FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 2000
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from
to
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Commission file number 0-13972
PENN TREATY AMERICAN CORPORATION
--------------------------------
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-1664166
------------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification No.)
3440 Lehigh Street, Allentown, PA 18103
----------------------------------------
(Address, including zip code, of principal executive offices)
(610) 965-2222
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal
year, if change since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
The number of shares outstanding on the Registrant's common stock, par value
$.10 per share, as of May 8, 2000 was 7,807,589.
1
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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 7 of this report, respectively. 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.
("UIG"), Network Insurance Senior Health Divisision ("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
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<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Condensed Balance Sheets
(amounts in thousands)
<CAPTION>
March 31 December 31,
2000 1999
-------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Investments:
Bonds, available for sale at market (cost of $383,021 and $365,701, respectively) $ 370,585 $ 353,688
Equity securities at market value (cost of $19,089 and $17,853, respectively) 20,626 19,163
Policy loans 158 150
--------- ---------
Total investments 391,369 373,001
Cash and cash equivalents 16,671 17,347
Property and equipment, at cost, less accumulated depreciation of
$4,735 and $3,882, respectively 11,078 10,614
Unamortized deferred policy acquisition costs 219,409 208,519
Receivables from agents, less allowance for
uncollectable amounts of $199 and $199, respectively 2,267 2,713
Accrued investment income 6,509 5,918
Federal income tax recoverable 1,033 1,616
Cost in excess of fair value of net assets acquired, less
accumulated amortization of $2,344 and $2,021, respectively 28,049 22,357
Present value of future profits acquired 2,663 2,767
Receivable from reinsurers 15,028 15,070
Other assets 37,719 37,717
--------- ------
Total assets $ 731,795 $ 697,639
========= =========
LIABILITIES
Policy reserves:
Accident and health $ 282,987 $ 260,046
Life 12,306 12,167
Policy and contract claims 142,056 137,534
Accounts payable and other liabilities 14,201 12,887
Long-term debt 82,024 82,861
Deferred income taxes 34,150 33,459
--------- ---------
Total liabilities 567,724 538,954
--------- ---------
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, 8,191 and 8,191 shares issued 819 819
Additional paid-in capital 53,681 53,655
Accumulated other comprehensive income (7,193) (7,064)
Retained earnings 123,469 117,980
--------- ---------
170,776 165,390
Less 915 and 915, respectively, common shares held in treasury, at cost (6,705) (6,705)
--------- ---------
164,071 158,685
--------- ---------
Total liabilities and shareholders' equity $ 731,795 $ 697,639
========= =========
See accompanying notes to consolidated financial statements.
</TABLE>
3
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<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
(unaudited)
(amounts in thousands, except per share data)
<CAPTION>
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
<S> <C> <C>
Revenue:
Accident and health premiums $ 84,947 $ 66,166
Life premiums 1,091 893
-------- --------
86,038 67,059
Net investment income 6,161 5,183
Net realized capital gains 2,155 616
Other income 2,138 1,440
-------- --------
96,492 74,298
Benefits and expenses:
Benefits to policyholders 59,911 45,404
Commissions 25,286 21,608
Net policy acquisition costs deferred (10,890) (11,070)
General and administrative expense 11,073 9,842
Reserve for claim litigation 1,500 -
Interest expense 1,281 1,195
-------- --------
88,161 66,979
-------- --------
Income before federal income taxes 8,331 7,319
Provision for federal income taxes 2,840 2,415
-------- --------
Net income 5,491 4,904
-------- --------
Other comprehensive income:
Unrealized holding gain (loss) arising during period 1,959 (7,353)
Income (tax) benefit from unrealized holdings (666) 2,500
Reclassification adjustment for (gain) loss included in net income (2,155) (616)
Income (tax) benefit from reclassification adjustment 733 210
-------- --------
Comprehensive income 5,362 (355)
======== =========
Basic earnings per share $ 0.75 $ 0.65
Diluted earnings per share $ 0.64 $ 0.56
Weighted average number of shares outstanding 7,277 7,583
Weighted average number of shares outstanding (diluted) 9,948 10,355
See accompanying notes to consolidated financial statements.
