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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _______________ to _______________
Commission File No. 0-15972
PENN TREATY AMERICAN CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania 23-1664166
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(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
3440 Lehigh Street, Allentown, Pennsylvania 18103
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 965-2222
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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Common Stock, $.10 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
----------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 11, 1999 was $187,350,408.
The number of shares outstanding of the registrant's common stock as of
March 11, 1999 was 7,806,267.
Documents Incorporated By Reference:
(1) Proxy Statement for the 1998 Annual Meeting of Shareholders -
Part III
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PART I
Item 1. Business
(a) General
Penn Treaty American Corporation (the "Company") is one of the leading
providers of long-term nursing home and home health care insurance. The Company
markets its products primarily to persons age 65 and over through independent
insurance agents and underwrites its policies through its subsidiaries: Penn
Treaty Network America Insurance Company ("PTNA"), American Network Insurance
Company ("ANIC"), American Independent Network Insurance Company of New York
("AINIC") and Penn Treaty Life Insurance Company ("PTLIC"), of which all of the
common stock was sold by the Company on December 30, 1998 (collectively "the
Insurers"). The Company's principal products are individual fixed, defined
benefit accident and health insurance policies covering long-term skilled,
intermediate and custodial nursing home care and home health care. Policies are
designed to make the administration of claims simple, quick and sensitive to the
needs of the policyholders. As of December 31, 1998, long-term nursing home care
and home health care policies accounted for approximately 93% of the Company's
total annualized premiums in-force.
The Company introduced its first long-term nursing home care insurance
product in 1975 and its first home health care product in 1987. In late 1994,
the Company introduced its Independent Living policy, which provides coverage
over the full term of the policy for home care services furnished by an
unlicensed homemaker or companion as well as a licensed care provider. In late
1996 and throughout 1997, the Company began its introduction of its Personal
Freedom policies, which provide comprehensive coverage for nursing home and home
health care. The Company also introduced in late 1996 its Assisted Living
policy, which, as a nursing home plan, provides enhanced benefits and includes a
home health care rider. Available policy riders allow insureds to tailor their
policies and include an automatic annual benefit increase, benefits for adult
day-care centers and a return of premium benefit. The Company also markets and
sells life, disability, Medicare supplement and other hospital care insurance
products. During 1998, the Company developed its Secured Risk Nursing Facility
and Post Acute Recovery Plans, which provide limited benefits to higher risk
applicants.
Long-Term Care Industry
Long-term care insurance policies were first introduced in the 1970's.
Significant sales of these policies commenced in the mid-1980's. Typical early
policies provided limited nursing home coverage for a limited benefit period and
were subject to certain restrictions such as prior hospitalization and a
certificate of medical necessity. As awareness of the long-term care needs of
senior citizens has grown, the long-term care insurance industry has responded
with more diverse insurance offerings to provide needed benefits in a
cost-effective fashion. Requirements for prior hospitalization and medical
necessity are no longer standard and benefit periods have been extended up to
the life of the insured. Coverage for custodial care and home health care are
now offered by many insurers.
A survey conducted by a national industry organization estimated that the
number of long-term care policies in-force grew from 815,000 in 1987 to
approximately five million by the end of 1996, an average increase of more than
22% annually since 1987. The emphasis on long-term care insurance has evolved
primarily as a result of the aging of society, increasing life expectancies and
the escalating cost of care. According to a 1992 survey of the U.S. Bureau of
the Census, by the year 2050 the population age 65 and over is expected to grow
to approximately 98 million, or more than three times the 1990 figure, while the
population age 85 and over is expected to grow to 26 million, or more than eight
times the 1990 figure. Another study has suggested that at age 65 a person has a
43% chance of being confined to a nursing home during some time in his or her
life. The cost of care has also increased significantly. The U.S. Census Bureau
has estimated that from 1980 to 1997, the cost of care for Medicaid nursing home
residents increased from $8.7 billion to $32.5 billion.
Other factors causing growth of the long-term care insurance industry
include the lack of suitable alternatives for financing long-term care. There
are four primary alternatives to long-term care insurance: government programs
such as Medicare and Medicaid, personal assets, dependence on family members and
life insurance. Medicare offers only limited coverage of the cost of long-term
care. Medicaid is the single largest source of financing for nursing home care
in the U.S. However, since eligibility for Medicaid requires that its recipients
have a very small amount of assets or income, many individuals are forced to
deplete their assets in order to become eligible.
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Strategy
The Company's objective is to strengthen its position as a leader in
providing long-term care insurance to senior citizens. To meet this objective
and to continue to increase profitability, the Company is implementing the
following strategies:
Developing and qualifying new products with state insurance regulatory
authorities. As an innovator in home health care insurance, the Company has been
an originator in the field of long-term care insurance for over twenty-four
years. The Company introduced its Independent Living policy in 1994 which
provides coverage over the full term of the policy for services furnished by an
unlicensed homemaker or companion or a licensed care provider. More recently,
the Company began its introduction of its Personal Freedom policies, which
provide comprehensive coverage for nursing home and home health care. The
Company also introduced its Assisted Living policy, which, as a nursing home
plan, provides enhanced benefits and includes a home health care rider. During
1998, the Company developed its Secured Risk Nursing Facility and Post Acute
Recovery Plans, which provide limited benefits to higher risk applicants. The
Company intends to continue to develop new insurance products designed to meet
the needs of senior citizens and their families.
Increasing the size and productivity of the Company's network of independent
agents. The Company has significantly increased the number of producing agents
(agents who produce premiums for the Company on new policies) selling its
policies by focusing its efforts on certain geographic areas of the country
which have larger concentrations of individuals age 65 and over. The Company
intends to continue to recruit agents in these states and believes that it will
be able to continue to expand its business in these and other states.
Seeking to acquire existing insurance companies and blocks of in-force policies
underwritten by other insurance companies. The Company has augmented its premium
revenue from time to time through the acquisition of existing insurance
companies and blocks of policies underwritten by other insurance companies. The
Company intends to continue to evaluate complementary acquisitions and policy
blocks as a means of enhancing its revenue base.
Introducing existing products in newly licensed states. The Company is currently
licensed to market products in 50 states and the District of Columbia. Although
not all of the Company's products are currently eligible for sale in all of
these jurisdictions, the Company actively seeks to expand the regions where it
sells its products. Through the acquisition of ANIC in 1996, the Company
acquired licenses to conduct business in some new states, including New Jersey
and Massachusetts. These states are considered by the Company's management to
offer significant opportunities for sales growth. In addition, in 1998 the
Company received a license to underwrite accident and health insurance products
in New York through AINIC.
Corporate Background
The Company, which is registered and approved as a holding company under
the Pennsylvania Insurance Code, was incorporated in Pennsylvania on May 13,
1965 under the name Greater Keystone Investors, Inc., and changed its name to
Penn Treaty American Corporation on March 25, 1987. PTLIC was incorporated in
Pennsylvania under the name Family Security Life Insurance Company on June 6,
1962, and its name was changed to Quaker State Life Insurance Company on
December 29, 1969, at which time it was operating under a limited insurance
company charter. Quaker State Life Insurance Company was acquired by the Company
on May 4, 1976, and its name was changed to Penn Treaty Life Insurance Company.
On July 13, 1989, PTLIC acquired all of the outstanding capital stock of AMICARE
Insurance Company (formerly Fidelity Interstate Life Insurance Company), a stock
insurance company organized and existing under the laws of Pennsylvania which
changed its name to Network America Life Insurance Company on August 1, 1989.
On August 30, 1996, the Company consummated the acquisition of all of the
issued and outstanding capital stock of Health Insurance of Vermont, Inc.
("HIVT"), which has since changed its name to American Network Insurance
Company.
Senior Financial Consultants Company (the "Agency"), an insurance agency
owned by the Company, was incorporated in Pennsylvania on February 23, 1988
under the name Penn Treaty Service Company. On February 29, 1988, the Agency
acquired, among other assets, the rights to renewal commissions on a certain
block of PTLIC's existing in-force policies from Cher-Britt Agency, Inc., and an
option to purchase the rights to renewal commissions on a certain block of
PTLIC's existing policies from Cher-Britt Insurance Agency, Inc., an affiliated
company of Cher-Britt Agency, Inc. In connection with this acquisition, on March
3, 1988, the name of the Agency was changed to Cher-Britt Service Company. The
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option was exercised on March 3, 1989. The Agency's name was changed to Senior
Financial Consultants Company on August 9, 1994.
On December 31, 1997, PTLIC dividended its common stock ownership of PTNA
to the Company. At that time, PTNA assumed substantially all of the assets,
liabilities and premium in-force of PTLIC through a purchase and assumption
reinsurance agreement. On December 30, 1998, the Company sold its common stock
interest in PTLIC to an unaffiliated insurer. All remaining policies in-force
were assumed by PTNA through a 100% quota share agreement.
On November 25, 1998, the Company entered into 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.
b) Insurance Products
Since 1976, the Company has developed, marketed and underwritten fixed,
defined benefit accident and health insurance policies designed to be responsive
to changes in (i) the characteristics and needs of the senior citizen market,
(ii) governmental regulations and governmental benefits available for this
population segment and (iii) the health care and long-term care industries in
general. As of December 31, 1998, approximately 93% of the Company's total
annualized premiums in-force were derived from long-term care policies which
include nursing home and home health care policies. The Company's other lines of
insurance include (i) life insurance, (ii) Medicare supplement, (iii)
blue-collar disability coverage and (iv) various accident and health policies
and riders. The Company solicits input from both its independent agents and its
policyholders with respect to the changing needs of its insureds. In addition,
Company representatives regularly attend seminars to monitor significant trends
in the industry.
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The following table sets forth, as of the dates indicated, and for each
class of policies, the annualized premiums in-force, the percentage of total
annualized premiums, the number of policies in-force, and the average premium
per policy. Policies are classified by their base coverage but may include a
rider for a different coverage. For example, if a policyholder purchased a home
health care policy with a nursing home rider, premiums collected in connection
with the nursing home rider would be included in the home health care class.
<TABLE>
<CAPTION>
(annualized premiums in $000's)
Year ended December 31,
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1996 1997 1998
<S> <C> <C> <C> <C> <C> <C>
Nursing home care and comprehensive coverage:
Annualized premiums $ 89,692 62.6% $121,819 67.4% $182,977 74.0%
Number of policies 60,874 78,137 115,802
Average premium per policy $ 1,473 $ 1,559 $ 1,580
Long term home health care:
Annualized premiums $ 38,609 26.9% $ 42,921 23.8% $ 47,644 19.4%
Number of policies 34,594 38,553 41,040
Average premium per policy $ 1,116 $ 1,113 $ 1,161
Disability insurance
Annualized premiums $ 7,092 4.9% $ 7,145 4.0% $ 6,715 2.7%
Number of policies 16,674 16,373 15,704
Average premium per policy $ 425 $ 436 $ 428
Medicare supplement:
Annualized premiums $ 3,206 2.2% $ 4,248 2.4% $ 5,506 2.2%
Number of policies 2,757 4,018 4,970
Average premium per policy $ 1,163 $ 1,057 $ 1,108
Life insurance:
Annualized premiums $ 3,629 2.5% $ 3,567 2.0% $ 3,791 1.5%
Number of policies 6,112 6,262 6,752
Average premium per policy $ 594 $ 570 $ 562
Other insurance:
Annualized premiums $ 1,163 0.8% $ 1,015 0.6% $ 566 0.2%
Number of policies 6,509 5,827 3,377
Average premium per policy $ 179 $ 174 $ 168
Total annualized premiums in force (1) $143,391 100% $180,715 100% $247,201 100%
Total Policies 127,520 149,170 187,645
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(1) Excludes credit life and credit accident and health insurance premiums
in-force. Credit insurance premiums in-force are calculated as the cumulative
total of one-time premiums received by the Company for policies issued for terms
of up to 120 months. Credit insurance premiums in-force for the years ended
December 31, 1996, 1997, and 1998 were approximately $199,000, $180,000 and
$134,000, respectively.
Long-Term Care Generally. The majority of the Company's long-term care policies
is written on an annual basis and provides for guaranteed renewability at then
current premium rates at the option of the insured. The insured may elect to pay
premiums on a monthly, quarterly, semi-annual or annual basis. In addition, the
Company offers an automatic payment feature that allows policyholders to have
premiums automatically withdrawn from a checking account. The Company may
increase premium rates on a particular form of policy only upon approval of the
applicable insurance regulatory authority in each state.
As a supplement to some of its long-term care policies, the Company offers
various riders providing benefits, such as an automatic annual benefit increase
to help offset the effects of inflation and a return of premium option. The
return of premium benefit rider provides that after a policy has been in-force
for ten years, the policyholder is entitled to a return of 80% of all premiums
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paid during the ten year period less any claims paid by the Company. If,
however, claims exceed 20% of the premiums paid during the ten year period, no
return of premium is made. In addition, in most states the rider provides for a
pro-rata return of premium in the event of death or surrender beginning in the
sixth year. The Company also offers and encourages the purchase of home health
care riders to supplement its nursing home policies and nursing home riders to
supplement its home health care policies.
In the past, the Company offered numerous other riders to supplement its
long-term care policies. The need, however, for many of these riders has been
eliminated due to the incorporation of many of these benefits into the basic
coverage under the Company's newest long-term care policies. Among the built-in
benefits provided under the long-term care policies currently marketed by the
Company are hospice care and adult day care benefits, survivorship benefits (in
California only), and restoration of benefits. These policies also provide a
yearly wellness benefit (a payment made to policyholders who have not made a
claim, also available only in California), after the first year of the policy.
Long-Term Nursing Home Care. The Company's long-term nursing home care policies
generally provide a fixed benefit payable during periods of nursing home
confinement prescribed by a physician or necessitated by the policyholder's
cognitive impairment or inability to perform two or more activities of daily
living. These policies include built-in benefits for alternative plans of care,
waiver of premium after 90 days of benefit payments on a claim and unlimited
restoration of the policy's maximum benefit period. All levels of nursing care,
including skilled, custodial (assisted living) and intermediate care, are
covered and benefits continue even when the policyholder's required level of
care changes. Skilled nursing care refers to professional nursing care provided
by a medical professional (a doctor or registered or licensed practical nurse)
located at a licensed facility which cannot be provided by a non-medical
professional. Assisted living care generally refers to non-medical care, which
does not require professional treatment and can be provided by a non-medical
professional with minimal or no training. Intermediate nursing care is designed
to cover situations, which would otherwise fall between skilled and assisted
living care and includes situations in which an individual may require skilled
assistance on a sporadic basis.
The Company's current long-term nursing home care policies provide benefits
which are payable over periods ranging from one to five years and also for
lifetime coverage. These policies provide for a fixed daily benefit ranging from
$40 to $250 per day. Certain of the Company's nursing home care policies provide
benefits which are payable over periods ranging from six months to five years
and also with lifetime coverage, and from $800 to $5,000 per month of nursing
home benefits. The Company's Personal Freedom policies also provide
comprehensive coverage for nursing home and home health care, offering benefit
"pools of coverage" ranging from $75,000 to $250,000 total coverage, as well as
lifetime coverage. According to an independent study published in 1994, the
average cost of nursing home care was estimated to be approximately $37,000 per
year, resulting in an aggregate of more than $85,000 for the average nursing
home stay of approximately 2.3 years.
Long-Term Home Health Care. The Company's home health care policies generally
provide a benefit payable on an expense-incurred basis during periods of home
care prescribed by a physician or necessitated by the policyholder's cognitive
impairment or inability to perform two or more activities of daily living. These
policies cover the services of registered nurses, licensed practical nurses,
home health aides, physical therapists, speech therapists, medical social
workers and other similar home health practitioners. Benefits for home health
care policies currently being marketed by the Company are payable over periods
ranging from six months to five years, and also covering lifetime, and provide
from $40 to $160 per day of home benefits. The Company's home health care
policies also include built-in benefits for waiver of premium and unlimited
restoration of the policy's maximum benefit period.
In late 1994, the Company introduced its Independent Living policy. This
policy provides coverage over the full term of the policy for services furnished
by a homemaker, including a member of the insured's family, who is not a
qualified or licensed care provider ("Homemaker Services"). Homemaker Services
include cooking, shopping, housekeeping and assisting the insured with such
activities as laundry, correspondence, using the telephone and paying bills.
Historically, only limited coverage had been provided under certain of the
Company's home health care policies for Homemaker Services, typically for a
period of up to 30 days per calendar year during the term of the policy. The
Company's Independent Living policies covered disclosed pre-existing conditions
immediately upon policy issuance.
The Independent Living policy provides that the Company will waive the
elimination period, the time at the beginning of the period during which care is
provided for which no benefits are available under the policy (usually twenty
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days), if the insured agrees to utilize an independent care management agency
("Care Manager") referred by the Company. The Care Manager is engaged by the
Company at the time a claim is submitted to prepare a written assessment of the
insured's condition and to establish a written plan of care. The Company
believes that the Independent Living policy, which represents a significant
expansion of the benefits previously available for Homemaker Services, is the
first of its kind. The Company has subsequently incorporated the use of Care
Management in all of its new home health care policies.
The Company's Personal Freedom policy was first introduced during the
fourth quarter of 1996 and is currently being marketed in those states in which
regulatory approval has been received. This product is a comprehensive coverage
policy, which combines long-term care and home health care insurance. When
policyholders purchase this policy, with face value benefits ranging from
$50,000 to unlimited coverage, they may then access up to the face amount of the
policy for nursing home or home health care as needed subject to maximum daily
limits.
The Secured Risk Nursing Facility Plan was developed to meet the needs of
individuals having difficulty obtaining coverage due to certain medical
conditions. This plan offers protection to such individuals by providing
coverage for care in a nursing facility, or in the insured's home if he or she
chooses the optional Home Health Care Benefits. Features of this plan include
coverage for pre-existing conditions after six months, guaranteed renewal for
life, premiums that will not increase with age, and there is no prior
hospitalization required. An optional Lifetime Inflation Rider provides for an
increase of the selected Daily Benefit Amount, by 5% annually, on each
anniversary date for the lifetime of the policy. An optional Nonforfeiture
Shortened Benefit Rider provides the insured with the right to maintain a
portion of their benefit period in the event their policy lapses after being
continuously in-force for at least three (3) years.
The Post Acute Recovery Care Plan was designed to fill the gap in today's
dynamic health care environment in which early discharge after surgery forces
those who still require nursing care or medical supervision to shift their
recovery to nursing facilities or their own homes. The Post Acute Recovery Plan
coupled with optional home health care benefits, pays for medical recovery, in a
facility or in the insured's home, when their traditional health care coverage
stops. Features of this plan include immediate coverage (no elimination period
or deductible), coverage for pre-existing conditions after six months,
guaranteed renewal and premiums that will not increase with age. The Company
offers a "Care Solutions" service with this plan, in which a Care Coordinator
works with the insured to design a plan of care suited to meet his or her
individual needs. An optional Lifetime Inflation Rider provides for an increase
of the selected Daily Benefit Amount, by 5% annually, on each anniversary date
for the lifetime of the policy.
Disability Insurance. The Company underwrites and markets disability income
insurance entirely on an individual basis through ANIC. The various disability
policies concentrate on serving working class or "blue collar" individuals or
employees. The policies provide for benefit periods ranging from six months to
60 months with monthly benefit amounts ranging from $250 to $3,000. The Company
also offers mortgage disability and accident only disability policies.
Life Insurance. Beginning in August 1993, the Company began to market actively
its whole life insurance products which were approved by various state insurance
authorities during 1992 and 1993. These policies have face amounts of $2,000 to
$25,000 for individuals age 50-80 years and $2,000 to $10,000 for individuals
age 80-85 years. For the convenience of the insured, the Company offers three
premium payment options for these policies: (i) monthly, quarterly, semi-annual
or annual payments; (ii) one-time single premium payment; or (iii) two, three
and five year payment plans. These policies were developed to be sold by the
Company's agents to senior citizens so as to complete the Company's portfolio of
insurance products.
The life insurance products currently marketed by the Company have been
designed for the senior citizen market. The Company previously marketed life
insurance policies, including annual renewable term and whole life policies, to
all ages of insureds.
Medicare Supplement. The Company writes policies designed to provide coverage to
supplement benefits available under Medicare, such as payment of deductible
amounts. OBRA '90 enacted various changes in Medicare reimbursement, set more
stringent standards for Medicare supplement insurance policies and required that
states adopt these new standards in July 1992. OBRA '90 sets forth ten federally
standardized benefit plans of which the Company offers five such plans in most
states. With respect to these benefit packages, companies writing Medicare
supplement coverages must adopt at least the Basic Plan, which covers Medicare
Part A coinsurance amounts for in-patient hospitalization (without the Part A
deductible), the cost of the first three pints of blood and 20% of allowable
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charges under Medicare Part B. The other nine plans provide for the Basic Plan
coverage in addition to more extensive benefits such as skilled nursing home
coinsurance amounts, the Medicare Part A deductible, the Medicare Part B
deductible, 100% of Medicare Part B Excess Charges, Foreign Travel Emergency
Care, At-Home Recovery, Extended Drug Coverage and Preventive Care.
All Medicare supplement benefit plans offered by the Company are subject to
"open enrollment" and the Company is required to issue a policy to any person
applying for Medicare supplement insurance within six months of becoming
eligible for Medicare Part B, which generally occurs within the first six months
after a person's 65th birthday.
Other Insurance. The Company also sells other insurance products including
accidental death and dismemberment policies and cancer policies, of which the
aggregate premiums represented 0.2% of the Company's total annualized premium
in-force as of December 31, 1998.
(c) Marketing and Expansion
The Company's goal is to underwrite, market and sell its products
throughout the United States. The Company focuses its marketing efforts
primarily in those states (i) where it has successfully developed networks of
agents and (ii) which have the highest concentration of individuals whose
financial status and insurance needs are compatible with its products.
Agents. The Company employs no agents directly but relies instead on
relationships with independent agents and their sub-agents. In 1998, the
Company's policies were marketed through approximately 30,000 licensed agents.
