<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 June 30, 1999
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 number 0-13972
PENN TREATY AMERICAN CORPORATION
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-1664166
------------ ----------
(State or other jurisdiction of (IRS Employer
incorporation of organization) Identification No.)
3440 LEHIGH STREET, ALLENTOWN, PA 18103
---------------------------------------
(Address, including zip code, of principal executive offices)
(610) 965-2222
--------------
(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 August 10, 1999 was 7,808,589.
<PAGE>
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 8 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"), American Network Insurance Company ("ANIC"), American Independent
Network Insurance Company of New York ("AINIC") (collectively, "the Insurers"),
United Insurance Group Agency, Inc. ("UIG") and Senior Financial Consultants
(collectively, "the Agencies"), which are underwriters and marketers of
long-term care insurance products. PTNA is also an underwriter of life insurance
products.
2
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Condensed Balance Sheets
(amounts in thousands)
<CAPTION>
June 30, December 31,
1999 1998
---- ----
(unaudited)
ASSETS
<S> <C> <C>
Investments:
Bonds, available for sale at market (cost of $335,356 and $310,993, respectively) $ 330,696 $ 321,448
Equity securities at market value (cost of $17,034 and $15,090, respectively) 17,505 17,334
Policy loans 129 107
--------- ---------
Total investments 348,330 338,889
Cash and cash equivalents 45,382 38,402
Property and equipment, at cost, less accumulated depreciation of
$3,337 and $3,033, respectively 7,922 9,635
Unamortized deferred policy acquisition costs 180,843 157,385
Receivables from agents, less allowance for
uncollectable amounts of $166 and $166, respectively 1,612 1,804
Accrued investment income 5,178 4,889
Federal income tax recoverable 409 1,741
Cost in excess of fair value of net assets acquired, less
accumulated amortization of $1,525 and $1,029, respectively 22,853 6,349
Present value of future profits acquired 2,974 3,181
Receivable from reinsurers 13,121 12,288
Other assets 6,678 5,989
--------- ---------
Total assets $ 635,302 $ 580,552
--------- ---------
--------- ---------
LIABILITIES
Policy reserves:
Accident and health $ 227,639 $ 190,036
Life 10,040 9,434
Policy and contract claims 116,257 105,667
Accounts payable and other liabilities 12,277 8,639
Long-term debt 83,694 76,550
Deferred income taxes 28,992 32,556
--------- ---------
Total liabilities 478,899 422,882
--------- ---------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, par value $1.00; 5,000 shares authorized, none outstanding - -
Common stock, par value $.10; 10,000
shares authorized, 8,191 and 8,189 shares issued 819 819
Additional paid-in capital 53,574 53,516
Net unrealized appreciation (depreciation) of securities (2,765) 8,381
Retained earnings 106,481 96,660
--------- ---------
158,109 159,376
Less 606 common shares held in treasury, at cost (1,706) (1,706)
--------- ---------
156,403 157,670
--------- ---------
Total liabilities and shareholders' equity $ 635,302 $ 580,552
--------- ---------
--------- ---------
See accompanying notes to consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
(unaudited)
(amounts in thousands, except per share data)
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Accident and health premiums $ 71,212 $ 53,749 $137,378 $104,662
Life premiums 930 854 1,823 1,721
-------- -------- -------- --------
72,142 54,603 139,201 106,383
Net investment income 5,571 4,950 10,754 9,576
Net realized capital gains 3,227 76 3,843 6,791
Other income 1,657 89 3,097 164
-------- -------- -------- --------
82,597 59,718 56,895 122,914
Benefits and expenses:
Benefits to policyholders 49,305 38,093 94,709 72,376
Commissions 23,872 19,666 45,480 37,030
Net policy acquisition costs deferred (12,388) (12,034) (23,458) (20,309)
