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

For the Quarterly Period Ended ~~September~~March 3031, ~~2006~~2007

Commission File Number 0-4690

Financial Industries Corporation

(Exact name of registrant as specified in its charter)

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).

YES ¨ NO x

The number of shares outstanding of Registrant's common stock on ~~March~~May 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 ~~the~~our ~~Company’s~~ operations and financial results, the markets for our products, future results, ~~the~~ 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 products; (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 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–-Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 3-Quantitative and Qualitative Disclosures about Market ~~Risks~~Risk in Part 1, ~~and~~ 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.
Part I - Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets September 30, 2006 and December 31, 2005	4
Condensed Consolidated Balance Sheets March 31, 2007 and December 31, 2006	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 Operations For the three months ended March 31, 2007 and March 31, 2006	6
Condensed Consolidated Statements of Cash Flows For the nine month periods ended September 30, 2006 and September 30, 2005	10
Condensed Consolidated Statements of Cash Flows For the three months ended March 31, 2007 and March 31, 2006	8
Notes to Condensed Consolidated Financial Statements	1210
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	1918
Item 3. Quantitative and Qualitative Disclosures about Market Risk	25
Item 3. Quantitative and Qualitative Disclosures About Market Risk	24
Item 4. Controls and Procedures	2625
Part II – Other Information
Part II - Other Information
Item 1. Legal Proceedings	2726
Item 1A. Risk Factors	2928
Item 2. Changes in Securities and Use of Proceeds	29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3. Defaults Upon Senior Securities	2928
Item 4. Submission of Matters to a Vote of Security Holders	2928
Item 5. Other Information	2928
Item 6. Exhibits	2928
Signatures	3029

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands) (Unaudited)

	September 30, 2006			December 31, 2005 (1)
	March 31,		December 31,
ASSETS
	2007		2006 (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 available for sale, at fair value (amortized cost of $523,950 and $536,618 at March 31, 2007 and December 31, 2006, respectively)	$	510,879	$	520,957
Policy loans		35,412			37,637
Equity securities, at fair value (cost of $7,503 and $6,534 at March 31, 2007 and December 31, 2006, respectively)		9,785		9,805
Real estate held for sale		-			130
Policy loans		29,780		30,189
Short-term investments		~~16,847~~-		7,473	~~1,204~~
Total investments		~~670~~550,~~650~~444		568,424	~~643,630~~
Cash and cash equivalents		759,~~393~~968		55,603	~~63,581~~
Deferred policy acquisition costs		5014,~~432~~303		14,429	~~50,805~~
Present value of future profits of acquired business		147,~~509~~409		7,749	~~15,865~~
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
Agency advances and other receivables, net of allowances for doubtful accounts of $210 and $173 as of March 31, 2007 and December 31, 2006, respectively		4,140		929
Reinsurance receivables		3228,~~526~~589		29,061	~~38,108~~
Accrued investment income		75,~~420~~951		6,772	~~7,165~~
Due premiums		~~1,555~~283		237	~~2,048~~
Property and equipment, net		~~720~~435		550	~~1,033~~
Other assets		2,251			2,088
Deferred federal income taxes		2,296		1,891
Separate account assets		341,841			342,911
Other assets		2,143		1,679
Total assets	$	1,142,574		$	1,175,422
Separate account assets		351,139		350,987
Total assets	$	1,027,100	$	1,038,311

(1) Derived from audited 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 thousands) (Unaudited)

	September 30, 2006				December 31, 2005 (1)
	March 31,			December 31,
LIABILITIES AND SHAREHOLDERS’ EQUITY
	2007			2006 (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	$	446,517		$	453,671
Other policy claims and benefits payable		8,312				11,456
Future policy benefits		116,224			117,097
Notes payable		15,000				15,000
Other policy claims and benefits payable		8,334			6,907
Deferred federal income taxes		413				687
Notes payable		15,000			15,000
Other liabilities		2229,~~078~~169			33,968	~~25,146~~
Separate account liabilities		~~341~~351,~~841~~139			350,987	~~342,911~~
Total liabilities		1966,~~061,884~~383			977,630	~~1,093,351~~
Commitments and contingencies (See Note 8)
Commitments and contingencies (Note 8)
Shareholders’ equity:
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
Common stock, $.20 par value; 25,000 shares authorized in 2007 and 2006; 12,533 shares issued in 2007 and 2006; 10,210 shares outstanding in 2007 and 2006		2,507			2,507
Additional paid-in capital		70,~~373~~141			70,046	~~70,377~~
Accumulated other comprehensive loss		(139,~~144~~001	)		(9,586	~~(10,339~~)	)
Retained earnings		4317,~~735~~059			17,703	~~42,485~~
Common treasury stock, at cost, 2,647 and 2,668 shares in 2006 and 2005		(22,778	)			(22,956	)
Common treasury stock, at cost, 2,323 shares in 2007 and 2006		(19,989	)		(19,989	)
Total shareholders’ equity		8060,~~690~~717			60,681	~~82,071~~
Total liabilities and shareholders’ equity	$	1,~~142~~027,~~574~~100		$	$1,038,311	~~1,175,422~~

(1) Derived from audited 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

(In thousands except per share data) (Unaudited)

	Three Months Ended September 30,
	Three Months Ended March 31,
	2006				2005
	2007			2006
Revenues:
Premiums, net	$	62,~~152~~136		$	$907	~~5,925~~
Earned insurance charges		97,~~617~~699			8,023	~~9,919~~
Net investment income		8,~~636~~484			7,284	~~8,108~~
Real estate income		-				16
Net realized investment (losses) gains		(12	)		516
Net realized investment gains (losses)		1				(703	)
Other		2,315			657
Other		1,234				636
Total revenues		20,622			17,387
Total revenues		25,640				23,901
Benefits and expenses:
Benefits and expenses:
Policyholder benefits and expenses		8,307			8,180
Policyholder benefits and expenses		8,056				11,923
Interest expense on contractholders deposit funds		4,371			4,573
Interest expense on contractholders deposit funds		5,090				5,434
Amortization of deferred policy acquisition costs		469			195
Amortization of deferred policy acquisition costs		2,329				2,078
Amortization of present value of future profits of acquired business		279			285
Amortization of present value of future profits of acquired business		544				715
Operating expenses		6,189			5,227
Operating expenses		7,376				7,228
Interest expense		361			329
Interest expense		364				297
Total benefits and expenses		19,976			18,789
Total benefits and expenses		23,759				27,675
Income (loss) from continuing operations before federal income taxes		646			(1,402	)
Income (loss) before federal income taxes		1,881				(3,774	)
Federal income tax expense (benefit)		104			(185	)
Provision (benefit) for federal income taxes		586				(1,252	)
Income (loss) from continuing operations		542			(1,217	)
Net income (loss)	$	1,295			$	(2,522	)
Loss from discontinued operations, net of taxes		-			(569	)
Net income (loss)	$	542		$	(1,786	)

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

(In thousands except per share data) (Unaudited)

	Three Months Ended September 30,
	Three Months Ended March 31,
	2006			2005
	2007		2006
Net Income (Loss) Per Share:
Basic:
Weighted average common shares outstanding		910,~~856~~210		9,849	~~9,823~~
Basic income (loss) per share	$	0.13		$	(0.26	)
Basic earnings per share:
Diluted:
Income (loss) from continuing operations	$	0.05	$	(0.12	)
Weighted average common shares and common share equivalents		9,856			9,823
Discontinued operations		-		(0.06	)
Diluted income (loss) per share	$	0.13		$	(0.26	)
Net income (loss) per share	$	0.05	$	(0.18	)
Diluted:
Weighted average common shares and common stock equivalents		10,309		9,849
Diluted earnings per share:
Income (loss) from continuing operations	$	0.05	$	(0.12	)
Discontinued operations		-		(0.06	)
Net income (loss) per share	$	0.05	$	(0.18	)

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

(In thousands except per share data) (Unaudited)

	Nine Months Ended September 30,
	2006		2005
Revenues:
Premiums, net	$	17,508	$	17,906
Earned insurance charges		29,061		30,253
Net investment income		25,872		22,856
Real estate income		-		563
Net realized investment gains		502		8,567
Other		3,308		1,882
Total revenues		76,251		82,027
Benefits and expenses:
Policyholder benefits and expenses		28,743		31,859
Interest expense on contractholders deposit funds		15,396		16,581
Amortization of deferred policy acquisition costs		6,453		7,745
Amortization of present value of future profits of acquired business		1,717		2,038
Operating expenses		20,791		21,815
Interest expense		1,042		829
Total benefits and expenses		74,142		80,867
Income before federal income taxes		2,109		1,160
Provision for federal income taxes		859		143
Net income	$	1,250	$	1,017

