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 March 31, 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 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 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 our operations and financial results, the markets for our products, future results, the future development of our business, and the contingencies and uncertainties to which we may be subject, as well as other statements including words such as “anticipate,” “believe,” “plan,” “budget,” “could,” “designed,” “estimate,” “expect,” “intend,” “forecast,” “predict,” “project,” “may,” “might,” “should” and other similar expressions constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management’s current expectations and beliefs concerning financial results and economic conditions and are subject to known and unknown risks, uncertainties and other factors contemplated by the forward-looking statements. These factors include, among other things: (1) general economic conditions and other factors, including prevailing interest rate levels and stock market performance, which may affect the ability of FIC to sell its products, the market value of FIC’s investments and the lapse rate and profitability of policies; (2) FIC’s ability to achieve anticipated levels of operational efficiencies and cost-saving initiatives; (3) customer response to new products, distribution channels and marketing initiatives; (4) mortality, morbidity and other factors that may affect the profitability of FIC’s insurance products; (5) FIC’s ability to develop and maintain effective risk management policies and procedures and to maintain adequate reserves for future policy benefits and claims; (6) changes in the federal income tax laws and regulations that may affect the relative tax advantages of some of FIC’s products; (7) increasing competition in the sale of insurance 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 Risk in Part 1, and Item 1-Legal Proceedings in Part 2, and (14) other factors discussed in the Company’s other filings with the SEC, which are available free of charge on the SEC’s website at www.sec.gov. You should read carefully the above factors and all of the other information contained in this report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those indicated. All subsequent written and oral forward-looking statements attributable to the Company or to persons acting on our behalf are expressly qualified in their entirety by reference to these risks and uncertainties. There can be no assurance that other factors not currently anticipated by management will not also materially and adversely affect our results of operations. Each forward-looking statement speaks only as of the date of the particular statement and the Company undertakes no obligation to update or revise any forward-looking statement, except as required by federal securities laws.

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

INDEX

	Page No.


Part I - Financial Information

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets March 31, 2007 and December 31, 2006	4

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 three months ended March 31, 2007 and March 31, 2006	8

Notes to Condensed Consolidated Financial Statements	10

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	18

Item 3. Quantitative and Qualitative Disclosures About Market Risk	24

Item 4. Controls and Procedures	25

Part II - Other Information

Item 1. Legal Proceedings	26

Item 1A. Risk Factors	28

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	28

Item 3. Defaults Upon Senior Securities	28

Item 4. Submission of Matters to a Vote of Security Holders	28

Item 5. Other Information	28

Item 6. Exhibits	28

Signatures	29

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands) (Unaudited)

	March 31,		December 31,
	2007		2006 (1)
ASSETS
Investments:
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
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
Policy loans		29,780		30,189
Short-term investments		-		7,473
Total investments		550,444		568,424

Cash and cash equivalents		59,968		55,603
Deferred policy acquisition costs		14,303		14,429
Present value of future profits of acquired business		7,409		7,749
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		28,589		29,061
Accrued investment income		5,951		6,772
Due premiums		283		237
Property and equipment, net		435		550
Deferred federal income taxes		2,296		1,891
Other assets		2,143		1,679
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)

	March 31,			December 31,
	2007			2006 (1)
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Policy liabilities and contractholder deposit funds:
Contractholder deposit funds	$	446,517		$	453,671
Future policy benefits		116,224			117,097
Other policy claims and benefits payable		8,334			6,907
Notes payable		15,000			15,000
Other liabilities		29,169			33,968
Separate account liabilities		351,139			350,987
Total liabilities		966,383			977,630

Commitments and contingencies (Note 8)

Shareholders’ equity:
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		70,141			70,046
Accumulated other comprehensive loss		(9,001	)		(9,586	)
Retained earnings		17,059			17,703
Common treasury stock, at cost, 2,323 shares in 2007 and 2006		(19,989	)		(19,989	)
Total shareholders’ equity		60,717			60,681
Total liabilities and shareholders’ equity	$	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 STATEMENTS OF OPERATIONS

(In thousands except per share data) (Unaudited)

