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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from _______________ to _______________
Commission File No. 0-15972
PENN TREATY AMERICAN CORPORATION
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(Exact name of registrant as specified in its charter)
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<CAPTION>
Pennsylvania 23-1664166
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<S> <C>
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
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3440 Lehigh Street, Allentown, Pennsylvania 18103
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(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (610) 965-2222
Securities registered pursuant to Section 12(b) of the Act:
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Name of each exchange
Title of each class on which registered
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None NASDAQ Stock Market
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value
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(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 |X| NO |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 19, 1998 was $223,160,386.
The number of shares outstanding of the registrant's common stock as of March
19, 1998 was 7,795,996.
Documents Incorporated By Reference:
(1) Proxy Statement for the 1998 Annual Meeting of Shareholders - Part III
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PART I
Item 1. Business
(a) General
Penn Treaty American Corporation ("the Company") is one of the
leading providers of long-term nursing home and home health care insurance.
The Company markets its products primarily to persons age 65 and over through
independent insurance agents and underwrites its policies through three
subsidiaries, Penn Treaty Life Insurance Company, ("PTLIC"), Network America
Life Insurance Company ("Network America") and American Network Insurance
Company ("ANIC") (collectively "the Insurers"). The Company's principal
products are individual fixed, defined benefit accident and health insurance
policies covering long-term skilled, intermediate and custodial nursing home
care and home health care. Policies are designed to make the administration
of claims simple, quick and sensitive to the needs of the policyholders. As
of December 31, 1997, long-term nursing home care and home health care
policies accounted for approximately 91% of the Company's total annualized
premiums in-force.
On December 31, 1997, PTLIC entered an assumption reinsurance treaty
with Network America, whereby Network America effectively purchased all of
the premium in-force and assets and assumed all of the liabilities of PTLIC.
Network America simultaneously changed its name to Penn Treaty Network
America Insurance Company ("PTNA"). The Company has also filed with the
Internal Revenue Service requesting a favorable ruling regarding the tax-free
nature of the dividend of PTLIC common stock ownership of PTNA to the
Company. Upon receipt of a favorable ruling, PTNA will become a direct
subsidiary of the Company, and will no longer be a subsidiary of PTLIC.
Throughout the remainder of this document, all references to Network America,
whether in the present or with regard to occurences prior to December 31,
1997, are addressed as PTNA.
In 1997, the Company incorporated a new direct subsidiary, American
Independent Network Insurance Company of New York ("AINIC"). The Company is
seeking approval from the New York Department of Insurance to license AINIC
as an accident and health insurer. The Company anticipates receiving this
approval in April 1998.
The Company introduced its first long-term nursing home care
insurance product in 1975 and its first home health care product in 1987. In
late 1994, the Company introduced its Independent Living policy, which
provides coverage over the full term of the policy for home care services
furnished by an unlicensed homemaker or companion as well as a licensed care
provider. In late 1996 and throughout 1997, the Company began its
introduction of its Personal Freedom policies, which provide comprehensive
coverage for nursing home and home health care. The Company also introduced
in late 1996 its Assisted Living policy, which, as a nursing home plan,
provides enhanced benefits and includes a home health care rider. Available
policy riders allow insureds to tailor their policies and include an
automatic annual benefit increase, benefits for adult day-care centers and a
return of premium benefit. The Company also markets and sells life,
disability, Medicare supplement and other hospital care insurance products.
Long-Term Care Industry
Long-term care insurance policies were first introduced in the 1970's.
Significant sales of these policies commenced in the mid 1980's. Typical early
policies provided limited nursing home coverage for a limited benefit period and
were subject to certain restrictions such as prior hospitalization and a
certificate of medical necessity. As awareness of the long-term care needs of
senior citizens has grown, the long-term care insurance industry has responded
with more diverse insurance offerings to provide needed benefits in a
cost-effective fashion. Requirements for prior hospitalization and medical
necessity are no longer standard and benefit periods have been extended up to
the life of the insured. Coverages for custodial care and home health care are
now offered by many insurers.
A survey conducted by a national industry organization estimated that
the number of long-term care policies in-force grew from 815,000 in 1987 to
approximately 4,350,000 by the end of 1995, an average of more than 23% annually
since 1987. The emphasis on long-term care insurance has evolved primarily as a
result of the aging of society, increasing life expectancies and the escalating
cost of care. According to a 1992 survey of the U.S. Bureau of the Census, by
the year 2050 the population age 65 and over is expected to grow to
approximately 98 million, or more than three times the 1990 figure, while the
population age 85 and over is expected to grow to 26 million, or more than eight
times the 1990 figure. Another study has suggested that at age 65 a person has a
43% chance of being confined to a nursing home during some time in his or her
life. The cost of care has also increased
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significantly. It has been estimated by the U.S. Census Bureau that from 1980 to
1990, the cost of care for Medicaid nursing home residents increased from $8.7
billion to $21.5 billion.
Other factors causing growth of the long-term care insurance industry
include the lack of suitable alternatives for financing long-term care. There
are four primary alternatives to long-term care insurance: government programs
such as Medicare and Medicaid, personal assets, dependence on family members and
life insurance. Medicare offers only limited coverage of the cost of long-term
care. Medicaid is the single largest source of financing for nursing home care
in the U.S. However, since eligibility for Medicaid requires that its recipients
have a very small amount of assets or income, many individuals are forced to
deplete their assets in order to become eligible.
Strategy
The Company's objective is to strengthen its position as a leader in
providing long-term care insurance to senior citizens. To meet this objective
and to continue to increase profitability, the Company is implementing the
following strategies:
Developing and qualifying new products with state insurance regulatory
authorities. The Company has been an originator in the field of long-term
care insurance for over twenty years. The Company introduced its Independent
Living policy in 1994 which provides coverage over the full term of the
policy for services furnished by an unlicensed homemaker or companion or a
licensed care provider. Most recently, the Company began its introduction of
its Personal Freedom policies, which provide comprehensive coverage for
nursing home and home health care. The Company also introduced its Assisted
Living policy, which, as a nursing home plan, provides enhanced benefits and
includes a home health care rider. The Company intends to continue to develop
new insurance products designed to meet the needs of senior citizens and
their families.
Increasing the size and productivity of the Company's network of independent
agents. The Company has significantly increased the number of producing agents
(agents who produce premiums for the Company on new policies) selling its
policies by focusing its efforts on certain geographic areas of the country
which have larger concentrations of individuals age 65 and over. The Company
intends to continue to recruit agents in these states and believes that it will
be able to continue to expand its business in these and other states.
Seeking to acquire existing insurance companies and blocks of in-force policies
underwritten by other insurance companies. The Company has augmented its premium
revenue from time to time through the acquisition of existing insurance
companies and blocks of policies underwritten by other insurance companies. The
Company intends to continue to evaluate complementary acquisitions and policy
blocks as a means of enhancing its revenue base.
Introducing existing products in newly licensed states. The Company is
currently licensed to market products in 49 states and the District of
Columbia. Although not all of the Company's products are currently eligible
for sale in all of these jurisdictions, the Company actively seeks to expand
the regions where it sells its products. Through the acquisition of ANIC in
1996, the Company acquired licenses to conduct business in some new states,
including New Jersey and Massachusetts. These states are considered by the
Company's management to offer significant opportunities for sales growth. In
addition, the Company has applied for a license to underwrite accident and
health insurance products in New York. The Company is also continuing its
efforts to broaden its marketing within those states where it is already
licensed.
Corporate Background
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The Company, which is registered and approved as a holding company
under the Pennsylvania Insurance Code, was incorporated in Pennsylvania on May
13, 1965 under the name Greater Keystone Investors, Inc., and changed its name
to Penn Treaty American Corporation on March 25, 1987. PTLIC was incorporated in
Pennsylvania under the name Family Security Life Insurance Company on June 6,
1962, and its name was changed to Quaker State Life Insurance Company on
December 29, 1969, at which time it was operating under a limited insurance
company charter. Quaker State Life Insurance Company was acquired by the Company
on May 4, 1976, and its name was changed to Penn Treaty Life Insurance Company.
On July 13, 1989, PTLIC acquired all of the outstanding capital stock of AMICARE
Insurance Company (formerly Fidelity Interstate Life Insurance Company), a stock
insurance company organized and existing under the laws of Pennsylvania which
changed its name to Network America Life Insurance Company on August 1, 1989.
On December 31, 1997, PTLIC entered an assumption reinsurance treaty
with Network America, whereby Network America effectively purchased all of
the premium in-force, assets and liabilities of PTLIC. Network America
simultaneously changed its name to Penn Treaty Network America Insurance
Company. The Company has also filed with the Internal Revenue Service
requesting a favorable ruling regarding the tax-free nature of the dividend
of PTLIC common stock ownership of PTNA to the Company. Upon receipt of a
favorable ruling, PTNA will become a direct subsidiary of the Company, and
will no longer be a subsidiary of PTLIC.
Senior Financial Consulatants Company, an insurance agency owned by the
Company, was incorporated in Pennsylvania on February 23, 1988 under the name
Penn Treaty Service Company. On February 29, 1988, the Agency acquired, among
other assets, the rights to renewal commissions on a certain block of PTLIC's
existing in-force policies from Cher-Britt Agency, Inc., and an option to
purchase the rights to renewal commissions on a certain block of PTLIC's
existing policies from Cher-Britt Insurance Agency,Inc., an affiliated
company of Cher-Britt Agency, Inc. In connection with this acquisition, on
March 3, 1988, the name of the Agency was changed to Cher-Britt Service
Company. The option was exercised on March 3, 1989. The Agency's name was
changed to Senior Financial Consultants Company on August 9, 1994.
On August 30, 1996, the Company consummated the acquisition of all of the issued
and outstanding capital stock of Health Insurance of Vermont, Inc. ("HIVT"),
which has since changed its name to American Network Insurance Company.
(b) Insurance Products
Since 1976, the Company has developed, marketed and underwritten fixed,
defined benefit accident and health insurance policies designed to be responsive
to changes in (i) the characteristics and needs of the senior citizen market,
(ii) governmental regulations and governmental benefits available for this
population segment and (iii) the health care and long-term care industries in
general. As of December 31, 1997, approximately 91% of the Company's total
annualized premiums in-force were derived from long-term care policies which
include nursing home and home health care policies. The Company's other lines of
insurance include (i) life insurance, (ii) Medicare supplement, (iii)
blue-collar disability coverage and (iv) various accident and health policies
and riders. The Company solicits input from both its independent agents and its
policyholders with respect to the changing needs of its insureds. In addition,
Company representatives regularly attend seminars to monitor significant trends
in the industry.
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The following table sets forth, as of the dates indicated, and for each
class of policies, the annualized premiums (in thousands) in-force, the
percentage of total annualized premiums, the number of policies in-force, and
the average premium per policy. Policies are classified by their base coverage
but may include a rider for a different coverage. For example, if a policyholder
purchased a home health care policy with a nursing home rider, premiums
collected in connection with the nursing home rider would be included in the
home health care class.
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Year ended December 31,
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1995 1996 1997
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<S> <C> <C> <C> <C> <C> <C>
Long term nursing home care:
Annualized premiums $77,217 70.3% $89,692 62.6% $121,819 67.4%
Number of policies 53,084 60,874 78,137
Average premium per policy $1,455 $1,473 $1,559
Long term home health care:
Annualized premiums $24,881 22.6% $38,609 26.9% $42,921 23.8%
Number of policies 22,967 34,594 38,553
Average premium per policy $1,083 $1,116 $1,113
Disability insurance:
Annualized premiums $0 0.0% $7,092 4.9% $7,145 4.0%
Number of policies 0 16,674 46,373
Average premium per policy $0 $425 $154
Medicare supplement:
Annualized premiums $3,246 3.0% $3,206 2.2% $4,248 2.4%
Number of policies 2,527 2,757 4,018
Average premium per policy $1,285 $1,163 $1,057
Life insurance:
Annualized premiums $3,273 3.0% $3,629 2.5% $3,567 2.0%
Number of policies 5,270 6,112 6,262
Average premium per policy $621 $594 $570
Other insurance:
Annualized premiums $1,267 1.2% $1,163 0.8% $1,015 0.6%
Number of policies 7,161 6,509 5,827
Average premium per policy $177 $179 $174
Total annualized premiums in force (1) $109,884 100% $143,391 100% $180,715 100%
Total Policies 91,009 127,520 179,170
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(1) Excludes credit life and credit accident and health insurance premiums in
force. Credit insurance premiums in force are calculated as the cumulative total
of one-time premiums received by the Company for policies issued for terms of up
to 120 months. Credit insurance premiums in force for the years ended December
31, 1995, 1996, and 1997 were approximately $453,000, $199,000 and $180,000,
respectively.
Long-Term Care Generally. The majority of the Company's long-term care policies
are written on an annual basis and provide for guaranteed renewability at then
current premium rates at the option of the insured. The insured may elect to pay
premiums on a monthly, quarterly, semi-annual or annual basis. In addition, the
Company offers an automatic payment feature that allows policyholders to have
premiums automatically withdrawn from a checking account. The Company may
increase premium rates on a particular form of policy only upon approval of the
applicable insurance regulatory authority in each state.
As a supplement to some of its long-term care policies, the Company
offers various riders providing benefits, such as an automatic annual benefit
increase to help offset the effects of inflation and a return of premium option.
The return of premium benefit rider provides that after a policy has been in
force for ten years, the policyholder is entitled
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to a return of 80% of all premiums paid during the ten year period less any
claims paid by the Company. If, however, claims exceed 20% of the premiums paid
during the ten year period, no return of premium is made. In addition, in most
states the rider provides for a pro-rata return of premium in the event of death
or surrender beginning in the sixth year. The Company also offers and encourages
the purchase of home health care riders to supplement its nursing home policies
and nursing home riders to supplement its home health care policies.
In the past, the Company offered numerous other riders to supplement
its long-term care policies. The need, however, for many of these riders has
been eliminated due to the incorporation of many of these benefits into the
basic coverage under the Company's newest long-term care policies. Among the
built-in benefits provided under the long-term care policies currently marketed
by the Company are hospice care and adult day care benefits, survivorship
benefits (in California only), and restoration of benefits. These policies also
provide a yearly wellness benefit (a payment made to policyholders who have not
made a claim, also available only in California), after the first year of the
policy.
Long-Term Nursing Home Care. The Company's long-term nursing home care policies
generally provide a fixed benefit payable during periods of nursing home
confinement prescribed by a physician or necessitated by the policyholder's
cognitive impairment or inability to perform two or more activities of daily
living. These policies include built-in benefits for alternative plans of care,
waiver of premium after 90 days of benefit payments on a claim and unlimited
restoration of the policy's maximum benefit period. All levels of nursing care,
including skilled, custodial (assisted living) and intermediate care, are
covered and benefits continue even when the policyholder's required level of
care changes. Skilled nursing care refers to professional nursing care provided
by a medical professional (a doctor or registered or licensed practical nurse)
located at a licensed facility which cannot be provided by a non-medical
professional. Assisted living care generally refers to non-medical care which
does not require professional treatment and can be provided by a non-medical
professional with minimal or no training. Intermediate nursing care is designed
to cover situations which would otherwise fall between skilled and assisted
living care and includes situations in which an individual may require skilled
assistance on a sporadic basis.
The Company's current long-term nursing home care policies provide
benefits which are payable over periods ranging from one to five years and
also for lifetime coverage. These policies provide for a fixed daily benefit
ranging from $40 to $250 per day. Certain of the Company's nursing home care
policies provide benefits which are payable over periods ranging from six
months to five years and lifetime, and from $800 to $5,000 per month of
nursing home benefits. The Company's Personal Freedom policies also provide
comprehensive coverage for nursing home and home health care, offering
benefit "pools of coverage" ranging from $75,000 to $250,000 total coverage,
as well as lifetime coverage. According to an independent study published in
1994, the average cost of nursing home care was estimated to be approximately
$37,000 per year, resulting in an aggregate of more than $85,000 for the
average nursing home stay of approximately 2.3 years.
Long-Term Home Health Care. The Company's home health care policies generally
provide a benefit payable on an expense-incurred basis during periods of home
care prescribed by a physician or necessitated by the policyholder's
cognitive impairment or inability to perform two or more activities of daily
living. These policies cover the services of registered nurses, licensed
practical nurses, home health aides, physical therapists, speech therapists,
medical social workers and other similar home health practitioners. Benefits
for home health care policies currently being marketed by the Company are
payable over periods ranging from six months to five years, and also covering
lifetime, and provide from $40 to $160 per day of home benefits. On some home
health care policies sold by the Company since 1993, pre-existing conditions
disclosed on an application are not covered during the initial six months
following the effective date of the policy and there is no prior
hospitalization requirement. The Company's home health care policies also
include built-in benefits for waiver of premium and unlimited restoration of
the policy's maximum benefit period.
In late 1994, the Company introduced its Independent Living policy.
This policy provides coverage over the full term of the policy for services
furnished by a homemaker or companion, including a member of the insured's
family, who is not a qualified or licensed care provider ("Homemaker/Companion
Services"). Homemaker/Companion Services include cooking, shopping, housekeeping
and assisting the insured with such activities as laundry, correspondence, using
the telephone and paying bills. Historically, only limited coverage had been
provided under certain of the Company's home health care policies for
Homemaker/Companion Services,
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typically for a period of up to 30 days per calendar year during the term of the
policy. The Company's Independent Living policies covered disclosed pre-existing
conditions immediately upon policy issuance.
The Independent Living policy provides that the Company will waive the
elimination period, the time at the beginning of the period during which care is
provided for which no benefits are available under the policy (usually twenty
days), if the insured agrees to utilize an independent care management agency
("Care Manager") referred by the Company. The Care Manager is engaged by the
Company at the time a claim is submitted to prepare a written assessment of the
insured's condition and to establish a written plan of care. The Company
believes that the Independent Living policy, which represents a significant
expansion of the benefits previously available for Homemaker/Companion Services,
is the first of its kind. The Company has subsequently incorporated the use of
Care Management in all of its new home health care policies.
The most recent addition to the Company's long-term care product line
is its Personal Freedom policy. This policy was first introduced during the
fourth quarter of 1996 and is currently being marketed in those states in which
regulatory approval has been received. This product is a comprehensive coverage
policy, which combines long-term care and home health care insurance. When
policyholders purchase this policy, with face value benefits ranging from
$50,000 to unlimited coverage, they may then access up to the face amount of the
policy for nursing home or home health care as needed subject to maximum daily
limits.
Disability Insurance. The Company underwrites and markets disability income
insurance entirely on an individual basis through ANIC. The various disability
policies concentrate on serving working class or "blue collar" individuals or
employees. The policies provide for benefit periods ranging from six months to
60 months with monthly benefit amounts ranging from $250 to $3,000. The Company
also offers mortgage disability and accident only disability policies.
Life Insurance. Beginning in August 1993, the Company began to market actively
its whole life insurance products which were approved by various state insurance
authorities during 1992 and 1993. These policies have face amounts of $2,000 to
$25,000 for individuals age 50-80 years and $2,000 to $10,000 for individuals
age 80-85 years. For the convenience of the insured, the Company offers three
premium payment options for these policies: (i) monthly, quarterly, semi-annual
or annual payments; (ii) one-time single premium payment; or (iii) two, three
and five year payment plans. These policies were developed to be sold by the
Company's agents to senior citizens so as to complete the Company's portfolio of
insurance products.
The life insurance products currently marketed by the Company have been
designed for the senior citizen market. The Company previously marketed life
insurance policies, including annual renewable term and whole life policies, to
all ages of insureds.
Medicare Supplement. The Company writes policies designed to provide coverage to
supplement benefits available under Medicare, such as payment of deductible
amounts. OBRA `90 enacted various changes in Medicare reimbursement, set more
stringent standards for Medicare supplement insurance policies and required that
states adopt these new standards by July 31, 1992. OBRA `90 sets forth ten
federally standardized benefit plans of which the Company offers five such plans
in most states. With respect to these benefit packages, companies writing
Medicare supplement coverages must adopt at least the Basic Plan, which covers
Medicare Part A coinsurance amounts for in-patient hospitalization (without the
Part A deductible), the cost of the first three pints of blood and 20% of
allowable charges under Medicare Part B. The other nine plans provide for the
Basic Plan coverage in addition to more extensive benefits such as skilled
nursing home coinsurance amounts, the Medicare Part A deductible, the Medicare
Part B deductible, 100% of Medicare Part B Excess Charges, Foreign Travel
Emergency Care, At-Home Recovery, Extended Drug Coverage and Preventive Care.
All Medicare supplement benefit plans offered by the Company are
subject to "open enrollment" and the Company is required to issue a policy to
any person applying for Medicare supplement insurance within six months of
becoming eligible for Medicare Part B, which generally occurs within the first
six months after a person's 65th birthday.
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Because of lower profit margins associated with the Company's
Medicare supplement products, the Company has gradually de-emphasized the
marketing of these products. Medicare supplement premiums represented 2.4% of
the Company's annualized premiums in-force for the period ended December 31,
1997.
Other Insurance. The Company also sells other insurance products including
accidental death and dismemberment policies and cancer policies, of which the
aggregate premiums represented 0.6% of the Company's total annualized premium
in-force as of December 31, 1997.
(c) Marketing and Expansion
The Company's goal is to underwrite, market and sell its products
throughout the United States. The Company focuses its marketing efforts
primarily in those states (i) where it has successfully developed networks of
agents and (ii) which have the highest concentration of individuals whose
financial status and insurance needs are compatible with its products.
Agents. The Company employs no agents directly but relies instead on
relationships with independent agents and their sub-agents. In 1997, the
Company's policies were marketed through approximately 8,000 producing agents.
The Company provides assistance to its agents through the use of seminars,
underwriting training and field representatives who consult with agents on
underwriting matters, assist agents in research and accompany agents on
marketing visits to current and prospective policyholders.
Each independent agent must be authorized by contract to sell the
Company's products in each particular state in which the agent and the Company
are licensed. Some of the Company's independent agents are large general
agencies with many sales persons (sub-agents), while others are individuals
operating as sole proprietors. Some independent agents sell multiple lines of
insurance, while others concentrate primarily or exclusively on accident and
health insurance.
The Company generally does not impose production quotas or assign
exclusive territories to agents. The amount of insurance written for the Company
by individual independent agents varies. The Company periodically reviews and
terminates its agency relationships with non-producing or under-producing
independent agents or agents who do not comply with the Company's guidelines and
policies with respect to the sale of its products.
The Company is actively engaged in recruiting and training new agents.
