SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
( x ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
--------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 0-22316
--------------------
Penn-America Group, Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2731409
- ---------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
420 South York Road, Hatboro, Pennsylvania 19040
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(Address of principal executive offices, including zip code)
(215) 443-3600
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(Registrant's telephone number, including area code)
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 other 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 .
At May 13, 1999, 8,767,444 shares of the registrant's common stock, $.01 par
value, were outstanding.
Page 1
<PAGE>
Penn-America Group, Inc. and SubsidiarIES
Index
Page Number
Part I - Financial Information
Consolidated Unaudited Balance Sheets - March 31, 1999 and
December 31, 1998 3
Consolidated Unaudited Statements of Earnings - For the three
months ended March 31, 1999 and 1998 4
Consolidated Unaudited Statement of Stockholders' Equity -
For the three months ended March 31, 1999 5
Consolidated Unaudited Statements of Cash Flows -
For the three months ended March 31, 1999 and 1998 6
Notes to Unaudited Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Part II - Other Information 21
Page 2
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
--------- ---------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities:
Available for sale, at fair value (amortized cost 1999, $112,333;
1998, $103,365) $ 113,546 $ 105,598
Held to maturity, at amortized cost (fair value 1999, $22,397; 1998, $27,270) 22,247 26,956
Equity securities, at fair value (cost 1999, $26,962; 1998, $23,358) 27,838 25,238
Short-term investments, at cost, which approximates fair value -- 997
--------- ---------
Total investments 163,631 158,789
Cash 11,372 24,077
Receivables:
Accrued investment income 2,188 1,871
Premiums receivable, net 10,827 10,349
Reinsurance recoverable 17,861 18,766
--------- ---------
Total receivables 30,876 30,986
Prepaid reinsurance premiums 2,569 2,809
Deferred policy acquisition costs 8,692 8,728
Capital lease 1,905 2,051
Deferred income taxes 2,401 1,598
Income tax recoverable -- 884
Other assets 504 582
--------- ---------
Total assets $ 221,950 $ 230,504
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses $ 88,343 $ 88,937
Unearned premiums 33,294 34,253
Accounts payable and accrued expenses 838 1,179
Capitalized lease obligation 1,923 2,080
Other liabilities 3,677 3,425
Income tax payable 83 --
--------- ---------
Total liabilities 128,158 129,874
--------- ---------
Stockholders' equity:
Preferred stock, $.01 par value; authorized 2,000,000 shares;
none issued -- --
Common stock, $.01 par value; authorized 20,000,000 shares;
issued 1999, 9,948,326 and 1998 9,938,179 shares, outstanding 1999,
8,736,201 and 1998, 9,395,854 shares 99 99
Additional paid-in capital 69,127 69,035
Accumulated other comprehensive income 1,378 2,714
Retained earnings 36,540 34,779
Treasury stock, 1999, 1,212,125 shares; 1998, 542,325 shares, at cost (12,952) (5,643)
--------- ---------
94,192 100,984
Unearned compensation from restricted stock awards (400) (354)
--------- ---------
Total stockholders' equity 93,792 100,630
--------- ---------
Total liabilities and stockholders' equity $ 221,950 $ 230,504
========= =========
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
Page 3
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
(Unaudited)
For the three months ended March 31, 1999 and 1998
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended March 31,
1999 1998
-------- --------
<S> <C> <C>
Revenues:
Premiums earned $ 21,462 $ 23,035
Net investment income 2,410 2,775
Net realized investment gains (losses) 556 (34)
-------- --------
Total revenues 24,428 25,776
-------- --------
Losses and expenses:
Losses and loss adjustment expenses 13,724 14,291
Amortization of deferred policy acquisition costs 6,153 6,370
Other underwriting expenses 1,453 1,394
Interest expense 36 44
-------- --------
Total losses and expenses 21,366 22,099
-------- --------
Earnings before income tax 3,062 3,677
Income tax 853 1,097
-------- --------
Net earnings $ 2,209 $ 2,580
======== ========
Net earnings per share:
Basic $ 0.24 $ 0.26
Diluted $ 0.24 $ 0.26
Weighted average number of shares outstanding:
Basic 9,129 9,896
Diluted 9,204 10,009
Cash dividends per share $ 0.05 $ 0.05
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
Page 4
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(Unaudited)
For the three months ended March 31, 1999
(In thousands, except share data)
