-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VHG8MvidL+QOaRRFHX5FY8wisT/VTjiFG9cxq/cWoLGLNQ7p0C6dRX1FTDe9LpxF q+9HU5IotaV4yUxGgmNElA== 0000912057-97-011126.txt : 19970401 0000912057-97-011126.hdr.sgml : 19970401 ACCESSION NUMBER: 0000912057-97-011126 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PENN TREATY AMERICAN CORP CENTRAL INDEX KEY: 0000814181 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 231664166 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-15972 FILM NUMBER: 97568993 BUSINESS ADDRESS: STREET 1: 3440 LEHIGH ST CITY: ALLENTOWN STATE: PA ZIP: 18103 BUSINESS PHONE: 2159652222 MAIL ADDRESS: STREET 1: 3440 LEHIGH ST STREET 2: 3440 LEHIGH ST CITY: ALLENTOWN STATE: PA ZIP: 18103 10-K405 1 10K (69 PAGES) FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission File No. 0-15972 PENN TREATY AMERICAN CORPORATION -------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-1664166 ------------ ---------- (State or other (I.R.S. Employer jurisdiction of Identification No.) incorporation or organization) 3440 Lehigh Street, Allentown, Pennsylvania 18103 ------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (610) 965-2222 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- None Not Applicable Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.10 par value ---------------------------- (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 19, 1997 was $203,923,851. The number of shares outstanding of the registrant's common stock as of March 19, 1997 was 7,518,080. Documents Incorporated By Reference: (1) Proxy Statement for the 1996 Annual Meeting of Shareholders - Part III -1- PART I Item 1. Business (a) General The Company is one of the leading providers of long-term nursing home and home health care insurance. The Company markets its products primarily to persons age 65 and over through independent insurance agents and underwrites its policies through three subsidiaries, Penn Treaty Life Insurance Company, ("PTLIC"), Network America Life Insurance Company ("Network America") and American Network Insurance Company ("ANIC"). The Company's principal products are individual fixed, defined benefit accident and health insurance policies covering long-term skilled, intermediate and custodial nursing home care and home health care. Policies are designed to make the administration of claims simple, quick and sensitive to the needs of the policyholders. As of December 31, 1996, long-term nursing home care and home health care policies accounted for approximately 90% of the Company's total annualized premiums in force. The Company introduced its first long-term nursing home care insurance product in 1975 and its first home health care product in 1987. In late 1994, the Company introduced its Independent Living policy, which provides coverage over the full term of the policy for home care services furnished by an unlicensed homemaker or companion as well as a licensed care provider. Available policy riders allow insureds to tailor their policies and include an automatic annual benefit increase, benefits for adult day-care centers and a return of premium benefit. The Company also markets and sells life, disability, Medicare supplement and other hospital care insurance products. Long-Term Care Industry Long-term care insurance policies were first introduced in the 1970's. Significant sales of these policies commenced in the mid 1980's. Typical early policies provided limited nursing home coverage for a limited benefit period and were subject to certain restrictions such as prior hospitalization and a certificate of medical necessity. As awareness of the long-term care needs of senior citizens has grown, the long-term care insurance industry has responded with more diverse insurance offerings to provide needed benefits in a cost-effective fashion. Requirements for prior hospitalization and medical necessity are no longer standard and benefit periods have been extended up to the life of the insured. Coverages for custodial care and home health care are now offered by many insurers. A survey conducted by a national industry organization estimated that the number of long-term care policies in force grew from 815,000 in 1987 to approximately 3,800,000 by the end of 1994. While the number of policies sold has grown an average of more than 24% annually since 1987, this same survey indicated that only 11% of the population age 65 and over is covered by long-term care insurance. The emphasis on long-term care insurance has evolved primarily as a result of the aging of society, increasing life expectancies and the escalating cost of care. According to a 1992 survey of the U.S. Bureau of the Census, by the year 2050 the population age 65 and over is expected to grow to approximately 98 million, or more than three times the 1990 figure, while the population age 85 and over is expected to grow to 26 million, or more than eight times the 1990 figure. Another study has suggested that at age 65 a person has a 43% chance of being confined to a nursing home during some time in his or her life. The cost of care has also increased significantly. It has been