<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 March 31, 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 (I.R.S. Employer
incorporation of organization) Identification No.)
3440 LEHIGH STREET, ALLENTOWN, PA 18103
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(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 May 6, 1999 was 7,807,589.
<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 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"), 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
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<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Condensed Balance Sheets
(amounts in thousands)
<CAPTION>
March 31, December 31,
1999 1998
---- ----
(unaudited)
ASSETS
<S> <C> <C>
Investments:
Bonds, available for sale at market (cost of $328,396 and $310,993, respectively) $ 330,455 $ 321,448
Equity securities at market value (cost of $15,728 and $15,090, respectively) 18,399 17,334
Policy loans 118 107
--------- ---------
Total investments 348,972 338,889
Cash and cash equivalents 30,244 38,402
Property and equipment, at cost, less accumulated depreciation of
$3,249 and $3,033, respectively 10,329 9,635
Unamortized deferred policy acquisition costs 168,455 157,385
Receivables from agents, less allowance for
uncollectable amounts of $166 and $166, respectively 1,708 1,804
Accrued investment income 5,176 4,889
Cost in excess of fair value of net assets acquired, less
accumulated amortization of $1,287 and $1,029, respectively 23,091 6,349
Present value of future profits acquired 3,078 3,181
Receivable from reinsurers 12,632 12,288
Federal income tax recoverable 804 1,741
Other assets 7,907 5,989
--------- ---------
Total assets $ 612,396 $ 580,552
--------- ---------
--------- ---------
LIABILITIES
Policy reserves:
Accident and health $ 205,713 $ 190,036
Life 9,707 9,434
Policy and contract claims 111,323 105,667
Accounts payable and other liabilities 14,012 8,639
Note payable 7,167 -
Long-term debt 76,527 76,550
Deferred income taxes 30,600 32,556
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Total liabilities 455,049 422,882
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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, 8,189 and 8,189 shares issued 819 819
Additional paid-in capital 53,548 53,516
Net unrealized appreciation of securities 3,122 8,381
Retained earnings 101,564 96,660
--------- ---------
159,053 159,376
Less 606 common shares held in treasury, at cost (1,706) (1,706)
--------- ---------
157,347 157,670
--------- ---------
Total liabilities and shareholders' equity $ 612,396 $ 580,552
--------- ---------
--------- ---------
See accompanying notes to consolidated financial statements
</TABLE>
3
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<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 March 31,
----------------------------
1999 1998
---- ----
<S> <C> <C>
Revenue:
Accident and health premiums $ 66,166 $ 50,912
Life premiums 893 867
-------- --------
67,059 51,779
Net investment income 5,183 4,626
Net realized capital gains 616 6,715
Other income 1,440 76
-------- --------
74,298 63,196
Benefits and expenses:
Benefits to policyholders 45,404 34,282
Commissions 21,608 17,365
Net policy acquisition costs deferred (11,070) (8,275)
General and administrative expense 9,842 5,955
Interest expense 1,195 1,213
-------- --------
66,979 50,540
-------- --------
Income before federal income taxes 7,319 12,656
Provision for federal income taxes 2,415 4,285
-------- --------
Net income 4,904 8,371
-------- --------
Other comprehensive income:
Unrealized holding gain (loss) arising during period (7,353) 1,697
Income (tax) benefit from unrealized holdings 2,500 (577)
Reclassification adjustment for (gain) loss included in net income (616) (6,715)
Income (tax) benefit from reclassification adjustment 210 2,283
-------- --------
Comprehensive income $ (355) $ (5,059
-------- --------
-------- --------
Basic earnings per share $ 0.65 $ 1.11
Diluted earnings per share $ 0.56 $ 0.88
Weighted average number of shares outstanding 7,583 7,572
Weighted average number of shares outstanding (diluted) 10,355 10,418
See accompanying notes to consolidated financial statements
</TABLE>
4
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<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the Three Months Ended March 31,
(unaudited)
(amounts in thousands)
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Net cash flow from operating activities:
Net income $ 4,904 $ 8,371
Adjustments to reconcile net income to cash
provided by operations:
Amortization of intangible assets 452 272
Policy acquisition costs, net (11,070) (8,275)
Deferred income taxes 807 5,224
Depreciation expense 216 89
Compensation expense for agent options 27 -
Net realized capital gains (616) (6,715)
Increase (decrease) due to change in:
Receivables from agents 96 (31)
Receivable from reinsurers (344) (889)
Policy and contract claims 5,656 5,811
Policy reserves 15,950 11,457