General and administrative expense 9,805 6,120 19,647 12,075
Loss due to impairment of property and equipment 2,799 - 2,799 -
Interest expense 1,383 1,200 2,578 2,413
-------- -------- -------- --------
74,776 53,045 141,755 103,585
-------- -------- -------- --------
Income before federal income taxes 7,821 6,673 15,140 19,329
Provision for federal income taxes 2,581 2,182 4,996 6,467
-------- -------- -------- --------
Net income 5,240 4,491 10,144 12,862
-------- -------- -------- --------
Other comprehensive income:
Unrealized holding gain (loss) arising during period (5,692) 1,286 (13,045) 2,983
Income (tax) benefit from unrealized holdings 1,936 (437) 4,435 (1,014)
Reclassification adjustment for (gain) loss included in net income (3,227) (76) (3,843) (6,791)
Income (tax) benefit from reclassification adjustment 1,097 26 1,307 2,309
-------- -------- -------- --------
Comprehensive income $ (646) $ 5,290 $ (1,002) $ 10,349
-------- -------- -------- --------
-------- -------- -------- --------
Basic earnings per share $ 0.69 $ 0.59 $ 1.34 $ 1.70
Diluted earnings per share $ 0.59 $ 0.51 $ 1.14 $ 1.39
Weighted average number of shares outstanding 7,585 7,573 7,584 7,573
Weighted average number of shares outstanding (diluted) 10,382 10,427 10,369 10,423
See accompanying notes to consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the Six Months Ended June 30,
(unaudited)
(amounts in thousands)
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Net cash flow from operating activities:
Net income $ 10,144 $ 12,862
Adjustments to reconcile net income to cash
provided by operations:
Amortization of intangible assets 882 365
Policy acquisition costs, net (23,458) (20,309)
Deferred income taxes 2,178 6,881
Depreciation expense 304 186
Compensation expense for agent options 27 -
Net realized capital gains (3,843) (6,791)
Realized loss on disposal of property and equipment 2,799 -
Increase (decrease) due to change in:
Receivables from agents 754 (66)
Receivable from reinsurers (833) (2,067)
Policy and contract claims 10,590 10,699
Policy reserves 38,209 26,378
Accounts payable and other liabilities 2,349 1,091
Federal income taxes recoverable 1,385 (1,542)
Accrued investment income (289) (210)
Other, net (1,459) 25
--------- --------
Cash provided by operations 39,739 27,502
Cash flow from (used in) investing activities:
Net cash purchase of subsidiary (9,194) -
Proceeds from sales of bonds 34,525 10,828
Proceeds from sales of equity securities 16,412 22,045
Maturities of investments 2,897 5,792
Purchase of bonds (61,226) (27,794)
Purchase of equity securities (15,093) (3,169)
Acquisition of property and equipment (1,088) (440)
--------- --------
Cash provided by (used in) investing (32,767) 7,262
Cash flow from (used in) financing activities:
Proceeds from exercise of stock options 31 77
Repayments of long-term debt (23) (231)
-------- --------
Cash used in financing 8 (154)
-------- --------
Increase (decrease) in cash and cash equivalents 6,980 34,610
Cash balances:
Beginning of period 38,402 11,241
-------- --------
End of period $ 45,382 $ 45,851
-------- --------
-------- --------
Acquisition of subsidiary with note payable $ 7,167 $ -
-------- --------
-------- --------
See accompanying notes to consolidated financial statements.
</TABLE>
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
(unaudited)
(amounts in thousands, except per share data)
The Consolidated Financial Statements should be read in conjunction with these
notes and with the Notes to Consolidated Financial Statements included in the
Annual Report on Form 10-K for the year ended December 31, 1998 of Penn Treaty
American Corporation (the "Company"). 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.
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 June 30,
1999, shareholders' equity was decreased by $2,765 due to unrealized losses of
$4,189 in the investment portfolio. As of December 31, 1998, shareholders'
equity was increased by $8,381 due to unrealized gains of $12,699 in the
investment portfolio.