estimated by the U.S. Census Bureau that from 1980 to 1990, the cost of care for Medicaid nursing home residents increased from $8.7 billion to $21.5 billion. Other factors causing growth of the long-term care insurance industry include the lack of suitable alternatives for financing long-term care. There are four primary alternatives to long-term care insurance: government programs such as Medicare and Medicaid, personal assets, dependence on family members and life insurance. Medicare offers only limited coverage of the cost of long-term care. Medicaid is the single largest source of financing for nursing home care in the U.S. However, since eligibility for Medicaid requires that its recipients have a very small amount of assets or income, many individuals are forced to deplete their assets in order to become eligible. Strategy -2- The Company's objective is to strengthen its position as a leader in providing long-term care insurance to senior citizens. To meet this objective and to continue to increase profitability, the Company is implementing the following strategies: Developing and qualifying new products with state insurance regulatory authorities. The Company has been an originator in the field of long-term care insurance for over twenty years. The Company introduced its Independent Living policy in 1994 which provides coverage over the full term of the policy for services furnished by an unlicensed homemaker or companion or a licensed care provider. Most recently, the Company introduced a Life Plus policy which provides the security of whole life insurance plus the protection of long-term care coverage. The Company intends to continue to develop new insurance products designed to meet the needs of senior citizens and their families. Increasing the size and productivity of the Company's network of independent agents. The Company has significantly increased the number of producing agents (agents who produce premiums for the Company on new policies) selling its policies by focusing its efforts on certain geographic areas of the country which have larger concentrations of individuals age 65 and over. The Company intends to continue to recruit agents in these states and believes that it will be able to continue to expand its business in these and other states. Seeking to acquire existing insurance companies and blocks of in-force policies underwritten by other insurance companies. The Company has augmented its premium revenue from time to time through the acquisition of existing insurance companies and blocks of policies underwritten by other insurance companies. The Company intends to continue to evaluate complementary acquisitions and policy blocks as a means of enhancing its revenue base. Introducing existing products in newly licensed states. The Company is currently licensed to market products in 49 states and the District of Columbia. Although not all of the Company's products are currently eligible for sale in all of these jurisdictions, the Company actively seeks to expand the regions where it sells its products. Through the recent acquisition of ANIC, the company acquired licenses to conduct business in some new states, including New Jersey and Massachusetts. These states are considered by the Company's management to offer significant opportunities for sales growth. In addition, the Company has applied for a license to underwrite accident and health insurance products in New York. The Company is also continuing its efforts to broaden its marketing within those states where it is already licensed. Corporate Background The Company, which is registered and approved as a holding company under the Pennsylvania Insurance Code, was incorporated in Pennsylvania on May 13, 1965 under the name Greater Keystone Investors, Inc., and changed its name to Penn Treaty American Corporation on March 25, 1987. PTLIC was incorporated in Pennsylvania under the name Family Security Life Insurance Company on June 6, 1962, and its name was changed to Quaker State Life Insurance Company on December 29, 1969, at which time it was operating under a limited insurance company charter. Quaker State Life Insurance Company was acquired by the Company on May 4, 1976, and its name was changed to Penn Treaty Life Insurance Company. On July 13, 1989, PTLIC acquired all of the outstanding capital stock of AMICARE Insurance Company (formerly Fidelity Interstate Life Insurance Company), a stock insurance company organized and existing under the laws of Pennsylvania which changed its name to Network America Life Insurance Company on August 1, 1989. The Agency was incorporated in Pennsylvania on February 23, 1988 under the name Penn Treaty Service Company. On February 29, 1988, the Agency acquired, among other assets, the rights to renewal commissions on a certain block of PTLIC's existing in-force policies from Cher-Britt Agency, Inc., and an option to purchase the rights to renewal commissions on a certain block of PTLIC's existing policies from Cher-Britt Insurance Agency,Inc., an affiliated company of Cher-Britt Agency, Inc. In connection with this acquisition, on March 3, 1988, the name of the