<TABLE>
<CAPTION>
Unearned
Accumulated Compensation
Other From
Common Stock Additional Compre- Restricted
------------------ Paid-In hensive Retained Treasury Stock
Shares Amount Capital Income Earnings Stock Awards Total
---------- ------ --------- ------- ---------- ---------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1998 9,938,179 $99 $69,035 $2,714 $34,779 $(5,643) $(354) $100,630
Net earnings 2,209 2,209
Other comprehensive (losses) income,
net of tax:
Unrealized losses on investments, net of
reclassification adjustment (1,336) (1,336)
--------
Comprehensive income 873
--------
Issuance of common stock 10,147 92 92
Unearned compensation from restricted
stock awards (91) (91)
Amortization of compensation expense from
restricted stock awards issued 45 45
Cash dividends paid ($0.05 per share) (448) (448)
Purchase of treasury stock, 669,800 shares (7,309) (7,309)
---------------------------------------------------------------------------------
Balance at March 31, 1999 9,948,326 $99 $69,127 $1,378 $36,540 $(12,952) $(400) $93,792
=================================================================================
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
Page 5
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
For the three months ended March 31, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net earnings $ 2,209 $ 2,580
Adjustments to reconcile net earnings to net cash provided by
Operating activities:
Amortization and depreciation expense 190 120
Net realized investment (gains)/losses (556) 34
Deferred income tax (114) (227)
Net decrease in premiums receivable, prepaid reinsurance premiums
and unearned premiums (1,197) (1,052)
Net increase in unpaid losses and loss adjustment expenses
and reinsurance recoverable 312 1,216
(Increase) decrease in:
Accrued investment income (317) (171)
Deferred policy acquisition costs 36 39
Income tax recoverable 884 40
Other assets 46 (80)
Increase (decrease) in:
Accounts payable and accrued expenses (341) (784)
Income taxes payable 83 1,285
Other liabilities 252 478
-------- --------
Net cash provided by operating activities 1,487 3,478
-------- --------
Cash flows from investing activities:
Purchases of equity securities (5,179) (7,540)
Purchases of fixed maturities available for sale (13,013) (22,250)
Purchases of fixed maturities held to maturity (1,058) --
Proceeds from sales of equity securities 2,131 7,576
Proceeds from sales and maturities of fixed maturities available for sale 3,948 12,134
Proceeds from maturities and calls of fixed maturities held to maturity 5,773 7,096
Change in short-term investments 997 3,454
-------- --------
Net cash (used) provided by investing activities (6,401) 470
-------- --------
Cash flows from financing activities:
Issuance of common stock -- 188
Purchase of treasury stock (7,309) --
Principal payments on capital lease obligations (34) (32)
Dividends paid (448) (495)
-------- --------
Net cash (used) by financing activities (7,791) (339)
-------- --------
(Decrease) increase in cash (12,705) 3,609
Cash, beginning of period 24,077 2,163
-------- --------
Cash, end of period $ 11,372 $ 5,772
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 36 $ 44
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
Page 6
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Note 1 - Organization and Basis of Presentation
Penn-America Group, Inc. ("PAGI") is an insurance holding company whose
principal asset is the common stock of Penn-America Insurance Company
("Penn-America"). The "Company" refers to PAGI and Penn-America, as well as to
Penn-America's wholly-owned subsidiary, Penn-Star Insurance Company. Penn
Independent Corporation ("Penn Independent") currently owns approximately 35.3%
of the outstanding common stock of PAGI as of March 31, 1999.
The accompanying unaudited consolidated financial statements should be
read in conjunction with the financial statements and notes for the year ended
December 31, 1998. In the opinion of management, the financial information
reflects all adjustments (consisting only of normal recurring adjustments) which
are necessary for a fair presentation of the Company's financial position,
results of operations, and cash flows for the interim periods. The Company's
results of operations for interim periods are not necessarily indicative of the
results to be expected for the entire year.
Note 2 - Reinsurance
Premiums earned are net of amounts ceded to reinsurers of $1.7 and $1.9
million for the three months ended March 31, 1999 and March 31, 1998,
respectively. Losses and loss adjustment expenses are net of amounts ceded to
reinsurers of $600 thousand and $1.7 million for the three months ended March
31, 1999 and March 31, 1998, respectively.
