FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 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
PENN TREATY AMERICAN CORPORATION
--------------------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-1664166
------------ ----------
(State or other jurisdiction of (IRS Employer
incorporation of organization) Identification No.)
3440 Lehigh Street, Allentown, PA 18103
---------------------------------------
(Address, including zip code, of
principal executive offices)
(610) 965-2222
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(Registrant's telephone number, including area code)
Not Applicable
--------------
(Former name, former address and former fiscal
year, if change since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
The number of shares outstanding on the Registrant's common stock, par value
$.10 per share, as of August 11, 2000 was 7,809,384.
<PAGE>
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.
2
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
(amounts in thousands)
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
ASSETS
Investments:
Bonds, available for sale at market (cost of $406,714 adn $365,701, respectively) $390,109 $353,688
Equity securities at market value (cost of $18,557 and $17,853, respectively) 20,543 19,163
Policy loans 163 150
-------- --------
Total investments 410,815 373,001
Cash and cash equivalents 13,063 17,347
Property and equipment, at cost, less accumulated depreciation of
$5,024 and $4,515, respectively 11,833 10,614
Unamortized deferred policy acquisition costs 231,499 208,519
Receivables from agents, less allowance for
uncollectable amounts of $199 and $199, respectively 2,509 2,713
Accrued investment income 6,568 5,918
Federal income tax recoverable 223 1,616
Cost in excess of fair value of net assets acquired, less
accumulated amortization of $2,578 and $2,021, respectively 27,800 22,357
Present value of future profits acquired 2,559 2,767
Receivable from reinsurers 14,969 15,070
Other assets 37,781 37,717
-------- --------
Total assets $759,619 $697,639
======== ========
LIABILITIES
Policy reserves:
Accident and health $306,043 $260,046
Life 12,530 12,167
Policy and contract claims 148,246 137,534
Accounts payable and other liabilities 10,823 12,887
Long-term debt 82,006 82,861
Deferred income taxes 33,530 33,459
-------- --------
Total liabilities 593,178 538,954
-------- --------
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, 8191 and 8,191 shares issued 819 819
Additional paid-in capital 53,716 53,655
Accumulated other comprehensive income (9,648) (7,064)
Retained earnings 128,259 117,980
-------- --------
73,146 165,390
Less 915 and 915, respectively, common shares held in treasury, at cost (6,705) (6,705)
-------- --------
166,441 158,685
-------- --------
Total liabilities and shareholders' equity $759,619 $697,639
======== ========
See accompanying notes to consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
(unaudited)
(amounts in thousands, except per share data)
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------- ------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Premium revenue $ 86,825 $ 72,142 $172,863 $139,201
Net investment income 6,636 5,571 12,797 10,754
Net realized capital gains (1,414) 3,227 741 3,843
Other income 2,222 1,657 4,360 3,097
-------- -------- -------- --------
94,269 82,597 190,761 156,895
Benefits and expenses:
Benefits to policyholders 59,488 49,305 119,399 94,709
Commissions 26,086 23,872 51,372 45,480
Net policy acquisition costs deferred (12,090) (12,388) (22,980) (23,458)
General and administrative expense 12,261 9,805 23,334 19,647
Loss due to impairment of property and equipment - 2,799 - 2,799
Reserve for claim litigation - - 1,500 -
Interest expense 1,281 1,383 2,562 2,578
-------- -------- -------- --------
87,026 74,776 175,187 141,755
-------- -------- -------- --------
Income before federal income taxes 7,243 7,821 15,574 15,140
Provision for federal income taxes 2,455 2,581 5,295 4,996
-------- -------- -------- --------
Net income 4,788 5,240 10,279 10,144
-------- -------- -------- --------
Other comprehensive income:
Unrealized holding gain (loss) arising during period (5,134) (5,692) (3,175) (13,045)
Income (tax) benefit from unrealized holdings 1,746 1,936 1,080 4,435
Reclassification adjustment for (gain) loss included in net income 1,414 (3,227) (741) (3,843)
Income (tax) benefit from reclassification adjustment (481) 1,097 252 1,307
-------- -------- -------- --------
Comprehensive income $ 2,333 $ (646) $ 7,695 $ (1,002)
======== ======== ======== ========
Basic earnings per share $ 0.66 $ 0.69 $ 1.41 $ 1.34
Diluted earnings per share $ 0.56 $ 0.59 $ 1.20 $ 1.14
Weighted average number of shares outstanding 7,277 7,585 7,277 7,584