The Company provides assistance to its agents through the use of seminars,
underwriting training and field representatives who consult with agents on
underwriting matters, assist agents in research and accompany agents on
marketing visits to current and prospective policyholders.
Each independent agent must be authorized by contract to sell the Company's
products in each particular state in which the agent and the Company are
licensed. Some of the Company's independent agents are large general agencies
with many sales persons (sub-agents), while others are individuals operating as
sole proprietors. Some independent agents sell multiple lines of insurance,
while others concentrate primarily or exclusively on accident and health
insurance.
The Company generally does not impose production quotas or assign exclusive
territories to agents. The amount of insurance written for the Company by
individual independent agents varies. The Company periodically reviews and
terminates its agency relationships with non-producing or under-producing
independent agents or agents who do not comply with the Company's guidelines and
policies with respect to the sale of its products.
The Company is actively engaged in recruiting and training new agents.
Sub-agents are recruited by the independent agents and are licensed by the
Company with the appropriate state regulatory authorities to sell the Company's
policies. Independent agents are generally paid higher commissions than those
employed directly by an insurance company, in part to account for the expenses
of operating as an independent agent. The Company believes that the commissions
it pays to independent agents are competitive with the commissions paid by other
insurance companies selling similar policies. The independent agent's right to
renewal commissions is vested and commissions are paid as long as the policy
remains in-force, provided the agent continues to abide by the terms of the
contract. The Company generally permits its established independent agents to
collect the initial premium with the application and remit such premium to the
Company less the commission. New independent agents are required to remit the
full amount of initial premium with the application. The Company provides
assistance to its independent agents in connection with the processing of
paperwork and other administrative services.
Marketing General Agents. The Company selectively utilizes marketing general
agents for the purpose of recruiting independent agents and developing networks
of agents in various states. The Company has a marketing general agent for the
purpose of generating business for PTNA in various states. This marketing
general agent receives an overriding commission on business written in return
for recruiting, training, and motivating the independent agents. In addition,
this marketing general agent functions as a general agent for PTNA in various
states. In its capacity as marketing general agent and general agent, this agent
accounted for 21%, 18% and 17% of the total premiums earned by the Company
during 1996, 1997 and 1998, respectively.
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General Agents. The ten independent agents accounting for the most new business
premium revenue accounted for approximately 7% of the Company's new business
written during 1998. No other single grouping of agents accounted for more than
10% of the Company's new premium written in 1998. No underwriting or claims
processing authority has been delegated to any agents of the Company.
Group and Franchise Insurance. The Company also sells a relatively small amount
of group insurance. True group insurance ("Group Insurance") may be sold by the
Company through the issuance of a Group Master Policy to a group formed for
purposes other than the purchase of insurance, such as an employee group, an
association or a professional organization. The Group Master Policy is issued to
the group and all participating members are issued certificates of insurance,
which describe the benefits available under the policy. Eligibility for
insurance is guaranteed to all members of the group without an underwriting
review on an individual basis. The Company also sells franchise insurance
("Franchise Insurance") from time to time, which is individually underwritten
policies sold to an association or group. While Franchise Insurance is generally
presented to an employee group, association or professional organization, which
endorses the insurance, the policies are issued to individual group members.
Each application is underwritten and issuance of policies is not guaranteed to
members of the franchise group. The Company is currently seeking to expand its
Group Insurance and Franchise Insurance business and has recently enhanced its
marketing efforts towards this end. The Company's management considers these
areas to offer significant opportunities for sales growth.
Markets. The following chart shows premium revenues by state for each of the
states where the Company does business:
($000)
Year Ended December 31 Current
Year --------------------------- Year %
State Entered (l) 1996 1997 1998 of Total
- - ----- ----------- ---- ---- ---- --------
(in $000's)
Arizona 1988 $ 5,284 $ 7,253 $ 10,608 5%
California 1992 17,403 23,462 33,089 15%
Florida 1987 38,394 43,638 53,607 24%
Georgia 1990 1,545 1,737 2,174 1%
Illinois 1990 5,160 7,771 12,132 5%
Iowa 1990 1,805 2,081 2,976 1%
Maryland 1987 2,441 2,314 2,682 1%
Michigan 1989 2,460 3,463 4,108 2%
Missouri 1990 2,673 2,809 3,817 2%
Nebraska 1990 1,538 2,130 3,162 1%
North Carolina 1990 3,074 4,334 6,122 3%
Ohio 1989 3,682 4,428 7,162 3%
Pennsylvania 1972 22,056 24,420 28,821 13%
South Dakota 1990 1,845 2,269 2,743 1%
Texas 1990 3,550 3,809 6,732 3%
Virginia 1989 10,532 12,426 16,094 7%
Washington 1993 2,147 2,727 4,834 2%
All Other States (2) 4,602 16,609 22,829 11%
-------- -------- -------- ----
All States $130,191 $167,680 $223,692 100%
-------- -------- -------- ----
-------- -------- -------- ----
(1) Represents year in which the Company commenced sale of policies in each
state.
(2) Includes all states in which premiums represented one percent or less
of the Company's total premiums in 1998.
9
<PAGE>
(d) Administration
Underwriting.
The Company believes that the underwriting process through which an
accident and health insurance company, particularly one in the long-term care
segment, chooses to accept or reject an applicant for insurance is critical to
its success. All applications are reviewed by the Company's in-house
underwriting department and must be approved before a policy can be issued. The
Company considers age and medical history, among other factors, in deciding
whether to accept an application for coverage. With respect to medical history,
efforts are made to underwrite on the basis of the medical information listed on
the application, but an Attending Physician's Statement is often requested. In
all cases, a personal history interview is required, and a paramedic interview
is often conducted. In the event the Company determines that it cannot offer the
requested coverage, an alternative for suitable coverage for higher risk
applicants may be suggested to the agent. Accepted policies are usually issued
within seven working days from receipt of the information necessary to
underwrite the application. As noted above, while there is no individual
underwriting process for Group Insurance, the underwriting for Franchise
Insurance written by the Company is identical to that for individual policies.
In order to expedite the large volume of premiums generated from sales of
policies in Florida and California, the new business development and regulatory
requirements of New York, and the specialization required in the sale and
underwriting of disability coverage, the Company operates field offices in
Sarasota, Florida, Stockton, California, Middletown, New York and Colchester,
Vermont to underwrite and issue policies. These regional offices enable the
Company to respond more effectively and efficiently to its agents and
policyholders across the United States.
Applicants for insurance must respond to detailed medical questionnaires.
Physical examinations are not required for the Company's accident and health
insurance policies, but medical records are frequently requested. Pre-existing
conditions disclosed on the application for new long-term nursing home care and
most home health care policies are covered immediately upon approval of the
policy by the Company's underwriting department, while undisclosed pre-existing
conditions are not covered for six months in most states and two years in
certain other states. In addition, the Company's Independent Living policies
immediately cover all disclosed pre-existing conditions. In the case of
individual Medicare supplement policies, pre-existing conditions are generally
not covered during the six month period following the effective date of the
policy.
Claims.
All claims for policy benefits, except with respect to Medicare supplement
claims, are currently processed by the Company's claims department, which
includes a physician and nurses employed or retained as consultants by the
Company. The Company has historically utilized third party administrators to
process its Medicare supplement claims due to the typically small benefit amount
per claim and the large number of claims. The processing of all disability
claims is performed by ANIC.
The Company periodically utilizes the services of unaffiliated Care
Managers to review certain claims, particularly those made under home health
care policies. When a claim is filed, the Company may engage the Care Manager to
review the claim, including the specific health problem of the insured and the
nature and extent of health care services being provided. The Care Manager
assists both the Company and the insured by determining that the services
provided to the insured, and the corresponding benefits paid by the Company, are
appropriate under the circumstances. Under the terms of its Independent Living
policy, the Company will waive the elimination period, the time at the beginning
of the period during which care is provided for which no benefits are available
under the policy (usually twenty days), if the insured agrees to utilize a Care
Manager. The Company estimates that approximately 75% of all home health care
policies and 95% of all new home health care policies with care management
claims submitted in the last year have been submitted to Care Managers. The
Company anticipates that this usage will continue as both its business and the
need to manage effectively the processing of claims grow.
In 1997 and throughout 1998, the Company created and staffed an in-house
Care Management unit. This in house unit conducts the full range of care
management services, which were previously provided exclusively by
subcontractors. The Company intends to develop this unit as it believes it can
meet many of its care management needs more effectively and with less expense
than by relying on third party vendors.
10
<PAGE>
Systems Operations.
The Company operates and maintains its own computer system for all aspects
of the Company's operations, including: policy issuance; billing; claims
processing; commission reports; premium production by agent (state and product)
and general ledger. During 1998, the Company continued the installation of a new
computer system, including hardware and a variety of applications software,
which will enable the Company to (i) define and refine its underwriting and
claims functions so that data may be analyzed more usefully, (ii) target agents
and consumers more effectively and (iii) continue to manage the increasing
volume of information as the Company's business grows. The Company considers an
enhanced system critical to its ability to continue to provide the quality of
service for which the Company has been known to its policyholders and agents.
The Company completed the majority of its enhancements to its new systems in
1998, including the conversion of its general ledger and investment operations
applications. During 1999, the Company intends to convert new business
processing to its new systems by the end of the second quarter and renewal
processing by the end of the third quarter.
For discussion pertaining to the Company's readiness regarding Year 2000
issues, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Year 2000."
(e) Premiums
Premium rates for all lines of insurance written by the Company are subject
to state by state regulation. Premium regulations vary greatly among
jurisdictions and lines of insurance. Rates for the Company's insurance policies
are established by the Company's independent actuarial consultants and reviewed
by the insurance regulatory authorities as part of the licensing process in the
states where the Company markets its products. Before a rate change can be made,
the proposed change must be filed with and approved by the insurance regulatory
authorities.
As a result of minimum loss ratio standards imposed by state regulations,
the premiums charged by the Company with respect to all of its accident and
health polices are subject to reduction and/or corrective measures in the event
insurance regulatory agencies in states where the Company does business
determine that the Company's loss ratios either have not reached or will not
reach required minimum levels. See " Government Regulation".
(f) Future Policy Benefits and Claims Reserves
The Company is required to maintain reserves equal to the probable ultimate
liability for claims and related claims expenses with respect to all policies
in-force. Reserves, which are computed by the Company's actuarial consultants,
are established for (i) claims which have been reported but not yet paid, (ii)
claims which have been incurred but not yet reported and (iii) the discounted
present value of all future policy benefits less the discounted present value of
expected future premiums. See Note 4 of the Notes to Consolidated Financial
Statements.
The amount of reserves relating to reported and unreported claims incurred
is determined by periodically evaluating historical claims experience and
statistical information with respect to the probable number and nature of such
claims. The Company compares actual experience with estimates and adjusts its
reserves on the basis of such comparisons.
In addition to reserves for incurred claims, reserves are also established
for future policy benefits. The policy reserve represents the discounted present
value of future obligations that are likely to arise from the policies that the
Company underwrites, less the discounted present value of expected future
premiums on such policies. The reserve component is determined using generally
accepted actuarial assumptions and methods. However, the adequacy of this
reserve rests on the validity of the underlying assumptions that were used to
price the Company's products; the more important of these assumptions relate to
policy lapses, loss ratios and claim incidence rates.
The Company's long-term care experience, most of which is based on its
nursing home care products, is derived from the Company's twenty-four years of
significant claims experience with respect to this product line, and reserves
for these policies are based primarily upon this experience.
The Company began offering home health care coverage in 1987, and since
that time has realized a significant increase in the number of home health care
policies written by the Company. The Company's claims experience with home
11
<PAGE>
health care coverage is more limited than is its nursing home care claims
experience, and the Company's claims experience with respect to its Independent
Living policy, which it first offered in November 1994, and Assisted Living and
Personal Freedom policies, which it first offered in late 1996, is extremely
limited. The Company's claims experience to date with respect to certain of its
home health care products has been characterized by a higher than expected
number of claims with a longer than expected duration. Management of the Company
believes that individuals may be more inclined to utilize home health care than
nursing home care, which is generally a last resort to be considered only after
all other possibilities have been explored. Accordingly, management believes
that there is a greater potential for wide variations in claims experience in
its home health care insurance than exists with respect to nursing home care
insurance. The Company's actuarial consultants utilize both the Company's
experience and other industry-wide data in the computation of reserves for the
home health care product line.
In addition, more recent long-term care products, developed as a result of
regulation or market conditions, may incorporate more benefits with fewer
limitations or restrictions. For instance, OBRA '90 required that Medicare
supplement policies provide for guaranteed renewability and waivers of
pre-existing condition coverage limitations under certain circumstances. In
addition, the National Association of Insurance Commissioners (the "NAIC") has
recently adopted model long-term care policy language providing nonforfeiture
benefits and has proposed a rate stabilization standard for long-term care
policies, either or both of which may be adopted by the states in which the
Company writes policies. See "Government Regulation." The fluidity in market and
regulatory forces might limit the Company's ability to rely on historical claims
experience for the development of new premium rates and reserve allocations.
The Company employs utilizes the services of actuarial consultants (the
"Actuaries"), to price insurance products and establish reserves with respect to
those products. Additionally, the actuaries assist the Company in improving the
documentation of its reserve methodology, a process that has resulted in certain
adjustments to the Company's reserve levels. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Overview." Although
management believes that the Company's reserves are adequate to cover all policy
liabilities, there can be no assurance that reserves are adequate or that future
claims experience will be similar to, or accurately predicted by, the Company's
past or current claims experience.
12
<PAGE>
(g) Reinsurance
As is common in the insurance industry, the Company purchases reinsurance
to increase the number and size of the policies it may underwrite. Reinsurance
is purchased by insurance companies to insure their liability under policies
written to their insureds. By transferring, or ceding, certain amounts of
premium (and the risk associated with that premium) to reinsurers, the Company
can limit its exposure to risk. The Company currently reinsures any life
insurance policy to the extent the risk on that policy exceeds $50,000. The
Company currently reinsures its ordinary life policies through Reassurance
Company of Hannover (A.M. Best rating A). The Company also has reinsurance
agreements with Life Insurance Company of North America (A.M. Best rating A+)
and Transamerica Occidental Life Insurance Company (A.M. Best rating A+) to
reinsure term life policies whose risk exceeds $15,000, and with Employers
Reassurance Corporation (A.M. Best rating A+) to reinsure credit life policies
whose risk exceeds $15,000.
PTNA entered into a reinsurance agreement, effective in January 1994, to
cede 100% of certain life, accident and health and Medicare supplement insurance
policies issued by PTNA to Life and Health Insurance Company of America ("Life
and Health") (A.M. Best rating B-). This arrangement, known as a "fronting"
arrangement, is used when one insurer wishes to take advantage of another
insurer's ability to procure and issue policies. The fronting company remains
liable to the policyholder, even though all of its risk is reinsured. Because of
Life and Health's A.M. Best rating, PTNA structured their agreement with Life
and Health to require maintenance of securities in escrow for PTNA in an amount
at least equal to their statutory reserve credit. The value of these escrowed
securities, which consist of U.S. Government bonds, exceeded PTNA's related
statutory reserve credits as of December 31, 1998, which were approximately
$533,000. The policies subject to this fronting arrangement are being marketed
in six states to federal employees. Premium ceded under this agreement totaled
approximately $882,000, $779,000 and $777,000 in 1996, 1997 and 1998,
respectively.
In January 1991, PTNA entered into another fronting arrangement under which
PTNA ceded 100% of certain whole life and deferred annuity policies to Provident
Indemnity Life Insurance Company ("Provident Indemnity") (A.M. Best rating B).
No new policies have been ceded under this arrangement since December 31, 1995.
PTNA has structured its agreement with Provident Indemnity to require
maintenance of securities in escrow for PTNA in an amount at least equal to its
12
<PAGE>
statutory reserve credit. The value of these escrowed securities, which consist
of U.S. Government bonds, exceeds PTNA's related statutory reserve credit as of
December 31, 1998 of approximately $3,767,000. The policies, which are subject
to this fronting agreement, were intended for the funeral arrangement or
"pre-need" market, and were being underwritten in 24 states (with the largest
markets in California and Michigan). Total ceded life insurance in-force
approximated $12,121,000, $10,562,000 and $9,718,000 for 1996, 1997 and 1998,
respectfully.
Effective in October 1994, the Insurers entered into reinsurance agreements
with Cologne Life Reinsurance Company (A.M. Best rating A) with respect to their
home health care policies with benefit periods exceeding 36 months. Under these
reinsurance agreements, the Insurers are responsible for payment of claims
during the first 36 months of the benefit period, and the reinsurer will
reimburse the Insurers for 100% of all claims paid after such 36 month period.
Total reserve credits taken related to this agreement as of December 31, 1998
were approximately $3,233,000. Effective January 1998, no new policies were
reinsured under this treaty.
On December 31, 1998, the Company entered a funds withheld financial
reinsurance agreement with Cologne Life Reinsurance Company for statutory
purposes. Under the agreement, PTNA ceded the claims risk of approximately
$80,128,000 of nursing home premium and $124,605,000 of reserves to the
reinsurer. The effect of the transaction increased statutory surplus and net
gain from operations by $14,700,000. The Company believes this agreement does
not qualify as reinsurance according to Generally Accepted Accounting
Principles.
In May 1991, PTNA acquired a block of long-term care business under an
assumption reinsurance agreement with Providentmutual Life and Annuity Company
of America (formerly known as Washington Square Life Insurance Company). PTNA
assumed the obligations as insurer for all policies in-force as of that date.
PTNA received cash totaling $1,512,300, net of $513,500 as consideration for the
sale. Under this agreement, PTNA assumed a reinsurance treaty under which 66% of
the premiums assumed are, in turn, ceded by PTNA to a third party reinsurer. The
total accident and health premiums ceded under this treaty amounted to
approximately $1,081,000 in 1996, $1,002,000 in 1997 and $951,000 in 1998.
On December 28, 1990, PTNA entered into a reinsurance agreement with
Midland Mutual Life Insurance Company (A.M. Best rating A-) under which PTNA
acquired approximately 3,100 nursing home policies in 22 states with an
annualized premium of approximately $3,000,000. The Company recognized
approximately $1,662,000 of premium related to this acquisition in 1996,
$1551,000 in 1997 and $1,411,000 in 1998.
In the event a reinsurance company becomes insolvent or otherwise fails to
honor its obligations to the Company under any of its reinsurance agreements,
the Company would remain fully liable to the policyholder.
ANIC reinsures approximately $500,000 of premium with three Vermont
licensed companies. For a discussion of the amounts reinsured by the Company,
see Note 11 of the Notes to Consolidated Financial Statements.
For a discussion of A.M. Best ratings, see "A. M. Best Ratings and Standard
& Poor's Ratings."
(h) Investments
The Company invests in securities and other investments authorized by
applicable state laws and regulations and follows an investment policy designed
to maximize yield to the extent consistent with liquidity requirements and
preservation of assets. Investments are managed by Davidson Capital Management
of Wayne, Pennsylvania, First Union National Bank of Charlotte, North Carolina,
and Palisade Capital Management of Fort Lee, New Jersey. Over the past five
years, the Company has been able to meet its claims liabilities through
operations and has not had to utilize any of its investment assets.
13
<PAGE>
The following table shows the composition of the debt securities investment
portfolio (at carrying value), excluding short-term investments, by rating as of
December 31, 1998.
December 31, 1998
-----------------
Rating Amount Percent
------ ------ -------
(Dollar amount in thousands)
U.S. Treasury and U.S. Agency securities $138,207 43.1%
Aaa or AAA 36,418 11.3%
Aa or AA 43,712 13.6%
A 63,147 19.6%
Other or Not Rated 39,964 12.4%
-------- ------
Total $321,448 100.0%
-------- ------
-------- ------
As of December 31, 1998, 94.9% of the Company's total investments were
fixed income debt securities, 43.1% of which were securities of the United
States Government (or its agencies or instrumentalities). The balance of the
Company's investment portfolio consisted substantially of publicly traded equity
securities. As of December 31, 1998, the Company's bond investment portfolio
consisted substantially of investment grade securities, with 87.6% rated "A" or
better by either Moody's Debt Rating Service or Standard and Poor's Corporation.
The Company's investment policy is to purchase U.S. Treasury securities, U.S.
agency securities and investment-grade municipal and corporate securities with
the highest yield to maturity available, and to have 7% to 10% of the Company's
bond investment portfolio mature each year. The Company's policy also limits
high-yield investments (those rated below BBB-) to 5% percent of its total
portfolio and may only purchase bonds rated B or higher. The Company generally
buys investments maturing within two to 15 years of the date of the purchase. At
December 31, 1998, the average maturity of the Company's bond investment
portfolio was 6.3 years and the Company's investment portfolio contained no
direct investments in real estate. The Company has historically limited its
investments in equity securities. In 1997, the Company expanded its common stock
investments to approximately 7.8% of its total investments. Following the sale
of its portfolio in March 1998, the Company later purchased additional common
and preferred equities, comprising 5.1% of its portfolio at December 31, 1998.
The Company intends to limit its common stock investments to 10% of its total
investments. During March, 1998, the Company sold its entire equity securities
portfolio, or approximately $21,000,000 of invested assets. From this sale, the
Company recognized an approximate $6,400,000 capital gain. Also, during November
1998, the Company liquidated its entire tax-exempt bond portfolio, yielding an
approximate gain of $1,500,000.For additional information regarding the
Company's investments, see Note 3 of the Notes to Consolidated Financial
Statements.
During 1998, the Company evaluated and changed its investment policy to
allow for the acquisition of debt and equity securities rated "B" or better by
bond rating agencies. Included in the Company's investment strategy was the
decision to purchase convertible or preferred securities. The company hired an
investment management firm that specializes in convertible securities to manage
this portfolio. The management firm is also a principle shareholder of the
Company's common stock.
Market Risk of Financial Instruments. 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 72.2% of total
liabilities and reinsurance receivables on unpaid losses represent 2.1% of total
assets).
