<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 1998
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from
to
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Commission file number 0-13972
PENN TREATY AMERICAN CORPORATION
--------------------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-1664166
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(State or other jurisdiction of (I.R.S. Employer Identifi-
incorporation of organization) cation No.)
3440 Lehigh Street, Allentown, PA 18103
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(Address, including zip code, of
principal executive offices)
(610) 965-2222
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(Registrant's telephone number, including area code)
Not Applicable
--------------
(Former name, former address and former fiscal year,
if change since last report)
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
-- --
The number of shares outstanding on the Registrant's common stock, par
value $.10 per share, as of November 2, 1998 was 7,804,392.
1
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
The registrant's Unaudited Consolidated Balance Sheets, Statements of Operations
and Comprehensive Income and Statements of Cash Flows and Notes thereto required
under this item are contained on pages 3 through 7 of this report, respectively.
These financial statements represent the consolidation of the operations of the
registrant, and its subsidiaries, Penn Treaty Network America Insurance Company
("PTNA"), Penn Treaty Life Insurance Company ("PTLIC"), American Network
Insurance Company ("ANIC"), American Independent Network Insurance Company of
New York ("AINIC") and Senior Financial Consultants Company. PTNA, PTLIC, ANIC
and AINIC, (collectively, "the Insurers"), are underwriters of long-term care
insurance products. PTNA and PTLIC are also underwriters of life insurance
products.
Effective December 31, 1997, PTLIC dividended its common stock ownership of PTNA
to the registrant as a tax-exempt transaction. The registrant intends to sell
the charter and insurance licenses of PTLIC on or before December 31, 1998. In
the event it is not sold by that time, the charter will dissolve. No new
business may be written by PTLIC prior to its sale.
2
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PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
(amounts in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---- ----
(unaudited)
<S> <C> <C>
ASSETS
Investments:
Bonds, available for sale at market (cost of $305,464 and $271,315,
respectively) $ 321,615 $ 278,148
Equity securities at market value, (cost of $10,880 and $18,511, respectively) 10,837 23,554
Policy loans 104 85
--------- ---------
Total investments 332,556 301,787
Cash and cash equivalents 34,622 11,241
Property and equipment, at cost, less accumulated depreciation of
$2,656 and $2,399, respectively 9,415 8,753
Unamortized deferred policy acquisition costs 142,921 110,471
Receivables from agents, less allowance for
uncollectable amounts of $130 and $130, respectively 1,369 1,107
Accrued investment income 4,964 4,112
Federal income tax recoverable 587 1,182
Cost in excess of fair value of net assets acquired, less
accumulated amortization of $772 and $716, respectively 5,956 6,662
Present value of future profits acquired 3,285 3,597
Receivable from reinsurers 12,077 10,542
Other assets 5,821 6,318
--------- ---------
Total assets $ 553,573 $ 465,772
--------- ---------
--------- ---------
LIABILITIES
Policy reserves:
Accident and health $ 179,695 $ 139,963
Life 8,378 8,117
Policy and contract claims 95,500 78,142
Accounts payable and other liabilities 8,176 6,192
Long-term debt 76,502 76,752
Deferred income taxes 31,743 23,850
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Total liabilities 399,994 333,016
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SHAREHOLDERS' EQUITY
Preferred stock, par value $1.00; 5,000 shares authorized, none outstanding - -
Common stock, par value $.10; 25,000 and 10,000
shares authorized, 8,186 and 8,178 shares issued 818 818
Additional paid-in capital 53,301 53,194
Net unrealized appreciation of securities 10,632 7,838
Retained earnings 90,534 72,612
--------- ---------
155,285 134,462
Less 606 common shares held in treasury, at cost (1,706) (1,706)
--------- ---------
153,579 132,756
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Total liabilities and shareholders' equity $ 553,573 $ 465,772
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
3
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PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
(unaudited)