Weighted average number of shares outstanding (diluted) 9,976 10,382 9,963 10,369
See accompanying notes to consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the Six Months Ended June 30,
(unaudited)
(amounts in thousands)
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Net cash flow from operating activities:
Net income $ 10,279 $ 10,144
Adjustments to reconcile net income to cash
provided by operations:
Amortization of intangible assets 855 882
Policy acquisition costs, net (22,980) (23,458)
Deferred income taxes 1,402 2,178
Depreciation expense 509 304
Net realized capital gains (741) (3,843)
Realized loss on disposal of property and equipment - 2,799
Increase (decrease) due to change in:
Receivables from agents 204 754
Receivable from reinsurers 101 (833)
Policy and contract claims 10,712 10,590
Policy reserves 46,360 38,209
Accounts payable and other liabilities (2,064) 2,349
Federal income taxes recoverable 1,393 1,385
Accrued investment income (650) (289)
Other, net (28) (1,432)
-------- --------
Cash provided by operations 45,352 39,739
Cash flow from (used in) investing activities:
Net cash purchase of subsidiary (6,000) (9,194)
Proceeds from sales of bonds 57,671 34,525
Proceeds from sales of equity securities 15,527 16,412
Maturities of investments 7,976 2,897
Purchase of bonds (105,684) (61,226)
Purchase of equity securities (16,550) (15,093)
Acquisition of property and equipment (1,728) (1,088)
-------- --------
Cash used in investing (48,788) (32,767)
Cash flow (used in) from financing activities:
Proceeds from exercise of stock options 7 31
Repayments of long-term debt (855) (23)
-------- --------
Cash (used in) from financing (848) 8
-------- -
(Decrease) increase in cash and cash equivalents (4,284) 6,980
Cash balances:
Beginning of period 17,347 38,402
-------- --------
End of period $ 13,063 $ 45,382
======== ========
Acquisition of subsidiary with note payable $ - $ (7,167)
======== ========
See accompanying notes to consolidated financial statements.
</TABLE>
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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. Certain prior period amounts have been
reclassified to conform to current period presentation.
1. Investments
Management has categorized all of its investment securities as available
for sale since they may be sold in response to changes in interest rates,
prepayments, and similar factors. Investments in this classification are
reported at their current market value with net unrealized gains and losses, net
of the applicable deferred income tax effect, being added to or deducted from
the Company's total shareholders' equity on the balance sheet. As of June 30,
2000, shareholders' equity was decreased by $9,648 due to unrealized losses of
$14,619 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 June 30, 2000 and December 31, 1999 are as follows:
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
------------- -----------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
---- ------------ ---- ------------
<S> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of U.S
Government authorities
and agencies $124,129 $122,613 $118,547 $116,698
Obligations of states and
political sub-divisions 572 573 571 575
Mortgage backed securities 14,843 14,198 20,888 20,126
Debt securities issued by
foreign governments 17,185 17,226 18,533 17,599
Corporate securities 249,985 235,499 207,162 198,690
Equities 18,557 20,543 17,853 19,163
Policy Loans 163 163 150 150
-------- -------- -------- --------
Total Investments $425,434 $410,815 $383,704 $373,001
======== ======== ======== ========
Net unrealized gain (loss) (14,619) (10,703)
-------- --------
$ 410,815 $ 373,001
========== =========
</TABLE>
6
<PAGE>
2. 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. The Company is currently evaluating the impact of
SFAS No. 133 as relates to the embedded option values in its investment
portfolio.
3. Statutory Regulation:
In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance, which will replace the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting. The
Codification provides guidance for areas where statutory accounting has been
silent and changes current statutory accounting in some areas.
The Pennsylvania Insurance Department has adopted the Codification
guidance, effective January 1, 2001. The New York Insurance Department continues
to evaluate adoption of sections of Codification that do not conflict with New
York law. The Company has not estimated the effect of the Codification guidance
upon its financial condition or results of operations.
4. 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 the
Company 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 the Company's financial condition or results of operations.