14
<PAGE>
The hypothetical effects of changes in market rates or prices on the fair
values of financial instruments as of December 31, 1998, 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 $15,000,000 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 December 31, 1998 would have resulted in an
approximate $29,000,000 increase in the net fair value. If interest rates had
decreased by 100 basis points, there would have been an approximate $16,000,000
and $34,000,000 net decrease, respectively, in the fair net value of the
Company's total investments and debt.
The following table sets forth for the periods indicated certain information
concerning investment income.
<TABLE>
<CAPTION>
Investment Portfolio 1996 1997 1998
---- ---- ----
Year Ended December 31,
-----------------------
(Dollar amounts in thousands)
<S> <C> <C> <C>
Average balance of investments, cash and
cash equivalents during the period (at cost) $174,422 $284,323 $332,872
Net investment income 10,982 17,009 20,376
Average yield on investments 6.3% 6.0% 6.1%
</TABLE>
i) Selected Financial Information: Statutory Basis
The following table shows certain ratios derived from the Company's
insurance regulatory filings with respect to the Company's accident and health
policies presented in accordance with accounting principles prescribed or
permitted by insurance regulatory authorities ("SAP"), which differ from the
presentation under Generally Accepted Accounting Principles ("GAAP") and which
also differ from the presentation under SAP for purposes of demonstrating
compliance with statutorily mandated loss ratios. See, "Government Regulation".
Year ended December 31,
1996 1997 1998
---- ---- ----
Loss ratio (1)(4) 61.5% 70.9% 46.8%
Expense ratio (2)(4) 48.7% 57.9% 76.4%
------ ------ ------
Combined loss and expense ratio 110.2% 128.8% 123.2%
Persistency (3) 79.9% 83.1% 85.5%
(1) Loss ratio is defined as incurred claims and increases in policy reserves
divided by collected premiums.
(2) Expense ratio is defined as commissions and expenses incurred divided by
collected premiums.
(3) Persistency represents the percentage of premiums renewed, which the
Company calculates by dividing the total annual premiums in-force at the
end of each year (less first year business for that year) by the total
annual premiums in-force for the prior year. For purposes of this
calculation, a decrease in total annual premiums in-force at the end of any
year would be a result of non-renewal policies, including those policies
that have terminate by reason of death, laps e due to nonpaymen of
premiums, and/or conversion to other policies offered by the Company.
(4) The 1998 loss ratio and expense ratio are significantly affected by the
reinsurance of approximately $80,128,000 in premium on a statutory basis.
The Company's loss ratio has been higher in recent years due in part to a
mandated change in reserving method wherein underwriters of long-term care
products were required by the Pennsylvania Insurance Department, commencing in
October 1994, to use the one-year preliminary term reserve method, a means of
establishing initial benefit reserves for a policy after its first anniversary,
15
<PAGE>
instead of the two-year preliminary term method previously permitted. This
change had the effect of requiring companies to establish a full annual reserve
for a policy commencing at the end of the first policy year, instead of at the
end of the second policy year. The increase in the persistency rate in 1998,
1997 and 1996, signifying a greater percentage of policy renewals, also caused
the loss ratio to increase. This is due to the fact that as policies age, the
reserves associated with such policies must be increased. In addition, the
Company added approximately $12,000,000 to this reserve in 1997 as a result of
its reassessment of assumptions utilized in the actuarial determination of
reserves for current claims liabilities and incurred but unreported liabilities
for nursing home and home health care claims. The Company reviewed the
assumptions underlying its reserves in connection with its 1997 employment of a
new long-term care consulting actuary. The review encompassed certain actuarial
assumptions related to the Company's products' benefit utilization and duration.
Under SAP, costs associated with sales of new policies must be charged to
earnings as incurred. Because these costs, together with required reserves,
generally exceed first year premiums, statutory surplus may be reduced during
periods of increasing first year sales. Through November 1994, the Company was
able to expand its business from accumulation of statutory retained earnings and
from proceeds received from the Company's Common Stock offering completed in
December 1989. In December 1994, PTLIC's capital position was strengthened by a
$4,000,000 contribution from the Company. The capital position of the Insurers
was improved further by the contribution of $14,000,000 of the net proceeds of a
public offering of the Company's common stock to the capital and surplus of the
Insurers during the third quarter of 1995. In October 1996, the Company
contributed an additional $5,000,000 of the offering proceeds to PTNA. In
December 1996, the Company contributed $20,000,000, $20,000,000 and $5,000,000
to the capital and surplus of PTLIC, PTNA, and ANIC, respectively, from the
proceeds of its $74,750,000 convertible subordinated debt offering in November
1996. In December 1997, the Company contributed $5,000,000 to ANIC to support
its long-term care growth. In March 1998, the Company funded AINIC with
approximately $6,000,000 from the proceeds of the 1996 debt offering.
Mandated loss ratios are calculated in a manner which provides adequate
reserving for the long-term care insurance risks, using statutory lapse rates
and certain assumed interest rates. The statutorily assumed interest rates
differ from those used in developing reserves under GAAP. For this reason,
statutory loss ratios differ from loss ratios reported under GAAP. Mandatory
statutory loss ratios also differ from loss ratios reported on a current basis
under SAP for purposes of the Company's annual and quarterly state insurance
filings. The states in which the Company is licensed have the authority to
change these minimum ratios and to change the manner in which these ratios are
computed and the manner in which compliance with these ratios is measured and
enforced. The Company is unable to predict the impact of (i) the imposition of
any changes in the mandatory statutory loss ratios for individual or group
long-term care policies to which the Company may become subject, (ii) any
changes in the minimum loss ratios for individual or group long-term care or
Medicare supplement policies, or (iii) any change in the manner in which these
minimums are computed or enforced in the future. The Company has not been
informed by any state that it does not meet mandated minimums, and the Company
believes it is in compliance with all such minimum ratios. In the event the
Company is not in compliance with minimum statutory loss ratios mandated by
regulatory authorities with respect to certain policies, the Company may be
required to reduce or refund its premiums on such policies.
The Company's expense ratios are affected by the commissions paid to agents
on new business production, which is generally higher on new business than for
renewing policies. Statutory accounting requires commissions to be expensed as
paid. As a result, rapid growth in first year business results in higher expense
ratios.
(j) A.M. Best's Rating and Standard & Poor's Rating
The Insurers' rating with A.M. Best is "B++ (very good)." A.M. Best's
ratings are based on a comparative analysis of the financial condition and
operating performance for the prior year of the companies rated, as determined
by their publicly available reports. A.M. Best's classifications are A++ and A+
(superior), A and A- (excellent), B++ and B+ (very good), B and B- (good), C++
and C+ (fair), and C and C- (marginal), D (below minimum standards), E (under
state supervision) and F (in liquidation). A.M. Best's ratings are based upon
factors of concern to policyholders and insurance agents and are not directed
toward the protection of investors. In evaluating a company's financial and
operating performance, the rating agencies review the company's profitability,
leverage and liquidity as well as the company's book of business, the adequacy
and soundness of its reinsurance, the quality and estimated market value of its
assets, the adequacy of its reserves and the experience and competency of its
management. PTNA has a Standard & Poor's claims paying ability rating of "A-
(good)," which falls within the most secure range (AAA to BBB). ANIC is not
rated by Standard & Poor's.
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<PAGE>
(k) Competition
The Company operates in a highly competitive industry. Many of its
competitors have considerably greater financial resources, higher ratings from
A.M. Best and larger networks of agents than the Company. Many insurers offer
long-term care policies similar to those offered by the Company and utilize
similar marketing techniques. The Company actively competes with these insurers
in attracting and retaining agents by offering competitive products and
commission rates and quality underwriting, claims service and policyholder
service.
(l) Government Regulation
Insurance companies are subject to supervision and regulation in all states
in which they transact business. The Company is registered and approved as a
holding company under the Pennsylvania Insurance Code. PTNA is chartered and
licensed in Pennsylvania as a stock life insurance company. ANIC is chartered
and licensed in Vermont as a stock accident and health insurance company. On a
combined basis with its direct and indirect insurance subsidiaries, the Company
is currently licensed in all states except New York, where the Company has
formed a subsidiary and is seeking approval to operate as an insurer.
The extent of regulation of insurance companies varies, but generally
derives from state statutes which delegate regulatory, supervisory and
administrative authority to state insurance departments. Although many states'
insurance laws and regulations are based on models developed by the NAIC and are
therefore similar, variations among the laws and regulations of different states
are common.
The NAIC is a voluntary association of all of the state insurance
commissioners in the United States. The primary function of the NAIC is to
develop model laws on key insurance regulatory issues which can be used as
guidelines for individual states in adopting or enacting insurance legislation.
While the NAIC model laws are accorded substantial deference within the
insurance industry, these laws are not binding on insurance companies unless
adopted by the state, and variations from the model laws within the states is
common.
The Pennsylvania Department, the Vermont Department of Banking, Insurance,
Securities and Health Care Administration (the "Vermont Department"), the New
York Insurance Department (the "New York Department") and insurance regulatory
authorities in other jurisdictions, have broad administrative and enforcement
powers relating to the granting, suspending and revoking of licenses to transact
insurance business, the licensing of agents, the regulation of premium rates and
trade practices, the content of advertising material, the form and content of
insurance policies and financial statements and the nature of permitted
investments. In addition, regulators have the power to require insurance
companies to maintain certain deposits, capital, surplus and reserve levels
calculated in accordance with prescribed statutory standards. The Company
believes that its deposit, capital, surplus and reserve levels currently meet or
exceed all applicable regulatory requirements. The primary purpose of such
supervision and regulation is the protection of policyholders, not investors.
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
adoption upon its financial condition or results of operations.
The Company also is subject to the insurance holding company laws of
Pennsylvania and of the other states in which it is licensed to do business.
These laws generally require insurance holding companies and their subsidiary
insurers to register and file certain reports, including information concerning
their capital structure, ownership, financial condition and general business
operations. Further, states often require prior regulatory approval of changes
in control of an insurer and of intercorporate transfers of assets within the
holding company structure. The purchase of more than 10% of the outstanding
shares of Common Stock by one or more parties acting in concert requires the
prior approval of the Pennsylvania, Vermont and New York Departments, and may
subject such party or parties to the reporting requirements of the insurance
laws and regulations of Pennsylvania, Vermont and New York and to the prior
approval and/or reporting requirements of other jurisdictions in which the
17
<PAGE>
Company is licensed. In addition, officers, directors and 10% shareholders of
insurance companies, such as the Insurers, are subject to the reporting
requirements of the insurance laws and regulations of Pennsylvania, Vermont and
New York, as the case may be, and may be subject to the prior approval and/or
reporting requirements of other jurisdictions in which the Company is licensed.
Under Pennsylvania law, lending institutions, public utilities, bank
holding companies, savings and loan companies, and their affiliates,
subsidiaries, officers and employees may not be licensed or admitted as
insurers. If any of the foregoing entities or individuals (or any such entity
and its affiliates, subsidiaries, officers and employees in the aggregate)
acquires 5% or more of the outstanding shares of the Company's Common Stock,
such party may be deemed to be an affiliate, in which event the Company's
Certificate of Authority to do business in Pennsylvania may be revoked upon a
determination by the Department that such party exercises effective control over
the Company.
As part of their routine regulatory oversight process, state insurance
regulators periodically conduct detailed examinations of the books, records and
operations of insurers. During 1995, the Pennsylvania Department completed its
examination of PTLIC and PTNA for the five year period ended December 31, 1994
and had no recommendations for either PTLIC or PTNA. During 1995, the Vermont
Department completed its examination of ANIC for the three year period ended
December 31, 1994 and had no material recommendations. In addition to conducting
these examinations, state insurance regulatory authorities from time to time
also conduct separate market conduct examinations. These examinations focus on
an insurer's claims practices, policyholder complaints, policy forms,
advertising practices and other marketing aspects.
In recent years, there has been considerable legislative and regulatory
activity, at both the state and federal levels, with regard to long-term care
and Medicare supplement insurance. There is extensive federal and state
regulation applicable to the form and content of Medicare supplement policies,
including requirements for specified minimum benefits and loss ratios and
requirements relating to agent compensation and the sales practices of agents
and companies. For example, Pennsylvania, which had previously enacted
regulations governing Medicare supplement insurance, recently promulgated
regulations governing long-term care insurance. These regulations are effective
for policies written on or after February 8, 1995, and affect and/or regulate
areas including permissible policy practices and provisions, lapse provisions,
required disclosure provisions, post-claims underwriting, minimum standards for
home health and community care benefits, inflation protection provisions,
application forms and replacement coverage, reporting requirements, reserve
standards, loss ratios, filings for out-of-state group policies, marketing
standards, agent recommendations, pre-existing condition limitations, coverage
outlines, allowable shoppers guides and permitted compensation arrangements.
Most states mandate minimum benefit standards and loss ratios for long-term
care insurance policies and for other accident and health insurance policies.
Most states have adopted the NAIC's proposed standard minimum loss ratios of 65%
for individual Medicare supplement policies and 75% for group Medicare
supplement policies. A significant number of states, including Pennsylvania and
Florida, also have adopted the NAIC's proposed minimum loss ratio of 60% for
both individual and group long-term care insurance policies. Certain states,
including New Jersey and New York, have adopted a minimum loss ratio of 65% for
long-term care. The states in which the Company is licensed have the authority
to change these minimum ratios, the manner in which these ratios are computed
and the manner in which compliance with these ratios is measured and enforced.
The Pennsylvania Department is provided, on an annual basis, with a
calculation prepared by the Company's Actuaries regarding compliance with
required minimum loss ratios for Medicare supplement and credit policies. This
report is made available to all states. Although certain other policies (e.g.,
nursing home and hospital care policies) also have specific mandated loss ratio
standards, at the present there typically are no similar reporting requirements
in the states in which the Company does business for such other policies.
The NAIC has developed minimum capital and surplus requirements utilizing
certain risk-based factors associated with various types of assets, credit,
underwriting and other business risks. The Company did not experience any
problems meeting these requirements when they took effect in 1993. As of
December 31, 1998, the risk-based capital of PTNA, ANIC and AINIC were 1,154%,
357%, and 12,909%, respectively, of authorized control level capital.
In December 1986, the NAIC adopted the Long-Term Care Insurance Model Act
(the "Model Act"), which was adopted to promote the availability of long-term
care insurance policies, to protect applicants for such insurance and to
18
<PAGE>
facilitate flexibility and innovation in the development of long-term care
coverage. The Model Act establishes standards for long-term care insurance,
including provisions relating to disclosure and performance standards for
long-term care insurers, incontestability periods, nonforfeiture benefits,
severability, penalties and administrative procedures. Model regulations were
also developed by the NAIC to implement the Model Act. Some states have also
adopted standards relating to agent compensation for long-term care insurance.
In addition, from time to time, the federal government has considered adopting
standards for long-term care insurance policies, but has not enacted any such
legislation to date.
States also restrict the dividends the Company's insurance subsidiaries are
permitted to pay. Dividend payments will depend on profits arising from the
business of the Insurers, computed according to statutory formulae. In addition,
Pennsylvania law requires 30 days advance notice to the Pennsylvania Department
of any planned extraordinary dividend (any dividend paid within any twelve-month
period which exceeds the greater of (i) 10% of its surplus as shown in its most
recent annual statement filed with the Pennsylvania Department or (ii) its net
gain from operations, after policyholder dividends and federal income taxes and
before realized gains or losses, shown in such statement) and the Pennsylvania
Department may refuse to allow it to pay such extraordinary dividends. Under
Vermont insurance law, ANIC is also required to furnish 30 days advance written
notice of an extraordinary dividend to the Vermont Department, which may
disapprove the dividend. Vermont law defines an extraordinary dividend as a
dividend in excess of the lesser of (i) the net earnings of the company during
the preceding calendar year plus net income not paid out as dividends during the
prior two calendar years and (ii) 10% of the capital surplus of the company,
determined as of the immediately preceding December 31.
During 1993, the NAIC adopted model language that requires long-term care
policies to include a nonforfeiture benefit. The mandated inclusion of a
nonforfeiture benefit is intended to protect policyholders against the lapse (or
cancellation) of policies without some value returned to the policyholder.
Issuers of long-term care insurance policies are subject to a tax if they fail
to meet certain requirements set forth in the long-term care insurance model
regulations and the long-term care insurance model act as promulgated by the
NAIC (January 1993). The amount of the tax is $100 per insured for each day any
of the requirements are not met with respect to each qualified long-term care
insurance contract. During 1994, the NAIC adopted a standard calling for "rate
stabilization" of long-term care policies. Some states, such as Florida, have
adopted regulations, which require long-term care policies to include
nonforfeiture provisions. Other states, such as California, have adopted
regulations, which require long-term care policies to include provisions
allowing insureds to obtain protection against the effects of inflation.
Adoption of nonforfeiture benefits would increase the price of long-term care
policies, while rate stabilization provisions limit the Company's ability to
adjust to adverse loss experiences. The Company is in compliance with all such
regulations.
In September 1996, Congress enacted the Health Insurance Portability and
Accountability Act of 1996 ("the Act") which permits premiums paid for eligible
long-term care insurance policies after December 31, 1996 to be treated as
deductible medical expenses for the Internal Revenue Service. The deduction is
limited to a specified dollar amount ranging from $200 to $2,500, with the
amount of the deduction increasing with the age of the taxpayer. In order to
qualify for the deduction the insurance contract must, among other things,
provide for (i) limitations on pre-existing condition exclusions, (ii)
prohibitions on excluding individuals from coverage based on health status, and
(iii) guaranteed renewability of health insurance coverage. Although the Company
offers tax deductible policies, it will continue to offer a variety of
non-deductible policies as well. The Company has long-term care policies, which
qualify for tax exemption under the Act in all states in which it is licensed.
Periodically, the federal government has considered adopting a national
health insurance program. Although it does not appear that the federal
government will enact an omnibus health care reform law in the near future, the
passage of such a program could have a material impact upon the Company's
operations. In addition, legislation enacted by Congress could impact the
Company's business. Among the proposals are the implementation of certain
minimum consumer protection standards for inclusion in all long-term care
policies, including guaranteed renewability, protection against inflation and
limitations on waiting periods for pre-existing conditions. These proposals
would also prohibit "high pressure" sales tactics in connection with long-term
care insurance and would guarantee consumers access to information regarding
insurers, including lapse and replacement rates for policies and the percentage
of claims denied. Other pending legislation would permit premiums paid for
long-term care insurance to be treated as deductible medical expenses, with the
amount of the deduction increasing with the age of the taxpayer. As with any
pending legislation, it is possible that any laws finally enacted will be
substantially different than the current proposals. Accordingly, the Company is
unable to predict the impact of any such legislation on its business and
operations.
19
<PAGE>
(m) Employees
As of December 31, 1998, the Company had approximately 322 full-time
employees (not including independent agents), 229 of whom are employed in the
Company's home office. Of those employees in the Company's home office, 93 are
employed in various administrative services, 25 in sales, 42 in underwriting, 10
in compliance, 35 in claims, 15 in an executive capacity, and 9 in systems. The
Company had approximately 38 full-time employees employed in the Florida field
office as of December 31, 1998. As of December 31, 1998, the Company had 32 in
its California office, 23 employees in its Vermont office and two in its New
York office. Of the 95 field office employees, approximately 70 were in
underwriting and administration and 25 were in marketing. The Company is not a
party to any collective bargaining agreements and believes that its relationship
with its employees is good.
Item 2. Properties
The Company's principal offices in Allentown, Pennsylvania, occupy
approximately 30,000 square feet of office space in a 40,000 square foot
building, owned by the Company. The Company also leases additional office space
in Florida, California, Vermont and New York.
The Company owns a 2.42 acre parcel of land, which remains vacant, and an
8,000 square foot facility used for printing, mail processing and supply
warehousing, both located across the street from its home office.
Item 3. Legal Proceedings
The Insurers are parties to various lawsuits generally arising in the
normal course of business. The Company does not believe that the eventual
outcome of any such suit will have a material effect on its financial condition
or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of the fiscal year
ended December 31, 1998 to a vote of security holders.
20
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
The Common Stock of the Company is traded on the New York Stock Exchange
under the symbol PTA. The transfer agent and registrar for the Company's Common
Stock is First Union National Bank of Charlotte, North Carolina.
As of March 11, 1999 the Company had 7,806,267 shares of Common Stock
outstanding, held by approximately 406 stockholders of record. This latter
number was derived from the Company's shareholder records, and does not include
beneficial owners of the Company's Common Stock whose shares are held in the
names of various dealers, clearing agencies, banks, brokers, and other
fiduciaries.
The range of high and low sale prices, as reported by NASDAQ, for the
Company's Common Stock for the periods indicated below, is as follows:
High Low
1997
First Quarter 29 1/2 24 3/4
Second Quarter 30 7/8 23 7/8
Third Quarter 35 1/2 29 1/2
Fourth Quarter 34 1/2 28 3/4
1998
First Quarter 31 15/16 28
Second Quarter 32 3/4 29 1/4
Third Quarter 32 23 1/8
Fourth Quarter 29 1/8 18 5/8
The Company has never paid any cash dividends on its Common Stock and does
not intend to do so in the foreseeable future. It is the present intention of
the Company to retain any future earnings to support the continued growth of the
Company's business. Any future payment of dividends by the Company is subject to
the discretion of the Board of Directors and is dependent, in part, on any
dividends it may receive as the sole shareholder of PTNA, ANIC, AINIC, the
Agency and UIG. The payment of dividends by PTNA, ANIC and AINIC, respectively,
is in turn dependent on a number of factors, including their respective earnings
and financial condition, business needs and capital and surplus requirements,
and is also subject to certain regulatory restrictions and the effect that such
payment would have on their ratings by A.M. Best Company and Standard & Poor's.