Sub-agents are recruited by the independent agents and are licensed by the
Company with the appropriate state regulatory authorities to sell the Company's
policies. Independent agents are generally paid higher commissions than those
employed directly by an insurance company, in part to account for the expenses
of operating as an independent agent. The Company believes that the commissions
it pays to independent agents are competitive with the commissions paid by other
insurance companies selling similar policies. The independent agent's right to
renewal commissions is vested and commissions are paid as long as the policy
remains in force, provided the agent continues to abide by the terms of the
contract. The Company generally permits its established independent agents to
collect the initial premium with the application and remit such premium to the
Company less the commission. New independent agents are required to remit the
full amount of initial premium with the application. The Company provides
assistance to its independent agents in connection with the processing of
paperwork and other administrative services.
Marketing General Agents. The Company selectively utilizes marketing general
agents for the purpose of recruiting independent agents and developing
networks of agents in various states. The Company has a marketing general
agent for the purpose of generating business for PTLIC and PTNA in various
states. This marketing general agent receives an overriding commission on
business written in return for recruiting, training, and motivating the
independent agents. In addition, this marketing general agent functions as a
general agent for PTLIC and PTNA in various states. In its capacity as
marketing general agent and general agent, this agent accounted for 18%, 21%
and 27% of the total premiums earned by the Company during 1995, 1996 and
1997, respectively.
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General Agents. The ten independent agents accounting for the most new
business premium revenue accounted for approximately 7% of the Company's new
business written during 1997. No other single grouping of agents accounted
for more than 10% of the Company's new premium written in 1997. No
underwriting or claims processing authority has been delegated to any agents
of the Company.
Group and Franchise Insurance. The Company also sells a relatively small
amount of group insurance. True group insurance ("Group Insurance") may be
sold by the Company through the issuance of a Group Master Policy to a group
formed for purposes other than the purchase of insurance, such as an employee
group, an association or a professional organization. The Group Master Policy
is issued to the group and all participating members are issued certificates
of insurance which describe the benefits available under the policy.
Eligibility for insurance is guaranteed to all members of the group without
an underwriting review on an individual basis. The Company also sells
franchise insurance ("Franchise Insurance") from time to time, which is
individually underwritten policies sold to an association or group. While
Franchise Insurance is generally presented to an employee group, association
or professional organization which endorses the insurance, the policies are
issued to individual group members. Each application is underwritten and
issuance of policies is not guaranteed to members of the franchise group. The
Company is currently seeking to expand its Group Insurance and Franchise
Insurance business and has recently enhanced its marketing efforts towards
this end. The Company's management considers these areas to offer significant
opportunities for sales growth.
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Markets. The following chart shows premium revenues by state for each of the
states where the Company does business:
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Year Ended December 31,
Year ------------------------------------
State Entered (l) 1995 1996 1997
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(in thousands)
<S> <C> <C> <C> <C>
Arizona 1988 $3,603 $5,284 $7,253
California 1992 9,379 17,403 23,462
Florida 1987 33,116 38,394 43,638
Georgia 1990 995 1,545 1,737
Illinois 1990 4,084 5,160 7,771
Iowa 1990 1,459 1,805 2,081
Maryland 1987 1,969 2,441 2,314
Michigan 1989 1,123 2,460 3,463
Missouri 1990 2,540 2,673 2,809
Nebraska 1990 1,222 1,538 2,130
North Carolina 1990 2,046 3,074 4,334
Ohio 1989 2,989 3,682 4,428
Pennsylvania 1972 19,680 22,056 24,420
South Dakota 1990 1,487 1,845 2,269
Texas 1990 2,887 3,550 3,809
Virginia 1989 7,903 10,532 12,426
Washington 1993 1,165 2,147 2,727
All Other States (2) 5,843 7,063 16,610
-------- -------- --------
All States $102,367 $132,652 $167,681
======== ======== ========
</TABLE>
- ----------
(1) Represents year in which the Company commenced sale of policies in each
state.
(2) Includes all states in which premiums represented one percent or less of
the Company's total premiums in 1997.
(d) Administration
Underwriting.
The Company believes that the underwriting process through which an
accident and health insurance company, particularly one in the long-term care
segment, chooses to accept or reject an applicant for insurance is critical to
its success. All applications are reviewed by the Company's in-house
underwriting department and must be approved before a policy can be issued. The
Company considers age and medical history, among other factors, in deciding
whether to accept an application for coverage. With respect to medical history,
efforts are made to underwrite on the basis of the medical information listed on
the application, but an Attending Physician's Statement is often requested. In
all cases, a personal history interview is required, and a paramedic interview
is often conducted. In the event the Company determines that it cannot offer the
requested coverage, an alternative for suitable coverage for higher risk
applicants may be suggested to the agent. Accepted policies are usually issued
within seven working days from receipt of the information necessary to
underwrite the application. As noted above, while there is no individual
10
<PAGE>
underwriting process for Group Insurance, the underwriting for Franchise
Insurance written by the Company is identical to that for individual policies.
In order to expedite the large volume of premiums generated from sales
of policies in Florida, the increasing volume of premiums from sales of policies
in California, and the specialization required in the sale and underwriting of
disability coverage, the Company operates field offices in Sarasota, Florida,
Stockton, California and Colchester, Vermont to underwrite and issue policies.
These regional offices enable the Company to respond more effectively and
efficiently to its agents and policyholders across the United States.
Applicants for insurance must respond to detailed medical
questionnaires. Physical examinations are not required for the Company's
accident and health insurance policies, but medical records are frequently
requested. Pre-existing conditions disclosed on the application for new
long-term nursing home care and most home health care policies are covered
immediately upon approval of the policy by the Company's underwriting
department, while undisclosed pre-existing conditions are not covered for six
months in most states and two years in certain other states. In addition, the
Company's Independent Living policies immediately cover all disclosed
pre-existing conditions. In the case of individual Medicare supplement policies,
pre-existing conditions are generally not covered during the six month period
following the effective date of the policy.
Claims.
All claims for policy benefits, except with respect to Medicare
supplement claims, are currently processed by the Company's claims department,
which includes a physician and nurses employed or retained as consultants by the
Company. The Company has historically utilized third party administrators to
process its Medicare supplement claims due to the typically small benefit amount
per claim and the large number of claims. The processing of all disability
claims is performed by ANIC.
The Company periodically utilizes the services of unaffiliated Care
Managers to review certain claims, particularly those made under home health
care policies. When a claim is filed, the Company may engage the Care Manager to
review the claim, including the specific health problem of the insured and the
nature and extent of health care services being provided. The Care Manager
assists both the Company and the insured by determining that the services
provided to the insured, and the corresponding benefits paid by the Company, are
appropriate under the circumstances. Under the terms of its Independent Living
policy, the Company will waive the elimination period, the time at the beginning
of the period during which care is provided for which no benefits are available
under the policy (usually twenty days), if the insured agrees to utilize a Care
Manager. The Company estimates that approximately 95% of all new home health
care claims submitted in the last year have been submitted to Care Managers. The
Company anticipates that this usage will continue as both its business and the
need to manage effectively the processing of claims grow.
In 1997, the Company created and staffed an in-house Care Management
unit. This in-house unit conducts the full range of care management services,
which were previously provided exclusively by subcontractors. The Company
intends to develop this unit as it believes it can meet many of its care
management needs more effectively and with less expense than by relying on third
party vendors.
Systems Operations.
The Company operates and maintains its own computer system for all
aspects of the Company's operations, including: policy issuance; billing; claims
processing; commission reports; premium production by agent (state and product)
and general ledger. Throughout 1997, the Company continued the installation of a
new computer system, including hardware and a variety of applications software,
which will enable the Company to (i) define and refine its underwriting and
claims functions so that data may be analyzed more usefully, (ii) target agents
and consumers more effectively and (iii) continue to manage the increasing
volume of information as the Company's business grows. The Company considers an
enhanced system critical to its ability to continue to provide the quality of
service for which the Company has been known to its policyholders and agents.
The Company is using both in-house programmers and outside consultants in
installing the system, and expects the new system to be fully operational by the
end of 1998.
11
<PAGE>
The Company will continue to utilize its current system in an enhanced mode,
until the more-efficient application is installed.
Many computer systems are reliant upon a two-digit field in determining
the year for software applications involving dates. This use of a two-digit
field presents difficulty for computers and application programs in
differentiating between the year 1900 and 2000. The Company is in process of
replacing its computer application systems with new systems which are year 2000
compliant. The Company is also changing its current systems to a four digit date
field to avoid any potential year 2000 problems prior to its conversion to new
systems. The Company does not expect that year 2000 compliance will have a
material impact on its financial condition or results of operations.
Non-compliance could have an adverse effect on the operations of the Company.
(e) Premiums
Premium rates for all lines of insurance written by the Company are
subject to state by state regulation. Premium regulations vary greatly among
jurisdictions and lines of insurance. Rates for the Company's insurance policies
are established by the Company's independent actuarial consultants and reviewed
by the insurance regulatory authorities as part of the licensing process in the
states where the Company markets its products. Before a rate change can be made,
the proposed change must be filed with and approved by the insurance regulatory
authorities.
As a result of minimum loss ratio standards imposed by state
regulations, the premiums charged by the Company with respect to all of its
accident and health polices are subject to reduction and/or corrective measures
in the event insurance regulatory agencies in states where the Company does
business determine that the Company's loss ratios either have not reached or
will not reach required minimum levels. See "Government Regulation".
(f) Future Policy Benefits and Claims Reserves
The Company is required to maintain reserves equal to the probable
ultimate liability for claims and related claims expenses with respect to all
policies in force. Reserves, which are computed by the Company's actuarial
consultant, are established for (i) claims which have been reported but not yet
paid, (ii) claims which have been incurred but not yet reported and (iii) the
discounted present value of all future policy benefits less the discounted
present value of expected future premiums. See Note 4 of the Notes to
Consolidated Financial Statements.
The amount of reserves relating to reported and unreported claims
incurred is determined by periodically evaluating historical claims experience
and statistical information with respect to the probable number and nature of
such claims. The Company compares actual experience with estimates and adjusts
its reserves on the basis of such comparisons.
In addition to reserves for incurred claims, reserves are also
established for future policy benefits. The policy reserve represents the
discounted present value of future obligations that are likely to arise from the
policies that the Company underwrites, less the discounted present value of
expected future premiums on such policies. The reserve component is determined
using generally accepted actuarial assumptions and methods. However, the
adequacy of this reserve rests on the validity of the underlying assumptions
that were used to price the Company's products; the more important of these
assumptions relate to policy lapses, loss ratios and claim incidence rates.
The Company's long-term care experience, most of which is based on its
nursing home care products, is derived from the Company's twenty years of
significant claims experience with respect to this product line, and reserves
for these policies are based primarily upon this experience.
The Company began offering home health care coverage in 1987, and since
that time has realized a significant increase in the number of home health care
policies written by the Company. The Company's claims experience with home
health care coverage is more limited than is its nursing home care claims
experience, and the Company's claims experience with respect to its Independent
Living policy, which it first offered in November 1994,
12
<PAGE>
is extremely limited. The Company's claims experience to date with respect to
certain of its home health care products has been characterized by a higher than
expected number of claims with a longer than expected duration. Management of
the Company believes that individuals may be more inclined to utilize home
health care than nursing home care, which is generally a last resort to be
considered only after all other possibilities have been explored. Accordingly,
management believes that there is a greater potential for wide variations in
claims experience in its home health care insurance than exists with respect to
nursing home care insurance. The Company's actuarial consultants utilize both
the Company's experience and other industry-wide data in the computation of
reserves for the home health care product line.
In addition, more recent long-term care products, developed as a
result of regulation or market conditions, may incorporate more benefits with
fewer limitations or restrictions. For instance, OBRA '90 required that
Medicare supplement policies provide for guaranteed renewability and waivers
of pre-existing condition coverage limitations under certain circumstances.
In addition, the National Association of Insurance Commissioners ("The NAIC")
has recently adopted model long-term care policy language providing
nonforfeiture benefits and has proposed a rate stabilization standard for
long-term care policies, either or both of which may be adopted by the states
in which the Company writes policies. See "Government Regulation." The
fluidity in market and regulatory forces might limit the Company's ability to
rely on historical claims experience for the development of new premium rates
and reserve allocations.
The Company employs full-time actuarial support and utilizes the
services of actuarial consultants (the "Actuaries"), to price insurance products
and establish reserves with respect to those products. Additionally, the
actuaries assist the Company in improving the documentation of its reserve
methodology, a process which has resulted in certain adjustments to the
Company's reserve levels. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Overview." Although management believes that
the Company's reserves are adequate to cover all policy liabilities, there can
be no assurance that reserves are adequate or that future claims experience will
be similar to, or accurately predicted by, the Company's past or current claims
experience.
(g) Reinsurance
As is common in the insurance industry, the Company purchases
reinsurance to increase the number and size of the policies it may underwrite.
Reinsurance is purchased by insurance companies to insure their liability under
policies written to their insureds. By transferring, or ceding, certain amounts
of premium (and the risk associated with that premium) to reinsurers, the
Company can limit its exposure to risk. The Company currently reinsures any life
insurance policy to the extent the risk on that policy exceeds $50,000. The
Company currently reinsures its ordinary life policies through Reassurance
Company of Hannover (A.M. Best rating A-). The Company also has reinsurance
agreements with Life Insurance Company of North America (A.M. Best rating A+)
and Transamerica Occidental Life Insurance Company (A.M. Best rating A+) to
reinsure term life policies whose risk exceeds $15,000, and with Employers
Reassurance Corporation (A.M. Best rating A+) to reinsure credit life policies
whose risk exceeds $15,000.
PTLIC and PTNA have entered into a reinsurance agreement, effective
in January 1994, to cede 100% of certain life, accident and health and
Medicare supplement insurance policies issued by PTLIC and PTNA to Life and
Health Insurance Company of America ("Life and Health") (A.M. Best rating
B-). This arrangement, known as a "fronting" arrangement, is used when one
insurer wishes to take advantage of another insurer's ability to procure and
issue policies. The fronting company remains liable to the policyholder, even
though all of its risk is reinsured. Because of Life and Health's A.M. Best
rating, PTLIC and PTNA have structured their agreement with Life and Health
to require maintenance of securities in escrow for PTLIC and PTNA in an
amount at least equal to their statutory reserve credit. The value of these
escrowed securities, which consist of U.S. Government bonds, exceeded PTLIC's
and PTNA's related statutory reserve credits as of December 31, 1997, which
were approximately $459,000. The policies subject to this fronting
arrangement are being marketed in six states to federal employees. Premium
ceded under this agreement totaled $943,500, $882,465 and $779,162 in 1995,
1996 and 1997, respectively.
In January 1991, PTNA entered into another fronting arrangement under
which PTNA ceded 100% of certain whole life and deferred annuity policies to
Provident Indemnity Life Insurance Company ("Provident
13
<PAGE>
Indemnity"), (A.M. Best rating B). No new policies have been ceded under this
arrangement since December 31, 1995. PTNA has structured its agreement with
Provident Indemnity to require maintenance of securities in escrow for PTNA
in an amount at least equal to its statutory reserve credit. The value of
these escrowed securities, which consist of U.S. Government bonds, exceeds
PTNA's related statutory reserve credit as of December 31, 1997 of
approximately $3,700,000. The policies which are subject to this fronting
agreement were intended for the funeral arrangement or "pre-need" market, and
were being underwritten in 24 states (with the largest markets in California
and Michigan). Total ceded life insurance in force approximated $14,169,000,
$12,121,000 and $10,562,000 for 1995, 1996 and 1997, respectfully.
Effective in October 1994, the Insurers entered into reinsurance
agreements with Cologne Life Reinsurance Company (A.M. Best rating A+) with
respect to their home health care policies with benefit periods exceeding 36
months. Under these reinsurance agreements, the Insurers are responsible for
payment of claims during the first 36 months of the benefit period, and the
reinsurer will reimburse the Insurers for 100% of all claims paid after such 36
month period. Total reserve credits taken related to this agreement as of
December 31, 1997 were approximately $1,484,000. Effective January 1998, no new
policies will be reinsured under this treaty.
In May 1991, PTNA acquired a block of long-term care business under an
assumption reinsurance agreement with Providentmutual Life and Annuity Company
of America (formerly known as Washington Square Life Insurance Company). PTNA
assumed the obligations as insurer for all policies in force as of that date.
PTNA received cash totaling $1,512,300, net of $513,500 as consideration for the
sale. Under this agreement, PTNA assumed a reinsurance treaty under which 66% of
the premiums assumed are, in turn, ceded by PTNA to a third party reinsurer. The
total accident and health premiums ceded under this treaty amounted to
$1,174,792 in 1995, $1,081,380 in 1996 and $1,001,730 in 1997.
On December 28, 1990, PTNA entered into a reinsurance agreement with
Midland Mutual Life Insurance Company (A.M. Best rating A-) under which PTNA
acquired approximately 3,100 nursing home policies in 22 states with an
annualized premium of approximately $3,000,000. The Company recognized
$1,768,467 of premium related to this acquisition in 1995, $1,661,725 in 1996
and $1,550,667 in 1997.
In the event a reinsurance company becomes insolvent or otherwise fails
to honor its obligations to the Company under any of its reinsurance agreements,
the Company would remain fully liable to the policyholder.
ANIC reinsures approximately $500,000 of premium with three Vermont
licensed companies. For a discussion of the amounts reinsured by the Company,
see Note 11 of the Notes to Consolidated Financial Statements.
For a discussion of A.M. Best ratings, see "A. M. Best Ratings and
Standard & Poor's Ratings."
(h) Investments
The Company invests in securities and other investments authorized by
applicable state laws and regulations and follows an investment policy designed
to maximize yield to the extent consistent with liquidity requirements and
preservation of assets. Investments are managed by James M. Davidson & Company
of Wayne, Pennsylvania and First Union National Bank of Charlotte, North
Carolina. Over the past five years, the Company has been able to meet its
liabilities through operations and has not had to utilize any of its investment
assets.
14
<PAGE>
The following table shows the composition of the debt securities
investment portfolio (at carrying value), excluding short-term investments, by
rating as of December 31, 1997.
<TABLE>
<CAPTION>
December 31, 1997
-------------------
Rating Amount Percent
------ -------
(Dollar amounts
in thousands)
<S> <C> <C>
U.S. Treasury and U.S. Agency securities $167,856 60.3%
Aaa or AAA 43,888 15.8%
Aa or AA 28,471 10.2%
A 35,566 13.1%
Other 1,367 0.5%
-------- ------
Total $278,148 100.0%
======== ======
</TABLE>
As of December 31, 1997, over 92.2% of the Company's total
investments were fixed income debt securities, 60.3% of which were securities
of the United States Government (or its agencies or instrumentalities). The
balance of the Company's investment portfolio consisted principally of
publicly traded equity securities. As of December 31, 1997, substantially all
of the Company's bond investment portfolio consisted of investment grade
securities, with substantially 100% rated "A" or better by either Moody's
Debt Rating Service or Standard and Poor's Corporation. The Company's
investment policy is to purchase only U.S. Treasury securities, U.S. agency
securities and investment-grade municipal and corporate securities primarily
with an "A" or higher rating with the highest yield to maturity available,
and to have 7% to 10% of the Company's bond investment portfolio mature each
year. The Company generally buys investments maturing within two to 12 years
of the date of the purchase. At December 31, 1997, the average maturity of
the Company's bond investment portfolio was 5.8 years and the Company's
investment portfolio contained no collateralized mortgage obligations or
investments in real estate. The Company has historically limited its
investments in equity securities. In 1997, the Company expanded its common
stock investments to approximately 7.8% of its total investments. During
March 1998, the Company sold its entire equity securities portfolio, or
approximately $21,000,000 of invested assets. From this sale, the Company
recognized an approximate $6,5000,000 capital gain, which is reportable in
the first quarter of 1998. The Company intends to limit its common stock
investments to 10% of its total investments. For additional information
regarding the Company's investments, see Note 3 of the Notes to Consolidated
Financial Statements.
The following table sets forth for the periods indicated certain
information concerning investment income.
<TABLE>
<CAPTION>
Investment Portfolio 1995 1996 1997
-------- -------- --------
Year Ended December 31,
-----------------------
(Dollar amounts in thousands)
<S> <C> <C> <C>
Average balance of investments, cash and
cash equivalents during the period (at cost) $125,524 $174,422 $284,323
Net investment income 8,103 10,982 17,009
Average yield on investments 6.5% 6.3% 6.0%
</TABLE>
The Company's declining yield is reflective of lower market interest
rates, increased equity securities investments, and increased purchases of
tax-exempt investments.
15
<PAGE>
(i) Selected Financial Information: Statutory Basis
The following table shows certain ratios derived from the Company's
insurance regulatory filings with respect to the Company's accident and health
policies presented in accordance with accounting principles prescribed or
permitted by insurance regulatory authorities ("SAP"), which differ from the
presentation under Generally Accepted Accounting Principles ("GAAP") and which
also differ from the presentation under SAP for purposes of demonstrating
compliance with statutorily mandated loss ratios. See "Government Regulation".
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Loss ratio (1) 56.1% 61.5% 70.9%
Expense ratio (2) 50.4 48.7 57.9
----- ----- -----
Combined loss and expense ratio 106.5 110.2 128.8
Persistency (3) 77.4 79.9 83.1
</TABLE>
---------------
(1) Loss ratio is defined as incurred claims and increases in policy reserves
divided by earned premiums.
(2) Expense ratio is defined as commissions and expenses incurred divided by
earned premiums.
(3) Persistency represents the percentage of premiums renewed, which the Company
calculates by dividing the total annual premiums at the end of each year (less
first year business for that year) by the total annual premiums in force for the
prior year. For purposes of this calculation, a decrease in total annual
premiums in force at the end of any year would be a result of non-renewal
policies, including those policies that have terminated by reason of death,
lapse due to nonpayment of premiums, and/or conversion to other policies offered
by the Company.
The Company's loss ratio rose in 1995 and continued to rise in 1996
and 1997 from the prior year's level due in part to a mandated change in
reserving method wherein underwriters of long-term care products were
required by the Pennsylvania Insurance Department, commencing in October
1994, to use the one-year preliminary term reserve method, instead of the
two-year preliminary term method previously permitted. This change had the
effect of requiring companies to establish a full annual reserve for a policy
commencing at the end of the first policy year, instead of at the end of the
second policy year. The increase in the persistency rate in 1997, 1996 and
1995, signifying a greater percentage of policy renewals, also caused the
loss ratio to increase. This is due to the fact that as policies age, the
reserves associated with such policies must be increased. In addition, the
Company added approximately $12,000,000 to this reserve as a result of its
reassessment of assumptions utilized in the actuarial determination of
reserves for current claims liabilities and incurred but unreported
liabilities for nursing home and home health care claims. The Company
reviewed the assumptions underlying its reserves in connection with its
recent employment of a new long-term care consulting actuary. The review
encompassed certain actuarial assumptions related to the Company's products'
benefit utilization and duration.