Agency was changed to Cher-Britt Service Company. The option was exercised on March 3, 1989. The Agency's name was changed to "Senior Financial Consultants Company" on August 9, 1994. On August 30, 1996, the Company consummated the acquisition of all of the issued and outstanding capital stock of Health Insurance of Vermont, Inc. ("HIVT"), which has since changed its name to American Network Insurance Company. (b) Insurance Products Since 1976, the Company has developed, marketed and underwritten fixed, defined benefit accident and health insurance policies designed to be responsive to changes in (i) the characteristics and needs of the senior citizen market, -3- (ii) governmental regulations and governmental benefits available for this population segment and (iii) the health care and long-term care industries in general. As of December 31, 1996, approximately 90% of the Company's total annualized premiums in force were derived from long-term care policies which include nursing home and home health care policies. The Company's other lines of insurance include (i) life insurance, (ii) Medicare supplement, (iii) blue-collar disability coverage and (iv) various accident and health policies and riders. The Company solicits input from both its independent agents and its policyholders with respect to the changing needs of its insureds. In addition, Company representatives regularly attend seminars to monitor significant trends in the industry. The following table sets forth, as of the dates indicated, and for each class of policies, the annualized premiums (in thousands) in force, the percentage of total annualized premiums, the number of policies in force, and the average premium per policy. Policies are classified by their base coverage but may include a rider for a different coverage. For example, if a policyholder purchased a home health care policy with a nursing home rider, premiums collected in connection with the nursing home rider would be included in the home health care class.
Year ended December 31, --------------------------------------------------------------------------------- 1994 1995 1996 ---- ---- ---- Long term nursing home care: Annualized premiums $ 67,059 77.4% $ 77,217 70.3% $ 89,692 62.6% Number of policies 47,525 53,084 60,874 Average premium per policy $ 1,411 $ 1,455 $ 1,473 Long term home health care: Annualized premiums $ 11,822 13.6% $ 24,881 22.6% $ 38,609 26.9% Number of policies 12,637 22,967 34,594 Average premium per policy $ 936 $ 1,083 $ 1,116 Disability insurance Annualized premiums $ 0 0.0% $ 0 0.0% $ 7,092 4.9% Number of policies 0 0 16,674 Average premium per policy $ 0 $ 0 $ 425 Medicare supplement: Annualized premiums $ 3,604 4.2% $ 3,246 3.0% $ 3,206 2.2% Number of policies 2,988 2,527 2,757 Average premium per policy $ 1,206 $ 1,285 $ 1,163 Life insurance: Annualized premiums $ 2,754 3.2% $ 3,273 3.0% $ 3,629 2.5% Number of policies 4,012 5,270 6,112 Average premium per policy $ 686 $ 621 $ 594 Other insurance: Annualized premiums $ 1,389 1.6% $ 1,267 1.2% $ 1,163 0.8% Number of policies 7,895 7,161 6,509 Average premium per policy $ 176 $ 177 $ 179 Total annualized premiums in force (1) $ 86,628 100% $109,884 100% $143,391 100%
- ------------ (1) Excludes credit life and credit accident and health insurance premiums in force. Credit insurance premiums in force are calculated as the cumulative total of one-time premiums received by the Company for policies issued for terms of up to 120 months. Credit insurance premiums in force for the years ended December 31, 1994, 1995, and 1996 were approximately $702,000, $453,000 and $199,000, respectively. Long-Term Care Generally. The majority of the Company's long-term care policies are written on an annual basis and provide for guaranteed renewability at then current premium rates at the option of the insured. The insured may elect to pay premiums -4- on a monthly, quarterly, semi-annual or annual basis. In addition, the Company offers an automatic payment feature that allows policyholders to have premiums automatically withdrawn from a checking account. The Company may increase premium rates on a particular form of policy only upon approval of the applicable insurance regulatory authority in each state. Although the insured may elect to pay premiums on a monthly, quarterly or semi-annual basis, as of December 31, 1996, premiums on approximately 56.3% of the Company's long-term care policies in force were paid on an annual basis. As a supplement to some of its long-term care policies, the Company offers various riders providing benefits such as an automatic annual benefit increase to help offset the effects of inflation and a return of premium option. The return of premium benefit rider provides that after a policy has been in force for ten years, the policyholder is entitled to a return of 80% of all premiums paid during the ten year period less any claims paid by the Company. If, however, claims exceed 20% of the premiums paid during the ten year period, no return of premium is made. In addition, in most states the rider provides for a pro-rata return of premium in the event of death or