21
<PAGE>
Item 6. Selected Financial Data
The following selected consolidated statement of operations data and
balance sheet data of the Company as of and for the years ended December 31,
1994, 1995, 1996, 1997 and 1998, have been derived from the Consolidated GAAP
Financial Statements of the Company, which have been audited by
PricewaterhouseCoopers LLP, independent accountants.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(in thousands, except per share data and ratios)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
-----------------------------
Revenues:
Accident and health:
First year premiums $ 26,968 $ 36,770 $ 46,346 $ 55,348 $ 82,686
Renewal premiums 52,237 62,402 80,311 108,794 137,459
Life:
First year premiums 2,149 1,701 1,457 1,056 837
Renewal premiums 481 1,494 2,077 2,482 2,701
-------- -------- -------- -------- --------
Total premiums 81,835 102,367 130,191 167,680 223,692
Investment income, net 5,946 8,103 10,982 17,009 20,376
Net realized gains (losses) 8 46 20 1,417 9,209
Other income 305 347 342 417 885
-------- -------- -------- -------- --------
Total revenues 88,094 110,863 141,535 186,523 254,162
Benefits and expenses:
Benefits to policyholders 48,757 64,879 83,993 123,865 154,300
First year commissions 19,365 26,223 30,772 37,834 58,174
Renewal commissions 7,866 10,128 12,533 17,406 22,099
Net acquisition costs deferred (2) (7,643) (15,303) (19,043) (28,294) (46,915)
General and administrative expense 10,262 12,171 15,648 20,614 26,069
Interest expense 162 327 625 4,804 4,809
-------- -------- -------- -------- --------
Total benefits and expenses 78,769 98,425 124,528 176,229 218,536
-------- -------- -------- -------- --------
Income before federal income taxes 9,325 12,438 17,007 10,294 35,626
Provision for federal income taxes 2,562 3,609 4,847 2,695 11,578
-------- -------- -------- -------- --------
Net income $ 6,763 $ 8,829 $ 12,160 $ 7,599 $ 24,048
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Basic earnings per share (1) $ 1.45 $ 1.53 $ 1.70 $ 1.01 $ 3.17
-------- -------- -------- -------- --------
-------- -------- -------- -------- ---------
Diluted earnings per share $ 1.44 $ 1.51 $ 1.66 $ 0.98 $ 2.64
-------- -------- -------- -------- ---------
-------- -------- -------- -------- ---------
Weighted average shares outstanding (3) 4,669 5,772 7,165 7,540 7,577
Diluted shares outstanding (1) 4,687 5,842 7,528 7,758 10,402
GAAP Ratios:
Loss ratios 59.5% 63.4% 64.5% 73.9% 69.0%
Expense ratio 36.7% 32.8% 31.1% 31.2% 28.7%
-------- -------- -------- -------- --------
Total 96.2% 96.2% 95.6% 105.1% 97.7%
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Selected Statutory Data:
------------------------
Net premiums written $ 81,878 $102,145 $133,950 $167,403 $143,806
Statutory surplus (beginning of
period) $ 17,256 $ 21,067 $ 38,148 $ 81,795 $ 67,249
Ratio of net premiums written to
statutory surplus 4.7x 4.8x 3.5x 2.0x 2.1x
Balance Sheet Data:
-------------------
Total investments $ 91,490 $144,928 $212,662 $301,787 $338,889
Total assets 164,346 237,744 386,768 465,772 580,552
Total debt 6,372 2,206 77,115 76,752 76,550
Total liabilities 108,903 140,637 267,861 333,016 422,882
Shareholders' equity 55,444 97,107 118,907 132,756 157,670
Book value per share (3) $ 11.87 $ 13.93 $ 15.83 $ 17.53 $ 20.79
</TABLE>
(1) The Company adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share," which requires retroactive restatement of
basic and diluted earnings per share.
(2) For a discussion of policy acquisition costs, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations".
(3) Adjusted to give effect to a 50% stock dividend on the Common Stock
declared on April 19, 1995, payable to shareholders of record on May 3,
1995 and distributed on May 15, 1995.
22
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following table sets forth the components of the Company's condensed
statements of operations for the years ended December 31, 1996, 1997 and 1998,
expressed as a percentage of total revenues.
Year Ended December 31,
---------------------------
1996 1997 1998
---- ---- ----
Statement of Operations Data:
----------------------------
Revenues:
Accident and health:
First year premiums 32.7% 29.7% 32.5%
Renewal premiums 56.7% 58.3% 54.1%
Life:
First year premiums 1.0% 0.6% 0.3%
Renewal premiums 1.5% 1.3% 1.1%
------ ------ ------
Total premiums 91.9% 89.9% 88.0%
Investment income, net 7.9% 9.1% 8.1%
Net realized gains (losses) 0.0% 0.8% 3.6%
Other income 0.2% 0.2% 0.3%
------ ------ ------
Total revenues 100.0% 100.0% 100.0%
Benefits and expenses:
Benefits to policyholders 59.3% 66.4% 60.7%
First year commissions 21.7% 20.3% 22.9%
Renewal commissions 8.9% 9.3% 8.7%
Net policy acquisition costs deferred -13.5% -15.2% -18.5%
General and administrative expense 11.1% 11.1% 10.3%
Interest expense 0.4% 2.6% 1.9%
------ ------ ------
Total benefits and expenses 88.0% 94.5% 86.0%
------ ------ ------
------ ------ ------
Income before federal income taxes 12.0% 5.5% 14.0%
Provision for federal income taxes 3.4% 1.4% 4.5%
Net income 8.6% 4.1% 9.5%
----- ----- -----
----- ----- -----
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The Company develops and markets insurance products primarily designed for
the care of individuals age 65 and over. The Company's principal products are
individual fixed, defined benefit accident and health insurance policies which
consist of nursing home care, home health care, Medicare supplement and
long-term disability insurance. The Company's underwriting practices rely upon
the base of experience, which it has developed over twenty-four years of
providing nursing home care insurance, as well as upon available industry and
actuarial information. As the home health care market has developed, the Company
has encouraged the purchase of both nursing home care and home health care
coverage, and has introduced new life insurance products as well, thus providing
policyholders with enhanced protection while broadening the Company's policy
base. In late 1996, the Company introduced its Personal Freedom Plan and
Assisted Living Plan. Both plans are designed to provide comprehensive nursing
home and home health care coverage. During 1998, the Company developed its
Secured Risk Nursing Facility and Post Acute Recovery Plans, which provide
limited benefits to higher risk applicants. Long-term nursing home care and home
health care policies accounted for approximately 93% of the Company's total
annualized premiums in-force as of December 31, 1998 and approximately 82% of
its consolidated revenues for 1998.
The Company and its insurance subsidiaries are subject to the insurance
laws and regulations of each state in which they are licensed to write
insurance. These laws and regulations govern matters such as payment of
dividends, settlement of claims and loss ratios. Premiums charged for insurance
products must be approved by state regulatory authorities. In addition, the
Company and its insurance subsidiaries are required to establish and maintain
reserves with respect to reported and incurred but not reported losses, as well
as estimated future benefits payable under the Company's insurance policies.
These reserves must, at a minimum, comply with mandated standards.
The Company's results of operations are affected significantly by the
following factors:
Level of required reserves for policies in-force. The amount of reserves
relating to reported and unreported claims incurred is determined by
periodically evaluating historical claims experience and statistical information
with respect to the probable number and nature of such claims. Claim reserves
reflect actual experience through the most recent time period and policy
reserves reflect expectations of claims related to a block of business over its
entire life. The Company compares actual experience with estimates and adjusts
its reserves on the basis of such comparisons. Revisions to reserves are
reflected in the Company's results of operations through benefits to
policyholder's expense.
Policy premium levels. The Company attempts to set premium levels to ensure
profitability, subject to the constraints of competitive market conditions and
state regulatory approvals.
Deferred acquisition costs. In connection with the sale of its insurance
policies, the Company defers and amortizes a portion of the policy acquisition
costs over the related premium paying periods of the life of the policy. These
costs include all expenses directly related to the acquisition of the policy,
including commissions, underwriting and other policy issue expenses. The
amortization of deferred acquisition costs is determined using the same
projected actuarial assumptions used in computing policy reserves. Deferred
acquisition costs can be affected by unanticipated termination of policies
because, upon such unanticipated termination, the Company is required to expense
fully the deferred acquisition costs associated with the terminated policy.
The number of years a policy has been in effect. Claims costs tend to be higher
on policies that have been in-force for a longer period of time. As the policy
ages, it is more likely that the insured will have need for services covered by
the policy. However, the longer the policy is in effect, the more premium the
Company will receive.
Invesment income. The Company's investment portfolio consists primarily of
high-grade fixed income securities. Income generated from this portfolio is
largely dependent upon prevailing levels of interest rates. Due to the longevity
of the Company's investment portfolio duration (approximately 4.5 years),
investment interest income does not immediately reflect changes in market
interest rates. However, the Company is susceptible to changes in market rates
24
<PAGE>
when cash flows from maturing investments are reinvested at prevailing market
rates. As of December 31, 1998, approximately 5.1% of the Company's invested
assets were committed to high quality large capitalization common stocks.
Other factors which affect the Company's results of operations are
lapsation and persistency, both of which relate to the renewal of insurance
policies, and first year compared to renewal premiums. Lapsation is the
termination of a policy by nonrenewal and, pursuant to the Company's policy, is
automatic if and when premiums become more than 31 days overdue; however,
policies may be reinstated, if approved by the Company, within six months after
the policy lapses. Persistency represents the percentage of premiums renewed,
which the Company calculates by dividing the total annual premiums at the end of
each year (less first year business for that year) by the total annual premiums
in-force for the prior year. For purposes of this calculation, a decrease in
total annual premiums in-force at the end of any year would be a result of
non-renewal of policies, including those policies that have terminated by reason
of death, lapse due to nonpayment of premiums, and/or conversion to other
policies offered by the Company. First year premiums are premiums covering the
first twelve months a policy is in-force. Renewal premiums are premiums covering
all subsequent periods.
25
<PAGE>
Twelve Months Ended December 31, 1998 and 1997
(amounts in thousands, except per share data)
Accident and Health Premiums. First year accident and health premiums earned by
the Company, excluding disability premiums, in the twelve month period ended
December 31, 1998, increased 51.0% to $81,760, compared to $54,136 in 1997.
First year long-term care premiums in 1998 increased 51.9% to $80,126, compared
to $52,747 in 1997. The Company attributes its growth to continued improvements
in product offerings that competitively meet the needs of the long term care
marketplace. In addition, the Company actively recruits and trains agents to
sell its products. First year Medicare supplement premiums earned by the Company
in 1998 increased to $1,634 from $1,388 in 1997. The Company uses Medicare
supplement products as a marketing tool to compliment its other long-term care
offerings.
Renewal accident and health premiums earned by the Company in 1998
increased 27.6% to $131,669, compared to $103,185 in 1997. Renewal long-term
care premiums in 1998 increased 27.4% to $128,258, compared to $100,674 in 1997.
This increase reflects higher persistency and growth of in-force premiums.
Renewal Medicare supplement premiums earned by the Company in 1998 increased
35.8% to $3,411, compared to $2,511 in 1997.
In addition, ANIC, which the Company acquired on August 30, 1996, generated
disability premiums of $6,715 during 1998, down from $6,822 recognized in 1997.
Life Premiums. First year life premiums earned by the Company decreased
20.7% to $837, in 1998, compared to $1,056 in 1997. The Company's life business
has fluctuated between periods as the Company is focusing its marketing efforts
on its long-term care products. Renewal life premiums in 1998 increased to
$2,711, compared to $2,482 in 1997. This increase was primarily the result of
renewals of first-year policies written in 1997.
Net Investment Income. Net investment income earned by the Company for 1998
increased 19.8% to $20,376 from $17,009 for 1997, which is a result of higher
invested assets achieved through cash receipts from premiums with corresponding
reserve increases. During 1998, the Company sold its entire equity securities
portfolio, or approximately $21,000 of invested assets. From this sale, the
Company recognized an approximate $6,400 capital gain. Also, the Company
liquidated its tax-exempt bond holdings in order to recognize higher tax
equivalent yields. This sale generated an approximate $1,500 gain. The Company
recognized $1,417 of capital gains in 1997. The Company s average yield on
invested assets and cash balances was 6.1% in 1998 compared to 6.0% in 1997.
Benefits to Policyholders. Benefits to policyholders in 1998 increased
24.6% to $154,300, compared to $123,865 in 1997. Accident and health benefits to
policyholders in 1998 increased 24.4% to $151,247 compared to $121,608 in 1997.
The 1998 loss ratio for accident and health business was 68.7%, compared to
74.1% in 1997. The decrease in the Company's loss ratio is attributable in part
to the impact of improved persistency upon the reserves held for future
anticipated losses. However, in 1997 the Company added approximately $12,000 to
this reserve in 1997 as a result of its reassessment of assumptions utilized in
the actuarial determination of reserves for current reserves. This resulted in a
higher loss ratio for 1997. The remaining growth in benefits is attributable to
new premium growth. Management expects the loss ratio to increase with time due
to the impact of a maturing portfolio. Also, due to the Company's policy of
discounting reserves, reserve releases will typically be less than actual claims
payments. Management believes that interest earnings from invested assets will
be sufficient to offset the difference between claims payments and reserve
releases. During 1998, expenses for care management services of approximately
$1,684 were classified as benefits to policyholders. The Company utilizes care
management services in order to attempt to reduce overall claims expense and as
a result in 1997, the Company included approximately $1,041 of care management
expenses as benefits to policyholders.
Commissions. Commissions to agents increased 45.3% to $80,273 in 1998 compared
to $55,240 in 1997. Included are ANIC commissions on long-term disability
policies, which generated $1,084 of expenses in 1998.
First year commissions on total accident and health business in 1998
increased 56.2% to $56,594, compared to First year commissions on total accident
and health business in 1998 increased 56.2% to $56,594, compared to $36,240 in
1997, 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 1998 and 66.9% in 1997. The commission ratio
increased in 1998 as a result of the increased sale of policies to younger
individuals. The Company pays higher first year commissions on younger policies
due to its expectation that these policies will generate revenues for more years
26
<PAGE>
than at older issue ages. First year commissions on life business in 1998
decreased 17.4% to $726, compared to $879 in 1997, directly reflecting the
Company's reduction in first year life premiums. The ratio of first year life
commissions to first year life premiums was 86.8% in 1998 compared to 83.2% in
1997 due to an increase in single premium policies sold.
Renewal commissions on accident and health business in 1998 increased 28.0%
to $21,226, compared to $16,580 in 1997, remaining consistent with the increase
in renewal premiums discussed above. The ratio of renewal accident and health
commissions to renewal accident and health premiums was 16.1% in 1998 and 16.1%
in 1997. This ratio fluctuates in relation to the age of the policies in-force
and the rates of commissions paid to the producing agents.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs
in 1998 increased 65.8% to $46,915 compared to $28,294 in 1997, primarily due to
higher commission rates paid for first year premiums as a result of the sale of
younger age policies, which pay a higher commission percentage in the first
year. The result of higher persistency incorporated into reserve factors is
lengthier amortization of expenses and reduced net expenses in earlier periods.
This deferral is net of amortization, which decreases or increases as the
Company's actual persistency is higher or lower than the persistency assumed for
reserving purposes. The deferral of policy acquisition costs has remained
consistent with the growth of premiums, and the growth in amortization of policy
acquisition costs has been modified by improved persistency.
General and Administrative Expenses. General and administrative expenses in 1998
increased 26.5% to $26,069, compared to $20,614 in 1997. General and
administrative expenses, excluding goodwill and convertible debt cost
amortization, as a percentage of premiums were 11.3% in 1998, compared to 11.9%
in 1997. Also, the Company incurred approximately $100 of expense related to its
original listing on the New York Stock Exchange. Economies of scale recognized
from premium growth were partially offset by consulting expenses of
approximately $300,000 from the Company's Y2K readiness projects and new systems
conversions.
Net Income. Net income of $24,048 for 1998 was $16,449 or 216.5% above 1997
income of $7,599. Net income includes income tax provisions of $11,578 and
$2,695, for the 1998 and 1997 periods, respectively. Income before federal
income taxes increased in 1998 by $25,332 or 246.1% to $35,626. This increase
was primarily attributable to premium growth and capital gains realized from
bond and equity sales. The Company made a 1998 provision for federal income
taxes of $11,578, reflecting an effective rate of 32.5%, as compared to an
effective 1997 tax rate of 26.2%.
Comprehensive Income. During 1998, the Company's investment portfolio generated
increases in unrealized gains of $10,032, compared to 1997 gains of $9,867.
After accounting for deferred taxes from these gains, shareholders' equity
increased by $24,591 from comprehensive income during 1998, compared to $13,176
in 1997, or an increase of $11,415 or 86.6%.
27
<PAGE>
Twelve Months Ended December 31, 1997 and 1996
(amounts in thousands, except per share data)
Accident and Health Premiums. First year accident and health premiums earned by
the Company, excluding the contribution of ANIC, in the twelve month period
ended December 31, 1997, increased 22.8% to $54,136, compared to $44,072 in
1996. First year long-term care premiums in 1997 increased 21.3% to $52,747,
compared to $43,479 in 1996. The Company attributes its growth to continued
improvements in product offerings, which competitively meet the needs of the
long term care marketplace. In addition, the Company actively recruits and
trains agents to sell its products. Management believes that it is no longer
relevant to measure separate growth for nursing home and home health care
policies given the Company's sale of comprehensive coverage plans and plans with
attached riders. First year Medicare supplement premiums earned by the Company
in 1997 increased to $1,388 from $592 in 1996. The Company uses Medicare
supplement products as a marketing tool to compliment its other long-term care
offerings.
Renewal accident and health premiums earned by the Company in 1997
increased 28.5% to $103,185, compared to $80,311 in 1996. Renewal long-term care
premiums in 1997 increased 29.5% to $100,674, compared to $77,734 in 1996. This
increase reflects higher persistency and growth of in-force premiums. Renewal
Medicare supplement premiums earned by the Company in 1997 decreased 2.6% to
$2,511 compared to $2,577 in 1996. This trend is consistent with the Company's
decision not to actively pursue Medicare supplement business.
In addition, ANIC, which the Company acquired on August 30, 1996, generated
accident and health premiums, comprised primarily of long-term disability
coverage, of $6,822 during 1997, up from $2,274 recognized in 1996. Due to the
accounting of the ANIC acquisition as a purchase, only four months of 1996
income and expense were recognized by the Company.
Life Premiums. First year life premiums earned by the Company decreased 27.5% to
$1,056, in 1997, compared to $1,457 in 1996. The Company's life business has
remained stable as the Company is focusing its marketing efforts on its
long-term care products. Renewal life premiums in 1997 increased to $2,482,
compared to $2,077 in 1996. This increase was primarily the result of renewals
of first-year policies written in 1996.
Net Investment Income. Net investment income earned by the Company for 1997
increased 54.9% to $17,009 from $10,982 for 1996. This increase was primarily
the result of growth in the Company's investment assets due to continued premium
growth, and additional funds of approximately $72,000 obtained from the issuance
of convertible debt late in 1996. From this sale, the Company recognized an
approximate $6,500 capital gain, which is reportable in the first quarter of
1998. The Company recognized $1,417 of capital gains in 1997 due primarily to
its desire to bolster investment earnings, which are reduced by the Company's
investments in equity securities. Fixed income levels are lower from dividends
received rather than interest from bonds.
Benefits to Policyholders. Benefits to policyholders in 1997 increased 47.5% to
$123,865, compared to $83,993 in 1996, including ANIC expenses of $2,846.
Accident and health benefits to policyholders, excluding disability, in 1997
increased 45.3% to $118,942 compared to $81,860 in 1996. The Company's accident
and health loss ratio was 75.6% in 1997, compared to 64.9% in 1996. The increase
in the Company's loss ratio is attributable in part to the impact of improved
persistency upon the reserves held for future anticipated losses. In addition,
the Company added approximately $12,000 to this reserve as a result of its
reassessment of assumptions utilized in the actuarial determination of reserves
for current claims liabilities and incurred but unreported liabilities for
nursing home and home health care claims. The Company reviewed the assumptions
underlying its reserves in connection with its recent employment of a new
long-term care consulting actuary. The review encompassed certain actuarial
assumptions related to the Company's products' benefit utilization and duration.
During 1997, expenses for care management services of approximately $1,041 were
classified as benefits to policyholders. The Company utilizes care management
services in order to attempt to reduce overall claims expense. In 1996, the
Company included approximately $450 of care management expenses as general and
administrative expenses. Had this expense been classified as benefits to
policyholders during 1996, the total 1996 loss ratio would have increased by
.35% of premiums to 64.9%. The ANIC loss ratio was 41.7% in 1997 and 47.4% in
1996.
Life benefits to policyholders, including paid claims and reserve increases
in 1997 decreased to $2,076, compared to $2,133 for 1996. The life loss ratio
was 58.7% in 1997, compared to 60.4% in 1996.
28
<PAGE>
Commissions. Commissions to agents increased 27.6% to $55,240 in 1997 compared
to $43,305 in 1996. Included are ANIC commissions on long-term disability
policies, which generated $1,251 of expenses in 1997.
First year commissions on accident and health business in 1997, and ANIC,
increased 23.9% to $36,240, compared to $29,243 in 1996, corresponding to the
increase in first year accident and health premiums. The ratio of first year
accident and health commissions to first year accident and health premiums was
66.9% in 1997 and 66.4% in 1996. First year commissions on life business in 1997
decreased 18.9% to $879, compared to $1,084 in 1996, directly reflecting the
Company's reduction in first year life premiums. The ratio of first year life
commissions to first year life premiums was 83.2% in 1997 compared to 74.4% in
1996 due to an increase in single premium policies sold.
Renewal commissions on accident and health business in 1997 increased 34.7%
to $16,580, compared to $12,313 in 1996, remaining consistent with the increase
in renewal premiums discussed above. The ratio of renewal accident and health
commissions to renewal accident and health premiums was 16.1% in 1997 and 15.4%
in 1996. This ratio fluctuates in relation to the age of the policies in-force
and the rates of commissions paid to the producing agents.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs
in 1997 increased 48.6% to $28,294 compared to $19,043 in 1996, primarily due to
an increase in policyholder persistency used in the establishment of deferred
acquisition cost reserve factors. The result of higher persistency incorporated
into reserve factors is lengthier amortization of expenses and reduced net
expenses in earlier periods. This deferral is net of amortization, which
decreases or increases as the Company's actual persistency is higher or lower
than the persistency assumed for reserving purposes. The deferral of policy
acquisition costs has remained consistent with the growth of premiums, and the
growth in amortization of policy acquisition costs has been modified by improved
persistency.