	Three Months Ended March 31,
	2007			2006
Revenues:
Premiums, net	$	2,136		$	907
Earned insurance charges		7,699			8,023
Net investment income		8,484			7,284
Net realized investment (losses) gains		(12	)		516
Other		2,315			657
Total revenues		20,622			17,387

Benefits and expenses:
Policyholder benefits and expenses		8,307			8,180
Interest expense on contractholders deposit funds		4,371			4,573
Amortization of deferred policy acquisition costs		469			195
Amortization of present value of future profits of acquired business		279			285
Operating expenses		6,189			5,227
Interest expense		361			329
Total benefits and expenses		19,976			18,789

Income (loss) from continuing operations before federal income taxes		646			(1,402	)
Federal income tax expense (benefit)		104			(185	)

Income (loss) from continuing operations		542			(1,217	)

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 March 31,
	2007		2006
Net Income (Loss) Per Share:

Basic:
Weighted average common shares outstanding		10,210		9,849

Basic 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	)

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 CASH FLOWS

(In thousands) (Unaudited)

	Three Months Ended March 31,
	2007			2006
Continuing Operations:

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	542		$	(1,786	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Loss from discontinued operations		-			569
Amortization of deferred policy acquisition costs		469			195
Amortization of present value of future profits of acquired business		279			285
Net realized (gains) losses on investments		12			(516	)
Depreciation		108			124
(Increase) decrease in accrued investment income		821			(74	)
(Increase) decrease in agency advances and other receivables		(2,739	)		645
(Increase) decrease in due premiums		(46	)		30
Increase in deferred policy acquisition costs		(1,060	)		(189	)
Increase in other assets		(464	)		(212	)
Increase in policy liabilities and accruals		1,119			84
Increase (decrease) in other liabilities		(4,799	)		14,629
Increase in deferred federal income taxes		(685	)		(464	)
Other, net		(1,740	)		1,792
Net cash provided by (used in) operating activities		(8,183	)		15,112

CASH FLOWS FROM INVESTING ACTIVITIES:
Fixed maturities purchased		(29,013	)		(51,953	)
Proceeds from sales and maturities of fixed maturities		41,402			9,241
Proceeds froms sales of invested real estate		-			646
Net decrease in short-term investments		7,473			1,204
Net decrease in policy loans		409			632
Purchase of property and equipment		(5	)		(7	)
Net cash provided by (used in) investing activities		20,266			(40,237	)

					(continued)

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

Index

FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued

(In thousands) (Unaudited)

	Three Months Ended March 31,
	2007			2006
CASH FLOWS FROM FINANCING ACTIVITIES:
Contractholder fund deposits	$	5,987		$	7,363
Contractholder fund withdrawals		(13,705	)		(16,485	)
Net cash used in financing activities		(7,718	)		(9,122	)

Net increase (decrease) in cash		4,365			(34,247	)

Cash and cash equivalents, beginning of year		55,603			36,906

Cash and cash equivalents, end of period	$	59,968		$	2,659

Discontinued Operations:
Net cash used in operating activities of discontinued operations	$	-		$	(11,092	)

Net cash used in investing activities of discontinued operations		-			(6,999	)

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.

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 March 31, 2007, its consolidated results of operations for the three months ended March 31, 2007 and 2006, and its consolidated cash flows for the three months ended March 31, 2007 and 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, 2006 condensed consolidated balance sheet data was derived from the audited consolidated financial statements included in the Company’s 2006 Annual Report on Form 10-K filed with the SEC (“2006 Annual Report”) which includes all disclosures required by GAAP. Therefore, these unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company included in the 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, 2006, to March 31, 2007:

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

Balance at December 31, 2006	$	2,159		$	(7,676	)	$	(4,069	)	$	(9,586	)
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 months ended March 31, 2007 and 2006 is summarized as follows:

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

Net income (loss)	$	542		$	(1,786	)
Other comprehensive income (loss), net of tax:
Unrealized gains on securities:
Unrealized holdings gains ( losses) arising during the period		555			(6,211	)
Reclassification adjustments for losses included in net income		(12	)		-
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

4.	Earnings Per Share

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

	Three Months Ended March 31,
	2007		2006
	(In thousands except per share data)

Numerator:
Income (loss) from continuing operations	$	542	$	(1,217	)

Denominator:
Weighted average common shares outstanding:
Basic		10,210		9,849
Common stock options		99		-
Repurchase of treasury stock		-		-

Diluted		10,309		9,849

Per share:
Basic	$	0.05	$	(0.12	)
Diluted	$	0.05	$	(0.12	)

5.	Retirement Plans

A. Family Life

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.