Note 3 - Comprehensive Income
Accumulated other comprehensive income of the Company consists solely
of net unrealized (losses) gains on investment securities.
Page 7
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
The following are components of other comprehensive (losses) income (in
thousands):
<TABLE>
<CAPTION>
Three months ended March 31, 1999
-------------------------------------------------------
Before Tax Tax Net of Tax
Amount Expense Amount
-------------- ------------ -------------
<S> <C> <C> <C>
Unrealized losses on investments:
Unrealized holding losses arising
during period $(1,468) $ 499 $ (969)
Less: reclassification adjustment for
gains realized in net earnings (556) 189 (367)
=======================================================
Other comprehensive loss $(2,024) $ 688 $(1,336)
=======================================================
</TABLE>
<TABLE>
<CAPTION>
Three months ended March 31, 1998
-------------------------------------------------------
Before Tax Tax Net of Tax
Amount Expense Amount
-------------- ------------ -----------
<S> <C> <C> <C>
Unrealized gains on investments:
Unrealized holding gains arising
during period $ 669 $ (234) $ 435
Add: reclassification adjustment for
losses realized in net earnings 34 (12) 22
=======================================================
Other comprehensive income $ 703 $ (246) $ 457
=======================================================
</TABLE>
For the three months ended March 31, 1998, comprehensive income of $3,037,000
consisted of net income of $2,580,000 and other comprehensive income of
$457,000.
Page 8
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 4 - Basic and Diluted Earnings Per Share
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations (in thousands, except per
share data):
Three months ended
March 31,
----------------------
1999 1998
------- -------
Basic EPS:
Net Earnings $ 2,209 $ 2,580
------- -------
Weighted average common
shares outstanding 9,129 9,896
------- -------
Basic EPS $ 0.24 $ 0.26
======= =======
Diluted EPS:
Net Earnings $ 2,209 $ 2,580
------- -------
Weighted average common
shares outstanding 9,129 9,896
Additional shares outstanding
after the assumed exercise
of options by applying the
treasury stock method 75 113
------- -------
Total weighted average common
shares outstanding 9,204 10,009
======= =======
Diluted EPS $ 0.24 $ 0.26
======= =======
Page 9
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 5- Segment Information
In 1998, the Company implemented Statement of Financial Accounting
Standard No. 131, "Disclosures about Segments of an Enterprise and Related
Information" which establishes standards about a company's operating segments.
The Company has two reportable segments: personal lines and commercial
lines. These segments are managed separately because they have different
customers, pricing and expense structures. The Company does not allocate assets
between segments because assets are reviewed in total by management for
decision-making purposes.
The accounting policies of the segments are the same as those more
fully described in the summary of significant accounting policies in the
Company's annual report. The Company evaluates segment profit based on profit or
loss from operating activities. Segments profits or losses from operations is
pre-tax and does not include unallocated expenses but does include investment
income attributable to insurance transactions. Segment profit or loss therefore
excludes federal income taxes, unallocated expenses and investment income
attributable to equity as opposed to investment income attributable to insurance
transactions.
The Company currently has one major customer accounting for more than
10% of the Company's revenue. The Company derived approximately 12.8% and 21.5%
of its revenues from this agent for the three months ended March 31, 1999 and
1998, respectively. This major customer is the agent who writes personal
non-standard automobile coverage in the states of California and Nevada. The
Company announced on April 28, 1999 that it would be running off the California
automobile book with this customer. The Company had previously announced the
runoff of the Nevada automobile book with this agent in January 1999.
