SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2000
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from _______________ to _____________
Commission file number 0-13972
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PENN TREATY AMERICAN CORPORATION
3440 LEHIGH STREET, ALLENTOWN, PA 18103
(610) 965-2222
Incorporated in Pennsylvania I.R.S. Employer ID No.
23-1664166
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [ X ] NO [ ]
The number of shares outstanding on the Registrant's common stock, par value
$.10 per share, as of November 3, 2000 was 7,819,384.
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PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements
Penn Treaty American Corporation is one of the leading providers of long-term
nursing home and home health care insurance. Our Unaudited Consolidated Balance
Sheets, Statements of Operations and Comprehensive Income and Statements of Cash
Flows and Notes thereto required under this item are contained on pages 3
through 8 of this report. Our financial statements represent the consolidation
of our operations and our subsidiaries, Penn Treaty Network America Insurance
Company ("Penn Treaty Network"), American Network Insurance Company ("American
Network"), American Independent Network Insurance Company of New York ("American
Independent"), Penn Treaty (Bermuda) Ltd. ("Penn Treaty (Bermuda)")
(collectively the "Insurers"), United Insurance Group Agency, Inc. ("United
Insurance Group"), Network Insurance Senior Health Division ("NISHD") and Senior
Financial Consultants (collectively the "Agencies"), which are underwriters and
marketers of long-term care insurance products. Penn Treaty Network is also an
underwriter of life insurance products.
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PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
(amounts in thousands)
September 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
ASSETS
Investments:
Bonds, available for sale at market (cost of $415,423 and $365,701, respectively) $ 404,902 $ 353,688
Equity securities at market value (cost of $16,885 and $17,853, respectively) 17,481 19,163
Policy loans 169 150
--------- ---------
Total investments 422,552 373,001
Cash and cash equivalents 32,896 17,347
Property and equipment, at cost, less accumulated depreciation of
$5,333 and $4,515, respectively 12,200 10,614
Unamortized deferred policy acquisition costs 240,610 208,519
Receivables from agents, less allowance for
uncollectable amounts of $199 and $199, respectively 2,783 2,713
Accrued investment income 6,948 5,918
Federal income tax recoverable -- 1,616
Cost in excess of fair value of net assets acquired, less
accumulated amortization of $2,991 and $2,021, respectively 27,387 22,357
Present value of future profits acquired 2,455 2,767
Receivable from reinsurers 15,078 15,070
Other assets 40,636 37,717
--------- ---------
Total assets $ 803,545 $ 697,639
========= =========
LIABILITIES
Policy reserves:
Accident and health $ 327,481 $ 260,046
Life 12,352 12,167
Policy and contract claims 156,670 137,534
Accounts payable and other liabilities 12,431 12,887
Federal income tax payable 2,044 --
Long-term debt 81,987 82,861
Deferred income taxes 34,239 33,459
--------- ---------
Total liabilities 627,204 538,954
--------- ---------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, par value $1.00; 5,000 shares authorized, none outstanding -- --
Common stock, par value $.10; 25,000 shares authorized, 8,192 and 8,191 shares issued 819 819
Additional paid-in capital 53,744 53,655
Accumulated other comprehensive income (6,550) (7,064)
Retained earnings 135,033 117,980
--------- ---------
183,046 165,390
Less 915 and 915, respectively, common shares held in treasury, at cost (6,705) (6,705)
--------- ---------
176,341 158,685
--------- ---------
Total liabilities and shareholders' equity $ 803,545 $ 697,639
========= =========
See accompanying notes to consolidated financial statements
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3
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PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
(unaudited)
(amounts in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Premium revenue $ 91,963 $ 72,165 $ 264,826 $ 211,366
Net investment income 6,874 5,967 19,671 16,721
Net realized capital gains 503 269 1,244 4,112
Other income 2,383 1,564 6,743 4,661
--------- --------- --------- ---------
101,723 79,965 292,484 236,860
Benefits and expenses:
Benefits to policyholders 61,120 49,623 180,519 144,332
Commissions 25,716 23,167 77,088 68,647
Net policy acquisition costs deferred (9,111) (12,201) (32,091) (35,659)
General and administrative expense 12,951 10,576 36,285 30,223
Loss due to impairment of property and equipment -- -- -- 2,799
Reserve for claim litigation (500) -- 1,000 --
Interest expense 1,281 1,315 3,843 3,893
--------- --------- --------- ---------
91,457 72,480 266,644 214,235
--------- --------- --------- ---------
Income before federal income taxes 10,266 7,485 25,840 22,625
Provision for federal income taxes 3,490 2,470 8,786 7,466
--------- --------- --------- ---------
Net income 6,776 5,015 17,054 15,159
--------- --------- --------- ---------
Other comprehensive income:
Unrealized holding gain (loss) arising during period 5,197 (4,482) 2,022 (17,528)
Income (tax) benefit from unrealized holdings (1,767) 1,524 (687) 5,960
Reclassification adjustment for (gain) loss included in net income (503) (269) (1,244) (4,112)
Income (tax) benefit from reclassification adjustment 171 91 423 1,397
--------- --------- --------- ---------
Comprehensive income $ 9,874 $ 1,879 $ 17,568 $ 876