(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.

Index

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

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

6.	Stock Options

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.

The fair value of the option award was estimated on the date of grant using a Black-Scholes option pricing model. Significant assumptions used in the calculation of fair value are as follows:

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 $351.1 million of separate account assets as of March 31, 2007 (not including the value of the Company’s own investment in one of the accounts), as compared to $351.0 million at the end of 2006. 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 2007 and future years. However, as this 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.

Index

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.

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

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

On April 17, 2007, Manhattan Life and Family Life, filed a civil suit in the 215^th Judicial District Court, Harris County, Texas, against Family Life Corporation, Investors Life and FIC Insurance Services, L.P. (“FICIS”), each a subsidiary of the Company. The suit alleges that: a) Family Life Corporation breached the Stock Purchase Agreement with Manhattan Life by competing with Family Life and accepting insurance “directly or indirectly” from active accounts of Family Life; b) FICIS breached the Administrative Services Agreement with Family Life by willfully communicating with or willfully assisting with the communication by its affiliates with policyholders in a manner intended to solicit Family Life accounts on behalf of Investors Life; c) FICIS breached fiduciary duties owed to Family Life in the administration and management of the accounts of the policy holders of Family Life by assisting in the conversion of Family Life policies to the policies of Investors Life, and by their actions, Investors Life and Family Life Corporation aided and abetted such breach of fiduciary duty; and, d) Family Life Corporation, Investors Life and FICIS have tortiously interfered with existing contracts of Family Life with its policyholders, including the Stock Purchase Agreement and the Administrative Services Agreement. 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 3 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 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.	Related Party Transactions

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 Engagement Letter, which 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.

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 March 31, 2007, compared with December 31, 2006, and its results of operations for the three months ended March 31, 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, 2006, to which the reader is directed for additional information.

Results of Operations - Three Months Ended March 31, 2007 and 2006

For the three-month period ended March 31, 2007, FIC’s net income was $542,000 (basic and diluted income of $.05 per common share) compared to a net loss of $1,786,000 (basic and diluted loss of $0.18 per common share) for the comparable 2006 period. However, in analyzing the Company’s results of operations, a separation of results between continuing and discontinued operations provides a more meaningful view. As previously described in Note 3 in the accompanying condensed consolidated financial statements, the Company sold Family Life on December 29, 2006, resulting in a loss from discontinued operations. Included in the net loss for the first quarter of 2006 is a loss from discontinued operations, net of taxes, of $569,000. Income from continuing operations totaled $542,000 for the three months ended March 31, 2007, while loss from continuing operations totaled $1,217,000 for the comparable 2006 period.

The following 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 this Item 2 reflect the continuing operations of FIC and its subsidiaries, exclusive of Family Life. References to income and loss from operations are identified as continuing operations or discontinued operations, while references to net income or net loss reflect the consolidated net results of both continuing and discontinued operations.

In 2007, FIC’s net gain was affected by the following significant items as compared to 2006 amounts:

Increase in premiums earned of $1.2 million due primarily to increases in sales of final expense whole life insurance and mortgage protection term insurance products.

Increase in net investment income of $1.2 million primarily due to dividend income received on investments in equity securities.

Increase in other revenues of $1.7 million due to additional fees earned on separate accounts and fees earned for services performed under an administrative services agreement with Family Life.

Increase in operating expenses of $1.0 million primarily due to higher audit, actuarial, accounting and other consulting, and legal fees.

The above described items need to be taken into consideration in drawing comparisons between the operating results for the three months ended March 31, 2007 and 2006.