Accounts payable and other liabilities 3,730 2,505
Federal income taxes recoverable 937 (1,229)
Accrued investment income (287) (118)
Other, net (1,457) (1,752)
-------- --------
Cash provided by operations 19,000 14,720
Cash flow from (used in) investing activities:
Net cash purchase of subsidiary (9,194) -
Proceeds from sales of bonds 12,190 6,224
Proceeds from sales of equity securities 3,236 22,045
Maturities of investments 2,869 2,995
Purchase of bonds (32,282) (2,355)
Purchase of equity securities (3,352) (193)
Acquisition of property and equipment (608) (238)
-------- --------
Cash provided by (used in) investing (27,141) 28,478
Cash flow from (used in) financing activities:
Proceeds from exercise of stock options 6 11
Repayments of long-term debt (23) (192)
-------- --------
Cash used in financing (17) (181)
-------- --------
Increase (decrease) in cash and cash equivalents (8,158) 43,017
Cash balances:
Beginning of period 38,402 11,241
-------- --------
End of period $ 30,244 $ 54,258
-------- --------
-------- --------
Acquisition of subsidiary with note payable $ (7,167) $ -
-------- --------
-------- --------
See accompanying notes to consolidated financial statements.
</TABLE>
5
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 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. Certain prior period amounts have been
reclassified to conform to 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 March 31, 1999, shareholders' equity was increased by $3,122
due to unrealized gains of $4,730 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 March 31, 1999 and December 31, 1998 are as follows:
<TABLE>
<CAPTION>
March 31, 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 U.S
Government authorities
and agencies $ 118,149 $ 121,075 $ 124,664 $ 132,031
Obligations of states and
political sub-divisions 571 627 2,660 2,864
Mortgage backed securities 49,099 46,007 10,368 10,407
Debt securities issued by
foreign governments 11,411 11,668 2,974 3,109
Corporate securities 149,166 151,078 170,327 173,037
Equities 15,728 18,399 15,090 17,334
Policy Loans 118 118 107 107
--------- --------- --------- ---------
Total Investments $ 344,242 $ 348,972 $ 326,190 $ 338,889
--------- --------- --------- ---------
--------- --------- --------- ---------
Net unrealized gain 4,730 12,699
--------- ---------
$ 348,972 $ 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 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.
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:
On November 25, 1998, the Company entered a purchase agreement to acquire
all of the common stock of United Insurance Group Agency, Inc., a Michigan based
consortium of long-term care insurance agencies. The acquisition was effective
January 1, 1999, 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, is 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.
5. Reconciliation of Earnings Per Share:
A reconciliation of the numerator and denominator of the basic earnings per
share computation to the numerator and denominator of the diluted earnings per
share computation follows. Basic earnings per share excludes dilution and is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share reflect the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock.
7
<PAGE>
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
(amounts in thousands, except per share data)
(unaudited)
Three Months Ended Mar 31,
--------------------------
1999 1998
---- ----
Net income $ 4,904 $ 8,371
Weighted average common shares outstanding 7,583 7,572
Basic earnings per share $ 0.65 $ 1.11
------- -------
------- -------
Net income $ 4,904 $ 8,371
Adjustments net of tax:
Interest expense on convertible debt 783 773
Amortization of debt offering costs 61 60
------- -------
Diluted net income $ 5,748 $ 9,204
------- -------
------- -------
Weighted average common shares outstanding 7,583 7,572
Common stock equivalents due to dilutive
effect of stock options 144 218
Shares converted from convertible debt 2,628 2,628
------- -------
Total outstanding shares for diluted earnings
per share computation 10,355 10,418
Diluted earnings per share $ 0.56 $ 0.88
------- -------
------- -------
8
<PAGE>
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
THREE MONTHS ENDED MARCH 31, 1999 AND 1998:
(amounts in thousands, except per share data)
Accident and Health Premiums. First year accident and health premiums
earned in the three month period ended March 31, 1999 (the "1999 quarter"),
including long-term care and Medicare supplement, increased 24.6% to $21,320,
compared to $17,106 in the same period in 1998 (the "1998 quarter"). First year
long-term care premiums earned in the 1999 quarter increased 28.3% to $21,150,
compared to $16,491 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. The Company has expanded its sales force
through the appointment and licensing of new, national general agencies. Also,
management has actively recruited new agents and filed new products in states
other than in its normal geographic concentration.