Under SAP, costs associated with sales of new policies must be
charged to earnings as incurred. Because these costs, together with required
reserves, generally exceed first year premiums, statutory surplus may be
reduced during periods of increasing first year sales. Through November 1994,
the Company was able to expand its business from accumulation of statutory
retained earnings and from proceeds received from the Company's Common Stock
offering completed in December, 1989. In December 1994, PTLIC's capital
position was strengthened by a $4,000,000 contribution from the Company. The
capital position of the Insurers was improved further by the contribution of
$14,000,000 of the net proceeds of a public offering of common stock to the
capital and surplus of the Insurers during the third quarter of 1995. In
October 1996, the Company contributed an additional $5,000,000 of the
offering proceeds to PTNA. In December 1996, the Company contributed
$20,000,000, $20,000,000 and $5,000,000 to the capital and surplus of PTLIC,
PTNA, and ANIC, respectively, from the proceeds of its $74,750,000
convertible subordinated debt offering in November 1996.
16
<PAGE>
Mandated loss ratios are calculated in a manner which provides adequate
reserving for the long-term care insurance risks, using statutory lapse rates
and certain assumed interest rates. The statutorily assumed interest rates
differ from those used in developing reserves under GAAP. For this reason,
statutory loss ratios differ from loss ratios reported under GAAP. Mandatory
statutory loss ratios also differ from loss ratios reported on a current basis
under SAP for purposes of the Company's annual and quarterly state insurance
filings. The states in which the Company is licensed have the authority to
change these minimum ratios and to change the manner in which these ratios are
computed and the manner in which compliance with these ratios is measured and
enforced. The Company is unable to predict the impact of (i) the imposition of
any changes in the mandatory statutory loss ratios for individual or group
long-term care policies to which the Company may become subject, (ii) any
changes in the minimum loss ratios for individual or group long-term care or
Medicare supplement policies, or (iii) any change in the manner in which these
minimums are computed or enforced in the future. The Company has not been
informed by any state that it does not meet mandated minimums, and the Company
believes it is in compliance with all such minimum ratios. In the event the
Company is not in compliance with minimum statutory loss ratios mandated by
regulatory authorities with respect to certain policies, the Company may be
required to reduce or refund its premiums on such policies.
(j) A.M. Best's Rating and Standard & Poor's Rating
The Insurers rating with A.M. Best is "B++ (very good)." A.M. Best's
ratings are based on a comparative analysis of the financial condition and
operating performance for the prior year of the companies rated, as determined
by their publicly available reports. A.M. Best's classifications are A++ and A+
(superior), A and A- (excellent), B++ and B+ (very good), B and B-(good), C++
and C+ (fair), and C and C- (marginal), D (below minimum standards), E (under
state supervision) and F (in liquidation). A.M. Best's ratings are based upon
factors of concern to policyholders and insurance agents and are not directed
toward the protection of investors. In evaluating a company's financial and
operating performance, the rating agencies review the company's profitability,
leverage and liquidity as well as the company's book of business, the adequacy
and soundness of its reinsurance, the quality and estimated market value of its
assets, the adequacy of its reserves and the experience and competency of its
management. PTLIC and PTNA also have a Standard & Poor's claims paying ability
rating of "A- (good)," which falls within the most secure range (AAA to BBB).
ANIC is not rated by Standard & Poor's.
(k) Competition
The Company operates in a highly competitive industry. Many of its
competitors have considerably greater financial resources, higher ratings from
A.M. Best and larger networks of agents than the Company. Many insurers offer
long-term care policies similar to those offered by the Company and utilize
similar marketing techniques. The Company actively competes with these insurers
in attracting and retaining agents by offering competitive products and
commission rates and quality underwriting, claims service and policyholder
service.
(l) Government Regulation
Insurance companies are subject to supervision and regulation in all
states in which they transact business. The Company is registered and
approved as a holding company under the Pennsylvania Insurance Code. PTLIC
and PTNA are chartered and licensed in Pennsylvania as stock life insurance
companies. ANIC is chartered and licensed in Vermont as a stock accident and
health insurance company. On a combined basis with its direct and indirect
insurance subsidiaries, the Company is currently licensed in all states,
except New York, where the Company has formed a subsidiary and is seeking
approval to operate as an insurer.
The extent of regulation of insurance companies varies, but generally
derives from state statutes which delegate regulatory, supervisory and
administrative authority to state insurance departments. Although many states'
insurance laws and regulations are based on models developed by the NAIC and are
therefore similar, variations among the laws and regulations of different states
are common.
The NAIC is a voluntary association of all of the state insurance
commissioners in the United States. The primary function of the NAIC is to
develop model laws on key insurance regulatory issues which can be used as
guidelines for individual states in adopting or enacting insurance legislation.
While the NAIC model laws are
17
<PAGE>
accorded substantial deference within the insurance industry, these laws are not
binding on insurance companies unless adopted by the state, and variations from
the model laws within the states is common.
The Pennsylvania Department, the Vermont Department of Banking,
Insurance, Securities and Health Care Administration (the "Vermont Department")
and insurance regulatory authorities in other jurisdictions, have broad
administrative and enforcement powers relating to the granting, suspending and
revoking of licenses to transact insurance business, the licensing of agents,
the regulation of premium rates and trade practices, the content of advertising
material, the form and content of insurance policies and financial statements
and the nature of permitted investments. In addition, regulators have the power
to require insurance companies to maintain certain deposits, capital, surplus
and reserve levels calculated in accordance with prescribed statutory standards.
The Company believes that its deposit, capital, surplus and reserve levels
currently meet or exceed all applicable regulatory requirements. The primary
purpose of such supervision and regulation is the protection of policyholders,
not investors.
The Company also is subject to the insurance holding company laws of
Pennsylvania and of the other states in which it is licensed to do business.
These laws generally require insurance holding companies and their subsidiary
insurers to register and file certain reports, including information concerning
their capital structure, ownership, financial condition and general business
operations. Further, states often require prior regulatory approval of changes
in control of an insurer and of intercorporate transfers of assets within the
holding company structure. The purchase of more than 10% of the outstanding
shares of Common Stock by one or more parties acting in concert requires the
prior approval of the Pennsylvania and Vermont Departments, and may subject such
party or parties to the reporting requirements of the insurance laws and
regulations of Pennsylvania and Vermont and to the prior approval and/or
reporting requirements of other jurisdictions in which the Company is licensed.
In addition, officers, directors and 10% shareholders of insurance companies,
such as the Insurers, are subject to the reporting requirements of the insurance
laws and regulations of Pennsylvania and Vermont, as the case may be, and may be
subject to the prior approval and/or reporting requirements of other
jurisdictions in which the Company is licensed.
Under Pennsylvania law, lending institutions, public utilities, bank
holding companies, savings and loan companies, and their affiliates,
subsidiaries, officers and employees may not be licensed or admitted as
insurers. If any of the foregoing entities or individuals (or any such entity
and its affiliates, subsidiaries, officers and employees in the aggregate)
acquires 5% or more of the outstanding shares of Common Stock, such party may be
deemed to be an affiliate, in which event the Company's Certificate of Authority
to do business in Pennsylvania may be revoked upon a determination by the
Department that such party exercises effective control over the Company.
As part of their routine regulatory, oversight process state insurance
regulators periodically conduct detailed examinations of the books, records and
operations of insurers. During 1995, the Pennsylvania Department completed its
examination of PTLIC and PTNA for the five year period ended December 31, 1994
and had no recommendations for either PTLIC or PTNA. During 1995, the Vermont
Department completed its examination of ANIC for the three year period ended
December 31, 1994 and had no material recommendations. In addition to conducting
these examinations, state insurance regulatory authorities from time to time
also conduct separate market conduct examinations. These examinations focus on
an insurer's claims practices, policyholder complaints, policy forms,
advertising practices and other marketing aspects.
In recent years, there has been considerable legislative and regulatory
activity, at both the state and federal levels, with regard to long-term care
and Medicare supplement insurance. There is extensive federal and state
regulation applicable to the form and content of Medicare supplement policies,
including requirements for specified minimum benefits and loss ratios and
requirements relating to agent compensation and the sales practices of agents
and companies. For example, Pennsylvania, which had previously enacted
regulations governing Medicare supplement insurance, recently promulgated
regulations governing long-term care insurance. These regulations are effective
for policies written on or after February 8, 1995, and impact, affect and/or
regulate areas including permissible policy practices and provisions, lapse
provisions, required disclosure provisions, post-claims underwriting, minimum
standards for home health and community care benefits, inflation protection
provisions, application forms and replacement coverage, reporting requirements,
reserve standards, loss ratios, filings for
18
<PAGE>
out-of-state group policies, marketing standards, agent recommendations,
pre-existing condition limitations, coverage outlines, allowable shoppers guides
and permitted compensation arrangements.
Most states mandate minimum benefit standards and loss ratios for
long-term care insurance policies and for other accident and health insurance
policies. Most states have adopted the NAIC's proposed standard minimum loss
ratios of 65% for individual Medicare supplement policies and 75% for group
Medicare supplement policies. A significant number of states, including
Pennsylvania and Florida, also have adopted the NAIC's proposed minimum loss
ratio of 60% for both individual and group long-term care insurance policies.
The states in which the Company is licensed have the authority to change these
minimum ratios, the manner in which these ratios are computed and the manner in
which compliance with these ratios is measured and enforced.
The Department is provided, on an annual basis, with a calculation
prepared by the Company's independent consulting actuary regarding compliance
with required minimum loss ratios for Medicare supplement and credit policies.
This report is made available to all states. Although certain other policies
(e.g., nursing home and hospital care policies) also have specific mandated loss
ratio standards, at the present there typically are no similar reporting
requirements in the states in which the Company does business for such other
policies.
The NAIC has developed minimum capital and surplus requirements
utilizing certain risk-based factors associated with various types of assets,
credit, underwriting and other business risks. The Company did not experience
any problems meeting these requirements when they took effect in 1993. As of
December 31, 1997, the risk-based capital of PTLIC, PTNA and ANIC were 659% ,
682%, and 329% respectively, of authorized control level capital.
In December 1986, the NAIC adopted the Long-Term Care Insurance Model
Act (the "Model Act"), which was adopted to promote the availability of
long-term care insurance policies, to protect applicants for such insurance and
to facilitate flexibility and innovation in the development of long-term care
coverage. The Model Act establishes standards for long-term care insurance,
including provisions relating to disclosure and performance standards for
long-term care insurers, incontestability periods, nonforfeiture benefits,
severability, penalties and administrative procedures. Model regulations were
also developed by the NAIC to implement the Model Act. Some states have also
adopted standards relating to agent compensation for long-term care insurance.
In addition, from time to time, the federal government has considered adopting
standards for long-term care insurance policies, but has not enacted any such
legislation to date. The Company believes that its new policies are in
compliance with the Model Act.
States also restrict the dividends the Company's insurance subsidiaries
are permitted to pay. Dividend payments will depend on profits arising from the
business of the Insurers, computed according to statutory formulae. In addition,
Pennsylvania law requires PTLIC and PTNA to furnish the Pennsylvania Department
30 days advance notice of any planned extraordinary dividend (any dividend paid
within any twelve-month period which exceeds the greater of (i) 10% of its
surplus as shown in its most recent annual statement filed with the Pennsylvania
Department or (ii) its net gain from operations, after policyholder dividends
and federal income taxes and before realized gains or losses, shown in such
statement) and the Pennsylvania Department may refuse to allow it to pay such
extraordinary dividends. Under Vermont insurance law, ANIC is also required to
furnish 30 days advance written notice of an extraordinary dividend to the
Vermont Department which may disapprove the dividend. Vermont law defines an
extraordinary dividend as a dividend in excess of the lesser of (i) the net
earnings of the company during the preceding calendar year plus net income not
paid out as dividends during the prior two calendar years and (ii) 10% of the
capital surplus of the company, determined as of the immediately preceding
December 31.
OBRA '90 enacted various changes in Medicare reimbursement and set new
standards for Medicare supplement insurance policies. Among the changes in
reimbursement are (i) an increase in the premium paid by participants under Part
B and (ii) an extension until September 30, 1995 of the authority of the
Medicare program to use data provided by the Social Security Administration and
the Internal Revenue Service to improve collection in Medicare secondary payor
cases. Among the new standards for Medicare supplement insurance policies are
those requiring (i) guaranteed renewability, (ii) mandatory state reporting on
the implementation and enforcement of Medicare supplement policy standards,
(iii) the obtaining of statements by insurers from purchasers as to whether
19
<PAGE>
they are already covered by another Medicare supplement policy or by Medicaid
and (iv) a waiver of pre-existing condition coverage limitations for policies
that replace existing policies.
During 1993, the NAIC adopted model language that requires long-term
care policies to include a nonforfeiture benefit. The mandated inclusion of a
nonforfeiture benefit is intended to protect policyholders against the lapse (or
cancellation) of policies without some value returned to the policyholder.
Issuers of long-term care insurance policies are subject to a tax if they fail
to meet certain requirements set forth in the long-term care insurance model
regulations and the long-term care insurance model act as promulgated by the
NAIC (January 1993). The amount of the tax is $100 per insured for each day any
of the requirements are not met with respect to each qualified long-term care
insurance contract. During 1994, the NAIC adopted a standard calling for "rate
stabilization" of long-term care policies. Some states, such as Florida, have
adopted regulations which require long-term care policies to include
nonforfeiture provisions. Other states, such as California, have adopted
regulations which require long-term care policies to include provisions allowing
insureds to obtain protection against the effects of inflation. Adoption of
nonforfeiture benefits would increase the price of long-term care policies,
while rate stabilization provisions limit the Company's ability to adjust to
adverse loss experiences. The Company is in compliance with all such
regulations.
In September 1996, Congress enacted the Health Insurance Portability
and Accountability Act of 1996 ("the Act") which permits premiums paid for
eligible long-term care insurance policies after December 31, 1996 to be
treated as deductible medical expenses for the Internal Revenue Service. The
deduction is limited to a specified dollar amount ranging from $200 to
$2,500, with the amount of the deduction increasing with the age of the
taxpayer. In order to qualify for the deduction the insurance contract must,
among other things, provide for (i) limitations on pre-existing condition
exclusions, (ii) prohibitions on excluding individuals from coverage based on
health status, and (iii) guaranteed renewability of health insurance
coverage. Although the Company intends to offer tax deductible policies, it
will continue to offer a variety of non-deductible policies as well. The
Company has filed long-term care policies which qualify for tax exemption
under the Act in all states in which it is licensed.
Periodically, the federal government has considered adopting a
national health insurance program. Although it does not appear that the
federal government will enact an omnibus health care reform law in the near
future, the passage of such a program could have a material impact upon the
Company's operations. In addition, legislation enacted by Congress could
impact the Company's business. Among the proposals are the implementation of
certain minimum consumer protection standards for inclusion in all long-term
care policies, including guaranteed renewability, protection against
inflation and limitations on waiting periods for pre-existing conditions.
These proposals would also prohibit "high pressure" sales tactics in
connection with long-term care insurance and would guarantee consumers access
to information regarding insurers, including lapse and replacement rates for
policies and the percentage of claims denied. Other pending legislation would
permit premiums paid for long-term care insurance to be treated as deductible
medical expenses, with the amount of the deduction increasing with the age of
the taxpayer. As with any pending legislation, it is possible that any laws
finally enacted will be substantially different than the current proposals.
Accordingly, the Company is unable to predict the impact of any such
legislation on its business and operations.
20
<PAGE>
(m) Employees
As of December 31, 1997, the Company had approximately 253 full-time
employees (not including independent agents), 168 of whom are employed in the
Company's home office. Of those employees in the Company's home office, 34
are employed in various administrative services, 28 in sales, 34 in
underwriting, 18 in accounting, nine in compliance, 25 in claims, 16 in an
executive capacity, and four in systems. The Company had approximately 36
full-time employees employed in the Florida field office as of December 31,
1997. Of the Florida employees, 27 are employed in underwriting and
administrative services and nine are employed in marketing. As of December 31,
1997, the Company had 24 employees in its California office and had 25 employees
in its Vermont office. The Company is not a party to any collective bargaining
agreements and believes that its relationship with its employees is good.
Item 2. Properties
The Company's principal offices in Allentown, Pennsylvania, occupy
approximately 25,500 square feet of office space in a 40,000 square foot
building, owned by the Company. The Company also leases additional office space
in Florida and California, and owns office space in Vermont.
The Company owns a 2.42 acre parcel of land and a warehouse, both
located across the street from its home office for future use. The warehouse
is currently used for storage and houses the Company's printing equipment.
Item 3. Legal Proceedings
The Insurers are parties to various lawsuits generally arising in the
normal course of business. The Company does not believe that the eventual
outcome of any such suit will have a material effect on its financial condition
or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of the
fiscal year ended December 31, 1997 to a vote of security holders.
21
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
The Common Stock of the Company is traded in the over-the-counter
market and is included on the NASDAQ Stock Market ("NASDAQ") under the symbol
PTAC. The transfer agent and registrar for the Company's Common Stock is First
Union National Bank of Charlotte, North Carolina.
As of March 19, 1998 the Company had 7,795,996 shares of Common Stock
outstanding, held by approximately 429 stockholders of record. This latter
number was derived from the Company's shareholder records, and does not include
beneficial owners of the Company's Common Stock whose shares are held in the
names of various dealers, clearing agencies, banks, brokers, and other
fiduciaries.
The range of high and low sale prices, as reported by NASDAQ, for the
Company's Common Stock for the periods indicated below, is as follows:
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1996
First Quarter 19 15 1/4
Second Quarter 21 1/2 18 1/2
Third Quarter 24 3/4 17
Fourth Quarter 26 22 1/2
1997
First Quarter 29 1/2 24 3/4
Second Quarter 30 7/8 23 7/8
Third Quarter 35 1/2 29 1/2
Fourth Quarter 34 1/2 28 3/4
</TABLE>
The Company has never paid any cash dividends on its Common Stock and
does not intend to do so in the foreseeable future. It is the present intention
of the Company to retain any future earnings to support the continued growth of
the Company's business. Any future payment of dividends by the Company is
subject to the discretion of the Board of Directors and is dependent, in part,
on any dividends it may receive as the sole shareholder of PTLIC, ANIC and the
Agency, and which PTLIC may in turn receive as the sole shareholder of PTNA. The
payment of dividends by PTLIC, ANIC and PTNA, respectively, is in turn dependent
on a number of factors, including their respective earnings and financial
condition, business needs and capital and surplus requirements, and is also
subject to certain regulatory restrictions and the effect that such payment
would have on their ratings by A.M. Best Company and Standard & Poor's.
22
<PAGE>
Item 6. Selected Financial Data
The following selected consolidated statement of operations data and
balance sheet data of the Company as of and for the years ended December 31,
1993, 1994, 1995, 1996 and 1997, have been derived from the Consolidated GAAP
Financial Statements of the Company, which have been audited by Coopers and
Lybrand L.L.P., independent accountants.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
(in thousands, except per share data and ratios)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Accident and health:
First year premiums $ 25,836 $ 26,968 $ 36,770 $ 46,346 $ 55,348
Renewal premiums 43,615 52,237 62,402 80,311 108,794
Life:
First year premiums 361 2,149 1,701 1,457 1,056
Renewal premiums 169 481 1,494 2,077 2,483
--------- --------- --------- --------- ---------
Total premiums 69,981 81,835 102,367 130,192 167,681
Investment income, net 4,979 5,946 8,103 10,982 17,009
Net realized gains (losses) 182 8 46 20 1,417
Other income 321 305 347 342 417
--------- --------- --------- --------- ---------
Total revenues 75,463 88,094 110,863 141,536 186,524
Benefits and expenses:
Benefits to policyhholders 40,829 48,757 64,879 83,993 123,865
First year commissions 16,722 19,365 26,223 30,772 37,834
Renewal commissions 7,060 7,866 10,128 12,533 17,406
Net acquisition costs deferred (2) (6,640) (7,643) (15,303) (19,043) (28,294)
General and administrative expenses 9,350 10,262 12,171 15,648 20,614
Interest expense 184 162 327 625 4,804
--------- --------- --------- --------- ---------
Total benefits and expenses 67,505 78,769 98,425 124,529 176,230
--------- --------- --------- --------- ---------
Income before federal income taxes 7,958 9,325 12,438 17,008 10,294
Provision for federal income taxes 2,137 2,562 3,609 4,847 2,695
--------- --------- --------- --------- ---------
Net income $ 5,821 $ 6,763 $ 8,829 $ 12,161 $ 7,599
========= ========= ========= ========= =========
Basic earnings per share (1) $ 1.24 $ 1.45 $ 1.53 $ 1.70 $ 1.01
========= ========= ========= ========= =========
Diluted earnings per share (1) $ 1.24 $ 1.44 $ 1.51 $ 1.66 $ 0.98
========= ========= ========= ========= =========
Weighted average shares outstanding (3) 4,689 4,669 5,772 7,165 7,540
Diluted shares outstanding (1) 4,697 4,687 5,842 7,528 7,758
GAAP Ratios:
Loss ratios 58.3% 59.5% 63.4% 64.5% 73.9%
Expense ratio 38.1% 36.7% 32.8% 31.1% 31.2%
--------- --------- --------- --------- ---------
Total 96.4% 96.2% 96.2% 95.6% 105.1%
========= ========= ========= ========= =========
Selected Statutory Data:
Net premiums written $ 69,898 $ 81,878 $ 102,145 $ 133,950 $ 167,403
Statutory surplus (beginning of
period) $ 12,301 $ 17,256 $ 21,067 $ 38,148 $ 81,795
Ratio of net premiums written to
statutory surplus 5.7x 4.7x 4.8x 3.5x 2.0x
Balance Sheet Data:
Total investments $ 77,891 $ 91,490 $ 144,928 $ 212,662 $ 301,786
Total assets 136,948 164,346 237,744 386,768 465,770
Total debt 2,516 6,372 2,206 77,115 76,752
Total liabilities 85,599 108,903 140,637 267,861 333,015
Shareholders' equity (4) 51,349 55,444 97,107 118,907 132,775
Book value per share (3)(4) $ 11.00 $ 11.87 $ 13.93 $ 15.83 $ 17.53
</TABLE>
23
<PAGE>
(1) The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share," which requires retroactive restatement of basic and
diluted earnings per share.
(2) For a discussion of policy acquisition costs, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations".
(3) Adjusted to give effect to a 50% stock dividend on the Common Stock declared
on April 19, 1995, payable to shareholders of record on May 3, 1995 and
distributed on May 15, 1995.
(4) The Company adopted Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," on
January 1, 1994. For a discussion of the impact of this change on shareholders'
equity, see "Management's Discussion and Analysis of Financial
Condition-Liquidity and Capital Resources."