General and Administrative Expenses. General and administrative expenses in 1997
increased 31.7% to $20,614, compared to $15,648 in 1996. ANIC expenses accounted
for $2,317 in 1997, which includes the amortization of goodwill and the present
value of future profits. In addition, the Company recognized approximately $400
in non-recurring settlement charges in 1997 due to the consolidation of certain
ANIC operations at the Company's headquarters. The settlement charges stemmed
from severance costs, contract terminations and movement of operations. General
and administrative expenses, excluding goodwill and convertible debt cost
amortization, as a percentage of revenues were 11.9% in 1997, compared to 12.5%
in 1996, which is due in part to the inclusion of approximately $450 of care
management expenses in general and administrative expense in 1996 (.39% of
premiums). Economies of scale achieved in 1997 were offset by ANIC consolidation
charges and additional actuarial, compliance and legal fees associated with the
duplicate filings of tax qualified plans in many states.
Net Income. Net income of $7,599 (including a contribution of $2,014 from ANIC)
for 1997 was $4,562 or 37.5% below 1996 income of $12,160. Net income includes
income tax provisions of $2,695 and $4,847 for the 1997 and 1996 periods,
respectively. Income before federal income taxes decreased in 1997 by $6,713 or
39.5% to $10,294. This decrease was primarily attributable to the addition of
approximately $12,000 to the Company's pending claim reserves as discussed in
"Benefits to Policyholders." The Company made a 1997 provision for federal
income taxes of $2,695, reflecting an effective rate of 26.2%, as compared to an
effective 1996 tax rate of 28.5%.
Comprehensive Income. During 1997, the Company's investment portfolio generated
increases in unrealized gains of $9,867, compared to a $2,699 decrease in 1996.
After accounting for deferred taxes on these gains, shareholders' equity
increased due to comprehensive income by $13,176 and $12,160 in 1997 and 1996,
respectively.
29
<PAGE>
New Accounting Principles
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 128, "Earnings per Share" ("SFAS
128"). SFAS 128 establishes standards for computing and presenting earnings per
share, and simplifies the standards for computing earnings per share previously
found in Accounting Principles Board Opinion No. 15, "Earnings per Share." SFAS
128 prescribes that for all financial statements with effective dates after
December 31, 1997, primary and fully diluted earnings per share will be replaced
with basic and diluted earnings per share, and these amounts are required to be
shown on the face of the income statement. Prior year per share amounts must
also be restated if applicable. The Company adopted SFAS 128.
The FASB recently issued Statement 130, "Reporting Comprehensive Income," which
requires that changes in comprehensive income be shown in a financial statement
that is displayed with the same prominence as other financial statements. While
not mandating a specific financial statement format, Statement 130 requires that
an amount representing total comprehensive income be reported for fiscal years
beginning after December 15, 1997. Restatement for earlier years is required for
comparative purposes. The Company has no material effect on its financial
condition or results of operations due to the adoption of Statement 130.
SFAS 128, however, prescribes that if the components of diluted earnings per
share are anti-dilutive, then diluted earnings per share will not differ from
basic earnings per share. In 1997, the Company reported basic and diluted
earnings per share of $1.01 and $.98, respectively. Since the exclusion of the
impact of interest expense from the Company's convertible debt would be
anti-dilutive, the future anticipated conversion of the debt into additional
shares is not included in the calculation of diluted earnings per share. The
Company anticipates that approximately 2,600 additional shares will be issued in
the future for the conversion of debt. However, the Company also expects that
approximately $3,550 of annual after-tax interest expense due to this
convertible debt would be excluded from the diluted earnings per share
calculation.
The FASB recently issued Statement 130, "Reporting Comprehensive Income," which
requires that changes in comprehensive income be shown in a financial statement
that is displayed with the same prominence as other financial statements. While
not mandating a specific financial statement format, Statement 130 requires that
an amount representing total comprehensive income be reported for fiscal years
beginning after December 15, 1997. Restatement for earlier years is required for
comparative purposes. The Company has no material effect on its financial
condition or results of operations due to the adoption of Statement 130.
In 1997, the FASB also issued Statement 131, "Disclosures about Segments of an
Enterprise and Related Information," establishing standards for the way that
public business enterprises report information about operating segments in
annual and interim financial statements and requiring presentation of a measure
of profit or loss, certain specific revenue and expense items and segment
assets. The Company has no reportable operating segments as a monoline long-term
care insurer.
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.
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.
30
<PAGE>
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 already) 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
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.
31
<PAGE>
Liquidity and Capital Resources
(amounts in thousands)
The Company's consolidated liquidity requirements have historically been
created and met from the operations of its insurance subsidiaries. The Company's
primary sources of cash are premiums, investment income and maturities of
investments. The Company has provided, and may continue to provide, cash through
public offerings of its common stock, capital markets activities or debt
instruments. The primary uses of cash are policy acquisition costs (principally
commissions), payments to policyholders, investment purchases and general and
administrative expenses.
Statutory requirements allow insurers to pay dividends only from statutory
earnings as approved by the state insurance commissioner. Statutory earnings are
generally lower than publicly-reported earnings due to the immediate or
accelerated recognition of all costs associated with premium growth and benefit
reserves. The Company has not and does not intend to pay shareholder dividends
in the near future due to these requirements, choosing to retain statutory
surplus to support continued premium growth. See "Dividend Policy" and
"Business-Government Regulation."
The Company's cash flows were attributable to cash provided by operations,
cash used in investing, and cash provided by financing. The Company's cash
increased $27,161 in 1998 primarily due to the sale of $92,860 in bonds and
equity securities and the maturity of $31,640 of bonds. These sources of funds
coupled with $55,126 from operations more than offset $154,544 used to acquire
bonds and equity securities. The major provider of cash from operations was
premium revenue used to fund reserve increases of $78,915.
The Company's cash decreased by $40,373 in 1997 primarily due to the
purchase of $134,199 in bonds, which more than offset cash provided by
operations and $44,080 in proceeds from the sale of bonds. The major provider of
cash from operations was additions to reserves of $59,038 in 1997.
Cash increased in 1996 by $42,733, which was primarily due to $72,208 in
proceeds from the Company's convertible debt issuance. This increase, coupled
with $31,268 provided by operations, was more than sufficient to provide for
$93,046 of bond and equity purchases in 1996.
The Company invests in securities and other investments authorized by
applicable state laws and regulations and follows an investment policy designed
to maximize yield to the extent consistent with liquidity requirements and
preservation of assets. At December 31, 1998, the average maturity of the
Company's bond portfolio was 6.3 years, and its market value represented 103.4%
of its cost, with a current unrealized gain of $10,455. Its equity portfolio
exceeded cost by $2,244 at December 31, 1998. The Company's equity portfolio
exceeded cost by $5,042 in 1997 and $1,605 in 1996. On December 31, 1997, the
average maturity of the Company's bond portfolio was 5.8 years, and its market
value exceeded its cost by approximately $1,605 or 102.5% of its cost.
During 1998, the Company evaluated and changed its investment policy to
allow for the acquisition of debt and equity securities rated "B" or better by
bond rating agencies. Included in the Company's investment strategy was the
decision to purchase convertible or preferred securities. The Company hired an
investment management firm that specializes in convertible securities to manage
this portfolio, The management firm is also a principle shareholder of the
Company's common stock.
As of December 31, 1998, shareholders' equity was increased by $8,381 due
to unrealized gains of $12,698 in the investment portfolio. As of December 31,
1997, shareholders' equity was increased by $7,838 due to unrealized gains of
$11,875 in the investment portfolio. As of December 31, 1996, shareholders'
equity was increased by $2,261 due to unrealized gains of $3,426 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. 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 December 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.
32
<PAGE>
In November 1996, the Company contributed $5,000,000 of the net proceeds of
its July 1995 public offering to PTNA. In December 1996, the Company contributed
$20,000, $20,000 and $5,000 to the surplus of PTLIC, PTNA and ANIC,
respectively, from the proceeds of the convertible subordinated debt. In March
1998, the Company contributed approximately $6,000 of the proceeds from the debt
offering to AINIC to initially capitalize the subsidiary. The remaining funds
were retained at the parent level in order to service the future interest
payments on the debt. In 1998, ANIC paid a dividend of $493 to the Company. The
Company believes that its insurance subsidiaries' capital and surplus presently
meet or exceed the requirements in all jurisdictions in which they are licensed.
On December 31, 1997, PTLIC dividended its common stock ownership of PTNA
to the Company. At that time, PTNA assumed substantially all of the assets,
liabilities and premium in-force of PTLIC through a purchase and assumption
reinsurance agreement. On December 30, 1998, the Company sold its common stock
interest in PTLIC to an unaffiliated insurer. All remaining policies in-force
were assumed by PTNA through a 100% quota share agreement.
On November 26, 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 installment note.
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 through 1999 by funds generated from its most
recent stock offering, the Company's issuance of convertible subordinated debt
and from operations. The Company's expects future capital market activities will
be necessary to support an ongoing growth.
In the event (i) the Company fails to maintain minimum loss ratios
calculated in accordance with statutory guidelines, (ii) the Company fails to
meet other requirements mandated and enforced by regulatory authorities,
(iii) the Company has adverse claims experience in the future, (iv) the Company
is unable to obtain additional financing to support future growth, or (v) the
economy continues to affect the buying powers of senior citizens, the Company's
results of operations, liquidity and capital resources could be adversely
affected.
33
<PAGE>
CERTAIN 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 CERTAIN STATES, 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.
34
<PAGE>
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Refer to Business - Investments
Item 8. Financial Statements and Supplementary Data
35
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Pages
Report of Independent Accountants F-2
Financial Statements:
Consolidated Balance Sheets as of December 31,
1998 and 1997 F-3
Consolidated Statements of Income and Comprehensive Income
for the years ended December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Shareholders'
Equity for the years ended December 31, 1998,
1997 and 1996 F-5
Consolidated Statements of Cash Flows for the
years ended December 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7-25
<PAGE>
Report of Independent Accountants
To the Board of Directors of Penn Treaty American Corporation
Allentown, Pennsylvania
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and comprehensive income, of shareholders'
equity and of cash flows, present fairly, in all material respects, the
financial position of Penn Treaty American Corporation and Subsidiaries (the
"Company") at December 31, 1998 and 1997 and the results of their operations and
their cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standard, which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PricewaterhouseCoopers LLP
- - ------------------------------
PricewaterhouseCoopers LLP
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 8, 1999
F-2
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
as of December 31, 1998 and 1997
($000)
<CAPTION>
ASSETS 1998 1997
---- ----
<S> <C> <C>
Investments:
Bonds, available for sale at market (cost of $310,993 $ 321,448 $ 278,148
and $271,315, respectively)
Equity securities at market value (cost of $15,090 17,334 23,554
and $18,511, respectively)
Policy loans 107 85
--------- ---------
Total investments 338,889 301,787
Cash and cash equivalents 38,402 11,241
Property and equipment, at cost, less accumulated depreciation
of $2,906 and $2,399, respectively 9,635 8,753
Unamortized deferred policy acquisition costs 157,385 110,471
Receivables from agents, less allowance for
uncollectable amounts of $166 and $130, respectively 1,804 1,107
Accrued investment income 4,889 4,112
Federal income tax recoverable 1,741 1,182
Cost in excess of fair value of net assets acquired, less
accumulated amortization of $1,029 and $716, respectively 6,349 6,662
Present value of future profits acquired 3,181 3,597
Receivable from reinsurers 12,288 10,542
Other assets 5,989 6,318
--------- ---------
Total assets $ 580,552 $ 465,772
--------- ---------
--------- ---------
LIABILITIES
Policy reserves:
Accident and health $ 190,036 $ 138,441
Life 9,434 8,117
Policy and contract claims 105,667 79,664
Accounts payable and other liabilities 8,639 6,192
Long-term debt 76,550 76,752
Deferred income tax liability 32,556 23,850
--------- ---------
Total liabilities 422,882 333,016
--------- ---------
--------- ---------
Commitments and contingencies (Note 10)
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, 8,189 and 8,178 shares issued, 819 818
respectively
Additional paid-in capital 53,516 53,194
Accumulated other comprehensive income 8,381 7,838
Retained earnings 96,660 72,612
--------- ---------
159,376 134,462
Less 606 common shares held in treasury, at cost (1,706) (1,706)
--------- ---------
157,670 132,756
--------- ---------
Total liabilities and shareholders' equity $ 580,552 $ 465,772
--------- ---------
--------- ---------
See accompanying notes to consolidated financial statements.
</TABLE>
F-3
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
for the years ended December 31, 1998, 1997, and 1996
($000)
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Revenue:
Accident and health premiums $220,145 $164,142 $126,657
Life premiums 3,547 3,538 3,534
-------- -------- --------
223,692 167,680 130,191
Net investment income 20,376 17,009 10,982
Net realized capital gains 9,209 1,417 20
Other income 885 417 342
-------- -------- --------
254,162 186,523 141,535
Benefits and expenses:
Benefits to policyholders 154,300 123,865 83,993
Commissions 80,273 55,240 43,305
Net policy acquisition costs deferred (46,915) (28,294) (19,043)
General and administrative expenses 26,069 20,614 15,648
Interest expense 4,809 4,804 625
-------- -------- --------
218,536 176,229 124,528
-------- -------- --------
Income before federal income taxes 35,626 10,294 17,007
Provision for federal income taxes 11,578 2,695 4,847
-------- -------- --------
Net income $ 24,048 $ 7,599 $ 12,160
-------- -------- --------
-------- -------- --------
Other comprehensive income:
Unrealized holding gain (loss) arising during period 10,032 9,867 (2,699)
Income (tax) benefit from unrealized holdings (3,411) (3,355) 917
Reclassification adjustment for (gain) loss included
in net income (9,209) (1,417) (20)
Income (tax) benefit from reclassification adjustment 3,131 482 7
-------- -------- --------
Comprehensive income $ 24,591 $ 13,176 $ 10,365
-------- -------- --------
-------- -------- --------
Basic earnings per share $ 3.17 $ 1.01 $ 1.70
Diluted earnings per share $ 2.64 $ 0.98 $ 1.66
Weighted average number of shares outstanding 7,577 7,540 7,165
Weighted average number of shares outstanding
(Diluted) 10,402 7,758 7,528
See accompanying notes to consolidated financial statements.
</TABLE>
F-4
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 1998, 1997, and 1996
($000)
<CAPTION>
Accumulated
Common Stock Additional Other Total
---------------- Paid-In Comprehensive Retained Treasury Shareholders'
Shares Amount Capital Income Earnings Stock Equity
------ ------ ------- ------ -------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 7,577 $ 758 $ 41,147 $ 4,056 $ 52,853 $ (1,706) $ 97,108
Net income 12,160 12,160
Shares issued for the acquisi-
tion of Health Insurance
of Vermont 473 47 10,824 10,871
Other comprehensive income (1,795) (1,795)
Exercised options proceeds 67 7 557 564
---------------------------------------------------------------------------------
Balance, December 31, 1996 8,117 812 52,528 2,261 65,013 (1,706) 118,908
Net income 7,599 7,599
Other comprehensive income 5,577 5,577
Exercised options proceeds 61 6 666 672
---------------------------------------------------------------------------------
Balance, December 31, 1997 8,178 818 53,194 7,838 72,612 (1,706) 132,756
Net income 24,048 24,048
Other comprehensive income 543 543
Option-based compensation 183 183
Exercised options proceeds 11 1 139 140
---------------------------------------------------------------------------------
Balance, December 31, 1998 8,189 $ 819 $ 53,516 $ 8,381 $ 96,660 $ (1,706) $ 157,670
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
</TABLE>
F-5
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the years ended December 31, 1998, 1997, and 1996
($000)
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net cash flow from operating activities:
Net income $ 24,048 $ 7,599 $ 12,160
Adjustments to reconcile net income to cash
provided by operations:
Amortization of intangible assets 729 693 326
Deferred income taxes 8,426 2,181 3,095
Depreciation expense 629 468 375
Realized gain on sale of insurance charter (300) - -
Net realized capital (gains) losses (9,209) (1,417) (20)
Increase (decrease) due to change in:
Receivables from agents (697) 436 (268)
Receivables from reinsurers (1,746) (437) (904)
Policy acquisition costs, net (46,914) (28,294) (19,043)
Policy and contract claims 26,003 22,124 6,886
Policy reserves 52,912 36,914 29,844
Accounts payable and other liabilities 2,447 1,424 1,208
Federal income tax recoverable (559) (1,006) (175)
Federal income tax payable - - (183)
Accrued investment income (777) (531) (963)
Other, net 134 (459) (1,070)
--------- --------- ---------
Cash provided by operations 55,126 39,695 31,268
Cash flow from (used in) investing activities:
Acquisition of business, net of cash received - - (1,218)
Proceeds from sale of property and equipment 714 - -
Proceeds from sales of bonds 70,702 44,080 16,684
Proceeds from sales of equity securities 25,158 3,436 304
Proceeds from sale of insurance charter 300 - -
Maturities of investments 31,640 18,863 18,572
Purchase of bonds (139,350) (134,199) (85,092)
Purchase of equity securities (15,194) (11,430) (7,954)
Acquisition of property and equipment (1,873) (1,128) (2,111)
--------- --------- ---------
Cash used in investing (27,903) (80,378) (60,815)
Cash flow from (used in) financing activities:
Proceeds from convertible debt offering - - 72,208
Proceeds from exercise of stock options 140 673 564
Repayments of long-term debt (202) (363) (492)
--------- --------- ---------
Cash provided by (used in) financing (62) 310 72,280
--------- --------- ---------
(Decrease) increase in cash and cash equivalents 27,161 (40,373) 42,733
Cash balances:
Beginning of period 11,241 51,614 8,881
--------- --------- ---------
End of period $ 38,402 $ 11,241 $ 51,614
--------- --------- ---------
--------- --------- ---------
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 4,797 $ 4,795 $ 161
Cash paid during the year for federal income taxes $ 3,710 $ 1,200 $ 2,110
Non-cash investing activities:
Common stock issued for business acquisition $ - $ - $ 10,871
Purchase of block of renewal commission through $ - $ - $ 650
installment note
See accompanying notes to consolidated financial statements.
</TABLE>
F-6
<PAGE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(amounts in thousands, except per share information)
1. Summary of Significant Accounting Policies:
Basis of Presentation:
The accompanying consolidated financial statements of Penn Treaty
American Corporation and its Subsidiaries (the Company) have been
prepared in accordance with generally accepted accounting principles
(GAAP) and include Penn Treaty Network America Insurance Company
(PTNA), American Network Insurance Company (ANIC), American
Independent Network Insurance Company of New York (AINIC) and Penn
Treaty Life Insurance Company (PTLIC), of which all of the common
stock was sold by the Company on December 30, 1998, and Senior
Financial Consultants Company. All significant intercompany
transactions and balances have been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to the
current year presentation.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent liabilities and the reported amounts of revenues and
expenses. Actual results could differ from those estimates.
The Company is subject to interest rate risk to the extent its
investment portfolio cash flows are not matched to its insurance
liabilities. Management believes it manages this risk through analyis
of investment cash flows and actuarial input regarding future
insurance liabilities.
Nature of Operations:
The Company sells accident and health, life and disability insurance
through its wholly-owned subsidiaries. The Company's principal lines
of business are long-term care products and home health care products.
The Company distributes its products principally through managing
general agents and independent agents. The Company operates its home
office in Allentown, Pennsylvania and has satellite offices in
California, Florida, New York and Vermont, whose principal functions
are to market and underwrite new business. State regulatory
authorities have powers relating to granting and revoking licenses to
transact business, the licensing of agents, the regulation of premium
rates and trade practices, the form and content of insurance policies,
the content of advertising material, financial statements and the
nature of permitted practices. The Company is licensed to operate in
50 states. Sales in Florida, Pennsylvania, and California accounted
for approximately 24%, 13% and 15%, respectively, of the Company's
premiums for the year ended December 31, 1998. No other state sales
accounted for more than 10% of the Company's premiums for the year
ended December 31, 1998.
Investments:
The Company accounts for its investments according to the provisions
of Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities" ("SFAS No.
115"). SFAS No. 115 requires all entities to allocate their
investments among three categories as applicable: (1) trading, (2)
available for sale and (3) held to maturity. Management categorized
all of its investment securities as available for sale since they may
be sold in response to changes in interest rates, prepayments and
similar factors. Investments in this classification are reported as
F-7
<PAGE>
the current market value with net unrealized gains or losses, net of
the applicable deferred income tax effect, being added to or deducted
from the Company's total shareholders' equity on the balance sheet.
As of December 31, 1998, shareholders' equity was increased by
approximately $8,381 due to net unrealized gains of approximately
$12,699. As of December 31, 1997, shareholders' equity was increased
by approximately $7,838 due to net unrealized gains of approximately
$11,875 in the investment portfolio.
Realized investment gains and losses, including provisions for market
declines considered to be other than temporary, are included in
income. Gains and losses on sales of investment securities are
computed on the specific identification method.
Policy loans are stated at the aggregate unpaid principal balance.
Unamortized Deferred Policy Acquisition Costs:
The costs primarily related to and varying with the acquisition of new
business, principally commissions, underwriting and policy issue
expenses, have been deferred. These deferred costs are amortized over
the related premium-paying periods utilizing the same projected
premium assumptions used in computing reserves for future policy
benefits. Net policy acquisition costs deferred, on the consolidated
statements of operations, are net of amortization of $16,277, $11,977
and $13,678 for the years ended December 31, 1998, 1997, and 1996,
respectively. Recoverability of deferred acquisition costs, in certain
instances, may be dependent upon the Company's ability to obtain
future rate increases. The ability to obtain these increases is
subject to regulatory approval, but is not guaranteed.