(amounts in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Accident and health premiums $ 57,575 $ 41,533 $ 162,237 $ 120,430
Life premiums 830 908 2,551 2,782
-------- -------- --------- ---------
58,405 42,441 164,788 123,212
Net investment income 5,432 4,585 15,008 12,581
Net realized capital gains 532 775 7,323 935
Other income 75 125 239 305
-------- -------- --------- ---------
64,444 47,926 187,358 137,033
Benefits and expenses:
Benefits to policyholders 40,535 29,510 112,911 86,370
Commissions 20,655 14,166 57,685 40,511
Net policy acquisition costs deferred (12,141) (8,186) (32,450) (24,961)
General and administrative expense 6,765 5,325 18,840 15,478
Interest expense 1,173 1,193 3,586 3,584
-------- -------- --------- ---------
56,987 42,008 160,572 120,982
-------- -------- --------- ---------
Income before federal income taxes 7,457 5,918 26,786 16,051
Provision for federal income taxes 2,399 1,746 8,866 4,70
-------- -------- --------- ---------
Net income 5,058 4,172 17,920 11,348
-------- -------- --------- ---------
Other comprehensive income:
Unrealized holding gain (loss) arising during period 8,594 (3,033) 11,577 2,876
Income (tax) benefit from unrealized holdings (2,922) 1,031 (3,936) (978)
Reclassification adjustment for (gain) loss included
in net income (532) (775) (7,323) (935)
Income (tax) benefit from reclassification adjustment 181 264 2,490 318
-------- -------- --------- ---------
Comprehensive income $ 10,379 $ 1,659 $ 20,728 $ 12,629
-------- -------- --------- ---------
-------- -------- --------- ---------
Basic earnings per share $ 0.67 $ 0.55 $ 2.37 $ 1.51
Diluted earnings per share $ 0.57 $ 0.49 $ 1.96 $ 1.35
Weighted average number of shares outstanding 7,580 7,551 7,575 7,531
Weighted average number of shares outstanding (diluted) 10,421 10,425 10,407 10,381
</TABLE>
See accompanying notes to consolidated financial statements.
4
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PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30,
(unaudited)
(amounts in thousands)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Net cash flow from operating activities:
Net income $ 17,920 $ 11,348
Adjustments to reconcile net income to cash
provided by operations:
Amortization of intangible assets 816 829
Policy acquisition costs, net (32,450) (24,961)
Deferred income taxes 6,652 4,184
Depreciation expense 284 316
Net realized capital gains (7,323) (935)
Increase (decrease) due to change in:
Receivables from agents (262) (30)
Receivable from reinsurers (1,535) (487)
Policy and contract claims 17,358 6,189
Policy reserves 39,993 34,173
Accounts payable and other liabilities 1,984 1,129
Federal income taxes recoverable 595 (24)
Accrued investment income (852) (799)
Other, net 479 (1,918)
-------- --------
Cash provided by operations 43,659 29,014
Cash flow from (used in) investing activities:
Proceeds from sales of bonds 35,060 13,575
Proceeds from sales of equity securities 22,640 2,672
Maturities of investments 14,919 15,796
Purchase of bonds (83,384) (89,942)
Purchase of equity securities (8,026) (8,573)
Acquisition of property and equipment (1,345) (946)
-------- --------
Cash used in investing (20,136) (67,418)
Cash flow from (used in) financing activities:
Proceeds from exercise of stock options 108 477
Repayments of long-term debt (250) (254)
-------- --------
Cash from (used in) financing (142) 223
-------- --------
Increase (decrease) in cash and cash equivalents 23,381 (38,181)
Cash balances:
Beginning of period 11,241 51,613
-------- --------
End of period $ 34,622 $ 13,432
-------- --------
-------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(unaudited)
The Consolidated Financial Statements should be read in conjunction with these
notes and with the Notes to Consolidated Financial Statements included in Penn
Treaty American Corporation's ("the Company's") Annual Report on Form 10-K for
the year ended December 31, 1997.
In the opinion of management, the summarized financial information reflects all
adjustments (consisting only of normal recurring adjustments) which are
necessary for a fair presentation of the financial position and results of
operations for the interim periods. Certain prior period amounts have been
reclassified to conform with current period presentation.
1. Investments
Management has 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 their current market value with net
unrealized gains and 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 September 30, 1998,
shareholders' equity was increased by $10,646 due to unrealized gains
of $16,109 in the investment portfolio. As of December 31, 1997,
shareholders' equity was increased by $7,838 due to unrealized gains
of $11,876 in the investment portfolio.