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

(In thousands except per share data) (Unaudited)

	Nine Months Ended September 30,
	2006		2005
Net Income Per Share:
Basic:
Weighted average common shares outstanding		9,856		9,813
Net income per share	$	0.13	$	0.10
Diluted:
Weighted average common shares and common share equivalents		9,856		9,813
Net income per share	$	0.13	$	0.10

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

(In thousands) (Unaudited)

	Nine Months Ended September 30,
	Three Months Ended March 31,
	2006				2005
	2007			2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Continuing Operations:
Net income	$	1,250			$	1,017
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Net income (loss)	$	542		$	(1,786	)
Amortization of deferred policy acquisition costs		6,453				7,745
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Amortization of present value of future profits of acquired business		1,717				2,038
Loss from discontinued operations		-			569
Net realized gains on investments		(502	)			(9,606	)
Amortization of deferred policy acquisition costs		469			195
Depreciation		341				1,763
Amortization of present value of future profits of acquired business		279			285
Increase in accrued investment income		(255	)			(1,158	)
Net realized (gains) losses on investments		12			(516	)
Decrease (increase) in agent advances and other receivables		493				1,520
Depreciation		108			124
Decrease (increase) in due premiums		493				(114	)
(Increase) decrease in accrued investment income		821			(74	)
Increase in deferred policy acquisition costs		(5,082	)			(5,802	)
(Increase) decrease in agency advances and other receivables		(2,739	)		645
Decrease (increase) in other assets		(163	)			37
(Increase) decrease in due premiums		(46	)		30
Increase (decrease) in policy liabilities and accruals		(7,396	)			779
Increase in deferred policy acquisition costs		(1,060	)		(189	)
Decrease in other liabilities		(3,068	)			(3,567	)
Increase in other assets		(464	)		(212	)
Increase in deferred federal income taxes		1,172				1,258
Increase in policy liabilities and accruals		1,119			84
Net activity from trading securities		-				(759	)
Increase (decrease) in other liabilities		(4,799	)		14,629
Other, net		22				(1,218	)
Increase in deferred federal income taxes		(685	)		(464	)
Net cash used in operating activities		(4,525	)			(6,067	)
Other, net		(1,740	)		1,792
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash provided by (used in) operating activities		(8,183	)		15,112
Fixed maturities purchased		(59,840	)			(151,494	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Real estate capital expenditures		-				(544	)
Fixed maturities purchased		(29,013	)		(51,953	)
Proceeds from sales and maturities of fixed maturities		4041,~~641~~402			9,241	~~59,880~~
Proceeds from sales of invested real estate		646				101,067
Proceeds froms sales of invested real estate		-			646
Net (increase) decrease in short-term investments		(15,643	)			58,312
Net decrease in short-term investments		7,473			1,204
Net decrease in policy loans		~~2,225~~409			632	~~1,648~~
Purchase of property and equipment		(335	)		(7	~~(307~~)	)
Net cash provided by (used in) investing activities		~~(32~~20,~~004~~266	)		(40,237	~~68,562~~)
					(continued)

(continued)

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

108

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued

(In thousands) (Unaudited)

	Nine Months Ended September 30,
	Three Months Ended March 31,
	2006				2005
	2007			2006
CASH FLOWS FROM FINANCING ACTIVITIES:
Contractholder fund deposits	$	245,~~273~~987		$	$7,363	~~25,376~~
Contractholder fund withdrawals		(4313,~~932~~705	)		(16,485	~~(52,962~~)	)
Net cash used in financing activities		(197,~~659~~718	)		(9,122	~~(27,586~~)	)
Net increase (decrease) in cash		~~(56~~4,~~188~~365	)		(34,247	~~34,909~~)
Cash and cash equivalents, beginning of year		6355,~~581~~603			36,906	~~52,044~~
Cash and cash equivalents, end of period	$	759,~~393~~968		$	$2,659	~~86,953~~
Supplemental Cash Flow Disclosures:
Discontinued Operations:
Income taxes refunded	$	4,341			$	-
Net cash used in operating activities of discontinued operations	$	-		$	(11,092	)
Interest paid	$	1,026			$	805
Net cash used in investing activities of discontinued operations		-			(6,999	)
Treasury stock distributions	$	174			$	316
Net cash used in financing activities of discontinued operations		-			(321	)
Decrease in cash and cash equivalents		-			(18,412	)
Cash and cash equivalents at beginning of year		-			26,675
Cash and cash equivalents at end of period	$	-		$	8,263
Supplemental Cash Flow Disclosures:
Income taxes refunded	$	-		$	1,227
Interest paid	$	363		$	330

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

119

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1.	Basis of Presentation and Consolidation

The financial statements included herein have been presented to conform to the requirements of Form 10-Q.

The accompanying unaudited condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments) necessary to present fairly the consolidated financial position of the Company at ~~September~~March 3031, ~~2006~~2007, its consolidated results of operations for the three months ~~and~~ended ~~nine~~March ~~months ended~~31, ~~September~~ 2007 ~~30, 2006~~ and ~~2005~~ 2006, and its consolidated cash flows for the ~~nine~~three months ended ~~September 30~~March 31, ~~2006~~ 2007 and ~~2005~~2006 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, ~~2005 condensed~~2006 condensed consolidated balance sheet data was derived from the audited ~~consolidated~~ consolidated financial statements included in the Company’s ~~2005~~2006 Annual Report on Form 10-K filed with the SEC (“~~2005~~2006 Annual Report”), which includes all ~~disclosures~~ disclosures required by GAAP. Therefore, these unaudited condensed consolidated ~~financial~~ financial statements should be read in conjunction with the consolidated ~~financial~~ financial statements of the Company included in the ~~2005~~2006 Annual Report.

The condensed consolidated financial statements include the accounts of Financial Industries Corporation (“FIC”) and its wholly owned subsidiaries. Intercompany items and transactions have been eliminated.

Adoption of New Accounting Pronouncements

Income Taxes

Effective January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes − an Interpretation of FASB Statement No. 109” ("FIN 48"), which clarifies the accounting for uncertainty in tax positions. FIN 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheets; and provides transition and interim period guidance, among other provisions. FIN 48 requires companies to determine whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. As a result of the implementation of FIN 48, the Company recognized a $1,441,000 increase in the liability for unrecognized tax benefits and a $255,000 increase in deferred tax assets resulting in a $1,186,0000 reduction to the January 1, 2007 balance of retained earnings. The Company also reclassified, at adoption, $3,522,000 of current tax liabilities (previously recorded as a reduction to current tax receivables) and $503,000 of deferred tax liabilities to the liability for unrecognized tax benefits included within other liabilities.

Insurance Contracts

Effective January 1, 2007, the Company adopted Statement of Position 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts” (“SOP 05-1”). SOP 05-1 provides guidance on accounting by insurance enterprises for DAC on internal replacements of insurance and investment contracts other than those specifically described in 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.” SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. It is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The adoption of SOP 05-1 did not have a material impact on the Company’s condensed consolidated financial statements.

Servicing of Financial Assets

Effective January 1, 2007, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140” (“SFAS 156”). Among other requirements, SFAS 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations. The adoption of SFAS 156 did not have a material impact on the Company’s condensed consolidated financial statements.

Index

Future Adoption of New Accounting Pronouncements

In September, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a common definition for 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 condensed consolidated financial statements.

In February, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits all entities the option to measure most financial instruments and certain other items at fair value at specified election dates and to report related unrealized gains and losses in earnings. The fair value option will generally be applied on an instrument-by-instrument basis and is generally an irrevocable election. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is evaluating which eligible financial instruments, if any, it will elect to account for at fair value under SFAS 159 and the related impact on the Company’s condensed consolidated financial statements.

