Service cost for benefits earned during the year	$	3,672		$	11,448		$	11,016		$	34,344
Expected return on plan assets	(342,053)		(1,026,159)
Interest cost on projected benefit obligation		262,037			261,812			786,111			785,436
Amortization of unrecognized prior service cost	-		-
Expected return on plan assets		(350,036	)		(344,766	)		(1,050,108	)		(1,034,298	)
Amortization of unrecognized (gains)/losses	43,775		131,325
Amortization of unrecognized prior service cost		-			-			-			-
Recognition of net loss due to settlement	-		-
Amortization of unrecognized losses		46,022			33,920			138,066			101,760
Net periodic benefit cost	$ 130,630		$ 391,890
Recognition of net loss due to settlement		-			-			-			-
Net periodic benefit cost	$	(38,305	)	$	(37,586	)	$	(114,915	)	$	(112,758	)

6.	Stock Option Plans and Other Equity Incentive Plans

~~The~~ In December 2004, ~~Company follows~~ the ~~disclosure-only~~FASB ~~provisions~~issued of SFAS No. 123(R), “Share-Based Payment.” SFAS 123(R) is a revision of SFAS 123, “Accounting for Stock-Based Compensation,” aswhich ~~amended~~was originally issued by ~~SFAS~~the NoFASB in 1995. ~~148~~As originally issued, ~~“Accounting~~SFAS 123 ~~for~~provided ~~Stock~~companies ~~Based~~with ~~Compensation~~the option to either record expense for share-based ~~Transition~~payments ~~and~~under ~~Disclosure.”~~a ~~SFAS~~fair Novalue model, or to simply disclose the impact of the expense. SFAS 123(R) ~~allows~~requires companies to ~~follow~~measure ~~existing~~the cost ~~accounting~~of ~~rules~~share-based payments to employees using a fair value model, and to recognize that cost over the relevant service period. In addition, SFAS 123(~~APB 25~~R) ~~provided~~requires that ~~pro~~an ~~forma~~estimate ~~disclosures~~of ~~are~~future award forfeitures be made at the grant date, while SFAS 123 permitted recognition of ~~what~~forfeitures ~~net~~on an ~~income~~as ~~and~~incurred ~~earnings~~basis. SFAS ~~per~~123(R) ~~share~~was ~~would~~originally ~~have~~effective ~~been~~July ~~had~~1, 2005, but was later deferred by the ~~company~~Securities ~~recognized~~and ~~expense~~Exchange Commission and will become effective for ~~stock-based~~all awards ~~based~~granted, onmodified, ~~their~~repurchased, ~~fair~~or ~~value~~cancelled by the atCompany ~~date~~beginning January 1, 2006. The adoption of ~~grant~~this statement on January 1, 2006 did not have a material impact on the Company’s consolidated financial statements.

~~For purpose of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period~~7. ~~Pro~~Separate ~~forma income information is as follows (in thousands except for net income per share) for the three and nine months ended September 30:~~ Accounts

		Three Months Ended September 30,		Nine Months Ended September 30,
			2003		2003
		2004	(restated) (1)	2004	(restated) (1)
Net loss as reported		$ (4,845)	$ (6,369)	$ (10,912)	$ (11,782)
Pro forma compensation expense,
	net of tax benefits	-	-	-	-
Net loss - pro forma		$ (4,845)	$ (6,369)	$ (10,912)	$ (11,782)
Net loss per share:
	Basic as reported	$ (0.49)	$ (0.66)	$ (1.11)	$ (1.22)
	Diluted as reported	$ (0.49)	$ (0.66)	$ (1.11)	$ (1.22)
	Basic - pro forma	$ (0.49)	$ (0.66)	$ (1.11)	$ (1.22)
	Diluted - pro forma	$ (0.49)	$ (0.66)	$ (1.11)	$ (1.22)

The Company’s insurance subsidiary, Investors Life Insurance Company of North America (“Investors Life”) had $341.8 million of separate account assets as of September 30, 2006 (not including the value of the Company’s own investment in one of the accounts), as compared to $342.9 million at the end of 2005. These assets include (a) two variable annuity separate accounts that permit contractholders to allocate their contract values among a selection of third-party mutual funds and (b) assets held in custodian accounts in connection with investment annuity contracts. The investment annuity business is reinsured with Symetra Life Insurance Company (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10% coinsurance basis, with Investors Life retaining 10% of such business. Since the reinsurance treaty is on a coinsurance basis, Investors Life is contingently liable to the policyholders in the event that the reinsurer is unable to fulfill its obligations under the treaty. Investors Life is not marketing new separate account annuity contracts.

(Effective June 1), ~~See~~2006, ~~Note~~Investors 2Life recaptured the previously reinsured investment annuity business with Symetra Life resulting in the retention of 100% of this business. The Company expects the recapture of this previously reinsured business to increase revenues in 2006 and future years. However, as this is a closed block of business, the revenues are expected to decrease as the policies in force decline.

78. ~~Dividends~~ ~~Declared~~Commitments and Contingencies

~~On December 13, 2002, the Board declared a dividend of $0~~T.05 David ~~per~~Porter ~~common share payable on January 24, 2003, to record holders as of January 3, 2003~~v. NoFinancial ~~dividends~~Industries have been declared subsequently. At its meeting on December 13, 2002, the Board modified the previously announced dividend policy. Under the revised policy, the payment of dividends is subject to the discretion of the Board of Directors, and will depend on, among other things, the financial condition of the Company, Corporation

On May 31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis County, Texas District Court (the “Court”), against the Company, seeking to compel the Company to hold an annual meeting of shareholders. FIC has been unable to solicit proxies for an annual meeting because it has not been able to comply with Rule 14a-3 of the Securities Exchange Act of 1934, which requires that the Company provide an annual report containing current financial statements to shareholders in connection with an annual meeting.

Mr. Porter sued under Article 2.24(B) of the Texas Business Corporation Act, which provides that if an annual meeting of shareholders is not held within any 13-month period and a written consent of shareholders has not been executed instead of a meeting, any court of competent jurisdiction in the county in which the principal office of the corporation is located may, on the application of any shareholder, summarily order a meeting to be held. On August 7, 2006, the Company entered into an Agreed Order On Plaintiff’s Motion to Compel Annual Shareholders Meeting and agreed among other things to hold an annual shareholders meeting for the election of directors on December 6, 2006. The Company made arrangements for, and was prepared to hold, an annual meeting of shareholders on December 6, 2006, as required by the Agreed Order, but the Company was unable to hold the meeting on the appointed date because no quorum was present.

Index

On December 12, 2006, FIC filed a Motion for Summary Judgment seeking dismissal of Porter’s suit on the grounds that the Agreed Order did not dispense with the requirement of a quorum; the lack of a quorum was a direct and foreseeable result of Mr. Porter’s insistence on a one-sided solicitation and election; FIC had complied with its obligations under the Agreed Order and Mr. Porter has obtained all relief sought by his petition. FIC’s Motion for Summary Judgment remains pending and has not been heard.

Prior to a hearing on FIC’s Motion for Summary Judgment, Mr. Porter applied for a temporary restraining order and temporary injunction requiring the Company to convene one or more additional meetings of shareholders, contending that in the absence of a quorum on December 6, Texas law and the Company’s bylaws entitled a majority of the shareholders in attendance to choose a date to which the meeting would be adjourned. The District Court held a hearing on Porter’s application, and on December 22, 2006 entered an order requiring among other things that FIC hold an annual shareholders meeting for the election of directors on January 16, 2007, but stating that if a quorum was not present on that date, FIC would not be required to hold an annual meeting of shareholders at any time before July 17, 2007. The Company made arrangements for, and was prepared to hold, an annual meeting of shareholders on January 16, 2007, as required by the Court’s order, but the Company was again unable to hold the meeting on the appointed date because no quorum was present. No further action has been taken by Mr. Porter, whose suit remains pending.

Litigation with Equita Financial and Insurance Services of Texas, Inc. and M&W Insurance Services, Inc.

On June 2, 2005, Equita and M&W Insurance Services, Inc. (“M&W”) filed a civil suit in Travis County, Texas District Court against the Company. The suit alleges that, in entering into certain agreements with the plaintiffs, the Company made certain misrepresentations and omissions as to its business and financial condition. The agreements referenced in the suit consist of (a) an option agreement entered into in June 2003 between Equita and the Company, granting Equita the right to purchase shares of FIC’s common stock at $16.42 per share, if certain sales goals were achieved under an exclusive marketing agreement between Equita and a subsidiary of the Company (the “Option Agreement”), (b) a stock purchase agreement entered into in June 2003 between M&W and the Roy F. and Joann Cole Mitte Foundation, pertaining to the purchase of 204,918 shares of FIC’s common stock (the Stock Purchase Agreement”), and (c) a registration rights agreement entered into in June 2003 among the plaintiffs and the Company, whereby the Company agreed to file and maintain a shelf registration statement with respect to the shares of FIC’s common stock purchased by M&W from the Mitte Foundation or which may be acquired in the future by Equita under the option agreement (the “Registration Rights Agreement,” and, collectively, the “Agreements”).

The suit alleges that the Company breached the provisions of the Option Agreement by refusing to indemnify the plaintiffs for losses relating to the alleged breach of certain representations and warranties included in the Option Agreement. The plaintiffs also allege that the Company required M&W to purchase 204,918 shares of FIC common stock from the Mitte Foundation as a condition of Equita’s obtaining, in June 2003, an exclusive marketing agreement with a subsidiary of the Company pertaining to the distribution of insurance products in the “senior market” (the “Marketing Agreement”), and that such requirement was motivated by the desire of the Company’s management to obtain certain proxy rights obtained under a settlement agreement with the Mitte Foundation and the Mitte family. The plaintiffs further allege that the Company breached the provisions of the Registration Rights Agreement by failing to file a shelf registration with the SEC with respect to the shares of FIC’s common stock purchased by M&W from the Mitte Foundation and the shares which may be acquired in the future by Equita under the provisions of the Option Agreement. The plaintiffs seek rescission of the Agreements; damages in an amount equal to the $3 million that M&W paid to acquire FIC shares from the Mitte Foundation, together with interest and attorney’s fees and unspecified expenses; and an unspecified amount of exemplary damages.

Late in 2005, the Company’s two life insurance subsidiaries, Investors Life and Family Life, intervened in the lawsuit to assert claims that Equita had breached its obligations under the Marketing Agreement with respect to the distribution of insurance products, thereby causing damages to the life insurance subsidiaries. Equita moved to dismiss the intervention, but at a hearing on December 20, 2005, the court denied Equita’s motion. As a result, Investors Life and Family Life will be permitted to assert their claims against Equita in this lawsuit.

Deposition discovery with respect to both the case filed by Equita and M&W, and the claims in intervention asserted by Family Life and Investors Life, began in October of 2006.

In response to a motion for partial summary judgment, the Company has stipulated to certain elements of some of the causes of action asserted by Equita and M&W, including that certain representations and warranties made in the Option Agreement were partially incorrect, and that FIC was unable to comply with certain of its obligations under the Option Agreement. FIC did not stipulate, and continues to dispute, other elements of certain of the causes of action asserted by Equita and M&W, and disputes other causes of action in their entirety.

Index

On or about May 8, 2007, Equita and M&W amended their petition, removing their claims under the Texas Securities Act and common-law fraud. FIC intends to vigorously oppose the lawsuit and any effort by Equita and M&W to recover damages from FIC, and the life insurance subsidiary intends to vigorously prosecute its claims in intervention against Equita.

The Manhattan Life Insurance Company and Family Life Insurance Company v. Family Life Corporation, Investors Life Insurance Company of North America and FIC Insurance Services, L.P.

On April 17, 2007, Manhattan Life and Family Life, filed a civil suit in the 215^th Judicial District Court, Harris County, Texas, against Family Life Corporation, Investors Life and FIC Insurance Services, L.P. (“FICIS”), each a subsidiary of the Company. The suit alleges that: a) Family Life Corporation breached the Stock Purchase Agreement with Manhattan life by competing with Family Life and accepting insurance “directly or indirectly” from active accounts of Family Life; b) FICIS breached the Administrative Services Agreement with Family Life by willfully communicating with or willfully assisting with the communication by its affiliates with policyholders in a manner intended to solicit Family Life accounts on behalf of Investors Life; c) FICIS breached fiduciary duties owed to Family Life in the administration and management of the accounts of the policy holders of Family Life by assisting in the conversion of Family Life policies to the policies of Investors Life, and by their actions, Investors Life and Family Life Corporation aided and abetted such breach of fiduciary duty; and, d) Family Life Corporation, Investors Life and FICIS have tortiously interfered with existing contracts of Family Life with its policyholders, including the Stock Purchase Agreement and the Administrative Services Agreement. In addition, FICIS has filed, and intends to vigorously prosecute, a counterclaim for amounts due and owing by Family Life for services performed pursuant to the Administrative Services Agreement. See note 9 regarding the sale of Family Life Insurance Company.

Management Conclusion on Legal Proceedings

In the opinion of the Company’s management, it is not currently possible to estimate the impact, if any, that the ultimate resolution of the foregoing legal proceedings will have on the Company’s results of operations, financial position or cash flows. Accordingly, no accrual for possible losses has been recorded in the accompanying consolidated financial statements for such legal proceedings.

Other Litigation

FIC and its insurance subsidiaries are regularly involved in litigation, both as a defendant and as a plaintiff. The litigation naming the insurance subsidiaries as defendant ordinarily involves our activities as a provider of insurance products. Management does not believe that any of this other litigation, either individually or in the aggregate, will have a material adverse effect on the Company’s results of operations, financial position, or cash flows.

9.	Subsequent Events

Sale of Family Life Insurance Company

On December 29, 2006, the Company completed the sale of its wholly owned subsidiary, Family Life Insurance Company to The Manhattan Life Insurance Company ("Manhattan Life"). The cash sales price was $28.0 million, subject to certain post closing adjustments as set forth in the definitive agreement dated December 8, 2006.

Prior to the sale, Family Life owned 648,640 shares of FIC common stock. Such shares are reflected as common treasury stock in the accompanying consolidated financial statements. In conjunction with this transaction, the Company acquired from Family Life 324,320 of these shares and the remaining 324,320 shares remained with Family Life at the time of sale. Also, prior to the closing of the sale, the Family Life Pension Plan, along with its assets and liabilities, was transferred from Family Life Insurance Company to its upstream parent company, Family Life Corporation (“FLC”). FLC is wholly owned by FIC and all current and future obligations of the Family Life Pension Plan are the responsibility of FLC.

In conjunction with the sale, Investors Life also entered into a coinsurance arrangement with Manhattan Life related to sales of certain future insurance products historically marketed by Family Life, such as traditional mortgage protection term life insurance.

At September 30, 2006, Family Life had assets totaling approximately $121.9 million and capital and surplus totaling approximately $16.3 million, as reported on a statutory basis of accounting for insurance regulatory purposes. The GAAP equity basis in Family Life, including other adjustments that affected the determination of loss from the sale, totaled approximately $52 million on the sale date. Accordingly, a GAAP loss of $24.4 million resulted from this sale.

Index

Amendment of Subordinated Loans

FIC and FLC have subordinated notes payable to Investors Life with an unpaid balance of $15.4 million at September 30, 2006 and December 31, 2005. With the approval of the Texas Department of Insurance, the loans were restructured as of March 9, 2006. As amended, the loans provided for a one year moratorium on principal payments for the period from March 12, 2006, to December 12, 2006, with principal payments to resume on March 12, 2007, with ten equal quarterly principal payments until the maturity date of June 12, 2009. These notes have been eliminated in the consolidated financial statements. The Company retired these subordinated notes payable on December 29, 2006 using a portion of the proceeds from the sale of Family Life Insurance Company.

Index

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion addresses the financial condition of Financial Industries Corporation (“FIC”) as of September 30, 2006, compared with December 31, 2005, and its results of operations for the three and nine-month periods ended September 30, 2006, compared with the same period last year. This discussion should be read in conjunction with Management’s Discussion and Analysis included in FIC’s Form 10-K for the year ended December 31, 2005, to which the reader is directed for additional information.

Results of Operations – Three Months Ended September 30, 2006 and 2005

For the three month period ended September 30, 2006, the Company reported net income of $1.3 million (basic and diluted income $0.13 per common share) on revenues of $25.6 million compared to a net loss of $2.5 million (basic and diluted loss of $0.26 per common share) on revenues of $23.9 million for the three month period ended September 30, 2005. The three months ended September 30, 2006 and 2005 include the impact of certain trends and changes in the business of the Company which are dominant in the results of the nine months ended September 30, 2006 and 2005. These items are described in the nine-month results of operations below. Of these results, certain significant items of change between the three months ended September 30, 2006 and 2005 which contribute to an improvement in net income of $3.8 million between periods are as follows:

Increase in net investment income of $528,000 primarily due to increased holdings in fixed maturities and higher interest rates;

Increase in other revenues of $598,000, primarily due to additional fee income resulting from the termination of a coinsurance agreement by an insurance subsidiary of the Company effective June 1, 2006. Under the agreement, the Company had ceded 90% of the risk associated with certain investment annuity policies classified as separate accounts business;

Decline in realized losses of $704,000 primarily due to a $1 million impairment recorded for an investment in a fixed maturity security in 2005;

Decrease in policyholder benefits and expenses of $3.9 million primarily resulting from the decline in the amount of death claims;

Increase in provision for federal income taxes of $1.8 million.