surrender beginning in the sixth year. The Company also offers and encourages the purchase of home health care riders to supplement its nursing home policies and nursing home riders to supplement its home health care policies. In the past, the Company offered numerous other riders to supplement its long-term care policies. The need, however, for many of these riders has been eliminated due to the incorporation of many of these benefits into the basic coverage under the Company's newest long-term care policies. Among the built-in benefits provided under the long-term care policies currently marketed by the Company are hospice care and adult day care benefits, survivorship benefits, restoration of benefits and a guaranteed upgrade option pursuant to which the policyholder may increase the benefits available under the policy during the first two years if no claims have been made. These policies also provide a yearly wellness benefit (a payment made to policyholders who have not made a claim) after the first year of the policy. Long-Term Nursing Home Care. The Company's long-term nursing home care policies generally provide a fixed benefit payable during periods of nursing home confinement prescribed by a physician or necessitated by the policyholder's cognitive impairment or inability to perform two or more activities of daily living. These policies include built-in benefits for alternative plans of care, waiver of premium after 90 days of benefit payments on a claim and unlimited restoration of the policy's maximum benefit period. The policies also provide that pre-existing conditions disclosed on the application are covered immediately as of the effective date of the policy, and there is no "prior hospitalization" requirement. Historically, most nursing home policies required that a policyholder must have been discharged from a hospital within a certain number of days prior to being confined in a nursing home. The Company has phased out the prior hospitalization requirement on its new policies and has made a policy rider to eliminate the prior hospitalization requirement available to policyholders of the Company's older policies. Additionally, all levels of nursing care, including skilled, custodial and intermediate care, are covered and benefits continue even when the policyholder's required level of care changes. Skilled nursing care refers to professional nursing care provided by a medical professional (a doctor or registered or licensed practical nurse) located at a licensed facility which cannot be provided by a non-medical professional. Custodial care refers to non-medical care which does not require professional treatment and can be provided by a non-medical professional with minimal or no training. Intermediate nursing care is designed to cover situations which would otherwise fall between skilled and custodial care and includes situations in which an individual may require skilled assistance on a sporadic basis. The Company's current long-term nursing home care policies provide benefits which are payable over periods ranging from one to five years and lifetime. These policies provide for a fixed daily benefit ranging from $40 to $200 per day. Certain of the Company's nursing home care policies provide benefits which are payable over periods ranging from six months to five years and lifetime, and from $800 to $5,000 per month of nursing home benefits. According to an independent study published in 1994, the average cost of nursing home care was estimated to be approximately $37,000 per year, resulting in an aggregate of more than $85,000 for the average nursing home stay of approximately 2.3 years. Long-Term Home Health Care. The Company's home health care policies generally provide a benefit payable on an expense-incurred basis during periods of home care prescribed by a physician or necessitated by the policyholder's cognitive impairment or inability to perform two or more activities of daily living. These policies cover the services of registered nurses, -5- licensed practical nurses, home health aides, physical therapists, speech therapists, medical social workers and other similar home health practitioners. Benefits for home health care policies currently being marketed by the Company are payable over periods ranging from six months to five years and lifetime and provide from $40 to $160 per day of home benefits. The Company also has policies outstanding that provide benefits which are payable over periods ranging from six months to three years and in amounts ranging from $5.00 to $20.00 per hour of home benefits subject to a limit of eight hours per day. Some of these policies require prior hospitalization as a condition to receipt of benefits. On all home health care policies sold by the Company since 1993, pre-existing conditions disclosed on an application are not covered during the initial six months following the effective date of the policy and there is no prior hospitalization requirement. The Company's home health care policies also include built-in benefits for waiver of premium and unlimited restoration of the policy's maximum benefit period. A