2.	Accumulated Other Comprehensive Income (Loss) and Comprehensive Income (Loss)

The following is a reconciliation of accumulated other comprehensive income (loss) from December 31, ~~2005~~2006, to ~~September~~March 3031, ~~2006 (in thousands)~~2007:

	Net Unrealized Appreciation (Depreciation) of Equity Securities			Net Unrealized Gain (Loss) on Fixed Maturities Available for Sale	~~Net Unrealized Gain (Loss) on Fixed Maturities Available for Sale~~		Minimum Pension Liability		~~Other~~	Total Accumulated Other Comprehensive Income (Loss)			~~Total Accumulated Other Comprehensive Income (Loss)~~
Balance at December 31, 2005	$	1,651			$	(5,914	)		$	(6,076	)		$	(10,339	)
	(In thousands)
Current Period Change		40				(2,845	)			-				(2,805	)
Balance at December 31, 2006	$	2,159		$	(7,676	)	$	(4,069	)	$	(9,586	)
Balance at September 30, 2006	$	1,691			$	(8,759	)		$	(6,076	)		$	(13,144	)
Current Period Change		(653	)		1,196			42			585
Balance at March 31, 2007	$	1,506		$	(6,480	)	$	(4,027	)	$	(9,001	)

The comprehensive income (loss) for the three ~~and nine~~ months ~~ending~~ended ~~September 30~~March 31, ~~2006~~ ~~and~~2007 ~~2005~~ and 2006 is summarized as follows ~~(in thousands)~~:

	Three Months Ended September 30,							Nine Months Ended September 30,
	Three Months Ended March 31,
	2006				2005			2006			2005
	2007			2006
Net income (loss)	$	1,295			$	(2,522	)	$	1,250		$	1,017
	(In thousands)
Other comprehensive income, net of tax:
Net income (loss)	$	542		$	(1,786	)
Unrealized gains on securities:
Other comprehensive income (loss), net of tax:
Unrealized holdings gains (losses) arising during the period		7,995				(4,332	)		(2,796	)		(2,401	)
Unrealized gains on securities:
Reclassification adjustments for gains (losses) included in net loss		1				(683	)		(9	)		(311	)
Unrealized holdings gains ( losses) arising during the period		555			(6,211	)
Total other comprehensive income (loss)		7,996				(5,015	)		(2,805	)		(2,712	)
Reclassification adjustments for losses included in net income		(12	)		-
Comprehensive income (loss)	$	9,291			$	(7,537	)	$	(1,555	)	$	(1,695	)
Change in pension liability		42			-
Total other comprehensive income (loss)		585			(6,211	)
Comprehensive income (loss)	$	1,127		$	(7,997	)

3.	Discontinued Operations - Sale of Family Life Insurance Company

On December 29, 2006, Financial Industries Corporation completed the sale of its wholly owned subsidiary, Family Life Insurance Company, to The Manhattan Life Insurance Company for $28.0 million in cash. In accordance with SFAS 144, the condensed consolidated financial statements reflect the operating results of Family Life Insurance Company as discontinued operations, adjusted for certain activities as described below.

Index

Prior to the sale, the Company transitioned the sales force of Family Life to a new division of Investors Life, FIC’s remaining insurance subsidiary. Although Investors Life is now selling similar products as those that were sold by Family Life, there are notable differences. The insurance is written on Investors Life policy forms and leads are no longer obtained from lending institutions. Leads are now purchased through other sources and the focus is on a different market demographic than the previous Family Life target market. The new division also now sells final expense insurance products, which was not a market focus for Family Life. Additionally, as a condition of the sales agreement, the new division of Investors Life is prohibited from selling products to existing policyholders and related customers of Family Life for five years.

In connection with the sale of Family Life, Investors Life entered into a coinsurance agreement with Family Life pursuant to which Investors Life will cede to Family Life (a wholly-owned subsidiary of Manhattan Life) 35% of the face amount of mortgage protection term policies written by the Family Sales Division during the five-year period beginning April 1, 2007 and ending March 31, 2012. Such business will be administered by Investors Life, and Investors Life will receive allowances for its expenses on the portion of the business that is ceded. Accordingly, the Company accrued a deferred revenue liability of $1.4 million in conjunction with recording the sale of Family Life, equal to the estimated net present value of future business expected to be ceded to Manhattan Life. Costs associated with the Family Life agents while affiliated with Family Life, much of which were capitalized and amortized as deferred policy acquisition costs, are included in discontinued operations.

Prior to the sale, Investors Life assumed certain universal life insurance and annuity contracts written by Family Life under reinsurance treaties between the companies. Effective September 30, 2006, Family Life and Investors Life executed recapture agreements related to these reinsurance treaties effectively terminating these treaties and removing Investors Life from any liability for life insurance and annuity contracts written by Family Life. Accordingly, all revenues and costs associated with these universal life insurance and annuity contracts are included in discontinued operations.

Also, prior to the closing of the sale, the Family Life Pension Plan, along with its assets and liabilities, was transferred from Family Life to its upstream parent company and all current and future obligations of the Family Life Pension Plan remain the responsibility of the Company. Accordingly, the Family Life Pension Plan liabilities and costs were not included in discontinued operations.

Family Life owned 648,640 shares of FIC common stock prior to the sale. Such shares were reflected as common treasury stock in the Company’s consolidated financial statements. Immediately preceding and as a condition of the sale of Family Life, 324,320 of these shares were acquired by the Company and the remaining 324,320 shares remained with Family Life at the time of the sale. Accordingly, the shares that remained with Family Life are now reflected as outstanding common stock shares as of December 31, 2006, and have been reflected as a sale of treasury stock in the accompanying condensed consolidated financial statements.

Family Life shared certain operating costs, including personnel, premises, equipment and software, and other office and administrative expenses with FIC and its other subsidiaries through various sharing agreements. These agreements with Family Life were terminated upon its sale and Family Life did not retain any employees, equipment, software or liability for leases. Accordingly, the discontinued operations of Family Life were adjusted to eliminate the estimated continuing expenses associated with these shared operating costs.

In conjunction with the sale, Family Life also entered into an administrative services agreement with the Company for a three month period following the sale. Pursuant to the agreement, the Company provided administrative services for Family Life through March 31, 2007, at which time Manhattan Life assumed all responsibilities for administering the Family Life business. The Company earned fees totaling $807,000 in the first quarter of 2007 for services performed for Family Life in accordance with the agreement.

Index

34. Earnings Per Share

The following table reflects the calculation of basic and diluted earnings (loss) per share:

	Three Months Ended September 30,						Nine Months Ended September 30,
	Three Months Ended March 31,
	2006			2005			2006		2005
	2007		2006
	(in thousands except per share data)
	(In thousands except per share data)
BASIC:
Numerator:
Net income (loss)	$	1,295		$	(2,522	)	$	1,250	$	1,017
Income (loss) from continuing operations	$	542	$	(1,217	)
Weighted average common shares outstanding		9,856			9,823			9,856		9,813
Denominator:
Basic income (loss) per share	$	0.13		$	(0.26	)	$	0.13	$	0.10
Weighted average common shares outstanding:
DILUTED:
Basic		10,210		9,849
Net income (loss)	$	1,295		$	(2,522	)	$	1,250	$	1,017
Common stock options		99		-
Weighted average common shares outstanding		9,856			9,823			9,856		9,813
Repurchase of treasury stock		-		-
Diluted income (loss) per share	$	0.13		$	(0.26	)	$	0.13	$	0.10
Diluted		10,309		9,849
Per share:
Basic	$	0.05	$	(0.12	)
Diluted	$	0.05	$	(0.12	)

Options to purchase shares of common stock were not included in the computation of diluted earnings per share because the inclusion would result in an anti-dilutive effect in periods in which a net loss was incurred.

4. Net Realized Investment Gains

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 sales 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 (approximately 76,000 square feet) 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 $10.6 million on the sale, which includes both a realized gain of $8.5 million in the quarter ended June 30, 2005 and a deferred gain of $2.1 million to be recognized as a reduction of office lease expenses over the period from the sale date through March 31, 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.

During the third quarter of 2005, the Company identified a fixed maturity security which was considered impaired and reduced its carrying value by $1 million.

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.

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.

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.

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 occurred on September 30, 2006 due to the settlement of several former employees’ plan obligations through the payment of lump sums. A settlement occurs whenever the lump sums paid during the year exceed the sum of the plans Service Cost and Interest Cost components of expense for that year. The settlement resulted in the recognition of a $295,736 charge to expense for 2006.13

~~The pension costs for the Family Life Pension Plan include the following components at September 30, 2006 and 2005:~~Index

	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

The pension costs for the Family Life Pension Plan include the following components at March 31, 2007 and 2006:

	Three Months Ended March 31,
	2007			2006
	(In thousands)

Service cost for benefits earned during the year	$	-		$	-
Interest cost on projected benefit obligation		101			110
Expected return on plan assets		(100	)		(102	)
Amortization of unrecognized prior service cost		-			-
Amortization of unrecognized losses		18			23
Recognition of net loss due to settlement		-			-

Net periodic benefit cost	$	19		$	31

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 NHCEs effective March 31, 2006. All plan participants accrued benefits are now frozen.