The amortized cost and estimated market value of investments available
for sale as of June 30, 1999 and December 31, 1998 are as follows:
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
------------- -----------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
---- ------------ ---- ------------
<S> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of US
Government authorities
and agencies $ 123,060 $ 124,509 $ 124,664 $ 132,031
Obligations of states and
political sub-divisions 2,655 2,676 2,660 2,864
Mortgage backed securities 18,955 18,399 10,368 10,407
Debt securities issued by
foreign governments 11,014 10,884 2,974 3,109
Corporate securities 179,672 174,228 170,327 173,037
Equities 17,034 17,505 15,090 17,334
Policy Loans 129 129 107 107
--------- --------- --------- ---------
Total Investments $ 352,519 $ 348,330 $ 326,190 $ 338,889
--------- --------- --------- ---------
--------- --------- --------- ---------
Net unrealized gain (loss) (4,189) 12,699
--------- ---------
$ 348,330 $ 338,889
--------- ---------
--------- ---------
</TABLE>
6
<PAGE>
2. New Accounting Principles:
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 has adopted SOP 97-3, and established a gross
liability of $1,066 for future assessments and a gross asset of $1,046 for
premium tax offsets related to those assessments for the period ended June 30,
1999.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as "derivatives") and for
hedging activities. SFAS No. 133 requires an entity to recognize all derivatives
as either assets or liabilities in the statement of financial position and
measure those instruments at fair value. While the Company is presently
evaluating the impact of SFAS No. 133, the adoption of SFAS No. 133 is not
expected to have a material impact on the Company's financial condition or
results of operations.
Statement of Position 98-1 "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" (SOP 98-1) was issued by the
American Institute of Certified Public Accountants in March 1998 and provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. The statement is effective for 1999 financial statements. The
adoption of SOP 98-1 has not had a material impact on the Company's financial
condition or results of operations.
3. Statutory Regulation:
In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance, which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting. The
Codification provides guidance for areas where statutory accounting has been
silent and changes current statutory accounting in some areas.
The Pennsylvania Insurance Department has adopted the Codification
guidance, effective January 1, 2001. The Company has not estimated the effect of
the Codification guidance upon its financial condition or results of operations.
4. Acquisition of Business:
Effective January 1, 1999, the Company acquired all of the common
stock of United Insurance Group Agency, Inc., a Michigan based consortium of
long-term care insurance agencies, for the amount of $18,192, of which $8,078
was in the form of a three-year zero-coupon installment note. The installment
note, after discounting for imputed interest, was recorded as a note payable of
$7,167. The acquisition is accounted for as a purchase, for which the Company
recognized goodwill of $17,000 that is being amortized over 25 years. The
Company expects that the proforma effect of consolidating the financial results
of UIG prior to 1999 would be immaterial to the Company's financial condition
or results of operations.
7
<PAGE>
5. Reconciliation of Earnings Per Share:
The following describes the 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. Basic earnings per
share excludes dilution and is computed by dividing income available to common
shareholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflect the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock.
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 5,240 $ 4,491 $10,144 $12,862
Weighted average common shares outstanding 7,585 7,573 7,584 7,573
Basic earnings per share $ 0.69 $ 0.59 $ 1.34 $ 1.70
------- ------- ------- -------
------- ------- ------- -------
Net income $ 5,240 $ 4,491 $10,144 $12,862
Adjustments net of tax:
Interest expense on convertible debt 783 786 1,565 1,554
Amortization of debt offering costs 61 61 122 121
------- ------- ------- -------
Diluted net income $ 6,084 $ 5,338 $11,831 $14,537
------- ------- ------- -------
------- ------- ------- -------
Weighted average common shares outstanding 7,585 7,573 7,584 7,573
Common stock equivalents due to dilutive
effect of stock options 169 226 157 222
Shares converted from convertible debt 2,628 2,628 2,628 2,628
------- ------- ------- -------
Total outstanding shares for diluted earnings
per share computation 10,382 10,427 10,369 10,423
Diluted earnings per share $ 0.59 $ 0.51 $ 1.14 $ 1.39
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
6. Impairment of Property and Equipment:
During the second quarter, 1999, the Company determined to discontinue
its planned implementation of its LifePro computer system. To date, the Company
had capitalized $2,799 of expenditures related to this project, including
licensing costs and fees paid to outside parties for system development and
implementation. As the system was not yet placed in service, none of these costs
had previously been depreciated on the Company's Consolidated Statements of
Operations and Comprehensive Income. Upon determining not to utilize these
fixed assets, their value became fully impaired and the Company recognized the
entire amount as current period expense.
8
<PAGE>
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
THREE MONTHS ENDED JUNE 30, 1999 AND 1998:
(amounts in thousands, except per share data)
Premiums. First year premiums earned in the three month period ended
June 30, 1999 (the "1999 quarter"), including long-term care, disability, life
and Medicare supplement, increased 15.1% to $24,080, compared to $20,913 in the
same period in 1998 (the "1998 quarter"). First year long-term care premiums
earned in the 1999 quarter increased 18.1% to $23,589, compared to $19,966 in
the 1998 quarter. 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 the general public has become more
educated regarding the benefits of long-term care insurance, which has added to
its growth.