The amortized cost and estimated market value of investments
available for sale as of September 30, 1998 and December 31, 1997 are
as follows:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
<S> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of U.S.
Government authorities
and agencies $ 149,657 $ 160,013 $ 163,277 $ 167,856
Obligations of states and
political sub-divisions
22,454 21,915 30,515 32,152
Debt securities issued by
foreign governments
205 208 204 205
Corporate securities
133,147 139,479 77,319 77,934
Equities
10,880 10,837 18,511 23,554
Policy Loans
104 104 85 85
---- ---- --- --
Total Investments $ 316,427 $ 332,556 $ 289,911 $ 301,787
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net unrealized gain 16,109 11,876
---------- ----------
$ 332,556 $ 301,787
---------- ----------
---------- ----------
</TABLE>
6
<PAGE>
2. New Accounting Principle:
The Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standard 130, "Reporting Comprehensive Income," which requires that
changes in comprehensive income be shown in a financial statement with the same
prominence as in 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 has adopted 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 expects
to report segment information for only its primary product of long-term care
insurance. It's other products, including disability and life insurance,
comprise an immaterial portion of the Company's total revenues. The Company
expects to report segment information for only its primary product of long-term
care insurance. It's other products, including disability and life insurance,
comprise an immaterial portion of the Company's total revenues. 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 employer's disclosures about
pension and other postretirement benefits. The Company expects that the adoption
of Statement 132, which is effective for fiscal periods beginning after December
15, 1997, 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.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Three Months Ended September 30, 1998 and 1997:
(amounts in thousands, except per share data)
Accident and Health Premiums. First year accident and health premiums
earned in the three month period ended September 30, 1998 (the "1998 quarter"),
including long-term care and Medicare supplement, increased 49.2% to $21,173,
compared to $14,192 in the same period in 1997 (the "1997 quarter"). First year
long-term care premiums earned in the 1998 quarter increased 51.2% to $20,837,
compared to $13,784 in the 1997 quarter. These results reflect increased market
demand for the Company's newest products, which include nursing home coverage
with attached home health care riders, and its Assisted Living and Personal
Freedom policies, which combine the benefit coverage of skilled, assisted living
and custodial nursing home and home health care protection under one benefit
plan. The Company introduced these plans in late 1996 and management believes
this increase is indicative of the growing need for comprehensive coverage.
First year Medicare supplement premiums earned by the Company in the 1998
quarter decreased to $336 from $408 in the 1997 quarter. Total new business for
this product remains low due to the Company's continued reduced emphasis of its
Medicare supplement products because of lower profit margins associated with
this line of business.
Renewal accident and health premiums earned by the Company in the 1998 quarter
increased 35.5% to $34,714, compared to $25,626 in the 1997 quarter. Renewal
long-term care premiums earned in the 1998 quarter increased 35.1% to $33,854,
compared to $25,049 in the 1997 quarter. This increase reflects renewals of a
larger base of in-force policies. In recent years, the Company has experienced
significant growth in first year premium sales, which produces increased renewal
rates in subsequent years.
Disability and Life Premiums. The Company earned $1,688 in disability
premium in the 1998 quarter, compared to $1,714 in the 1997 quarter. During the
1998 quarter, first year disability premiums were $238 and renewal premiums were
$1,450. First year life premiums earned by the Company in the 1998 quarter
decreased 16.2% to $227, compared to $271 in the 1997 quarter. Renewal life
premiums earned by the company in the 1998 quarter declined to $603, compared to
$637 in the 1997 quarter.
Net Investment Income. Net investment income earned by the Company for the
1998 quarter increased 18.5% to $5,432, from $4,585 for the 1997 quarter.
Management attributes this growth to larger invested assets, which continue to
grow with increased premiums. New investments have been made at lower rates than
in the past due to reduced market interest rates.
Benefits to Policyholders. Total benefits to policyholders in the 1998
quarter increased 37.4% to $40,535 compared to $29,510 in the 1997 quarter.