recent addition to the Company's long-term care product line is its Independent Living policy. This policy was first introduced in the fourth quarter of 1994. This policy provides coverage over the full term of the policy for services furnished by a homemaker or companion, including a member of the insured's family, who is not a qualified or licensed care provider ("Homemaker/Companion Services"). Homemaker/Companion Services include cooking, shopping, housekeeping and assisting the insured with such activities as laundry, correspondence, using the telephone and paying bills. Historically, only limited coverage had been provided under certain of the Company's home health care policies for Homemaker/Companion Services, typically for a period of up to 30 days per calendar year during the term of the policy. The Independent Living policy provides that the Company will waive the elimination period, the time at the beginning of the period during which care is provided for which no benefits are available under the policy (usually twenty days), if the insured agrees to utilize an independent case management agency ("Case Manager") referred by the Company. The Case Manager is engaged by the Company at the time a claim is submitted to prepare a written assessment of the insured's condition and to establish a written plan of care. The Company believes that the Independent Living policy, which represents a significant expansion of the benefits previously available for Homemaker/Companion Services, is the first of its kind. The Company has subsequently incorporated the use of Case Management in all of its new home healthcare policies. Disability Insurance. The Company underwrites and markets disability income insurance entirely on an individual basis through ANIC. The various disability policies concentrate on serving working class or "blue collar" individuals or employees. The policies provide for benefit periods ranging from 6 months to 60 months with monthly benefit amounts ranging from $250 to $3,000. The Company also offers mortgage disability and accident only disability policies. Life Insurance. Beginning in August 1993, the Company began to market actively its whole life insurance products which were approved by various state insurance authorities during 1992 and 1993. These policies have face amounts of $2,000 to $25,000 for individuals age 50-80 years and $2,000 to $10,000 for individuals age 80-85 years. For the convenience of the insured, the Company offers three premium payment options for these policies: (i) monthly, quarterly, semi-annual or annual payments; (ii) one-time single premium payment; or (iii) two, three and five year payment plans. These policies were developed to be sold by the Company's agents to senior citizens so as to complete the Company's portfolio of insurance products. The most recent addition to the Company's long-term care product line is its Life Plus policy. This policy was first introduced during the third quarter of 1996 and is currently being marketed in those states in which regulatory approval has been received. This product is a whole life insurance policy that also offers the protection of long-term care coverage. When policyholders purchase this policy, with face value benefits ranging from $50,000 to $250,000, they have the option of customizing their policy by electing to add a nursing home and/or home health care rider. The policyholder may then access up to the face amount of the policy for nursing home or home health care as needed. This reduces the face amount of the policy at a rate of 4% a month for nursing home benefits received and 2% a month for home health care benefits received. The life insurance products currently marketed by the Company have been designed for the senior citizen market. The Company previously marketed life insurance policies, including annual renewable term and whole life policies, to all ages of insureds. Medicare Supplement. The Company writes policies designed to provide coverage to supplement benefits available under Medicare, such as payment of deductible amounts. OBRA `90 enacted various changes in Medicare reimbursement, set more stringent standards for Medicare supplement insurance policies and required that states adopt these new standards by July 31, 1992. OBRA `90 sets forth ten federally standardized benefit plans of which the Company offers five such plans in most states. With respect to these benefit packages, every company writing Medicare supplement coverages must adopt at least the Basic Plan, which covers Medicare Part A coinsurance amounts for in-patient hospitalization (without the Part A deductible), the cost of the first three pints of blood and 20% of allowable charges under Medicare Part B. The other nine plans provide for the Basic Plan coverage in addition to more extensive benefits such as skilled nursing home coinsurance amounts, the Medicare -6- Part A deductible, the Medicare Part B deductible, 100% of Medicare Part B Excess Charges, Foreign Travel Emergency Care, At-Home Recovery, Extended Drug Coverage and Preventive Care. All Medicare supplement benefit plans offered by