7
<PAGE>
5. Reconciliation of Earnings Per Share:
The following describes the reconciliation of the numerator and denominator
of the basic earnings per share computation to the numerator and denominator of
the diluted earnings per share computation. Basic earnings per share excludes
dilution and is computed by dividing income available to common shareholders by
the weighted-average number of common shares outstanding for the period. Diluted
earnings per share reflect the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock.
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------- ------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 4,788 $ 5,240 $10,279 $10,144
Weighted average common shares outstanding 7,277 7,585 7,277 7,584
Basic earnings per share $ 0.66 $ 0.69 $ 1.41 $ 1.34
======= ======= ======= =======
Net income $ 4,788 $ 5,240 $ 10,279 $10,144
Adjustments net of tax:
Interest expense on convertible debt 772 783 1,542 1,565
Amortization of debt offering costs 60 61 120 122
------- ------- -------- -------
Diluted net income $ 5,620 $ 6,084 $ 11,941 $11,831
======= ======= ======== =======
Weighted average common shares outstanding 7,277 7,585 7,277 7,584
Common stock equivalents due to dilutive
effect of stock options 71 169 58 157
Shares converted from convertible debt 2,628 2,628 2,628 2,628
------- ------- ------ --------
Total outstanding shares for diluted earnings
per share computation 9,976 10,382 9,963 10,369
Diluted earnings per share $ 0.56 $ 0.59 $ 1.20 $ 1.14
======= ======= ======= =======
</TABLE>
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operaitons.
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, and have
introduced new life insurance products as well, 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.
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 and policy
reserves reflect expectations of claims related to a block of business over its
entire life. 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.
9
<PAGE>
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 June 30, 2000,
approximately 5.0% 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
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.
10
<PAGE>
Three Months Ended June 30, 2000 and 1999
(amounts in thousands, except per share data)
Premiums. Total premium revenue earned in the three month period ended June 30,
2000 ("the 2000 quarter"), including long-term care, disability, life and
Medicare supplement, increased 20.4% to $86,825, compared to $72,142 in the same
period in 1999 ("the 1999 quarter").
First year long-term care premiums earned in the 2000 quarter increased
5.2% to $24,824, compared to $23,589 in the 1999 quarter. 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.
Renewal premiums earned in the 2000 quarter increased 28.5% to $61,757,
compared to $48,062 in the 1999 quarter. Renewal long-term care premiums earned
in the 2000 quarter increased 29.7% to $58,494, compared to $45,136 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 19.1% to $6,636, from $5,571 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 (Losses). During the 2000 quarter, we recognized
capital losses of $1,414, compared to gains of $3,227 in the 1999 quarter. The
2000 quarter losses resulted primarily from the sale of a portion of our
convertible bond portfolio, which occurred as a result of increasing interest
rates and volatility in the underlying common stock of these bonds. The funds
from these sales were subsequently invested in similar investments.
Other Income. We recorded $2,222 in other income during the 2000 quarter, up
from $1,657 in the 1999 quarter. The increase is primarily attributable to an
increase of 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.
Benefits to Policyholders. Total benefits to policyholders in the 2000 quarter
increased 20.7% to $59,488, compared to $49,305 in the 1999 quarter. Our loss
ratio, or policyholder benefits to premiums, was 68.5% in the 2000 quarter,
compared to 68.3% in the 1999 quarter. This ratio is expected to grow as the
percentage of new business premium to total premium decreases. As discussed
under "Premiums," new premium in the 2000 quarter grew less as a percentage of
the total portfolio than in prior periods, causing the loss ratio to increase.
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 9.3% to $26,086 in the 2000
quarter, compared to $23,872 in the 1999 quarter.
11
<PAGE>
First year commissions on accident and health business in the 2000 quarter
decreased .2% to $16,312, compared to $16,343 in the 1999 quarter. The ratio of
first year accident and health commissions to first year accident and health
premiums was 65.4% in the 2000 quarter and 69.0% 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.
Renewal commissions on accident and health business in the 2000 quarter
increased 35.6% to $9,596, compared to $7,077 in the 1999 quarter, consistent
with the increase in renewal premiums discussed above. The ratio of renewal
accident and health commissions to renewal accident and health premiums was
16.1% in the 2000 quarter and 15.3% in the 1999 quarter.
Commission expense during the 2000 quarter was reduced by the netting of
$1,227 from override commissions paid to the Agencies by affiliated insurers.
During the 1999 quarter, commissions were reduced by $519.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs
in the 2000 quarter decreased 2.4% to $12,090, compared to $12,388 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.