========= ========= ========= =========
Basic earnings per share $ 0.93 $ 0.66 $ 2.34 $ 2.00
Diluted earnings per share $ 0.76 $ 0.57 $ 1.88 $ 1.71
Weighted average number of shares outstanding 7,277 7,585 7,277 7,584
Weighted average number of shares outstanding (diluted) 9,982 10,363 9,970 10,366
See accompanying notes to consolidated financial statements
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4
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<CAPTION>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30,
(unaudited)
(amounts in thousands)
2000 1999
---- ----
<S> <C> <C>
Net cash flow from operating activities:
Net income $ 17,054 $ 15,159
Adjustments to reconcile net income to cash
provided by operations:
Amortization of intangible assets 1,552 814
Policy acquisition costs, net (32,091) (35,659)
Deferred income taxes 515 3,324
Depreciation expense 818 840
Net realized capital gains (1,244) (4,112)
Realized loss on disposal of property and equipment -- 2,799
Increase (decrease) due to change in:
Receivables from agents (70) 489
Receivable from reinsurers (8) (1,048)
Policy and contract claims 19,136 18,985
Policy reserves 67,620 54,866
Accounts payable and other liabilities (456) 3,484
Federal income taxes recoverable 1,616 1,794
Federal income taxes payable 2,044 468
Accrued investment income (1,030) (1,052)
Other, net (3,105) (2,503)
--------- ---------
Cash provided by operations 72,351 58,648
Cash flow from (used in) investing activities:
Net cash purchase of subsidiary (6,000) (9,194)
Proceeds from sales of bonds 97,406 55,698
Proceeds from sales of equity securities 24,341 20,361
Maturities of investments 10,282 4,741
Purchase of bonds (156,693) (100,721)
Purchase of equity securities (22,867) (19,921)
Acquisition of property and equipment (2,404) (2,986)
--------- ---------
Cash used in investing (55,935) (52,022)
Cash flow (used in) from financing activities:
Proceeds from exercise of stock options 7 31
Repayments of long-term debt (874) (43)
--------- ---------
Cash used in financing (867) (12)
--------- ---------
Increase in cash and cash equivalents 15,549 6,614
Cash balances:
Beginning of period 17,347 38,402
--------- ---------
End of period $ 32,896 $ 45,016
========= =========
Acquisition of subsidiary with note payable $ -- $ 7,167
========= =========
See accompanying notes to consolidated financial statements
</TABLE>
5
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2000
(unaudited)
(amounts in thousands, except per share data)
The Consolidated Financial Statements should be read in conjunction with these
notes and with the Notes to Consolidated Financial Statements included in the
Annual Report on Form 10-K for the year ended December 31, 1999 of Penn Treaty
American Corporation (the "Company"). In the opinion of management, the
summarized financial information reflects all adjustments (consisting only of
normal recurring adjustments), which are necessary for a fair presentation of
the financial position and results of operations for the interim periods.
1. Investments:
Management has categorized all of its investment securities as available
for sale since they may be sold in response to changes in interest rates,
prepayments and similar factors. Investments in this classification are
reported at their current market value with net unrealized gains and
losses, net of the applicable deferred income tax effect, being added to or
deducted from the Company's total shareholders' equity on the balance
sheet. As of September 30, 2000, shareholders' equity was decreased by
$6,550 due to unrealized losses of $9,925 in the investment portfolio. As
of December 31, 1999, shareholders' equity was decreased by $7,064 due to
unrealized losses of $10,703 in the investment portfolio.
The amortized cost and estimated market value of investments available for
sale as of September 30, 2000 and December 31, 1999 are as follows:
September 30, 2000 December 31, 1999
------------------ -----------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
U.S. Treasury securities
and obligations of U.S.
Government authorities
and agencies $ 122,362 $ 122,864 $ 118,547 $ 116,698
Obligations of states and
political sub-divisions 571 577 571 575
Mortgage backed securities 14,541 17,357 20,888 20,126
Debt securities issued by
foreign governments 17,339 16,697 18,533 17,599
Corporate securities 260,610 247,407 207,162 198,690
Equities 16,885 17,481 17,853 19,163
Policy Loans 169 169 150 150
--------- --------- --------- ---------
Total Investments $ 432,477 $ 422,552 $ 383,704 $ 373,001
========= ========= ========= =========
Net unrealized gain (loss) (9,925) (10,703)
--------- ---------
$ 422,552 $ 373,001
========= =========
6
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2. Policy Reserves and Policy and Contract Claims:
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.
3. New Accounting Principle:
In June 1998, the Financial Accounting Standards Board 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, as amended by SFAS No. 137 "Deferral of the Effective Date of FAS 133",
which is effective for all fiscal quarters of all fiscal years beginning after
June 15, 2000, 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. We are currently evaluating the impact of SFAS No.
133 as relates to the embedded option values in our investment portfolio.
4. Statutory Regulation:
In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance, which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting. The
Codification provides guidance for areas where statutory accounting has been
silent and changes current statutory accounting in some areas.