the Company are subject to "open enrollment" and the Company is required to issue a policy to any person applying for Medicare supplement insurance within six months of becoming eligible for Medicare Part B, which generally occurs within the first six months after a person's 65th birthday. Because of lower profit margins associated with the Company's Medicare supplement products, the Company has gradually de-emphasized the marketing of these products. Medicare supplemental premiums represented 2.2% of the Company's annualized premiums in-force for the period ended December 31, 1996. Other Insurance. The Company also sells other insurance products including accidental death and dismemberment policies, and cancer policies, of which the aggregate premiums represented 0.8% of the Company's total annualized premium in-force as of December 31, 1996. (c) Marketing and Expansion The Company's goal is to underwrite, market and sell its products throughout the United States. The Company focuses its marketing efforts primarily in those states (i) where it has successfully developed networks of agents and (ii) which have the highest concentration of individuals whose financial status and insurance needs are compatible with its products. Agents. The Company employs no agents directly but relies instead on relationships with independent agents and their sub-agents. In 1996, the Company's policies were marketed through approximately 7,500 producing agents, an increase of 46% over the number of producing agents in 1995. The Company provides assistance to its agents through the use of seminars, underwriting training and field representatives who consult with agents on underwriting matters, assist agents in research and accompany agents on marketing visits to current and prospective policyholders. -7- Each independent agent must be authorized by contract to sell the Company's products in each particular state in which the agent and the Company are licensed. Some of the Company's independent agents are large general agencies with many sales persons (sub-agents), while others are individuals operating as sole proprietors. Some independent agents sell multiple lines of insurance, while others concentrate primarily or exclusively on accident and health insurance. The Company generally does not impose production quotas or assign exclusive territories to agents. The amount of insurance written for the Company by individual independent agents varies. The Company periodically reviews and terminates its agency relationships with non-producing or under-producing independent agents or agents who do not comply with the Company's guidelines and policies with respect to the sale of its products. The Company is actively engaged in recruiting and training new agents. Sub-agents are recruited by the independent agents and are licensed by the Company with the appropriate state regulatory authorities to sell the Company's policies. Independent agents are generally paid higher commissions than those employed directly by an insurance company, in part to account for the expenses of operating as an independent agent. The Company believes that the commissions it pays to independent agents are competitive with the commissions paid by other insurance companies selling similar policies. The independent agent's right to renewal commissions is vested and commissions are paid as long as the policy remains in force, provided the agent continues to abide by the terms of the contract. The Company generally permits its established independent agents to collect the initial premium with the application and remit such premium to the Company less the commission. New independent agents are required to remit the full amount of initial premium with the application. The Company provides assistance to its independent agents in connection with the processing of paperwork and other administrative services. Marketing General Agents. The Company selectively utilizes marketing general agents for the purpose of recruiting independent agents and developing networks of agents in various states. The Company has a marketing general agent for the purpose of generating business for PTLIC and Network America in various states. This marketing general agent receives an overriding commission on business written in return for recruiting, training, and motivating the independent agents. In addition, this marketing general agent functions as a general agent for PTLIC and Network America in various states. In its capacity as marketing general agent and general agent, this agent accounted for 20%, 18% and 21% of the total premiums earned by the Company during 1994, 1995 and 1996, respectively. General Agents. The ten independent general agents accounting for the most new business premium revenue accounted for approximately 27% of the Company's new business written during 1996. In 1996, no independent general agents, other than the marketing general agent discussed above, accounted for more than 10% of the Company's total premium income. No underwriting or claims processing authority has been delegated to any agents of the Company. Group and Franchise