Renewal accident and health premiums earned by the Company in the 1999 quarter
increased 35.2% to $43,214, compared to $31,950 in the 1998 quarter. Renewal
long-term care premiums earned in the 1999 quarter increased 34.7% to $41,919,
compared to $31,119 in the 1998 quarter. This increase reflects renewals of a
larger base of in-force policies. Renewal Medicare supplement premiums in the
1999 quarter increased 55.8% to $1,295, compared to $831 in the 1998 quarter.
Net Investment Income. Net investment income earned by the Company for the
1999 quarter increased 12.0% to $5,183, from $4,626 for the 1998 quarter. The
Company also earned $616 in capital gains during the 1999 quarter. These gains
were primarily attributable to the sale from the Company's investment portfolio
of convertible securities and preferred equity securities. This portfolio is
managed in order to maximize investment income. In the 1998 quarter, the Company
recognized approximately $6,400 in capital gains due to the sale of its common
stock portfolio.
Other Income. The Company recognized $1,440 of other income in the 1999
quarter, compared to $76 in the 1998 quarter. The 1999 increase was primarily
attributable to the acquisition of United Insurance Group Agency, Inc. (UIG)
during 1999, which as a sales agency recorded $1,382 in commission income in the
1999 quarter.
Benefits to Policyholders. Total benefits to policyholders in the 1999
quarter increased 32.4% to $45,404 compared to $34,282 in the 1998 quarter. In
addition to paid claims, benefits to policyholders increased $15,950 in the 1999
quarter due to increases in policy reserves (the actuarial reserve established
for the future incurral of claims) and $5,656 in policy and contract claim
reserves (the reserve established for current claims incidence). The Company's
loss ratio, or benefits to premiums, was 67.7% in the 1999 quarter, compared to
66.2% 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 $450 or .7% and $300 or .6% of premiums in the 1999 and 1998
quarters, respectively.
9
<PAGE>
Commissions. Commissions to agents increased 24.4% to $21,608 in the 1999
quarter compared to $17,365 in the 1998 quarter.
First year commissions on accident and health business in the 1999 quarter
increased 23.1% to $14,446, compared to $11,739 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 67.8% in the 1999 quarter and 68.6% in the 1998 quarter.
Renewal commissions on accident and health business in the 1999 quarter
increased 34.2% to $6,679, compared to $4,976 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
15.5% in the 1999 quarter and 15.6% 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.
Commission expense in the 1999 quarter was reduced by $550 due to the
elimination of commissions paid to UIG by Company subsidiaries.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition
costs in the 1999 quarter increased 33.8% to $11,070 compared to $8,275 in the
1998 quarter, 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.
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 the 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 65.3% to $9,842, compared to $5,955 in the 1998
quarter. This increase is due to variable expense growth, management additions,
information technology expenditures and support staff additions. UIG costs added
$1,910 to general and administrative expenses in the 1999 quarter, including
amortization of goodwill of $180 from the purchase.
Provision for Federal Income Taxes. The provision for federal income taxes
recorded by the Company for the 1999 quarter was $2,415, compared to $4,285 for
the 1998 quarter. The effective tax rates of approximately 33% and 34% in the
1999 and 1998 quarters, respectively, are below the normal federal corporate
rate as a result of of small life deductions and dividend received deductions
attributable to equity investments.
Comprehensive Income. During the 1999 quarter, the Company's investment
portfolio generated unrealized losses of $7,353 due to higher market interest
rates, compared to 1998 quarter gains of $1,696. After accounting for deferred
taxes from these gains, shareholders' equity decreased by $356 from
comprehensive losses during the 1999 quarter, compared to comprehensive income
of $5,059 in the 1998 quarter.
10
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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. All
application systems that 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.