The Pennsylvania and New York Insurance Departments have adopted the
Codification guidance, effective January 1, 2001. We have not estimated the
effect of the Codification guidance upon our financial condition or results of
operations. There is no effect upon our financial condition or results of
operations as prepared in accordance with generally accepted accounting
principles.
5. Acquisition of Business:
On January 10, 2000, PTNA entered a purchase agreement to acquire all of
the common stock of Network Insurance Senior Health Division (NISHD), a Florida
brokerage insurance agency. The acquisition was effective January 1, 2000, for
cash of $6,000. The acquisition is accounted for as a purchase, for which we
recorded $6,000 of goodwill, to be amortized over 20 years. The proforma effect
of consolidating the financial results of NISHD prior to 2000 would be
immaterial to our financial condition or results of operations.
7
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6. Reconciliation of Earnings Per Share:
The following describes the reconciliation of the numerator and
denominator of the basic earnings per share computation to the numerator and
denominator of the diluted earnings per share computation. Basic earnings per
share excludes dilution and is computed by dividing income available to common
shareholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflect the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock.
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<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------- -----------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $6,776 $ 5,015 $17,054 $15,159
Weighted average common shares outstanding 7,277 7,585 7,277 7,584
Basic earnings per share $ 0.93 $ 0.66 $ 2.34 $ 2.00
====== ======= ======= =======
Net income $6,776 $ 5,015 $17,054 $15,159
Adjustments net of tax:
Interest expense on convertible debt 771 783 1,542 2,348
Amortization of debt offering costs 60 61 180 183
------ ------- ------- -------
Diluted net income $7,606 $ 5,858 $18,777 $17,689
====== ======= ======= =======
Weighted average common shares outstanding 7,277 7,585 7,277 7,584
Common stock equivalents due to dilutive
effect of stock options 77 150 65 154
Shares converted from convertible debt 2,628 2,628 2,628 2,628
------ ------- ------- -------
Total outstanding shares for diluted earnings
per share computation 9,982 10,363 9,970 10,366
Diluted earnings per share $ 0.76 $ 0.57 $ 1.88 $ 1.71
====== ======= ======= =======
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
OVERVIEW
Our principal products are individual, defined benefit accident and health
insurance policies that consist of nursing home care, home health care, Medicare
supplement and long-term disability insurance. Our underwriting practices rely
upon the base of experience, which we have developed over 28 years of providing
nursing home care insurance, as well as upon available industry and actuarial
information. As the home health care market has developed, we have encouraged
the purchase of both nursing home care and home health care coverage, thus
providing policyholders with enhanced protection while broadening our policy
base.
Our 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. State regulatory authorities must approve premiums
charged for insurance products. In addition, our 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 our insurance policies. These reserves must, at a minimum, comply with
mandated standards.
8
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Our 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. We compare actual
experience with estimates and adjust our reserves on the basis of such
comparisons. Revisions to reserves are reflected in our current results of
operations through benefits to policyholders' expense.
We also maintain reserves for policies that are not currently in claim
based upon actuarial expectations that a policy may go on claim in the future.
These reserves are calculated based on factors that include estimates for
mortality, morbidity, interest rates and persistency. Factor components
generally include assumptions that are consistent with both our experience and
industry practices.
Policy premium levels. We attempt to set premium levels to ensure profitability,
subject to the constraints of competitive market conditions and state regulatory
approvals. Premium levels are reviewed on new product filings, as well as for
rate increases as claims experience warrants.
Deferred acquisition costs. In connection with the sale of our insurance
policies, we defer and amortize a portion of the policy acquisition costs over
the related premium paying periods of the life of the policy. These costs
include all expenses that are directly related to and vary with 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, we are 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 need services covered by the
policy. However, the longer the policy is in effect, the more premium we will
receive.
Investment income. Our 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 our
investment portfolio duration (approximately 5.0 years), investment interest
income does not immediately reflect changes in market interest rates. However,
we are susceptible to changes in market rates when cash flows from maturing
investments are reinvested at prevailing market rates. As of September 30, 2000,
approximately 4.1% of our invested assets were committed to high quality large
capitalization common stocks and preferred stocks of smaller corporations.
Lapsation and persistency. Factors that affect our 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 our policy, is automatic
if and when premiums become more than 31 days overdue; however, policies may be
reinstated, if approved, within six months after the policy lapses. Persistency
represents the percentage of premiums renewed, which we calculate 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 us. First year
premiums are premiums covering the first twelve months a policy is in-force.
Renewal premiums are premiums covering all subsequent periods.
Policies renew or lapse for a variety of reasons, due both to internal and
external causes. We believe that our efforts to address any policyholder
concerns or questions in an expedient fashion help to ensure ongoing policy
9
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renewal. We also believe that we enjoy a favorable policyholder reputation for
providing desirable policy benefits, minimal premium rate increases and
efficient claims processing. We work closely with our licensed agents, who play
an integral role in policy conservation and policyholder communication.
External factors also contribute to policy renewal or lapsation. Economic
cycles can influence a policyholder's ability to continue the payment of
insurance premiums when due. New government/ legislative initiatives have raised
public awareness of the escalating costs of long-term care, which we believe
boosts new sales and promotes renewal payments. Recent initiatives also include
tax relief for certain long-term care insurance coverage, which promotes new and
renewal payments.