24
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following table sets forth the components of the Company's
condensed statements of operations for the years ended December 31, 1995, 1996
and 1997, expressed as a percentage of total revenues.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
Statement of Operations Data:
Revenues:
Accident and health:
First year premiums 33.2% 32.7% 29.7%
Renewal premiums 56.3% 56.7% 58.3%
Life:
First year premiums 1.5% 1.0% 0.6%
Renewal premiums 1.3% 1.5% 1.3%
----- ----- -----
Total premiums 92.3% 91.9% 89.9%
Investment income, net 7.4% 7.9% 9.1%
Net realized gains (losses) 0.0% 0.0% 0.8%
Other income 0.3% 0.2% 0.2%
----- ----- -----
Total revenues 100.0% 100.0% 100.0%
Benefits and expenses:
Benefits to policyholders 58.5% 59.3% 66.4%
First year commissions 23.7% 21.7% 20.3%
Renewal commissions 9.1% 8.9% 9.3%
Net policy acquisition costs deferred -13.8% -13.5% -15.2%
General and administrative expense 11.0% 11.1% 11.1%
Interest expense 0.3% 0.4% 2.6%
----- ----- -----
Total benefits and expenses 88.8% 88.0% 94.5%
----- ----- -----
Income before federal income taxes 11.2% 12.0% 5.5%
Provision for federal income taxes 3.2% 3.4% 1.4%
----- ----- -----
Net income 8.0% 8.6% 4.1%
===== ===== =====
</TABLE>
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The Company develops and markets insurance products primarily
designed for individuals age 65 and over. The Company's principal products
are individual fixed, defined benefit accident and health insurance policies
which consist of nursing home care, home health care, Medicare supplement and
long-term disability insurance. The Company's underwriting practices rely
upon the base of experience which it has developed over twenty years of
providing nursing home care insurance, as well as upon available industry and
actuarial information. As the home health care market has developed, the
Company has encouraged the purchase of both nursing home care and home health
care coverage, and has introduced new life insurance products as well, thus
providing policyholders with enhanced protection while broadening the
Company's policy base. In late 1996, the Company introduced its Personal
Freedom Plan and Assisted Living Plan. Both plans are designed to provide
comprehensive nursing home and home health care coverage. Long-term nursing
home care and home health care policies accounted for approximately 91% of
the Company's total annualized premiums in force as of December 31, 1997 and
approximately 82% of its consolidated revenues for 1997.
The Company and its insurance subsidiaries are subject to the insurance
laws and regulations of each state in which they are licensed to write
insurance. These laws and regulations govern matters such as payment of
dividends, settlement of claims and loss ratios. Premiums charged for insurance
products must be approved by state regulatory authorities. In addition, the
Company and its insurance subsidiaries are required to establish and maintain
reserves with respect to reported and incurred but not reported losses, as well
as estimated future benefits payable under the Company's insurance policies.
These reserves must, at a minimum, comply with mandated standards.
The Company's results of operations are affected significantly by the
following factors:
Level of required reserves for policies in force. The amount of reserves
relating to reported and unreported claims incurred is determined by
periodically evaluating historical claims experience and statistical information
with respect to the probable number and nature of such claims. Claim reserves
reflect actual experience through the most recent time period and policy
reserves reflect expectations of claims related to a block of business over its
entire life. The Company compares actual experience with estimates and adjusts
its reserves on the basis of such comparisons. Revisions to reserves are
reflected in the Company's results of operations through benefits to
policyholders expense.
Policy premium levels. The Company attempts to set premium levels to ensure
profitability, subject to the constraints of competitive market conditions and
state regulatory approvals.
Deferred acquisition costs. In connection with the sale of its insurance
policies, the Company defers and amortizes a portion of the policy acquisition
costs over the related premium paying periods of the life of the policy. These
costs include all expenses directly related to the acquisition of the policy,
including commissions, underwriting and other policy issue expenses. The
amortization of deferred acquisition costs is determined using the same
projected actuarial assumptions used in computing policy reserves. Deferred
acquisition costs can be affected by unanticipated termination of policies
because, upon such unanticipated termination, the Company is required to expense
fully the deferred acquisition costs associated with the terminated policy.
The number of years a policy has been in effect. Claims costs tend to be higher
on policies which have been in force for a longer period of time. As the policy
ages, it is more likely that the insured will have need for services covered by
the policy. However, the longer the policy is in effect, the more premium the
Company will receive.
Investment income. The Company's investment portfolio consists primarily of
high-grade fixed income securities. Income generated from this portfolio is
largely dependent upon prevailing levels of interest rates. Due to the longevity
of the Company's investment portfolio duration (approximately 4 years),
investment interest income does not immediately reflect changes in market
interest rates. However, the Company is susceptible to changes in market rates
when cash flows from maturing investments are reinvested at prevailing market
rates. As of December 31,
26
<PAGE>
1997, approximately 7.8% of the Company's invested assets were committed to high
quality large capitalization common stocks. During March, 1998, the Company sold
its entire equity securities portfolio, or approximately $21,000,000 of invested
assets. From this sale, the Company recognized an approximate $6,500,000 capital
gain, which will be included in its first quarter 1998 results.
Other factors which affect the Company's results of operations are
lapsation and persistency, both of which relate to the renewal of insurance
policies, and first year compared to renewal premiums. Lapsation is the
termination of a policy by nonrenewal and, pursuant to the Company's policy, is
automatic if and when premiums become more than 31 days overdue; however,
policies may be reinstated, if approved by the Company, within six months after
the policy lapses. Persistency represents the percentage of premiums renewed,
which the Company calculates by dividing the total annual premiums at the end of
each year (less first year business for that year) by the total annual premiums
in force for the prior year. For purposes of this calculation, a decrease in
total annual premiums in force at the end of any year would be a result of
non-renewal of policies, including those policies that have terminated by reason
of death, lapse due to nonpayment of premiums, and/or conversion to other
policies offered by the Company. First year premiums are premiums covering the
first twelve months a policy is in force. Renewal premiums are premiums covering
all subsequent periods.
27
<PAGE>
Results of Operations
Quarterly Data
The unaudited quarterly data for the Company for each quarter of 1996
and 1997 have been derived from unaudited financial statements and include all
adjustments, consisting only of normal recurring accruals, which the Company
considers necessary for a fair presentation of the results of operations for
these periods. Such quarterly operating results are not necessarily indicative
of the Company's future results of operations.
The following table presents unaudited quarterly data for the Company
for each quarter of 1996 and 1997.
<TABLE>
<CAPTION>
1996
--------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share data and ratios)
<S> <C> <C> <C> <C>
Accident and health premiums $ 29,524 $ 31,344 $ 31,511 $ 34,279
Life premiums 946 866 874 848
Total premiums 30,470 32,210 32,385 35,127
Investment income, net 2,386 2,505 2,602 3,489
Net realized capital gains and losses and
other income 137 137 88 0
Total revenues 32,993 34,853 35,075 38,616
Benefits to policyholders 19,787 21,832 20,161 22,213
Commissions & expenses 13,493 14,171 14,509 16,780
Net policy acquisition costs deferred (4,170) (5,303) (4,054) (5,516)
Net income $ 2,693 $ 2,883 $ 3,098 $ 3,487
Net income per share (basic) $ 0.39 $ 0.41 $ 0.43 $ 0.46
GAAP loss ratio 64.9% 67.8% 62.3% 63.2%
GAAP expense ratio 30.7 27.6 32.4 33.5
Total 95.6% 95.4% 94.7% 96.7%
</TABLE>
<TABLE>
<CAPTION>
1997
--------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share data and ratios)
<S> <C> <C> <C> <C>
Accident and health premiums $ 38,816 $ 40,081 $ 41,533 $ 43,712
Life premiums 894 981 908 756
Total premiums 39,710 41,062 42,441 44,468
Investment income, net 3,893 4,103 4,585 4,428
Net realized capital gains and losses and
other income 128.8 212 900 593.3
Total revenues 43,732 45,377 47,926 49,489
Benefits to policyholders 25,303 31,556 29,510 37,495
Commissions & expenses 17,874 18,624 19,491 19,865
Net policy acquisition costs deferred (5,492) (11,282) (8,187) (3,333)
Net income $ 3,448 $ 3,730 $ 4,173 ($ 3,749)
Net income per share (basic) $ 0.46 $ 0.50 $ 0.55 -$0.50
GAAP loss ratio 63.7% 76.8% 69.5% 84.3%
GAAP expense ratio 34.2 20.8 29.4 39.9
Total 97.9% 97.6% 98.9% 124.2%
</TABLE>
28
<PAGE>
Twelve Months Ended December 31, 1997 and 1996
Accident and Health Premiums. First year accident and health premiums earned by
the Company, excluding the contribution of ANIC, in the twelve month period
ended December 31, 1997, increased 22.8% to $54,135,630, compared to $44,071,649
in 1996. First year long-term care premiums in 1997 increased 21.3% to
$52,747,317, compared to $43,478,707 in 1996. The Company attributes its growth
to continued improvements in product offerings, which competitively meet the
needs of the long term care marketplace. In addition, the Company actively
recruits and trains agents to sell its products. Management believes that it is
no longer relevant to measure separate growth for nursing home and home health
care policies given the Company's sale of comprehensive coverage plans and plans
with attached riders. First year Medicare supplement premiums earned by the
Company in 1997 increased to $1,388,313 from $592,083 in 1996. The Company
uses Medicare supplement products as a marketing tool to compliment its other
long-term care offerings.
Renewal accident and health premiums earned by the Company in 1997
increased 28.5% to $103,184,695, compared to $80,311,319 in 1996. Renewal
long-term care premiums in 1997 increased 29.5% to $100,673,867, compared to
$77,734,271 in 1996. This increase reflects higher persistency and growth of
in-force premiums. Renewal Medicare supplement premiums earned by the Company in
1997 decreased 2.6% to $2,510,828, compared to $2,577,048 in 1996. This trend is
consistent with the Company's decision not to actively pursue Medicare
supplement business.
In addition, ANIC, which the Company acquired on August 30, 1996,
generated accident and health premiums, comprised primarily of long-term
disability coverage, of $6,821,784 during 1997, up from $2,274,442 recognized in
1996. Due to the accounting of the ANIC acquisition as a purchase, only four
months of 1996 income and expense were recognized by the Company.
Life Premiums. First year life premiums earned by the Company decreased 27.5% to
$1,055,873, in 1997, compared to $1,457,044 in 1996. The Company's life business
has remained stable as the Company is focusing its marketing efforts on its
long-term care products. Renewal life premiums in 1997 increased to $2,482,542,
compared to $2,077,325 in 1996. This increase was primarily the result of
renewals of first-year policies written in 1996.
Net Investment Income. Net investment income earned by the Company for 1997
increased 54.9% to $17,008,955 from $10,982,131 for 1996. This increase was
primarily the result of growth in the Company's investment assets due to
continued premium growth, and additional funds of approximately $72,000,000
obtained from the issuance of convertible debt late in 1996. The Company
recognized $1,416,659, of capital gains in 1997 due primarily to its desire
to bolster investment earnings, which are reduced by the Company's
investments in equity securities. Fixed income levels are lower from
dividends received rather than interest from bonds. During March 1998, the
Company sold its entire equity securities portfolio, or approximately
$21,000,000 of invested assets. From this sale, the Company recognized an
approximate $6,5000,000 capital gain, which is reportable in the first
quarter of 1998.
Benefits to Policyholders. Benefits to policyholders in 1997 increased 47.5%
to $123,865,143, compared to $83,993,132 in 1996, including ANIC expenses of
$2,846,272. Accident and health benefits to policyholders in 1997 increased
45.3% to $118,942,408 compared to $81,860,045 in 1996. The Company's accident
and health loss ratio was 75.6% in 1997, compared to 64.9% in 1996. The
increase in the Company's loss ratio is attributable in part to the impact of
improved persistancy upon the reserves held for future anticipated losses. In
addition, the Company added approximately $12,000,000 to this reserve as a
result of its reassessment of assumptions utilized in the actuarial
determination of reserves for current claims liabilities and incurred but
unreported liabilities for nursing home and home health care claims. The
Company reviewed the assumptions underlying its reserves in connection with
its recent employment of a new long-term care consulting actuary. The review
encompassed certain actuarial assumptions related to the Company's products'
benefit utilization and duration. During 1997, expenses for care management
services of approximately $1,041,000 were classified as benefits to
policyholders. The Company utilizes care management services in order to
attempt to reduce overall claims expense. In 1996, the Company included
approximately $450,000 of care management expenses as general and
administrative expenses. Had this expense been classified as benefits to
policyholders during 1996, the total 1996 loss ratio would have increased by
.35% of premiums to 64.9%. The ANIC loss ratio was 41.7% in 1997 and 47.4% in
1996.
29
<PAGE>
Life benefits to policyholders, including paid claims and reserve
increases, in 1997 decreased to $2,076,463, compared to $2,133,087 for 1996.
The life loss ratio was 58.7% in 1997, compared to 60.4% in 1996.
Commissions. Commissions to agents increased 27.6% to $55,240,438 in 1997
compared to $43,305,148 in 1996. Included are ANIC commissions on long-term
disability policies, which generated $1,251,476 of expenses in 1997.
First year commissions on accident and health business in 1997,
excluding ANIC, increased 23.9% to $36,240,021, compared to $29,243,102 in
1996, corresponding to the increase in first year accident and health
premiums. The ratio of first year accident and health commissions to first
year accident and health premiums was 66.9% in 1997 and 66.4% in 1996. First
year commissions on life business in 1997 decreased 18.9% to $878,961,
compared to $1,083,892 in 1996, directly reflecting the Company's reduction
in first year life premiums. The ratio of first year life commissions to
first year life premiums was 83.2% in 1997 compared to 74.4% in 1996 due to
an increase in single premium policies sold.
Renewal commissions on accident and health business in 1997 increased
34.7% to $16,580,473, compared to $12,312,521 in 1996, remaining consistent with
the increase in renewal premiums discussed above. The ratio of renewal accident
and health commissions to renewal accident and health premiums was 16.1% in 1997
and 15.4% in 1996. This ratio fluctuates in relation to the age of the policies
in force and the rates of commissions paid to the producing agents.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition
costs in 1997 increased 48.6% to $28,294,358 compared to $19,042,509 in 1996,
primarily due to an increase in policyholder persistency used in the
establishment of deferred acquisition cost reserve factors. The result of
higher persistency incorporated into reserve factors is lengthier
amortization of expenses and reduced net expenses in earlier periods. This
deferral is net of amortization, which decreases or increases as the
Company's actual persistency is higher or lower than the persistency assumed
for reserving purposes. The deferral of policy acquisition costs has remained
consistent with the growth of premiums, and the growth in amortization of
policy acquisition costs has been modified by improved persistency.
General and Administrative Expenses. General and administrative expenses in 1997
increased 31.7% to $20,613,908, compared to $15,647,715 in 1996. ANIC expenses
accounted for $2,317,068 in 1997, which includes the amortization of goodwill
and the present value of future profits. In addition, the Company recognized
approximately $400,000 in non-recurring settlement charges in 1997 due to the
consolidation of certain ANIC operations at the Company headquarters. The
settlement charges stemmed from severance costs, contract terminations and
movement of operations. General and administrative expenses, excluding goodwill
and convertible debt cost amortization, as a percentage of revenues were 11.9%
in 1997, compared to 12.5% in 1996, which is due in part to the inclusion of
approximately $450,000 of care management expenses in general and administrative
expense in 1996 (.39% of premiums). Economies of scale achieved in 1997 were
offset by ANIC consolidation charges and additional actuarial, compliance and
legal fees associated with the duplicate filings of tax qualified plans in many
states.
Net Income. Net income of $7,598,580 (including a contribution of $2,013,569
from ANIC) for 1997 was $4,561,767 or 37.5% below 1996 income of $12,160,347.
Net income includes income tax provisions of $2,695,435 and $4,847,000, for
the 1997 and 1996 periods, respectively. Income before federal income taxes
decreased in 1997 by $6,713,332 or 39.5% to $10,294,015. This decrease was
primarily attributable to the addition of approximately $12,000,000 to the
Company's pending claim reserves as discussed in "Benefits to Policyholders."
The Company made a 1997 provision for federal income taxes of $2,695,435
reflecting an effective rate of 26.2%, as compared to an effective 1996 tax
rate of 28.5%.
30
<PAGE>
Twelve Months Ended December 31, 1996 and 1995
Accident and Health Premiums. First year accident and health premiums earned by
the Company, excluding the contribution of ANIC, in the twelve month period
ended December 31, 1996, increased 19.9% to $44,071,649, compared to $36,769,835
in 1995. First year long-term care premiums in 1996 increased 19.1% to
$43,478,707, compared to $36,507,436 in 1995. This increase was primarily
attributable to increased sales of home health care policies, which increased to
$19,866,692 for 1996 from $14,560,437 for 1995. Premiums from sales of nursing
home care policies increased from $21,946,999 in 1995 to $23,612,015 in 1996.
Management believes that the increase in the sale of home health care policies
reflects the continued growth in the home health care market. Management further
believes that the lower increase in the sale of nursing home policies primarily
resulted from nursing home policies increasingly being sold as riders to home
care policies as opposed to separate stand-alone policies. First year Medicare
supplement premiums earned by the Company in 1996 increased to $592,083 from
$262,399 in 1995. The Company places reduced emphasis upon this product due to
reduced profitability caused by regulation.
Renewal accident and health premiums earned by the Company in 1996
increased 28.7% to $80,311,319, compared to $62,402,068 in 1995. Renewal
long-term care premiums in 1996 increased 30.4% to $77,734,271, compared to
$59,624,488 in 1995. This increase reflects higher persistency and growth of
in-force premiums. Renewal Medicare supplement premiums earned by the Company in
1996 decreased 7.2% to $2,577,048, compared to $2,777,580 in 1995. This trend is
consistent with the Company's decision not to actively pursue Medicare
supplement business.
In addition, ANIC, which the Company acquired on August 30, 1996,
generated accident and health premiums, comprised primarily of long-term
disability coverage, of $2,274,442 during 1996.
Life Premiums. First year life premiums earned by the Company decreased 14.3% to
$1,457,044, in 1996, compared to $1,700,549 in 1995. The Company's life business
has remained stable as the Company is focusing its marketing efforts on its
Independent Living policy and its other long-term care products. Renewal life
premiums in 1996 increased to $2,077,325, compared to $1,494,153 in 1995. This
increase was primarily the result of renewals of first-year policies written in
1995.
In order to enhance the marketability of certain products, the Company
has recently emphasized offering new policyholders a monthly premium payment
plan. The Company believes that the lower monthly payment is more attractive
than the historical larger annual premium payment and that offering the monthly
payment option enables it to sell more policies. However, because the Company
records premiums when due, and a higher percentage of new policy holders opted
for the monthly payment option in 1996 compared with 1995, management believes
that it has experienced a delay in premium recognition of approximately
$5,000,000 throughout 1996.
Net Investment Income. Net investment income earned by the Company for 1996
increased 35.5% to $10,982,131 from $8,102,809 for 1995. This increase was
primarily the result of growth in the Company's investment assets due to
continued premium growth, additional funds of approximately $22,000,000 from the
Company's public offering in July 1995, and additional funds of approximately
$72,000,000 obtained from the issuance of convertible debt late in 1996.
Benefits to Policyholders. Benefits to policyholders in 1996 increased 29.5% to
$83,993,132, including ANIC expenses of $1,078,073, compared to $64,879,275 in
1995. Accident and health benefits to policyholders in 1996 increased 29.6% to
$81,860,045 compared to $63,175,068 in 1995. The Company's accident and health
loss ratio was 64.9% in 1996, compared to 63.7% in 1995. This increase in loss
ratio was due, in part, to the increase in premium and policies of the Company's
Independent Living policy which is reserved for at a higher rate, and also to
improved persistency. In addition, management believes that claims were reported
more quickly throughout 1996 due to the Company's offer to waive a policy
elimination period if the insured agreed to utilize a Care Manager. See
"Business-Claims." Management believes that this acceleration of reported claims
was completely recognized by the end of 1996. During 1996, expenses for care
management services of approximately $450,000 were classified as general and
administrative expenses. The Company utilizes care management services in order
to reduce overall
31
<PAGE>
claims expense. Had this expense been classified as Benefits to Policyholders,
the total 1996 loss ratio would have increased by .35% of premiums to 64.9%
compared to 63.4% in 1995.
Life benefits to policyholders in 1996 increased to $2,133,087,
compared to $1,704,207 for 1995. The life loss ratio was 60.4% in 1996, compared
to 53.3% in 1995. This increase relates to the maturing of the life products
that the Company first introduced in 1993.
Commissions. Commissions to agents increased 19.1% to $43,305,148 in 1996
compared to $36,351,140 in 1995. Included are ANIC commissions on long-term
disability policies, which generated $445,084 of expenses in 1996.
For the Company, excluding ANIC, first year commissions on accident and
health business in 1996 increased 17.4% to $29,243,102, compared to $24,897,878
in 1995, corresponding to the increase in first year accident and health
premiums. The ratio of first year accident and health commissions to first year
accident and health premiums was 66.4% in 1996 and 67.7% in 1995. First year
commissions on life business in 1996 decreased 18.2% to $1,083,892, compared to
$1,325,521 in 1995, directly reflecting the Company's reduction in first year
life premiums. The ratio of first year life commissions to first year life
premiums was 74.4% in 1996 compared to 78.0% in 1995.
Renewal commissions on accident and health business in 1996 increased
23.6% to $12,312,521, compared to $9,964,110 in 1995, remaining consistent with
the increase in renewal premiums discussed above. The ratio of renewal accident
and health commissions to renewal accident and health premiums was 15.4% in 1996
and 16.0% in 1995. This ratio fluctuates in relation to the age of the policies
in force and the rates of commissions paid to the producing agents.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs
in 1996 increased 24.4% to $19,042,509 compared to $15,303,161 in 1995,
consistent with the growth of the Company's business. This deferral is net of
amortization, which decreases or increases as the Company's actual persistency
is higher or lower than the persistency assumed for reserving purposes. The
deferral of policy acquisition costs has remained consistent with the growth of
premiums, and the growth in amortization of policy acquisition costs has been
modified by improved persistency.
General and Administrative Expenses. General and administrative expenses in 1996
increased 28.6% to $15,647,715, compared to $12,170,913 in 1995. ANIC expenses
accounted for $928,385 in 1996, which includes the amortization of goodwill and
the present value of future profits. Without the ANIC increase in expenses,
general and administrative costs would have increased 20.9%. This amount also
includes an additional $450,000 of care management charges, which will be
reported as policyholder benefits in subsequent years. General and
administrative expenses as a percentage of revenues were 11.1% in 1996, compared
to 11.0% in 1995, which is due to the additional costs of ANIC and care
management.