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 ) and/or seek other vendors which
are compliant.
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 has spent approximately $300,000 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
Company estimates that this amount represents approximately 15% of its total
information technology budget. 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
11
<PAGE>
reasons rather than for Y2K. The Company expects the impact of Y2K to have no
material impact upon its financial condition and 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, investment income and maturities of
investments. The Company has provided, and may continue to provide, cash through
public offerings of its common stock, capital markets activities or debt
instruments. The primary uses of cash are policy acquisition costs (principally
commissions), payments to policyholders, investment purchases and general and
administrative expenses.
Statutory requirements allow insurers to pay dividends only from statutory
earnings as approved by the state insurance commissioner. Statutory earnings are
generally lower than publicly reported earnings due to the immediate or
accelerated recognition of all costs associated with premium growth and benefit
reserves. The Company has not and does not intend to pay shareholder dividends
in the near future due to these requirements, choosing to retain statutory
surplus to support continued premium growth.
The Company's cash flows in the 1999 quarter were attributable to cash
provided by operations, cash used in investing, and cash provided by financing.
The Company's cash decreased by $8,158 in the 1999 quarter primarily due to the
purchase of UIG for $9,194 in net cash and a note payable for $8,078. The major
provider of cash from operations was premiums used to fund additions to reserves
of $21,606 in the 1999 quarter. The primary uses of cash, other than the UIG
acquisition were to policy acquisition costs of $11,070 and the purchase of
bonds of $32,282.
The Company's cash increased by $43,017 in the 1998 quarter primarily due
to the sale of $22,045 of its equity securities portfolio and cash from
operations of $14,720. The major provider of cash from operations was premiums
used to fund additions to reserves of $17,210 in the 1998 quarter.
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 approximately 100.6% of its cost at March 31, 1999, compared to
103.4% on December 31, 1998, with a current unrealized gain of $2,059 at March
31, 1999, compared to $10,455 on December 31, 1998. Its equity portfolio, which
consisted of common and preferred stock at March 31, 1999, exceeded cost by
$2,671, compared to $2,244 on December 31, 1998.
As of March 31, 1999, shareholders' equity was increased by $3,122 due to
unrealized gains of $4,730 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 Company's debt currently consists primarily of a mortgage note in the
approximate amount of $1,800 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
12
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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 controls
100% of the voting stock its subsidiaries insurers. In the event the Parent is
unable to meet its financial obligations, becomes insolvent, or discontinues
operations, its subsidiaries 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 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 from
current funds.
In the event (i) the Company fails to maintain minimum loss ratios
calculated in accordance with statutory guidelines, (ii) the Company fails to
meet other requirements mandated and enforced by regulatory authorities, (iii)
the Company has adverse claims experience in the future, (iv) the Company is
unable to obtain additional financing to support future growth, or (v) the
economy adversely affect the buying power of senior citizens, the Company's
results of operations, liquidity and capital resources could be adversely
affected.
Some of the information presented in this report 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 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, the Company's ability to expand
its network of productive independent agents and the performance of the
Company's investment portfolio.
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
13
<PAGE>
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.
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
established strategies, asset quality standards, asset allocations and other
relevant criteria for its portfolio to manage its exposure to market risk. In
addition, maturities are structured after projecting liability cash flows with
actuarial models. 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 71.8% 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 March 31, 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 increase 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 March 31, 1999 would have resulted in an approximate
$19,000,000 increase 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 decrease, respectively, in the net fair value of the Company's
total investments and debt.
14
<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
Not Applicable
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:
United Insurance Group Agency, Inc. Stock Purchase and Employment
Agreements.
15
<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: May 14, 1999 /s/ Irving Levit
------------------- ----------------------------------------
Irving Levit
Chairman of the Board, President and
Chief Executive Officer
Date: May 14, 1999 /s/ Cameron B. Waite
------------------- ----------------------------------------
Cameron B. Waite
Chief Financial Officer
16
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<MULTIPLIER> 1,000
<S> <C>
<PERIOD-START> JAN-01-1999
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 330,455
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0
0
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67,059
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<INCOME-PRETAX> 7,319
<INCOME-TAX> 2,415
<INCOME-CONTINUING> 4,904
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<EPS-PRIMARY> 0.65
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