Lapsation and persistency can positively and adversely impact future
earnings. Improved persistency generally results in higher renewal premium and
reduced amortization of deferred acquisition costs than anticipated. However,
higher persistency may lead to increased claims in future periods. Additionally,
increased lapsation can result in reduced premium collection, accelerated
deferred acquisition cost amortization and anti-selection of higher-risk,
remaining policyholders.
THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999:
(amounts in thousands, except per share data)
Premiums. Total premium revenue earned in the three month period ended September
30, 2000 (the "2000 quarter"), including long-term care, disability, life and
Medicare supplement, increased 27.4% to $91,963, compared to $72,165 in the same
period in 1999 (the "1999 quarter").
First year long-term care premiums earned in the 2000 quarter increased
13.6% to $27,240, compared to $23,986 in the 1999 quarter. We attribute our
growth to the development and sale of our group product line, continued
improvements in product offerings, which competitively meet the needs of the
long term care marketplace, and growth from recent expansion into new states,
such as New Jersey, Connecticut and New York.
Renewal premiums earned in the 2000 quarter increased 34.3% to $64,723,
compared to $48,179 in the 1999 quarter. Renewal long-term care premiums earned
in the 2000 quarter increased 35.4% to $60,220, compared to $44,471 in the 1999
quarter. This increase reflects renewals of a larger base of in-force policies,
as well as a continued increase in policyholder persistency.
Net Investment Income. Net investment income earned for the 2000 quarter
increased 15.2% to $6,874, from $5,967 for the 1999 quarter. Management
attributes this growth to more invested assets as a result of higher established
reserves, as well as higher interest rates achieved on newly invested funds.
Net Realized Capital Gains. During the 2000 quarter, we recognized capital gains
of $503, compared to gains of $269 in the 1999 quarter. These gains were
recorded as a result of our normal treasury management operations.
Other Income. We recorded $2,383 in other income during the 2000 quarter, up
from $1,564 in the 1999 quarter. The increase is attributable to commissions
earned by United Insurance Group on sales of insurance products underwritten by
unaffiliated insurers and to income generated from corporate owned life
insurance policies. In addition, the 2000 quarter results include the receipt of
a settlement from a previously disclosed lawsuit. The details of the lawsuit are
undisclosed as a condition of the settlement agreement.
10
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Benefits to Policyholders. Total benefits to policyholders in the 2000 quarter
increased 23.2% to $61,120, compared to $49,623 in the 1999 quarter. Our loss
ratio, or policyholder benefits to premiums, was 66.5% in the 2000 quarter,
compared to 68.8% in the 1999 quarter.
During the 2000 quarter, we implemented a rate increase on certain of our
return of premium riders. Individual policyholders were offered the option to
accept the rate increase on future premium payments or to have prior rider
payments refunded with interest. As a result of this option, our loss ratio
during the quarter was reduced due to the cancellation and return of this
premium and the subsequent release of the related reserves held for the future
payment of these benefits.
Claims experience can differ from our expectations due to numerous factors,
including mortality rates, duration of care and type of care utilized. When we
experience deviation from our estimates, we typically seek premium rate
increases that are sufficient to offset future deviation. We have been generally
successful in the past in obtaining state insurance department approvals for
these increases when deemed to be actuarially sound.
Commissions. Commissions to agents increased 11.0% to $25,716 in the 2000
quarter, compared to $23,167 in the 1999 quarter.
First year commissions on accident and health business in the 2000 quarter
increased 12.7% to $18,009, compared to $15,980 in the 1999 quarter. The ratio
of first year accident and health commissions to first year accident and health
premiums was 66.3% in the 2000 quarter and 68.0% in the 1999 quarter. The mix of
policyholder issue ages for new business affects the percentage of commissions
paid for new business due to our age-scaled commission rates. Generally, younger
policyholder sales receive a higher commission percentage. The lower commission
percentage in the 2000 quarter is reduced by our sale of group insurance
premium, which was primarily commission free.
Renewal commissions on accident and health business in the 2000 quarter
increased 24.8% to $9,444, compared to $7,565 in the 1999 quarter, consistent
with the increase in renewal premiums discussed above when adjusted for the
impact of commission free group policies. The ratio of renewal accident and
health commissions to renewal accident and health premiums was 15.3% in the 2000
quarter and 16.6% in the 1999 quarter.
Commission expense during the 2000 quarter was reduced by the netting of
$1,052 from override commissions paid to the Agencies by the Insurers. During
the 1999 quarter, commissions were reduced by $753.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs
in the 2000 quarter decreased 25.3% to $9,111 compared to $12,201 in the 1999
quarter.
Deferred costs are typically all costs that are directly related to, and
vary with, the acquisition of policies. These costs include the variable portion
of commissions, which are defined as the first year commission rate less
ultimate renewal commission rates, and variable general and administrative
expenses related to policy underwriting. Deferred costs are amortized over the
life of the policy based upon actuarial assumptions, including persistency of
policies in-force. In the event a policy lapses prematurely due to death or
termination of coverage, the remaining unamortized portion of the deferred
amount is immediately recognized as expense in the current period.