Property and Equipment:
Property and equipment are stated at cost, less accumulated
depreciation and amortization. Expenditures for improvements, which
materially increase the estimated useful life of the asset, are
capitalized. Expenditures for repairs and maintenance are charged to
operations as incurred. Depreciation is provided principally on a
straight-line basis over the related asset's estimated life. Upon sale
or retirement, the cost of the asset and the related accumulated
depreciation are removed from the accounts and the resulting gain or
loss, if any, is included in operations.
Cash and Cash Equivalents:
Cash and cash equivalents include highly liquid debt instruments
purchased with a maturity of three months or less.
Cost in Excess of Fair Value of Net Assets Acquired:
The costs in excess of fair value of net assets acquired (goodwill)
for acquisitions made under purchase accounting methods are being
amortized to expense on a straight-line basis over a 10- to 40-year
range. During 1998, 1997 and 1996, approximately $316, $316 and $400
was amortized to expense, respectively.
Present Value of Future Profits Acquired:
The present value of future profits of ANIC's acquired business is
being amortized over the life of the insurance business acquired.
During 1998, 1997 and 1996, approximately $415, $415 and $138 was
amortized to expense, respectively.
F-8
<PAGE>
Other Assets:
Other assets consist primarily of due and unpaid insurance premiums
and unamortized debt offering costs.
Income Taxes:
Deferred income taxes relate principally to temporary differences in
reporting policy acquisition costs and policy reserves for financial
statement and income tax purposes. Deferred income tax assets and
liabilities have been recorded for temporary differences between the
reported amounts of assets and liabilities in the accompanying
financial statements and those in the Company's income tax return.
Premium Recognition:
Premiums on accident and health insurance, the majority of which is
guaranteed renewable, and life insurance are recognized when due.
Estimates of premiums due but not yet collected are accrued.
Policy Reserves and Policy and Contract Claims:
The Company establishes liabilities to reflect the impact of level
renewal premiums and the increasing risks of claims losses as
policyholders age.
The present value of estimated future policy benefits to be paid to or
on behalf of policyholders less the present value of estimated future
net premiums to be collected from policyholders is accrued when
premium revenue is recognized. Those estimates are based on
assumptions, such as estimates of expected investment yield,
mortality, morbidity, withdrawals and expenses, applicable at the time
insurance contracts are made, including a provision for the risk of
adverse deviation. These reserves differ from policy and contract
claims, which are recognized when insured events occur.
Policy and contract claims reserves include amounts representing: (1)
an estimate, based upon prior experience, for accident and health
claims reported, and incurred but unreported losses; (2) the actual in
force amounts for reported life claims and an estimate of incurred but
unreported claims; (3) an estimate of future administrative expenses,
which would be utilized to adjudicate existing claims. The methods for
making such estimates and establishing the resulting liabilities are
continually reviewed and updated and any adjustments resulting
therefrom are reflected in earnings currently.
The establishment of appropriate reserves is an inherently uncertain
process, including estimates for amounts of benefits and length of
benefit period for each claim, and there can be no assurance that the
ultimate liability will not materially exceed the Company's claim and
policy reserves and have a material adverse effect on the Company's
results of operations and financial condition. Due to the inherent
uncertainty of estimating reserves, it has been necessary, and may
over time continue to be necessary, to revise estimated future
liabilities as reflected in the Company's policy reserves and policy
and contract claims.
In late 1994, the Company began marketing its Independent Living
policy, a home health care insurance product which provides coverage
over the full term of the policy for services furnished by a homemaker
or companion who is not a qualified or licensed care provider. In late
1996, the Company began marketing its Personal Freedom policy, a
comprehensive nursing home and home health care product, and its
Assisted Living policy, a revised nursing home with attached home
F-9
<PAGE>
health care rider policy. In 1998, the Company introduced its Secured
Risk policy, a limited benefit plan made available to higher risk
applicants. Because of the Company's relatively limited claims
experience with these products, the Company may incur higher than
expected loss ratios and may be required to adjust further its reserve
levels with respect to these products.
The Company discounts all policy and contract claims, which involve
fixed periodic payments extending beyond one year. This is consistent
with the method allowed for statutory reporting, the long duration of
claims, and industry practice for long-term care policies. Benefits
are payable over periods ranging from six months to five years, and
are also available for lifetime coverage. These liabilities are
discounted using an assumed rate of 6.75% for 1998 and 1997, 7% for
1996, 6% for 1995, 1994, 1993 and 1992 claims and 8% for claims in
1991 and prior.
New Accounting Principles:
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 128, "Earnings
per Share" ("SFAS 128"). SFAS 128 establishes standards for computing
and presenting earnings per share, and simplifies the standards for
computing earnings per share previously found in Accounting Principles
Board Opinion No. 15, "Earnings per Share." SFAS 128 prescribes that
for all financial statements with effective dates after December 31,
1997, primary and fully diluted earnings per share will be replaced
with basic and diluted earnings per share, and these amounts are
required to be shown on the face of the income statement. Prior year
per share amounts must also be restated if applicable. Diluted
earnings per share for 1996 is increased $.02 from previously reported
fully diluted earnings per share due to the use of the average market
price of Company shares in utilizing the treasury stock methodology to
account for the dilutive nature of outstanding stock options.
A reconciliation of the numerator and denominator of the basic
earnings per share computation to the numerator and denominator of the
diluted earnings per share computation follows. Basic earnings per
share excludes dilution and is computed by dividing income available
to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflect the
potential dilution that could occur if securities or other contracts
to issue common stock were exercised or converted into common stock.
F-10
<PAGE>
<TABLE>
<CAPTION>
For the Periods Ended December 31,
----------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income $ 24,048 $ 7,599 $ 12,160
Weighted average common shares outstanding 7,577 7,540 7,165
Basic earnings per share $ 3.17 $ 1.01 $ 1.70
----------------------------------
----------------------------------
Net income $ 24,048 $ 7,599 $ 12,160
Adjustments net of tax:
Interest expense on convertible debt 3,154 - 320
Amortization of debt offering costs 245 - 22
----------------------------------
Diluted net income $ 27,447 $ 7,599 $ 12,502
----------------------------------
----------------------------------
Weighted average common shares outstanding 7,577 7,540 7,165
Common stock equivalents due to dilutive
effect of stock options 196 218 144
Shares converted from convertible debt 2,629 - 219
----------------------------------
Total outstanding shares for fully diluted earnings
per share computation 10,402 7,758 7,528
Diluted earnings per share $ 2.64 $ 0.98 $ 1.66
----------------------------------
----------------------------------
</TABLE>
SFAS 128, however, prescribes that if the components of diluted
earnings per share are anti-dilutive, then diluted earnings per share
will not differ from basic earnings per share. In 1997, the Company
reported basic and diluted earnings per share of $1.01 and $.98,
respectively. Since the exclusion of the impact of interest expense
from the Company's convertible debt would be anti-dilutive, the future
anticipated conversion of the debt into additional shares is not
included in the calculation of diluted earnings per share.
As of January 1, 1998, the Company adopted SFAS No. 130,
"Comprehensive Income," which establishes standards for the reporting
and disclosure of comprehensive income and its components (revenues,
expenses, gains and losses). SFAS No. 130 requires that all items
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements.
In 1997, the FASB also issued Statement 131, "Disclosures about
Segments of an Enterprise and Related Information," establishing
standards for the way that public business enterprises report
information about operating segments in annual and interim financial
statements and requiring presentation of a measure of profit or loss,
certain specific revenue and expense items and segment assets. The
Company has no reportable operating segments because long-term care
represents 93% of the Company's premium if at December 31, 1998.
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.
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
F-11
<PAGE>
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.
2. Sale of Insurance Charter
On December 30, 1998, the Company sold all of the common stock of
PTLIC to an unaffiliated insurance company. The Company received
approximately $3,300 in cash representing the final value of PTLIC's'
statutory capital and surplus at December 30, 1998 and a purchase
premium. All policies in-force were reinsured through a 100% quota
share agreement to PTNA. PTLIC was sold as a nameless corporate
entity, licensed to sell life and health products in 12 states.
3. Investments and Financial Instruments:
The Company's bond and equity securities investment portfolio is
comprised primarily of investment grade securities at December 31,
1998. Securities are classified as "investment grade" by utilizing
ratings furnished by independent bond rating agencies.
The amortized cost and estimated market value of investments in debt
securities as of December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
December 31, 1998
--------------------------------------------------------------
Amortized Gross Unrealized Gross Unrealized Estimated
Cost Gains Losses Market Value
--------- ---------------- ---------------- ------------
<S> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of U.S
Government authorities
and agencies $124,664 $ 7,458 $ (91) $132,031
Mortgage backed securities 10,368 88 (49) 10,407
Obligations of states and
political sub-divisions 2,660 204 0 2,864
Debt securities issued by
foreign governments 2,974 182 (47) 3,109
Corporate securities 170,327 3,273 (563) 173,037
---------------------------------------------------------------
$310,993 $ 11,205 $(750) $321,448
---------------------------------------------------------------
---------------------------------------------------------------
December 31, 1997
--------------------------------------------------------------
Amortized Gross Unrealized Gross Unrealized Estimated
Cost Gains Losses Market Value
--------- ---------------- ---------------- ------------
U.S. Treasury securities
and obligations of U.S
Government authorities
and agencies $152,028 $ 4,438 $ (90) $156,376
Mortgage backed securities 11,249 232 0 11,481
Obligations of states and
political sub-divisions 30,515 1,638 0 32,153
Debt securities issued by
foreign governments 204 0 0 204
Corporate securities 77,319 872 (257) 77,934
---------------------------------------------------------------
$271,315 $ 7,180 $(347) $278,148
---------------------------------------------------------------
---------------------------------------------------------------
</TABLE>
F-12
<PAGE>
The amortized cost and estimated market values of debt securities at
December 31, 1998 by contractual maturity are shown below. Expected
maturities may differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call
or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Estimated
Cost Market Value
--------- ------------
<S> <C> <C>
Due in one year or less $ 10,424 $ 10,534
Due after one year through five years 107,419 111,068
Due after five years through ten years 157,077 162,925
Due after ten years 36,073 36,921
----------- -----------
$ 310,993 $ 321,448
----------- -----------
----------- -----------
</TABLE>
The amortized cost and estimated market values of mortgage-backed
securities at December 31, 1998 by contractual maturity are shown
below. Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Estimated
Cost Market Value
--------- ------------
<S> <C> <C>
Due in one year or less $ - $ -
Due after one year through five years - -
Due after five years through ten years 478 475
Due after ten years 9,890 9,933
--------- ---------
$ 10,368 $ 10,408
--------- ---------
--------- ---------
</TABLE>
Gross proceeds and realized gains and losses on the sales of debt
securities, excluding calls, were as follows:
<TABLE>
<CAPTION>
Gross Gross
Realized Realized
Proceeds Gains Losses
-------- -------- --------
<S> <C> <C> <C>
1998 $ 70,702 $ 2,395 $ 3
1997 $ 44,080 $ 787 $ 256
1996 $ 16,684 $ 145 $ 16
</TABLE>
Gross proceeds and realized gains and losses on the sales of equity
securities were as follows:
<TABLE>
<CAPTION>
Gross Gross
Realized Realized
Proceeds Gains Losses
-------- -------- --------
<S> <C> <C> <C>
1998 $ 25,158 $ 6,891 $ 400
1997 $ 3,436 $ 964 $ 89
1996 $ 304 $ 11 $ 122
</TABLE>
Gross unrealized gains (losses) pertaining to equity securities were
as follows:
<TABLE>
<CAPTION>
Gross Gross
Original Unrealized Unrealized Estimated
Cost Gains Losses Market Value
-------- ---------- ---------- ------------
<S> <C> <C> <C> <C>
1998 $ 15,090 $ 2,558 $ (314) $ 17,334
1997 $ 18,511 $ 5,362 $ (319) $ 23,554
1996 $ 9,643 $ 1,718 $ (113) $ 11,248
</TABLE>
F-13
<PAGE>
Net investment income is applicable to the following investments:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Bonds $ 18,519 $ 16,025 $ 10,263
Equity securities 342 340 92
Cash and short-term investments 1,794 946 796
---------------------------------
Investment income 20,655 17,311 11,151
Investment expense (279) (302) (169)
---------------------------------
Net investment income $ 20,376 $ 17,009 $ 10,982
---------------------------------
---------------------------------
</TABLE>
Pursuant to certain statutory licensing requirements, as of
December 31, 1998, the Company had on deposit bonds aggregating $7,145
in insurance department safekeeping accounts. The Company is not
permitted to remove the bonds from these accounts without approval of
the regulatory authority.
4. Policy Reserves and Claims:
Policy reserves have been computed principally by the net level
premium method based upon estimated future investment yield,
mortality, morbidity, withdrawals and other benefits. The composition
of the policy reserves at December 31, 1998 and 1997 and the
assumptions pertinent thereto are presented below:
Amount of Policy Reserves
as of December 31,
1998 1997
---- ----
Accident and health $ 190,819 $ 139,963
Annuities and other 136 141
Ordinary life, individual 9,298 7,976
Years of Issue Discount Rate
-------------- -------------
Accident and health 1976 to 1986 7.0%
1987 7.5%
1988 to 1991 8.0%
1992 to 1995 6.0%
1996 7.0%
1997 to 1998 6.8%
Annuities and other 1977 to 1983 6.5% & 7.0%
Ordinary life, individual 1962 to 1998 3.0% to 5.5%
Basis of Assumption
-------------------
Accident and health Morbidity and withdrawals based on actual
and projected experience.
Annuities and other Primarily funds on deposit inclusive of
accrued interest.
Ordinary life, individual Mortality based on 1955-60 Intercompany
Mortality Table Combined Select and
Ultimate.
F-14
<PAGE>
Policy and contract claims include approximately $83,631 and $65,143
at December 31, 1998 and 1997, respectively, that are discounted at
varying interest rates. The amount of discount was $2,284 and $4,101
at December 31, 1998 and 1997, respectively.
<TABLE>
<CAPTION>
Activity in policy and contract claims is summarized as follows:
1998 1997
---- ----
<S> <C> <C>
Balance at January 1 $ 79,664 $ 57,539
less reinsurance recoverable 2,650 1,278
-------- --------
77,014 56,261
Incurred related to:
Current year 91,395 70,520
Prior years 9,016 15,955
-------- --------
Total incurred 100,411 86,475
Paid related to:
Current year 22,744 22,194
Prior years 52,402 43,528
-------- --------
Total paid 75,146 65,722
Net balance at Demember 31 102,332 77,014
plus reinsurance recoverable 3,335 2,650
-------- --------
Balance at December 31 $105,667 $ 79,664
-------- --------
-------- --------
</TABLE>
The amounts related to prior years' incurral of claims reflects the
accretion of interest due to the discounting of pending claim reserves
as well as adjustments to reflect actual versus estimated claims
experience. In 1997, the Company added to claim reserves as a result
of its reassessment of assumptions utilized in the actuarial
determination of reserves for current claims liabilities and incurred
but unreported liabilities for nursing home and home health care
claims. The Company reviewed the assumptions underlying its reserves
in connection with its recent employment of a new long-term care
consulting actuary. The review encompassed certain actuarial
assumptions related to the Company's products' benefit utilization and
duration.
F-15
<PAGE>
5. Long-Term Debt:
Long-term debt at December31, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Convertible, subordinated debt issued in November 1996, with a
semi-annual coupon of 6.25% annual percentage rate. Debt is callable
after December 2, 1999 at declining redemption values and matures in
2003. Prior to maturity, the debt is convertible to shares of the
Company's common stock at $28.44 per share. $74,750 $74,750
Mortgage loan with interest rate fixed for five years at 6.85%
effective September 1998, which repriced from 7.3% in 1997. Although
carrying a variable rate of LIBOR + 90 basis points, the loan has an
effective fixed rate due to an offsetting swap with the same
institution. Current monthly payment of $16 based on a fifteen year
amortization schedule with a balloon payment due September 2003;
collateralized by property with depreciated cost of $2,493 and $2,560
as of December 31, 1998 and 1997, respectively. 1,800 1,840
Installment note for purchase of block of renewal commissions in
January 1996, payable over two years with interest accrued at 7%. 0 162
------- -------
$76,550 $76,752
------- -------
------- -------
</TABLE>
Maturities of mortgage and other debt are as follows:
<TABLE>
<S> <C>
1999 $ 77
2000 77
2001 82
2002 88
2003 76,226
-------
$76,550
-------
-------
</TABLE>
F-16
<PAGE>
6. Federal Income Taxes:
The provision for Federal income taxes for the years ended December 31
consisted of:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Current $ 3,152 $ 514 $ 1,752
Deferred 8,426 2,181 3,095
-------- -------- --------
$ 11,578 $ 2,695 $ 4,847
-------- -------- --------
-------- -------- --------
</TABLE>
Deferred income tax assets and liabilities have been recorded for
temporary differences between the reported amounts of assets and
liabilities in the accompanying financial statements and those in the
Company's income tax return. Management believes the existing net
deductible temporary differences are realizable on a more likely than
not basis. The sources of these differences and the approximate tax
effect are as follows for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Net operating loss carryforward $ 1,932 $ 2,659
Policy reserves 14,469 8,044
Alternative minimum tax carryforward 192 40
---------- ----------
Total deferred tax assets $ 16,593 $ 10,743
---------- ----------
---------- ----------
Deferred policy acquisition costs $(42,799) $(28,142)
Present value of future profits acquired (1,082) (1,223)
Premiums due and unpaid (932) (952)
Other (18) (238)
Unrealized appreciation on investments (4,318) (4,038)
---------- ----------
Total deferred income taxes $(49,149) $(34,593)
---------- ----------
---------- ----------
Net deferred income tax (liability) $(32,556) $(23,850)
---------- ----------
---------- ----------
</TABLE>
The Company has net operating loss carry-forwards of approximately
$5,714, which have been generated by taxable losses at the Company's
non-life parent, and if unused, will expire during 2012 and 2013.
A reconciliation of the income tax provision computed using the
Federal income tax rate of 34% to income before Federal income taxes
is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Computed Federal income tax (benefit)
provision at statutory rate $12,113 $ 3,500 $ 5,782
Small life insurance company
deduction (376) (0) (560)
Tax-exempt interest income (336) (501) (478)
Other 177 (304) 103
------- ------- -------
$11,538 $ 2,695 $ 4,847
------- ------- -------
------- ------- -------
</TABLE>
At December 31, 1998, the accumulated earnings of the Company for
Federal income tax purposes included $1,453 of "Policyholders'
Surplus", a special memorandum tax account. This memorandum account
balance has not been currently taxed, but income taxes computed at
then-current rates will become payable if surplus is distributed.
Provisions of the Deficit Reduction Act of 1984 do not permit further
additions to the "Policyholders' Surplus" account. "Shareholders'
Surplus" represents an accumulation of taxable income (net of tax
thereon) plus the dividends received deduction, tax-exempt interest,
and certain other special deductions as provided by such Act. At
F-17
<PAGE>
December 31, 1998, the combined balance in the "Shareholders' Surplus"
account amounted to approximately $74,569. There is no present
intention to make distributions in excess of "Shareholders' Surplus."
7. Statutory Information:
The Company's insurance subsidiaries (PTNA, ANIC and AINIC) are
required by insurance laws and regulations to maintain minimum capital
and surplus. At December 31, 1998 and 1997, the subsidiaries' capital
and surplus exceeded the minimum required capital and surplus in all
states in which they are licensed to conduct business.
Under Pennsylvania and Vermont insurance law, dividends may be paid
from PTNA, ANIC or AINIC only from statutory profits of earned surplus
and require Insurance Department approval if the dividend is in excess
of the lesser of 10% of surplus or net statutory income of the prior
year. In 1998, ANIC paid a dividend to the Company in the amount of
$397.
Net income and capital and surplus as reported in accordance with
statutory accounting principles for the Company's insurance
subsidiaries are as follows:
1998 1997 1996
---- ---- ----
Net income (loss) $ 7,507 $(10,287) $(4,513)
Capital and surplus $76,022 $ 73,400 $81,795
Total reserves, including policy and contract claims, reported to
statutory authorities were approximately $159,861 and $7,652 less than
those recorded for GAAP as of December 31, 1998 and 1997,
respectively. This increase is attributable to a funds withheld
financial reinsurance agreement entered into on December 31, 1998. For
further discussion, see Note 11.
The National Association of Insurance Commissioners (NAIC) has
established risk-based capital standards that life and health insurers
and reinsurers must meet. In concept, risk-based capital standards are
designed to measure the acceptable amount of capital an insurer should
have based on the inherent and specific risks of each insurer.
Insurers failing to meet their benchmark capital level may be subject
to scrutiny by the insurer's domiciled insurance department and,
ultimately, rehabilitation or liquidation. Based on the NAIC's
currently adopted standards, the Company has capital and surplus in
excess of the required levels. The differences in statutory net income
compared to GAAP are primarily due to the immediate expensing of
acquisition costs, reserving methodologies, reinsurance and deferred
income taxes. Due to these differences, under statutory accounting
there is a net loss and decrease in surplus, called surplus strain, in
years of high growth. The surplus needed to sustain growth must be
raised externally or from profits from existing business.
In 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.
F-18
<PAGE>
8. Pension Plan and 401(k) Plan:
Until August 1, 1996, the Company maintained a defined contribution
pension plan covering substantially all employees. The Company
contributed 3% of each eligible employee's annual covered payroll to
the plan. All contributions were subject to limitations imposed by the
Internal Revenue Code on retirement plans and Section 401(k) plans.
Upon the termination of the plan on August 1, 1996, each participant
became fully vested. A pro rata portion of the 1996 scheduled
contribution was put into the plan upon termination. Expense for this
pension plan was $30 for the year ended December 31, 1996.