Renewal premiums earned by the Company in the 1999 quarter increased 42.7% to
$48,062, compared to $33,690 in the 1998 quarter. Renewal long-term care
premiums earned in the 1999 quarter increased 46.5% to $45,136, compared to
$30,805 in the 1998 quarter. This increase reflects renewals of a larger base of
in-force policies. The Company believes that this increase also reflects an
increase in persistency (renewals as a percentage of total prior year business).
Net Investment Income. Net investment income earned by the Company for
the 1999 quarter increased 12.5% to $5,571, from $4,950 for the 1998 quarter.
Management attributes this growth to more invested assets as a result of
higher established reserves.
Net Realized Capital Gains. During the 1999 quarter, the Company
realized $3,227 in capital gains, primarily from the sale of certain of its
equity securities investments. Capital gains include the sale of certain
securities in the Company's convertible equities portfolio, which are generally
purchased with the intent of sale upon conversion to common stock. In the 1998
quarter, the Company recognized $76 from capital gains.
Other Income. The Company recorded $1,657 in other income during the
1999 quarter, up from $89 in the 1998 quarter.
Benefits to Policyholders. Total benefits to policyholders in the 1999
quarter increased 29.4% to $49,305 compared to $38,093 in the 1998 quarter.
During the 1999 quarter, the Company paid $22,053 in claims or 30.6% of
premiums. The Company's loss ratio, or benefits to premiums, was 68.3% in the
1999 quarter, compared to 69.8% in the 1998 quarter.
The Company uses independent care managers to monitor claims and to ensure
proper utilization of policyholder benefits in its home health care coverage.
The expenses related to care management included in benefits to policyholders
were approximately $529 or .7% and $375 or .7% of premiums in the 1999 and 1998
quarters, respectively.
Commissions. Commissions to agents increased 21.4% to $23,872 in the
1999 quarter, compared to $19,666 in the 1998 quarter.
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<PAGE>
First year commissions on accident and health business in the 1999 quarter
increased 15.1% to $16,343, compared to $14,196 in the 1998 quarter,
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 69.0% in the 1999 quarter and 69.3% in the 1998 quarter.
Renewal commissions on accident and health business in the 1999 quarter
increased 43.1% to $7,077, compared to $4,944 in the 1998 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
15.3% in the 1999 quarter and 15.7% in the 1998 quarter. This ratio fluctuates
in relation to the age of the policies in force and the rates of commissions
paid to the agents.
Net Policy Acquisition Costs Deferred. The net deferred policy
acquisition costs in the 1999 quarter increased 2.9% to $12,388 compared to
$12,034 in the 1998 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.
Deferred costs are typically all costs deemed to vary with the acquisition of
new premiums. These costs include the variable portion of commissions, which are
defined as the first year commission rate less renewal commission rates, and
variable general and administrative expenses related to policy underwriting.
General and Administrative Expenses. General and administrative
expenses in the 1999 quarter increased 60.2% to $9,805, compared to $6,120 in
the 1998 quarter. The 1999 quarter includes UIG expense of $1,955, which
includes $160 goodwill amortization. While the remaining Company expense is
above 1998 quarter levels due to variable expense growth consistent with premium
growth, it is unchanged from the first quarter of 1999. Management believes
that staff additions, systems upgrades and additional product filings made
in 1998, which are reflected in the 1999 results will not be repeated in 1999,
as represented by lower quarterly expense growth.
The Company has also undertaken various expense savings initiatives, such as
remote office consolidation and the outsourcing of printing, supply and
licensing functions, which it expects to reduce future expense growth.
Loss Due to Impairment of Property and Equipment. During the 1999
quarter, the Company determined to discontinue its planned implementation of its
LifePro computer system. To date, the Company had capitalized $2,799 of
expenditures related to this project, including licensing costs and fees paid to
outside parties for system development and implementation. As the system was not
yet placed in service, none of these costs had previously been depreciated on
the Company's Consolidated Statements of Operations and Comprehensive Income.
Upon determining not to utilize these fixed assets, their value became fully
impaired and the Company recognized the entire amount as current period expense.