Results of Operations – Nine Months Ended September 30, 2006 and 2005

For the nine-month period ended September 30, 2006, FIC’s net income was $1.3 million (basic and diluted income of $0.13 per common share) on revenues of $76.2 million as compared to net income of $1.0 million (basic and diluted earnings of $0.10 per common share) on revenues of $82.0 million in the first nine months of 2005.

In 2006, FIC’s net income was affected by the following items:

Reduction in earned insurance charges of $1.2 million primarily due to the decline in the cost of insurance charges consistent with the trend of run-off of business;

Increase in net investment income of $3.0 million, primarily due to the effects of higher market interest rates and increased levels of fixed maturity securities investments during the nine months of 2006 compared to the first nine months of 2005;

Reduction in net realized investment gains of $8.1 million, primarily due to the sale of River Place Pointe office complex in 2005;

Increase in other revenues of $1.4 million, principally due to interest received on a federal income tax refund totaling approximately $0.6 million and additional fee income totaling approximately $0.5 million resulting from the recapture of the coinsurance agreement discussed previously;

Decline in policyholder benefits and expenses of $3.1 million, primarily resulting from a decrease in the amount of death benefits;

Decrease in interest on contractholders deposit funds of $1.2 million due primarily to lower funds on deposit;

Decline in operating expenses of $1.0 million;

Increase in provision for federal income tax of $716,000.

The above described items need to be taken into consideration in drawing comparisons between the operating results for the nine months ended September 30, 2006 and 2005.

Index

Revenues

Premium revenues reported for traditional life insurance products are recognized when due. Premium income for the first nine months of 2006, net of reinsurance ceded, was $17.5 million, as compared to $17.9 million in the first nine months of 2005. This source of revenues is related to the traditional life insurance book of business of FIC’s insurance subsidiaries for both first year and renewal premiums.

In accordance with GAAP, deposits received by FIC in connection with annuity contracts and premiums received for universal life (“UL”) insurance policies are reflected in FIC’s financial statements as increases in liabilities for contractholder deposit funds and not as revenues. Earned insurance charges assessed against these deposits are reported as revenue. For the nine months ended September 30, 2006 and 2005, annuity deposits and UL premiums totaled $24.3 million and $25.4 million, respectively.

The decline in UL premiums and annuity deposits reflects the net run-off of business from the Company’s existing book of business, and declining sales of new UL policies. Although the Company is focusing on reversing these trends on an overall basis, management has de-emphasized the sale of annuity and UL products due primarily to the current interest-rate environment and certain design features of FIC’s current annuity products. Most of the Company’s marketing efforts are now focused on the sale of traditional life insurance products, such as mortgage protection term insurance and final expense whole life insurance. Liabilities for contractholder deposit funds have declined from $546.9 million at September 30, 2005 to $520.4 million at September 30, 2006.

Earned insurance charges totaled $29.1 million for the first nine months of 2006, as compared to charges of $30.3 million in the same period of 2005. These revenues primarily consist of UL cost of insurance charges, but also include policy surrender charges, and policy administration charges. The decline in earned insurance charges from 2005 to 2006 is primarily due to reduced UL cost of insurance charges resulting from the net run-off of business.

Net investment income for the first nine months of 2006 was $25.9 million as compared to $22.9 million in the same period of 2005. The increase in net investment income from 2005 to 2006 was primarily attributable to 1) an increase in the income received from the Company’s interest-bearing investments, resulting from increasing interest rates during 2006 and 2) an increase in total investments in fixed maturities, equity securities, and short-term investments compared to the first nine months of 2005, primarily due to reinvestment of real estate sales proceeds into such securities. The Company’s average yield on investments and cash equivalents, excluding real estate, increased approximately 33 basis points over the comparable prior period. The Company’s average holdings of investments and cash equivalents, excluding real estate, increased approximately $28 million over the comparable prior period.

Real estate income was primarily earned from the leases on the buildings at the Company’s River Place Pointe office complex in Austin, Texas. Real estate income (revenues from leases less associated operating expenses and depreciation) was $0 and $563,000 for the nine-month period ended September 30, 2006 and 2005, respectively. In June 2005, the Company sold the River Place Pointe property. Also, as of December 31, 2005, the Company owned three remaining real estate properties held for sale with a total carrying value of $130,000. All three properties were sold in January 2006. Accordingly, the Company no longer has real estate income in 2006.

Net realized investment gains were $502,000 in the first nine months of 2006, as compared to $8.6 million in the first nine months of 2005. The realized gains for 2006 were primarily from the sale of the Company’s remaining real estate properties classified as held for sale, as previously described. The realized gains for 2005 were primarily from the sales of fixed maturity securities and the Company’s River Place Pointe office complex. As described in Note 4 to the accompanying financial statements, the Company recognized a realized gain of $8.5 million in the quarter ended June 30, 2005 from the sale of the River Place Pointe office complex.

Other income was $3.3 million in the first nine months of 2006, as compared to $1.9 million for the same period of 2005. The significant increase in 2006 is primarily due to $573,000 of interest income received on Federal income tax refunds related to prior year amended tax returns, and increases in fee income resulting from the recapture of previously reinsured investment annuity separate account business as described in Note 7.

Index

Benefits and Expenses

Policyholder benefits and expenses, which consist primarily of death benefit claims, were $28.7 million in the first nine months of 2006, as compared to $31.9 million in the first nine months of 2005. The decline in policyholder benefits and expenses in 2006 was primarily attributable to lower death claims.

Interest expense on contractholder deposit funds represents interest paid or credited to contractholders on cash values accumulated in their universal life insurance and annuity accounts. Interest expense totaled $15.4 million in the first nine months of 2006, as compared to $16.6 million in the same period of the year 2005. As discussed previously, the decline in UL premiums and annuity deposits reflects the net run-off of business from the Company’s existing book of business, and consequently the decrease in interest expense in 2006 is primarily attributable to this overall reduction in the level of contractholder deposit funds.

The level of market interest rates can effect the interest spread which is the difference in the Company’s investment portfolio rate and the interest rates credited on policyholder contracts for universal life insurance and annuities. The Company responded to lower market rates in 2004 and 2005 by lowering many of the credited rates on its policies in these periods. However, universal life insurance and annuity policies have contractual minimum guaranteed rates and credited rates cannot be lower than such minimums. Because many of the Company’s policies have minimum guaranteed rates of 4.0%, the market interest rate environment in prior periods put pressure on the Company’s interest spread. Market rate increases in 2005 and 2006 have improved the Company’s interest spread.

Amortization of deferred policy acquisition costs (DAC) for the first nine months of 2006 was $6.5 million, as compared to $7.7 million in the same period in 2005. These expenses represent the amortization of the costs of producing new business, which consists primarily of agents’ commissions and certain policy issuance and underwriting costs. For traditional life insurance business, DAC is amortized over the estimated premium-paying period of the policies in proportion to annual premium revenue. For interest sensitive products, these costs are amortized in relation to the estimated annual gross profits of the policies. The level of policy lapses and surrenders can also have a significant impact on the amount of amortization, which was experienced in the second quarter of 2006. Lower policy lapses and surrenders for certain blocks of traditional life business resulted in the reduced amortization.

Present value of future profits of acquired business (PVFP) is amortized in a similar manner as DAC, as previously described, for acquired traditional and interest sensitive business. Amortization of PVFP totaled $1.7 million and $2.0 million for the nine months ended September 30, 2006 and 2005, respectively. The amortization is consistent with the run-off of the acquired blocks of business.

Operating expenses for the first nine months of 2006 were $20.8 million, as compared to $21.8 million in the first nine months of 2005. The Company has implemented many cost reduction measures in 2004 and 2005, as well as 2006, and this continues to be a critical focus for the Company. However, audit, actuarial, accounting and other consulting, and legal expenses continue to represent a significant component of operating expenses as the Company completes its delinquent SEC filings with a target of becoming current on all filings at the end of the second quarter of 2007. These fees totaled approximately $7.3 million and $5.5 million for the nine months ended September 30, 2006 and 2005, respectively.

Interest expense was $1.0 million and $829,000 for the nine months ended September 30, 2006 and 2005, respectively. The interest expense relates to debt service on $15 million aggregate principal amount of floating rate Senior Notes due 2033 (the “Senior Notes”). The Senior Notes bear interest quarterly at the three-month LIBOR rate plus 4.2%. The higher interest expense in 2006 is a direct result of the increase in the LIBOR rate.

Taxes

The provision for federal income taxes on loss from operations, before cumulative effect of change in accounting principles, reflects tax provisions totaling $859,000 and $143,000 for the nine months ended September 30, 2006 and 2005, respectively. These tax amounts equate to effective tax provision rates of 40.7% and 12.3% for the nine months ended September 30, 2006 and 2005, respectively. The primary reason for the deviation from the expected statutory tax rate of 34% for the Company is due to increases in the valuation allowance for deferred tax assets. Deferred income tax assets are subject to ongoing evaluation of whether such assets will be realized. Realization of deferred tax assets is dependent upon the Company's generation of sufficient taxable income in the future to recover tax benefits that cannot be recovered from taxes paid in prior periods. If future taxable income is not expected, the Company establishes a valuation allowance, when based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. The Company’s deferred tax assets are primarily comprised of net operating losses of FIC and its non-life insurance subsidiaries.

Index

Liquidity and Capital Resources

Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. FIC is an insurance holding company whose principal assets consist of its insurance subsidiaries - Family Life Insurance Company (“Family Life”) and Investors Life Insurance Company of North America (“Investors Life”). As a holding company, FIC’s ability to pay interest and principal on its debt, pay its expenses, and pay dividends on its common stock depend substantially upon its receipt of dividends or other cash flow from these subsidiaries.

Liquidity management is designed to ensure that adequate funds are available to meet all current and future financial obligations. The Company meets its liquidity requirements primarily by funding cash used in operations with cash flows provided by investing activities. Proper liquidity management is crucial to preserve stable, reliable, and cost-effective sources of cash to meet the future benefit payments under our various insurance and deposit contracts, pay operating expenses (including interest and income taxes), and maintain reserve requirements. In this process, we focus on our assets and liabilities, and the impact of changes in both short-term and long-term interest rates, market liquidity and other factors. We believe we have the ability to generate adequate cash flows to fund obligations as they come due.

At the holding company level, FIC’s principal current ongoing liquidity demands relate to the payment of principal and interest on its indebtedness. As of September 30, 2005, Investors Life held $15.4 million of notes receivable from the Company (the “Affiliated Notes”) with quarterly interest payments at an annual rate of 5%. Although this intercompany indebtedness is eliminated on FIC’s condensed consolidated balance sheets, it creates a debt service requirement at the holding company level.

With the approval of the Texas Department of Insurance, the Affiliated Notes were restructured as of March 9, 2006. As amended, the loans provide for a one year moratorium on principal payments for the period from March 12, 2006, to December 12, 2006, with principal payments to resume on March 12, 2007, with ten equal quarterly principal payments until the maturity date of June 12, 2009. As previously described in Note 9 of the accompanying financial statements, the Company retired the Affiliated Notes on December 29, 2006, using a portion of the proceeds from the sale of Family Life Insurance Company.

The holding company’s other principal liquidity requirement is debt service on the $15 million of Senior Notes. These notes require quarterly interest payments at a variable interest rate of the three-month LIBOR rate plus 4.2%. The principal amount of the Senior Notes must be repaid in a single payment in 2033.

In addition to these debt service requirements, the holding company must pay its expenses in connection with Board of Directors fees, insurance costs, corporate overhead, certain audit and accounting fees, and legal and consulting expenses as incurred. The holding company has not paid any dividends to its shareholders since early in 2003, and management does not anticipate the payment of such dividends in the near future.

In June 2004, FIC, with the approval of the Texas Department of Insurance, formed a service company subsidiary and transferred to it many of the administrative functions of the insurance companies. The new service company charges each insurance company a monthly service fee that is calculated using a formula based on policies under management, new policies issued, managed assets, and other factors. Profits earned by the service company are paid as dividends to the holding company, providing an additional source of liquidity at the holding company level.

The ability of Family Life and Investors Life to pay dividends to FIC and help meet these holding-company liquidity demands is subject to restrictions set forth in the insurance laws and regulations of Texas, its domiciliary state. Texas limits how and when Family Life and Investors Life can pay such dividends by (a) including the “greater of" standard for payment of dividends to shareholders and (b) requiring that prior notification of a proposed dividend be given to the Texas Department of Insurance. Under the “greater of" standard, an insurer may pay a dividend in an amount equal to the greater of: (i) 10% of the capital and surplus or (ii) the insurer's net gain from operations for the previous year.

Liquidity considerations at FIC’s insurance subsidiaries are different in nature than for the holding company. Sources of cash for FIC’s insurance subsidiaries consist of premium payments and deposits from policyholders and annuity holders, charges on policies and contracts, investment income, and proceeds from the sale of investment assets. These funds are applied primarily to provide for the payment of claims under insurance and annuity policies, payment of policy withdrawals, surrenders and loans, operating expenses, taxes, investments in portfolio securities, and shareholder dividends.

A primary liquidity consideration with respect to life insurance and annuity products is the risk of early policyholder and contractholder withdrawal. Deposit fund liabilities for universal life and annuity products as of September 30, 2006 were $520.4 million, compared to $542.2 million at December 31, 2005. Individual life insurance policies are less susceptible to withdrawal than are annuity contracts because life insurance policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. At September 30, 2006, the bulk of the liabilities for contractholder deposit funds on FIC’s balance sheet, $367.5 million, represented insurance products, as compared to $152.9 million of annuity product liabilities.

Index

Since each insurance company holds large portfolios of highly liquid publicly traded debt securities, raising cash through asset sales is available should other sources of liquidity fail to provide cash as needed. In this regard, however, the insurance companies must be concerned about such sales at inopportune times, when adverse movements in interest rates may have depressed the market price of securities so that sales would result in the realization of significant losses. To guard against such an outcome, FIC’s management monitors benefits paid and surrenders of insurance products to provide projections of future cash requirements. Also as part of this monitoring process, FIC performs cash flow testing of assets and liabilities at each year-end to evaluate the match between the planned maturities of the insurance company assets and the likely liquidity needs of the companies over time. Such cash-flow testing, prescribed by insurance laws and regulations, models the likely performance of assets and liabilities over time, using a wide variety of future interest rate scenarios.

There can be no assurance that future experience regarding benefits and surrenders will be similar to the historic experience on which such cash-flow testing is based, since withdrawal and surrender levels are influenced by such factors as the interest-rate environment and general economic conditions as well as the claims-paying and financial strength ratings of FIC’s insurance subsidiaries.

Cash and cash equivalents at September 30, 2006 were $7.4 million compared to $63.6 million at December 31, 2005. The $56.2 million decrease in cash and cash equivalents at September 30, 2006 from December 31, 2005 was due primarily to reinvestment of cash into fixed maturity securities and short-term investments. This was partially offset by the net payout of contractholder deposits and use of cash by operations.

Net cash used in operating activities was $4.5 million for the nine month period ended September 30, 2006, compared to $6.1 million for the same period of 2005. The decrease in cash used by operating activities of $1.5 million from 2005 to 2006 was primarily attributable to the change in net realized gains in investments as a result of the sale of the River Place Pointe office complex, agent advances and other receivables, policy liabilities and accruals and deferred income taxes.

Net cash used in investing activities was $32 million in the nine month period ended September 30, 2006, compared to $68.6 million provided by investing activities for the same period of 2005. The cash provided by investing activities in 2005 was due primarily to proceeds received from the sale of the River Place Pointe office complex in 2005. Most of this cash was then reinvested in fixed maturities and short-term investments in 2006.

Net cash used in financing activities was $19.7 million in the first nine months of 2006, compared to cash used in financing activities of $27.6 million in the first nine months of 2005. The most significant components of the Company’s financing activities are contractholder fund deposits and withdrawals for annuity and universal life insurance policies. For the nine months ended September 30, 2006 and 2005, contractholder fund withdrawals exceeded deposits by $19.7 million and $27.6 million respectively. The change in net withdrawals in 2006 is due to a decline in deposits in 2006 from 2005 of $1.1 million and a decrease in withdrawals of $9.0 million for the same period.

In light of the information and considerations outlined above, management believes at this time that the liquidity of FIC and its subsidiaries is sufficient to meet the needs of its business, including its debt service requirements.

Financial Condition

During the nine months ended September 30, 2006, the equity of the shareholders of the Company (that is, the excess of the Company’s assets over its liabilities) declined by $1.4 million. The primary changes resulting in the net decrease to shareholders’ equity are detailed as follow:

•

Net income for the nine months of $1.3 million;

•

$2.8 million increase in accumulated other comprehensive loss from the change in net unrealized losses on investments in fixed maturity securities available for sale.