The pension costs for the ILCO Pension Plan include the following components at March 31, 2007 and 2006:

	Three Months Ended March 31,
	2007			2006
	(In thousands)

Service cost for benefits earned during the year	$	-		$	4
Interest cost on projected benefit obligation		275			262
Expected return on plan assets		(375	)		(350	)
Amortization of unrecognized prior service cost		-			-
Amortization of unrecognized losses		25			46
Recognition of net loss due to settlement		-			-

Net periodic benefit cost	$	(75	)	$	(38	)

Index

~~The pension~~6. ~~costs~~Stock ~~for the ILCO Pension Plan include the following components at September 30, 2006 and 2005:~~Options

	Three Months Ended Sept. 30,						Nine Months Ended Sept. 30,
	2006			2005			2006			2005
Service cost for benefits earned during the year	$	3,672		$	11,448		$	11,016		$	34,344
Interest cost on projected benefit obligation		262,037			261,812			786,111			785,436
Expected return on plan assets		(350,036	)		(344,766	)		(1,050,108	)		(1,034,298	)
Amortization of unrecognized prior service cost		-			-			-			-
Amortization of unrecognized losses		46,022			33,920			138,066			101,760
Recognition of net loss due to settlement		-			-			-			-
Net periodic benefit cost	$	(38,305	)	$	(37,586	)	$	(114,915	)	$	(112,758	)

FIC entered into a stock option agreement on February 1, 2007 with it’s chief executive officer, William Prouty, pursuant to which Mr. Prouty was issued an option to purchase 150,000 shares of the common stock of FIC at a price of $7.45 per share. Fifty percent (50%) of the option vested on February 1, 2007, and the remaining fifty percent (50%) will vest on June 21, 2007 (see Note 9 “Related Party Transactions”). The option expires on June 21, 2009. The Company recognized compensation expense of $95,000, and a related tax benefit of $0, in the quarter ended March 31, 2007 related to the 50% vested portion of the option.

6The fair value of the option award was estimated on the date of grant using a Black-Scholes option pricing model. ~~Stock~~Significant ~~Option~~assumptions ~~Plans~~used ~~and~~in ~~Other~~the calculation ~~Equity~~of ~~Incentive~~fair ~~Plans~~value are as follows:

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS 123(R) is a revision of SFAS 123, “Accounting for Stock-Based Compensation,” which was originally issued by the FASB in 1995. As originally issued, SFAS 123 provided companies with the option to either record expense for share-based payments under a fair value model, or to simply disclose the impact of the expense. SFAS 123(R) requires companies to measure the cost of share-based payments to employees using a fair value model, and to recognize that cost over the relevant service period. In addition, 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 basis. SFAS 123(R) was originally effective July 1, 2005, but was later deferred by the Securities and Exchange Commission and will become effective for all awards granted, modified, repurchased, or cancelled by the Company beginning January 1, 2006. The adoption of this statement on January 1, 2006 did not have a material impact on the Company’s consolidated financial statements.

Options granted		150,000
Stock price on date of grant	$	7.45
Exercise price	$	7.45
Expected life, in years		2.387
Estimated annualized volatility		18.4	%
Dividend yield		0.0	%
Risk-free interest rate		4.9	%

The expected term is derived using a simplified method calculation as defined in SEC Staff Accounting Bulletin Topic 14.D.2, for “plain vanilla” options as that term is further defined in the bulletin, and represents the period of time that the options are expected to be outstanding. Volatility is a measure of the amount by which a financial variable, such as share price, has fluctuated or is expected to fluctuate during a period. The calculated volatility was derived from the option pricing model utilizing FIC historical share price data. The dividend yield is assumed to be zero, since FIC has not paid dividends since 2003, and management does not anticipate the payment of such dividends in the near future.

7.	Separate Accounts

The Company’s insurance subsidiary, Investors Life Insurance Company of North America (“Investors Life”) had $~~341~~351.81 million of separate account assets as of ~~September~~ March 3031, ~~2006~~2007 (not including the value of the Company’s own investment in ~~one~~ one of the accounts), as compared to $~~342~~351.90 million at the end of ~~2005~~2006. These assets include (a) two variable annuity separate accounts that permit ~~contractholders~~ 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~~ 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~~2007 and future years. However, as this is is a closed block of business, the revenues are expected to decrease as the policies in force decline.

8.	Commitments and Contingencies

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, 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 215th Judicial District Court, Harris County, Texas, against Family Life Corporation, Investors ~~Life~~ Life and FIC Insurance Services, L.P. (“FICIS”), each a subsidiary of the Company. The suit alleges that: a) Family Life Corporation breached ~~the~~ the Stock Purchase Agreement with Manhattan ~~life~~Life by competing with Family Life ~~and~~ 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~~ 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. The Company intends to vigorously defend the suit, and has filed an answer denying the plaintiffs’ claims. 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~~Note 93 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 condensed consolidated financial statements for such legal proceedings.

Other Litigation

FIC and its insurance ~~subsidiaries~~subsidiary 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~~Related ~~Events~~Party Transactions

~~Sale~~FIC entered into an Engagement Letter (the "Engagement Letter"), dated February 1, 2007, between FIC and DLB Capital Fund FNIN, LLC ("DLB"), pursuant to which FIC agreed to pay DLB $439,996 for management consulting services over the term of the ~~Family~~Engagement ~~Life~~Letter, ~~Insurance~~which ~~Company~~shall terminate on January 31, 2008, unless terminated earlier in accordance with the Engagement Letter. DLB is a Wilton, Connecticut based private equity firm focusing primarily on the financial services sector. The group was formed to specialize in management buyouts, corporate divestitures, leveraged buyouts, re-capitalizations and public to private transactions. William Prouty is a principal and founding member of DLB and shall continue his interest in DLB while serving as the Chief Executive Officer of FIC.

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~~March 3031, ~~2006~~2007, compared with December 31, ~~2005~~2006, ~~and~~ and its results of operations for the three ~~and~~months ~~nine-month periods~~ ended ~~September~~ 30March 31, ~~2006~~2007, 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~~2006, to which the reader is directed for additional information.

Results of Operations –- Three Months Ended ~~September~~March 3031, ~~2006~~2007 and ~~2005~~ 2006

For the three -month period ended ~~September~~March 3031, ~~2006~~2007, ~~the~~FIC’s ~~Company reported~~ net income ~~of $1.3~~ ~~million~~was $542,000 (basic and diluted income of $0.1305 per common share) ~~on revenues of $25.6 million~~ compared to a net loss of $~~2.5~~1,786,000 ~~million~~ (basic and diluted loss of $0.2618 per common share) onfor ~~revenues~~the ofcomparable 2006 ~~$23~~period.9 ~~million~~However, ~~for~~in analyzing the ~~three~~Company’s ~~month~~results ~~period ended~~of ~~September 30~~operations, ~~2005.~~a separation ~~The~~of ~~three~~results ~~months~~between ~~ended~~continuing ~~September~~and ~~30,~~discontinued ~~2006~~operations ~~and 2005~~provides ~~include~~ a more ~~the~~meaningful ~~impact~~view. ofAs ~~certain~~previously ~~trends~~described ~~and~~in ~~changes~~Note 3 in the ~~business~~accompanying condensed ofconsolidated financial statements, the Company ~~which~~ ~~are~~sold ~~dominant~~Family inLife on December ~~the~~29, ~~results~~2006, ofresulting ~~the~~in ~~nine~~a ~~months~~loss ~~ended~~from ~~September~~discontinued ~~30,~~operations. ~~2006~~Included ~~and~~ in the ~~2005.~~net ~~These~~loss ~~items~~for ~~are~~the ~~described~~first inquarter ~~the~~of ~~nine-month~~2006 ~~results~~is ofa ~~operations below. Of~~loss ~~these~~from ~~results~~discontinued operations, ~~certain~~net ~~significant~~of ~~items~~taxes, of ~~change~~$569,000. ~~between~~Income from continuing operations totaled $542,000 for the three months ended ~~September~~March 3031, ~~2006~~2007, ~~and~~while ~~2005~~loss ~~which~~from ~~contribute to an~~continuing ~~improvement~~ operations intotaled ~~net income of~~ $~~3.8~~1,217,000 ~~million~~for ~~between~~the ~~periods~~comparable ~~are~~2006 ~~as follows:~~period.