Page 10
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
The following is a summary of the Company's segment revenues, expenses
and profit for the three months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
(in thousands) March 31, 1999
Commercial Personal Total
-------------------------------------------
<S> <C> <C> <C>
Premiums earned $ 16,614 $ 4,848 $ 21,462
Net investment income from
insurance operations 1,297 228 1,525
-------------------------------------------
Total segment revenues 17,911 5,076 22,987
-------------------------------------------
Segment losses and LAE 10,117 3,607 13,724
Segment expenses 5,000 1,577 6,577
-------------------------------------------
Total segment expenses 15,117 5,184 20,301
-------------------------------------------
Segment profit (loss) $ 2,794 $ (108) $ 2,686
Plus unallocated items:
Net investment income from equity 1,441
Unallocated expenses (1,065)
Income taxes (853)
--------
Net earnings $ 2,209
========
(in thousands) March 31, 1998
Commercial Personal Total
-------------------------------------------
Premiums earned $ 14,955 $ 8,080 $ 23,035
Net investment income from
insurance operations 979 288 1,267
-------------------------------------------
Total segment revenues 15,934 8,368 24,302
-------------------------------------------
Segment losses and LAE 9,113 5,178 14,291
Segment expenses 4,205 2,515 6,720
-------------------------------------------
Total segment expenses 13,318 7,693 21,011
-------------------------------------------
Segment profit $ 2,616 $ 675 $ 3,291
Plus unallocated items:
Net investment income from equity 1,474
Unallocated expenses (1,088)
Income taxes (1,097)
--------
Net earnings $ 2,580
========
</TABLE>
Page 11
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
As of March 31, 1999, the Company's insurance business comprised two
distinct segments: commercial lines, which represent approximately 80% of the
Company's gross written premiums, and minimum limits non-standard personal
automobile insurance. The Company announced on April 28, 1999, that it would
run-off its remaining portfolio of the personal lines automobile business, which
was underwritten through a single agent in California. This followed a move
earlier this year to eliminate the rest of the Company's personal automobile
portfolio of this business in six other states.
Results of Operations
Segment Premiums for the Three Months Ended March 31, 1999 and 1998
Commercial Premiums:
Gross written premiums for commercial lines in the first quarter of
1999 increased 3.2% to $17.6 million compared with $17.1 million for the first
quarter of 1998; net written premiums increased 6.6% to $16.3 million compared
with $15.3 million in 1998. Effective January 1, 1999, the Company increased its
retention on its casualty reinsurance treaty from $500,000 to $1,000,000. The
increase in net written premiums for commercial lines is partially attributable
to this increase in retention. The Company's retention on its property treaty
for 1999 remained unchanged at $300,000.
The statutory combined ratio for commercial lines increased to 95.3%
compared with 92.6% for the three month periods ended March 31, 1999 and 1998,
respectively due primarily to the expense ratio, which increased to 34.4%
compared with 31.6% during the same periods. The increase in the expense ratio
is attributable primarily to an increase in the commission the Company pays to
its commercial agents, from 20% to 22%. The loss ratio in commercial lines
improved to 60.9% in the first quarter of 1999 compared with 61.0% in the first
quarter of 1998.
Personal Automobile Premiums:
Gross written premiums for personal automobile lines decreased 40.5% in
the first quarter of 1999 to $4.5 million compared with $7.5 million for the
same quarter in 1998; net written premiums decreased 40.7% to $4.4 million
compared with $7.5 million in 1998. The decrease was due largely to actions the
Company took to limit losses in this business by cutting-back production. Of the
$4.5 million of premiums written in the first quarter of 1999, $2.4 million was
written in California as compared with $4.3 million written in California in the
first quarter of 1998.
Page 12
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
The statutory combined ratio for personal automobile lines increased to
112.3% for the three months ended March 31, 1999 compared with 99.3% in the same
period of 1998, due primarily to the loss ratio, which increased to 74.4%
compared with 64.1% in 1998. The expense ratio in personal automobile lines was
37.9% and 35.2% for the three month periods ended March 31, 1999 and 1998,
respectively. The increase in the expense ratio is attributable primarily to the
40.5% decline in written premium for non-standard personal automobile insurance.
Three Months Ended March 31, 1999 and 1998
Premiums earned decreased 6.8% to $21.5 million for the three months
ended March 31, 1999 from $23.0 million for the three months ended March 31,
1998, due to a 40.0% decrease in personal lines automobile premiums earned,
partially offset by an 11.1% increase in commercial premiums earned.
Net investment income decreased 13.1 % to $2.4 million for the three
months ended March 31, 1999, from $2.8 million for the three months ended March
31, 1998. This decrease resulted principally from an overall decline in invested
assets, an increased investment in tax-exempt municipal securities and a
decrease in investment yields from 6.67% as of March 31, 1998 to 6.22% as of
March 31, 1999. The decline in invested assets is due to capital used to
purchase treasury stock and decreased cashflow from operations attributed to the
overall decline in written premiums. Investment in tax-exempt municipal
securities increased 236% to $38.3 million in the first quarter of 1999 compared
to $11.4 million in the same quarter of 1998.