Assets

The Company’s life insurance subsidiaries have investment management agreements with Conning Asset Management (“Conning”). Under these agreements, Conning manages the investment security portfolios of the Company’s life insurance subsidiaries in accordance with investment policies set by the Company’s Board of Directors. The investment policies comply with legal requirements of state insurance laws and regulations that are applicable to the Company’s insurance company subsidiaries. They also emphasize sensitivity to the way that FIC’s liabilities are likely to change over time and with changes in general interest rate levels. In practical terms, this means that the Company focuses almost all of its investment in investment-grade securities, keeping the schedule of anticipated asset maturities in line with its projected cash needs. It also means that the Company attempts to keep the duration of its investment assets (a measure of the sensitivity of their value to changes in interest rates) in line with the duration of the Company’s liabilities.

~~results of operations, capital and cash requirements, future prospects, regulatory restrictions on the payment of dividends, as well as other factors deemed to be relevant by the Board of Directors.~~Index

8Over the past several years, the Company has decreased its investment in mortgage-backed securities (including asset-backed securities) significantly. ~~Acquisition~~ This trend continued into 2006. Expressed as a percentage of ~~Subsidiaries~~its total investment in fixed maturities, these ratios were 24.4% and ~~Related~~22.1% ~~Transactions~~at December 31, 2005 and September 30, 2006 respectively. Such securities are sensitive to changes in prevailing interest rates, since interest rate levels affect the rate at which the underlying mortgage obligations are repaid. FIC’s insurance subsidiaries have reduced the risk of prepayment associated with mortgage-backed securities by investing in planned amortization class (“PAC”), target amortization class (“TAC”) instruments and scheduled bonds. These investments are designed to amortize in a predictable manner by shifting the risk of prepayment of the underlying collateral to other investors in other tranches (“support classes”) of the CMO.

~~The~~During the ~~Company~~first ~~acquired~~nine ~~Paragon~~months ~~Benefits,~~of ~~Inc.~~2006, ~~The~~net ~~Paragon~~unrealized ~~Group,~~losses ~~Inc.,~~on ~~Paragon~~fixed ~~National,~~maturities available ~~Inc.,~~for ~~Total~~sale ~~Consulting~~increased ~~Group, Inc~~$2.,8 ~~and JNT Group, Inc~~million. The ~~(collectively~~increase ~~the “New Era companies”)~~ in ~~June,~~unrealized losses ~~2003,~~was ~~for~~primarily ~~approximately~~related ~~$4.2~~to ~~million~~increases in ~~cash and 47,395 shares of FIC common stock with a fair~~ market ~~value of $646,000 which were distributed from treasury shares in June 2003~~interest rates. The ~~New~~Company’s ~~Era~~general ~~companies~~investment ~~consulted~~philosophy inis ~~the design of planned benefit programs for secondary school systems, provided administrative services for the related plans, insurance brokerage services~~ to ~~plan~~hold ~~participants,~~fixed maturities ~~and investment advisory services~~ for ~~such~~long-term ~~plans and other clients~~investment. ~~In connection with the acquisition~~ Accordingly, the ~~six~~Company ~~principals~~has of the ability ~~New~~and ~~Era~~intent ~~companies~~to ~~entered~~hold ~~into~~securities ~~three-year~~to ~~and~~maturity ~~five-year~~or ~~employment~~until ~~agreements under which~~ they ~~would~~recover ~~receive FIC stock, with a market~~ in value ~~of approximately $2~~.~~4 million on the date of the agreements, during the term of their employment.~~ The ~~purchase~~Company ~~price~~does ofnot ~~the~~currently ~~New~~anticipate ~~Era companies and~~ the ~~grants~~need ~~of stock pursuant~~ to ~~the~~sell securities ~~employment~~in ~~contracts~~unrealized ~~were~~loss ~~not~~positions ~~tied~~for toliquidity ~~the future performance of the New Era companies~~purposes.

~~The~~FIC’s equity ~~purchase~~securities ~~price~~consist ~~paid~~primarily ~~for~~of ~~the~~its ~~New~~investment ~~Era~~in ~~companies~~the ~~(including~~investment ~~transaction~~funds underlying ~~fees~~the ~~and~~separate ~~excluding~~accounts ~~contingent~~business ~~consideration amounts accounted for as compensation as described above) was $4.9 million. The acquisition~~ of ~~the~~Investors ~~New~~Life ~~Era~~Insurance ~~companies was accounted for in accordance with Statement~~ Company of North ~~Financial~~America ~~Accounting Standards No. 141, “Business Combinations”~~ (“~~SFAS~~Investors ~~No. 141~~Life”). ~~This~~However, ~~statement~~during ~~required~~2005, ~~that FIC estimate~~ the ~~fair~~Company ~~value~~increased its ofequity ~~assets~~securities ~~acquired~~holdings ~~and~~by ~~liabilities~~investing ~~assumed~~$2.0 asmillion ofin ~~the~~a ~~date~~corporate ofbond mutual ~~the~~fund ~~acquisition~~as ~~and~~part ~~allocate~~of ~~the~~a ~~purchase~~strategy ~~price~~ to ~~those~~increase ~~assets~~diversification and ~~liabilities.~~enhance overall ~~The~~investment ~~purchase~~performance. ~~price~~As ~~was~~of ~~allocated~~September ~~as follows: $116~~30,~~000~~ ~~to cash~~2006, ~~$158,000~~the tomarket ~~agency~~value of FIC’s ~~advances~~equity ~~and~~securities ~~other~~was ~~receivables,~~ $~~288,000~~11.3 ~~to property~~million, ~~plant~~compared ~~and equipment, $28,000~~ to ~~other assets,~~ $~~182,000 to other liabilities, and $4~~10.59 million toat ~~goodwill~~December 31, ~~and other intangibles (included in other assets)~~2005.

~~The~~FIC’s real ~~performance~~estate ofinvestment ~~the~~was ~~New~~primarily ~~Era~~related ~~companies~~to ~~after~~ the ~~acquisition~~River ~~was~~Place ~~substantially~~Pointe ~~below~~office complex ~~expectations~~(“River ~~and~~Place ~~after~~Pointe”) ~~reviewing~~owned ~~their~~by ~~long-term~~Investors ~~prospects~~Life. ~~the~~At ~~Company~~March ~~determined~~31, to2005, ~~sell~~FIC’s investment ~~them~~totaled $89.8 Onmillion ~~December~~in 31this 600,000 ~~2003~~sq. ft., ~~the~~seven-building ~~New~~office complex ~~Era~~on ~~companies~~48 ~~were~~acres ~~sold~~in toAustin, ~~five~~Texas. ofFIC ~~the~~and ~~original~~its ~~principals~~insurance ~~for~~company ~~nominal~~subsidiaries occupied ~~consideration~~one ~~and~~of the ~~cancellation~~seven buildings. Three of ~~their~~the ~~employment~~other ~~agreements.~~buildings ~~(The~~were substantially ~~employment~~leased, ~~contract~~but ofthree ~~the~~buildings ~~sixth~~remained ~~principal~~vacant ~~was~~as ~~terminated~~of ~~earlier~~March in31, ~~2003~~2005.) The Inproject ~~connection~~was ~~with~~sold ~~these~~in ~~cancellations~~June 2005, ~~the~~in ~~five~~a ~~principals~~cash ~~each~~transaction, ~~received~~for $103 million. The Company realized a ~~payment~~gain of $10~~,000~~.6 ~~from~~million on the ~~Company~~sale, ~~and~~which ~~the~~included ~~FIC~~both ~~common~~a realized ~~stock~~gain ~~granted~~of ~~pursuant~~$8.5 tomillion ~~those~~recorded ~~agreements,~~in ~~with~~2005 and a ~~market~~deferred ~~value~~gain of ~~approximately~~ $2.1 million atto ~~December~~be recognized as a reduction of office lease expenses over the period from the sale date through March 31, ~~2003,~~2008. ~~reverted~~The deferred gain represents an amount equal to the estimated excess rent to be paid under the lease agreement through March 31, 2008 over the prevailing rate at the time of sale. The Company’s remaining real estate properties held for sale totaling $130,000 at December 31, 2005, were sold in January, 2006.

~~The~~Agency advances ~~loss~~and ~~from~~other ~~operations~~receivables oftotaled ~~the~~$13.3 ~~New~~million ~~Era~~and ~~companies~~$8.2 ~~for~~million ~~the~~at September ~~period~~30, ~~from~~2006 ~~acquisition~~and ~~through~~ December 31, ~~2003~~2005, ~~was~~respectively. The $15.21 million. increase ~~The~~was ~~Company~~primarily ~~also~~due ~~incurred~~to a ~~loss~~receivable ofrelated ~~$4.9~~to ~~million~~a onsecurities ~~the~~transaction, where ~~sale~~a ofsecurity ~~the~~matured ~~New~~at ~~Era~~quarter ~~companies.~~end ~~These~~but ~~losses and~~ the ~~aggregate~~cash ~~$50,000~~was innot ~~cancellation~~received ~~payments to the principals~~until ~~totaled~~ after ~~$6.1~~September ~~million~~30, ~~which~~2006, ~~was~~thereby ~~recorded~~resulting asin athe ~~loss~~receivable ~~from~~balance. ~~discontinued~~This increase ~~operations~~was inpartially ~~the~~offset ~~consolidated~~by ~~statement~~a ofreduction ~~operations~~in ~~for~~current ~~the~~federal ~~year~~income ~~ended December 31, 2003~~taxes receivable.

Investors Life had $341.8 million of separate account assets as of September 30, 2006 (not including the value of the Company’s own investment in one of the accounts), as compared to $342.9 million at the end of 2005. ~~New~~ ~~Accounting~~These ~~Pronouncements~~assets include (a) two variable annuity separate accounts that permit contractholders to allocate their contract values among a selection of third-party mutual funds and (b) assets held in custodian accounts in connection with investment annuity contracts. The investment annuity business is reinsured with Symetra Life Insurance Company (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10% coinsurance basis, with Investors Life retaining 10% of such business. Since the reinsurance treaty is on a coinsurance basis, Investors Life is contingently liable to the policyholders in the event that the reinsurer is unable to fulfill its obligations under the treaty. Investors Life is not marketing new separate account annuity contracts.

InEffective June ~~December 2004~~1, ~~the FASB issued SFAS No. 123(R)~~2006, ~~“Share-Based~~Investors ~~Payment.”~~Life ~~SFAS 123(R)~~recaptured ~~is a revision of SFAS 123, “Accounting for Stock-Based Compensation,” which was originally issued by~~ the ~~FASB~~previously inreinsured ~~1995.~~investment annuity Asbusiness ~~originally issued, SFAS 123 provided companies~~ with ~~the~~Symetra ~~option~~Life toresulting ~~either~~in ~~record expense for share-based payments under a fair value model, or to simply disclose~~ the ~~impact~~retention of ~~the~~100% ~~expense~~of this business. ~~SFAS 123(R)~~The ~~requires~~Company ~~companies~~expects ~~to measure~~ the ~~cost~~recapture of ~~share-based~~this ~~payments~~previously reinsured business to ~~employees~~increase ~~using~~revenues ain ~~fair~~2006 ~~value model,~~ and tofuture ~~recognize that cost over the relevant service period~~years. ~~In addition~~However, ~~SFAS 123(R) requires that an estimate of future award forfeitures be made at the grant date, while SFAS 123 permitted recognition of forfeitures on an~~ as ~~incurred~~this ~~basis. This statement~~ is ~~effective for all awards granted, modified, repurchased, or cancelled after June 15, 2005,~~ ~~and,~~ a closed asblock aof ~~result~~business, the ~~Company~~revenues ~~will~~are ~~adopt SFAS 123(R) beginning January 1, 2006. The adoption of this statement is not~~ expected to ~~have~~decrease aas ~~material impact on~~ the ~~Company’s~~policies in ~~consolidated~~force ~~financial statements~~decline.

In May 2005, the FASB issued SFAS No. 154 “Accounting Changes and Error Corrections- A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” This Statement changes the requirements for the accounting for and reporting of a change in accounting principle. Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement. When

it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable.Index

This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS No. 154 carries forward without change the guidance contained in APB Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. This statement is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005, with earlier adoption permitted. As a result, and due to the restatement included within the accompanying 2003 consolidated financial statements, the Company adopted SFAS No. 154 for the correction of errors reported after December 31, 2005. Liabilities

In September 2005, the American Institute of Certified Public Accountants (“AICPA”), issued Statement of Position (“SOP”) 05-01, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts.” The Company’s ~~SOP 05~~insurance-01related ~~provides~~liabilities ~~guidance~~(future onpolicy ~~accounting~~benefits ~~by insurance enterprises for deferred acquisition costs on internal replacements of insurance~~ and contractholder ~~investment~~deposit ~~contracts other than those specifically described in Statement of Financial Accounting Standards (“SFAS”~~funds) ~~97,~~were ~~“Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and For Realized Gains and Losses from the Sale of Investments~~$674.~~” The~~2 ~~SOP~~million ~~05-01~~at ~~defines~~September ~~an internal replacement as a modification in product benefits~~30, ~~features~~2006, ~~rights, or coverages that occurs by the exchange of a contract for a new contract, or by~~ ~~amendment,~~ compared ~~endorsement, or rider~~ to ~~a contract, or by the election of a feature or coverage within a contract~~$698. ~~The~~2 ~~SOP~~million ~~05-01~~at ~~is effective for internal replacements occurring in fiscal years beginning after~~ December 1531, ~~2006, with earlier adoption encouraged~~2005. The ~~Company~~decrease ~~has~~in ~~not~~these insurance-related ~~completed~~liabilities anreflects ~~assessment of~~ the ~~estimated~~business ~~impact of SOP 05~~run-01off onas ~~its consolidated financial statements~~previously described.

InDeferred federal ~~June~~income ~~2006,~~taxes ~~the~~at ~~FASB~~December ~~issued FASB Interpretation (“FIN”) No. 48~~31, ~~Accounting~~2005 ~~for~~reflected ~~Uncertainty~~a innet ~~Income~~liability ~~Taxes - an interpretation~~ of ~~FASB Statement No~~ $687,000. This ~~109~~deferred ~~(“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a~~ tax position ~~taken~~changed ~~or expected~~ to ~~be taken in~~ a ~~tax~~net ~~return.~~liability ~~FIN 48 also provides guidance on derecognition~~of $413,000 ~~classification,~~at ~~treatment~~September ~~of interest and penalties~~30, ~~and disclosure of such positions~~2006. This ~~FIN~~significant 48change ~~will~~in bedeferred taxes ~~applied~~was ~~prospectively~~primarily ~~and~~due ~~will~~to betax ~~effective~~benefits ~~for~~associated ~~fiscal~~with ~~years~~unrealized ~~beginning~~losses ~~after December 15, 2006. The~~ on the Company’s isfixed ~~currently~~maturity ~~evaluating~~securities ~~the~~portfolio, ~~impact~~resulting offrom ~~FIN~~increases 48in market ~~and~~interest ~~does~~rates ~~not~~during ~~expect adoption to have a material impact on~~ the ~~Company’s~~first ~~consolidated~~nine ~~financial~~months ~~statements~~of 2006.

In September, 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 will be applied prospectively and is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. SFAS 157 is not expected to have a material impact on the Company’s consolidated financial statements.Capital Adequacy

InFinancial intermediaries ~~September,~~such ~~2006,~~as ~~the~~FIC ~~FASB~~depend ~~issued~~on ~~SFAS~~their ~~No.~~equity ~~158,~~capital ~~“Employers’~~to ~~Accounting~~absorb ~~for~~short-term fluctuations ~~Defined~~in ~~Benefit~~asset ~~Pension~~ and ~~Other~~liability ~~Postretirement~~values ~~Plans,~~in antheir ~~amendment~~financial ofstructures. ~~FASB~~They also ~~Statements~~count ~~No.~~on ~~87,~~equity ~~88,~~capital ~~106,~~to ~~and~~support ~~132(R)”~~the growth of the business. ~~Under~~ ~~this~~One ~~new~~typical measure ~~standard,~~of ~~companies~~the ~~must~~strength ~~recognize~~of a ~~net~~financial ~~liability~~holding orcompany ~~asset~~such toas ~~report~~FIC is the ~~funded~~simple ratio ~~status~~ of ~~their~~its ~~defined~~shareholders’ ~~benefit~~equity ~~pension~~to ~~and~~its ~~other~~total ~~postretirement~~assets. ~~benefit~~For ~~plans~~FIC onthis ~~their~~ratio ~~balance~~was ~~sheets. The~~7% at ~~effective~~September ~~date~~30, of2006 ~~the~~and ~~recognition~~December ~~and~~31, ~~disclosure~~2005. ~~provisions~~If ~~for~~separate ~~calendar-year~~account ~~public~~assets ~~companies~~were not included (which management believes is ~~for~~appropriate) ~~calendar~~this ~~years~~ratio ~~ending~~would ~~after~~have ~~December~~been higher ~~15,~~by ~~2006. The~~3% ~~Company~~and is2.9% ~~currently~~at ~~evaluating~~September ~~the~~30, ~~impact~~2006 ofand ~~this~~December ~~new~~31, ~~standard~~2005, ~~but~~respectively. Management itbelieves isthat ~~not~~its ~~expected~~current toequity ~~have~~capital ais ~~significant~~sufficient ~~effect~~to onmeet the Company’s ~~consolidated~~current ~~financial~~liabilities ~~statements~~and ~~for~~to ~~the~~fund ~~year~~growth ~~ending~~at ~~December~~currently ~~31, 2006~~planned levels.