·The following ~~Increase~~sections of this Item 2 reflect Family Life as discontinued operations pursuant to SFAS 144 as previously described. Accordingly, unless otherwise noted, amounts and analysis in ~~net~~this ~~investment~~Item ~~income~~2 reflect the continuing operations of FIC ~~$528~~and its subsidiaries,~~000~~ ~~primarily~~exclusive ~~due~~of Family Life. References to ~~increased~~income and loss ~~holdings~~from inoperations ~~fixed~~are ~~maturities~~identified ~~and~~as ~~higher~~continuing ~~interest~~operations ~~rates;~~or discontinued operations, while references to net income or net loss reflect the consolidated net results of both continuing and discontinued operations.

~~· Increase in other revenues of $598~~In 2007,~~000,~~ FIC’s ~~primarily~~net ~~due~~gain towas ~~additional~~affected ~~fee income resulting from the termination of a coinsurance agreement~~ by ~~an insurance subsidiary of~~ the ~~Company~~following ~~effective~~significant ~~June~~items 1,as compared to 2006. ~~Under the agreement, the Company had ceded 90% of the risk associated with certain investment annuity policies classified as separate accounts business;~~amounts:

· ~~Decline~~Increase in ~~realized~~premiums ~~losses~~earned of $~~704,000~~1.2 ~~primarily~~million due primarily to aincreases $1in ~~million~~sales ~~impairment~~of ~~recorded~~final ~~for~~expense anwhole ~~investment~~life ininsurance aand ~~fixed~~mortgage ~~maturity~~protection ~~security~~term ininsurance ~~2005;~~products.

· ~~Decrease~~Increase in ~~policyholder~~net ~~benefits~~investment ~~and~~income ~~expenses~~ of $31.92 million primarily ~~resulting~~due ~~from~~to ~~the~~dividend ~~decline~~income inreceived ~~the~~on ~~amount~~investments ofin ~~death~~equity ~~claims;~~securities.

· Increase in ~~provision~~other ~~for~~revenues ~~federal income taxes~~ of $1.87 million due to additional fees earned on separate accounts and fees earned for services performed under an administrative services agreement with Family Life.

~~Results~~ · Increase in operating expenses of ~~Operations~~$1.0 –million ~~Nine~~primarily ~~Months~~due ~~Ended~~to ~~September~~higher 30audit, ~~2006~~actuarial, accounting and ~~2005~~ other consulting, and legal fees.

~~For~~The ~~the~~ above ~~nine-month~~ described ~~period~~items ~~ended~~need ~~September~~to ~~30,~~be ~~2006,~~taken ~~FIC’s~~into ~~net~~consideration ~~income~~in ~~was~~drawing ~~$1.3 million~~comparisons ~~(basic~~ between ~~and~~the ~~diluted~~operating ~~income~~results offor ~~$0.13~~the ~~per~~three ~~common~~months ~~share)~~ended onMarch ~~revenues~~31, ~~of $76.2~~2007 ~~million as compared to net income of $1.0 million (basic~~ and ~~diluted earnings~~ ~~of $0~~ 2006.~~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~~revenues for the first ~~nine~~three months of ~~2006~~2007, net of reinsurance ceded, ~~was~~ were $172.51 million, as compared to $170.9 million in the first ~~nine~~ three months of ~~2005~~ of 2006. This source of revenues is related to the traditional life insurance book of business of FIC’s insurance ~~subsidiaries~~subsidiary for both first year and renewal premiums. The increase in premiums is primarily due to increases in sales of final expense whole life insurance and mortgage protection term insurance products, along with decreases in reinsurance premium expenses.

In accordance with GAAP, deposits received ~~by FIC~~ in connection with annuity ~~contracts~~ contracts and premiums received for universal life (“UL”) insurance policies are reflected in the ~~FIC’s~~condensed consolidated 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~~ three months ended ~~September~~March 3031, ~~2006~~2007 and ~~2005~~2006, annuity deposits and UL premiums totaled $246.3 0 million and $257.4 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 since 2004 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~~475.97 million at ~~September 30~~March 31, ~~2005~~2006 to $~~520~~446.45 million at ~~September~~March 3031, ~~2006~~2007.

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.18

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

Earned insurance charges totaled $7.7 million for the first three months of 2007, compared to $8.0 million for the same period of 2006. These revenues primarily consist of UL cost of insurance charges, but also include policy surrender charges, and policy administration charges. The decrease in earned insurance charges from 2006 to 2007 is primarily due to reduced UL cost of insurance charges resulting from the net run-off of business.

Net investment income for the first three months of 2007 was $8.5 million as compared to $7.3 million for the same period of 2006. The higher net investment income in 2007 versus 2006 was primarily attributable to an increase in dividend income earned on the Company’s investments in equity securities totaling $749,000. Dividend income earned on the equity securities totaled $970,000 for the first three months of 2007 as compared to $221,000 for the comparable 2006 period. The remaining increase in net investment income is primarily due to improved investment yields.

Net realized investment losses were $12,000 in the first three months of 2007, as compared to $516,000 of realized gains in the first three months of 2006. The realized losses for 2007 were from the sale of a fixed maturity security. The realized gains for 2006 were from the sale of the Company’s remaining real estate properties classified as held for sale.

Other revenues totaled $2.3 million and $0.7 million for the three months ended March 31, 2007 and 2006, respectively. The significant increase in other revenues in 2007 is partially due to fees earned related to the Company’s separate accounts. As previously described in Note 7 of the accompanying condensed consolidated financial statements, 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 recapture of this previously reinsured separate accounts business increased other revenues in 2007 by approximately $500,000 as compared with the corresponding period of 2006.

Other revenues also increased in 2007 due to fees earned for services performed under an administrative services agreement with Family Life. As previously described in Note 3 of the accompanying condensed consolidated financial statements, Family Life entered into an administrative services agreement with the Company for a three month period following the sale of Family Life. Pursuant to the agreement, the Company provided administrative services for Family Life through March 31, 2007, at which time Manhattan Life assumed all responsibilities for administering the Family Life business. The Company earned fees totaling $807,000 in the first quarter of 2007 for services performed for Family Life in accordance with the agreement.

Benefits and Expenses

Policyholder benefits and expenses, which consist primarily of death benefit claims, were $288.73 million in the first ~~nine~~three months of ~~2006~~2007, as compared to $318.92 million in the first ~~nine~~three months of ~~2005~~2006. ~~The~~While ~~decline~~the increase in ~~policyholder~~traditional ~~benefits~~premium revenues ~~and~~for ~~expenses~~2007 also increased the corresponding traditional policy reserve in expenses, ~~2006~~this was ~~primarily~~substantially ~~attributable~~offset toby lower death claims in 2007 versus 2006.

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 $154.4 million in the first ~~nine~~three months of ~~2006~~2007, as compared to $164.6 million in the same period of the year ~~2005~~2006. 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~~ interest expense in ~~2006~~2007 is primarily attributable to this overall reduction in ~~the~~ 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 insubsequent to 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.19

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

Amortization of deferred policy acquisition costs (DAC) for the first three months of 2007 was $469,000, as compared to $195,000 for the same period in 2006. 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 in any reporting period. The increase in amortization in 2007 from the comparable 2006 period is primarily due to the increased sales of traditional business by Investors Life since the third quarter of 2006 and the amortization relating to the DAC capitalized on these sales.

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 $279,000 and $285,000 for the three months ended March 31, 2007 and 2006, respectively. The amortization is consistent with the run-off of the acquired blocks of business.

Operating expenses for the first three months of 2007 were $6.2 million, as compared to $5.2 million in the first three months of 2006. 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 the filing of this Form 10-Q. These fees totaled $2.5 million and $1.8 million for the three months ended March 31, 2007 and 2006, respectively. With the filing of this Form 10-Q, the Company is now current with its SEC filing requirements. Accordingly, the Company expects significant reductions going forward in its audit, actuarial, accounting and consulting expenses.

Interest expense was $361,000 and $329,000 for the three months ended March 31, 2007 and 2006, 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 2007 is a direct result of the increase in the LIBOR rate. Interest expense for the three months ended March 31, 2007 and 2006 reflects an average annual interest rate of approximately 9.6% and 8.8%, respectively.