In conjunction with its decision to discontinue its implementation
project, the Company filed suit against the software manufacturer and several
consultants, alleging misrepresentations by all accused parties regarding the
system's capabilities and ability to meet the Company's expectations.
Provision for Federal Income Taxes. The provision for federal income
taxes recorded by the Company for the 1999 quarter increased to $2,581, compared
to $2,182 for the 1998 quarter. The effective tax rates of 33.0% and 32.7% in
the 1999 and 1998 quarters, respectively, are below the normal federal corporate
10
<PAGE>
rate as a result of small life deductions and dividend received deductions
attributable to equity investments, which are partially offset by non-deductible
goodwill amortization.
Comprehensive Income. During the 1999 quarter, the Company's investment
portfolio generated unrealized losses of $8,919 due to increased market interest
rates, compared to 1998 quarter unrealized gains of $1,210. After accounting for
deferred taxes from these gains, shareholders' equity decreased by $646 from
comprehensive losses during the 1999 quarter, compared to comprehensive income
of $5,290 in the 1998 quarter.
SIX MONTHS ENDED JUNE 30, 1999 AND 1998:
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Premiums. First year premiums earned in the six month period ended June
30, 1999 (the "1999 period"), including long-term care, disability, life and
Medicare supplement, increased 18.4% to $45,782, compared to $38,669 in the same
period in 1998 (the "1998 period"). First year long-term care premiums earned in
the 1999 period increased 22.1% to $44,739, compared to $36,648 in the 1998
period. The Company attributes its growth to continued improvements in product
offerings, which competitively meet the needs of the long term care marketplace,
and expansion into new states, such as New Jersey, Connecticut and New York. In
addition, the Company has been actively recruiting and training agents to sell
its products.
Renewal premiums earned by the Company in the 1999 period increased 38.0% to
$93,419, compared to $67,715 in the 1998 period. Renewal long-term care premiums
earned in the 1999 period increased 40.6% to $87,055, compared to $61,925 in the
1998 period. This increase reflects renewals of a larger base of in-force
policies. The Company believes that this increase also reflects an increase in
persistency (renewals as a percentage of total prior year business).
Net Investment Income. Net investment income earned by the Company for
the 1999 period increased 12.3% to $10,754, from $9,576 for the 1998 period. The
Company has focused its short-term investment strategy upon fixed income
securities in order to increase net investment income.
Net Realized Capital Gains. During the 1999 period, the Company
realized $3,843 in capital gains, generated primarily from the sale of certain
of its equity securities portfolio and from the management of its convertible
securities portfolio, which are generally sold at or near conversion of the
security to its underlying common stock. During the 1998 period, the Company
recognized $6,791 in capital gains, primarily due to the sale of its equity
securities portfolio, which it reestablished throughout 1998 and during the 1999
period.
Other Income. The Company recorded $3,097 of other income in the 1999
period, compared to $164 in the 1998 period. The recognition of $2,932 from UIG
as commission income was responsible for the majority of the increase in the
1999 period.
Benefits to Policyholders. Total benefits to policyholders in the 1999
period increased 30.9% to $94,709 compared to $72,376 in the 1998 period.
The Company's loss ratio (the ratio of benefits to policyholders to premiums)
was 68.0% in both the 1999 and 1998 periods. Management believes that the loss
ratio has remained unchanged due to new premiums, which generally require lower
reserves as a percentage of premium, collection of premium rate increases and
lower paid claims as a percentage of premium.
11
<PAGE>
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 $979 or .7% and $675 or .6% of premiums in the
1999 and 1998 periods, respectively.
Commissions. Commissions to agents increased 22.8% to $45,480 in the
1999 period compared to $37,030 in the 1998 period.
First year commissions on accident and health business in the 1999 period
increased 18.7% to $30,789, compared to $25,937 in the 1998 period,
corresponding to the increase in first year accident and health premiums and to
the issuance of younger age policies, which typically pay a higher first year
commission rate. The ratio of first year accident and health commissions to
first year accident and health premiums was 68.4% in the 1999 period and 68.6%
in the 1998 period.
Renewal commissions on accident and health business in the 1999 period increased
38.7% to $13,756, compared to $9,920 in the 1998 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 15.4% in the 1999
period and 15.6% in the 1998 period.