Losses and loss adjustment expenses decreased 3.9% to $13.7 million for
the three months ended March 31, 1999, from $14.3 million for the three months
ended March 31, 1998, due to a decline in net premiums earned, partially offset
by an increase in the personal lines loss ratio.
Amortization of deferred policy acquisition costs decreased 3.1% to
$6.2 million for the three months ended March 31, 1999, from $6.4 million for
the three months ended March 31, 1998. The decrease was primarily attributable
to a decline in net premiums earned, and partially offset by an increase in
commission rates for commercial business from 20% to 22%.
The overall loss ratio for the Company increased to 63.9% for the three
months ended March 31, 1999, from 62.0% for the three months ended March 31,
1998, due to the increase in the loss ratio in personal automobile to 74.4% at
March 31, 1999, from 64.1% at March 31, 1998. The statutory expense ratio
increased to 35.2% for the three months ended March 31,
Page 13
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
1999, from 32.8% for the three months ended March 31, 1998. The principal causes
for the increase in the expense ratio were the 8.9% decline in net premiums
written for the quarter ended March 31, 1999, compared to the same quarter in
1998 and the increase in the commercial lines commission rate to 22% from 20%.
The overall statutory combined ratio increased to 99.1% for the three months
ended March 31, 1999, from 94.8% for the three months ended March 31, 1998.
As a result of the factors described above, the Company's net income
for the three months ended March 31, 1999 decreased 14.4% to $2.2 million or
$0.24 per share (basic and diluted), from $2.6 million or $0.26 per share (basic
and diluted) for the three months ended March 31, 1998.
Liquidity and Capital Resources
PAGI is a holding company, the principal asset of which is the common
stock of Penn-America. PAGI's cash flows depend primarily on dividends and other
payments from Penn-America. PAGI uses these funds to pay (i) operating expenses,
(ii) taxes and other payments, and (iii) dividends to PAGI stockholders.
Penn-America's source of funds consists primarily of premiums, investment income
and proceeds from sales and redemptions of investments. Funds are used by
Penn-America principally to pay claims and operating expenses, to purchase
investments and to make dividend and other payments to PAGI.
Net cash provided by operating activities decreased 57.2% to $1.5
million for the three months ended March 31, 1999, from $3.5 million for the
three months ended March 31, 1998, due primarily to the reduction in personal
lines automobile gross written premiums in 1999.
Net cash used by investing activities was $6.4 million for the three
months ended March 31, 1999, compared to $470 thousand provided by investing
activities for the three months ended March 31, 1998. The increase in cash used
by investing activities is due primarily to cash that was not fully invested as
of year-end 1998, which was invested during the first quarter of 1999.
Net cash used by financing activities was $7.8 million for the three
months ended March 31, 1999, compared to $339 thousand for the same period in
1998. The principal reason for the use of cash by financing activities was the
purchase of 669,800 shares of treasury stock totaling $7.3 million during the
quarter ended March 31, 1999. The Company announced a corporate stock buy-back
program in July 1998. As of April 28, 1999, the Board of Directors had
authorized the repurchase of up to two million shares. As of March 31, 1999, the
Company has acquired 1.2 million shares at an average cost of $10.71 per share.
The funding for the treasury stock program has been primarily provided by
dividends from the Company's insurance subsidiary, Penn-America Insurance
Company. During the quarter ended March 31, 1999, Penn-America Insurance Company
paid a dividend of $9.0 million to the Company.
Page 14
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
The Company believes that it has sufficient liquidity to meet its
anticipated insurance obligations and operating and capital expenditure needs.
The Company's investment strategy emphasizes quality, liquidity and
diversification, as well as total return. With respect to liquidity, the Company
considers liability durations, specifically related to loss reserves, when
determining desired investment maturities. In addition, maturities have been
staggered to produce cash flows for loss payments and reinvestment
opportunities. The average duration of the fixed maturity portfolio as of March
31, 1999 was approximately 4.0 years.