Net deferred costs declined as a percentage of premiums during the 2000
quarter primarily due to lower first year commissions paid as a percentage of
first year premiums. First year commission rates were reduced as a result of our
sale of group policies, which were largely commission-free. In addition, the
income statement credit for deferred costs is reduced due to lower first year
premium growth as a percentage of total portfolio amortization from prior year
deferrals.
11
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General and Administrative Expenses. General and administrative expenses in the
2000 quarter increased 22.5% to $12,951, compared to $10,576 in the 1999
quarter. The 2000 and 1999 quarters include $1,963 and $2,006, respectively, of
general and administrative expenses related to United Insurance Group expense.
Management attributes much of its expense growth to printing and distribution
costs related to its new group product line and newer policy forms. In addition,
management believes that current cost savings initiatives, such as remote office
consolidation and outsourcing of certain administrative functions, has reduced
the level of overall expenses (excluding United Insurance Group and goodwill
amortization) as a percentage of premiums.
Reserve for Claim Litigation. During the first quarter of 2000, we established a
$1,500 reserve for the potential payment of a jury awarded compensatory damage
judgement of approximately $2,000. We subsequently filed a motion for remittitur
of this award. During the 2000 quarter, the award was reduced to $1,000. The
plaintiff has appealed this decision, which requires the appellate court to
reverse the new ruling or grant a new trial. We have reduced our reserve by $500
to $1,000 pending further development.
Provision for Federal Income Taxes. Our provision for federal income taxes in
the 2000 quarter increased 41.3% to $3,490, compared to $2,470 for the 1999
quarter. The effective tax rates of 34.0% and 33.0% in the 2000 and 1999
quarters, respectively, are at or below the normal federal corporate rate as a
result of credits form the small life insurance company deduction, as well as
our investments in tax-exempt bonds, corporate owned life insurance and from
dividends received that are partially exempt from taxation, which are partially
offset by non-deductible goodwill amortization.
Comprehensive Income. During the 2000 quarter, our investment portfolio
generated pre-tax unrealized gains of $4,694, compared to 1999 quarter
unrealized losses of $4,751. After accounting for deferred taxes from these
gains and losses and net income, shareholders' equity increased by $9,874 from
comprehensive income during the 2000 quarter, compared to comprehensive income
of $1,879 in the 1999 quarter.
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999:
(amounts in thousands, except per share data)
Premiums. Total premiums earned in the nine month period ended September 30,
2000 (the "2000 period"), including long-term care, disability, life and
Medicare supplement, increased 25.3% to $264,826, compared to $211,366 in the
same period in 1999 (the "1999 period").
First year long-term care premiums earned in the 2000 period increased 5.6%
to $77,687, compared to $73,568 in the 1999 period. We attribute our growth to
continued improvements in product offerings, which competitively meet the needs
of the long-term care marketplace, and growth from recent expansion into new
states, such as New Jersey, Connecticut and New York. In addition, we introduced
our group plan in the 2000 period, which offers long-term care insurance to
group members on a guaranteed acceptance basis.
Renewal premiums earned in the 2000 period increased 35.8% to $187,139,
compared to $137,798 in the 1999 period. Renewal long-term care premiums earned
in the 2000 period increased 38.0% to $176,319, compared to $127,726 in the 1999
period. This increase reflects renewals of a larger base of in-force policies,
as well as a continued increase in policyholder persistency.
Net Investment Income. Net investment income earned for the 2000 period
increased 17.6% to $19,671, from $16,721 for the 1999 period. Management
attributes this growth to more invested assets as a result of higher established
reserves. Investment income is reduced, however, by our use of invested cash for
the acquisition of NISHD on January 1, 2000.
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Net Realized Capital Gains. During the 2000 period, we recognized capital gains
of $1,244, compared to gains of $4,112 in the 1999 period. Capital gains and
losses are generally recorded as a result of our normal investment management
operations. However, in the 1999 period, we intentionally recognized capital
gains sufficient to offset expenses of approximately $2,800 as a result of the
impairment of certain of our fixed assets.
Other Income. We recorded $6,743 in other income during the 2000 period, up from
$4,661 in the 1999 period. The increase is attributable to a settlement of a
previously disclosed lawsuit, of which the details are undisclosed as a
condition of the settlement agreement, and to income generated from corporate
owned life insurance policies.
In addition, the 2000 period includes the receipt of a settlement from a
previously disclosed lawsuit. The details of the lawsuit are undisclosed as a
condition of the settlement agreement.
Benefits to Policyholders. Total benefits to policyholders in the 2000 period
increased 25.1% to $180,519, compared to $144,332 in the 1999 period. Our loss
ratio, or policyholder benefits to premiums, was 68.2% in the 2000 period,
compared to 68.3% in the 1999 period. This ratio is expected to grow as the
percentage of new business premium to total premium decreases.
Claims experience can differ from our expectations due to numerous factors,
including mortality rates, duration of care and type of care utilized. When we
experience deviation from our estimates, we typically seek premium rate
increases that are sufficient to offset future deviation. We have been generally
successful in the past in obtaining state insurance department approvals for
these increases when deemed to be actuarially sound.