Accident and health benefits to policyholders, excluding disability benefits, in
the 1998 quarter increased 40.1% to $39,374 compared to $28,098 in the 1997
quarter. The Company's accident and health loss ratio (the ratio of benefits to
policyholders to total accident and health premiums) was 71.6% in the 1998
quarter, compared to 70.6% in the 1997 quarter. This increase is for maturing
business and is within Management's expectations. In the 1998 quarter, incurred
claims as a percentage of accident and health premiums were 47.6% compared to
8
<PAGE>
42.1% in the 1997 quarter. The incurred loss ratio has increased due to the
establishment of higher claim reserves per newly opened claim. The Company's
paid loss ratio has declined to 34.0% in the 1998 quarter, compared to 38.0% in
the 1997 quarter. The Company uses independent care managers to control claims
in its home health care coverage. The amounts due to care management included in
benefits to policyholders were approximately $525 or .9% and $300 or .8% of
premiums in the 1998 and 1997 quarters, respectively.
Commissions. Commissions to agents increased 45.8% to $20,655 in the 1998
quarter compared to $14,166 in the 1997 quarter.
First year commissions on accident and health business in the 1998 quarter
increased 54.0% to $14,743 compared to $9,576 in the 1997 quarter, corresponding
to the increase in first year accident and health premiums and an increase in
younger (below age 65) policies being sold at higher first year commissions. The
ratio of first year accident and health commissions to first year accident and
health premiums was 69.6% in the 1998 quarter and 67.5% in the 1997 quarter.
First year commissions on life business in the 1998 quarter decreased 45.7% to
$133, compared to $245 in the 1997 quarter. First year disability commissions,
at 57.9% of premiums, were $138 in the 1998 quarter, compared to 59.4% of
premiums in the 1997 quarter.
Renewal commissions on accident and health business in the 1998 quarter
increased 55.1% to $6,142, compared to $3,959 in the 1997 quarter, consistent
with the increase in renewal premiums discussed above. The ratio of renewal
accident and health commissions to renewal accident and health premiums was
17.7% in the 1998 quarter and 15.4% in the 1997 quarter. This ratio fluctuates
in relation to the age of the policies in force and the rates of commissions
paid to the agents. Life renewal commissions were 9.7% of premiums in the 1998
quarter compared to 11.7% in the 1997 quarter. Renewal commissions of $131 were
9.1% of disability premiums.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition
costs in the 1998 quarter increased 48.3% to $12,141 compared to $8,186 in the
1997 quarter. 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. Cost deferrals are higher in the current period
due to the deferral of higher commissions and longer than anticipated policy
duration.
General and Administrative Expenses. General and administrative expenses in
the 1998 quarter increased 27.0% to $6,765, compared to $5,325 in the 1997
quarter. This increase was due to variable expense growth, yet is below the
37.6% rise in premiums. The Company attributes these savings to efficiencies in
its processing areas and to utilization of its existing capacity.
Provision for Federal Income Taxes. The provision for federal income taxes
recorded by the Company for the 1998 quarter increased 37.4% to $2,399, compared
to $1,746 for the 1997 quarter. This increase is primarily attributable to the
Company's higher anticipated tax rates due to lower tax-exempt bond holdings and
reduced small life company exemptions. The effective tax rates of approximately
32% and 30% in the 1998 and 1997 quarters, respectively, are below the normal
federal corporate rate as a result of credits from the small life insurance
company deduction as well as the Company's investments in tax-exempt bonds.
9
<PAGE>
Nine Months Ended September 30, 1997 and 1996:
(amounts in thousands, except per share data)
Accident and Health Premiums. First year accident and health premiums
earned in the nine month period ended September 30, 1998 (the "1998 period"),
including long-term care and Medicare supplement, increased 47.1% to $58,959,
compared to $40,088 in the same period in 1997 (the "1997 period"). First year
long-term care premiums earned in the 1998 period increased 47.1% to $57,484,
compared to $39,086 in the 1997 period. These results reflect increased market
demand for the Company's newest products, which include nursing home coverage
with attached home health care riders, and its Assisted Living and Personal
Freedom policies, which combine the benefit coverage of skilled, assisted living
and custodial nursing home and home health care protection in one comprehensive
benefit plan. Management believes this increase is indicative of the growing
need for comprehensive coverage following its late 1996 introduction of the
plans. First year Medicare supplement premiums earned by the Company in the 1998
period increased to $1,475 from $1,002 in the 1997 period.