10Insurance companies are subject to regulation under state law. ~~Commitments~~ Among other requirements, these state laws and ~~Contingencies~~regulations impose capital adequacy requirements on insurance companies. Using a calculation that takes into account the quality, liquidity, maturities, and amounts of its assets and liabilities, each insurance company is required to calculate its “risk-based capital” (or “RBC”). Total adjusted capital must exceed 200% of the authorized control level RBC to avoid supervisory activity by the insurance regulators. As of December 31, 2006, the total adjusted capital of Investors Life was approximately 584% of its authorized control level risk-based capital.

~~Mitte~~State regulators ~~Settlement~~also use NAIC IRIS ratios to monitor capital adequacy requirements. The NAIC ratios cover 12 categories of financial data with defined “usual” ranges for each such category. The ratios are intended to provide insurance regulators with “early warnings” as to when a company might warrant special attention. An insurance company may fall outside of the usual range for one or more ratios, and such variances may result from specific transactions that are, by themselves, immaterial or eliminated at the consolidation level. In certain states, insurers with more than three IRIS ratios outside of the NAIC usual ranges may be subject to increased regulatory oversight. For 2006 Investors Life had four ratios which were outside the usual ranges, which were primarily related to changes in investment income and changes in premium, product mix, and reserving. The ratios were outside the usual ranges primarily due to a recapture of ceded reinsurance by Family Life from Investors Life during 2006. This recapture occurred prior to the sale of Family Life. For statutory accounting purposes, the recapture affected premium income and change in policy reserves which caused ratios to fall outside the usual ranges. Excluding the effects of the reinsurance recapture, Investors Life would have had only one ratio outside the usual ranges, which related to investment income.

~~In 2002, the Company filed a lawsuit against Roy F~~ITEM 3. ~~Mitte~~QUANTITATIVE ~~(“Mitte”),~~AND ~~The~~QUALITATIVE ~~Roy~~DISCLOSURES F.ABOUT and Joann Cole Mitte Foundation (the “Foundation”), and Joann Mitte (collectively referred to as the “Defendants”). Mitte was the Chairman, President and Chief Executive Officer of FIC until he was placed on administrative leave in August, 2002. The administrative leave, and the subsequent action by the Board of Directors in October, 2002, to terminate the employment agreement between the Company and Mitte, resulted from an investigation conducted by the FIC Audit Committee. Subsequent to the filing of the lawsuit, Mitte filed a counterclaim against the Company alleging that the Company breached the employment agreement between the Company and Mr. Mitte by refusing to pay Mitte the severance benefits and compensation provided for under the employment agreement and amended thereto.MARKET RISK

~~On May 15, 2003, the Company entered into a settlement agreement with the Defendants and Scott Mitte (a director of the~~ General

FIC’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, principally interest yields 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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 that 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 that 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.

Company and the son of Roy Mitte) (the “Mitte Parties”). Under the terms of the agreement the Mitte Parties released the Company from any past, present or future claims which they may have against the Company, including any claims which Roy Mitte may assert under his employment agreement. In addition, the Company agreed to release the Mitte Parties from any past, present or future claims which the Company may have against the Mitte Parties. Index

The settlement provides for payments aggregating $3 million by the Company to Roy Mitte in equal installments of $1 million on June 1, 2003, June 1, 2004 and June 1, 2005, with a provision for acceleration of payments in the event of a change in control. The settlement agreement also includes provisions whereby, the Company agrees (i) to use reasonable efforts to locate purchasers over a twoInterest-year period for 1,552,206 shares of FIC common stock owned by the Foundation at a price of $14.64 per share, (ii) to purchase (or, alternatively, locate a purchaser) on or before June 1, 2003 for 39,820 shares of FIC common stock owned by Roy Mitte and 35,502 shares of common stock held in the ESOP account of Roy Mitte, at a price of $14.64 per share. The agreement also includes provisions related to the continuation of health insurance of Roy and Joann Mitte and payment for the cancellation of options held by Roy Mitte toRate purchase 6,600 shares of FIC common stock. The Company has recognized a charge of $2.9 million in 2003 for the discounted amounts to be paid under the settlement agreement, which is reflected in the consolidated statement of operations for the nine months ended September 30, 2003, as litigation settlement. Risk

~~As a condition of the obligations of the~~ The Company ~~under~~manages the ~~settlement~~interest-rate ~~agreement,~~risk ~~the~~inherent ~~Mitte~~in ~~Parties~~its ~~agreed~~fixed tomaturity ~~grant~~assets relative ~~a limited proxy~~ to the ~~persons~~interest-rate ~~named~~risk asinherent ~~proxies by FIC~~ in ~~any~~its ~~proxy statement filed by FIC with the SEC~~liabilities. ~~With~~Generally, we manage ~~respect~~interest-rate torisk ~~the~~based ~~future~~on ~~shareholders meetings,~~ the ~~proxy~~application ~~may~~of bea ~~voted~~commonly ~~“for”~~used ~~all~~model. The model ~~nominees~~projects ~~for~~ the ~~Board~~impact of ~~Directors~~interest ~~named~~rate changes on ~~FIC’s proxy statement, “against” any proposal by~~ a ~~person~~range ~~other than FIC for the removal~~ of ~~any~~factors, including ~~members~~duration ofand ~~the~~potential ~~Board~~prepayment. ofFor ~~Directors~~example, ~~“withheld”~~assuming asan toimmediate increase ~~nominees for the Board~~ of ~~Directors~~100 ~~proposed~~basis bypoints ~~any~~in ~~person~~interest ~~other~~rates, ~~than~~the ~~FIC~~net ~~and~~hypothetical ~~“against”~~loss ~~any~~in fair ~~proposal~~market byvalue ~~any~~related ~~person~~to ~~other~~the ~~than~~financial ~~FIC~~instruments toincluded ~~amend~~in the ~~bylaws~~Company’s condensed orconsolidated ~~articles~~balance ofsheets ~~FIC.~~is ~~The~~estimated ~~proxy also extends~~ to ~~certain matters which may~~ be ~~proposed~~$31.1 bymillion ~~FIC~~ at September ~~the 2004 annual meeting of shareholders~~30, or2006 ~~any~~and ~~later~~$26.6 ~~annual~~million orat ~~special~~December ~~meeting~~31, ~~regarding~~2005. ~~changes~~For inpurposes of the ~~ownership percentage required in~~ ~~order~~ foregoing ~~for~~estimate, afixed ~~shareholder~~maturity tosecurities ~~call~~available afor ~~special~~sale ~~meeting of shareholders~~ and ~~the~~short-term investments ~~elimination~~were oftaken ~~cumulative~~into ~~voting~~account. The ~~granting~~fair ofvalue ~~the proxy is generally conditioned upon the performance~~ of ~~the~~such ~~scheduled~~assets ~~purchases~~was of$624.0 million ~~the~~at ~~shares~~September of30, ~~FIC~~2006 ~~common~~and ~~stock~~$595.0 ~~owned~~million byat ~~the~~December ~~Foundation~~31, 2005.

TThe fixed income investments of the Company include certain mortgage-backed securities (excluding asset backed securities). ~~David~~The ~~Porter~~market vvalue of such securities was $134.4 ~~Financial~~million ~~Industries~~at ~~Corporation~~September 30, 2006 and $145.5 million at December 31, 2005. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in the fair value related to such mortgage-backed securities is estimated to be $10.4 million at September 30, 2006 and $10.7 million at December 31, 2005.

OnSeparate account ~~May~~assets ~~31,~~have 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis County, Texas District Court (the “Court”), against the Company. The suit alleges that the Company refuses to hold a shareholder meeting because FIC is currently unable to comply with Rule 14a-3 of the Securities Exchange Act of 1934. The Company claims that because FIC is not currently in a position to solicit proxies in connection with an annual meeting, or to provide an annual report to its shareholders, FIC does not believe it is currently able to hold an annual shareholders’ meeting at which its shareholders will be fully informed or represented. The suit is brought under Article 2.24(B) of the Texas Business Corporation Act, which states that if an annual meeting of shareholders is not held within any 13-month period and a written consent of shareholders has not been ~~executed instead of a meeting~~included, ~~any court~~since ofgains competent jurisdiction in the county in which the principal office of the corporation is located may, on the application of any shareholder, summarily order a meeting to be held. Mr. Porter is asking the Court to compel the Company to have a shareholder meeting; to order FIC to send notice of the meeting to the Company’s shareholders at its expense; to order the Company to provide Mr. Porter with a list of shareholders as of the record date for the meeting, and ~~for~~losses ~~costs and attorney’s fees. The Company filed its answer~~ on ~~June~~those 30, 2006. On July 18, 2006, plaintiffs filed a motion to compel an annual shareholders meeting. On August 7, 2006, the Company entered into an Agreed Order On Plaintiff’s Motion to Compel Annual Shareholders Meeting (the “Order”) and agreed (1) to hold an annual shareholders meeting for the election of directors on December 6, 2006, even if the Company has not filed all relevant financial statements with the SEC or whetherassets ~~management~~ generally isaccrue ~~able~~ to ~~solicit proxies for~~ the ~~meeting; (2) that the record date for the annual shareholders meeting shall be October 24, 2006 (the “Record Date”); (3) that on or before October 27, 2006, the Company shall serve Mr~~policyholders. Porter with a complete list of shareholders as of the Record Date and (4) in the event that the Board of Directors of FIC, between the date of the Order and the December 6, 2006 annual meeting, votes to sell either or both of FIC’s life insurance subsidiaries without first obtaining approval of FIC’s shareholders, FIC will announce such impending transaction to the public through a Form 8-K filed with the SEC, and will agree to allow Mr. Porter a reasonable amount of expedited discovery prior to the closing of such transaction(s) so that Mr. Porter may determine whether or not to seek a restraining order or temporary injunctive relief preventing the closing of such transaction(s). In such event, Mr. Porter will also appear for deposition by the Company’s counsel, at a mutually agreeable time and place prior to any hearing on an application for restraining order or temporary injunctive relief.

~~Litigation~~The Company ~~with~~generally ~~Otter~~does ~~Creek~~not ~~Partnership~~use I,derivative Lfinancial instruments to manage its exposure to fluctuations in interest rates.P.

~~During 2003, Otter Creek Management Inc~~ITEM 4., ~~(“Otter~~CONTROLS ~~Creek~~AND ~~Management”), solicited proxies for the Company’s 2003~~ PROCEDURES

The Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) or 15d-15(e) of the Exchange Act, are designed to ensure that information required to be disclosed in its reports filed with the SEC is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely discussions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and are subject to certain limitations, including the exercise of judgment by individuals, the inability to identify unlikely future events, and the inability to eliminate misconduct completely. As a result, there can be no assurance that the Company’s disclosure controls and procedures will prevent all errors or fraud or ensure that all material information will be made known to management in a timely fashion.

Management has completed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. This evaluation has allowed management to make conclusions, as set forth below, regarding the state of the Company’s disclosure controls and procedures as of September 30, 2006. Based on its evaluation and the identification of material weakness in internal control over financial reporting described below, and because of an inability to file the Quarterly Report on Form 10-Q within the statutory time period, FIC’s Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2006, FIC’s disclosure controls and procedures were ineffective.

Management had assessed our internal control over financial reporting as of December 31, 2005, the end of our most recent fiscal year. Management based its assessment on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As disclosed in the Company’s Annual Report on Form 10−K for the fiscal year ended December 31, 2005, in performing its assessment of internal control over financial reporting, management determined that material weaknesses existed in the Company’s internal controls relating to the following areas: control environment, risk assessment, control monitoring, financial close and reporting, segregation of duties, reconciliations, use of third-party service providers, safeguarding of assets, reinsurance, and policy data integrity.

During the third quarter of 2006, the Company continued to improve reinsurance processing by installing new software to automatically generate reinsurance transactions when reinsurance related policy changes were made on the Company’s second largest policy administration system. Although improvements have been made in the reinsurance internal controls, additional remediation efforts are required in order to completely eliminate the reinsurance material weakness described in the Company’s 2005 Form 10-K.

Annual Meeting of Stockholders (the “2003 Annual Meeting”) held on July 31, 2003, seeking the election of seven nominees to the Board of Directors of the Company in opposition to the ten candidates selected by the then incumbent Board of Directors. Otter Creek Management is an investment advisory firm that manages three investment funds that are shareholders of the Company: Otter Creek Partners I, LP (“Otter Creek Partners”), Otter Creek International Ltd. and HHMI XIII, LLC (together with Otter Creek Management and Otter Creek Partners, “Otter Creek”). Index

In addition ~~connection~~to ~~with~~the ~~this~~above ~~solicitation~~remediation ~~of proxies~~actions, onduring ~~June 13, 2003, Otter Creek Partners commenced a lawsuit in~~ the ~~District~~third ~~Court~~quarter inof ~~Travis County, Texas, Cause No. GN302872 (~~2006 the Company ~~“Litigation”)~~moved ~~seeking,~~its ~~among~~internal ~~other~~stock ~~things,~~transfer toprocessing ~~compel the Company~~ to ~~hold~~an ~~the~~outside ~~previously delayed 2003 Annual Meeting~~service provider. ~~Otter~~ New ~~Creek~~internal ~~also~~control ~~sought~~activities inwere ~~the~~established ~~Litigation~~during ~~to neutralize~~ the third ~~effect~~quarter of a2006 ~~proxy~~in ~~obtained~~order byto ~~the~~ensure ~~Company~~that ~~from~~activities ~~the~~related ~~Mitte~~to ~~Family (~~the administration ~~“Mitte~~by ~~Proxy”)~~this ~~the~~group ~~preceding~~produced ~~month~~reliable ~~whereby~~financial ~~the incumbent board was able to vote 1,627,610 shares in favor of its nominees~~reporting.

Following the initiation of this litigation and a hearing before the court, the court ordered the Company not to amend its bylaws in a manner that would adversely affect voting or other matters relating to the Annual Meeting and election of directors and not to reschedule such Annual Meeting scheduled for July 31, 2003, or the record date of the Annual MeetingPART II. OTHER INFORMATION

~~At the meeting, six of the seven Otter Creek nominees were elected to the Board: R~~ITEM 1. LEGAL Keith Long, J. Bruce Boisture, Salvador Diaz-Verson Jr., Patrick E. Falconio, Richard H. Gudeman and Lonnie L. Steffen. The shares covered by the Mitte Proxy were all voted in favor of the incumbent nominees at the 2003 Annual Meeting. Had Otter Creek been successful in neutralizing the effect of the Mitte Proxy, all seven of the Otter Creek nominees would have been elected.PROCEEDINGS

~~Following~~The Company ~~the 2003 Annual Meeting, Otter Creek~~ and ~~FIC~~its ~~completed~~subsidiaries aare ~~settlement~~defendants ~~with respect to the lawsuit~~ in ~~December~~certain ~~2003.~~legal ~~Under~~actions ~~the settlement agreement, the Company reimbursed Otter Creek for $250,000 in proxy expenses in 2003. An additional $475,000 of proxy and litigation expenses will be submitted~~ related to the ~~Company’s~~normal ~~shareholders~~business ~~for~~operations ~~approval at the next Annual Meeting~~ of ~~Shareholders. If payment of~~ the ~~additional $475,000 is so approved, the amount will be expensed by the~~ Company ~~in the year of approval~~. ~~The~~Management ~~Board~~believes ~~of Directors will recommend~~ that ~~shareholders approve~~ the resolution ~~reimbursement. The settlement also included mutual releases between the Company and Otter Creek and its affiliates. The Chairman~~ of ~~the~~such ~~Board~~legal ofactions ~~Directors~~will ofnot ~~the~~have ~~Company,~~a R.material ~~Keith~~impact ~~Long,~~on is the condensed ~~President~~consolidated ~~and~~financial ~~owner of the General Partner of Otter Creek Partners I, L~~statements.P.