The Company's fixed maturity portfolio of $135.8 million was 83% of the
total investment portfolio as of March 31, 1999. Approximately 99% of these
securities were rated "A-" or better by Standard & Poor's or Moody's. Equities,
the majority of which consist of preferred stocks, were $27.8 million or 17% of
total investments as of March 31, 1999.
As of March 31, 1999, the investment portfolio contained $22.6 million
of mortgage/ asset-backed obligations, which represents 13.8% of the total
investments as of March 31, 1999. All of these securities are "AAA" rated
securities issued by government, government-related agencies or publicly held
corporations, are publicly traded, and have market values obtained from an
independent pricing service. Changes in estimated cash flows due to changes in
prepayment assumptions from the original purchase assumptions are revised based
on current interest rates and the economic environment. The Company had no other
derivative financial instruments, real estate or mortgages in the investment
portfolio as of March 31, 1999.
During the first quarter, the Company engaged another asset manager,
Madison Monroe, Inc. to invest $10,000,000 of it's investment portfolio. As of
March 31, 1999, the entire amount was invested in U.S. Treasury strip bonds. One
of the principals of Madison Monroe is a party related to the controlling
shareholder of the Company.
The principal source of cash for the payment of dividends to PAGI's
stockholders is dividends from Penn-America. Penn-America is required by law to
maintain a certain minimum surplus on a statutory basis and is subject to
risk-based capital requirements and regulations under which payment of dividends
from statutory surplus may require prior approval from the Pennsylvania
regulatory authorities. The maximum dividend that may be paid in 1999 by
Penn-America to PAGI without prior approval of regulatory authorities is
$9,455,000.
Page 15
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
The Year 2000
Introduction
The "Year 2000", or Y2K, refers to the problems that automated systems
could encounter as the year 2000 approaches due to computers' or other
electronic devices' inability to register the year 2000 correctly, rather than
as the year 1900. In this regard, the Company relies on its existing information
technology systems ("IT systems") to operate and to monitor all major aspects of
the Company's business, including underwriting, claims and various financial
systems. The Company also relies, to a lesser extent, on the IT systems of its
general agents and, indirectly, on those of the producing retail insurance
brokers. Finally, the Company relies on certain critical non-information
technology systems ("non-IT systems"), such as electricity, telephones,
facsimile machines, heating and air-conditioning and fire protection systems.
Any disruption in the operation of the IT and non-IT systems of either the
Company or any of its critical customers, vendors or suppliers could have a
material adverse effect on the Company's business, results of operations or
financial condition.
State of Readiness
IT systems: In an effort to remediate the problems associated with the
Year 2000, the Company, in 1996, evaluated all its computer codes to determine
what software programs would be affected by date-sensitive fields. After this
identification process was completed, the Company hired an outside vendor to
implement the recoding that was required. In July 1997, the Company successfully
ran its first trial of all the revised programs. Based upon testing to date, the
Company believes that its programs are Year 2000 compliant. The Company,
however, continues to run periodic tests to make sure the programs will function
properly. The next series of tests are scheduled to be run prior to July 4, 1999
in connection with implementation of a new processing program. As of this date,
approximately 13,230 policies have been successfully processed as renewals
bearing an effective date on or after January 1, 2000.
The Company's IT systems have also been tested against hypothetical
information supplied by its general agents. The IT systems currently are able to
read properly the information provided. Assuming the general agents don't alter
their records, the Company reasonably believes that its IT systems will function
properly. To the extent the general agents' records change, the Company requires
that the agents provide notice.
The Company's management information systems rely primarily on an
integrated property-casualty software package that is processed on an IBM AS/400
computer system. The system is leased from IBM and kept current or near current
in both hardware and operating systems. The IBM AS/400 model was upgraded in the
fourth quarter of 1998 to Version 4, which is reported by IBM to be fully
compliant with Year 2000.
Page 16
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
The Company uses a Novell Local Area Network (LAN) to connect all
employees to the computer system. The LAN is reported to be Year 2000 compliant.
The LAN is used primarily for "service" applications including word processing,
spreadsheets and E-mail. The majority of the LAN-based applications are
Microsoft products and are current or near current in their software releases.