Renewal accident and health premiums earned by the Company in the 1998 period
increased 31.5% to $101,207, compared to $76,984 in the 1997 period. Renewal
long-term care premiums earned in the 1998 period increased 31.6% to $98,742,
compared to $75,055 in the 1997 period. This increase reflects renewals of a
larger base of in-force policies and continued increases in persistency
(renewals as a percentage of total prior year business). The Company has also
experienced significant growth in recent years of first year premiums, which is
now reflected in renewals. Renewal Medicare supplement premiums in the 1998
period increased 27.8% to $2,465, compared to $1,928 in the 1997 period.
Disability and Life Premiums. The Company earned $5,033 in disability premium in
the 1998 period. During the 1998 period, first year disability premiums were
$724 and renewal premiums were $4,309. First year life premiums earned by the
Company in the 1998 period decreased 24.9% to $623, compared to $829 in the 1997
period. Renewal life premiums earned by the Company in the 1998 period increased
to $2,551, compared to $1,953 in the 1997 period.
Net Investment Income. Net investment income earned by the Company for the
1998 period increased 19.3% to $15,008, from $12,581 for the 1997 period. This
increase was primarily the result of higher investable assets. This growth
however was reduced by the lower interest rate environment available for
investments made during the 1998 period. The Company also recognized $7,323 of
capital gains during the 1998 period as a result of the sale of its equities and
tax-free bond portfolios. Benefits to Policyholders. Total benefits to
policyholders in the 1998 period increased 31.0% to $112,911 compared to $86,370
in the 1997 period.
Accident and health benefits to policyholders, excluding disability benefits, in
the 1998 period increased 30.7% to $107,910 compared to $82,290 in the 1997
period. The Company's accident and health loss ratio (the ratio of benefits to
policyholders to total accident and health premiums) was 69.3% in the 1998
period, compared to 71.3% in the 1997 period. Although Management normally
expects the loss ratio to grow year over year, the 1997 period included
actuarial factor adjustments that temporarily increased the loss ratio in that
period. The Company uses independent care managers to monitor and control claims
in its home health care coverage. The amounts due to care management included in
benefits to policyholders were approximately $1,200 or .7% and $700 or .7% of
premiums in the 1998 and 1997 periods, respectively.
10
<PAGE>
Commissions. Commissions to agents increased 42.4% to $57,685 in the 1998
period compared to $40,511 in the 1997 period.
First year commissions on accident and health business in the 1998 period
increased 52.3% to $40,784, compared to $26,785 in the 1997 period,
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 69.2% in the 1998 period and 66.8% in the 1997 period. First
year commissions on life business in the 1998 period decreased 30.2% to $478,
compared to $685 in the 1997 period. The ratio of first year life commissions to
first year life premiums was 76.8% in the 1998 period compared to 82.6% in the
1997 period. First year disability commissions, at 58.3% of premiums, were $423
in the 1998 period, compared to $560 in the 1997 period.
Renewal commissions on accident and health business in the 1998 period increased
35.4% to $16,062, compared to $11,865 in the 1997 period, consistent with the
increase in renewal premiums discussed above. The ratio of renewal accident and
health commissions to renewal accident and health premiums was 15.9% in the 1998
period and 15.4% in the 1997 period. Life renewal commissions were 9.3% of
premiums in the 1998 period compared to 12.0% in the 1997 period. Renewal
commissions of $391 were 9.1% of disability premiums.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition
costs in the 1998 period increased 30.0% to $32,450 compared to $24,961 in the
1997 period, 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. Generally, the deferral of policy acquisition costs remained
consistent with the growth of premiums.
General and Administrative Expenses. General and administrative expenses in
the 1998 period increased 21.7% to $18,840, compared to $15,479 in the 1997
period. This increase was due to variable expense growth related to the rise in
premiums, including premium taxes and costs related to underwriting new
policies.
Provision for Federal Income Taxes. The provision for federal income taxes
recorded by the Company for the 1998 period increased 88.5% to $8,866, compared
to $4,703 for the 1997 period. This increase is primarily attributable to the
capital gains recognized on the sale of the Company's equity portfolio. The
effective tax rates of approximately 33.1% and 29.3% in the 1998 and 1997
periods, respectively are below the normal federal corporate rate as a result of
credits from the small life insurance company deduction as well as the Company's
investments in tax-exempt bonds.