~~Litigation~~T. David ~~with~~Porter ~~Former~~v. ~~Employee~~Financial ofIndustries ~~Subsidiary~~Corporation

InOn May 31, ~~October 2003~~2006, ~~the~~T. ~~Company~~David ~~placed Earl Johnson~~Porter, ~~the~~an ~~then-president~~FIC ~~of JNT Group~~shareholder, ~~Inc.~~filed ~~(“JNT”),~~ a ~~subsidiary~~civil ofsuit ~~FIC that was later sold~~ in ~~December 2003 in the sale of the New Era companies~~Travis County, onTexas ~~administrative~~District ~~leave~~Court ~~pending an investigation of matters related to~~ (1)the ~~Johnson’s alleged termination of an employee in response to her request for information regarding her workers’ compensation rights arising out of an injury and (2~~“Court”), ~~his~~against ~~co-mingled and disorganized bookkeeping of JNT’s client accounts with those of a personal business owned by Mr. Johnson and run by him at~~ the ~~same~~Company, ~~office~~seeking ~~(using~~to compel the Company’s ~~employees~~ to dohold ~~so).~~an ~~Soon~~annual ~~after~~meeting ~~being interviewed in the course~~ of ~~that investigation, Mr~~shareholders. ~~Johnson resigned, alleging good reason under his employment agreement with a subsidiary of~~ FIC, onhas ~~the~~been unable ground that the change in the composition of the Board of Directors of FIC following the 2003 Annual Meeting of Shareholders resulted in a “change of control” under the provisions of his employment agreement. The employment agreement provided that if Mr. Johnson were to ~~voluntarily~~solicit ~~terminate~~proxies ~~his employment~~ for ~~good~~an ~~reason,~~annual hemeeting ~~would~~because ~~receive~~it ~~compensation~~has ~~and~~not ~~benefits~~been ~~for~~able to comply ~~the~~with ~~remainder~~Rule ~~of the three~~14a-~~year~~3 ~~term~~ of the ~~agreement~~Securities ~~and~~Exchange ~~would~~Act ~~become~~of ~~fully vested in 17~~1934,~~899~~ ~~restricted~~which ~~shares~~requires that ofthe ~~FIC stock. The~~ Company ~~notified~~provide ~~Mr.~~an ~~Johnson~~annual ~~that~~report ~~his~~containing ~~resignation~~current ~~was~~financial statements ~~not for “good reason” pursuant~~ to ~~his~~shareholders ~~employment agreement. Under that agreement, termination without good reason results~~ in ~~forfeiture~~connection ofwith ~~future~~an ~~salary~~annual ~~and benefits, as well as forfeiture of the restricted shares of FIC common stock~~meeting.

InMr. Porter ~~November~~sued ~~2003,~~under MrArticle 2.24(B) ~~Johnson~~of ~~and~~the ~~his~~Texas ~~wife,~~Business ~~Carol~~Corporation ~~Johnson~~Act, ~~filed~~which provides ~~suit~~that inif ~~Harris~~an ~~County,~~annual ~~Texas~~meeting ~~District~~of ~~Court~~shareholders ~~against~~is ~~the~~not ~~Company,~~held ~~FIC~~within ~~Financial~~any 13-month ~~Services,~~period ~~Inc. (“FICFS”)~~ and ana ~~employee~~written consent of ~~the~~shareholders ~~Company.~~has ~~The~~not ~~suit,~~been ~~which~~executed instead ~~sought~~of ana ~~unspecified~~meeting, ~~amount~~any court of ~~damages~~competent ~~and~~jurisdiction ~~injunctive~~in ~~relief,~~the ~~alleges~~county ~~that~~ in which the ~~defendants~~principal ~~interfered~~office ~~with~~of the ~~non-JNT~~corporation ~~contract~~is ~~and~~located ~~business~~may, ~~relationships~~on of the ~~plaintiffs~~application of any shareholder, ~~made~~summarily ~~slanderous~~order ~~statements~~a ~~regarding~~meeting ~~the~~to ~~plaintiffs,~~be ~~and~~held. ~~accessed~~On ~~computer~~August ~~files~~7, at2006, the Company ~~JNT~~entered ~~offices~~into ~~relating~~an Agreed Order On Plaintiff’s Motion to ~~the~~Compel ~~non-JNT~~Annual Shareholders ~~business~~Meeting ~~relationships~~and ofagreed ~~the~~among ~~plaintiffs,~~other ~~without~~things to hold an annual shareholders meeting for the ~~consent~~election of ~~the~~directors ~~plaintiffs~~on December 6, 2006. The Company ~~suit~~made ~~also~~arrangements ~~alleged~~for, ~~conspiracy~~and was prepared to hold, ~~conversion~~an annual meeting of shareholders on December 6, ~~and~~2006, ~~various~~as ~~other~~required ~~torts~~by the Agreed Order, ~~all~~but ~~related~~the Company was unable to hold the ~~defendants’~~meeting ~~investigation~~on ofthe ~~plaintiff’s~~appointed ~~business~~date ~~practices~~because atno ~~JNT.~~quorum was present.

~~Subsequently~~On December 12, ~~Mr.~~2006, ~~Johnson~~FIC filed a ~~demand~~Motion for ~~arbitration~~Summary ~~under~~Judgment ~~his~~seeking ~~employment~~dismissal of Porter’s ~~agreement,~~suit ~~which~~on ~~has~~the grounds that the Agreed Order did not dispense with the requirement of a ~~mandatory~~quorum; ~~arbitration~~the ~~clause~~lack of a quorum was a direct and foreseeable result of Mr. InPorter’s insistence on a one-sided solicitation and election; FIC had complied with its obligations under the ~~arbitration,~~Agreed Order and Mr. ~~Johnson~~Porter has obtained all relief sought ~~damages~~by his petition. FIC’s Motion for ~~breach~~Summary ofJudgment remains ~~contract~~pending and ~~various~~has ~~other~~not ~~benefits~~been ~~relating~~ heard.

27Prior to a hearing on FIC’s Motion for Summary Judgment, Mr. Porter applied for a temporary restraining order and temporary injunction requiring the Company to convene one or more additional meetings of shareholders, contending that in the absence of a quorum on December 6, Texas law and the Company’s bylaws entitled a majority of the shareholders in attendance to choose a date to which the meeting would be adjourned. The District Court held a hearing on Porter’s application, and on December 22, 2006 entered an order requiring among other things that FIC hold an annual shareholders meeting for the election of directors on January 16, 2007, but stating that if a quorum was not present on that date, FIC would not be required to hold an annual meeting of shareholders at any time before July 17, 2007. The Company made arrangements for, and was prepared to hold, an annual meeting of shareholders on January 16, 2007, as required by the Court’s order, but the Company was again unable to hold the meeting on the appointed date because no quorum was present. No further action has been taken by Mr. Porter, whose suit remains pending.

to the termination of his employment contract, totaling $913,133.40. In connection with the arbitration, FIC submitted a counter-claim, alleging that Mr. Johnson committed multiple breaches of his employment agreement, and that he breached his fiduciary duty to FIC as a result of his actions in conducting the business of JNT, thereby entitling FIC to a dismissal of plaintiff’s claims. Prior to the hearing on the arbitration, the Harris County Court ordered that the matters raised in that lawsuit by Mr. Johnson (though not Carol Johnson) be combined with the arbitration.

An arbitration hearing on Johnson’s contract claims was conducted in April 2005. On July 21, 2005, the Arbitrator issued an interim award in which he denied all of Johnson’s claims for breach of contract, as well as Johnson’s claims with respect to the restricted shares of FIC stock. In denying Johnson’s claims, the Arbitrator concluded that:

(1) Johnson had committed multiple and material breaches of his employment agreement by operating a personal tax and accounting business out of office space and using employees, utilities and other items, all paid for by FICFS; by engaging in a self-dealing transaction involving the payment to himself of $25,000 out of funds held by JNT in a suspense account, an account to which JNT owed fiduciary duties to its customers and clients; and by firing an employee of JNT on the same day that the employee inquired about possible workers compensation benefits in connection with an on-the-job injury,

(2) Johnson’s breaches of his employment agreement occurred prior to the time that he was placed on administrative leave, thereby precluding him from maintaining a breach of contract suit against FIC and FICFS, and

(3) The change in the majority of the Board of Directors of FIC resulting from the 2003 Annual Meeting of FIC’s shareholders did not constitute a “change of control” under Johnson’s employment agreement, thereby denying Johnson’s claim that he was entitled to a “good reason” termination of his employment agreement.

In addition, the Arbitrator awarded FICFS $28,000, plus interest at the rate of 6% per annum from July 21, 2005, to the date of payment, with respect to Johnson’s unauthorized conversion of funds held in the JNT suspense account. The order confirming the arbitration award was signed on February 27, 2006, by the Harris County district judge and the Company is currently pursuing collection of the judgment. No amounts have been recorded in the Company’s financial statements for such judgment.

With respect to the matters raised by Mr. Johnson in the Harris County lawsuit, which were referred by the Court to the arbitration, following his loss in the arbitration of the employment agreement, Mr. Johnson notified the Arbitrator that he would not pursue arbitration of his other claims. In addition, in May 2006, Mrs. Johnson filed a notice of non-suit with respect to the claims made by her in the Harris County lawsuit. Accordingly, this matter is now closed.

Litigation with Equita Financial and Insurance Services of Texas, Inc. and M&W Insurance Services, Inc.

On June 2, 2005, Equita and M&W Insurance Services, Inc. (“M&W”) filed a civil suit in Travis County, Texas District Court against the Company. The suit alleges that, in entering into certain agreements with the plaintiffs, the Company made certain misrepresentations and omissions as to its business and financial condition. The agreements referenced in the suit consist of (a) an option agreement entered into in June 2003 between Equita and the Company, granting Equita the right to purchase shares of FIC’s common stock at $16.42 per share, if certain sales goals were achieved under an exclusive marketing agreement between Equita and a subsidiary of the Company (the “Option Agreement”), (b) a stock purchase agreement entered into in June 2003 between M&W and the Roy F. and Joann Cole Mitte Foundation, pertaining to the purchase of 204,918 shares of FIC’s common stock (the Stock Purchase Agreement”), and (c) a registration rights agreement entered into in June 2003 among the plaintiffs and the Company, whereby the Company agreed to file and maintain a shelf registration statement ~~which~~with respect to the shares of FIC’s common stock purchased by M&W from the Mitte Foundation or which may be acquired in the future by Equita under the option agreement (the “Registration Rights Agreement,” and, collectively, the “Agreements”).

The suit alleges that the Company breached the provisions of the Option Agreement by refusing to indemnify the plaintiffs for losses relating to the alleged breach of certain representations and warranties included in the Option Agreement. The plaintiffs also allege that the Company required M&W to purchased 204,918 shares of FIC common stock from the Mitte Foundation as a condition of Equita’s obtaining, in June 2003, an exclusive marketing agreement with a subsidiary of the Company pertaining to the distribution of insurance products in the “senior market” (the “Marketing Agreement”), and that such requirement was motivated by the desire of the Company’s management to obtain certain proxy rights obtained under a settlement agreement with the Mitte Foundation and the Mitte family. The plaintiffs further allege that the Company breached the provisions of the Registration Rights Agreement by failing to file a shelf registration with the SEC with respect to the shares of FIC’s common stock purchased by M&W from the Mitte Foundation and the shares which may be acquired in the future by Equita under the provisions of the Option Agreement. The plaintiffs seek rescission of the Agreements; damages in an amount equal to the $3 million that M&W paid to acquire FIC shares from the Mitte Foundation, together with interest and attorney’s fees and unspecified expenses; and an unspecified amount of exemplary damages.27

28Index

Deposition discovery with respect to both the case filed by Equita and M&W, and the claims in intervention asserted by Family Life and Investors Life, isbegan ~~set to begin~~ in October of 2006.

~~Shareholder~~On or about ~~Claim~~May 8, 2007, Equita and M&W amended their petition, removing their claims under the Texas Securities Act and common-law fraud. FIC intends to vigorously oppose the lawsuit and any effort by Equita and M&W to recover damages from FIC, and the life insurance subsidiary intends to vigorously prosecute its claims in intervention against Equita.

The Manhattan ~~Company~~Life ~~received~~Insurance aCompany ~~demand~~and ~~letter~~Family inLife ~~April~~Insurance ~~2004~~Company ~~from a law firm representing an individual shareholder (Mr~~v. ~~Cook)~~Family Life ~~who~~Corporation, ~~owns~~Investors ~~530~~Life ~~shares~~Insurance ~~of the~~ Company’s ~~common~~of ~~stock,~~North ~~which~~America ~~letter set forth certain allegations~~ and ~~notified~~FIC Insurance ~~the~~Services, ~~Registrant that the shareholder intended to file a shareholder derivative lawsuit (the “Demand Letter”)~~L. P.

~~In May 2004~~On April 17, ~~FIC~~2007, byManhattan Life and ~~through~~Family ~~its Special Litigation Committee~~Life, filed a ~~petition~~civil suit in the ~~250th~~215th Judicial District Court, ofHarris ~~Travis~~ County, Texas, ~~(the~~against ~~“Court”)~~Family Life Corporation, ~~seeking~~Investors toLife and FIC ~~have~~Insurance ~~the~~Services, ~~Court~~L.P. ~~appoint~~(“FICIS”), each a ~~panel~~subsidiary of ~~independent~~the Company. The ~~and~~suit ~~disinterested~~alleges ~~persons~~that: ~~pursuant~~a) toFamily ~~Section~~Life HCorporation ~~(3)~~breached the ofStock ~~Article~~Purchase ~~5.14~~Agreement ofwith ~~the~~Manhattan ~~Texas~~life ~~Business~~by ~~Corporation~~competing ~~Act~~with toFamily ~~investigate~~Life and ~~the~~accepting ~~allegations,~~insurance ~~and~~“directly ~~stay~~or ~~any~~indirectly” ~~shareholder~~from ~~derivative~~active ~~actions.~~accounts ~~Subsequently,~~of onFamily Life; ~~June~~b) 1,FICIS ~~2004,~~breached the ~~Court~~Administrative ~~issued~~Services anAgreement ~~Order~~with ~~appointing~~Family ~~Eugene~~Life by ~~Woznicki,~~willfully ~~Kenneth~~communicating S.with ~~Shifrin,~~or ~~John~~willfully D.assisting ~~Barnett~~with ~~and~~the F.communication by its ~~Gary~~affiliates ~~Valdez~~with aspolicyholders in a ~~panel~~manner ofintended ~~independent~~to ~~and~~solicit ~~disinterested~~Family ~~persons~~Life accounts ~~(the~~on ~~“Panel”)~~behalf toof ~~make~~Investors ~~determinations~~Life; ~~contemplated~~c) byFICIS ~~Section~~breached Ffiduciary ofduties ~~Article~~owed to Family ~~5.14~~Life ofin the ~~Texas~~administration ~~Business~~and ~~Corporation~~management ~~Act~~of inthe ~~connection~~accounts ~~with~~of the ~~Demand~~policy holders ~~Letter~~of ~~and~~Family ~~staying~~Life ~~any~~by ~~shareholder~~assisting ~~derivative~~in ~~actions~~the ~~relating~~conversion toof ~~the~~Family ~~letter~~Life ~~until~~ policies to the ~~Panel’s~~policies ~~review~~of ~~was~~Investors ~~completed~~Life, and aby ~~determination~~their ~~was~~actions, ~~made~~Investors byLife ~~the~~and ~~panel~~Family Life asCorporation ~~to what,~~aided ifand ~~any,~~abetted ~~further~~such ~~action~~breach ~~was~~of tofiduciary beduty; ~~taken.~~and, ~~Messrs.~~d) ~~Woznicki~~Family Life Corporation, ~~Shifrin~~Investors Life and ~~Barnett~~FICIS ~~are~~have ~~independent~~tortiously ~~directors~~interfered with existing contracts of ~~FIC.~~Family ~~Mr.~~Life ~~Valdez~~with isits ~~neither~~policyholders, aincluding ~~director~~the ~~nor~~Stock Purchase anAgreement ~~employee~~and ofthe ~~FIC.~~Administrative MrServices Agreement. ~~Valdez~~In isaddition, FICIS has ~~the~~filed, ~~founder~~ and ~~president~~intends ofto ~~Focus~~vigorously ~~Strategies~~prosecute, ~~L.L.C.~~a counterclaim for amounts due and isowing ~~active~~by inFamily ~~various~~Life ~~community~~for ~~and~~services ~~civic~~performed ~~organizations~~pursuant into the ~~Austin,~~Administrative Services ~~Texas area~~Agreement.

Following an extensive review of the claims made by the individual shareholder, the Panel, in January 2005, filed with the court a Petition for Declaratory Judgment pursuant to the Texas Declaratory Judgments Act and Article 5.14 of the Texas Business Corporations Act (the “Petition”). The Petition describes the process used by the Panel and its counsel in considering the matters raised in the Demand Letter and the submittal provided by counsel for the shareholder. The Petition advised the Court that, after consideration of the evidence obtained through its inquiry, the Panel had unanimously made a good faith determination that the continuation of the Committee’s derivative proceeding and the commencement of any further derivative proceedings based on the allegations made by the individual shareholder was not in the best interests of FIC.

On October 10, 2005, the 250th District Court of Travis County, Texas, heard for trial on the merits the matters raised by the Panel in the Petition (Financial Industries Corporation v. Tom Cook (Cause No. GN 401513). After consideration of the pleadings, evidence and authorities submitted by counsel for the Company, the Court issued a Final Judgment on October 10, 2005, in which it ruled that the determinations made by the Panel, as reflected in a report submitted to the Court by a Special Litigation Committee appointed by the Registrant’s Board of Directors, were made: (1) in good faith, (2) after the Panel conducted a reasonable inquiry, and (3) based on the factors deemed appropriate under the circumstances by the Panel. The Court’s ruling otherwise dismissed with prejudice the derivative proceedings involved in this matter. The Final Judgment was approved as to form and substance by counsel for the Registrant and by counsel for the defendant.