The LAN also consists of personal computers ("PCs") that are attached
to a series of servers. All PCs have been tested and correctly recognize the
Year 2000. The IT Department of the Company supports an Internet web site and
various stand-alone third party PC software applications. These packages were
assessed for any Year 2000 problems. The Company continues to test these
packages to ensure their compliance. Testing should be complete by June, 1999.
The IT Department also supports FormMaker, a document management software
package developed by DocuCorp which is used by the majority of general agents to
produce Penn-America policies. FormMaker has been tested and, in its current
release, is reported by DocuCorp to be Year 2000 compliant.
Non-IT systems: The Company has identified, and relies on, the
following non-IT systems in its daily operations: telephones, voicemail,
facsimile machines and heating and air conditioning and fire protection systems.
The telephone system was tested as compliant. The voicemail system was
identified as non-compliant and was replaced with a compliant system in
September 1998. The heating and air conditioning systems have been tested and
are compliant. The Company has been informed that all of the remaining systems
will not be effected by the Year 2000 and the Company has received written
confirmation to this effect.
The Company continues to respond to requests for information from
customers, suppliers and vendors with whom the Company does business, including
various departments of insurance. The Company was recently informed of a
soon-to-be scheduled Year 2000 compliance examination by the Insurance
Department of Pennsylvania, the Company's state of domicile.
Key Customers, Suppliers and Vendors: As part of its remediation plan,
the Company is analyzing the Year 2000 readiness of the Company's critical
outside customers (including general agents), vendors and suppliers. Each
department of the Company was asked to identify key customers, suppliers and
vendors with whom the Company has an interdependent, material business
relationship. In September 1998, the Company sent approximately 188 surveys to
those identified customers/suppliers/vendors to ask them: to provide the current
status of their Y2K plan; whether they will be compliant; and what plans they
have in place in the event they will not be compliant. Of the 188 surveys sent
out, 100 were returned with responses indicating that the recipients were or
would be compliant, 88 did not respond. In December 1998, the Company sent out a
second request for information to those who had not yet responded and for newly
identified critical customers, suppliers and vendors. As of April 30, 1999, the
responses were as
Page 17
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
follows: 55 indicated that they were compliant; 112 indicated that they would be
compliant before January 1, 2000; and 24 have yet to respond. The Company is in
the process of sending out a final request. Those that do not respond will be
deemed non-compliant and the Company will find an alternative source for that
information or service. For those that have responded that they will be
compliant, the Company plans to issue a follow-up letter on or about the dates
on which they indicated they will be compliant in order to confirm that status.
Despite all the procedures the Company has in place, there can be no guarantee
that the systems of other companies on which the Company's business relies will
be converted in a timely fashion, or that failure to convert by another company
or a conversion that is incompatible with the Company's systems will not have a
materially adverse effect on the Company and its operations.
Cost
The Company incurred costs of approximately $60,000 to recode its
internal programs. The costs were incurred by the Company to test significant
insurance hardware and software that the Company believes are compliant. These
costs are and will be minimal as these costs are built into the Company's
standard disaster recovery testing program. The current standard testing costs
approximately $28,000 per year. The Company does not separately track the
internal costs incurred for the Y2K project. Such costs are related primarily to
payroll costs for the Company's information services personnel. The Company also
incurred an additional $13,000 to upgrade its voicemail system. Additional
expenses may arise in the upcoming year. Management believes that at this time
these costs will approximate $10,000.
Risks
The risks associated with the Company's inability to resolve all Year
2000 issues include the possibility of system failures or miscalculations
causing disruption in operations including, among other things, an inability to
process transactions, to send invoices, to send or to receive E-mail and
voicemail, or conduct similar normal business activities. Additionally, failure
of third parties upon whom the Company's business relies to remediate their Year
2000 problems in a timely fashion could result in disruption in the receipt and
processing of insurance policies, claims, payment of receivables and general
problems related to the Company's daily operations. If any of these
contingencies were to occur, the disruption in business could be temporary or
permanent, depending on the degree of failure. Until the Company receives
responses from all of the Company's agents and suppliers, the overall risks
associated with the Year 2000 remain difficult to describe accurately and to
quantify; and there can be no guarantee that the Year 2000 issue will not have a
material adverse effect on the Company and its operations.
Page 18
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
If the Year 2000 problem is not solved by the Company and its business
partners, the Company could face business disruption, operational problems,
financial losses, legal liability and similar risks to the business. These risks
could have a material adverse impact on the Company.