</TABLE>
4
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<TABLE>
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the Three Months Ended March 31,
(unaudited)
(amounts in thousands)
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Net cash flow from operating activities:
Net income $ 5,491 $ 4,904
Adjustments to reconcile net income to cash
provided by operations:
Amortization of intangible assets 502 452
Policy acquisition costs, net (10,890) (11,070)
Deferred income taxes 758 807
Depreciation expense 220 216
Net realized capital gains (2,155) (616)
Increase (decrease) due to change in:
Receivables from agents 446 96
Receivable from reinsurers 42 (344)
Policy and contract claims 4,522 5,656
Policy reserves 23,080 15,950
Accounts payable and other liabilities 1,314 3,730
Federal income taxes recoverable 583 937
Accrued investment income (591) (287)
Other, net (69) (1,431)
-------- --------
Cash provided by operations 23,253 19,000
Cash flow from (used in) investing activities:
Net cash purchase of subsidiary (6,000) (9,194)
Proceeds from sales of bonds 18,501 12,190
Proceeds from sales of equity securities 7,535 3,236
Maturities of investments 4,207 2,869
Purchase of bonds (38,521) (32,282)
Purchase of equity securities (8,130) (3,352)
Acquisition of property and equipment (684) 608)
-------- --------
Cash used in investing (23,092) (27,141)
Cash flow from (used in) financing activities:
Proceeds from exercise of stock options - 6
Repayments of long-term debt (837) (23)
-------- --------
Cash used in financing (837) (17)
-------- --------
Decrease in cash and cash equivalents (676) (8,158)
Cash balances:
Beginning of period 17,347 38,402
-------- --------
End of period $ 16,671 $ 30,244
======== ========
Acquisition of subsidiary with note payable $ - $ (7,167)
======== ========
See accompanying notes to consolidated financial statements.
</TABLE>
5
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 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 March
31, 2000, shareholders' equity was decreased by $7,193 due to unrealized losses
of $10,899 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 March 31, 2000 and December 31, 1999 are as follows:
<TABLE>
<CAPTION>
March 31, 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 $ 120,335 $ 118,778 $ 118,547 $ 116,698
Obligations of states and
political sub-divisions 572 572 571 575
Mortgage backed securities 21,419 20,409 20,888 20,126
Debt securities issued by
foreign governments 17,501 17,589 18,533 17,599
Corporate securities 223,194 213,237 207,162 198,690
Equities 19,089 20,626 17,853 19,163
Policy Loans 158 158 150 150
-------- --------- --------- ---------
Total Investments $ 402,268 $ 391,369 $ 383,704 $ 373,001
========= ========= ========== =========
Net unrealized gain (loss) (10,899) (10,703)
--------- --------
$ 391,369 $ 373,001
========= =========
</TABLE>
6
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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. We are currently evaluating the impact of SFAS No.
133 as relates to the embedded option value of our investments in convertible
bonds.
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 has not
yet adopted the Codification guidance. 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
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5. Reconciliation of Earnings Per Share:
A reconciliation of the numerator and denominator of the basic earnings per
share computation to the numerator and denominator of the diluted earnings per
share computation follows. Basic earnings per share excludes dilution and is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share reflect the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock.
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
Net income $ 5,491 $ 4,904
Weighted average common shares outstanding 7,277 7,583
Basic earnings per share $ 0.75 $ 0.65
======= =======
Net income $ 5,491 $ 4,904
Adjustments net of tax:
Interest expense on convertible debt 770 783
Amortization of debt offering costs 60 61
------- -------
Diluted net income $ 6,321 $ 5,748
======= =======
Weighted average common shares outstanding 7,277 7,583
Common stock equivalents due to dilutive
effect of stock options 43 144
Shares converted from convertible debt 2,628 2,628
------- -------
Total outstanding shares for diluted earnings
per share computation 9,948 10,355
Diluted earnings per share $ 0.64 $ 0.56
======= =======
8
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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, 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 policyholder's 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
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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 March 31, 2000,
approximately 5.3% 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
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Three Months Ended March 31, 2000 and 1999
(amounts in thousands, except per share data)
Premiums. Total premium revenue earned in the three month period ended March 31,
2000 ("the 2000 quarter"), including long-term care, disability, life and
Medicare supplement, increased 28.3% to $86,038, compared to $67,059 in the same
period in 1999 ("the 1999 quarter").
First year long-term care premiums earned in the 2000 quarter increased
16.6% to $24,671, compared to $21,150 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. In addition, we
introduced our group plan in the 2000 quarter, 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 quarter.
Renewal premiums earned in the 2000 quarter increased 33.7% to $60,659,
compared to $45,357 in the 1999 quarter. Renewal long-term care premiums earned
in the 2000 quarter increased 36.3% to $57,155, compared to $41,919 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 18.9% to $6,161, from $5,183 for the 1999 quarter. 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 quarter, we recognized capital gains
of $2,155, compared to gains of $616 in the 1999 quarter. The gains in both
periods were recorded as a result of our normal investment management
operations.
Other Income. We recorded $2,138 in other income during the 2000 quarter, up
from $1,440 in the 1999 quarter. 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.
Benefits to Policyholders. Total benefits to policyholders in the 2000 quarter
increased 32.0% to $59,911, compared to $45,404 in the 1999 quarter. Our loss
ratio, or policyholder benefits to premiums, was 69.6% in the 2000 quarter,
compared to 67.7% 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 17.0% to $25,286 in the 2000
quarter, compared to $21,608 in the 1999 quarter.