Management Conclusion on Legal Proceedings

Index

Other Litigation

FIC and its insurance subsidiaries are regularly involved in litigation, both as a defendant and as a plaintiff. The litigation naming the insurance subsidiaries as defendant ordinarily involves our activities as a provider of insurance products. Management does not believe that any of this other litigation, either individually or in the aggregate, will have a material adverse effect on the Company’s ~~business~~results orof operations, financial ~~condition~~position, or cash flows.

11ITEM 1A. ~~Subsequent~~ RISK ~~Events~~FACTORS

~~Sale~~ As of September ~~Real~~30, ~~Estate~~2006, there have been no material changes to risk factors as previously disclosed in the Company’s 2005 Form 10-K.

On June 1, 2005, the Company sold the River Place Pointe office complex to a non-affiliated party in an all-cash transaction for a gross purchase price of $103 million. The office complex is located in Austin, Texas. Under the terms of the sale agreement, the Company entered into a lease with the purchaser with respect to all of the space in Building One for a five-year term at a rate of $28.00 per square foot, which was the prevailing rental rate at the time that FIC and its subsidiaries occupied the building in July 2000. The lease provides the Company with a right of cancellation of the lease at March 31, 2008. The Company will realize a gain of $10.1 million on the sale, which includes both a current 2005 realized gain of $8.0 million and a deferred gain of $ITEM 2.1 CHANGES ~~million~~IN toSECURITIES beAND ~~recognized~~USE ~~over the period from the sale date through March 31, 2008.~~OF PROCEEDS

At September 30, 2004, the Company had $589,000 of real estate held for sale, consisting of six properties. Three of these properties were sold in 2005 and the remaining three properties were sold in early 2006. Realized gains on the sales totaled $761,000 and $517,000 in 2005 and 2006, respectively.None

~~Amendment~~ITEM 3. DEFAULTS ofUPON ~~Subordinated Loans~~SENIOR SECURITIES

FIC and FLC have subordinated notes payable to Investors Life with an unpaid balance of $15.4 million at September 30, 2004. With the approval of the Texas Department of Insurance, the loans were restructured as of March 9, 2006. As amended, the loans provide for a one year moratorium on principal payments for the period from March 12, 2006, to December 12, 2006, with principal payments to resume on March 12, 2007, with ten equal quarterly principal payments until the maturity date of June 12, 2009. These notes have been eliminated in the consolidated financial statements.None

ITEM 2 4. SUBMISSION ~~MANAGEMENT'S DISCUSSION AND ANALYSIS~~ OF ~~FINANCIAL~~MATTERS ~~CONDITION~~TO ~~AND~~A ~~RESULTS~~VOTE OF ~~OPERATIONS~~SECURITY HOLDERS

~~The~~There were ~~following~~no ~~discussion~~matters ~~addresses~~submitted ~~the~~to ~~financial~~a vote ~~condition~~ of ~~Financial~~security ~~Industries~~holders ~~Corporation~~during ~~(“FIC”)~~the asthird ofquarter ~~September 30, 2004, compared with December 31, 2003, and its results~~ of ~~operations for the three and nine-month periods ended September 30, 2004, compared with the same period last year~~2006. This discussion should be read in conjunction with the consolidated financial statements included in FIC’s Form 10-K for the year ended December 31, 2004, filed with the SEC contemporaneously with this Form-Q filing.

~~Restatement~~ITEM 5. OTHER INFORMATION

In this Item 2, references to results for the three and nine month period ended September 30, 2003 are to restated results. As discussed in the Notes to the Condensed Consolidated Financial Statements above, the Company has restated the consolidated financial statements for the fiscal year ended December 31, 2003 and the unaudited condensed consolidated financial statements for the four quarters of year 2003. The details of the significant adjustments and resulting restatement are described in Note 2 of the accompanying consolidated financial statements.None

~~Results of Operations – Three Months Ended September 30, 2004 and 2003~~ITEM 6. EXHIBITS

~~For the three month period ended September 30, 2004, the Company reported~~ (a) ~~net loss of $4.8 million and basic and diluted loss per common share of $0.49 compared to a net loss of $6.4 million and basic and diluted loss per common share~~ Exhibits

3031.1 Certification of Chief Executive Officer of FIC pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

~~of $0~~31.662 ~~for~~Certification ~~the three month period ended September 30, 2003. The three months ended September 30, 2004 and 2003 include the impact~~ of ~~certain~~Chief ~~trends~~Financial ~~and~~Officer ~~changes in the business~~ of ~~the~~FIC ~~Company~~pursuant ~~which~~to ~~are~~Section ~~dominant~~302 ~~in the results~~ of the ~~nine months ended September 30, 2004 and 2003. These items are described in the nine~~Sarbanes-~~month~~Oxley ~~results~~Act of operations below. Of these results, certain significant items of change between the three months ended September 30, 2004 and 2003 which contribute to a decline in net loss of $1.5 million between periods are as follows:2002

•32.1 ~~Decline~~Certification ~~in premiums earned~~ of ~~$2.2~~Chief ~~million~~Executive ~~noted~~Officer ~~primarily due to the run-off in the Company’s existing books~~ of ~~business~~FIC ~~and~~pursuant ato ~~decline~~18 inU.S.C. ~~new~~Section ~~policies in Investors Life, offset by increases in new policies in Family Life.~~1350

•32.2 ~~Decline~~Certification inof ~~net~~Chief ~~investment~~Financial ~~income~~Officer of ~~$1.5~~FIC ~~million~~pursuant ~~due predominately~~ to ~~reductions~~18 inU.S.C. ~~the~~Section ~~interest earnings on the Company’s interest-bearing investments, notably due to reinvestment of investment proceeds into lower-yielding securities and an overall decline in investments held.~~1350

~~• Increase in net realized gains of $1.4 million due to sales of securities through the realignment of the Company’s portfolio in accordance with new investment policies.~~29

~~• Decrease in interest expense on contractholder deposits of $526,000 primarily due to a reduction in interest rates credited to the policyholders.~~Index

• Decrease in operating expenses of $2.6 million resulting from the reduction of unusual expenses occurring in the three months ended September 30, 2003 and significant reductions in staffing levels beginning in late 2003.Signatures

~~Results~~Pursuant to ofthe ~~Operations~~requirements –of ~~Nine~~the ~~Months~~Securities ~~Ended~~Exchange ~~September~~Act 30of 1934, ~~2004~~the ~~and~~registrant has duly ~~2003~~caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

For the nine-month period ended September 30, 2004, FIC’s net loss was $10.9 million (basic and diluted loss of $1.11 per common share) on revenues of $78.4 million as compared to net loss of $11.8 million (basic and diluted loss of $1.22 per common share) on revenues of $86.1 million in the first nine months of 2003.

	FINANCIAL INDUSTRIES CORPORATION
	(Registrant)


Date: May 31, 2007	By:	/s/ William B. Prouty

	William B. Prouty
	Chief Executive Officer


Date: May 31, 2007	By:	/s/ Vincent L. Kasch
	Vincent L. Kasch
	Chief Financial Officer
	(Principal Accounting and Financial Officer)

~~In 2004, FIC’s net loss was affected by the following significant and unusual items:~~ 30

• Significantly higher policyholder benefits and expenses totaling $36.4 million for the nine months ended September 30, 2004, compared to $34.8 million for the same period in 2003. A substantial portion of this increase was related to higher death benefits.

• Effective January 1, 2004, the Company adopted Statement of Position (“SOP”) 03-01, “Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-Duration Contracts and for Separate Accounts.” This resulted in recognizing additional income totaling $229,000, net of taxes, as a cumulative effect of change in accounting principle in 2004. The implementation of this SOP changed the pattern of recognition of bonus interest credited to contractholders for certain of the Company’s insurance products.

• Significant auditing, actuarial, accounting, consulting, and legal fees were incurred throughout 2004, much of which was associated with the internal review of the Company’s financial accounts and resulting restatement of prior years’ financial statements as reported in its 2003 Form 10-K filing.

• Excess of cost over net assets acquired, or goodwill, totaling $752,000 was written off as an operating expense in 2004 as a result of the Company’s annual impairment analysis of such asset.

In 2003, FIC’s net loss was affected by the following significant and unusual items:

• $2.9 million of expense related to the settlement of the litigation between FIC and Roy F. Mitte (the former Chairman and Chief Executive Officer of the Company) and the Roy F. and Joann Cole Mitte Foundation.

• $0.4 million paid to William P. Tedrow in connection with the New Era acquisition in June 2003 (see Company’s Quarterly Report on Form 10-Q for the three-month period ended June 30, 2003, for a further description of this payment).

• $1.6 million paid in investment banking fees for strategic business plan reviews and in legal fees and other expenses for proxy matters and litigation related to the 2003 annual meeting of shareholders.

The above described significant and unusual items need to be taken into consideration in drawing comparisons between the operating results for the nine months ended September 30, 2004 and 2003.

Revenues

Premium revenues reported for traditional life insurance products are recognized when due. Both renewal premiums and first-year premiums have declined from 2003 to 2004. Premium income for the first nine months of 2004, net of reinsurance ceded, was $17.8 million, as compared to $23.7 million in the first nine months of 2003. This source of revenues is related to the traditional life insurance book of business of FIC’s insurance subsidiaries. The decrease in

premium income reflects the run-off in the Company’s existing traditional life insurance book of business. This decrease in renewal premiums is exceeding first year premium production levels, resulting in the overall decline in premium revenues on traditional life insurance products.

In accordance with GAAP, deposits received by FIC in connection with annuity contracts and premiums received for universal life (“UL”) insurance policies are reflected in FIC’s financial statements as increases in liabilities for contractholder deposit funds and not as revenues. Annual charges made against these deposits are reported as revenue. For the nine months ended September 30, 2004 and 2003, annuity deposits and UL premiums totaled $31.7 million and $44.5 million, respectively.

Earned insurance charges totaled $31.5 million for the first nine months of 2004, as compared to charges of $30.6 million in the same period of 2003. These revenues primarily consist of UL cost of insurance charges, but also include policy surrender charges, and policy administration charges.

Net investment income for the first nine months of 2004 was $23.9 million as compared to $27.9 million in the same period of 2003. The decrease in net investment income from 2003 to 2004 was primarily attributable to 1) a decline in the income received from the Company’s interest-bearing investments, resulting from decreasing interest rates during 2003 and 2004 and 2) significant reinvestment of investment proceeds from sales, maturities, and mortgage-backed security prepayments in lower-yielding securities during this period.

Real estate income is primarily earned from the leases on the buildings at the Company’s River Place Pointe office complex in Austin, Texas. Real estate income (revenues from leases less associated operating expenses and depreciation) was $1.3 million for the nine-month period ended September 30, 2004, compared to $1.7 million during the same period in 2003. This decline is attributable primarily to additional operating expenses and depreciation for the buildings of River Place Pointe. In June 2005, the Company sold the River Place Pointe property, and accordingly, the Company will no longer have significant real estate-related income subsequent to June 2005 as the sales proceeds were reinvested primarily in fixed maturity securities.

Net realized investment gains were $2.3 million in the first nine months of 2004, as compared to $0.3 million in the first nine months of 2003. The realized gains for 2004 were primarily from the sales of fixed maturity securities and one of the Company’s real estate properties classified as held for sale. The realized gains for 2003 were primarily from the sales of fixed maturity securities.

Benefits and Expenses

Policyholder benefits and expenses, which consist primarily of death benefit claims, were $36.4 million in the first nine months of 2004, as compared to $34.8 million in the first nine months of 2003. The increase in policyholder benefits and expenses was primarily attributable to both higher death benefit claims and surrenders of traditional life insurance policies.

Interest expense on contractholder deposit funds represents interest paid or credited to contractholders on cash values accumulated in their universal life insurance and annuity accounts. Interest expense totaled $17.5 million in the first nine months of 2004, as compared to $19.9 million in the same period of the year 2003. The decrease in interest expense in 2004 was primarily attributable to reductions in interest rates credited to policyholders, as the Company managed its interest spread in response to the low and declining interest rates that characterized 2004 and 2003.

With the decline in market interest rates from 2001, there can be effects on the interest spread which is the difference in the Company’s investment portfolio rate and the interest rates credited on policyholder contracts for universal life insurance and annuities. The Company responded to the lower market rates by lowering many of the credited rates on its policies during 2003 and 2004. However, universal life insurance and annuity policies have contractual minimum guaranteed rates and credited rates cannot be lower than such minimums. Because many of the Company’s policies have minimum guaranteed rates of 4.0%, the market interest rate environment in recent years has put pressure on the Company’s interest spread.

Amortization of deferred policy acquisition costs (DAC) for the first nine months of 2004 was $8.7 million, as compared to $9.4 million in the same period in 2003. These expenses represent the amortization of the costs of producing new business,

which consists primarily of agents’ commissions and certain policy issuance and underwriting costs. DAC is amortized over the premium-paying period of the policies in proportion to estimated annual premium revenue for traditional life insurance business. For interest sensitive products, these costs are amortized in relation to the estimated annual gross profits of the policies. The level of policy lapses and surrenders can also have a significant impact on the amount of amortization in any reporting period.

Present value of future profits on acquired businesses (PVFP) is amortized in a similar manner as DAC, as previously described, for traditional and interest sensitive business. Amortization of PVFP totaled $2.5 million and $2.9 million for the nine months ended September 30, 2004 and 2003, respectively. The amortization is consistent with the run-off of the acquired blocks of business.

Operating expenses for the first nine months of 2004 were $25.1 million, as compared to $29.9 million in the first nine months of 2003. This decrease in the level of operating expenses is partially the result of several unusual items occurring during the first nine months of 2003. The operating expenses for the nine months ended September 30, 2003, included: (i) legal expenses related to litigation and proxy matters; and (ii) fees paid to Solomon Smith Barney related to the matter set forth in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 28, 2003.

Operating expenses in 2004 also include a write off of excess of cost over net assets acquired, or goodwill, totaling $752,000 resulting from the Company’s annual impairment analysis of such asset. The goodwill was originally recognized by ILCO in connection with its acquisitions, including Investors Life. The impairment of the entire goodwill asset was triggered by the significant decline in the Company’s stock price from December 31, 2003 to June 30, 2004. The Company’s stock price is a significant component in the valuation calculation as required in the impairment analysis.

During 2004, the Company took significant steps to reduce the level of general operating expenses. Subsequent to the changes in the Board and management in late 2003 and early 2004, a comprehensive review of the Company’s staffing and operational structure was performed. This review identified numerous opportunities in these areas for reductions in the Company’s cost structure, given the current levels of sales and business in force. Accordingly, significant reductions in staffing levels were achieved in late 2003 and during 2004. The Company also closed its Seattle branch office and records storage facility, upgraded various operating and accounting systems, and restructured employee benefit programs.

In addition to normal operating expenses, the Company incurred litigation expense of $2.9 million in the first nine months of 2003 related to the Mitte Settlement (see Note 10, “Commitments and Contingencies” in the accompanying condensed consolidated financial statements for further discussion of the Mitte Settlement). This expense was reflected separately as litigation settlement in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2003.

Interest expense for 2004 and 2003 totaled $624,000 and $286,000, respectively. The interest expense relates to debt service on $15 million the Company borrowed in 2003 through issuance of trust preferred notes (the “2003 Notes”). The Company utilized the borrowing proceeds to pay for its acquisition of the New Era Companies and to repay advances that it had received from one of its insurance company subsidiaries for operating expenses. The 2003 Notes bear interest quarterly at the three-month LIBOR rate plus 4.2%.

Taxes

The provision for federal income taxes on loss from operations, before cumulative effect of change in accounting principles, reflects tax benefits totaling $1.3 million and $2.4 million for the nine months ended September 30, 2004 and 2003, respectively. These tax amounts equate to effective tax benefit rates of (10.3%) and (16.8%) for the nine months ended September 30, 2004 and 2003, respectively. The primary reason for the significant deviation from the expected statutory tax rate of 34% for the Company is due to the establishment of a valuation allowance and increases to this allowance for deferred tax assets. Deferred income tax assets are subject to ongoing evaluation of whether such assets will be realized. Realization of deferred tax assets is dependent upon the Company’s generation of sufficient taxable income in the future to recover tax benefits that cannot be recovered from taxes paid in prior periods. If future taxable income is not expected, the Company establishes a valuation allowance, when based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized. The Company’s deferred tax assets are primarily comprised of net operating losses of FIC and its non-life insurance wholly owned subsidiaries.

Change in Accounting Principle

Effective January 1, 2004, the Company adopted Statement of Position (“SOP”) 03-01, “Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-Duration Contracts and for Separate Accounts.” This resulted in recognizing additional income totaling $229,000, net of taxes, as a cumulative effect of change in accounting principle in 2004. The implementation of this SOP resulted in a change in the pattern of recognition of bonus interest credited to contractholders for certain of the Company’s insurance products.

Liquidity and Capital Resources

Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. FIC is an insurance holding company whose principal assets consist of its ownership interests in its insurance subsidiaries - Family Life Insurance Company (“Family Life”) and Investors Life Insurance Company of North America (“Investors Life”). As a holding company, FIC’s ability to pay interest and principal on its debt, pay its expenses, and pay dividends on its common stock depend substantially upon its receipt of dividends or other cash flow from its subsidiaries.