11
<PAGE>
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 and investment income. 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.
The Company's cash flows in the 1998 period were attributable to cash used in by
operations, cash used in investing, and cash provided by financing. The
Company's cash increased by $23,381 in the 1998 period primarily due to the sale
of $22,640 of its equity securities portfolio and cash from operations of
$43,659. The major provider of cash from operations was premiums, which were
used to fund additions to reserves of $57,352 in the 1998 period. The major uses
of cash were commissions paid to agents and the purchase of bonds of $83,384.
The Company's cash decreased by approximately $38,181 in the 1997 period
primarily due to the purchase of approximately $98,515 of investments, which
more than offset cash from operations of approximately $29,014. The major
provider of cash from operations was premiums used to fund additions to reserves
of approximately $40,363 in the 1997 period.
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. The market value of the Company's bond portfolio represented 105.3% of
its cost at September 30, 1998, compared to 102.5% at December 31, 1997, with a
current unrealized gain of $16,152 at September 30, 1998, compared to $6,833 at
December 31, 1997. Its equity portfolio, at September 30, 1998, was below cost
by $43, compared to $5,043 above cost on December 31, 1997, reflecting the sale
and capture of $7,323 in capital gains during 1998. As of December 31, 1997,
shareholders' equity was increased by $7,838 due to unrealized gains in the
investment portfolio. As of September 30, 1998, shareholders' equity was
increased by $10,646 due to unrealized gains in the investment portfolio.
The Company's debt currently consists primarily of a mortgage note in the
approximate amount of $2,000 and $74,750 in convertible subordinated debt. The
convertible debt, issued in November 1996, is convertible at $28.44 per share,
and unless converted, is outstanding until November 2003. The debt carries a
fixed interest coupon of 6.25%, payable semi-annually. The mortgage note is
currently amortized over 15 years, and has a balloon payment due on the
remaining outstanding balance in September 2003. 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 6.85% fixed rate of
interest.
12
<PAGE>
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 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 the Company's debt
issuance, its public offering in 1995 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, (v) the economy continues
to effect the buying powers of senior citizens, or (vi) the Company fails to
maintain its current ratings from A. M. Best or Standard & Poor's, the Company's
results of operations, liquidity and capital resources could be adversely
affected.
Year 2000
As many computer systems and other equipment with embedded chips or processors
use only two digits to represent the year, they may be unable to accurately
process certain data before, during or after the year 2000. As a result,
business and governmental entities are at risk for possible miscalculations or
systems failures causing disruptions in their business operations. This is
commonly known as the Year 2000 ("Y2K") issue. The Y2K issue can arise at any
point in the Company's supply, billing, processing, sales or financial chains.
The Company and each of its subsidiaries are in the process of implementing a
Y2K readiness program with the objective of having all of their significant
operations functioning properly with respect to Y2K before January 1, 2000. The
first component of the Y2K project was to identify all systems and hardware,
which would be impacted by the Y2K issue. This portion of the project has been
completed for the Company and for all of its subsidiaries.
The second component of the Y2K project involves the actual remediation and
replacement of various systems and hardware, which will be affected by the Y2K
issue. The Company and its insurance subsidiaries are using both internal and
external resources to complete this process. Each system has been assigned a
priority for Y2K completion, beginning with the most critical projects. Many
application systems, which are not Y2K compliant, have been slated for
replacement with a new Y2K compliant system. The Company expects to complete the
installation and conversion to these new systems by the summer of 1999.
13
<PAGE>
As part of the Y2K project, significant service providers, vendors, suppliers,
and customers that are believed to be critical to business operations after
January 1, 2000, have been identified and steps are being undertaken in an
attempt to reasonably ascertain their level of readiness through questionnaires,
interviews, on-site visits and other available means.
Because of the reliance upon new application systems to alleviate the risk of
business operations due to the Y2K issue, the Company cannot guarantee that
these systems will be implemented successfully or in a timely fashion. In the
event that one or all of these new system conversions are unsuccessful, the
Company could experience interruptions in its business operations which are
critical to its ongoing profitability and sustainability. However, the Company
believes that its efforts in converting to new systems will be successful, and
does not anticipate any failures or unnecessary delays in its critical functions
as a result of the Y2K issue. By the end of the second quarter, 1999, the
company will review its progress in the completion of Y2K preparedness, both on
in-house systems and external vendors. In the event either is not expected to be
completed prior to January 1, 2000, the Company will correct its existing
systems (which are substantially Y2K compliant already) and/or seek other
vendors which are compliant.