Net Income. Net income of $12,160,347 (including a contribution of $299,354 from
ANIC) for 1996 was $3,331,464 or 37.7% above 1995 income of $8,828,883. Net
income includes income tax provisions of $4,847,000 and $3,609,000, for 1996 and
1995 period, respectively. Income before federal income taxes increased in 1996
by $4,569,464 or 36.7% to $17,007,347. This increase was primarily attributable
to the continuing growth of premiums earned. The Company made a 1996 provision
for federal income taxes of 4,847,000 or 28.5%, as compared to an effective 1995
tax provision rate of 29.0%.
32
<PAGE>
New Accounting Principles
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 128, "Earnings per Share"
("SFAS 128"). SFAS 128 establishes standards for computing and presenting
earnings per share, and simplifies the standards for computing earnings per
share previously found in Accounting Principles Board Opinion No. 15, "Earnings
per Share." SFAS 128 prescribes that for all financial statements with effective
dates after December 31, 1997, primary and fully diluted earnings per share will
be replaced with basic and diluted earnings per share, and these amounts are
required to be shown on the face of the income statement. Prior year per share
amounts must also be restated if applicable. Basic earnings per share for 1995
and 1996 are unaffected by this change, however, diluted earnings per share are
reported for 1995, which was not previously reported. Also, diluted earnings per
share for 1996 is increased $.02 from previously reported fully diluted earnings
per share due to the use of the average market price of Company shares in
utilizing the treasury stock methodology to account for the dilutive nature of
outstanding stock options.
SFAS 128, however, prescribes that if the components of diluted
earnings per share are anti-dilutive, then diluted earnings per share will not
differ from basic earnings per share. In 1997, the Company reported basic and
diluted earnings per share of $1.01 and $.98, respectively. Since the exclusion
of the impact of interest expense from the Company's convertible debt would be
anti-dilutive, the future anticipated conversion of the debt into additional
shares is not included in the calculation of diluted earnings per share. The
Company anticipates that approximately 2,600,000 additional shares will be
issued in the future for the conversion of debt. However, the Company also
expects that approximately $3,550,000 of annual after-tax interest expense due
to this convertible debt would be excluded from the diluted earnings per share
calculation.
The FASB recently issued Statement 130, "Reporting Comprehensive
Income," which requires that changes in comprehensive income be shown in a
financial statement that is displayed with the same prominence as other
financial statements. While not mandating a specific financial statement format,
Statement 130 requires that an amount representing total comprehensive income be
reported for fiscal years beginning after December 15, 1997.
33
<PAGE>
Restatement for earlier years is required for comparative purposes. The Company
anticipates no material effect on its financial condition or results of
operations due to the adoption of Statement 130.
The FASB also issued Statement 131, "Disclosures about Segments of an
Enterprise and Related Information." This Statement, which supersedes Statement
14, Financial Reporting for Segments of a Business Enterprise, changes the way
public companies report information about segments. The Statement, which is
based on the management approach to segment reporting, includes requirements to
report selected segment information quarterly and entity-wide disclosures about
products and services, major customers, and the material countries in which the
entity holds assets and reports revenues. The Statement is effective for periods
beginning after December 15, 1997. Restatement for earlier years is required for
comparative purposes unless impracticable. Statement 131 need not be applied to
interim periods in the initial year; however, in subsequent years, interim
period information must be presented on a comparative basis. The Company
believes that the adoption of Statement 131 will not have a material impact on
its financial condition or results of operations.
In 1998, the FASB issued Statement 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits," which revises employers disclosures
about pension and other postretirement benefits. The Company expects that the
adoption of Statement 132 will have no material impact on its financial
condition or results of operations.
Statement of Position 97-3, "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments" (SOP 97-3) was issued by the
American Institute of Certified Public Accountants in December 1997 and provides
guidance for determining when an insurance or other enterprise should recognize
a liability for guaranty-fund assessments and guidance for measuring the
liability. The statement is effective for 1999 financial statements with early
adoption permitted. The Company does not expect adoption of this statement to
have a material effect on its financial position or results of operations.
Impact of the Year 2000 on Information Systems.
Many computer systems are reliant upon a two-digit field in determining
the year for software applications involving dates. This use of a two-digit
field presents difficulty for computers and application programs in
differentiating between the year 1900 and 2000. The Company is in process of
replacing its computer application systems with new systems which are year 2000
compliant. The Company is also changing its current systems to a four digit date
field to avoid any potential year 2000 problems prior to its conversion to new
systems. The Company does not expect that year 2000 compliance will have a
material impact on its financial condition or results of operations.
Non-compliance could have an adverse effect on the operations of the Company.
Liquidity and Capital Resources
The Company's consolidated liquidity requirements have historically
been created and met from the operations of its insurance subsidiaries. The
Company's primary sources of cash are premiums, investment income and
maturities of investments. The Company has provided, and may continue to
provide, cash through public offerings of its common stock, capital markets
activities or debt instruments. The primary uses of cash are policy acquisition
costs (principally commissions), payments to policyholders, investment purchases
and general and administrative expenses.
Statutory requirements allow insurers to pay dividends only from
statutory earnings as approved by the state insurance commissioner. Statutory
earnings are generally lower than publicly-reported earnings due to the
immediate or accelerated recognition of all costs associated with premium growth
and benefit reserves. The Company has not and does not intend to pay shareholder
dividends in the near future due to these requirements, choosing to retain
statutory surplus to support continued premium growth. See "Dividend Policy" and
"Business-Government Regulation."
34
<PAGE>
The Company's cash flows are attributable to cash provided by
operations, cash used in investing, and cash provided by financing. The
Company's cash decreased by approximately $40,000,000 in 1997 primarily due
to the purchase of approximately $134,000,000 in bonds, which more than
offset cash from operations and approximately $44,000,000 in proceeds from
the sale of bonds. The major provider of cash from operations was additions
to reserves of approximately $59,000,000 in 1997.
Cash increased in 1996 by approximately $43,000,000, which was
primarily due to approximately $72,000,000 in proceeds from the Company's
convertible debt issuance. This increase, coupled with approximately $31,000,000
provided by operations, was more than sufficient to provide for approximately
$93,000,000 of bond and equity purchases in 1996.
Cash increased in 1995 by approximately $2,000,000, primarily due to
approximately $26,000,000 provided by the Company's common stock offering. These
funds and cash from operations of approximately $24,000,000 were used to
purchase approximately $54,000,000 in bonds.
The Company invests in securities and other investments authorized by
applicable state laws and regulations and follows an investment policy designed
to maximize yield to the extent consistent with liquidity requirements and
preservation of assets. At December 31, 1997, the average maturity of the
Company's bond portfolio was 5.8 years, and its market value represented
approximately 102.5% of its cost, with a current unrealized gain of $6,832,967.
Its equity portfolio exceeded cost by $5,042,112 at December 31, 1997. The
Company's equity portfolio exceeded cost by $1,604,604 in 1996 and $503,083 in
1995. On December 31, 1996, the average maturity of the Company's bond portfolio
was 5.3 years, and its market value exceeded its cost by approximately
$1,821,387 or .9% of its cost. On December 31, 1995, the average maturity of the
Company's portfolio was 6.4 years and its market value exceeded cost by 4.1% or
approximately $5,643,000.
In July 1995, the Company consummated a public offering of 2,300,000
shares of common stock, from which it realized net proceeds of approximately
$22,000,000, including the proceeds from the exercise of the underwriters'
over-allotment option.
As of December 31, 1997, shareholders' equity was increased by
$7,837,550 due to unrealized gains of $11,875,079 in the investment portfolio.
As of December 31, 1996, shareholders' equity was increased by $2,261,154 due to
unrealized gains of $3,425,991 in the investment portfolio. As of December 31,
1995, shareholders' equity was increased by $4,055,788 due to unrealized gains
of $6,145,649 in the investment portfolio.
The Company's debt currently consists primarily of a mortgage note in
the approximate amount of $2,000,000 and $74,750,000 in convertible subordinated
debt. The convertible debt, issued in November 1996, is convertible at $28.44
per share until November 2003. The debt carries a fixed interest coupon of
6.25%, payable semi-annually. The mortgage note is currently amortized over 12
years, and has a balloon payment due on the remaining outstanding balance in
September 1998. Although the note carries a variable interest rate, the Company
has entered into an amortizing swap agreement with the same bank, with a
notional amount equal to the outstanding debt, which has the effect of
converting the note to a fixed rate of interest.
The capital position of PTLIC and PTNA was improved by the contribution
of $14,000,000 of the net proceeds of the public offering in 1995 to the capital
and surplus of PTLIC and PTNA during the third quarter of 1995. In November
1996, the Company contributed an additional $5,000,000 of the net proceeds of
the public offering in July 1995 to PTNA. In December, 1996, the Company
contributed $20,000,000, $20,000,000, and $5,000,000 to the surplus of PTLIC,
PTNA and ANIC, respectively, from the proceeds of the convertible subordinated
debt. The remaining funds were retained at the parent level in order to service
the future interest payments on the debt. The Company believes that its
insurance subsidiaries' capital and surplus presently meet or exceed the
requirements in all jurisdictions in which they are licensed.
The Company consists of the Insurers and a non-insurer parent company,
Penn Treaty American Corporation ("the Parent"). The Parent directly or
indirectly controls 100% of the voting stock of the
35
<PAGE>
subsidiary insurers. In the event the Parent is unable to meet its financial
obligations, becomes insolvent, or discontinues operations, the Insurers'
financial condition and results of operations could be materially affected.
The Parent currently has the obligation of making semi-annual interest
payments attributable to the Company's convertible debt. In that the dividend
ability of the subsidiaries is restricted, the Parent must rely on its own
liquidity and cash flows to make all required interest installments. Management
believes that the Parent holds sufficient liquid funds to meet its obligations
for the foreseeable future.
The Company's continued growth is dependent upon its ability to (i)
continue marketing efforts to expand its historical markets, (ii) continue to
expand its network of agents and effectively market its products in states where
its insurance subsidiaries are currently licensed and (iii) fund such marketing
and expansion while at the same time maintaining minimum statutory levels of
capital and surplus required to support such growth. Management believes that
the funds necessary to accomplish the foregoing, including funds required to
maintain adequate levels of statutory surplus in the Company's insurance
subsidiaries can be met for the foreseeable future by funds generated from its
most recent stock offering, the Company's issuance of convertible subordinated
debt and from operations.
In the event (i) the Company fails to maintain minimum loss ratios
calculated in accordance with statutory guidelines, (ii) the Company fails to
meet other requirements mandated and enforced by regulatory authorities, (iii)
the Company has adverse claims experience in the future, (iv) the Company is
unable to obtain additional financing to support future growth, or (v) the
economy continues to effect the buying powers of senior citizens, the Company's
results of operations, liquidity and capital resources could be adversely
affected.
SOME OF THE INFORMATION PRESENTED IN THIS FILING CONSTITUTE FORWARD
LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SEUCRITIES LITIGATION
REFORM ACT OF 1995. ALTHOUGH THE COMPANY BELEIVES THAT ITS EXPECTATIONS ARE
BASED ON REASONABLE ASSUMPTIONS WITHIN THE BOUNDS OF ITS KNOWLEDGE OF ITS
BUSINESS AND OPERATIONS, THERE CAN BE NO ASSURANCE THAT ACTUAL RESULTS OF
THE COMPANY'S OPERATIONS WILL NOT DIFFER MATERIALLY FROM ITS EXPECTATIONS.
FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER FROM EXPECTATIONS INCLUDE,
AMONG OTHERS, THE ADEQUACY OF THE COMPANY'S LOSS RESERVES, THE COMPANY'S
ABILITY TO QUALIFY NEW INSURANCE PRODUCTS, THE COMPANY'S ABILITY TO COMPLY
WITH GOVERNMENT REGULATIONS, THE ABILITY OF SENIOR CITIZENS TO PURCHASE THE
COMPANY'S PRODUCTS IN LIGHT OF THE INCREASING COSTS OF HEALTH CARE AND THE
COMPANY'S ABILITY TO EXPAND ITS NETWORK OF PRODUCTIVE INDEPENDENT AGENTS.
36 <PAGE>
Item 7A. Quantatative and Qualitative Disclosures Amount Market Risks
Not applicable.
Item 8. Financial Statements and Supplementary Data
37
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Pages
-----
Report of Independent Accountants F-2
Financial Statements:
Consolidated Balance Sheets as of December 31,
1997 and 1996 F-3
Consolidated Statements of Operations for the
years ended December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Changes in Shareholders'
Equity for the years ended December 31, 1997,
1996 and 1995 F-5
Consolidated Statements of Cash Flows for the
years ended December 31, 1997, 1996 and 1995 F-6
Notes to Consolidated Financial Statements F-7-F-24
F-1
<PAGE>
Report of Independent Accountants
To the Board of Directors of Penn Treaty American Corporation
Allentown, Pennsylvania
We have audited the accompanying consolidated balance sheets of Penn Treaty
American Corporation and Subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Penn Treaty
American Corporation and Subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 11, 1998
F-2
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
as of December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
ASSETS
Investments:
Bonds, available for sale at market,
(amortized cost $271,315,125 and
$199,508,579, respectively) $ 278,148,092 $ 201,329,966
Equity securities at market value, (cost of
$18,511,470 and $9,642,912, respectively) 23,553,582 11,247,516
Policy loans 84,757 84,232
------------- -------------
Total investments 301,786,431 212,661,714
Cash and cash equivalents 11,240,925 51,612,067
Property and equipment, at cost, less accumulated depreciation of
$2,399,107 and $2,205,407, respectively 8,752,509 8,092,028
Unamortized deferred policy acquisition costs 110,470,626 82,176,268
Receivables from agents, less allowance for
uncollectable amounts of $130,000 and $231,000, respectively 1,106,908 1,543,382
Accrued investment income 4,112,114 3,581,077
Federal income tax recoverable 1,181,709 175,219
Cost in excess of fair value of net assets acquired, less
accumulated amortization of $715,913 and $389,203, respectively 6,661,630 6,042,786
Present value of future profits acquired 3,596,667 4,011,668
Receivable from reinsurers 10,542,275 10,105,654
Other assets 6,318,292 6,766,129
------------- -------------
Total assets $ 465,770,086 $ 386,767,992
============= =============
LIABILITIES
Policy reserves:
Accident and health $ 139,962,685 $ 101,119,912
Life 8,116,565 8,523,267
Policy and contract claims 78,141,574 57,539,380
Accounts payable and other liabilities 6,192,353 4,768,441
Long-term debt 76,752,063 77,114,592
Deferred income taxes 23,849,502 18,795,316
------------- -------------
Total liabilities 333,014,742 267,860,908
------------- -------------
Commitments and contingencies (Note 10)
SHAREHOLDERS' EQUITY
Preferred stock, par value $1.00; 5,000,000 -- --
shares authorized, none outstanding
Common stock, par value $.10; 25,000,000 and 10,000,000
shares authorized, 8,177,529 and 8,116,464 shares issued 817,752 811,646
Additional paid-in capital 53,194,134 52,526,956
Net unrealized appreciation of securities 7,837,550 2,261,154
Retained earnings 72,611,782 65,013,202
------------- -------------
134,461,218 120,612,958
Less 605,629 common shares held in treasury, at cost (1,705,874) (1,705,874)
------------- -------------
132,755,344 118,907,084
------------- -------------
Total liabilities and shareholders' equity $ 465,770,086 $ 386,767,992
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
for the years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Revenue:
Accident and health premiums $ 164,142,109 $ 126,657,410 $ 99,171,903
Life premiums 3,538,415 3,534,369 3,194,702
------------- ------------- -------------
167,680,524 130,191,779 102,366,605
Net investment income 17,008,955 10,982,131 8,102,809
Net realized capital gains 1,416,659 19,960 46,431
Other income 416,935 342,388 347,113
------------- ------------- -------------
186,523,073 141,536,258 110,862,958
Benefits and expenses:
Benefits to policyholders 123,865,143 83,993,132 64,879,275
Commissions 55,240,438 43,305,148 36,351,140
Net policy acquisition costs deferred (28,294,358) (19,042,509) (15,303,161)
General and administrative expenses 20,613,908 15,647,715 12,170,913
Interest expense 4,803,927 625,425 326,908
------------- ------------- -------------
176,229,058 124,528,911 98,425,075
------------- ------------- -------------
Income before federal income taxes 10,294,015 17,007,347 12,437,883
Provision for federal income taxes 2,695,435 4,847,000 3,609,000
------------- ------------- -------------
Net Income $ 7,598,580 $ 12,160,347 $ 8,828,883
=====================================================
Basic earnings per share $ 1.01 $ 1.70 $ 1.53
Diluted earnings per share $ 0.98 $ 1.66 $ 1.51
Weighted average number of shares outstanding 7,540,354 7,164,782 5,771,558
Weighted average number of shares outstanding
(Diluted) 7,757,936 7,528,071 5,841,901
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Unrealized
Appreciation
(Depreciation)
Common Stock Additional Net of Total
----------------------- Paid-In Deferred Retained Treasury Shareholders'
Shares Amount Capital Taxes Earnings Stock Equity
------ ------ ------- ----- -------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 5,276,913 $ 527,691 $ 15,311,594 $ (2,713,842) $44,023,972 $(1,705,874) $ 55,443,541
Net income 8,828,883 8,828,883
Proceeds from public offering 2,300,000 230,000 25,835,000 26,065,000
Change in net unrealized
loss on investments 6,769,630 6,769,630
--------------------------------------------------------------------------------------------------
Balance, December 31, 1995 7,576,913 757,691 41,146,594 4,055,788 52,852,855 (1,705,874) 97,107,054
Net income 12,160,347 12,160,347
Shares issued for the acquisi-
tion of Health Insurance
of Vermont 472,644 47,264 10,823,553 10,870,817
Change in net unrealized
gains on investments (1,794,634) (1,794,634)
Exercised options proceeds 66,907 6,691 556,809 563,500
--------------------------------------------------------------------------------------------------
Balance, December 31, 1996 8,116,464 811,646 52,526,956 2,261,154 65,013,202 (1,705,874) 118,907,084
Net income 7,598,580 7,598,580
Change in net unrealized
gains on investments 5,576,396 5,576,396
Exercised options proceeds 61,065 6,106 667,178 673,284
--------------------------------------------------------------------------------------------------
Balance, December 31, 1997 8,177,529 $ 817,752 $ 53,194,134 $ 7,837,550 $72,611,782 $(1,705,874) $132,755,344
==================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net cash flow from operating activities:
Net income $ 7,598,580 $ 12,160,347 $ 8,828,883
Adjustments to reconcile net income to cash
provided by operations:
Amortization of intangible assets 693,164 325,987 35,760
Deferred income taxes 2,181,497 3,095,000 2,726,032
Depreciation expense 467,848 375,092 353,589
Net realized capital (gains) losses (1,416,659) (19,960) (46,431)
Increase (decrease) due to change in:
Receivables from agents 436,474 (267,901) (126,917)
Receivable from reinsurers (436,621) (904,238) (1,205,581)
Policy acquisition costs, net (28,294,358) (19,042,509) (15,303,161)
Policy and contract claims 20,602,194 6,885,661 8,862,180
Policy reserves 38,436,071 29,844,074 20,097,887
Accounts payable and other liabilities 1,423,912 1,207,846 543,209
Federal income tax recoverable (1,006,490) (175,219) 481,799
Federal income tax payable -- (183,249) 183,249
Accrued investment income (531,037) (963,477) (808,701)
Other, net (458,610) (1,070,083) (512,600)
------------- ------------- -------------
Cash provided by operations 39,695,965 31,267,371 24,109,197
Cash flow from (used in) investing activities:
Acquisition of business, net of cash received -- (1,218,204) --
Proceeds from sales of bonds 44,080,109 16,684,028 5,356,956
Proceeds from sales of equity securities 3,436,251 303,560 --
Maturities of investments 18,862,880 18,571,559 5,421,112
Purchase of bonds (134,198,812) (85,092,419) (53,912,071)
Purchase of equity securities (11,429,961) (7,953,520) --
Acquisition of property and equipment (1,128,329) (2,110,844) (1,219,810)
------------- ------------- -------------
Cash used in investing (80,377,862) (60,815,840) (44,353,813)
Cash flow from (used in) financing activities:
Proceeds from stock offering -- -- 26,065,000
Proceeds from convertible debt offering -- 72,207,500 --
Proceeds from excercise of stock options 673,284 563,500 --
Repayments of long-term debt (362,529) (491,525) (4,166,092)
------------- ------------- -------------
Cash provided by financing 310,755 72,279,475 21,898,908
------------- ------------- -------------
(Decrease) increase in cash and cash equivalents (40,371,142) 42,731,006 1,654,292
Cash balances:
Beginning of period 51,612,067 8,881,061 7,226,769
------------- ------------- -------------
End of period $ 11,240,925 $ 51,612,067 $ 8,881,061
=====================================================
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 4,795,321 $ 161,102 $ 327,205
Cash paid during the year for federal income taxes $ 1,200,000 $ 2,109,955 $ 217,920
Non-cash investing activities:
Common stock issued for business acquisition $ -- $ 10,870,815 $ --
Purchase of block of renewal commission through installment note $ -- $ 650,000 $ --
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies:
Basis of Presentation:
The accompanying consolidated financial statements of Penn Treaty
American Corporation and its Subsidiaries (the Company) have been
prepared in accordance with generally accepted accounting principles
(GAAP) and include Penn Treaty Life Insurance Company (PTLIC), Penn
Treaty Network America Insurance Company (Network America), American
Network Insurance Company (ANIC) and Senior Financial Consultants
Company. All significant intercompany transactions and balances have
been eliminated in consolidation. Certain prior year amounts have been
reclassified to conform with the current year presentation.
In 1997, the Company incorporated a new subsidiary, American
Independent Network Insurance Company of New York (AINIC), which it
intends to license as an insurer in 1998.
On December 31, 1997, PTLIC entered an assumption reinsurance treaty
with Network America (formerly Network America Life Insurance Company),
whereby Network America effectively purchased all of the premium
in-force, assets and liabilities of PTLIC. Network America
simultaneously changed its name to Penn Treaty Network America
Insurance Company (PTNA). The Company has also filed with the Internal
Revenue Service requesting a favorable ruling regarding the tax-free
nature of the dividending of PTLIC common stock ownership of PTNA to
the Company. Upon acceptance of a favorable ruling, PTNA will become a
direct subsidiary of the Company, and will no longer be a direct
subsidiary of PTLIC.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
liabilities and the reported amounts of revenues and expenses. Actual
results could differ from those estimates.
The Company is subject to interest rate risk to the extent its
investment portfolio cash flows are not matched to its insurance
liabilities. Management believes it manages this risk through modeling
of the cash flows under reasonable scenarios.