Liquidity management is designed to ensure that adequate funds are available to meet all current and future financial obligations. The Company meets its liquidity requirements primarily by positive cash flows from the operations of subsidiaries, and to a lesser extent, cash flows provided by investing activities. Proper liquidity management is crucial to preserve stable, reliable, and cost-effective sources of cash to meet the future benefit payments under our various insurance and deposit contracts, pay operating expenses (including interest and income taxes), and maintain reserve requirements. In this process, we focus on our assets and liabilities, and the impact of changes in both short-term and long-term interest rates, market liquidity and other factors. We believe we have the ability to generate adequate cash flows for operations on a short-term and a long-term basis.

At the holding company level, FIC’s principal current ongoing liquidity demands relate to the payment of principal and interest on its indebtedness. As of September 30, 2004, Investors Life held $15.4 million of notes receivable from FIC (the “Affiliated Notes”) that represented the remaining indebtedness related to the Family Life acquisition. Although this intercompany indebtedness is eliminated on FIC’s condensed consolidated balance sheets, it creates a debt service requirement at the holding company level. In June 2004, with approval of the Texas Department of Insurance, the Affiliated Notes were amended to provide for:

a) no principal payments until March 12, 2006;

b) principal payments each quarter of $1,536,927, commencing March 12, 2006, and ending with a final payment on June 12, 2008; and

c) interest payments each quarter, at an annual rate of 5.0%.

Again with the approval of the Texas Department of Insurance, the loans were restructured as of March 9, 2006. As amended, the loans provide for a one year moratorium on principal payments for the period from March 12, 2006, to December 12, 2006, with principal payments to resume on March 12, 2007, with ten equal quarterly principal payments until the maturity date of June 12, 2009.

The holding company’s other principal liquidity requirement is debt service on the $15 million of 2003 Notes that it issued in connection with the acquisition of the New Era Companies and to repay advances it had received from one of its insurance company subsidiaries for operating expenses. These notes require quarterly interest payments at a variable interest rate of the three-month LIBOR rate plus 4.2%. The principal amount of the 2003 Notes must be repaid in a single payment in 2033.

The ability of Family Life and Investors Life to pay dividends to FIC and meet these holding-company liquidity demands is subject to restrictions set forth in the insurance laws and regulations of Texas, its domiciliary state. Texas limits how and when Family Life and Investors Life can pay such dividends by (a) including the “greater of” standard for payment of dividends to shareholders and (b) requiring that prior notification of a proposed dividend be given to the Texas Department of Insurance. Under the “greater of” standard, an insurer may pay a dividend in an amount equal to the greater of: (i) 10% of the capital and surplus or (ii) the insurer's net gain from operations for the previous year.

In June 2004, FIC, with the approval of the Texas Department of Insurance, created a service company subsidiary and transferred to it many of the administrative functions of the insurance companies. The new service company charges each

insurance company a monthly service fee that is calculated using a formula based on policies under management, new policies issued, managed assets, and other factors. Profits earned by the service company are paid as dividends to the holding company, providing an additional source of liquidity at the holding company level.

A primary liquidity consideration with respect to life insurance and annuity products is the risk of early policyholder and contractholder withdrawal. Deposit fund liabilities for universal life and annuity products as of September 30, 2004 were $578.3 million, compared to $593.9 million at December 31, 2003. Individual life insurance policies are less susceptible to withdrawal than are annuity contracts because life insurance policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. At September 30, 2004, the bulk of the liabilities for contractholder deposit funds on FIC’s balance sheet, $404.5 million, represented insurance products, as compared to only $173.8 million of annuity product liabilities.

Cash and cash equivalents at September 30, 2004 were $14.0 million compared to $82.4 million at December 31, 2003. The $68.4 million decrease in cash and cash equivalents at September 30, 2004 from December 31, 2003 was due primarily to reinvestment of cash into purchases of fixed maturity securities and short-term investments, and to net contractholder deposit funds withdrawals made during the nine months ended September 30, 2004. Cash and cash equivalents at September 30, 2003 was $143.3 million.

Net cash provided by operating activities was $6.2 million for the nine month period ended September 30, 2004, compared to $1.5 million for the same period of 2003. The increase in cash provided by operating activities of $7.7 million from 2003 to 2004 was primarily attributable to increases in other liabilities, offset by decreases in agent advances and other receivables and policy liabilities and accruals. Additionally, net activity from trading securities also contributed a portion of the change.

Net cash used by investing activities was $52.2 million in the nine month period ended September 30, 2004, compared to $32.7 million used by investing activities for the same period of 2003. The $19.5 million increase in cash used by investing activities in 2004 was due primarily to net purchases of fixed maturity securities and an increase in short-term investments.

Net cash used in financing activities was $22.4 million in the first nine months of 2004, compared to cash provided by financing activities of $11.4 million in the first nine months of 2003. The most significant components of the Company’s financing activities are contractholder fund deposits and withdrawals for annuity and universal life insurance policies. For the nine months ended September 30, 2004 and 2003, contractholder fund withdrawals exceeded deposits by $22.4 million and $2.9 million respectively. The significant change in net withdrawals in 2004 is due to a decline in deposits in 2004 from 2003 of $12.8 million and an increase in withdrawals of $6.7 million for the same period. Additionally, the Company had bank borrowings of $15.0 million during the nine months ended September 30, 2003.

Financial Condition

Assets

During 2004, the equity of the shareholders of the Company (that is, the excess of the Company’s assets over its liabilities) declined by $10.9 million. This change, resulting in the net decrease to shareholders’ equity, is primarily due to the net loss for the nine months of $10.9 million.

During 2003, the Company reduced its investment in cash and short-term investments significantly, shifting funds to investments in debt instruments. A substantial portion of these funds, along with proceeds from maturing investments and sales, were reinvested during the first half of the year in assets (collateralized mortgage obligations (“CMOs”), asset-backed securities, and private placements) that the then-incumbent management of the Company expected would increase overall returns on invested assets. Following a review of the investment portfolios of the life insurance subsidiaries of the Company in September 2003, the Investment Committee of the Company’s then newly elected Board of Directors recommended the engagement of a third-party investment manager to provide ongoing, professional management of the portfolios. In October 2003, the life insurance subsidiaries entered into investment management agreements with Conning. Under these agreements, Conning manages the investment security portfolios of the Company’s life insurance subsidiaries in accordance with investment policies set by the Company’s Board of Directors.

The Company, working with Conning, also revised the investment policies of its insurance subsidiaries. The new policies reiterate compliance with legal requirements of state insurance laws and regulations that are applicable to the Company’s insurance company subsidiaries. They also emphasize sensitivity to the way that FIC’s liabilities are likely to change over time and with changes in general interest rate levels. In practical terms, this means that the Company now focuses almost all of its investment in investment-grade securities, keeping the schedule of anticipated asset maturities in line with its projected cash needs. It also means that the Company attempts to keep the duration of its investment assets (a measure of the sensitivity of their value to changes in interest rates) in line with the duration of the Company’s liabilities.

The Company commenced the realignment of the Company’s life insurance subsidiaries’ portfolios in accordance with these new policies in the fourth quarter of 2003. The Company continued the realignment of the portfolio in 2004. During the first quarter of 2004, the Company began to reduce its investment in mortgage-backed securities (including asset-backed securities). Such securities are sensitive to changes in prevailing interest rates, since interest rate levels affect the rate at which the underlying mortgage obligations are repaid. FIC’s insurance subsidiaries have reduced the risk of prepayment associated with mortgage-backed securities by investing in planned amortization class (“PAC”), target amortization class (“TAC”) instruments and scheduled bonds. These investments are designed to amortize in a predictable manner by shifting the risk of prepayment of the underlying collateral to other investors in other tranches (“support classes”) of the CMO.

FIC’s equity securities consist primarily of its investment in the investment funds underlying the separate accounts business of Investors Life Insurance Company of North America (“Investors Life”). As of September 30, 2004, the market value of FIC’s equity securities was $7.8 million, compared to $7.9 million at December 31, 2003. The decrease is related to a decrease in the value of the underlying funds in the separate accounts.

FIC’s real estate investment is primarily related to the development of the River Place Pointe project (“River Place Pointe”) by Investors Life. At September 30, 2004, FIC’s investment totaled $88.6 million in this 600,000 sq. ft., seven-building office complex on 48 acres in Austin, Texas. FIC and its insurance company subsidiaries occupy one of the seven buildings. Three of the other buildings were substantially leased, but three buildings remained unleased as of September 30, 2004. The project was sold in June 2005, in a cash transaction, for $103 million. The Company will realize a gain of $10.1 million on the sale, which includes both a current 2005 realized gain of $8 million and a deferred gain of $2.1 million to be recognized over the period from the sale date through March 31, 2008.

Investors Life had $350.2 million of separate account assets as of September 30, 2004 (not including the value of the Company’s own start-up investment in one of the accounts), as compared to $358.3 million at the end of 2003. These assets include (a) two variable annuity separate accounts that permit contractholders to allocate their contract values among a selection of third-party mutual funds and (b) assets held in custodian accounts in connection with investment annuity contracts. The investment annuity business is reinsured with Symetra Life Insurance Company (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10% coinsurance basis, with Investors Life retaining 10% of such business. Since the reinsurance treaty is on a coinsurance basis, Investors Life is contingently liable to the policyholders in the event that the reinsurer is unable to fulfill its obligations under the treaty. Investors Life is not marketing new separate account annuity contracts.

Effective June 1, 2006, Investors Life recaptured the previously reinsured investment annuity business with Symetra Life resulting in the retention of 100% of this business. The Company expects the recapture of this previously reinsured business to increase revenues in 2006 and future years. However, as this is a closed block of business, the revenues are expected to decrease as the policies in force decline.

Liabilities

The Company’s insurance-related liabilities (future policy benefits and contractholder deposit funds) were $739.7 million at September 30, 2004, compared to $763.1 million at December 31, 2003. The decrease in these insurance-related liabilities reflects the business run-off as previously described.

During the nine months ended September 30, 2004, deferred income taxes have increased $1.6 million from December 31, 2003, most notably due to the tax effects of decreases in deferred policy acquisition costs and increases in net operating loss carryforwards and pension liabilities. These are offset by a valuation allowance based on future realization of deferred tax assets. This valuation allowance has been increased due to the continuing net losses of the Company.

Capital Adequacy

Financial intermediaries such as FIC depend on their equity capital to absorb short-term fluctuations in asset and liability values in their financial structures. They also count on equity capital to support the growth of the business. One typical measure of the strength of a financial holding company such as FIC is the simple ratio of its shareholders’ equity to its total assets. For FIC, excluding its separate account assets (which are not relevant for this purpose), at September 30, 2004, this ratio was 10.4%, compared to 11.2% at the end of 2003. Management believes that its current equity capital is sufficient to meet the Company’s current liabilities and to fund growth at currently planned levels.

FIC’s two insurance company subsidiaries are subject to regulation under state law. Among other requirements, these state laws and regulations impose capital adequacy requirements on insurance companies. Using a calculation that takes into account the quality, liquidity, maturities, and amounts of its assets and liabilities, each insurance company is required to calculate its “risk-based capital” (or “RBC”). The company’s total adjusted capital must exceed 200% of the authorized control level RBC to avoid supervisory activity by the insurance regulators. As of December 31, 2005, the total adjusted capital of FIC’s insurance subsidiaries, Family Life and Investors Life, was approximately 717% and 560% of its authorized control level risk-based capital, respectively. The RBC ratio of Investors Life improved significantly as a result of the June 2005 sale of the River Place Pointe real estate investment.

State regulators also use NAIC IRIS ratios to monitor capital adequacy requirements. The NAIC ratios cover 12 categories of financial data with defined “usual” ranges for each such category. The ratios are intended to provide insurance regulators with “early warnings” as to when a given company might warrant special attention. An insurance company may fall outside of the usual range for one or more ratios, and such variances may result from specific transactions that are, by themselves, immaterial or eliminated at the consolidation level. In certain states, insurers with more than three IRIS ratios outside of the NAIC usual ranges may be subject to increased regulatory oversight. For 2004, each of the Company’s insurance subsidiaries had six IRIS ratios outside of the usual ranges. However, for 2005, Family Life had five ratios and Investors Life had two ratios which were outside the usual ranges. For Family Life, the ratios outside the usual ranges were primarily related to changes in capital and surplus, net income, investment income, and non-admitted assets. For Investors Life, the ratios outside the usual ranges were primarily related to investment income and changes in premium. Despite the IRIS ratio results for 2005, both Family Life and Investors Life continue to maintain capital and surplus positions which significantly exceed risk-based capital (“RBC”) and other regulatory requirements.

Critical Accounting Policies

The accounting policies below have been identified as critical to the understanding of the results of operations and financial position. The application of these critical accounting policies in preparing the financial statements requires management to use significant judgments and estimates concerning future results or other developments, including the likelihood, timing or amount of one or more future transactions. Actual results may differ from these estimates under different assumptions or conditions. On an ongoing basis, estimates, assumptions and judgments are evaluated based on historical experience and various other information believed to be reasonable under the circumstances. For a detailed discussion of other significant accounting policies, see Note 1 – Organization and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Accounting for Premiums on Universal Life Policies and for Annuity Deposits

In accordance with accounting principles generally accepted in the United States of America (“GAAP”), universal life insurance premiums and annuity deposits received are reflected in FIC’s consolidated financial statements as increases in liabilities for contractholder deposit funds and not as revenues. Instead revenues from such contracts consist of amounts assessed against policyholder account balances for mortality, policy administration and surrender charges, and are recognized in the period in which the benefits and services are provided. Similarly, surrender benefits paid relating to universal life insurance policies and annuities are reflected as decreases in liabilities for contractholder deposit funds and not as expenses.

Investments

The Company’s principal investments are in fixed maturity securities and real estate; all of which are exposed to three primary sources of investment risk: credit, interest rate and liquidity. The fixed maturity securities, which are all classified as available for sale, are carried at their fair value in the Company’s balance sheet, with unrealized gains or losses recorded in accumulated other comprehensive income. The investment portfolio is monitored regularly to ensure that investments which may be other than temporarily impaired are identified in a timely fashion and properly valued, and that impairments are charged against earnings as realized investment losses. The valuation of the investment portfolio involves a variety of assumptions and estimates, especially for investments that are not actively traded. Fair values are obtained from a variety of external sources. The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. This process involves monitoring market events that could impact issuers’ credit ratings, business climate, management changes, litigation and government actions, and other similar factors. This process also involves monitoring late payments, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. At the end of each quarter, all securities are reviewed where fair value is less than ninety percent of amortized cost for six months or more to determine whether impairments should be recorded. The analysis focuses on each issuer’s ability to service its debts and the length of time the security has been trading below cost. This quarterly process includes an assessment of the credit quality of each investment in the entire securities portfolio. The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other-than-temporary. Relevant facts and circumstances considered include (1) the length of time the fair value has been below cost, (2) the financial position of the issuer, including the current and future impact of any specific events, and (3) the Company’s ability and intent to hold the security to maturity or until it recovers in value. To the extent the Company determines that a security is deemed to be other than temporarily impaired, the difference between amortized cost and fair value would be charged to income as a realized investment loss. There are a number of significant risks and uncertainties inherent in the process of monitoring impairments and determining if an impairment is other-than-temporary. These risks and uncertainties include (1) the risk that the Company’s assessment of an issuer’s ability to meet all of its contractual obligations will change based on changes in the credit characteristics of that issuer, (2) the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated, (3) the risk that fraudulent information could be provided to the Company’s investment professionals who determine the fair value estimates and other-than-temporary impairments, and (4) the risk that new information obtained by the Company or changes in other facts and circumstances lead the Company to change its intent to hold the security to maturity or until it recovers in value. Any of these situations could result in a charge to income in a future period.

Real Estate

The Company monitors the performance of its real estate properties on an ongoing basis and identifies properties it intends to hold for investment and properties it intends to sell. Properties held for investment are classified as investment real estate and are stated at cost less accumulated depreciation. Depreciation is provided using straight-line methods over estimated useful lives of 5 to 40 years, or for leasehold improvements the minimum lease term if shorter. Real estate income is reported net of expenses incurred to operate the properties and depreciation expenses. The Company reviews its investment real estate properties on an on-going basis for impairment using a probability-weighted estimation of the expected net undiscounted future cash flows. If the expected net undiscounted future cash flows are less than the net book value of the property, the excess of the net book value over the Company’s estimate of fair value of the asset is recognized as a realized loss in the consolidated statement of operations and the new cost basis is depreciated over the property’s remaining life.

Properties that are identified for sale and actively marketed by the Company are classified as real estate held for sale and are stated at the lower of cost less accumulated depreciation or net realizable value. No depreciation is recorded while the property is classified as held for sale. Net realizable value is determined by the Company based on the estimated selling price less direct costs of the sale.

Deferred Policy Acquisition Costs and Present Value of Future Profits of Acquired Business

The costs of acquiring new business, including certain costs of issuing policies and certain other variable selling expenses (principally commissions), are included in deferred policy acquisition costs (“DAC”). DAC is capitalized and then amortized to reflect an appropriate expense in relation to the projected stream of profits (for universal life and annuity products) or to the premium revenue stream (for traditional life products). Similarly, when existing blocks of business are acquired, an intangible capital asset (termed “present value of future profits of acquired business” or “PVFP”) reflecting the costs of acquiring the business is created and then amortized over what is judged to be an appropriate term relative to the expected revenues and profitability of the block.