Net Policy Acquisition Costs Deferred. Net deferred policy acquisition
costs in the 1999 period increased 15.5% to $23,458 compared to $20,309 in the
1998 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 1999 period increased 62.7% to $19,647, compared to $12,075 in
the 1998 period. The 1999 period includes UIG expense of $3,865, including $340
goodwill amortization. While the remaining Company expense has grown over the
1998 period with overall premium growth, Management believes that current cost
savings initiatives, such as remote office consolidation and outsourcing of
certain administrative functions, will reduce this growth in the future. Expense
levels during 1999 have remained flat following various 1998 second half
increases, which included management additions, the New York Stock Exchange
listing and Y2K remediation.
Loss Due to Impairment of Property and Equipment. During the 1999
quarter, the Company determined to discontinue its planned implementation of its
LifePro computer system. To date, the Company had capitalized $2,799 of
expenditures related to this project, including licensing costs and fees paid to
outside parties for system development and implementation. As the system was not
yet placed in service, none of these costs had previously been depreciated on
the Company's Consolidated Statements of Operations and Comprehensive Income.
Upon determining not to utilize these fixed assets, their value became fully
impaired and the Company recognized the entire amount as current period expense.
Provision for Federal Income Taxes. The provision for federal income
taxes recorded by the Company for the 1999 period decreased 22.7% to $4,996,
compared to $6,467 for the 1998 period. The effective tax rates of 33.0% and
33.5% in the 1999 and 1998 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 or from
dividends received which are partially exempt from taxation.
12
<PAGE>
Comprehensive Income. During the 1999 period, the Company's investment
portfolio generated unrealized losses of $16,888 due to increased market
interest rates, compared to 1998 period unrealized losses of $3,808. After
accounting for deferred taxes from these gains, shareholders' equity decreased
by $1,002 from comprehensive losses during the 1999 period, compared to
comprehensive income of $10,349 in the 1998 period.
YEAR 2000 Readiness Disclosure
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.
Prior to the second quarter, 1999, the Company intended to replace its existing
computer system with a new system that was vendor-certified as Y2K compliant. In
the event the new system was unable to be implemented prior to January 1, 2000,
or could not process Y2K functions upon installation, the Company employed
internal and external programmers to ensure Y2K compliance of its current
operating system as a contingency. This contingency development was completed
prior to January 1999, and to date has passed all substantial testing.
During the second quarter, 1999, the Company determined to discontinue its
planned implementation of its new system, finding that the system was unable to
fully perform its expected operations. The Company determined to continue
operations utilizing its current system, which is currently processing all
long-term care operations and is believed to be fully Y2K compliant. Final
testing on all aspects of the current system will be performed during the fourth
quarter, 1999.
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.
The Company cannot guarantee that final testing will be successful. In the event
that one or all of these system tests 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
final systems testing will be successful, and does not anticipate any failures
13
<PAGE>
or unnecessary delays in its critical functions as a result of the Y2K issue. In
the event final testing fails, the Company believes that critical functions can
be performed manually until program enhancements can be made.
Since January 1999, the Company has been testing its system using Y2K dates and
has not experienced any difficulties or problems. Any policy written with an
annual collection of premium has been successfully processed since January 1999,
with no interruption of services.
The Company believes that in addition to its computer-related systems, other
operations may be affected due to embedded Y2K problems. These operations could
include, among others, telephone, electrical and security systems. The Company
has relied upon vendor certification for all such systems. In the event of
failure, the Company has identified secondary vendors for all major services.
The Company also believes that a temporary disruption of any of these services
woul have no material effect upon its financial condition or results of
operations.
The Company has spent approximately $350,000 to date related to modifying
existing systems to become Y2K compliant, and anticipates the expenditure of
approximately $50,000 more before the end of the fourth quarter, 1999. The
Company estimates that this amount represents approximately 15% of its total
information technology budget. The Company expects the impact of Y2K to have no
material impact upon its financial condition or results of operations.
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 1999 period were attributable to cash provided
by operations, cash used in investing, and cash used in financing. The Company's
cash increased by $6,980 in the 1999 period primarily due to the sale of $16,412
of its equity securities portfolio and cash from operations of $39,739. The
major provider of cash from operations was premiums used to fund additions to
reserves of $48,799 in the 1999 period. The primary uses of cash were
commissions deferred as additions to policy acquisition costs of $23,458, the
purchase of bonds of $61,226 and net cash of $9,194 paid for the acquisition of
UIG.