General and Administrative Expenses. General and administrative expenses in the
2000 quarter increased 25.0% to $12,261, compared to $9,805 in the 1999 quarter.
The 2000 and 1999 quarters include $2,102 and $1,955, 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.
Loss Due to Impairment of Property and Equipment. During the 1999 quarter, 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. The suit is still is process.
12
<PAGE>
Provision for Federal Income Taxes. Our provision for federal income taxes for
the 2000 quarter decreased 4.9% to $2,455, compared to $2,581 for the 1999
quarter. The effective tax rates of 33.9% and 33.0% in the 2000 quarter and the
1999 quarter, respectively, are 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 quarter, our investment portfolio
generated pre-tax, unrealized losses of $3,720, compared to the 1999 quarter
period unrealized losses of $8,919. After accounting for deferred taxes from
these losses, shareholders' equity increased by $2,333 from comprehensive income
during the 2000 quarter, compared to comprehensive losses of $646 in the 1999
quarter.
Six Months Ended June 30, 2000 and 1999
(amounts in thousands, except per share data)
Premiums. Total premium revenue earned in the six month period ended June 30,
2000 ("the 2000 period"), including long-term care, disability, life and
Medicare supplement, increased 24.2% to $172,863, compared to $139,201 in the
same period in 1999 ("the 1999 period").
First year long-term care premiums earned in the 2000 period increased
10.6% to $49,495, compared to $44,739 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. This plan generated
approximately $1,650 of additional premium in the 2000 period.
Renewal premiums earned in the 2000 period increased 31.0% to $122,416,
compared to $93,419 in the 1999 period. Renewal long-term care premiums earned
in the 2000 period increased 33.4% to $116,099, compared to $87,055 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 19.0% to $12,797, from $10,754 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.
Net Realized Capital Gains. During the 2000 period, we recognized capital gains
of $741, compared to gains of $3,843 in the 1999 period. The gains in both
periods were recorded as a result of our normal investment management
operations.
Other Income. We recorded $4,360 in other income during the 2000 period, up from
$3,097 in the 1999 period. The increase is attributable to an increase of
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.
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Benefits to Policyholders. Total benefits to policyholders in the 2000 period
increased 26.1% to $119,399, compared to $94,709 in the 1999 period. Our loss
ratio, or policyholder benefits to premiums, was 69.1% in the 2000 period,
compared to 68.0% in the 1999 period. This ratio is expected to grow as the
percentage of new business premium to total premium decreases. As discussed
under "Premiums," new premium in the 2000 quarter grew less as a percentage of
the total portfolio than in prior periods, causing the loss ratio to increase.
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 13.0% to $51,372 in the 2000
period, compared to $45,480 in the 1999 period.
First year commissions on accident and health business in the 2000 period
increased 5.1% to $32,373, compared to $30,789 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 65.1% in the 2000 period and 68.4% in the 1999 period.
Renewal commissions on accident and health business in the 2000 period
increased 36.8% to $18,817, compared to $13,756 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
15.9% in the 2000 period and 15.4% in the 1999 period.
Commission expense during the 2000 period was reduced by the netting of
$2,064 from override commissions paid to the Agencies by affiliated insurers.
During the 1999 period, commissions were reduced by $1,070.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs
in the 2000 period decreased 2.0% to $22,980, compared to $23,458 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
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.
General and Administrative Expenses. General and administrative expenses in the
2000 period increased 18.8% to $23,334, compared to $19,647 in the 1999 period.
The 2000 and 1999 periods include $4,256 and $3,865, 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
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the level of expenses (excluding United Insurance Group and goodwill
amortization) as a percentage of premiums, which declined to 10.7% in the 2000
period, compared to 11.0% in the 1999 period.
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.
We are vigorously pursuing all of our legal rights and remedies to reverse or
substantially reduce this award, including motion for remittiter, post trial
motions and appeal. In the event that our efforts are unsuccessful in full or in
part to reduce the award, we established a $1,500 litigation reserve for the
potential future payment of this judgement.
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. The suit is still is process.