On August 1, 1996, the Company adopted a 401(k) retirement plan,
covering substantially all employees with one year of service. Under
the plan, participating employees may contribute up to 15% of their
annual salary on a pre-tax basis. The Company, under the plan, equally
matches employee contributions up to the first 3% of the employee's
salary. The Company and employee portion of the plan is vested
immediately. The Company's expense related to this 401(k) plan was
$98, $93 and $36 for the years ended December 31, 1998, 1997 and 1996,
respectively. The Company may elect to make a discretionary
contribution to the plan, which will be contributed proportionately to
each eligible employee. The Company did not make a discretionary
contribution in 1998, 1997 or 1996.
ANIC maintained a defined benefit pension plan for all ANIC employees
in 1996. This plan was subsequently terminated in 1997, with all
eligible employees joining the Company's 401(k) plan. There was no
1997 or 1996 contribution expense for this plan. Upon the termination
of the plan, the Company completed an actuarial review of its
liability to plan participants. As a result of this review, the
Company recognized approximately $125 of reduced expense in 1997 due
to the overaccrual of its liability upon the purchase of ANIC in 1996.
9. Stock Option Plans:
At December 31, 1998, the Company had three stock-based compensation
plans which are described below. The Company has adopted the
disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, ("SFAS No. 123"), and applies APB Opinion No. 25
"Accounting for Stock Issued to Employees" and related Interpretations
in accounting for its plans. Accordingly, no compensation cost has
been recognized for its fixed employee stock option plans. Had
compensation cost for the Company's employee stock-based compensation
plans been determined based on the fair value at the grant dates for
awards under those plans consistent with the method of SFAS No. 123,
the Company's net income and earnings per share would have been
reduced to the pro forma amounts indicated below. The effects of
applying the SFAS No. 123 proforma disclosure are not indicative of
future amounts.
F-19
<PAGE>
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net Income As reported $ 24,048 $ 7,599 $ 12,160
Proforma $ 23,791 $ 7,426 $ 12,095
Basic Earnings Per Share As reported $ 3.17 $ 1.01 $ 1.70
Proforma $ 3.14 $ 0.98 $ 1.69
Diluted Earnings Per Share As reported $ 2.64 $ 0.98 $ 1.66
Proforma $ 2.61 $ 0.96 $ 1.65
</TABLE>
Compensation cost is estimated using an option-pricing model with the
following assumptions for 1996, 1997 and 1998: an expected life
ranging from 5.3 to 8.3 years, volatility of 27.9% for 1996 and 26.4%
for 1997 and a risk free rate ranging from 5.71% to 6.35%. The
weighted average fair value of those options granted in years prior to
and including 1996 and 1997 was $8.25 and $12.24, respectively. No
options were granted under these plans in 1998. No compensation
expense is calculated for those options granted prior to 1995.
The Company's 1987 Employee Incentive Stock Option Plan, which
provided for the granting of options to purchase up to 1,200 shares of
common stock. This plan expired in 1997 and was subsequently replaced
by the 1998 Employee, Non-Qualified Incentive Stock Option Plan. The
1998 Plan allows for the grant of options to purchase up to 600,000
shares of common stock. No new options may be granted under the 1987
Plan. The maximum allowable term of each option is ten years (five
years in the case of holders of more than 10% of the combined voting
power of all classes of outstanding stock), and the options become
exercisable in four equal, annual installments commencing one year
from the option grant date.
Effective May 1995, the Company adopted a Participating Agent Stock
Option Plan which provides for the granting of options to purchase up
to 300 shares of common stock. The exercise price of all options
granted under the plan may not be less than the fair market value of
the shares on the date of grant. The maximum allowable term of each
option is ten years, and the options become exercisable in four equal,
annual installments commencing one year from the option grant
date.SFAS No. 123 requires that the deemed value of options granted to
non-employees be recognized as compensation expense over the estimated
life of the option. The estimated fair value of these options was
$7.77 and $11.56 for options granted in 1996 and 1997, respectively.
No agent options were granted in 1998.
F-20
<PAGE>
The following is a summary of the Company's option activity, including
grants, exercises, forfeitures and average price information:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ --------------------- ---------------------
Exercise Exercise Exercise
Price Price Price
Options Per Option Options Per Option Options Per Option
------------------- --------------------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 574 $ 19.22 510 $ 14.84 396 $ 10.88
Granted 0 $ - 125 $ 32.57 185 $ 21.03
Exercised 11 $ 14.91 61 $ 11.04 67 $ 8.61
Canceled 9 $ 16.03 0 $ - 4 $ 12.38
--------- --------- ---------
Outstanding at end of year 554 $ 19.59 574 $ 19.22 510 $ 14.84
--------- --------- ---------
--------- --------- ---------
Exercisable at end of year 305 $ 15.47 218 $ 12.63 200 $ 10.45
--------- --------- ---------
--------- --------- ---------
</TABLE>
Outstanding Remaining Exercisable
at December Contractual at December
Range of Exercise Prices 31, 1998 Life (Yrs) 31, 1998
-----------------------------------
8.71 5 2 5
8.92 27 4 26
9.81 45 4 45
11.17 14 3 14
12.28 26 3 26
12.38 78 7 57
12.63 15 7 11
13.61 48 7 21
20.50 126 8 59
22.55 48 8 14
32.25 93 9 23
35.48 29 9 4
---------- ----------
554 305
---------- ----------
---------- ----------
10. Commitments and Contingencies:
Operating Lease Commitments:
The total net rental expenses under all leases amounted to
approximately $260, $202 and $174 for the years ended December 31,
1998, 1997 and 1996, respectively.
During May 1987, the Company assigned its rights and interests in a
land lease to a third party for $175. The agreement indemnifies the
Company against any further liability with respect to future lease
payments. The Company remains contingently liable to the lessor under
the original deed of lease for rental payments of $16 per year, the
amount being adjustable based upon changes in the consumer price index
since 1987, through the year 2063.
Line of Credit:
In June 1997, the Company was given an unsecured, uncommitted line of
credit from a bank for up to $3,000, which was unused at December 31,
1998. The line of credit is renewable annually, carries no origination
or carrying fees, and if used, will carry a variable rate of interest
equal to the London Interbank Offering Rate (LIBOR) plus .75% annually
on the outstanding balance.
F-21
<PAGE>
Litigation:
The Company is a defendant in various lawsuits arising in the ordinary
course of business. In the opinion of management, the resolution of
these lawsuits will not have a material effect on the financial
condition or results of operations of the Company.
11. Reinsurance:
PTNA is party to reinsurance agreements to cede 100% of benefits
exceeding 36 months on certain home health care policies. Total
reserve credits taken related to this agreement as of December 31,
1997 and 1996 were approximately $2,912 and $859, respectively.
Effective January 1, 1998, no new business was reinsured under this
facility.
The Company currently reinsures with unaffiliated companies any life
insurance policy to the extent the risk on that policy exceeds $50.
Effective January 1994, PTNA entered into a reinsurance agreement to
cede 100% of certain life, accident and health and Medicare supplement
insurance to a third party insurer. Total reserve credits taken
related to this agreement as of December 31, 1998 and 1997 were
approximately $533 and $569, respectively.
PTNA is party to a reinsurance agreement to cede 100% of certain whole
life and deferred annuity policies to be issued by PTNA to a third
party insurer. These policies are intended for the funeral arrangement
or "pre-need" market. Total reserve credits taken related to this
agreement as of December 31, 1998 and 1997 were approximately $3,223
and $3,427, respectively. The third party reinsurer maintains
securities at least equal to the statutory reserve credit in escrow
with a bank. Effective January 1, 1996, this Agreement was modified,
and as a result, no new business is reinsured under this facility.
Effective December 31, 1998, PTNA entered a funds withheld financial
reinsurance agreement with an unaffiliated reinsurer. Under the
agreement, PTNA ceded the claims risk of a material portion of its
long-term care policies. This transference of risk qualifies the
agreement for statutory treatment of reinsurance. PTNA expects, but is
not obligated to recapture the ceded policies and their cumulative
profits after December 31, 2000. The agreement is not considered
reinsurance according to FASB Statement 113 "Accounting and Reporting
for Reinsurance of Short-Duration and Long-Duration Contracts", and is
therefore not treated as reinsurance in the Company's Consolidated
Financial Statements other than the $300 financing fee paid to the
reinsurer, which is recorded as commission expense. As a result of
this agreement, 1998 statutory surplus was increased by approximately
$14,700.
PTNA is party to a coinsurance agreement on a previously acquired
block of long- term care business whereby 66% is ceded to a third
party. At December 31, 1998 and 1997, reserve credits taken related to
this treaty were approximately $1,852 and $1,947, respectively.
ANIC reinsures approximately $500 of its risk with three reinsuring
companies, all of which are authorized to do business in the State of
Vermont.
F-22
<PAGE>
The Company has assumed and ceded reinsurance on certain life and
accident and health contracts under various agreements. The tables
below highlight the amounts shown in the accompanying consolidated
statements of operations, which are net of reinsurance activity:
Ceded to Assumed
Gross Other from Other Net
Amount Companies Companies Amount
------ --------- --------- ------
December 31, 1998
- - -----------------
Ordinary Life Insurance
In-Force $66,644 $14,848 $ 0 $51,796
Premiums:
Accident and health 222,895 3,294 544 220,145
Life 3,970 425 2 3,547
Benefits to Policyholders:
Accident and health 78,179 1,625 297 76,851
Life 2,005 22 0 1,983
Inc (dec) in Policy Reserves:
Accident and health 75,356 940 (20) 74,396
Life 1,248 178 0 1,070
Commissions $80,929 $739 $ 83 $80,273
December 31, 1997
- - -----------------
Ordinary Life Insurance
In-Force $65,964 $16,636 $ 0 $49,328
Premiums:
Accident and health 167,187 3,546 501 164,142
Life 4,044 506 0 3,538
Benefits to Policyholders:
Accident and health 86,829 2,770 258 84,317
Life 1,790 523 0 1,267
Inc (dec) in Policy Reserves:
Accident and health 37,743 260 (11) 37,472
Life (407) (1,216) 0 809
Commissions $56,193 $1,028 $ 75 $55,240
December 31, 1996
- - -----------------
Ordinary Life Insurance
In-Force $66,932 $18,004 $ 0 $48,928
Premiums:
Accident and health 130,551 4,438 544 126,657
Life 4,147 612 0 3,535
Benefits to Policyholders:
Accident and health 54,824 1,170 419 54,073
Life 1,632 477 0 1,155
Inc (dec) in Policy Reserves:
Accident and health 28,568 764 (17) 27,787
Life 1,404 426 0 978
Commissions $44,770 $1,547 $ 82 $43,305
The Company remains contingently liable in the event that the
reinsuring companies are unable to meet their obligations.
F-23
<PAGE>
12. Transactions with Related Parties:
Irv Levit Insurance Management Corporation ("IMC"), an insurance
agency which is owned by the President of the Company, produced
approximately $41, $50 and $55 of new and renewal premiums for PTLIC,
for the years ended December 31, 1998, 1997 and 1996, respectively,
for which it received commissions of approximately $10, $13 and $12
respectively.
IMC also received commission overrides on business written for PTLIC
by certain agents, principally general agents who were IMC agents
prior to January 1979 and any of their sub-agents hired prior and
subsequent to January 1979. For the years ended December 31, 1998,
1997 and 1996, IMC commission overrides totaled approximately $559,
$534 and $539, respectively.
13. Major Agencies:
A managing general agent accounted for approximately 17%, 18% and 21%
of total premiums in 1998, 1997 and 1996, respectively.
14. Concentrations of Credit Risk:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents and investments. The Company places its cash and cash
equivalents and investments with high quality financial institutions,
and attempts to limit the amount of credit exposure to any one
institution. However, at December 31, 1998, and at other times during
the year, amounts in any one institution exceeded the Federal Deposit
Insurance Corporation limits.
15. Fair Value of Financial Instruments:
Fair values are based on estimates using present value or other
valuation techniques where quoted market prices are not available.
Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. The
fair value amounts presented do not purport to represent and should
not be considered representative of the underlying value of the
Company.
The methods and assumptions used to estimate the fair values of each
class of the financial instruments described below are as follows:
Investments -- The fair value of fixed maturities and equity
securities are based on quoted market prices. It is not practicable to
determine the fair value of policy loans since such loans are not
separately transferable and are often repaid by reductions to benefits
and surrenders.
Cash and cash equivalents -- The statement value approximates fair
value.
F-24
<PAGE>
Long-term debt -- The statement value approximates the fair value of
mortgage debt and capitalized leases, since the instruments carry
interest rates, which approximate market value. The convertible,
subordinated debt, as a publicly traded instrument, has a readily
accessible fair market value, and, as such is reported at that value.
December 31, 1998 December 31, 1997
-------------------- ----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ----- -------- -----
Financial assets:
Investments
Bonds, available for sale $ 321,448 $ 321,448 $ 278,148 $ 278,148
Equity securities 17,334 17,334 23,554 23,554
Policy loans 107 107 85 85
Cash and cash equivalents 38,402 38,402 11,241 11,241
Financial liabilities:
Convertible debt $ 74,750 $ 69,133 $ 74,750 $ 58,058
Mortgage and other debt 1,800 1,800 2,002 2,002
16. Subsequent Event:
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
installment note.The acquisition was effective January 1, 1999. 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 and results of operations.
F-25
<PAGE>
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENT SCHEDULE
Pages
Report of Independent Accountants on Schedule S-2
Schedule II -- Condensed Financial Information
of Registrant S-3 - S-5
S-1
<PAGE>
Report of Independent Accountants
To the Board of Directors of Penn Treaty American Corporation
Allentown, Pennsylvania
Our report on the consolidated financial statements of Penn Treaty
American Corporation and Subsidiaries is included on page F-2 of this
Form 10-K. In connection with our audits of such financial statements,
we have also audited the related financial statement schedule listed
in the index on page S-1 of this Form 10-K.
In our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as
a whole, presents fairly, in all material respects, the information
required to be included therein.
/s/ PricewaterhouseCoopers LLP
------------------------------
PricewaterhouseCoopers LLP
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 8, 1999
S-2
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES (PARENT COMPANY)
Schedule II - Condensed Financial Information of Registrant
Balance Sheets
as of December 31, 1998 and 1997
($000)
<CAPTION>
ASSETS 1998 1997
---- ----
<S> <C> <C>
Bonds, available for sale at market (amortized
cost $4,402 and $22,676, respectively) $ 4,452 $ 23,382
Equity securities at market (cost $1,055 and
$3,099, respectively) 994 3,179
Cash and cash equivalents 15,275 963
Investment in subsidiaries* 211,524 179,263
Other assets 3,351 4,086
---------- ----------
Total assets $235,596 $210,873
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Long-term debt $ 74,750 $ 74,750
Accrued interest payable 389 389
Accounts payable 189 242
Deferred income taxes - 267
Due to subsidiaries* 2,598 2,468
---------- ----------
Total liabilities 77,926 78,116
---------- ----------
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, 8,189 and 8,178
shares issued, respectively 819 818
Additional paid-in capital 53,516 53,194
Unrealized appreciation, net of deferred taxes 8,381 7,838
Retained earnings 96,660 72,612
---------- ----------
159,376 134,462
Less 606 of common shares held in treasury, at cost (1,706) (1,706)
---------- ----------
Total shareholders' equity 157,670 132,756
---------- ----------
Total liabilities and shareholders' equity $235,596 $210,872
---------- ----------
---------- ----------
* Eliminated in consolidation.
The condensed financial information should be read in
conjunction with the Penn Treaty American Corporation and
Subsidiaries consolidated statements and notes thereto.
</TABLE>
S-3
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES (PARENT COMPANY)
Schedule II - Condensed Financial Information of Registrant
Statements of Operations
for the years ended December 31, 1998, 1997, and 1996
($000)
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Management fees* $ 296 $ 56 $ 56
Investment income 2,426 1,818 836
General and administrative expense 1,032 1,295 274
Interest on convertible debt 4,672 4,672 448
---------- ---------- ----------
Gain (loss) before equity in undistributed
net earnings of subsidiaries* (2,982) (4,093) 170
Equity in undistributed net earnings of
subsidiaries* 27,030 11,692 11,990
---------- ---------- ----------
Net income 24,048 7,599 12,160
Retained earnings, beginning of year 72,612 65,013 52,853
--------- --------- ---------
Retained earnings, end of year $ 96,660 $ 72,612 $ 65,013
--------- --------- ---------
--------- --------- ---------
*Eliminated in consolidation.
The condensed financial information should be read in
conjunction with the Penn Treaty American Corporation and
Subsidiaries consolidated statements and notes thereto.
</TABLE>
S-4
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES (PARENT COMPANY)
Schedule II - Condensed Financial Information of Registrant
Statements of Cash Flows
for the years ended December 31, 1998, 1997, and 1996
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net Income $ 24,048 $ 7,599 $ 12,160
Adjustments to reconcile net income to cash
provided by (used in) operations:
Equity in undistributed earnings of
subsidiaries (27,030) (11,692) (11,991)
Depreciation and amortization 464 425 114
Net realized (gains) losses (791) (103) 5
Increase (decrease) due to change in:
Due to/from subsidiaries 130 1,067 440
Other, net (65) 13 (2,631)
---------- --------- ---------
Net cash provided by (used in)
operations (3,244) (2,691) (1,903)
---------- --------- ---------
Cash flows from investing activities:
Sales and maturities of investments 25,790 14,202 12,372
Purchase of investments (4,682) (27,470) (17,315)
Acquisition of property and equipment (32) (39) (397)
Contribution to subsidiary (6,659) - (53,093)
---------- --------- ---------
Net cash provided by (used in) 14,417 (13,307) (58,433)
investing activities ---------- --------- ---------
Cash flows from financing activities:
Proceeds from convertible debt offering - - 74,750
Proceeds from exercise of stock options 140 673 564
Repayment of mortgages and other borrowings - (88) 740
Proceeds from sale of PTLIC 3,000 - -
---------- --------- ---------
Net cash provided by financing
activities 3,140 585 76,054
---------- --------- ---------
Increase (decrease) in cash and cash
equivalents 14,313 (15,413) 15,718
Cash and cash equivalents balances:
Beginning of year 962 16,375 657
---------- ---------- ----------
End of year $ 15,275 $ 962 $ 16,375
---------- ---------- ----------
---------- ---------- ----------
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 4,672 $ 4,674 $ 8
---------- ---------- ----------
---------- ---------- ----------
The condensed financial information should be read in
conjunction with the Penn Treaty American Corporation and
Subsidiaries consolidated statements and notes thereto.
</TABLE>
S-5
<PAGE>
Item 9. Changes in and Disagreement with Accountants on Accounting and
Financial Disclosure
Not Applicable
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1999 Annual Meeting of Shareholders.
Item 11. Executive Compensation
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1999 Annual Meeting of Shareholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1999 Annual Meeting of Shareholders.
Item 13. Certain Relationship and Related Transactions
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1999 Annual Meeting of Shareholders.
36
<PAGE>
PART IV
-------
Item 14. Exhibits, Financial Statements, Schedule and Reports on Form 8-K
(a) The following documents are filed as a part of this report.
(1) Financial Statements.
Pages
-----
Report of Independent Accountants............................. F-2
Consolidated Balance Sheets at December 31, 1998 and 1997
........................................................ F-3
Consolidated Statements of Operations for the years
ended December 31, 1998, 1997, and 1996................. F-4
Consolidated Statements of Shareholders'
Equity for the years ended December 31, 1998, 1997, and
1996.................................................... F-5
Consolidated Statements of Cash Flow for the years
ended December 31, 1998, 1997, and 1996................. F-6
Notes to Consolidated Financial Statements.................... F-7-F-25
(2) Financial Statement Schedule.
Report of Independent Accountants on Schedule................. S-2
Schedule II - Condensed Financial Information of
Registrant.............................................. S-3-S-5
37
<PAGE>
(3) EXHIBITS.
3.1 Restated and Amended Articles of Incorporation of Penn
Treaty American Corporation. ****
3.1(b) Amendment to Restated and Amended Articles of
Incorporation of Penn Treaty American Corporation.
*****
3.2 Amended and Restated By-laws of Penn Treaty American
Corporation, as amended. *****
4. Form of Penn Treaty American Corporation Common Stock
Certificate. *
4.1 Indenture dated as of November 26, 1996 between Penn
Treaty American Corporation and First Union National
Bank, as trustee (including forms of
Notes)(incorporated by reference to Exhibit 4.1 to Penn
Treaty American Corporation's current report on Form
8-K filed on December 6, 1996).