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First year commissions on accident and health business in the 2000
quarter increased 11.2% to $16,061, compared to $14,446 in the 1999 quarter, due
to the increase in first year accident and health premiums and to the issuance
of policies to younger applicants, for which we typically pay a higher first
year commission rate. Commission growth is lower than premium growth as no
commission was paid for our new group policies. The ratio of first year accident
and health commissions to first year accident and health premiums was 64.8% in
the 2000 quarter and 67.8% in the 1999 quarter.
Renewal commissions on accident and health business in the 2000 quarter
increased 38.1% to $9,221, compared to $6,679 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
15.7% in the 2000 quarter and 15.5% in the 1999 quarter.
Commission expense during the 2000 quarter was reduced by the netting
of $869 from United Insurance Group and NISHD override commissions paid to those
companies by affiliated insurers. During the 1999 quarter, commissions were
reduced by $550.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs
in the 2000 quarter decreased 1.6% to $10,890, compared to $11,070 in the 1999
quarter.
Deferred costs are typically all costs that are directly related to,
and vary with, the acquisition of new premiums. These costs include the variable
portion of commissions, which are defined as the first year commission rate less
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 12.5% to $11,073, compared to $9,842 in the 1999 quarter.
The 2000 and 1999 quarters include $2,154 and $1,910, 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 UIG and goodwill amortization) as a percentage
of premiums, which declined to 10.0% in the 2000 quarter, compared to 11.4% in
the 1999 quarter.
Reserve for Claim Litigation. Subsequent to the end of the 2000 quarter, 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.
Provision for Federal Income Taxes. Our provision for federal income taxes for
the 2000 quarter increased 17.6% to $2,840, compared to $2,415 for the 1999
quarter. The effective tax rates of 34.1% 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 and from dividends received that are
partially exempt from taxation, which are partially offset by non-deductible
goodwill amortization.
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Comprehensive Income. During the 2000 quarter, our investment portfolio
generated pre-tax, unrealized gains of $1,959, compared to the 1999 quarter
period unrealized losses of $7,353. After accounting for deferred taxes from
these gains, shareholders' equity increased by $5,362 from comprehensive income
during the 2000 quarter, compared to comprehensive losses of $355 in the 1999
quarter.
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 are generally lower than publicly-reported earnings 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 quarter, our cash flows were attributable to cash provided
by operations, cash used in investing and cash used in financing. Our cash
decreased $676 in the 2000 quarter primarily due to the purchase of $46,651 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 $30,243 in bonds and equity
securities. These sources of funds were supplemented with $23,253 from
operations. The major provider of cash from operations was premium revenue used
to fund reserve additions of $27,602.
Our cash decreased $8,158 in the 1999 quarter primarily due to the
acquisition of $35,634 in bonds and equity securities. The use of these funds
more than offset $19,000 from operations and $18,295 provided from the sale and
maturity of bonds and equity securities. The major provider of cash from
operations was premium revenue used to fund reserve increases of $21,606. We
also used $9,194 in cash to purchase United Insurance Group in the 1999 quarter.
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 March 31, 2000, the market value of our bond portfolio represented
96.8% of our cost, with a current unrealized loss of $12,436. Our equity
portfolio exceeded cost by $1,537 at March 31, 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 March 31, 2000, shareholders' equity was decreased by $7,193 due
to unrealized losses of $10,899 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.
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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 March 31, 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.
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 NISHD 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.
14
<PAGE>
Certain information presented in this filing constitutes
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Although 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 comply
with government regulations, the ability of senior citizens to purchase our
products given the increasing costs of health care, our ability to defend
ourselves against adverse litigation, the modality of premium revenue and our
ability to expand our network of productive independent agents. For additional
information, please refer to "Overview" and our reports filed with the
Securities and Exchange Commission.
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 value of our investments in convertible
bonds.
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
15
<PAGE>
insurance liabilities and reinsurance receivables are excluded in the
hypothetical effects (insurance liabilities represent 77.0% of total liabilities
and reinsurance receivables on unpaid losses represent 2.1% 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 March 31, 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 $11,887,000 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 March 31, 2000 would have resulted in an approximate $22,799,000
decrease in the net fair value. If interest rates had decreased by 100 and 200
basis points, there would have been an approximate $12,964,000 and $27,118,000
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 March 31, 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.
Subsequent to the end of the first 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.
16
<PAGE>
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
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
Not Applicable
17
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
Network Insurance Senior Health Division Stock Purchase.
Notification of jury assessment of punitive damage award.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant had duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENN TREATY AMERICAN CORPORATION
--------------------------------
Registrant
Date: May 14, 2000 /s/ Irving Levit
------------ ----------------------------------------
Irving Levit
Chairman of the Board, President and
Chief Executive Officer
Date: May 14, 2000 /s/ Cameron B. Waite
------------ ----------------------------------------
Cameron B. Waite
Chief Financial Officer
19
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