Taxes

The provision for federal income taxes of $104,000 on income from continuing operations reflects an effective tax rate of 16.1% for the three months ended March 31, 2007. The benefit for federal income taxes of $185,000 on loss from continuing operations reflects an effective tax benefit rate of 13.2% for the three months ended March 31, 2006. The primary reason for the deviation from the expected statutory tax rate of 34% for the Company is due to changes in the valuation allowance for deferred tax assets generated by its non-life insurance entities. 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.

Liquidity and Capital Resources

Liquidity describes the ability of a company to generate sufficient cash flows to ~~meet~~ meet the cash requirements of business operations. FIC is an insurance holding company whose principal assets consist of its insurance ~~subsidiaries~~subsidiary, -Investors ~~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~~Investors Life.

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.20

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~~As ~~each insurance company holds large portfolios~~ of ~~highly liquid publicly traded~~ ~~debt~~ March ~~securities~~31, ~~raising~~2006, ~~cash~~Investors ~~through~~Life ~~asset~~held ~~sales~~$15.4 ismillion ~~available should other sources~~ of ~~liquidity~~notes ~~fail~~receivable ~~to provide cash as needed. In this regard, however,~~from ~~the insurance companies must be concerned about such sales at inopportune times,~~ FIC ~~when~~ that ~~adverse~~represented ~~movements~~the inremaining ~~interest~~indebtedness ~~rates~~related ~~may~~to ~~have depressed~~ the ~~market~~Family ~~price~~Life ~~of securities~~ acquisition. soAlthough ~~that~~this ~~sales~~intercompany ~~would~~indebtedness ~~result~~was ineliminated ~~the realization of significant losses.~~on ~~To guard against such an outcome,~~ FIC’s ~~management monitors benefits paid and~~ ~~surrenders~~ consolidated ofbalance ~~insurance products to provide projections of future cash requirements. Also as part of this monitoring process~~sheets, ~~FIC~~it ~~performs~~created ~~cash~~a ~~flow testing~~debt ofservice ~~assets~~requirement ~~and liabilities~~ at ~~each year-end to evaluate~~ the ~~match between~~ ~~the~~ holding ~~planned maturities of the insurance~~ company ~~assets~~level. ~~and~~These ~~the~~notes ~~likely~~were ~~liquidity needs~~paid ofoff ~~the~~by ~~companies~~FIC ~~over~~on ~~time.~~December ~~Such cash-flow testing~~29, ~~prescribed by~~ ~~insurance~~ 2006 using ~~laws~~proceeds ~~and~~from ~~regulations, models~~ the ~~likely~~sale ~~performance~~ of ~~assets~~Family ~~and liabilities over time, using a wide variety of future interest rate scenarios~~Life.

~~There~~At ~~can~~ the be holding nocompany ~~assurance~~level, ~~that~~FIC’s ~~future~~principal ~~experience~~current ~~regarding~~ongoing ~~benefits~~liquidity ~~and~~demands ~~surrenders will~~relate ~~be similar~~ to ~~the~~debt ~~historic~~service ~~experience~~ on ~~which~~$15 ~~such~~million ~~cash-flow~~of ~~testing~~senior isnotes ~~based, since~~that ~~withdrawal~~it ~~and~~issued ~~surrender~~in ~~levels~~May ~~are~~2003. These notes ~~influenced~~require byquarterly ~~such~~interest ~~factors~~payments asat a variable interest rate of the ~~interest~~ three-month LIBOR rate ~~environment~~plus ~~and~~4.2% ~~general~~(which ~~economic~~yielded ~~conditions~~an asaverage ~~well~~rate asof ~~the~~approximately ~~claims-paying~~ 9.6% ~~and~~for ~~financial~~the ~~strength~~first ~~ratings~~quarter of ~~FIC’s~~2007). ~~insurance~~The principal amount of the notes ~~subsidiaries~~ must be repaid in a single payment in 2033.

~~Cash~~In ~~and cash~~ addition ~~equivalents~~to atdebt ~~September 30~~service, ~~2006~~the ~~were~~holding ~~$7.4~~company ~~million~~must ~~compared~~pay toits ~~$63.6~~expenses in ~~million~~ connection atwith ~~December~~Board ~~31,~~of ~~2005.~~Directors ~~The~~fees, ~~$56.2~~insurance ~~million~~costs, ~~decrease~~corporate inoverhead, certain ~~cash~~audit and ~~cash equivalents~~accounting ~~at September 30~~fees, ~~2006~~and ~~from~~legal ~~December~~and ~~31,~~consulting ~~2005~~expenses ~~was~~as incurred. ~~due~~The ~~primarily to reinvestment~~holding ofcompany ~~cash~~has ~~into~~not ~~fixed~~paid ~~maturity~~any ~~securities~~dividends ~~and~~to ~~short-term~~its ~~investments.~~shareholders ~~This~~ since ~~was~~2003, ~~partially~~and ~~offset~~management bydoes ~~the~~not ~~net~~anticipate ~~payout~~the payment of ~~contractholder~~such ~~deposits and~~dividends ~~use~~ in of the ~~cash~~near ~~by operations~~future.

~~Net~~The ~~cash used~~ ability inof ~~operating~~Investors ~~activities~~Life ~~was~~to ~~$4.5~~pay ~~million~~dividends ~~for~~to ~~the~~FIC ~~nine~~and ~~month~~meet ~~period~~these ~~ended~~holding-company ~~September~~ liquidity ~~30,~~demands ~~2006,~~is ~~compared~~subject to ~~$6.1~~restrictions ~~million~~set ~~for~~forth in the ~~same~~insurance laws ~~period~~and regulations of ~~2005~~Texas, its domiciliary state. ~~The~~Texas limits how and when ~~decrease~~ Investors Life incan ~~cash~~pay ~~used~~such dividends by ~~operating~~(a) ~~activities~~including the “greater of” ~~$1.5~~standard ~~million~~for payment ~~from~~of ~~2005~~dividends to shareholders and (b) requiring that prior ~~2006 was~~ notification ~~primarily~~of ~~attributable~~a proposed dividend be given to the ~~change~~Texas inDepartment ~~net~~of Insurance. ~~realized~~Under ~~gains~~the “greater of” standard, an insurer may pay a dividend in ~~investments~~an ~~as a~~ amount ~~result~~equal ofto the ~~sale~~greater of: ~~the~~(i) ~~River~~10% ~~Place~~of ~~Pointe~~the ~~office~~policyholder ~~complex,~~surplus ~~agent~~or (ii) ~~advances~~the ~~and~~ insurer’s ~~other~~statutory ~~receivables,~~net ~~policy~~gain ~~liabilities~~from ~~and~~operations ~~accruals~~for ~~and~~the ~~deferred~~previous ~~income taxes~~year.

~~Net~~In ~~cash~~ June ~~used~~ 2004, inFIC, ~~investing~~with ~~activities~~the ~~was~~approval ~~$32~~of ~~million~~the inTexas Department of Insurance, created FIC Insurance Services, L.P., a service company subsidiary, and transferred to it many of the ~~nine~~administrative ~~month~~functions ~~period~~of ~~ended~~the insurance companies. The new ~~September~~ service company 30charges Investors Life a monthly service fee that is calculated using a formula based on policies under management, ~~2006~~new policies issued, ~~compared~~managed assets, and toother ~~$68~~factors.6 ~~million~~Profits ~~provided~~earned by ~~investing~~the ~~activities~~service company are paid as dividends ~~for~~ to the ~~same~~holding ~~period~~company, providing an additional source of ~~2005.~~liquidity ~~The~~at the holding ~~cash~~company ~~provided~~level. Profits earned by ~~investing~~the ~~activities~~service incompany ~~2005~~are expected ~~was~~ to decrease ~~due~~in ~~primarily~~2007, toas ~~proceeds~~fees ~~received~~will ~~from~~decline due to the sale of ~~the~~Family ~~River~~Life ~~Place Pointe~~on ~~office~~ December ~~complex~~29, ~~in 2005~~2006. ~~Most~~This ofagreement ~~this~~with ~~cash~~the service company was ~~then~~terminated by Family ~~reinvested~~Life inupon ~~fixed maturities~~the ~~and~~sale ~~short-term~~of ~~investments~~Family inLife ~~2006~~to The Manhattan Life Insurance Company.