10.05 PTAC 1998 Employee Incentive Stock Option Plan
10.1 Penn Treaty American Corporation 1987 Employee
Incentive Stock Option Plan. * 10.2 Penn Treaty
American Corporation 1995 Agent Stock Option Plan. ****
10.3 Penn Treaty American Corporation Employees' Pension
Plan. *
10.4 Reinsurance Treaty between Penn Treaty Life Insurance
Company and NRG America Life Reassurance Corp. *
10.5 Assumption Agreement dated May 12, 1994 between
Reassurance Company of Hannover and Penn Treaty Life
Insurance Company. ****
10.6 Reinsurance Agreement between Penn Treaty Life
Insurance Company and Life Insurance Company of North
America, effective as of June 1, 1976. * 10.7 Personal
Accident Quota Share issued to Penn Treaty Life
Insurance Company by American Accident Reinsurance
Group, effective as of November 23, 1982. *
10.8 Credit Life Quota Share Reinsurance Agreement between
Penn Treaty Life Insurance Company and The Centennial
Life Insurance Company, effective as of August 15,
1977. *
10.9 Treaty Endorsement replacing The Centennial Life
Insurance Company with Puritan Life Insurance Company,
effective June 1, 1986. ****
10.10 Endorsement replacing Puritan Life Insurance Company
with Employers Reassurance Corporation, effective as of
December 31, 1986. ****
10.11 Reinsurance Agreement between Washington Square Life
Insurance Company and Cologne Life Insurance Company,
effective March 1, 1987. ****
38
<PAGE>
10.12 Reinsurance Agreements between Penn Treaty Life
Insurance Company and Cologne Life Reinsurance Company,
effective October 1, 1994. ****
10.13 Reinsurance Agreements between Network America Life
Insurance Company and Cologne Life Reinsurance Company,
effective October 1, 1994. ****
10.14 Reinsurance Agreement between Penn Treaty Life
Insurance Company and Transamerica Occidental Life
Insurance Company, effective April 1, 1988. ****
10.15 Reinsurance Agreement between Network America Life
Insurance Company and Provident Indemnity Life
Insurance Company, effective January 1, 1991, as
amended on November 30, 1993. ****
10.16 Quota Share Reinsurance Agreement between Network
America Life Insurance Company and Life and Health
Insurance Company of America, effective December 1,
1994. ****
10.17 Reinsurance Agreement between Penn Treaty Life
Insurance Company and Reassurance Company of Hannover,
effective January 1, 1995. ****
10.18 Administrative Services Agreement between Network
America Life Insurance Company and Midland Mutual Life
Insurance Company, effective June 25, 1991. ****
10.19 Administration and Agency Agreements between Penn
Treaty Life Insurance Company, Network America Life
Insurance Company and Tower Insurance Services, Inc.
effective December 1, 1993, relating to the Quota Share
Reinsurance Agreement between Network America Life
Insurance Company and Life and Health Insurance Company
of America, effective December 1, 1994. ****
10.20 Form of General Agent's Contract of Penn Treaty Life
Insurance Company. ****
10.21 Form of General Agent's Contract of Network America
Life Insurance Company. ****
10.22 Form of Managing General Agency Agreement. ****
10.23 Regional General Agents' Contract dated August 1, 1971
between Penn Treaty 10.23 Regional General Agents'
Contract dated August 1, 1971 between Penn Treaty Life
Insurance Company and Irving Levit of the Irv Levit
Insurance Management Corporation, as amended on August
15, 1971, May 26, 1976 and June 16, 1987, and by an
undated override commissions schedule. ***
10.24 Managing General Agent's Contract dated March 10, 1988
between Penn Treaty Life Insurance Company and
Ameri-Life and Health Services, Inc.****
10.25 Commission Supplement to General Agent's Contract
dated December 7, 1993 between Network America Life
Insurance Company and Network Insurance. ****
39
<PAGE>
10.26 Administrative Services Agreement dated February 14,
1995 between National Benefits Corporation and Penn
Treaty Life Insurance Company and Network America Life
Insurance Company. ****
10.27 Mortgage in the amount of $2,450,000 dated September
13, 1988 between Penn Treaty Life Insurance Company and
Merchants Bank, N.A. **
10.28 Amendments to Mortgage dated September 24, 1991,
October 13, 1992 and September 2, 1993. ****
10.29 Loan and Security Agreement by and between Penn Treaty
American Corporation and CoreStates Bank, N.A. dated
December 28, 1994.****
10.30 Investment Counseling Agreement dated May 3, 1995
between Penn Treaty American Corporation and James M.
Davidson & Company.****
10.31 Investment Counseling Agreement dated May 3, 1995
between Penn Treaty Life Insurance Company and James M.
Davidson & Co.****
10.32 Investment Counseling Agreement dated May 3, 1995
between Network America Life Insurance Company and
James M. Davidson & Company. ****
10.33 Assumption and Reinsurance Agreement dated December
22, 1997, between Penn Treaty Life Insurance Company
and Network America Life Insurance Company.
10.34 Quota Share Reinsurance Agreement between Penn Treaty
Life Insurance Company and Penn Treaty Network America.
10.35 Quota Share Reinsurance Agreement between Penn Treaty
Network America and Cologne Reinsurance.
10.36 Employment Contracts
10.46 Material Contract with Cameron B. Waite
10.47 Penn Treaty American Corporation 1998 Incentive Stock
Option Plan
10.48 Material Contract with A. J. Carden
11. See Notes to Consolidated Financial Statements, "Note
1."
21. Subsidiaries of the Registrant. ****
24. Consent of PricewaterhouseCoopers, LLP
27. Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1998.
40
<PAGE>
* Incorporated by reference to the Company's Registration Statement
on Form S-1 dated May 12, 1987, as amended.
** Incorporated by reference to the Company's Registration Statement on
Form S-1 dated November 17, 1989, as amended.
*** Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1989.
**** Incorporated by reference to the Company's Registration Statement on
Form S-1 dated June 30, 1995, as amended.
***** Incorporated by reference to the Company's Registration Statement on
Form S-3 dated February 19, 1999.
Executive Compensation Plans - see Exhibits 10.1, 10.2, 10.3 and 10.47
41
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PENN TREATY AMERICAN CORPORATION
Date: March 29, 1999 By: /s/ Irving Levit
---------------------------------
Irving Levit, Chairman of the
Board and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 29, 1999 By: /s/ Irving Levit
---------------------------------
Irving Levit, Chairman of the
Board and President
Date: March 29, 1999 By: /s/ A.J. Carden
---------------------------------
A.J. Carden, Executive Vice
President and Director
Date: March 29, 1999 By: /s/ Michael F. Grill
---------------------------------
Michael F. Grill, Treasurer
and Director
Date: March 29, 1999 By: /s/ Domenic P. Stangherlin
---------------------------------
Domenic P. Stangherlin,
Secretary and Director
Date: March 29, 1999 By: /s/ Jack D. Baum
---------------------------------
Jack D. Baum, Vice President,
Marketing and Director
Date: March 29, 1999 By: /s/ Emile Ilchuk
---------------------------------
Emile Ilchuk, Director
Date: March 29, 1999 By: /s/ C. Mitchell Goldman
---------------------------------
C. Mitchell Goldman, Director
Date: March 29, 1999 By: /s/ Glen A. Levit
---------------------------------
Glen A. Levit, Vice President,
Sales and Director
Date: March 29, 1999 By: /s/ David B. Trindle
---------------------------------
David B. Trindle, Director
42
<PAGE>
Exhibit 24
Consent of Independent Accountants
We consent to the incorporation by reference in the registration statement of
Penn Treaty American Corporation on Form S-8 (File No. 33-38330) of our reports
dated March 8, 1999 on our audits of the consolidated financial statements and
financial statement schedule of Penn Treaty American Corporation as of
December 31, 1998 and 1997 and for the years ended December 31, 1998, 1997 and
1996, which reports are included in this Annual Report on Form 10-K.
/s/ PricewaterhouseCoopers LLP
- - ---------------------------------
PricewaterhouseCoopers LLP
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 29, 1999
<PAGE>
EMPLOYMENT AGREEMENT
THIS AGREEMENT is made and entered into as of the ______ day of ____________
1998, by and between PENN TREATY NETWORK AMERICA INSURANCE COMPANY, a
Pennsylvania corporation, and its affiliates and parent corporation
(collectively, the "Company"), and A. J. CARDEN, residing at 5722 Schantz Road,
Allentown, PA 18104 ("Executive").
WHEREAS, Executive is presently employed by the Company as its Executive Vice
President; and
WHEREAS, the Company and Executive desire to set forth the terms on which
Executive shall continue to be
employed by the Company;
NOW, THEREFORE, in consideration of the promises and mutual covenants contained
herein and intending to be legally bound, the parties agree as follows:
1. Employment Duties.
(a) Capacity. The Company shall employ Executive, and Executive shall
serve as Executive Vice President of Penn Treaty Network America
Insurance Company, its parent, Penn Treaty American Corporation and
its affiliates, American Network Insurance Company and American
Independent Network Insurance Company of New York, on the terms and
subject to the conditions set forth in this Agreement. Executive shall
retain said titles and positions for at least the first two years of
the term of this Agreement, unless terminated sooner pursuant to
section 4 herein.
The Penn Treaty American Corporation directorship position currently
held by Executive shall continue until its term expires at the Penn
Treaty American Corporation annual meeting to be held in the year
2000, unless terminated sooner pursuant to section 4 herein. All
directorships currently held by Executive with Penn Treaty American
Corporation subsidiaries shall also continue until the companies'
respective annual meetings held in the year 2000, unless terminated
sooner pursuant to section 4 herein.
(b) Scope and Duties. Executive shall perform such executive and
managerial duties as are normally associated with the position of
Executive Vice President of the Company. The duties of Executive shall
be performed primarily in Pennsylvania and as otherwise agreed by the
parties hereto. Executive's principal place of business shall be at
the offices of the Company in Allentown, Pennsylvania or at such other
location(s) as the parties may agree from time to time. Executive
shall use his best efforts and devote reasonable time and attention to
the business and affairs of the Company and to use his best efforts to
perform faithfully and efficiently the responsibilities incidental to
Executive's position.
(c) Permitted Activities. Executive shall devote all of his business time
to his obligations to the Company pursuant to this Agreement, and
shall not, without the approval of the Board, render services of a
business nature to any other person or entity, if such activities
would materially interfere with the performance of Executive's duties
under this Agreement.
2. Terms of Employment. The term of Executive's full-time employment under
this Agreement will commence effective on January 1, 1999 and terminate on
December 31, 2001, unless terminated sooner pursuant to Section 4 herein
(the "Term").
<PAGE>
3. Compensation and Other Benefits.
(a) Base Salary. During the term of this Agreement, the Company shall pay
to Executive a base salary as set forth below ("Base Salary").
Executive's Base Salary shall be payable at the usual times for the
payment of the Company's other salaried employees, subject to
adjustment as provided herein.
(i) For the period from January 1, 1999 through December 31, 1999,
the Company shall pay to Executive an annual Base Salary of
$100,000.00 (one hundred thousand dollars).
(ii) For the period from January 1, 2000 through December 31, 2000,
the Company shall pay to Executive an annual Base Salary of
$80,000.00 (eighty thousand dollars).
(iii)For the period from January 1, 2001 through December 31, 2001,
the Company shall pay to Executive an annual Base Salary of
$60,000.00 (sixty thousand dollars).
(b) Expenses. During the term of employment hereunder, Executive shall be
entitled to receive prompt reimbursement for all reasonable and
necessary expenses incurred by him in performing services hereunder,
provided that such expenses are incurred and accounted for in
accordance with the policies and procedures established by the
Company. As of the effective date of this Agreement and during the
term of the Agreement and thereafter, Executive shall be solely
responsible for any and all payments related to the use of his
automobile.
(c) Other Benefits. During the term of Executive's employment under this
Agreement, Executive shall be entitled to receive all benefits (such
as medical, dental, disability and life insurance, paid vacation, sick
days and retirement plan coverage) as are generally available from
time to time to similarly situated employees of the company and the
portion of such benefits paid by Executive shall be consistent with
the portion of such benefits paid by similarly situated employees of
the Company. Executive shall, at his option, be eligible to
participate in any incentive compensation, stock option, stock
purchase or similar plans or programs as the Company may maintain for
compensating similarly situated employees at such level of
participation as the Board may determine in its reasonable discretion
based upon Executive's responsibilities and performance.
Any and all Penn Treaty American Corporation stock option grants
awarded to Executive prior to the term of this Agreement, shall remain
in force until their original expiration date of ten (10) years after
their respective grant date, regardless of whether such expiration
date extends beyond the term of this Agreement.
4. Termination.
(a) Termination by the Company. Executive's employment hereunder may be
terminated by the Company without any breach of this Agreement only
under the following circumstances:
(i) Death. Executive's employment hereunder shall terminate upon his
death.
(ii) Disability. If, as a result of Executive's incapacity due to
physical or mental illness, Executive shall have been absent from
his duties hereunder on a full-time basis for the entire period
of two consecutive months, and within thirty (30) days after
written notice of termination is given (which may occur before or
after the end of such two-month period) shall not have returned
to the performance of his duties hereunder on a full-time basis,
the Company may terminate Executive's employment hereunder.
<PAGE>
(iii)Cause. The Company may terminate Executive's employment
hereunder for "Cause." For purposes of this Agreement, "Cause"
shall include theft, falsification of records, fraud,
embezzlement, gross negligence or willful misconduct, causing the
Company or its successor to violate any federal, state, or local
law, or administrative regulation or ruling having the force and
effect of law, insubordination, conflict of interest, diversion
of corporate opportunity, failure to satisfy any performance
objectives for Executive which the Company has provided to
Executive in writing, conviction of Executive in connection with
a felony or conduct that results in publicity that has a material
adverse effect on the Company or its successor. Notwithstanding
the foregoing, Executive shall not be deemed to have been
terminated for Cause without (A) reasonable notice to Executive
setting forth the reasons for the Company's intention to
terminate him for Cause, (B) an opportunity for Executive,
together with his counsel, to be heard before the full Board with
reasonable advance notice of the time and place of meeting, and
(C) delivery to Executive of a Notice of Termination (as defined
in Section 4(c) hereof) stating that in the good faith opinion of
the Board, Executive was guilty of conduct constituting "Cause,"
and specifying the particulars thereof in detail.
(b) Termination Procedure.
(i) Notice of Termination. Any termination of Executive's employment
by the Company or by Executive (other than termination due to
Executive's death) shall be communicated by written Notice of
Termination to the other party hereto. For purposes of this
Agreement, a 'Notice of Termination" shall mean a written notice
which shall (A) indicate the specific termination provision in
this Agreement relied upon, (B) set forth in reasonable detail
the facts and circumstances claimed to provide a basis for
termination of Executive's employment under the provision so
indicated, and (C) specify the Date of Termination (as defined
below).
(ii) Date of Termination. "Date of Termination" shall mean:
(A) if Executive's employment is terminated by his death, the
date of his death,
(B) if the Executive's employment is terminated pursuant to
Section 4(a)(ii), thirty (30) days after Notice of
Termination is given (provided that Executive shall not have
returned to the performance of his duties on a full-time
basis during such thirty (30) day period),
(C) if Executive's employment is terminated pursuant to Section
4(a)(iii), the date specified in the Notice of Termination,
and
(D) if Executive's employment is terminated for any other
reason, the date on which a Notice of Termination is given,
provided that if within thirty (30) days after any Notice of
Termination is given, the party receiving such Notice of
Termination notifies the other party that a dispute exists
concerning the termination, the Date of Termination shall be
the date on which the dispute is finally determined, either
by mutual written agreement of the parties, by a binding and
final arbitration award or by a final judgment, order or
decree of a court of competent jurisdiction (the time for
appeal therefrom having expired and no appeal having been
perfected).
5. Compensation Upon Termination.
(a) Death. If Executive's employment is terminated by reason of his death,
this Agreement shallterminate without further obligations to
Executive's legal representatives under this Agreement, other than
those obligations accrued or earned and vested (if applicable) by
Executive as of the Date of Termination, including, for this purpose
[(i)] Executive's full Base Salary as earned through the Date of
Termination at the rate in effect on the Date of Termination. All such
Base Salary shall be paid to Executive's spouse or other designated
beneficiary (or if he leaves no spouse or other designated
beneficiary, to his estate) in a lump sum in cash within thirty (30)
days after the Date of Termination.
<PAGE>
(b) Disability. If Executive's employment is terminated by reason of
disability pursuant to Section 4 (a) (ii), this Agreement shall
terminate without further obligations to Executive, other than the
obligation to pay to Executive all Base Salary as earned through the
Date of Termination. All such Base Salary shall be paid to Executive
in a lump sum in cash within thirty (30) days after the Date of
Termination.
(c) Termination for Cause; Termination by Executive in Breach of
Agreement. If Executive's employment is terminated for Cause or if
Executive terminates his employment for any reason other than Good
Reason, this Agreement shall terminate without further obligations to
Executive other than the Company's obligation to pay to Executive Base
Salary accrued to the Date of Termination. Such salary shall be paid
to Executive in a lump sum in cash within thirty (30) days after the
Date of Termination.
6. Confidentiality.
(a) Executive shall keep confidential and not disclose or use in any way,
at any time, either during or subsequent to Executive's employment,
any trade secrets, information, knowledge, data or other confidential
information relating to the Company's products, know-how, data,
customer lists, business plans, marketing plans and strategies,
pricing strategies or other subject matter pertaining to the business
of the Company or any of its clients, customers, consultants or
affiliates, except as otherwise provided herein or with the prior
written consent of the Company. Moreover, Executive shall not deliver,
reproduce or in any way allow any trade secrets, information,
knowledge, data or other confidential information, or any
documentation relating thereto, to be delivered or used by any third
party, without the prior written consent of the Company.
(b) Executive recognizes that the Company has received and will receive
confidential information from third parties and that the Company has a
duty to maintain the confidentiality of this information and to use it
only for certain limited purposes. Executive shall maintain the
confidentiality of information received from third parties and shall
not disclose it to any person or entity without the prior written
consent of the Company, except as may be necessary to satisfy the
obligations of the Company to the third party or for the benefit of
the third party, consistent with the Company's agreement with such
third party.
7. Return of Confidential Material. In the event of termination of Executive's
employment for any reason whatsoever, Executive agrees to promptly
surrender and deliver to the Company all records, materials, equipment,
drawings, data and all other documents, as well as any copies thereof,
pertaining to any endeavor, development, invention, trade secret or other
confidential information of the Company.
8. Non-Competition.
(a) Executive understands that Executive is a key and significant employee
of the Company. In addition, Executive agrees that the Company is
engaged in its business in all fifty (50) states (the "Geographic
Scope'). Executive further agrees that the Company will continue
conducting its business in all parts of the Geographic Scope and
intends to sell its products in the Geographic Scope. As a result of
the foregoing, Executive expressly understands and agrees that the
non-competition provisions contained in this Agreement are intended to
be permissible and enforceable pursuant to the provisions of
applicable law.
Executive agrees that during his employment by the Company and its
successors and assigns, he will not, alone or as a member, employee,
agent, consultant, advisor, independent contractor, general partner,
officer, director, shareholder, investor, lender or guarantor of any
corporation, partnership or other entity, or in any other capacity,
directly or indirectly:
(i) participate or engage in the production, marketing, sale or
servicing of any product, or the provision of any service, that
directly relates to the business of the Company (a "Competitive
Business') in the Geographic Scope; or
(ii) permit the name of Executive to be used in connection with a
Competitive Business.
<PAGE>
9. Equitable Relief. Executive agrees and acknowledges that a breach by him of
any of the promises contained in this Agreement will cause irreparable
damage to the Company and that it will be impossible to estimate the damage
suffered by the Company in the event of any breach. Executive, therefore,
agrees that the Company shall be entitled as a matter of course to specific
performance as well as temporary and permanent injunctive relief from any
court of competent jurisdiction, thereby preventing further breach of this
Agreement. Each party further agrees that if the other prevails in a suit
under this Agreement, the nonprevailing party will reimburse the prevailing
party for its or his expenses, including costs and reasonable attorneys'
fees, incurred in connection with such a suit.
10. Governing Law. This Agreement shall be interpreted and construed in
accordance with the laws of the Commonwealth of Pennsylvania. If any
provision of this Agreement is determined to contravene applicable law, it
shall be deemed to be modified to the extent necessary to comply with any
such law or, if such modification is not possible, such provision shall be
deemed null and void, but shall not affect the obligations under any other
provision of this Agreement.
11. Arbitration. In the event of any dispute between Executive and the Company
under or related to the terms of this Agreement, the parties hereto agree
to submit such dispute to final and binding arbitration in Lehigh County,
Pennsylvania pursuant to the Arbitration Rules of the American Arbitration
Association. The decision of the arbitrator shall be final and binding on
both parties, provided, however, that in arriving at a decision, the
arbitrator shall find in favor of one party or the other, and shall not in
rendering his decision fashion a compromise or otherwise order an outcome
different than that proposed by one of the parties. Such arbitration
proceedings shall be completed not later than 90 days following submission,
except and only to the extent that such delay is attributable to the
unavoidable delay of the arbitrator.
12. Assignment. Executive acknowledges that the services to be rendered by him
hereunder are unique and personal. Accordingly, Executive may not assign
any of his rights or delegate any of his duties or obligations hereunder
without the prior written consent of the Company. Upon such consent, the
rights and obligations of Executive under this Agreement shall be binding
upon his heirs, assigns and legal representatives.
13. Miscellaneous.
(a) All notices, requests or other communications required or permitted
hereunder shall be by (i) personal delivery, (ii) first class United
States mail, postage prepaid, (iii) overnight delivery service,
charges prepaid or (iv) telecopy or other means of electronic
transmission, if confirmed promptly by any of the methods specified in
clauses (i), (ii) or (iii) of this sentence, and in writing as
follows:
If to Executive:
A. J. Carden
5722 Schantz Road
Allentown, PA 18104
If to the Company:
Penn Treaty Network America Insurance Company
3440 Lehigh Street
Allentown, PA 18103
Attention: Irving Levit
Telefax: 610-967-4616
; or to such other addresses as may be specified by like notice.
Notices shall be deemed given on the earlier of (I) physical delivery,
(ii) if given by facsimile transmission, upon transmission to the
telefax number specified in this Agreement, (iii) two calendar days
after mailing by prepaid first class mail and (iv) one calendar day
after mailing by prepaid overnight delivery service.
(b) This Agreement sets forth the entire agreement of the parties with
respect to the subject matter hereof, and supersedes all prior
agreements, whether written or oral, including without limitation that
certain Change in Control Agreement between Executive and the Company
dated June 6, 1996. This Agreement may be amended only by writing
signed by both parties hereto.
<PAGE>
(c) The Company may withhold from any amounts payable under this Agreement
such federal, state or local taxes as shall be required to be withheld
pursuant to any applicable law or regulation.
(d) No waiver of any provision of this Agreement shall be valid until it
is in writing and signed by the person or party against whom it is
charged.
(e) The invalidity or unenforceability of any provision of this Agreement
shall not affect the otherprovisions hereof, and this Agreement shall
be construed as if such invalid or unenforceable provision were
omitted.
(f) Sections 6, 7, 8, 9 and 10 shall survive the termination of this
Agreement for any reason whatsoever.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first set forth above.
PENN TREATY NETWORK AMERICA EXECUTIVE
INSURANCE COMPANY
By:
--------------------------- ------------------------
A. J. Carden
Title:
------------------------
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-START> JAN-01-1998
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 321,448
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 17,334
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 338,889
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0
0
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223,692
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<INCOME-TAX> 11,578
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</TABLE>