The Company's cash flows in the 1998 period were attributable to cash provided
by operations, cash used in investing, and cash provided by financing. The
Company's cash increased by $34,610 in the 1998 period primarily due to the sale
of $22,045 of its equity securities portfolio and cash from operations of
$27,502. The major provider of cash from operations was premiums used to fund
14
<PAGE>
additions to reserves of approximately $37,077 in the 1998 period. The primary
uses of cash were additions to policy acquisition costs of $20,309 and the
purchase of bonds of $27,794.
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 98.6% of
its cost at June 30, 1999, compared to 103.4% at December 31, 1998, with a
current unrealized loss of $4,660 at June 30, 1999, compared to an unrealized
gain of $10,455 at December 31, 1998. Its equity portfolio, which consisted of
preferred and common stock at June 30, 1999, exceeded cost by $471, compared to
$2,244 on December 31, 1998.
As of June 30, 1999, shareholders' equity was decreased by $2,765 due to
unrealized losses in the investment portfolio. As of December 31, 1998,
shareholders' equity was increased by $8,381 due to unrealized gains in the
investment portfolio.
The Company's debt currently consists primarily of a mortgage note in the amount
of $1,777 and $74,750 in convertible subordinated debt and a note payable of
$7,167 for the purchase of UIG. 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 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 fixed rate of interest. The note payable,
although carrying a zero percent coupon, is discounted at six percent and is
payable in installments over three years.
The Company consists of the Insurers, the Agencies 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 (1) continue
marketing efforts to expand its historical markets, (2) continue to expand its
network of agents and effectively market its products in states where its
insurance subsidiaries are currently licensed and (3) 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 (1) the Company fails to maintain minimum loss ratios calculated in
accordance with statutory guidelines, (2) the Company fails to meet other
requirements mandated and enforced by regulatory authorities, (3) the Company
has adverse claims experience in the future, (4) the Company cannot obtain
additional financing to support future growth, or (5) the economy continues to
15
<PAGE>
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 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 that 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.
NEW ACCOUNTING PRINCIPLES:
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 has adopted SOP 97-3, and established a gross liability
of $1,066 for future assessments and a gross asset of $1,046 for premium tax
offsets related to those assessments during the 1999 quarter.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as "derivatives") and for
hedging activities. SFAS No. 133 requires an entity to recognize all derivatives
as either assets or liabilities in the statement of financial position and
measure those instruments at fair value. While the Company is presently
evaluating the impact of SFAS No. 133, the adoption of SFAS No. 133 is not
expected to have a material impact on the Company's financial condition or
results of operations.
Statement of Position 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" (SOP 98-1) was issued by the American
Institute of Certified Public Accountants in March 1998 and provides guidance on
accounting for the costs of computer software developed or obtained for internal
use. The statement is effective for 1999 financial statements. The adoption of
SOP 98-1 has not had a material impact on the Company's financial condition or
results of operations.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
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.
A significant portion of assets and liabilities are financial instruments, which
are subject to the market risk of potential losses from adverse changes in
market rates and prices. The Company's primary market risk exposures relate to
interest rate risk on fixed rate domestic medium-term instruments and, to a
lesser extent, domestic short- and long-term instruments. The Company has
16
<PAGE>
established strategies, asset quality standards, asset allocations and other
relevant criteria for its portfolio to manage its exposure to market risk. The
Company currently has only one derivative instrument outstanding, an interest
rate swap on its mortgage, with the same bank, which is used as a hedge to
convert the mortgage to a fixed interest rate. All of the Company's financial
instruments are held for purposes other than trading. The Company's portfolio
does not contain any significant concentrations in single issuers (other than
U.S. treasury and agency obligations), industry segments or geographic regions.
Caution should be used in evaluating overall market risk from the information
below, since actual results could differ materially because the information was
developed using estimates and assumptions as described below, and because
insurance liabilities and reinsurance receivables are excluded in the
hypothetical effects (insurance liabilities represent 73.9% of total liabilities
and reinsurance receivables on unpaid losses represent 2.1% of total assets).