Commissions. Commissions to agents increased 12.3% to $77,088 in the 2000 period
compared to $68,647 in the 1999 period.
First year commissions on accident and health business in the 2000 period
increased 6.0% to $50,382, compared to $47,513 in the 1999 period, due to the
increase in first year accident and health premiums. Commission growth is lower
than premium growth as no commission was paid for our new group policies. The
mix of policyholder issue ages for new business affects the percentage of
commissions paid for new business due to our age-scaled commission rates.
Generally, younger policyholder sales receive a higher commission percentage.
The ratio of first year accident and health commissions to first year accident
and health premiums was 65.5% in the 2000 period and 65.7% in the 1999 period.
Renewal commissions on accident and health business in the 2000 period
increased 30.6% to $28,261, compared to $21,647 in the 1999 period, consistent
with the increase in renewal premiums discussed above. The ratio of renewal
accident and health commissions to renewal accident and health premiums was
15.7% in the 2000 period and 16.5% in the 1999 period.
Commission expense during the 2000 period was reduced by the netting of
$3,652 from override commissions paid to the Agencies by affiliated insurers.
During the 1999 period, commissions were reduced by $1,823. The 2000 period
override commissions include approximately $1,200 from NISHD, which we purchased
in January 2000.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs
in the 2000 period decreased 10.0% to $32,091 compared to $35,659 in the 1999
period.
Deferred costs are typically all costs that are directly related to, and
vary with, the acquisition of policies. These costs include the variable portion
of commissions, which are defined as the first year commission rate less
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ultimate renewal commission rates, and variable general and administrative
expenses related to policy underwriting. Deferred costs are amortized over the
life of the policy based upon actuarial assumptions, including persistency of
policies in-force. In the event a policy lapses prematurely due to death or
termination of coverage, the remaining unamortized portion of the deferred
amount is immediately recognized as expense in the current period.
Although new premiums have increased in the 2000 period, lower first year
commissions from our group product line have resulted in lower deferrals. In
addition, amortization of previously deferred costs offsets a portion of the
current period deferral, especially when new premium growth slows as has been
the case in the 2000 period.
General and Administrative Expenses. General and administrative expenses in the
2000 period increased 20.1% to $36,285, compared to $30,223 in the 1999 period.
The 2000 and 1999 periods include $6,219 and $5,871, respectively, of general
and administrative expenses related to United Insurance Group expense.
Management believes that current cost savings initiatives, such as remote office
consolidation and outsourcing of certain administrative functions, has reduced
the level of expenses (excluding United Insurance Group and goodwill
amortization) as a percentage of premiums, which declined to 11.4% in the 2000
period, compared to 11.5% in the 1999 period.
Loss Due to Impairment of Property and Equipment. During the 1999 period, we
determined to discontinue our planned implementation of our LifePro computer
system. At June 30, 1999, we had capitalized $2,799 of expenditures related to
this project, including licensing costs and fees paid to outside parties for
system development and implementation. As the system was not yet placed in
service, none of these costs had previously been depreciated on our Consolidated
Statements of Operations and Comprehensive Income. Upon determining not to
utilize these fixed assets, their value became fully impaired and we recognized
the entire amount as current period expense.
In conjunction with our decision to discontinue our implementation project, we
filed suit against the software manufacturer and several consultants, alleging
misrepresentations by all accused parties regarding the system's capabilities
and ability to meet our expectations. A portion of the lawsuit was settled for
an undisclosed amount as previously discussed. However, portions of the suit are
still in process.
Reserve for Claim Litigation. During the 2000 period, we were notified that a
jury awarded a compensatory judgement of $24 and a punitive award of $2,000 in
favor of the plaintiff against one of our subsidiaries in a disputed claim case.
The trial judge subsequently remitted the award to $1,000. The plaintiff has
appealed this decision, which could result in an overturn of the court's
decision of the granting of a new trial. In the event that our continued efforts
are unsuccessful in full or in part to reduce the award, we established a $1,000
litigation reserve for the potential future payment of this judgement.
Provision for Federal Income Taxes. Our provision for federal income taxes for
the 2000 period decreased 17.7% to $8,786, compared to $7,466 for the 1999
period. The effective tax rates of 34.0% and 33.0% in the 2000 and 1999 periods,
respectively, are at or below the normal federal corporate rate as a result of
credits from the small life insurance company deduction, as well as our
investments in tax-exempt bonds, corporate owned life insurance and from
dividends received that are partially exempt from taxation, which are partially
offset by non-deductible goodwill amortization.
Comprehensive Income. During the 2000 period, our investment portfolio generated
pre-tax unrealized gains of $778, compared to 1999 period unrealized losses of
$21,640. After accounting for deferred taxes from these gains, shareholders'
equity and net income increased by $17,568 from comprehensive income during the
2000 period, compared to comprehensive income of $876 in the 1999 period.