Revenues

Premium revenues reported for traditional life insurance products are recognized when due. Premium revenues for the first three months of 2007, net of reinsurance ceded, were $2.1 million, as compared to $0.9 million in the first three months of 2006. This source of revenues is related to the traditional life insurance book of business of FIC’s insurance 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 in connection with annuity contracts and premiums received for universal life (“UL”) insurance policies are reflected in the 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 three months ended March 31, 2007 and 2006, annuity deposits and UL premiums totaled $6.0 million and $7.4 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 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 funds have declined from $475.7 million at March 31, 2006 to $446.5 million at March 31, 2007.

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 $8.3 million in the first three months of 2007, as compared to $8.2 million in the first three months of 2006. While the increase in traditional premium revenues for 2007 also increased the corresponding traditional policy reserve expenses, this was substantially offset by 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 $4.4 million in the first three months of 2007, as compared to $4.6 million in the same period of the year 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 expense in 2007 is primarily attributable to this overall reduction in the level of contractholder deposit funds.

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

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 the cash requirements of business operations. FIC is an insurance holding company whose principal assets consist of its insurance subsidiary, 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 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.

Index

As of March 31, 2006, Investors Life held $15.4 million of notes receivable from FIC that represented the remaining indebtedness related to the Family Life acquisition. Although this intercompany indebtedness was eliminated on FIC’s consolidated balance sheets, it created a debt service requirement at the holding company level. These notes were paid off by FIC on December 29, 2006 using proceeds from the sale of Family Life.

At the holding company level, FIC’s principal current ongoing liquidity demands relate to debt service on $15 million of senior notes that it issued in May 2003. These notes require quarterly interest payments at a variable interest rate of the three-month LIBOR rate plus 4.2% (which yielded an average rate of approximately 9.6% for the first quarter of 2007). The principal amount of the notes must be repaid in a single payment in 2033.

In addition to debt service, 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 2003, and management does not anticipate the payment of such dividends in the near future.

The ability of Investors Life to pay dividends to FIC and meet these holding-company liquidity demands is subject to restrictions set forth in the insurance laws and regulations of Texas, its domiciliary state. Texas limits how and when 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 policyholder surplus or (ii) the insurer’s statutory net gain from operations for the previous year.

In June 2004, FIC, with the approval of the Texas Department of Insurance, created FIC Insurance Services, L.P., a service company subsidiary, and transferred to it many of the administrative functions of the insurance companies. The new service company charges Investors Life 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. Profits earned by the service company are expected to decrease in 2007, as fees will decline due to the sale of Family Life on December 29, 2006. This agreement with the service company was terminated by Family Life upon the sale of Family Life to The Manhattan Life Insurance Company.

Liquidity considerations at Investors Life are different in nature than for the holding company. Sources of cash for Investors Life 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 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 three months ended March 31, 2007, the equity of the shareholders of the Company (that is, the excess of the Company’s assets over its liabilities) increased by $36,000. Changes resulting in the increase to shareholders’ equity are detailed as follow:

Net income for the quarter of $542,000.

Reduction to beginning retained earnings of $1,186,000 for the implementation of FIN 48 related to income taxes as described in Note 1 to the accompanying 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.

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 22.0% and 22.2% at December 31, 2006 and March 31, 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 quarter of 2007, net unrealized losses on fixed maturities available for sale decreased $1.2 million. The decrease in unrealized losses was primarily related to 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 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”). As of March 31, 2007, the market value of FIC’s equity securities was $9,785,000, compared to $9,805,000 at December 31, 2006. The Company also received dividend income totaling $970,000 in the first quarter of 2007 related to these equity securities.

Agency advances and other receivables were $4.1 million and $929,000 at March 31, 2007 and December 31, 2006, respectively. The increase was primarily related to the implementation of FIN 48 as described in Note 1 to the accompanying condensed consolidated financial statements. Liabilities for unrecognized tax benefits, previously recorded as a reduction to current tax receivables, were reclassified and reported as other liabilities at March 31, 2007 in accordance with the new reporting requirements of FIN 48.