Nature of Operations:
The Company sells accident and health, life and disability insurance
through its wholly-owned subsidiaries. The Company's principal lines of
business are long-term care products and home health care products. The
Company distributes its products principally through managing general
agents and independent agents. The Company operates its home office in
Allentown, Pennsylvania and has satellite offices in California,
Florida and Vermont, whose principal functions are to market and
underwrite new business. State regulatory authorities have powers
relating to granting and revoking licenses to transact business, the
licensing of agents, the regulation of premium rates and trade
practices, the form and content of insurance policies, the content of
advertising material, financial statements and the nature of permitted
practices. The Company is licensed to operate in 49 states. Sales in
Florida, Pennsylvania, and California accounted for approximately
26%, 15% and 14%, respectively, of the Company's premiums for the year
ended December 31, 1997. No other state sales accounted for more than
10% of the Company's premiums for the year ended December 31, 1997.
F-7
<PAGE>
Investments:
The Company accounts for its investments according to the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" ("SFAS No. 115").
SFAS No. 115 requires all entities to allocate their investments among
three categories as applicable: (1) trading, (2) available for sale,
and (3) held to maturity. Management categorized all of its investment
securities as available for sale since they may be sold in response to
changes in interest rates, prepayments, and similar factors.
Investments in this classification are reported at the current market
value with net unrealized gains or losses, net of the applicable
deferred income tax effect, being added to or deducted from the
Company's total shareholders' equity on the balance sheet.
As of December 31, 1996, shareholders' equity was increased by
approximately $2,261,000 due to net unrealized gains of approximately
$3,426,000 in the investment portfolio. As of December 31, 1997
shareholders' equity was increased by approximately $7,838,000 due to
net unrealized gains of approximately $11,875,000.
Realized investment gains and losses, including provisions for market
declines considered to be other than temporary, are included in income.
Gains and losses on sales of investment securities are computed on the
specific identification method.
Policy loans are stated at the aggregate unpaid principal balance.
Unamortized Deferred Policy Acquisition Costs:
The costs primarily related to and varying with the acquisition of new
business, principally commissions, underwriting and policy issue
expenses, have been deferred. These deferred costs are amortized over
the related premium-paying periods utilizing the same projected premium
assumptions used in computing reserves for future policy benefits. Net
policy acquisition costs deferred, on the consolidated statements of
operations, are net of amortization of $11,977,144, $13,678,181, and
$11,720,966 for the years ended December 31, 1997, 1996, and 1995,
respectively.
Property and Equipment:
Property and equipment are stated at cost, less accumulated
depreciation and amortization. Expenditures for improvements which
materially increase the estimated useful life of the asset are
capitalized. Expenditures for repairs and maintenance are charged to
operations as incurred. Depreciation is provided principally on a
straight-line basis over the related asset's estimated life. Upon sale
or retirement, the cost of the asset and the related accumulated
depreciation are removed from the accounts and the resulting gain or
loss, if any, is included in operations.
Cash and Cash Equivalents:
Cash and cash equivalents include highly liquid debt instruments
purchased with a maturity of three months or less.
Cost in Excess of Fair Value of Net Assets Acquired:
The costs in excess of fair value of net assets acquired (goodwill) for
acquisitions made under purchase accounting methods are being amortized
to expense on a straight-line basis over a 10 to 40-year range.
F-8
<PAGE>
Present Value of Future Profits Acquired:
The present value of future profits of ANIC's acquired business is
being amortized over the life of the insurance business acquired.
During 1997 and 1996, approximately $415,000 and $138,000 was amortized
to expense, respectively.
Other Assets:
Other assets consist primarily of due and unpaid insurance premiums and
unamortized debt offering costs.
Income Taxes:
Deferred income taxes relate principally to temporary differences in
reporting policy acquisition costs and policy reserves for financial
statement and income tax purposes. Deferred income tax assets and
liabilities have been recorded for temporary differences between the
reported amounts of assets and liabilities in the accompanying
financial statements and those in the Company's income tax return.
Premium Recognition:
Premiums on accident and health insurance, the majority of which is
guaranteed renewable, and life insurance are recognized when due.
Estimates of premiums due but not yet collected are accrued.
Policy Reserves and Policy and Contract Claims:
The Company establishes liabilities to reflect the impact of level
renewal premiums and the increasing risks of claims losses as
policyholders age.
The present value of estimated future policy benefits to be paid to or
on behalf of policyholders less the present value of estimated future
net premiums to be collected from policyholders is accrued when premium
revenue is recognized. Those estimates are based on assumptions, such
as estimates of expected investment yield, mortality, morbidity,
withdrawals and expenses, applicable at the time insurance contracts
are made, including a provision for the risk of adverse deviation.
These reserves differ from policy and contract claims, which are
recognized when insured events occur.
Policy and contract claims include amounts representing: (1) an
estimate, based upon prior experience, for accident and health claims
reported, and incurred but unreported losses; (2) the actual in force
amounts for reported life claims and an estimate of incurred but
unreported claims. The methods for making such estimates and
establishing the resulting liabilities are continually reviewed and
updated and any adjustments resulting therefrom are reflected in
earnings currently.
The establishment of appropriate reserves is an inherently uncertain
process, and there can be no assurance that the ultimate liability will
not materially exceed the Company's claim and policy reserves and have
a material adverse effect on the Company's results of operations and
financial condition. Due to the inherent uncertainty of estimating
reserves, it has been necessary, and may over time continue to be
necessary, to revise estimated future liabilities as reflected in the
Company's policy reserves and policy and contract claims.
F-9
<PAGE>
In late 1994, the Company began marketing its Independent Living
policy, a home health care insurance product which provides coverage
over the full term of the policy for services furnished by a homemaker
or companion who is not a qualified or licensed care provider. In
late 1996, the Company began marketing its Personal Freedom policy, a
comprehensive nursing home and home health care product, and its
Assisted Living policy, a revised nursing home with attached home
health care rider policy. Because of the Company's relatively limited
claims experience with these products, the Company may incur higher
than expected loss ratios and may be required to adjust further its
reserve levels with respect to these products.
The Company discounts all policy and contract claims which involve
fixed periodic payments extending beyond one year. This is consistent
with the method allowed for statutory reporting, the long duration
of claims, and industry practice for long-term care policies. Benefits
are payable over periods ranging from six months to five years, and
are also available for lifetime coverage. These liabilites are
discounted using an assumed rate of 6.75% for 1997, 7% for 1996, 6%
for 1995, 1994, 1993 and 1992 claims and 8% for claims in 1991 and
prior.
New Accounting Principles:
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 128, "Earnings
per Share" ("SFAS 128"). SFAS 128 establishes standards for computing
and presenting earnings per share, and simplifies the standards for
computing earnings per share previously found in Accounting Principles
Board Opinion No. 15, "Earnings per Share." SFAS 128 prescribes that
for all financial statements with effective dates after December 31,
1997, primary and fully diluted earnings per share will be replaced
with basic and diluted earnings per share, and these amounts are
required to be shown on the face of the income statement. Prior year
per share amounts must also be restated if applicable. Basic earnings
per share for 1995 and 1996 are unaffected by this change, however,
diluted earnings per share are reported for 1995, which was not
previously reported. Also, diluted earnings per share for 1996 is
increased $.02 from previously reported fully diluted earnings per
share due to the use of the average market price of Company shares in
utilizing the treasury stock methodology to account for the dilutive
nature of outstanding stock options.
A reconciliation of the numerator and denominator of the basic earnings
per share computation to the numerator and denominator of the diluted
earnings per share computation follows. Basic earnings per share
excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock.
<TABLE>
<CAPTION>
For the Periods Ended December 31,
-------------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net income $7,598,580 $12,160,347 $8,828,883
Weighted average common shares outstanding 7,540,354 7,164,782 5,771,558
Basic earnings per share $1.01 $1.70 $1.53
=================================================
Net income $7,598,580 $12,160,347 $8,828,883
Adjustments net of tax:
Interest expense on convertible debt - 320,314 -
Amortization of debt offering costs - 22,964 -
-------------------------------------------------
Diluted net income $7,598,580 $12,503,625 $8,828,883
=================================================
Weighted average common shares outstanding 7,540,354 7,164,782 5,771,558
Common stock equivalents due to dilutive
effect of stock options 217,582 144,261 70,343
Shares converted from convertible debt - 219,028 -
-------------------------------------------------
Total outstanding shares for fully diluted earnings
per share computation 7,757,936 7,528,071 5,841,901
Diluted earnings per share $0.98 $1.66 $1.51
=================================================
</TABLE>
F-10
<PAGE>
SFAS 128, however, prescribes that if the components of diluted
earnings per share are anti-dilutive, then diluted earnings per share
will not differ from basic earnings per share. In 1997, the Company
reported basic and diluted earnings per share of $1.01 and $.98,
respectively. Since the exclusion of the impact of interest expense
from the Company's convertible debt would be anti-dilutive, the future
anticipated conversion of the debt into additional shares is not
included in the calculation of diluted earnings per share. The Company
anticipates that approximately 2,600,000 additional shares will be
issued in the future for the conversion of debt. However, the Company
also expects that approximately $3,550,000 of annual after-tax interest
expense due to this convertible debt would be excluded from the diluted
earnings per share calculation.
The FASB recently issued Statement 130, "Reporting Comprehensive
Income," which requires that changes in comprehensive income be shown
in a financial statement that is displayed with the same prominence as
other financial statements. While not mandating a specific financial
statement format, Statement 130 requires that an amount representing
total comprehensive income be reported for fiscal years beginning after
December 15, 1997. Restatement for earlier years is required for
comparative purposes. The Company anticipates no material effect on its
financial condition or results of operations due to the adoption of
Statement 130.
The FASB also issued Statement 131, "Disclosures about Segments of an
Enterprise and Related Information." This Statement, which supersedes
Statement 14, Financial Reporting for Segments of a Business
Enterprise, changes the way public companies report information about
segments. The Statement, which is based on the management approach to
segment reporting, includes requirements to report selected segment
information quarterly and entity-wide disclosures about products and
services, major customers, and the material countries in which the
entity holds assets and reports revenues. The Statement is effective
for periods beginning after December 15, 1997. Restatement for earlier
years is required for comparative purposes unless impracticable.
Statement 131 need not be applied to interim periods in the initial
year; however, in subsequent years, interim period information must be
presented on a comparative basis. The Company believes that the
adoption of Statement 131 will not have a material impact on its
financial condition or results of operations.
In 1998, the FASB issued Statement 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits," which revises employers
disclosures about pension and other postretirement benefits. The
Company expects that the adoption of Statement 132 will have no
material impact on its financial condition or results of operations.
Statement of Position 97-3, "Accounting by Insurance and Other
Enterprises for Insurance- Related Assessments" (SOP 97-3) was issued
by the American Institute of Certified Public Accountants in December
1997 and provides guidance for determining when an insurance or other
enterprise should recognize a liability for guaranty-fund assessments
and guidance for measuring the liability. The statement is effective
for 1999 financial statements with early adoption permitted. The
Company does not expect adoption of this statement to have a material
effect on its financial position or results of operations.
2. Acquisitions of Businesses
On August 30, 1996, the Company acquired ANIC. Pursuant to the merger,
ANIC shareholders received stock consideration consisting of 472,644
shares of the Company's common stock and
F-11
<PAGE>
cash consideration of $2,200,380. Using the market value of the
Company's common stock at the date of closing, the value of the shares
of Company common stock issued on the merger was $10,870,817. For 1997
and the four-month period ended December 31, 1996, ANIC generated
premiums of $6,821,784 and $2,274,442, respectively, and net income of
$2,828,413 and $299,354, respectively. The acquisition was accounted
for as a purchase.
In connection with this purchase, the Company recognized goodwill in
the amount of $5,298,134, which is being amortized, straight-line, over
a 25 year period. The operating results of ANIC have been included in
the consolidated statement of income from the date of acquisition.
Consolidated pro forma net income and earnings per share would not have
been materially different from the reported amounts for fiscal 1996 and
1995.
On January 29, 1996, the Company acquired the rights to all renewal
commissions on a block of in-force policies and sub-agent contracts
from a marketing general agent. This agreement includes insurance
policies of PTLIC and other unaffiliated insurance companies. The cost
of the acquisition was $650,000. The Company recognized $280,290 and
$251,108 of commission income in 1997 and 1996, respectively, from this
acquisition.
3. Investments and Financial Instruments:
The Company's bond investment portfolio is comprised primarily of
investment grade securities at December 31, 1997. Securities are
classified as "investment grade" by utilizing ratings furnished by
independent bond rating agencies.
The amortized cost and estimated market value of investments in debt
securities as of December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
December 31, 1997
------------------------------------------------------------------------
Amortized Gross Unrealized Gross Unrealized Estimated
Cost Gains Losses Market Value
---- ----- ------ ------------
<S> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of U.S
Government authorities
and agencies $163,276,895 $4,669,734 ($90,220) $167,856,409
Obligations of states and
political sub-divisions 30,514,705 1,637,627 0 32,152,332
Debt securities issued by
foreign governments 204,552 448 (77) 204,923
Corporate securities 77,318,973 872,019 (256,564) 77,934,428
------------------------------------------------------------------------
$271,315,125 $7,179,828 ($346,861) $278,148,092
========================================================================
<CAPTION>
December 31, 1996
------------------------------------------------------------------------
Amortized Gross Unrealized Gross Unrealized Estimated
Cost Gains Losses Market Value
---- ----- ------ ------------
<S> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of U.S
Government authorities
and agencies $149,354,655 $2,116,948 ($1,275,588) $150,196,015
Obligations of states and
political sub-divisions 30,460,952 1,076,049 0 31,537,001
Debt securities issued by
foreign governments 424,275 21,725 (750) 445,250
Corporate securities 19,068,114 61,013 (169,427) 18,959,700
Other debt securities 200,583 0 (8,583) 192,000
------------------------------------------------------------------------
$199,508,579 $3,275,735 ($1,454,348) $201,329,966
========================================================================
</TABLE>
F-12
<PAGE>
The amortized cost and estimated market value of debt securities at
December 31, 1997 by contractual maturity, are shown below. Expected
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
Amortized Estimated
Cost Market Value
---- ------------
<S> <C> <C>
Due in one year or less $9,250,256 $9,294,500
Due after one year through five years 99,187,482 99,781,548
Due after five years through ten years 128,161,921 133,334,241
Due after ten years 34,715,466 35,737,803
------------- --------------
$271,315,125 $278,148,092
============= ==============
</TABLE>
Gross proceeds and realized gains and losses on the sales of debt
securities, excluding calls, were as follows:
<TABLE>
<CAPTION>
Gross Gross
Realized Realized
Proceeds Gains Losses
-------- ----- ------
<S> <C> <C> <C>
1997 $44,080,109 $ 787,356 $ 256,475
1996 $16,684,028 $ 145,371 $ 15,834
1995 $ 5,356,956 $ 53,648 $ 7,500
</TABLE>
Gross proceeds and realized gains and losses on the sales of equity
securities were as follows:
<TABLE>
<CAPTION>
Gross Gross
Realized Realized
Proceeds Gains Losses
-------- ----- ------
<S> <C> <C> <C>
1997 $ 3,436,251 $ 963,714 $ 88,869
1996 $ 303,560 $ 11,178 $ 122,157
1995 $ -- $ -- $ --
</TABLE>
Gross unrealized gains (losses) pertaining to equity securities
were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Original Realized Realized Market
Cost Gains Losses Value
----------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
1997 $18,511,470 $5,361,106 $(318,994) $ 23,553,582
1996 9,642,912 1,171,865 (113,261) 11,247,516
1995 2,102,529 561,509 (58,426) 2,605,612
</TABLE>
Net investment income is applicable to the following investments:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Bonds $16,025,290 $10,262,611 $7,756,571
Equity securities 339,577 92,358 27,920
Cash and short-term investments 946,044 796,319 480,274
---------------------------------------
Investment income 17,310,911 11,151,288 8,264,765
Investment expense (301,956) (169,157) (161,956)
---------------------------------------
Net investment income $17,008,955 $10,982,131 $8,102,809
=======================================
</TABLE>
Pursuant to certain statutory licensing requirements, as of December
31, 1997, the Company had on deposit bonds aggregating $8,043,843 in
insurance department safekeeping accounts. The Company is not permitted
to remove the bonds from these accounts without approval of the
regulatory authority.
F-13
<PAGE>
4. Policy Reserves and Claims:
Policy reserves have been computed principally by the net level
premium method based upon estimated future investment yield,
mortality, morbidity, withdrawals and other benefits. The composition
of the policy reserves at December 31, 1997 and 1996 and the
assumptions pertinent thereto are presented below:
<TABLE>
<CAPTION>
Amount of Policy Reserves
as of December 31,
1997 1996
---- ----
<S> <C> <C>
Accident and health $139,962,685 $101,119,912
Annuities and other 140,999 339,910
Ordinary life, individual 7,975,566 8,183,357
<CAPTION>
Years of Issue Discount Rate
-------------- -------------
<S> <C> <C>
Accident and health 1976 to 1986 7.0%
1987 7.5%
1988 to 1991 8.0%
1992 to 1995 6.0%
1996 7.0%
1997 6.8%
Annuities and other 1977 to 1983 6.5% & 7.0%
Ordinary life, individual 1962 to 1997 3.0% to 5.5%
Basis of Assumption
Accident and health Morbidity and withdrawals based
on actual and projected
experience.
Annuities and other Primarily funds on deposit
inclusive of accrued interest.
Ordinary life, individual Mortality based on 1955-60
Intercompany Mortality Table
Combined Select and Ultimate.
</TABLE>
Policy and contract claims include approximately $65,143,000 and
$45,300,000 at December 31, 1997 and 1996, respectively, that are
discounted at varying interest rates. The amount of discount was
$4,101,000 and $3,618,000 at December 31, 1997 and 1996, respectively.
Total reserves, including policy and contract claims, reported to
statutory authorities were approximately $7,652,000 and $3,510,000 less
than those recorded for GAAP as of December 31, 1997 and 1996,
respectively.
F-14
<PAGE>
Activity in policy and contract claims is summarized as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Balance at January 1 $57,539,380 $50,206,608
Less reinsurance recoverables 1,277,942 1,576,207
----------- -----------
Net balance at January 1 56,261,438 48,630,401
Incurred related to:
Current year 70,520,327 52,128,679
Prior years 14,433,152 3,099,034
----------- -----------
Total incurred 84,953,479 55,227,713
Paid related to:
Current year 22,194,682 15,894,011
Prior years 43,528,989 32,149,776
----------- -----------
Total paid 65,723,671 48,043,787
Reserves purchased from ANIC -- 447,111
Net balance at December 31 75,491,246 56,261,438
Plus reinsurance recoverables 2,650,328 1,277,942
----------- -----------
Balance at December 31 $78,141,574 $57,539,380
============================
</TABLE>
The amounts related to prior years' incurral of claims reflects the
accretion of interest due to the discounting of pending claim reserves
as well as adjustments to reflect actual versus estimated claims
experience. In 1997, the Company added to claim reserves as a result of
its reassessment of assumptions utilized in the actuarial determination
of reserves for current claims liabilities and incurred but unreported
liabilities for nursing home and home health care claims. The Company
reviewed the assumptions underlying its reserves in connection with its
recent employment of a new long-term care consulting actuary. The
review encompassed certain actuarial assumptions related to the
Company's products' benefit utilization and duration.
F-15
<PAGE>
5. Long-Term Debt:
Long-term debt, at December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Convertible, subordinated debt issued in November 1996, with
semi-annual coupon of 6.25% annual percentage rate.
Debt is callable after December 2, 1999 at declining redemption
values and matures in 2003. Prior to maturity, the debt is
convertible to shares of the Company's common stock at
$28.44. $74,750,000 $74,750,000
Mortgage loan with interest rate fixed for two years at 7.3%
effective September 1996, which repriced from 6.6% in 1995.
Although carrying a variable rate, the loan has an effective
fixed rate due to an offsetting swap with the same institution.
Current monthly payment of $20,103 based on a twelve year
amortization schedule with a balloon payment due September 14,
1998; collateralized by property with depreciated cost of
$2,559,888 and $2,630,429 as of December 31, 1997 and 1996,
respectively. 1,839,563 1,951,176
Installment note for purchase of block of renewal
commissions in January 1996, payable over two
years with interest accrued at 7%. 162,500 325,000
Capital lease 0 88,416
----------- -----------
$76,752,063 $77,114,592
=========== ===========
</TABLE>
Maturities of mortgage and other debt are as follows:
<TABLE>
<S> <C>
1998 $ 2,002,063
1999 --
2000 --
2001 --
2002 --
Thereafter 74,750,000
----------
$76,752,063
===========
</TABLE>
F-16
<PAGE>
6. Federal Income Taxes:
The provision for Federal income taxes for the years ended December 31
consisted of:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current $ 513,938 $1,752,000 $ 882,968
Deferred 2,181,497 3,095,000 2,726,032
--------- --------- ---------
$2,695,435 $4,847,000 $3,609,000
========== ========== ==========
</TABLE>
Deferred income tax assets and liabilities have been recorded for
temporary differences, between the reported amounts of assets and
liabilities in the accompanying financial statements and those in the
Company's income tax return. Management believes the existing net
deductible temporary differences are realizable on a more likely than
not basis. The sources of these differences and the approximate tax
effect are as follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Net operating loss carryforward $ 2,658,493 $ --
Policy reserves 8,044,121 4,690,679
Alternative minimum tax carryforward 39,901 599,000
------------- ------------
Total deferred tax assets $ 10,742,515 $ 5,289,679
============= ============
Deferred policy acquisition costs $ (28,141,592) $(20,677,263)
Present value of future profits acquired (1,222,867) (1,344,700)
Premiums due and unpaid (952,032) (829,600)
Other (238,000) (68,595)
Unrealized appreciation on investments (4,037,526) (1,164,837)
------------- ------------
Total deferred income taxes $ (34,592,017) $(24,084,995)
============= ============
Net deferred income tax asset (liability) $ (23,849,502) $(18,795,316)
============= ============
</TABLE>
The Company has net operation loss carry-forwards of approximately
$7,8000,000, which, if unused, will expire in 2012. A reconciliation
of the income tax provision computed using the Federal income tax rate
of 34% to income before Federal income taxes is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Computed Federal income tax (benefit)
provision at statutory rate $3,499,965 $5,782,000 $4,289,000
Small life insurance company
deduction (0) (560,000) (577,000)
Tax-exempt interest income (500,988) (478,000) (431,000)
Other (303,542) 103,000 328,000
---------- ---------- ----------
$2,695,435 $4,847,000 $3,609,000
========== ========== ==========
</TABLE>
At December 31, 1997, the accumulated earnings of the Company for
Federal income tax purposes included $1,452,589 of "Policyholders'
Surplus", a special memorandum tax account. This memorandum account
balance has not been currently taxed, but income taxes computed at
then-current rates will become payable if surplus is distributed.