~~Net~~Liquidity ~~cash used~~ considerations inat ~~financing~~Investors ~~activities~~Life ~~was~~are ~~$19.7~~different ~~million~~ in ~~the~~nature ~~first~~than ~~nine~~for ~~months~~the ofholding ~~2006, compared to cash used in financing activities of $27~~ company.6 ~~million~~Sources ~~in the first nine months~~ of ~~2005.~~cash ~~The~~for ~~most~~Investors ~~significant~~Life ~~components~~consist of ~~the~~premium ~~Company’s financing~~payments ~~activities~~ and deposits ~~are~~from ~~contractholder~~policyholders ~~fund deposits~~ and ~~withdrawals for~~ annuity ~~and universal~~holders, ~~life~~charges ~~insurance~~on policies~~. For~~ ~~the nine months ended~~and ~~September 30~~ contracts, ~~2006~~investment income, and ~~2005,~~proceeds ~~contractholder~~from ~~fund~~the ~~withdrawals~~sale ~~exceeded~~of ~~deposits~~investment ~~by $19~~ assets.7 These ~~million~~funds ~~and~~are ~~$27.6~~applied ~~million~~primarily ~~respectively.~~to ~~The~~provide ~~change~~for inthe ~~net~~payment ~~withdrawals~~of claims in under insurance ~~2006~~and isannuity ~~due~~policies, topayment ~~a decline in deposits in 2006 from 2005~~ of ~~$1.1~~policy ~~million~~withdrawals, surrenders and ~~a decrease~~ loans, inoperating ~~withdrawals~~expenses, oftaxes, ~~$9.0~~investments ~~million~~in ~~for~~portfolio ~~the~~securities, and shareholder ~~same period~~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 March 31, 2007 were $446.5 million, compared to $453.7 million at December 31, 2006. 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 March 31, 2007, the bulk of the liabilities for contractholder deposit funds on FIC’s condensed consolidated balance sheet, $311.9 million, represented insurance products, as compared to $134.6 million of annuity product liabilities.

Since Investors Life holds a portfolio 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, Investors Life 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 Investors Life.

Index

Cash and cash equivalents at March 31, 2007 were approximately $60.0 million compared to $55.6 million at December 31, 2006. The $4.4 million increase in cash and cash equivalents at March 31, 2007 from December 31, 2006 was due primarily to cash flows from investing activities.

Net cash used in operating activities was $8.2 million for the three month period ended March 31, 2007, compared to $15.1 million provided by operating activities for the same period of 2006. The predominant changes in net cash used in operating activities between 2007 and 2006 are due to payments of $15.2 million in the first quarter of 2007 for amounts due for unsettled transactions for purchased securities and decreases in other liabilities.

Net cash provided by investing activities was $20.3 million for the three month period ended March 31, 2007, compared to net cash used in investing activities totaling $40.2 million for the same period of 2006. The significant increase in cash provided by investing activities was due primarily to higher levels of sales and maturities of fixed maturity securities in 2007 totaling $41.4 million versus $9.2 million for the comparable 2006 period. Additionally, purchases of fixed maturity securities totaled $29.0 million in 2007 compared to $52.0 million in 2006.

Net cash used in financing activities was $7.7 million in the first three months of 2007, compared to $9.1 million in the first three months of 2006. The components of the Company’s financing activities are contractholder fund deposits and withdrawals for annuity and universal life insurance policies. For the three months ended March 31, 2007 and 2006, contractholder fund withdrawals exceeded deposits resulting in the net cash used in financing activities. While contractholder fund deposits totaled $6.0 million, contractholder fund withdrawals were $13.7 million in the first quarter of 2007. The reduced net withdrawals in 2007 compared to 2006 is due to a decline in deposits in 2007 from 2006 of $1.4 million, more than offset by a decrease in withdrawals of $2.8 million for the same period, due to a decrease in surrenders.

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~~three months ended ~~September~~March 3031, ~~2006~~2007, the equity of the shareholders of the Company (that is, the excess of the Company’s assets over its liabilities) ~~declined~~ increased by $136,000.4 ~~million.~~Changes ~~The primary changes~~ resulting in the ~~net~~increase ~~decrease~~ to shareholders’ equity are detailed as follow:

•· Net income for the ~~nine~~quarter ~~months~~ of $1542,000.~~3 million;~~

•· ~~$2.8~~Reduction ~~million~~to ~~increase~~beginning inretained ~~accumulated~~earnings ~~other~~of ~~comprehensive~~$1,186,000 ~~loss~~for ~~from~~ the ~~change~~implementation inof ~~net~~FIN ~~unrealized~~48 ~~losses~~related onto ~~investments~~income taxes as described in ~~fixed~~Note ~~maturity~~1 ~~securities~~to ~~available~~the ~~for~~accompanying ~~sale~~condensed consolidated financial statements.

Increase of $95,000 in additional paid-in capital related to the issuance of stock options during the first quarter as described in Note 6 to the accompanying condensed consolidated financial statements.

Changes in accumulated other comprehensive income for items as detailed below:

Decrease in net unrealized losses on fixed maturities available for sale of $1,196,000.

Decrease in appreciation of investments in equity securities of $653,000.

Decrease in pension liability of $42,000.

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.

2322

Index

Over the past several years, the Company has decreased its investment in mortgage-backed securities (including asset-backed securities) significantly. This trend continued into 2006 and 2007. Expressed as a percentage of its total investment in fixed maturities, these ratios were 2422.40% and 22.12% at December 31, 2006 ~~2005~~ and ~~September~~ 30 March 31, ~~2006~~2007 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.

During the first ~~nine~~quarter ~~months~~ of ~~2006~~2007, net unrealized losses on fixed maturities ~~available~~ available for sale ~~increased~~decreased $21.82 million. The ~~increase~~decrease in unrealized losses was primarily related to ~~increases~~decreases in market interest rates. The Company’s general investment philosophy is to hold fixed maturities for long-term investment. Accordingly, the Company has the ability and intent to hold securities to maturity or until they recover in value. The Company does not currently anticipate the need to ~~sell~~ sell securities in unrealized loss positions for liquidity purposes.

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”). However, during 2005, the Company increased its equity securities holdings by investing $2.0 million in a corporate bond mutual fund as part of a strategy to increase diversification and enhance overall investment performance. As of ~~September~~March 3031, ~~2006~~2007, the market value of FIC’s equity securities was $~~11.3 million~~9,785,000, compared to $~~10.~~9,805,000 ~~million~~ at December 31, 2006. ~~2005~~The Company also received dividend income totaling $970,000 in the first quarter of 2007 related to these equity securities.

~~FIC’s~~Agency ~~real~~ advances ~~estate~~and ~~investment~~other ~~was~~receivables ~~primarily~~were ~~related to the River Place Pointe office complex (“River Place Pointe”) owned by Investors Life. At March 31, 2005, FIC’s investment totaled~~ $894.81 million inand ~~this 600~~$929,000 ~~sq.~~at ~~ft.~~March 31, ~~seven-building office~~2007 ~~complex~~ and onDecember 4831, ~~acres in Austin~~2006, ~~Texas~~respectively. ~~FIC~~The ~~and~~increase ~~its~~was ~~insurance~~primarily ~~company subsidiaries~~related ~~occupied~~ to ~~one of~~ the implementation ~~seven buildings. Three~~ of ~~the~~FIN ~~other~~48 ~~buildings were substantially leased, but three buildings remained vacant~~ as ofdescribed ~~March 31, 2005. The project was sold~~ in ~~June~~Note ~~2005,~~1 into athe ~~cash~~accompanying ~~transaction, for $103 million.~~condensed ~~The Company~~ consolidated ~~realized~~financial ~~a gain of $10~~statements.6 ~~million~~Liabilities onfor ~~the~~unrecognized ~~sale,~~tax ~~which included both a~~benefits, ~~realized~~ previously ~~gain of $8.5 million~~ recorded ~~in 2005 and a deferred gain of $2.1 million to be recognized~~ as a reduction ofto ~~office~~current ~~lease~~tax ~~expenses~~receivables, ~~over~~were ~~the period~~reclassified ~~from~~ and ~~the~~reported ~~sale~~as ~~date~~other ~~through~~liabilities at March 31, ~~2008.~~2007 ~~The~~in ~~deferred~~accordance ~~gain represents an~~with ~~amount equal to~~ the ~~estimated excess rent to be paid under the lease agreement~~new ~~through~~ reporting ~~March~~requirements ~~31, 2008 over the prevailing rate at the time~~ of ~~sale.~~FIN ~~The Company’s remaining real estate properties held for sale totaling $130,000 at December 31, 2005, were sold in January, 2006~~48.