Additionally, the Company may be exposed to insurance risk related to
Y2K exposures of its insureds. In order to mitigate this risk, the Company
generally began endorsing applicable new and renewal policies with effective
dates after November 1, 1998 with an exclusion endorsement. This endorsement
excludes Y2K computer and related electronic exposures by using the standard
industry exclusion. Certain states, however, may not accept this exclusion in
all cases.
Contingency Plan
The Company has completed a first draft of a Year 2000 Contingency Plan
and anticipates having a final draft of the plan in place by the fourth quarter
of 1999. In the meantime, the Company maintains a Disaster Recovery Plan to
address various potential business interruptions.
The current Disaster Recovery Plan addresses the availability and
compatibility of hardware offsite that could be placed into action by the
Company. In September 1998, the Company tested the offsite facility and the
operation of significant insurance software that had been made Year 2000
compliant, as well as the operation of the offsite hardware. Under these test
conditions, all dates were rolled forward to January 1, 2000. The test results
indicated that the Company's significant insurance-related software are
compliant.
The testing facility has indicated that the majority of its hardware
and equipment is fully compliant as of December, 1998. The testing facility
further noted that it will not upgrade certain of its systems until the first
quarter of 1999 so as to afford all subscribers an opportunity to upgrade their
systems. The Company is following up with the testing facility on its system
upgrades at this time. The testing facility is also available if electric, heat,
water, telephones and office space should be required.
The foregoing is a "Year 2000 Readiness Disclosure" pursuant to the
Year 2000 Readiness Disclosure Act.
Page 19
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
(continued)
Readers are cautioned that forward-looking statements contained in the
Year 2000 disclosure contained herein should be read in conjunction with the
Company's disclosure titled "Safe Harbor Provisions of the Private Securities
Litigation Reform Act of 1995". Forward-looking statements include, but are not
limited to, whether the Company will complete its remediation and testing in a
timely fashion, whether remediation will cost more than anticipated, the impact
of redeploying staff and the effect of third parties on the Company's ability to
function after the century date change.
New Accounting Standards
In June 1998, Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities", was issued
and established standards for accounting and reporting of derivative instruments
and hedging activities. The statement is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. The Company is in the process of
determining the effect, if any, of this statement on its financial statements.
Page 20
<PAGE>
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Default Upon Senior Securities - None
Item 4. Submission of Matters to a Vote by Security Holders -None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
On April 28, 1999, the Company filed with the Securities &
Exchange Commission a report on Form 8-K which reported that on
April 28, 1999, the Company issued a press release announcing
first quarter earnings, the run-off of writing non-standard
personal automobile insurance in the State of California, the
complete run-off of all non-standard automobile and an increase by
500,000 in the authorized shares under the Company's stock
buy-back program for a total authorization of two million shares
by the Board.
Page 21
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Penn-America Group, Inc.
Date: May 17, 1999 By: /s/ Jon S. Saltzman
------------------ -----------------------------------
Jon S. Saltzman
President and
Chief Executive Officer
By: /s/ Rosemary R. Ferrero
-----------------------------------
Rosemary R. Ferrero
Principal Finance and
Accounting Officer
Page 22
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Balance Sheet and Statement of Earnings at March 31,1999
(unaudited) and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 113,546
<DEBT-CARRYING-VALUE> 22,247
<DEBT-MARKET-VALUE> 0
<EQUITIES> 27,838
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 163,631
<CASH> 11,372
<RECOVER-REINSURE> 17,861
<DEFERRED-ACQUISITION> 8,692
<TOTAL-ASSETS> 221,950
<POLICY-LOSSES> 88,343
<UNEARNED-PREMIUMS> 33,294
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 99
<OTHER-SE> 93,693
<TOTAL-LIABILITY-AND-EQUITY> 221,950
21,462
<INVESTMENT-INCOME> 2,410
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<OTHER-INCOME> 0
<BENEFITS> 13,724
<UNDERWRITING-AMORTIZATION> 6,153
<UNDERWRITING-OTHER> 1,453
<INCOME-PRETAX> 3,062
<INCOME-TAX> 853
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,209
<EPS-PRIMARY> .24
<EPS-DILUTED> .24
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
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</TABLE>