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LIQUIDITY AND CAPITAL RESOURCES:
Our consolidated liquidity requirements have historically been created and
met from the operations of our insurance subsidiaries. Our primary sources of
cash are premiums, investment income and maturities of investments. We have
provided, and may continue to provide, cash through public offerings of our
common stock, other 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 commissioners. Statutory earnings
are generally lower than earnings reported in accordance with generally accepted
accounting principles due to the immediate or accelerated recognition of all
costs associated with premium growth and benefit reserves. We have not and do
not intend to pay shareholder dividends in the near future due to these
requirements, choosing to retain statutory surplus to support continued premium
growth.
In the 2000 period, our cash flows were attributable to cash provided by
operations, cash used in investing and cash used in financing. Our cash
increased by $15,549 in the 2000 period primarily due to the maturity and sale
of $132,029 of our bonds and equity securities portfolio and cash from
operations of $72,351. The major provider of cash from operations was premium
revenue used to fund reserve additions of $86,756. The primary uses of cash
during the 2000 period were the purchase of $179,560 in bonds and equity
securities, $77,088 paid as agent commissions, and $6,000 used for the purchase
of NISHD.
Our cash flows in the 1999 period were attributable to cash provided by
operations, cash used in investing and cash used in financing. Our cash
increased by $6,614 in the 1999 period primarily due to the maturity and sale of
$80,800 of our bonds and equity securities portfolio and cash from operations of
$58,648. The major provider of cash from operations was premiums used to fund
additions to reserves of $73,851 in the 1999 period. The primary uses of cash
were commissions paid to agents of $68,647, the purchase of bonds and equity
securities of $120,642 and net cash of $9,194 paid for the acquisition of United
Insurance Group.
We invest 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 September 30, 2000, the market value of our bond portfolio
represented 97.5% of our cost, compared to 96.7% at December 31, 1999, with a
current unrealized loss of $10,521 at September 30, 2000, compared to an
unrealized loss of $12,013 at December 31, 1999. Our equity portfolio exceeded
cost by $596 and $1,310 at September 30, 2000 and December 31, 1999,
respectively.
As of September 30, 2000, shareholders' equity was decreased by $6,550 due
to unrealized losses of $9,925 in the investment portfolio. As of December 31,
1999, shareholders' equity was decreased by $7,064 due to unrealized losses of
$10,703 in the investment portfolio.
Our debt currently consists primarily of a mortgage note in the approximate
amount of $1,700 and $74,750 in convertible subordinated debt. The convertible
debt, issued in November 1996, is convertible into common stock 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, we have 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 of 6.85%.
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On January 1, 1999, we purchased all of the common stock of United
Insurance Group, a Michigan based consortium of long-term care insurance
agencies, for $18,192. As part of the purchase, we issued a note payable for
$8,078, which was in the form of a three-year zero-coupon installment note. The
installment note, after discounting for imputed interest, was recorded as a note
payable of $7,167, with a current outstanding balance of $5,554 at September 30,
2000. The remainder of the purchase was for cash.
Our company consists of the Insurers, the Agencies and a non-insurer parent
company, Penn Treaty American Corporation (the "Parent"). The Parent directly
controls 100% of the voting stock of the 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.
In addition to the United Insurance Group installment note obligation, the
Parent currently has the obligation of making semi-annual interest payments
attributable to its 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 from its current investments, dividend
capabilities of United Insurance Group and from its line of credit to meet its
obligations throughout 2000 and 2001. We may need to raise additional funds in
order to meet future cash requirements beyond the foreseeable future.
We believe that our insurance subsidiaries' capital and surplus presently
meet or exceed the requirements in all jurisdictions in which they are licensed.
Our continued growth is dependent upon our ability to (1) continue marketing
efforts to expand our historical markets, (2) continue to expand our network of
agents and effectively market our products and (3) fund such marketing and
expansion while at the same time maintaining minimum statutory levels of capital
and surplus required to support such growth. Management believes that the funds
necessary to accomplish the foregoing, including funds required to maintain
adequate levels of statutory surplus in our insurance subsidiaries, can be met
through 2000 by funds generated from non-insurance subsidiary dividends, current
and future financial reinsurance transactions, off-shore reinsurance through
Penn Treaty (Bermuda) and the availability of our line of credit facility. We
expect future capital market activities will be necessary to support our ongoing
growth; however, we continue to seek alternative measures. If alternative
measures to support our growth, such as reinsurance agreements, are
unsuccessful, we believe that additional capital would be required as early as
2001.
In the event (1) we fail to maintain minimum loss ratios calculated in
accordance with statutory guidelines, (2) we fail to meet other requirements
mandated and enforced by regulatory authorities, (3) we have adverse claims
experience in the future, (4) we are unable to obtain additional financing to
support future growth or (5) the economy continues to affect the buying powers
of senior citizens, our results of operations, liquidity and capital resources
could be adversely affected.