~~Agency~~Investors ~~advances~~ Life ~~and~~had ~~other receivables totaled~~ $13351.31 million ~~and~~of ~~$8.2~~separate ~~million~~account ~~at September~~assets ~~30,~~as ~~2006~~of ~~and~~March ~~December~~ 31, ~~2005~~2007 (not including the value of the Company’s own investment in one of the accounts), ~~respectively.~~as compared ~~The~~to $5351.10 million ~~increase~~ ~~was~~at ~~primarily~~the ~~due~~end toof 2006. These assets include (a) two variable ~~receivable~~annuity ~~related~~separate accounts that permit contractholders to allocate their contract values among a ~~securities~~selection ~~transaction,~~of third-party mutual funds and (b) assets ~~where~~ held ain ~~security~~custodian ~~matured~~accounts atin ~~quarter~~connection ~~end~~with ~~but~~investment ~~the~~annuity ~~cash~~contracts. The investment ~~was~~annuity ~~not~~business ~~received~~is ~~until~~reinsured with Symetra Life Insurance Company ~~after~~ (formerly ~~September~~Safeco 30Life Insurance Company), ~~2006~~a third-party reinsurer, ~~thereby~~on ~~resulting~~a 90%/10% coinsurance inbasis, ~~the~~with ~~receivable~~Investors ~~balance~~Life retaining 10% of such business. Since ~~This~~the ~~increase~~ reinsurance ~~was~~treaty ~~partially~~is ~~offset~~on by a ~~reduction~~coinsurance basis, Investors Life is contingently liable to the policyholders in ~~current~~the ~~federal~~event ~~income~~that ~~taxes~~the reinsurer is unable to ~~receivable~~ fulfill its obligations under the treaty. Investors Life is not marketing new separate account annuity contracts.

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, 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.

Index

Liabilities

The Company’s insurance-related liabilities (future policy benefits and contractholder deposit funds) were $~~674~~562.27 million at ~~September~~March 3031, ~~2006~~2007, ~~compared~~ compared to $~~698~~570.28 million at December 31, ~~2005~~2006. The decrease in these insurance-related liabilities reflects the business run-off as previously described.

~~Deferred~~Other ~~federal~~ liabilities, ~~income~~which ~~taxes~~totaled $29.2 million at ~~December~~March 31, ~~2005~~2007, ~~reflected~~compared ato $34.0 million ~~net~~at ~~liability~~December 31, 2006, consist primarily of accrued expenses, ~~$687~~ policyholder suspense liabilities,~~000~~ pension plan liabilities, amounts due on unsettled security transactions, and amounts held as agent or trustee. ~~This~~ The decrease ~~deferred~~in ~~tax~~other ~~position~~liabilities ~~changed~~is partially due to aamounts ~~net~~due ~~liability~~for ofunsettled transactions for purchased securities which totaled $~~413~~5.0 million at March 31,~~000~~ 2007, compared to a balance of $15.2 million at ~~September~~December 3031, 2006. This decrease from ~~significant~~unsettled ~~change~~transactions inwas ~~deferred taxes~~partially ~~was~~offset ~~primarily~~by ~~due~~the toreporting of a liability for unrecognized tax benefits ~~associated~~totaling ~~with~~$5.5 ~~unrealized~~million ~~losses~~resulting on from the ~~Company’s~~ implementation ~~fixed~~of ~~maturity~~FIN ~~securities~~48 ~~portfolio,~~as ~~resulting~~disclosed ~~from increases~~ in ~~market~~ ~~interest~~Note ~~rates~~1 ~~during~~to the ~~first~~accompanying ~~nine~~condensed consolidated ~~months~~financial ~~of 2006~~statements.

Index

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 this ratio was 75.9% at March ~~September~~31, 302007, ~~2006~~compared ~~and~~to 5.8% at December 31, ~~2005~~2006. IfThe ~~separate~~inclusion of separate account assets ~~were not included~~ (which ~~management~~are ~~believes~~not isrelevant ~~appropriate)~~for this ~~ratio~~purpose) ~~would~~reduced ~~have~~the ~~been~~ratio ~~higher~~ of shareholders’ equity to total assets by 3.1% and 23.90% at ~~September~~March 3031, ~~2006~~2007 and December 31, ~~2005~~2006, respectively. Management believes that its current equity capital is sufficient to meet the Company’s current liabilities and to fund growth at currently planned levels.

Insurance companies 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”). 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.

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 company might warrant special attention. An insurance company may fall outside of the usual range for ~~one~~ 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 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.

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 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.

Index

Interest-Rate Risk

The Company manages the interest-rate risk inherent in its fixed maturity 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 included in the Company’s condensed consolidated balance sheets is estimated to be $3127.16 million at ~~September~~ at 30March 31, ~~2006~~2007 and $26.61 million at December 31, ~~2005~~2006. For purposes of the ~~foregoing~~ foregoing estimate, fixed maturity securities available for sale and short-term investments were taken into account. The fair value of such assets was $~~624~~510.09 million at ~~September~~March 3031, ~~2006~~2007 and $~~595~~521.0 million at December 31, ~~2005~~ 2006.

The fixed income investments of the Company include certain mortgage-backed securities (excluding asset backed securities). The market value of such securities was $134.4 million at 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, 2005.24

Index

The fixed income investments of the Company include certain mortgage-backed securities (excluding asset backed securities). The market value of such securities was $105.3 million at March 31, 2007 and $106.3 million at December 31, 2006. 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 $8.8 million at March 31, 2007 and $8.6 million at December 31, 2006.

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

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 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 of the Company’'s disclosure controls and procedures as of ~~September~~March 3031, ~~2006~~ 2007. 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~~March 3031, ~~2006~~2007, FIC’'s disclosure controls and procedures were ineffective.

Management had assessed our internal control over financial reporting as of December 31, ~~2005~~ 2006, 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~~2006, 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~~reinsurance, ~~reconciliations, use of third-party service providers,~~ ~~safeguarding~~ policy ofholder ~~assets,~~benefits ~~reinsurance,~~ and ~~policy~~accounts ~~data~~payable ~~integrity~~and expenditures.

~~Following~~Although ~~its~~ there ~~identification~~were ofno ~~the~~significant ~~above-described~~ internal control ~~weaknesses,~~changes implemented during the ~~Company~~ first quarter of 2007, FIC has ~~been~~implemented ~~actively~~an ~~engaged~~Internal inControls Remediation Plan which is designed to resolve all previously identified material weaknesses by the ~~implementation~~end of the 2007 fiscal year. A component of ~~remediation~~the ~~efforts~~ Company’s plan was to ~~address~~resolve a material weakness involving the ~~material~~accuracy ~~weaknesses~~of insupplemental ~~its~~contract ~~internal~~payments by the ~~control~~end ~~over~~of ~~financial~~the 2nd ~~reporting~~ quarter of as2007. The Company has changed the expected resolution date of ~~September~~this 30item to July 31, ~~2006~~2007. ~~The~~At this time, the Company’s ~~major~~does ~~remediation~~not ~~activities~~anticipate any further ~~for~~ changes to previously published resolution dates related to internal control deficiencies. In the ~~third~~remaining ~~quarter~~three quarters of ~~2006~~2007, ~~are~~FIC ~~described~~expects ~~below~~to report on the implementation of new internal controls that will resolve each of the material weaknesses and thus minimize the risks that could impact the accuracy and reliability of FIC’s financial reporting.

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.25

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In addition to the above remediation actions, during the third quarter of 2006 the Company moved its internal stock transfer processing to an outside service provider. New internal control activities were established during the third quarter of 2006 in order to ensure that activities related to the administration by this group produced reliable financial reporting.

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

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

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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.

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.

Management Conclusion on Legal Proceedings

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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.

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ITEM 1A. RISK FACTORS

As of ~~September~~ March 3031, ~~2006~~2007, there have been no material changes to risk factors as previously disclosed in the Company’s ~~2005~~2006 Form 10-K.

ITEM 2. ~~CHANGES~~ INUNREGISTERED SALES OF EQUITY 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 ~~third~~ first quarter of ~~2006~~2007.

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

(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

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	FINANCIAL INDUSTRIES CORPORATION
	(Registrant)
Date: May 31, 2007	By:	/s/ William B. Prouty
Date: July 2, 2007	By:	/s/ William B. Prouty
	William B. Prouty
	Chief Executive Officer
Date: May 31, 2007	By:	/s/ Vincent L. Kasch
Date: July 2, 2007	By:	/s/ Vincent L. Kasch
	Vincent L. Kasch
	Chief Financial Officer
	(Principal Accounting and Financial Officer)

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