Provision for Federal Income Taxes. Our provision for federal income taxes for
the 2000 period increased 6.0% to $5,295, compared to $4,996 for the 1999
period. The effective tax rates of 34.0% and 33.0% in the 2000 period and the
1999 period, respectively, are 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 losses of $3,916, compared to the 1999 period unrealized
losses of $16,888. After accounting for deferred taxes from these gains,
shareholders' equity increased by $7,695 from comprehensive income during the
2000 period, compared to comprehensive losses of $1,002 in the 1999 period.
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, 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
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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
decreased $4,284 in the 2000 period primarily due to the purchase of $122,234 in
bonds and equity securities and $6,000 cash used for the purchase of NISHD. Cash
was provided primarily from the maturity and sale of $81,174 in bonds and equity
securities. These sources of funds were supplemented with $45,352 from
operations. The major provider of cash from operations was premium revenue used
to fund reserve additions of $57,072.
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 $6,980 in the 1999 period primarily due to the sale of $16,412 of
our equity securities portfolio and cash from operations of $39,739. The major
provider of cash from operations was premiums used to fund additions to reserves
of $48,799 in the 1999 period. The primary uses of cash were commissions
deferred as additions to policy acquisition costs of $23,458, the purchase of
bonds of $61,226 and net cash of $9,194 paid for the acquisition of United
Insurance Group.
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. At June 30, 2000, the market value of our bond portfolio represented
95.9% of our cost, with a current unrealized loss of $14,619. Our equity
portfolio exceeded cost by $1,986 at June 30, 2000. Our equity portfolio
exceeded cost by $1,310 at December 31, 1999 and the market value of our bond
portfolio was below our cost by $12,013.
As of June 30, 2000, shareholders' equity was decreased by $9,648 due to
unrealized losses of $14,619 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%.
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 the amount of $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 June 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
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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 for 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, but continue to seek alternative measures. If alternative measures to
support our growth 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 ourself from adverse litigation, and our
ability to expand our network of productive independent agents. For additional
information, please refer to "Overview" within our 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 porfolio.
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 78.7% of total liabilities
and reinsurance receivables on unpaid losses represent 2.0% 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 June 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
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hypothetical changes in market interest rate. A 200 basis point increase in
market rates at June 30, 2000 would have resulted in an approximate $26,000,000
decrease in the net fair value. If interest rates had decreased by 100 and 200
basis points, there would have been an approximate $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 June 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 second quarter 1999, we filed a lawsuit in state court, naming
IBM and others, for breach of contract and other claims. The lawsuit, filed June
28, 1999, in the Court of Common Pleas in Lehigh County, Pennsylvania, names
IBM, Tangent International Computer Consultants, Inc. of New York and The
Outsourcing Partnership LLC of Pennsylvania, and seeks damages for alleged
misrepresentations concerning its LifePro computer software.
During the second quarter 2000, 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. We are
vigorously pursuing all of our legal rights and remedies to reverse or
substantially reduce this award, including motion for remittiter, post trial
motions and appeal.
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.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
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Item 4. Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Shareholders was held on May 26, 2000. At such
meeting, the following matters were voted upon by the shareholders, receiving
the number of affirmative, negative and withheld votes, as well as abstentions
and broker non-votes, set forth below each matter.
(1) Election of three persons to the Company's Board of Directors as Class
I Directors to serve until the 2003 Annual Meeting of Shareholders and until
their successors are elected and have been qualified.
A.J. Carden
6,558,839 Affirmative 0 Negative
--------- -----
605,121 Withheld 0 Abstentions and broker
--------- ----- non-votes
Irving Levit
6,558,939 Affirmative 0 Negative
--------- -----
605,021 Withheld 0 Abstentions and broker
--------- ----- non-votes
Domenic P. Stangherlin
6,254,352 Affirmative 0 Negative
--------- -----
909,608 Withheld 0 Abstentions and broker
--------- ----- non-votes
(2) Ratification of the selection of PricewaterhouseCoopers LLP as
independent public accountants for the Company and its subsidiaries for the year
ending December 31, 2000.
7,128,413 Affirmative 4,362 Negative
--------- ------
0 Withheld 31,185 Abstentions and broker
--------- ------ non-votes
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed no reports on Form 8-K during the quarter ending June 30,
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
Dat: August 11, 2000 /s/ Irving Levit
--------------- -------------------------------------
Irving Levit
Chairman of the Board, President
and Chief Executive Officer
Date: August 11, 2000 /s/ Cameron B. Waite
--------------- -------------------------------------
Cameron B. Waite
Chief Financial Officer
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