Provisions of the Deficit Reduction Act of 1984 (the "Act") do not
permit further additions to the "Policyholders' Surplus" account.
"Shareholders' Surplus" represents an accumulation of taxable income
(net of tax thereon) plus the dividends received deduction, tax-exempt
interest, and certain other special deductions as provided by the Act.
At December 31, 1997, the combined balance in the "Shareholders'
Surplus" account amounted to approximately $25,771,000. There is no
present intention to make distributions in excess of "Shareholders'
Surplus."
F-17
<PAGE>
7. Regulatory Restrictions:
The Company's insurance subsidiaries (PTLIC, PTNA, and ANIC) are
required by insurance laws and regulations to maintain minimum capital
and surplus. At December 31, 1997 and 1996, the subsidiaries' capital
and surplus exceeded the minimum required capital and surplus in all
states in which they are licensed to conduct business.
Under Pennsylvania and Vermont insurance law, dividends may be paid
from PTLIC, PTNA or ANIC only from statutory profits of earned surplus
and require Insurance Department approval if the dividend is in excess
of the greater of 10% of surplus or net statutory income of the prior
year. No dividendes have been declared or paid in 1997, 1996, or 1995.
Net income and capital and surplus as reported in accordance with
statutory accounting principles for the Company's insurance
subsidiaries are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net income (loss) $(10,287,275) $(4,512,941) $839,491
Capital and surplus $73,399,828 $81,794,728 $32,291,981
</TABLE>
The National Association of Insurance Commissioners (NAIC) has
established risk-based capital standards that life and health insurers
and reinsurers must meet. In concept, risk-based capital standards are
designed to measure the acceptable amount of capital an insurer should
have based on the inherent and specific risks of each insurer. Insurers
failing to meet their benchmark capital level may be subject to
scrutiny by the insurer's domiciled insurance department and,
ultimately, rehabilitation or liquidation. Based on the NAIC's
currently adopted standards, the Company has capital and surplus in
excess of the required levels. The differences in statutory net income
compared to GAAP are primarily due to the immediate expensing of
acquisition costs, reserving methodologies, and deferred income taxes.
Due to these differences, under statutory accounting there is a net
loss and decrease in surplus, called surplus strain, in years of high
growth. The surplus needed to sustain growth must be raised externally
or from profits from existing business. In 1995, the Company received
permission to include $3,287,501 of this surplus strain, related to a
new required valuation method, as a charge to surplus.
8. Pension Plan and 401(k) Plan:
Until August 1, 1996, the Company maintained a defined contribution
pension plan covering substantially all employees. The Company
contributed 3% of each eligible employee's annual covered payroll to
the plan. All contributions were subject to limitations imposed by the
Internal Revenue Code on retirement plans and Section 401(k) plans.
Upon the termination of the plan on August 1, 1996, each participant
became fully vested. A prorata portion of the 1996 scheduled
contribution was put into the plan upon termination. Expense for this
pension plan was $30,000 and $55,000 for the years ended December 31,
1996 and 1995, respectively.
On August 1, 1996, the Company adopted a 401(k) retirement plan,
covering substantially all employees with one year of service. Under
the plan, participating employees may contribute up to
F-18
<PAGE>
15% of their annual salary on a pre-tax basis. The Company, under the
plan, equally matches employee contributions up to the first three
percent of the employee's salary. The Company and employee portion of
the plan is vested immediately. The Company expense related to this
401(k) plan was $93,152 and $36,000 for the years ended December 31,
1997 and 1996, respectively. The Company may elect to make a
discretionary contribution to the plan, which will be contributed
proportionately to each eligible employee. The Company did not make a
discretionary contribution in 1997 or 1996.
ANIC maintained a defined benefit pension plan for all ANIC employees
in 1996. This plan was subsequently terminated in 1997, with all
eligible employees joining the Company's 401(k) plan. There was no 1997
or 1996 contribution expense for this plan. Upon the termination of the
plan, the Company completed an actuarial review of its liability to
plan participants. As a result of this review, the Company recognized
approximately $125,000 of reduced expense in 1997 due to the
overaccrual of its liability upon the purchase of ANIC in 1996.
9. Stock Option Plans:
At December 31, 1997, the Company has two stock-based compensation
plans which are described below. The Company has adopted the
disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, ("SFAS No. 123"), and applies APB Opinion No. 25
"Accounting for Stock Issued to Employees" and related Interpretations
in accounting for its plans. Accordingly, no compensation cost has been
recognized for its fixed stock option plans. Had compensation cost for
the Company's two stock-based compensation plans been determined based
on the fair value at the grant dates for awards under those plans
consistent with the method of SFAS No. 123, the Company's net income
and earnings per share would have been reduced to the pro forma amounts
indicated below. The effects of applying the SFAS No. 123 proforma
disclosure are not indicative of future amounts.
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net Income As reported $7,598,580 $12,160,347 $8,828,883
Proforma $7,407,061 $12,075,410 $8,815,305
Basic Earnings Per Share As reported $1.01 $1.70 $1.53
Proforma $0.98 $1.69 $1.53
Diluted Earnings Per Share As reported $0.98 $1.66 $1.51
Proforma $0.95 $1.65 $1.51
</TABLE>
Compensation cost is estimated using the Black-Scholes model with the
following assumptions for 1995, 1996 and 1997: an expected life ranging
from 5.3 to 8.3 years, volatility of 27.9% for 1995 and 1996 and 26.4%
for 1997 and a risk free rate ranging from 5.71% to 6.35%. The weighted
average fair value of those options granted in 1995, 1996 and 1997 was
$4.98, $8.21 and $12.11, respectively. No compensation expense is
calculated for those options granted prior to 1995.
The Company has an Incentive Stock Option Plan which provides for the
granting of options to purchase up to 1,200,000 shares of common stock.
The exercise price of all options granted under
F-19
<PAGE>
the plan may not be less than the fair market value of the shares on
the date of grant (110% of fair market value in the case of any person
who holds more than 10% of the combined voting power of all classes of
outstanding stock). The maximum allowable term of each option is ten
years (five years in the case of holders of more than 10% of the
combined voting power of all classes of outstanding stock), and the
options become exercisable in four equal, annual installments
commencing one year from the option grant date.
Effective May, 1995, the Company adopted a Participating Agent Stock
Option Plan which provides for the granting of options to purchase up
to 300,000 shares of common stock. The exercise price of all options
granted under the plan may not be less than the fair market value of
the shares on the date of grant. The maximum allowable term of each
option is ten years, and the options become exercisable in four equal,
annual installments commencing one year from the option grant date.
The following is a summary of the Company's option activity, including
grants, exercises, forfeitures and average price information:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------- ----------------------------- ----------------------------
Exercise Exercise Exercise
Price Price Price
Options Per Option Options Per Option Options Per Option
-------------------------- ----------------------------- ----------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 510,108 14.84 396,015 10.88 229,914 9.52
Granted 124,850 32.61 184,800 21.03 166,100 14.13
Exercised 61,065 11.03 66,907 8.61 0 --
Canceled 0 -- 3,800 12.38 0 --
-------------- --------------- ----------------
Outstanding at end of year 573,893 19.11 510,108 14.84 396,015 10.88
============== =============== ================
Exercisable at end of year 218,118 12.63 200,540 10.45 197,929 9.79
============== =============== ================
</TABLE>
<TABLE>
<CAPTION>
Outstanding Remaining Exercisable
at December Contractual at December
Range of Exercise Prices 31, 1997 Life (Yrs) 31, 1997
-----------------------------------------------
<S> <C> <C> <C>
5.50 2,630 1 2,630
8.71 5,265 3 5,265
8.92 27,140 5 27,140
9.81 44,850 5 44,850
11.17 15,767 4 15,767
12.28 26,340 4 26,340
12.38 85,626 8 39,503
12.63 15,350 8 7,300
13.61 48,000 8 13,715
20.50 131,575 9 28,750
22.55 48,000 9 6,858
32.25 94,350 10 0
35.48 29,000 10 0
--------------- ----------------
573,893 218,118
=============== ================
</TABLE>
10. Commitments and Contingencies:
F-20
<PAGE>
Operating Lease Commitments:
The total net rental expenses under all leases amounted to
approximately $202,000, $174,000 and $142,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
During May 1987, the Company assigned its rights and interests in a
land lease to a third party for $175,000. The agreement indemnifies the
Company against any further liability with respect to future lease
payments. The Company remains contingently liable to the lessor under
the original deed of lease for rental payments of $16,080 per year, the
amount being adjustable based upon changes in the consumer price index
since 1987, through the year 2063.
Line of Credit:
In June 1997, the Company was given an unsecured, uncommitted line of
credit from a bank for up to $3,000,000, which was unused during 1997.
The line of credit is renewable annually, carries no origination or
carrying fees, and if used, will carry a variable rate of interest
equal to the London Interbank Offering Rate (LIBOR) plus .75% annually
on the outstanding balance.
Litigation:
The Company is a defendant in various lawsuits arising in the ordinary
course of business. In the opinion of management, the resolution of
these lawsuits will not have a significant effect on the financial
condition or results of operations of the Company.
11. Reinsurance:
PTLIC and PTNA are parties to reinsurance agreements to cede 100% of
benefits exceeding 36 months on certain home health care policies.
Total reserve credits taken related to this agreement as of December
31, 1997 and 1996 were approximately $2,912,000 and $859,000,
respectively. Effective January 1, 1998, no new business is reinsured
under this facility.
The Company currently reinsures with unaffiliated companies any life
insurance policy to the extent the risk on that policy exceeds $50,000.
Effective January, 1994, PTLIC and PTNA entered reinsurance agreements
to cede 100% of certain life, accident and health and Medicare
supplement insurance to a third party insurer. Total reserve credits
taken related to this agreement as of December 31, 1997 and 1996 were
approximately $569,000 and $530,000, respectively.
PTNA is party to a Reinsurance Agreement to cede 100% of certain whole
life and deferred annuity policies to be issued by PTNA to a third
party insurer. These policies are intended for the funeral arrangement
or "pre-need" market. Total reserve credits taken related to this
agreement as of December 31, 1997 and 1996 were approximately
$3,427,000 and $3,862,000, respectively. The third party reinsurer
maintains securities at least equal to the statutory reserve credit in
escrow with a bank. Effective January 1, 1996, this Agreement was
modified, and as a result, no new business is reinsured under this
facility.
PTNA is party to a coinsurance agreement on a previously acquired block
of long-term care business whereby 66% is ceded to a third party. At
December 31, 1997 and 1996, reserve credits taken related to this
treaty were approximately $1,947,000 and $1,615,000, respectively.
ANIC reinsures approximately $500,000 of its risk with three reinsuring
companies, all of which are authorized to do business in the State of
Vermont.
F-21
<PAGE>
The Company has assumed and ceded reinsurance on certain life and
accident and health contracts under various agreements. The tables
below highlight the amounts shown in the accompanying consolidated
statements of operations which are net of reinsurance activity:
<TABLE>
<CAPTION>
Assumed
Gross Ceded to from Other Net
Amount Other Companies Companies Amount
------ --------------- --------- ------
<S> <C> <C> <C> <C>
December 31, 1997
Ordinary Life Insurance
In-Force $65,964,000 $16,636,000 $0 $49,328,000
Premiums:
Accident and health 167,187,289 3,545,845 500,665 164,142,109
Life 4,044,650 506,235 0 3,538,415
Benefits to Policyholders:
Accident and health 86,828,400 2,769,750 258,029 84,316,679
Life 1,790,296 522,694 0 1,267,602
Inc (dec) in Policy Reserves:
Accident and health 37,743,083 260,451 (10,632) 37,472,000
Life (406,702) (1,215,563) 0 808,861
Commissions $56,193,489 $1,028,152 $75,100 $55,240,437
December 31, 1996
Ordinary Life Insurance
In-Force $66,932,000 $18,004,000 $0 $48,928,000
Premiums:
Accident and health 130,551,727 4,438,137 543,820 126,657,410
Life 4,146,768 612,399 0 3,534,369
Benefits to Policyholders:
Accident and health 54,823,330 1,169,942 419,457 54,072,845
Life 1,631,715 476,847 0 1,154,868
Inc (dec) in Policy Reserves:
Accident and health 28,567,856 763,605 (17,051) 27,787,200
Life 1,404,419 426,200 0 978,219
Commissions $44,770,782 $1,547,207 $81,573 $43,305,148
December 31, 1995
Ordinary Life Insurance
In-Force $63,653,000 $19,977,000 $0 $43,676,000
Premiums:
Accident and health 101,103,823 2,512,930 581,010 99,171,903
Life 4,815,878 1,621,176 0 3,194,702
Benefits to Policyholders:
Accident and health 46,073,992 1,542,816 83,631 44,614,807
Life 1,511,812 479,588 0 1,032,224
Inc (dec) in Policy Reserves:
Accident and health 18,569,195 (3,107) (12,041) 18,560,261
Life 1,257,267 585,284 0 671,983
Commissions $37,542,304 $1,278,316 $87,152 $36,351,140
</TABLE>
The Company remains contingently liable in the event that the
reinsuring companies are unable to meet their obligations.
12. Transactions with Related Parties:
F-22
<PAGE>
Irv Levit Insurance Management Corporation ("IMC"), an insurance agency
which is owned by the President of the Company, produced approximately
$50,000, $55,000, and $62,000 of new and renewal premiums for PTLIC,
for the years ended December 31, 1997, 1996 and 1995, respectively, for
which it received commissions of approximately $13,000, $12,000 and
$14,000, respectively.
IMC also received commission overrides on business written for PTLIC by
certain agents, principally general agents who were IMC agents prior to
January 1979 and any of their sub-agents hired prior and subsequent to
January 1979. For the years ended December 31, 1997, 1996 and 1995, IMC
commission overrides totaled approximately $534,000, $539,000, and
$517,000, respectively.
13. Major Agencies:
A managing general agent accounted for approximately 27%, 21% and 18%
of total premiums in 1997, 1996 and 1995, respectively.
14. Concentrations of Credit Risk:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents and investments. The Company places its cash and cash
equivalents and investments with high quality financial institutions,
and attempts to limit the amount of credit exposure to any one
institution. However, at December 31, 1997, and at other times during
the year, amounts in any one institution exceeded the Federal Deposit
Insurance Corporation limits.
15. Stock Dividend
On April 19, 1995, the Board of Directors of the Company declared a 50%
stock dividend payable to shareholders of record on May 3, 1995. The
dividend was distributed on May 15, 1995. Certain amounts comprising
shareholders' equity in these financial statements, weighted average
shares outstanding and earnings per share have been restated to reflect
this dividend.
16. Fair Value of Financial Instruments
Fair values are based on estimates using present value or other
valuation techniques where quoted market prices are not available.
Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. The
fair value amounts presented do not purport to represent and should not
be considered representative of the underlying value of the Company.
The methods and assumptions used to estimate the fair values of each
class of the financial instruments described below are as follows:
Investments -- The fair value of fixed maturities and equity securities
are based on quoted market prices. It is not practicable to determine
the fair value of policy loans since such loans are not separately
transferable and are often repaid by reductions to benefits and
surrenders.
Cash and cash equivalents -- The statement value approximates fair
value.
F-23
<PAGE>
Long-term debt -- The statement value approximates the fair value of
mortgage debt and capitalized leases, since the instruments carry
interest rates which approximate market value. The convertible,
subordinated debt, as a publicly traded instrument, has a readily
accessible fair market value, and, as such is reported at that value.
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
---------------------------------- ---------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
<S> <C> <C> <C> <C>
Financial assets:
Investments
Bonds, available for sale $278,148,092 $278,148,092 $201,329,966 $201,329,966
Equity securities 23,553,582 23,553,582 11,247,516 11,247,516
Policy loans 84,757 84,757 84,232 84,232
Cash and cash equivalents 11,240,925 11,240,925 51,612,067 51,612,067
Financial liabilities:
Convertible debt $74,750,000 $58,058,252 $74,750,000 $70,518,868
Mortgage and other debt 2,002,063 2,002,063 2,364,592 2,364,592
</TABLE>
F-24
<PAGE>
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENT SCHEDULE
<TABLE>
<CAPTION>
Pages
-----
<S> <C>
Report of Independent Accountants on Schedule S-2
Schedule II -- Condensed Financial Information
of Registrant S-3 - S-5
</TABLE>
S-1
<PAGE>
Report of Independent Accountants
To the Board of Directors of Penn Treaty American Corporation
Allentown, Pennsylvania
Our report on the consolidated financial statements of Penn Treaty American
Corporation and Subsidiaries is included on page F-2 of this Form 10-K. In
connection with our audits of such financial statements, we have also audited
the related financial statement schedule listed in the index on page S-1 of this
Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 11, 1998
S-2
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES (PARENT COMPANY)
Schedule II - Condensed Financial Information of Registrant
Balance Sheets
as of December 31, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
---- ----
<S> <C> <C>
Bonds, available for sale at market (amortized cost
$22,675,585 and $11,399,502, respectively) $ 23,381,984 $ 11,495,000
Equity securities at market (cost $3,098,810 and
$1,004,250, respectively) 3,178,812 994,500
Cash and cash equivalents 962,516 16,375,868
Investment in subsidiaries* 179,262,804 162,699,321
Other assets 4,085,960 4,408,050
------------- -------------
Total assets $ 210,872,076 $ 195,972,739
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Long-term debt $ 74,750,000 $ 74,838,415
Accrued interest payable 389,323 447,988
Accounts payable 242,129 349,223
Deferred income taxes 267,376 29,154
Due to subsidiaries* 2,467,904 1,400,875
------------- -------------
Total liabilities 78,116,732 77,065,655
------------- -------------
Shareholders' equity
Preferred stock, par value $1.00; 5,000,000 shares
authorized, none outstanding -- --
Common stock, par value $.10; 25,000,000 and 10,000,000 shares
authorized, 8,177,529 and 8,116,464 shares
issued, respectively 817,752 811,646
Additional paid-in capital 53,194,134 52,526,956
Unrealized appreciation, net of deferred taxes 7,837,550 2,261,154
Retained earnings 72,611,782 65,013,202
------------- -------------
134,461,218 120,612,958
Less 605,629 of common shares held in treasury, at cost (1,705,874) (1,705,874)
------------- -------------
Total shareholders' equity 132,755,344 118,907,084
------------- -------------
Total liabilities and shareholders' equity $ 210,872,076 $ 195,972,739
============= =============
</TABLE>
* Eliminated in consolidation.
The condensed financial information should be read
in conjunction with the Penn Treaty American Corporation and
Subsidiaries consolidated statements and notes thereto.
S-3
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES (PARENT COMPANY)
Schedule II - Condensed Financial Information of Registrant
Statements of Operations
for the years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Management fees* $ 56,400 $ 56,400 $ 56,400
Investment income 1,817,912 835,714 275,342
General and administrative expense 1,295,638 274,365 410,968
Interest on Convertible Debt 4,671,875 447,988 --
------------ ------------ ------------
Gain (loss) before equity in undistributed net
earnings of subsidiaries* (4,093,201) 169,761 (79,226)
Equity in undistributed net earnings of
subsidiaries* 11,691,781 11,990,586 8,908,109
------------ ------------ ------------
Net income 7,598,580 12,160,347 8,828,883
Retained earnings, beginning of year 65,013,202 52,852,855 44,023,972
------------ ------------ ------------
Retained earnings, end of year $ 72,611,782 $ 65,013,202 $ 52,852,855
============ ============ ============
</TABLE>
*Eliminated in consolidation.
The condensed financial information should be read
in conjunction with the Penn Treaty American Corporation and
Subsidiaries consolidated statements and notes thereto.
S-4
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES (PARENT COMPANY)
Schedule II - Condensed Financial Information of Registrant
Statements of Cash Flows
for the years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net Income $ 7,598,580 $ 12,160,347 $ 8,828,883
Adjustments to reconcile net income to cash
provided by (used in) operations:
Equity in undistributed earnings of subsidiaries (11,691,781) (11,990,586) (8,908,109)
Depreciation and amortization 425,244 113,741 99,528
Net realized (gains) losses (102,815) 5,495 (30,178)
Increase (decrease) due to change in:
Due to/from subsidiaries 1,067,029 440,307 302,568
Other, net 12,636 (2,631,436) (249,338)
------------ ------------ ------------
Net cash provided by (used in) operations (2,691,107) (1,902,132) 43,354
------------ ------------ ------------
Cash flows from investing activities:
Sales and maturities of investments 14,201,958 12,372,277 1,512,195
Purchase of investments (27,469,786) (17,314,915) (8,358,058)
Acquisition of property and equipment (39,285) (396,882) (883,629)
Contribution to subsidiary -- (53,092,644) (14,000,000)
------------ ------------ ------------
Net cash used in investing activities (13,307,113) (58,432,164) (21,729,492)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from convertible debt offering -- 74,750,000 --
Proceeds from exercise of stock options 673,284 563,500 --
Repayment of long term debt (88,416) 739,578 (4,052,835)
Proceeds from public offering -- -- 26,065,000
------------ ------------ ------------
Net cash provided by financing activities 584,868 76,053,078 22,012,165
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents (15,413,352) 15,718,782 326,027
Cash and cash equivalents balances:
Beginning of year 16,375,868 657,086 331,059
------------ ------------ ------------
End of year $ 962,516 $ 16,375,868 $ 657,086
============ ============ ============
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 4,674,409 $ 7,768 $ 199,218
============ ============ ============
</TABLE>
The condensed financial information should be read
in conjunction with the Penn Treaty American Corporation and
Subsidiaries consolidated statements and notes thereto.
S-5
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1998 Annual Meeting of Shareholders.
Item 11. Executive Compensation
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1998 Annual Meeting of Shareholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1998 Annual Meeting of Shareholders.
Item 13. Certain Relationship and Related Transactions
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1998 Annual Meeting of Shareholders.
38
<PAGE>
PART IV
Item 14. Exhibits, Financial Statements, Schedule and Reports on
Form 8-K
(a) The following documents are filed as a part of this report.
(1) Financial Statements.
<TABLE>
<CAPTION>
Pages
-----
<S> <C>
Report of Independent Accountants.................................. F-2
Consolidated Balance Sheets at December 31, 1997 and 1996
............................................................. F-3
Consolidated Statements of Operations for the years
ended December 31, 1997, 1996, and 1995...................... F-4
Consolidated Statements of Shareholders'
Equity for the years ended December 31, 1997, 1996, and
1995......................................................... F-5
Consolidated Statements of Cash Flow for the years
ended December 31, 1997, 1996, and 1995...................... F-6
Notes to Consolidated Financial Statements......................... F-7-F-24
(2) Financial Statement Schedule.
Report of Independent Accountants on Schedule...................... S-2
Schedule II - Condensed Financial Information of
Registrant................................................... S-3-S-5
</TABLE>
39
<PAGE>
(3) Exhibits.