Investors Life had $351.1 million of separate account assets as of March 31, 2007 (not including the value of the Company’s own investment in one of the accounts), as compared to $351.0 million at the end of 2006. These assets include (a) two variable annuity separate accounts that permit contractholders to allocate their contract values among a selection of third-party mutual funds and (b) assets held in custodian accounts in connection with investment annuity contracts. The investment annuity business is reinsured with Symetra Life Insurance Company (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10% coinsurance basis, with Investors Life retaining 10% of such business. Since the reinsurance treaty is on a coinsurance basis, Investors Life is contingently liable to the policyholders in the event that the reinsurer is unable to fulfill its obligations under the treaty. Investors Life is not marketing new separate account annuity contracts.

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

Liabilities

The Company’s insurance-related liabilities (future policy benefits and contractholder deposit funds) were $562.7 million at March 31, 2007, compared to $570.8 million at December 31, 2006. The decrease in these insurance-related liabilities reflects the business run-off as previously described.

Other liabilities, which totaled $29.2 million at March 31, 2007, compared to $34.0 million at December 31, 2006, consist primarily of accrued expenses, policyholder suspense liabilities, pension plan liabilities, amounts due on unsettled security transactions, and amounts held as agent or trustee. The decrease in other liabilities is partially due to amounts due for unsettled transactions for purchased securities which totaled $5.0 million at March 31, 2007, compared to a balance of $15.2 million at December 31, 2006. This decrease from unsettled transactions was partially offset by the reporting of a liability for unrecognized tax benefits totaling $5.5 million resulting from the implementation of FIN 48 as disclosed in Note 1 to the accompanying condensed consolidated financial 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 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 5.9% at March 31, 2007, compared to 5.8% at December 31, 2006. The inclusion of separate account assets (which are not relevant for this purpose) reduced the ratio of shareholders’ equity to total assets by 3.1% and 3.0% at March 31, 2007 and December 31, 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 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 investment income and changes in premium, product mix, and reserving. The ratios were outside the usual ranges primarily due to a recapture of ceded reinsurance by Family Life from Investors Life during 2006. This recapture occurred prior to the sale of Family Life. For statutory accounting purposes, the recapture affected premium income and change in policy reserves which caused ratios to fall outside the usual ranges. Excluding the effects of the reinsurance recapture, Investors Life would have had only one ratio outside the usual ranges, which related to investment income.

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.

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 $27.6 million at March 31, 2007 and $26.1 million at December 31, 2006. For purposes of the foregoing estimate, fixed maturity securities available for sale and short-term investments were taken into account. The fair value of such assets was $510.9 million at March 31, 2007 and $521.0 million at December 31, 2006.

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 made known to management in a timely fashion.

Management has completed an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. This evaluation has allowed management to make conclusions, as set forth below, regarding the state of the Company's disclosure controls and procedures as of March 31, 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 March 31, 2007, FIC's disclosure controls and procedures were ineffective.

Management had assessed our internal control over financial reporting as of December 31, 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, 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, control monitoring, financial close and reporting, reinsurance, policy holder benefits and accounts payable and expenditures.

Although there were no significant internal control changes implemented during the first quarter of 2007, FIC has implemented an Internal Controls Remediation Plan which is designed to resolve all previously identified material weaknesses by the end of the 2007 fiscal year. A component of the Company’s plan was to resolve a material weakness involving the accuracy of supplemental contract payments by the end of the 2^nd quarter of 2007. The Company has changed the expected resolution date of this item to July 31, 2007. At this time, the Company does not anticipate any further changes to previously published resolution dates related to internal control deficiencies. In the remaining three quarters of 2007, FIC expects 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.

Index

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.

Index

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

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.

Index

ITEM 1A. RISK FACTORS

As of March 31, 2007, there have been no material changes to risk factors as previously disclosed in the Company’s 2006 Form 10-K.

ITEM 2. UNREGISTERED 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 first quarter of 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

Index

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: July 2, 2007	By:	/s/ William B. Prouty
	William B. Prouty
	Chief Executive Officer


Date: July 2, 2007	By:	/s/ Vincent L. Kasch
	Vincent L. Kasch
	Chief Financial Officer
	(Principal Accounting and Financial Officer)

FINANCIAL INDUSTRIES CORP 10-Q