The hypothetical effects of changes in market rates or prices on the fair values
of financial instruments as of June 30, 1999, excluding insurance liabilities
and reinsurance receivables on unpaid losses because such insurance related
assets and liabilities are not carried at fair value, would have been as
follows:
If interest rates had increased by 100 basis points, there would have been an
approximate $10,000,000 decrease in the net fair value of the Company's
investment portfolio less its long-term debt or the related swap agreement. The
change in fair values was determined by estimating the present value of future
cash flows using models that measure the change in net present values arising
from selected hypothetical changes in market interest rate. A 200 basis point
increase in market rates at June 30, 1999 would have resulted in an approximate
$20,000,000 decrease in the net fair value. If interest rates had decreased by
100 and 200 basis points, there would have been an approximate $11,000,000 and
$23,000,000 net increase, respectively, in the net fair value of the Company's
total investments and debt.
17
<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.
During the second quarter, 1999, the Company filed a lawsuit in state court,
naming IBM and others, for breach of contract and other claims. The lawsuit,
filed Monday, June 28, 1999, in the Court of Common Pleas in Lehigh County,
Pennsylvania, names IBM, Tangent International Computer Consultants, Inc. of New
York and The Outsourcing Partnership LLC of Pennsylvania, and seeks damages for
alleged misrepresentations concerning its LifePro computer software.
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 adverse 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
The Company's Annual Meeting of Shareholders was held on May 28, 1999. At such
meeting, the following matters were voted upon by the shareholders, receiving
the number of affirmative, negative and withheld votes, as well as abstentions
and broker non-votes, set forth below each matter.
(1) Election of three persons to the Company's Board of Directors as
Class III Directors to serve until the 2002 Annual Meeting of Shareholders and
until their successors are elected and have been qualified.
Francis R. Grebe
5,411,307 Affirmative 0 Negative
--------- -------
0 Withheld 257,017 Abstentions and broker
--------- ------- non-votes
Michael F. Grill
5,412,707 Affirmative 0 Negative
--------- -------
0 Withheld 255,617 Abstentions and broker
--------- ------- non-votes
David B. Trindle
5,538,717 Affirmative 0 Negative
--------- -------
0 Withheld 129,607 Abstentions and broker
--------- ------- non-votes
18
<PAGE>
(2) Ratification of the selection of PricewaterhouseCoopers LLP as
independent public accountants for the Company and its subsidiaries for the year
ending December 31, 1998.
5,620,763 Affirmative 8,762 Negative
--------- -------
0 Withheld 38,799 Abstentions and broker
--------- ------- non-votes
ITEM 5. Other Information
On May 28, 1999, Emile G. Ilchuck resigned from the Company's Board of
Directors. The Board voted to fill the vacancy created by such resignation with
Alexander M. Clark. Mr. Clark is 65 years old and is Managing Director at
Advest, Incorporated. Advest has served as the Company's investment banker on
several transactions.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed no reports on Form 8-K during the quarter ending June
30, 1999.
19
<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 August 12, 1999 /s/ Irving Levit
--------------- --------------------------------------
Irving Levit
Chairman of the Board, President
and Chief Executive Officer
Date August 12, 1999 /s/ Cameron B. Waite
--------------- --------------------------------------
Cameron B. Waite
Chief Financial Officer
20
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<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-START> JAN-01-1999
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 330,696
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 17,505
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 348,330
<CASH> 45,382
<RECOVER-REINSURE> 13,121
<DEFERRED-ACQUISITION> 180,843
<TOTAL-ASSETS> 635,302
<POLICY-LOSSES> 237,679
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 116,257
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 83,694
0
0
<COMMON> 819
<OTHER-SE> 155,584
<TOTAL-LIABILITY-AND-EQUITY> 635,302
139,201
<INVESTMENT-INCOME> 10,754
<INVESTMENT-GAINS> 3,843
<OTHER-INCOME> 3,097
<BENEFITS> 94,709
<UNDERWRITING-AMORTIZATION> (23,458)
<UNDERWRITING-OTHER> 70,504
<INCOME-PRETAX> 15,140
<INCOME-TAX> 4,996
<INCOME-CONTINUING> 10,144
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 0
<EPS-BASIC> 1.34
<EPS-DILUTED> 1.14
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
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</TABLE>