Certain statements that we have made in this report may be considered
forward-looking within the meaning of the Private Securities Litigation Reform
Act of 1995. We believe that our expectations are based upon reasonable
assumptions within the bounds of our knowledge of our business and operations,
there can be no assurance that actual results of our operations will not differ
materially from our expectations. Factors which could cause actual results to
differ from expectations include, among others, the adequacy of our loss
reserves and our ability to meet statutory surplus requirements, especially in
light of our recent growth, our ability to qualify new insurance products for
sale in certain states, our ability to comply with government regulations, the
impact of securities transactions, the ability of senior citizens to purchase
our products in light of the increasing costs of health care, the modality of
premium revenue, our ability to defend ourselves from adverse litigation, and
our ability to expand our network of productive independent agents. For
additional information, please refer to "Overview" in this report and to our
other reports filed with the Securities and Exchange Commission.
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NEW ACCOUNTING PRINCIPLE:
In June 1998, the Financial Accounting Standards Board 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, as amended by SFAS No. 137 "Deferral of the Effective Date of FAS 133",
which is effective for all fiscal quarters of all fiscal years beginning after
June 15, 2000, 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. We are currently evaluating the impact of SFAS No.
133 as relates to the embedded option values in our investment portfolio.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
We invest in securities and other investments authorized by applicable
state laws and regulations and follow an investment policy designed to maximize
yield to the extent consistent with liquidity requirements and preservation of
assets.
A significant portion of assets and liabilities are financial instruments,
which are subject to the market risk of potential losses from adverse changes in
market rates and prices. Our primary market risk exposures relate to interest
rate risk on fixed rate domestic medium-term instruments and, to a lesser
extent, domestic short-term and long-term instruments. We have established
strategies, asset quality standards, asset allocations and other relevant
criteria for our portfolio to manage our exposure to market risk.
We currently have an interest rate swap on our mortgage, with the same
bank, which is used as a hedge to convert the mortgage to a fixed interest rate.
We believe that since the notional amount of the swap is amortized at the same
rate as the underlying mortgage, and that both financial instruments are with
the same bank, no credit or financial risk is carried with the swap.
Our financial instruments are held for purposes other than trading. Our
portfolio does not contain any significant concentrations in single issuers
(other than U.S. treasury and agency obligations), industry segments or
geographic regions.
We urge caution in evaluating overall market risk from the information
below. 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 79.2% of total liabilities
and reinsurance receivables on unpaid losses represent 1.9% of total assets).
Long-term debt, although not carried at fair value, is included in the
hypothetical effect calculation.
The hypothetical effects of changes in market rates or prices on the fair
values of financial instruments as of September 30, 2000, 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 $14,000,000 decrease in the net fair value of our investment
portfolio less our long-term debt and 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 September 30, 2000 would have resulted in an approximate
$26,000,000 decrease in the net fair value. If interest rates had decreased by
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100 and 200 basis points, there would have been an approximate $15,000,000 and
$32,000,000 net increase, respectively, in the net fair value of our total
investments and debt.
We hold certain mortgage and asset backed securities as part of our
investment portfolio. The fair value of these instruments may react in a convex
or non-linear fashion when subjected to interest rate increases or decreases.
The anticipated cash flows of these instruments may differ from expectations in
changing interest rate environments, resulting in duration drift or a varying
nature of predicted time-weighted present values of cash flows. The result of
unpredicted cash flows from these investments could cause the above hypothetical
estimates to change. However, we believe that our minimal invested amount in
these instruments and their broadly defined payment parameters sufficiently
outweigh the cost of computer models necessary to accurately predict their
possible impact to our investment income from the hypothetical effects of
changes in market rates or prices on the fair values of financial instruments as
of September 30, 2000.
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings
The Insurers are parties to various lawsuits generally arising in the
normal course of their insurance business.
During the 2000 period, we were notified that a jury awarded a compensatory
judgement of $24,000 and a punitive award of $2,000,000 in favor of the
plaintiff against one of our subsidiaries in a disputed claim case. The trial
judge subsequently remitted the award to $1,000,000. The plaintiff has appealed
this decision, which could result in an overturn of the court's decision or the
granting of a new trial. In the event that our continued efforts are
unsuccessful in full or in part to reduce the award, we established a $1,000,000
litigation reserve for the potential future payment of this judgement.
We do not believe that the eventual outcome of any of the suits to which we
are currently a party will have a material adverse effect on our financial
condition or results of operations. However, the outcome of any single event
could have a material impact upon the quarterly or annual financial results of
the period in which it occurs.
During the 1999 period, we determined to file a lawsuit regarding the
impairment of certain of our fixed assets. During the 2000 quarter, a portion of
that lawsuit was settled. The details are undisclosed as a condition of the
settlement agreement.
ITEM 2. Changes in Securities
Not Applicable
ITEM 3. Defaults Upon Senior Securities
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
Not Applicable
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ITEM 5. Other Information
Subsequent to the end of the third quarter of 2000, we announced the death of
Glen A. Levit, 33, Senior Vice President and President of the Insurers.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed no reports on Form 8-K during the quarter ended
September 30, 2000.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant had duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENN TREATY AMERICAN CORPORATION
Registrant
Date: November 14, 2000 /s/ Irving Levit
----------------- -------------------------------------
Irving Levit
Chairman of the Board, President
And Chief Executive Officer
Date: November 14, 2000 /s/ Cameron B. Waite
----------------- -------------------------------------
Cameron B. Waite
Chief Financial Officer