The Company has spent approximately $200,000 to date related to modifying
existing systems to become Y2K compliant, and anticipates the expenditure of
approximately $100,000 more before the end of the third quarter, 1999. The
majority of the Company's efforts and expenditures have related to the
installation of a new computer system, which, although correcting for Y2K
issues, is being implemented for normal processing reasons rather than for Y2K.
The Company expects the impact of Y2K to have no material impact upon its
Statements of Condition and Comprehensive Income.
Some of the information presented in this filing constitutes forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Although the Company believes 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 for sale in the states in which it is licensed and the
acceptance of such 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.
14
<PAGE>
New Accounting Principle:
The Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standard 130, "Reporting Comprehensive Income," which requires that
changes in comprehensive income be shown in a financial statement with the same
prominence as in 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 has adopted 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 expects
to report segment information for only its primary product of long-term care
insurance. It's other products, including disability and life insurance,
comprise an immaterial portion of the Company's total revenues. 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 employer's disclosures about
pension and other postretirement benefits. The Company expects that the adoption
of Statement 132, which is effective for fiscal periods beginning after December
15, 1997, 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.
15
<PAGE>
PART II OTHER INFORMATION
Item 1. Legal Proceedings
The Insurers are parties to various lawsuits generally arising in the normal
course of their insurance business. The Company does not believe that the
eventual outcome of any of the suits to which the Insurers are currently a party
will have a material effect on the financial condition or result of operations
of the Company.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 11 - Earnings Per Share Calculation
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed no reports on Form 8-K during the quarter ending
September 30, 1998.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant had duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENN TREATY AMERICAN CORPORATION
--------------------------------
Registrant
Date November 12, 1998 /s/ Irving Levit
----------------- ----------------
Irving Levit
President
Date November 12, 1998 /s/ Michael F. Grill
----------------- --------------------
Michael F. Grill
Treasurer
17
<PAGE>
Exhibit 11
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
(amounts in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 5,058 $ 4,172 $17,920 $11,348
Weighted average common shares outstanding 7,580 7,551 7,575 7,531
Basic earnings per share $ 0.67 $ 0.55 $ 2.37 $ 1.51
------- ------- ------- -------
------- ------- ------- -------
Net income $ 5,058 $ 4,172 $17,920 $11,348
Adjustments net of tax:
Interest expense on convertible debt 792 823 2,344 2,477
Amortization of debt offering costs 62 64 182 193
------- ------- ------- -------
Diluted net income $ 5,912 $ 5,059 $20,446 $14,018
------- ------- ------- -------
------- ------- ------- -------
Weighted average common shares outstanding 7,580 7,551 7,575 7,531
Common stock equivalents due to dilutive
effect of stock options 213 246 204 222
Shares converted from convertible debt 2,628 2,628 2,628 2,628
------- ------- ------- -------
Total outstanding shares for diluted earnings
per share computation 10,421 10,425 10,407 10,381
Diluted earnings per share $ 0.57 $ 0.49 $ 1.96 $ 1.35
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
18
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-START> JAN-01-1998
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 321,615
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 10,837
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 332,556
<CASH> 34,622
<RECOVER-REINSURE> 12,077
<DEFERRED-ACQUISITION> 142,921
<TOTAL-ASSETS> 553,573
<POLICY-LOSSES> 188,073
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 95,500
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 76,502
0
0
<COMMON> 818
<OTHER-SE> 152,761
<TOTAL-LIABILITY-AND-EQUITY> 553,573
164,788
<INVESTMENT-INCOME> 15,008
<INVESTMENT-GAINS> 7,323
<OTHER-INCOME> 239
<BENEFITS> 112,911
<UNDERWRITING-AMORTIZATION> (32,450)
<UNDERWRITING-OTHER> 80,111
<INCOME-PRETAX> 26,786
<INCOME-TAX> 8,866
<INCOME-CONTINUING> 17,920
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,920
<EPS-PRIMARY> 2
<EPS-DILUTED> 2
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