3.1 Restated and Amended Articles of Incorporation of Penn Treaty American
Corporation. ****
3.1(b) Amendment to Restated and Amended Articles of Incorporation of Penn
Treaty American Corporation. *****
3.2 Amended and Restated By-laws of Penn Treaty American Corporation, as
amended. *****
4. Form of Penn Treaty American Corporation Common Stock Certificate. *
4.1 Indenture dated as of November 26, 1996 between Penn Treaty American
Corporation and First Union National Bank, as trustee (including forms
of Notes)(incorporated by reference to Exhibit 4.1 to Penn Treaty
American Corporation's current report on Form 8-K filed on December 6,
1996).
10.1 Penn Treaty American Corporation Employee Incentive Stock Option Plan.*
10.2 Penn Treaty American Corporation Agent Stock Option Plan. ****
10.3 Penn Treaty American Corporation Employees' Pension Plan. *
10.4 Reinsurance Treaty between Penn Treaty Life Insurance Company and NRG
America Life Reassurance Corp. *
10.5 Assumption Agreement dated May 12, 1994 between Reassurance Company of
Hannover and Penn Treaty Life Insurance Company. ****
10.6 Reinsurance Agreement between Penn Treaty Life Insurance Company and
Life Insurance Company of North America, effective as of June 1, 1976.*
10.7 Personal Accident Quota Share issued to Penn Treaty Life Insurance
Company by American Accident Reinsurance Group, effective as of
November 23, 1982. *
10.8 Credit Life Quota Share Reinsurance Agreement between Penn Treaty Life
Insurance Company and The Centennial Life Insurance Company, effective
as of August 15, 1977. *
40
<PAGE>
10.9 Treaty Endorsement replace The Centennial Life Insurance Company with
Puritan Life Insurance Company, effective June 1, 1986.****
10.10 Endorsement replacing Puritan Life Insurance Company with Employers
Reassurance Corporation, effective as of December 31, 1986. ****
10.11 Reinsurance Agreement between Washington Square Life Insurance Company
and Cologne Life Insurance Company, effective March 1, 1987. ****
10.12 Reinsurance Agreements between Penn Treaty Life Insurance Company and
Cologne Life Reinsurance Company, effective October 1, 1994. ****
10.13 Reinsurance Agreements between Network America Life Insurance Company
and Cologne Life Reinsurance Company, effective October 1, 1994. ****
10.14 Reinsurance Agreement between Penn Treaty Life Insurance Company and
Transamerica Occidental Life Insurance Company, effective April 1,
1988. ****
10.15 Reinsurance Agreement between Network America Life Insurance Company
and Provident Indemnity Life Insurance Company, effective January 1,
1991, as amended on November 30, 1993. ****
10.16 Quota Share Reinsurance Agreement between Network America Life
Insurance Company and Life and Health Insurance Company of America,
effective December 1, 1994.****
10.17 Reinsurance Agreement between Penn Treaty Life Insurance Company and
Reassurance Company of Hannover, effective January 1, 1995.****
10.18 Administrative Services Agreement between Network America Life
Insurance Company and Midland Mutual Life Insurance Company, effective
June 25, 1991.****
10.19 Administration and Agency Agreements between Penn Treaty Life Insurance
Company, Network America Life Insurance Company and Tower Insurance
Services, Inc. effective December 1, 1993, relating to the Quota Share
41
<PAGE>
Reinsurance Agreement between Network America Life Insurance Company
and Life and Health Insurance Company of America, effective December 1,
1994. ****
10.20 Form of General Agent's Contract of Penn Treaty Life Insurance Company.
****
10.21 Form of General Agent's Contract of Network America Life Insurance
Company.****
10.22 Form of Managing General Agency Agreement.****
10.23 Regional General Agents' Contract dated August 1, 1971 between Penn
Treaty Life Insurance Company and Irving Levit of the Irv Levit
Insurance Management Corporation, as amended on August 15, 1971, May
26, 1976 and June 16, 1987, and by an undated override commissions
schedule. ***
10.24 Managing General Agent's Contract dated March 10, 1988 between Penn
Treaty Life Insurance Company and Ameri-Life and Health Services,
Inc.****
10.25 Commission Supplement to General Agent's Contract dated December 7,
1993 between Network America Life Insurance Company and Network
Insurance.****
10.26 Administrative Services Agreement dated February 14, 1995 between
National Benefits Corporation and Penn Treaty Life Insurance Company
and Network America Life Insurance Company. ****
10.27 Mortgage in the amount of $2,450,000 dated September 13, 1988 between
Penn Treaty Life Insurance Company and Merchants Bank, N.A. **
10.28 Amendments to Mortgage dated September 24, 1991, October 13, 1992 and
September 2, 1993. ****
10.29 Loan and Security Agreement by and between Penn Treaty American
Corporation and CoreStates Bank, N.A. dated December 28, 1994.****
10.30 Investment Counseling Agreement dated May 3, 1995 between Penn Treaty
American
42
<PAGE>
Corporation and James M. Davidson & Company.****
10.31 Investment Counseling Agreement dated May 3, 1995 between Penn Treaty
Life Insurance Company and James M. Davidson & Co.****
10.32 Investment Counseling Agreement dated May 3, 1995 between Network
America Life Insurance Company and James M. Davidson & Company. ****
10.33 Assumption and Reinsurance Agreement dated December 22, 1997, between
Penn Treaty Life Insurance Company and Network America Life Insurance
Company.
11. Statement re: computation of per share earnings. See Notes to
Consolidated Financial Statements (Note 1).
21. Subsidiaries of the Registrant. ****
24. Consent of Coopers & Lybrand, L.L.P.
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
27.3 Restated Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1997.
* Incorporated by reference to the Company's Registration Statement on Form
S-1 dated May 12, 1987, as amended.
** Incorporated by reference to the Company's Registration Statement on Form
S-1 dated November 17, 1989, as amended.
*** Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1989.
**** Incorporated by reference to the Company's Registration Statement on Form
S-1 dated June 30, 1995, as amended.
***** Incorporated by reference to the Company's Registration Statement on Form
S-3 dated February 20, 1997.
Executive Compensation Plans - see Exhibits 10.1 and 10.2
43
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PENN TREATY AMERICAN CORPORATION
Date: March 26, 1998 By: /s/ Irving Levit
---------------------------------------
Irving Levit, Chairman of the
Board and President
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Date: March 26, 1998 By: /s/ Irving Levit
---------------------------------------
Irving Levit, Chairman of the
Board and President
Date: March 26, 1998 By: /s/ A.J. Carden
---------------------------------------
A.J. Carden, Executive Vice
President and Director
Date: March 26, 1998 By: /s/ Michael F. Grill
---------------------------------------
Michael F. Grill, Treasurer
and Director
Date: March 26, 1998 By: /s/ Domenic P. Stangherlin
---------------------------------------
Domenic P. Stangherlin,
Secretary and Director
Date: March 26, 1998 By: /s/ Jack D. Baum
---------------------------------------
Jack D. Baum, Vice President,
Marketing and Director
Date: March 26, 1998 By: /s/ Emile Ilchuk
---------------------------------------
Emile Ilchuk, Director
Date: March 26, 1998 By: /s/ C. Mitchell Goldman
---------------------------------------
C. Mitchell Goldman, Director
Date: March 26, 1998 By: /s/ Glen A. Levit
---------------------------------------
Glen A. Levit, Vice President,
Sales and Director
44
<PAGE>
Date: March 26, 1998 By: /s/ David B. Trindle
---------------------------------------
David B. Trindle, Director
45
<PAGE>
EXHIBIT 10.33
<PAGE>
ASSUMPTION AND REINSURANCE AGREEMENT
THIS AGREEMENT is made this 22nd day of December , 1997, to be effective
as of 12:01 a.m. on December 31, 1997 (hereinafter the "Effective Date") subject
to the written prior approval of the Insurance Commissioner of the Commonwealth
of Pennsylvania, by and between Penn Treaty Life Insurance Company (hereinafter
"Ceding Company"), a Pennsylvania stock life insurance company wholly owned by
Penn Treaty American Corporation, and Network America Life Insurance Company
(hereinafter "Reinsuring Company"), a Pennsylvania stock life insurance company
wholly owned by Penn Treaty Life Insurance Company, all with offices at 3440
Lehigh Street, Allentown, Pennsylvania.
RECITALS
WHEREAS, the Parties are life insurance companies, domiciled in, duly
organized and existing under the laws of the Commonwealth of Pennsylvania, and
both are qualified to do business in Pennsylvania and licensed to issue policies
of insurance in Pennsylvania; and,
WHEREAS, the Ceding Company is a direct wholly-owned subsidiary and the
Reinsuring Company is an indirect wholly-owned subsidiary, respectively of Penn
Treaty American Corporation, a Pennsylvania corporation, and insurance holding
company ("Penn Treaty"); and
WHEREAS, the Boards of Directors of each of the Ceding Company, the
Reinsuring Company and Penn Treaty have determined that the business of the
Ceding Company and the Reinsuring Company can be conducted more efficiently as a
single entity and therefore deem it desirable and in the best interests of each
of the corporations that the asset and liability transfer and insurance policy
ceding and reinsurance and transfer actions set forth in this Agreement be
effectuated; and
WHEREAS, it is the intention of the parties hereto that the Ceding Company
shall cede and transfer to the Reinsuring Company and the Reinsuring Company
shall reinsure or assume from the Ceding Company all of the insurance policies
of the Ceding Company as more specifically described and listed on Exhibit "A",
which is attached hereto and made a part hereof, as of the Effective Date of
this Agreement; and
WHEREAS, as of the Effective Date, the principal assets of the Ceding
Company shall consist of the insurance licenses currently held by it along with
adequate levels of capital and surplus required to maintain such licenses.
NOW THEREFORE, in consideration of the foregoing and of the mutual
agreements, covenants and conditions herein contained, the Parties, intending to
be legally bound, agree as follows:
1. POLICIES CEDED AND REINSURED AND OTHER LIABILITIES
TRANSFERRED AND ASSUMED.
<PAGE>
1.1 Policies Ceded and Reinsured.
The Ceding Company hereby assigns, sets over and transfers to the
Reinsuring Company, as of the Effective Date, all of its rights, title and
interest in the insurance policies as stated and described in Exhibit "A", in
force as of the Effective Date (hereinafter referred to as "Reinsured
Policies"). The Reinsuring Company hereby purchases and assumes as direct
insurance all of the contractual obligations and rights with respect to the
Reinsured Policies with the same force and effect as if such policies had been
issued by the Reinsuring Company.
1.2 Purchase Price for Reinsured Policies.
At the Effective Date, the Reinsuring Company will assume the policies
ceded in exchange for an amount equal to the existing reserves of the Ceding
Company of approximately one hundred fifteen million dollars ($115,000,000).
1.3 Reserves and Other Liabilities Transferred.
The Ceding Company agrees to transfer to the Reinsuring Company, at the
Effective Date with respect to the reinsured policies, the gross Unearned
Premium Reserve, the Additional Contract Reserve and the Claim Reserve,
established by the Ceding Company and calculated as of December 31, 1997.
1.4 Claim Payments.
The Ceding Company shall retain the administrative and financial
responsibility for all claims with respect to the Reinsured Policies on or
before the Effective Date. The Reinsuring Company shall be financially and
administratively responsible for all claims with respect to the Reinsured
Policies after the Effective Date.
1.5 Reinsurance.
The Ceding Company is a party to a reinsurance agreement with an external
reinsurer, which provides reinsurance for certain of its policies which
reinsurance agreement is attached hereto as Exhibit "B". To the extent permitted
by law and by the terms of the reinsurance agreement, the Ceding Company hereby
assigns and delegates to the Reinsuring Company, as of the Effective Date, all
of its rights, duties and obligations under said reinsurance agreement. The
Reinsuring Company hereby agrees to accept said assignment and delegation.
1.6 Transfer of Future Premium and Cash.
Premiums as yet due and unpaid, reported or otherwise for the existing
business or additions thereto, as well as new business in transit as of the
Effective Date with respect to the reinsured policies will also be reinsured and
belong to the Reinsuring Company.
The Ceding Company shall transfer, convey, assign and pay over to the
Reinsuring Company all cash received after the Effective Date allocable to the
risk reinsured by the Reinsuring Company with respect to the Reinsured Policies
as of the Effective Date.
1.7 Premium Taxes.
The Reinsuring company accepts liability for all taxes incurred in
connection with the premiums received with respect to the Reinsured Policies
after the Effective Date.
<PAGE>
1.8 Future Premiums, Claims, Coverages and Solicitation of New Business.
(a) The Ceding Company and the Reinsuring Company agree that after the
Effective Date the Reinsuring Company shall be entitled to collect all future
premiums, and the Reinsuring Company shall be obligated to pay commissions,
taxes and claims and other contractual obligations with respect to the Reinsured
Policies, as if it were the original insurer, and the Reinsuring Company assumes
the rights, obligations and privileges of the Ceding Company with respect to the
Reinsured Policies as its own.
(b) After the Effective Date, the Reinsuring Company is entitled to change
premiums and to modify or cancel coverages and policies subject to policy
provisions and applicable Pennsylvania statutes.
(c) After the effective date of the Reinsured Policies the Reinsuring
Company is further entitled to negotiate, appoint or cancel agency and
administrative agreements at its sole discretion with respect to solicitation of
new business.
(d) The Ceding Company shall cooperate with the Reinsuring Company prior
to and after the Effective Date to make such changes and take such other actions
as needed to effectuate the provisions of this Section 1.8.
2. ASSUMPTION CERTIFICATE
The Reinsuring Company shall deliver to each policyholder of the Reinsured
Policies covered by this Agreement an Assumption Certificate in a form agreeable
to applicable insurance departments. Delivery of these materials shall be made
by U.S. Mail and shall take place not later than sixty (60) days after the
Effective Date or the receipt of all required regulatory approvals, whichever is
later.
3. AGENTS COMMISSIONS
The Reinsuring Company shall be responsible for and agrees to pay all
commissions on all premiums collected on Reinsured Policies after the Effective
Date. All agents of the Ceding Company, either by individual state approval or
by relicensing shall become agents of the Reinsuring Company, and all
commissions shall be protected. The Reinsuring Company's liability hereunder,
however, shall be limited to the rates of compensation specified in those
agreements between the Ceding Company and its agents of record on the Reinsured
Policies, (including vested terminated agents) or as amended by mutual agreement
between the Reinsuring Company and the Ceding Company's agents.
4. SALE OF OTHER ASSETS AND TRANSFER OF LIABILITIES.
4.1 Assets Purchased. In addition to the ceding and transfer of the
Reinsured Policies, as of the Effective Date the Ceding Company shall sell,
transfer, convey, grant, assign and deliver to the Reinsuring company, and the
Reinsuring Company shall purchase, accept, acquire and receive from the Ceding
Company all of the Right, title and interest in and to the following specific
assets of the Ceding Company, constituting substantially all assets of the
Ceding
<PAGE>
Company, tangible or intangible, real or personal, including, without
limitation, the following described assets owned and used by the Ceding Company
(collectively, the "Purchased Assets"):
(a) all real property, equipment, business machines, computers,
telephone systems, automobiles, furniture, furnishings and other
tangible personal property of the Ceding Company including, without
limitation, that listed in Schedule 4.1(a) hereto;
(b) all claims and rights under the contracts and real and personal
property leases of the Ceding Company listed in Schedule 4.1(b)
(c) all sales literature, promotional material and other general
files and printed forms used by the Ceding Company;
(d) all goodwill, trademarks, service marks and trade names used by
the Ceding Company, whether arising under common law or state or
federal trademark law (including, without limitation, the name "Penn
Treaty" when used in connection with the Reinsured Policies),
provided that the Reinsured Company hereby grants the Ceding Company
the right to use its name, and associated logos, with respect to its
continued corporate existence.
(e) all right, title and interest of the Ceding Company in and to
policyholder lists and other mailing lists of the Ceding Company,
and all computer tapes, printouts and other data with respect to
such policyholder and mailing lists;
(f) any and all prepaid expenses and deposits of the Ceding Company
as of the Effective Date, including any lease deposits;
(g) all inventory and supplies of the Ceding Company;
(h) all rights to leasehold improvements and fixtures; and
(i) all payroll records for all employees of the Ceding Company and
of Penn Treaty in the possession and control of the Ceding Company
and all pension plan assets under the management and control of the
Ceding Company.
The "Purchased Assets" shall include, without limitation, all properties
and assets of the Ceding Company as reflected in the 1996 Financial Statements
of the Ceding Company and all properties and assets acquired by the Ceding
Company after January 1, 1997, except those properties and assets disposed of
thereafter in the ordinary course of business and except for the "Retained
Assets" as defined below. The Parties hereby agree that the value of the
Purchased Assets shall be determined as of December 31, 1997 in full compliance
with all statutory accounting principles as audited by Coopers & Lybrand,
L.L.P.. The purchase price for the Purchased Assets shall be allocated among the
Purchased Assets as listed on Exhibit "C".
<PAGE>
4.2 Retained Assets. Notwithstanding the provisions of Section 4.1 hereof,
the following described assets of the Ceding Company shall not be acquired by
the Reinsuring Company, shall not constitute "Purchased Assets" and shall be
defined herein as the "Retained Assets":
(a) all insurance licenses issued to Penn Treaty Life Insurance
Company as set forth in Schedule 4.2(a) attached hereto;
(b) use of the name "Penn Treaty Life Insurance Company" together
with the logos of the Ceding Company, whether arising under common
law or state or federal trademark law;
(c) the Ceding Company's bank accounts, deposit accounts or similar
accounts;
(d) the Ceding Company's corporate minute books and records, general
ledgers and books of original entry, tax returns and tax records,
financial statements, any books or records relating to the Ceding
Company's general corporate affairs, the corporate seal of the
Ceding Company and any other records, reports or documentation
relating to the Retained Assets; and
(e) shares of the capital stock of the Ceding Company.
4.3 Assumption of Certain Liabilities. As of and after the Effective Date,
the Reinsuring Company shall assume and agree to perform and discharge, when
due, all obligations and liabilities of the Ceding Company of every kind or
character related to the Purchased Assets.
4.4 Transfer of Network America Capital Stock. Upon receipt of a favorable
Internal Revenue Service opinion regarding the tax-free nature of this
transaction, the Ceding Company shall dividend all 239,933 shares of Common
Stock, par value $6.25 per share (the "Common Stock"), of the Reinsuring Company
then held by the Ceding Company to Penn Treaty. At that time, each Director of
the Ceding Company shall transfer the one share of Common Stock of the
Reinsuring Company then held by such Director as a director qualifying share to
Penn Treaty. As a result of such transfers, as of that date, the Reinsuring
Company shall become a direct, wholly-owned subsidiary of Penn Treaty.
5. GOVERNING LAW
This Agreement shall be governed by, and construed in accordance with the
laws of the Commonwealth of Pennsylvania, without regard to principles of
conflicts of laws.
6. INADVERTENT ERRORS OR OMISSIONS
No inadvertent errors or omissions made by either the Ceding Company or
the Reinsuring Company shall relieve the other party of liability, provided such
errors or omissions are corrected as soon as possible.
<PAGE>
7. CLAIMS AGAINST CEDING COMPANY
In the event an insured under one of the Reinsured Policies covered under
this Agreement or a policyowner, his beneficiary, legal representative, or any
one acting on his behalf makes any claim, demand or commences any action or suit
based on a fact, or alleged set of circumstances, arising subsequent to the
Effective Date (whether groundless or otherwise) against the Ceding Company, its
shareholders, directors, officers, employees, and agents (collectively the
"Indemnified Party") in connection with any of the Reinsured Policies, the
Reinsuring Company agrees it will indemnify and hold harmless the Indemnified
Party from and against all liabilities, losses, damages, costs, and charges
(including counsel fees and all other expenses) of every nature and character as
the same may arise or be made against or incurred by the Indemnified Party. The
Reinsuring Company is permitted to control the defense of any such claim,
demand, action or suit.
8. RECAPTURE
The Ceding Company shall have no right to recapture the Reinsured
Policies, or have any claim to the business added to such policies after the
Effective Date.
9. APPROVAL OF REGULATORY AUTHORITIES
This Agreement shall be void and of no effect if it is deemed invalid or
contrary to the laws of Pennsylvania by a formal ruling issued by the Insurance
Commissioner of the Commonwealth of Pennsylvania or any other insurance
department prior to the Effective Date.
10. MISCELLANEOUS
10.1 The parties hereto bind and oblige themselves to do such further
acts, matters and deeds and to execute any and all such further and additional
instruments and agreements as may be found necessary or expedient to carry this
Agreement into full effect.
10.2 All of these terms and provisions of this Agreement shall be binding
upon and inure to the benefit of and be enforceable by the respective successors
and assigns of the Ceding Company and the Reinsuring Company.
10.3 The Agreement may be executed simultaneously in any number of
counterparts, each of which shall be deemed an original and all of which shall
constitute one and the same Agreement.
10.4 The titles to the various Sections hereof are inserted solely for
convenience or reference and are not a part of, nor shall they be used to
construe any term or provision of this Agreement.
<PAGE>
10.5 The provisions hereof are independent of and separable from each
other, and no provision shall be affected or rendered invalid or unenforceable
by virtue of the fact that for any reason any other or others of them may be
invalid or unenforceable in whole or in part.
10.6 This Agreement and all schedules and exhibits hereto constitute the
entire understanding between the parties hereto as to the subject matter hereof
and cannot be modified, amended or supplemented except in writing and signed by
the parties hereto. prior to the Effective Time, the Parties may agree to
terminate this Agreement in such manner as may be agreed by them in writing.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
by their respective officers and their respective corporate seals have been
affixed on the Effective Date.
(CORPORATE SEAL) NETWORK AMERICA LIFE
INSURANCE COMPANY
Attest: By:
---------------------- -----------------------------------
Sandra Kotsch Glen A. Levit
Assistant Secretary Title: President
(CORPORATE SEAL) PENN TREATY LIFE
INSURANCE COMPANY
Attest: By:
---------------------- -----------------------------------
Sandra Kotsch A. J. Carden
Assistant Secretary Title: Executive Vice President and
Chief Operating Officer
<PAGE>
Exhibit 24
Consent of Independent Accountants
We consent to the incorporation by reference in the registration statement of
Penn Treaty American Corporation on Form S-8 (File No. 33-38330) of our reports
dated March 11, 1998 on our audits of the consolidated financial statements and
financial statement schedule of Penn Treaty American Corporation as of December
31, 1997 and 1996 and for the years ended December 31, 1997, 1996 and 1995,
which reports are included in this Annual Report on Form 10-K.
Coopers & Lybrand, L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 30, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 278,148,092
<DEBT-CARRYING-VALUE> 0
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