Projections used to determine the rate of amortization of DAC and PVFP also require extensive assumptions about, among other things, interest margins, product loads, mortality rates, persistency rates, and maintenance expense levels. In setting the levels of DAC and PVFP amortization, important assumptions must also be made about the appropriate level at which blocks of policies will be aggregated for testing the acceptability of amortization schedules, and views vary widely on this topic. These assumptions involve judgment and are compared to actual experience on an ongoing basis. Significant changes in these assumptions can impact the carrying balance of DAC and PVFP and produce changes that must be reflected in the current period’s income as an unlocking adjustment. Loss recognition is evaluated periodically on an aggregate basis that combines deferred policy acquisition costs with the present value of future profits on acquired business.

Future Policy Benefits

FIC’s liability for future policy benefits accounted for 14.0% of its total liabilities at September 30, 2004, or 20.0% after excluding liabilities associated with separate accounts. These liabilities for future policy benefits, referred to as reserves, are estimated using actuarial methods based on assumptions about future receipts of premiums, interest yields, investment returns, expenses, mortality, morbidity, and persistency. These assumptions consider Company experience and industry standards. The assumptions vary by plan, age at issue, year of issue, and duration. They include estimates, shaped by judgment and experience, and have a substantial impact on the reported financial condition of the Company. Differences between actual experience and assumptions used in the pricing of these policies and in the establishment of liabilities may result in variability of net income in amounts which may be material.

Deferred Taxes

The Company computes deferred income taxes utilizing the asset and liability method. 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 bases of assets and liabilities using the tax rates which are expected to be in effect when these differences are anticipated to reverse. Deferred income tax assets are subject to ongoing evaluation of whether such assets will be realized. Realization of deferred tax assets is dependent upon the Company’s generation of sufficient taxable income in the future to recover tax benefits that cannot be recovered from taxes paid in prior periods. If future taxable income is not expected, the Company establishes a valuation allowance, when based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

General

FIC’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, 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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

The Company manages the interest-rate risk inherent in its fixed income assets relative to the interest-rate risk inherent in its 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 condensed consolidated balance sheets is estimated to be $30.2 million at September 30, 2004 and $38.4 million at December 31, 2003. For purposes of the foregoing estimate, fixed maturity securities held for maturity, available for sale, and held for trading, and short-term investments were taken into account. The fair value of such assets was $612.7 million at September 30, 2004 and $560.7 million at December 31, 2003.

The fixed income investments of the Company include certain mortgage-backed securities (excluding asset backed securities). The market value of such securities was $187.4 million at September 30, 2004 and $263.4 million at December 31, 2003. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in the fair value related to such mortgage-backed securities is estimated to be $14.9 million at September 30, 2004 and $19.1 million at December 31, 2003.

Separate account assets have not been included, since gains and losses on those assets generally accrue to the policyholders.

The Company generally does not use derivative financial instruments to manage its exposure to fluctuations in interest rates.

ITEM 4. CONTROLS AND PROCEDURES

Management has completed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. This evaluation has allowed management to make conclusions, as set forth below, regarding the state of the Company’s disclosure controls and procedures as of September 30, 2004. Based on its evaluation and the identification of material weakness in internal control over financial reporting described below, and because of an inability to file the Quarterly Report on Form 10-Q within the statutory time period, FIC’s Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2004, FIC’s disclosure controls and procedures were ineffective.

As more fully described in Note 2, “Restatement of Previously Issued Financial Statements” in the accompanying consolidated financial statements, in the course of completing the 2003 audited financial statements and, subsequently, the September, 2004 interim financial statements, management identified a significant number of internal control weaknesses in several key areas that had resulted in material misstatement of financial results. These include weaknesses in the following areas, among others: deferred policy acquisition costs; present value of future profits of acquired businesses; policy liabilities; reinsurance accounting; investment accounting; consolidation process; purchase accounting; financial reporting procedures and review process; and intercompany accounting.

Following its identification of the above-described internal control weaknesses, the Company has been actively engaged in the implementation of remediation efforts to address the material weaknesses in its internal control over financial reporting as of September 30, 2004, through the use of internal and external resources, including the design, documentation and testing of internal controls for the major processes related to financial reporting. There have been no changes in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Future plans include the development of a remediation plan to include establishing new controls to meet predefined control objectives, correcting improperly defined control activities and establishing procedures to ensure that control owners retain formal documented evidence that will clearly prove the effectiveness of established and newly implemented internal controls.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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 legal actions will not have a material impact on the condensed consolidated financial statements.

T. David Porter v. Financial Industries Corporation

On May 31, 2006, T. David Porter, an FIC shareholder, filed a civil suit in Travis County, Texas District Court (the “Court”), against the Company. The suit alleges that the Company refuses to hold a shareholder meeting because FIC is currently unable to comply with Rule 14a-3 of the Securities Exchange Act of 1934. The Company claims that because FIC is not currently in a position to solicit proxies in connection with an annual meeting, or to provide an annual report to its shareholders, FIC does not believe it is currently able to hold an annual shareholders’ meeting at which its shareholders will be fully informed or represented. The suit is brought under Article 2.24(B) of the Texas Business Corporation Act, which states that if an annual meeting of shareholders is not held within any 13-month period and a written consent of shareholders has not been executed instead of a meeting, any court of competent jurisdiction in the county in which the principal office of the corporation is located may, on the application of any shareholder, summarily order a meeting to be held. Mr. Porter is asking the Court to compel the Company to have a shareholder meeting; to order FIC to send notice of the meeting to the Company’s shareholders at its expense; to order the Company to provide Mr. Porter with a list of shareholders as of the record date for the meeting, and for costs and attorney’s fees. The Company filed its answer on June 30, 2006. On July 18, 2006, plaintiffs filed a motion to compel an annual shareholders meeting. On August 7, 2006, the Company entered into an Agreed Order On Plaintiff’s Motion to Compel Annual Shareholders Meeting (the “Order”) and agreed (1) to hold an annual shareholders meeting for the election of directors on December 6, 2006, even if the Company has not filed all relevant financial statements with the SEC or whether management is able to solicit proxies for the meeting; (2) that the record date for the annual shareholders meeting shall be October 24, 2006 (the “Record Date”); (3) that on or before October 27, 2006, the Company shall serve Mr. Porter with a complete list of shareholders as of the Record Date and (4) in the event that the Board of Directors of FIC, between the date of the Order and the December 6, 2006 annual meeting, votes to sell either or both of FIC’s life insurance subsidiaries without first obtaining approval of FIC’s shareholders, FIC will announce such impending transaction to the public through a Form 8-K filed with the SEC, and will agree to allow Mr. Porter a reasonable amount of expedited discovery prior to the closing of such transaction(s) so that Mr. Porter may determine whether or not to seek a restraining order or temporary injunctive relief preventing the closing of such transaction(s). In such event, Mr. Porter will also appear for deposition by the Company’s counsel, at a mutually agreeable time and place prior to any hearing on an application for restraining order or temporary injunctive relief.

Litigation with Otter Creek Partnership I, L.P.

During 2003, Otter Creek Management Inc., (“Otter Creek Management”), solicited proxies for the Company’s 2003 Annual Meeting of Stockholders (the “2003 Annual Meeting”) held on July 31, 2003, seeking the election of seven nominees to the Board of Directors of the Company in opposition to the ten candidates selected by the then incumbent Board of Directors. Otter Creek Management is an investment advisory firm that manages three investment funds that are shareholders of the Company: Otter Creek Partners I, LP (“Otter Creek Partners”), Otter Creek International Ltd. and HHMI XIII, LLC (together with Otter Creek Management and Otter Creek Partners, “Otter Creek”).

In connection with this solicitation of proxies, on June 13, 2003, Otter Creek Partners commenced a lawsuit in the District Court in Travis County, Texas, Cause No. GN302872 (the “Litigation”) seeking, among other things, to compel the Company to hold the previously delayed 2003 Annual Meeting. Otter Creek also sought in the Litigation to neutralize the effect of a proxy obtained by the Company from the Mitte Family (the “Mitte Proxy”) the preceding month whereby the incumbent board was able to vote 1,627,610 shares in favor of its nominees.

At the meeting, six of the seven Otter Creek nominees were elected to the Board: R. Keith Long, J. Bruce Boisture, Salvador Diaz-Verson Jr., Patrick E. Falconio, Richard H. Gudeman and Lonnie L. Steffen. The shares covered by the Mitte Proxy were all voted in favor of the incumbent nominees at the 2003 Annual Meeting. Had Otter Creek been successful in neutralizing the effect of the Mitte Proxy, all seven of the Otter Creek nominees would have been elected.

Following the 2003 Annual Meeting, Otter Creek and FIC completed a settlement with respect to the lawsuit in December 2003. Under the settlement agreement, the Company reimbursed Otter Creek for $250,000 in proxy expenses in 2003. An additional $475,000 of proxy and litigation expenses will be submitted to the Company’s shareholders for approval at the next Annual Meeting of Shareholders. If payment of the additional $475,000 is so approved, the amount will be expensed by the Company in the year of approval. The Board of Directors will recommend that shareholders approve the reimbursement. The settlement also included mutual releases between the Company and Otter Creek and its affiliates. The Chairman of the Board of Directors of the Company, R. Keith Long, is the President and owner of the General Partner of Otter Creek Partners I, L.P.

Litigation with Former Employee of Subsidiary

The Company placed Earl Johnson, the then-president of JNT Group, Inc. (“JNT”), a subsidiary of FIC that was later sold in December 2003 in the sale of the New Era companies, on administrative leave pending an investigation of matters related to (1) Johnson’s alleged termination of an employee in response to her request for information regarding her workers’ compensation rights arising out of an injury and (2) his co-mingled and disorganized bookkeeping of JNT’s client accounts with those of a personal business owned by Mr. Johnson and run by him at the same office (using the Company’s employees to do so). Soon after being interviewed in the course of that investigation, Mr. Johnson resigned, alleging good reason under his employment agreement with a subsidiary of FIC, on the ground that the change in the composition of the Board of Directors of FIC following the 2003 Annual Meeting of Shareholders resulted in a “change of control” under the provisions of his employment agreement. The employment agreement provided that if Mr. Johnson were to voluntarily terminate his employment for good reason, he would receive compensation and benefits for the remainder of the three-year term of the agreement and would become fully vested in 17,899 restricted shares of FIC stock. The Company notified Mr. Johnson that his resignation was not for “good reason” pursuant to his employment agreement. Under that agreement, termination without good reason results in forfeiture of future salary and benefits, as well as forfeiture of the restricted shares of FIC common stock.

In November 2003, Mr. Johnson and his wife, Carol Johnson, filed suit in Harris County, Texas District Court against the Company, FIC Financial Services, Inc. (“FICFS”) and an employee of the Company. The suit, which sought an unspecified amount of damages and injunctive relief, alleges that the defendants interfered with the non-JNT contract and business relationships of the plaintiffs, made slanderous statements regarding the plaintiffs, and accessed computer files at the JNT offices relating to the non-JNT business relationships of the plaintiffs, without the consent of the plaintiffs. The suit also alleged conspiracy, conversion, and various other torts, all related to the defendants’ investigation of plaintiff’s business

practices at JNT.

Subsequently, Mr. Johnson filed a demand for arbitration under his employment agreement, which has a mandatory arbitration clause. In the arbitration, Mr. Johnson sought damages for breach of contract and various other benefits relating to the termination of his employment contract, totaling $913,133.40. In connection with the arbitration, FIC submitted a counter-claim, alleging that Mr. Johnson committed multiple breaches of his employment agreement, and that he breached his fiduciary duty to FIC as a result of his actions in conducting the business of JNT, thereby entitling FIC to a dismissal of plaintiff’s claims. Prior to the hearing on the arbitration, the Harris County Court ordered that the matters raised in that lawsuit by Mr. Johnson (though not Carol Johnson) be combined with the arbitration.

Litigation with Equita Financial and Insurance Services of Texas, Inc. and M&W Insurance Services, Inc.

On June 2, 2005, Equita and M&W Insurance Services, Inc. (“M&W”) filed a civil suit in Travis County, Texas District Court against the Company. The suit alleges that, in entering into certain agreements with the plaintiffs, the Company made certain misrepresentations and omissions as to its business and financial condition. The agreements referenced in the suit consist of (a) an option agreement entered into in June 2003 between Equita and the Company, granting Equita the right to purchase shares of FIC’s common stock at $16.42 per share, if certain sales goals were achieved under an exclusive marketing agreement between Equita and a subsidiary of the Company (the “Option Agreement”), (b) a stock purchase agreement entered into in June 2003 between M&W and the Roy F. and Joann Cole Mitte Foundation, pertaining to the purchase of 204,918 shares of FIC’s common stock (the Stock Purchase Agreement”), and (c) a registration rights agreement entered into in June 2003 among the plaintiffs and the Company, whereby the Company agreed to file and maintain a shelf registration statement which respect to the shares of FIC’s common stock purchased by M&W from the Mitte Foundation or which may be acquired in the future by Equita under the option agreement (the “Registration Rights Agreement,” and, collectively, the “Agreements”). See “Item 1-Description of the Business-Marketing Agreement with Equita” and “Item 13 -Certain Relationships and Related Transactions.”

breached the provisions of the Registration Rights Agreement by failing to file a shelf registration with the SEC with respect to the shares of FIC’s common stock purchased by M&W from the Mitte Foundation and the shares which may be acquired in the future by Equita under the provisions of the Option Agreement. The plaintiffs seek rescission of the Agreements; damages in an amount equal to the $3 million that M&W paid to acquire FIC shares from the Mitte Foundation, together with interest and attorney’s fees and unspecified expenses; and an unspecified amount of exemplary damages.

Deposition discovery with respect to both the case filed by Equita and M&W, and the claims in intervention asserted by Family Life and Investors Life, is set to begin in October of 2006.

Shareholder Claim

The Company received a demand letter in April 2004 from a law firm representing an individual shareholder (Mr. Cook) who owns 530 shares of the Company’s common stock, which letter set forth certain allegations and notified the Registrant that the shareholder intended to file a shareholder derivative lawsuit (the “Demand Letter”).

In May 2004, FIC, by and through its Special Litigation Committee, filed a petition in the 250th District Court of Travis County, Texas (the “Court”), seeking to have the Court appoint a panel of independent and disinterested persons pursuant to Section H (3) of Article 5.14 of the Texas Business Corporation Act to investigate the allegations, and stay any shareholder derivative actions. Subsequently, on June 1, 2004, the Court issued an Order appointing Eugene Woznicki, Kenneth S. Shifrin, John D. Barnett and F. Gary Valdez as a panel of independent and disinterested persons (the “Panel”) to make determinations contemplated by Section F of Article 5.14 of the Texas Business Corporation Act in connection with the Demand Letter and staying any shareholder derivative actions relating to the letter until the Panel’s review was completed and a determination was made by the panel as to what, if any, further action was to be taken. Messrs. Woznicki, Shifrin and Barnett are independent directors of FIC. Mr. Valdez is neither a director nor an employee of FIC. Mr. Valdez is the founder and president of Focus Strategies, L.L.C. and is active in various community and civic organizations in the Austin, Texas area.

(2) after the Panel conducted a reasonable inquiry, and (3) based on the factors deemed appropriate under the circumstances by the Panel. The Court’s ruling otherwise dismissed with prejudice the derivative proceedings involved in this matter. The Final Judgment was approved as to form and substance by counsel for the Registrant and by counsel for the defendant.

Other Litigation

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the first nine months of 2004.

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

31.1 Certification of Chief Executive Officer of FIC pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 Certification of Chief Financial Officer of FIC pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1 Certification of Chief Executive Officer of FIC pursuant to 18 U.S.C. Section 1350.

32.2 Certification of Chief Financial Officer of FIC pursuant to 18 U.S.C. Section 1350.

(b) Reports on Form 8-K

(i) On July 9, 2004, the Registrant filed a Current Report on Form 8-K. The current report referred to a press release issued July 9, 2004 by the Company, which announced that the Company had received a letter from Nasdaq confirming that the Company’s common stock had been delisted from the Nasqdaq Stock Market effective July 1, 2004.

(ii) On August 4, 2004, the Registrant filed a Current Report on Form 8-K. The current report announced that Eugene E. Payne had submitted his resignation as a director of the Company effective July 27, 2004. The report also reported that Dr. Payne would receive a severance payment of $340,000 plus interest.

(iii) On August 9, 2004, the Registrant filed a Current Report on Form 8-K. The current report announced that the Company had filed a Form 12b-25, Notification of Late Filing, with respect to the filing of its report on Form 10-Q for the quarter ended June 30, 2004.

(iv) On September 9, 2004, the Registrant filed a Current Report on Form 8-K. The current report announced that the Company has identified certain accounting errors that will require the restatement of its shareholders' equity and financial statements for the periods ended September 30, 2003, June 30, 2003 and March 31, 2003. The Company further cautioned investors to no longer rely upon the financial statements included in its Form 10-Q for each of these quarters effected.

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