Insurance. The Company also sells a relatively small amount of group insurance. True group insurance ("Group Insurance") may be sold by the Company through the issuance of a Group Master Policy to a group formed for purposes other than the purchase of insurance, such as an employee group, an association or a professional organization. The Group Master Policy is issued to the group and all participating members are issued certificates of insurance which describe the benefits available under the policy. Eligibility for insurance is guaranteed to all members of the group without an underwriting review on an individual basis. The Company also sells franchise insurance ("Franchise Insurance") from time to time. While Franchise Insurance is generally presented to an employee group, association or professional organization which endorses the insurance, the policies are issued to individual group members. Each application is underwritten and issuance of policies is not guaranteed to members of the franchise group. The Company is currently seeking to expand its Group Insurance and Franchise Insurance business and has recently enhanced its marketing efforts towards this end. The Company's management considers these areas to offer significant opportunities for sales growth. Markets. The following chart shows premium revenues by state for each of the states where the Company does business: -8- Year Ended December 31, Year ------------------------------------- State Entered (l) 1994 1995 1996 ----- ----------- ---- ---- ---- (in thousands) Arizona 1988 $ 2,466 $ 3,603 $ 5,284 California 1992 4,585 9,379 17,403 Florida 1987 29,372 33,116 38,394 Georgia 1990 1,061 995 1,545 Illinois 1990 3,185 4,084 5,160 Iowa 1990 945 1,459 1,805 Maryland 1987 1,775 1,969 2,441 Missouri 1990 2,156 2,540 2,673 Nebraska 1990 1,101 1,222 1,538 North Carolina 1990 1,643 2,046 3,074 Ohio 1989 2,476 2,989 3,682 Pennsylvania 1972 17,628 19,680 22,056 South Dakota 1990 1,123 1,487 1,845 Texas 1990 1,851 2,887 3,550 Virginia 1989 5,570 7,903 10,532 Washington 1993 648 1,165 2,147 All Other States (2) 4,250 5,843 7,063 -------- -------- -------- All States $ 81,835 $102,367 $130,192 ======== ======== ======== - ----------- (1) Represents year in which the Company commenced sale of policies in each state. (2) Includes all states in which premiums represented one percent or less of the Company's total premiums in 1996. (d) Administration Underwriting. The Company believes that the underwriting process through which an accident and health insurance company, particularly one in the long-term care segment, chooses to accept or reject an applicant for insurance is critical to its success. All applications are reviewed by the Company's in-house underwriting department and must be approved before a policy can be issued. The Company considers age and medical history, among other factors, in deciding whether to accept an application for coverage. With respect to medical history, efforts are made to underwrite on the basis of the medical information listed on the application, but an Attending Physician's Statement is often requested. In all cases, a personal history interview is required, and a paramedic interview is often conducted. In the event the Company determines that it cannot offer the requested coverage, an alternative for suitable coverage for higher risk applicants may be suggested to the agent. Accepted policies are usually issued within seven working days from receipt of the information necessary to underwrite the application. As noted above, while there is no individual underwriting process for Group Insurance, the underwriting for Franchise Insurance written by the Company is identical to that for individual policies. In order to expedite the large volume of premiums generated from sales of policies in Florida, the increasing volume of premiums from sales of policies in California, and the specialization required in the sale and underwriting of disability coverage, the Company operates field offices in Sarasota, Florida, Stockton, California and Colchester, Vermont to underwrite and issue policies. These regional offices enable the Company to respond more effectively and efficiently to its agents and policyholders across the United States. Applicants for insurance must respond to detailed medical questionnaires. Physical examinations are not required for the Company's accident and health insurance policies, but medical records are frequently requested. Pre-existing conditions -9- disclosed on the application for new long-term nursing home care policies are covered immediately upon approval of the policy by the Company's underwriting department, while undisclosed pre-existing conditions are not covered for six months in most states and two years in certain other states. On certain of the Company's older nursing home policy forms and all home health care policies, pre-existing conditions disclosed on the application are not covered during the initial six months following the effective date of the policy and undisclosed pre-existing conditions are not covered for up to two years. In the case of individual Medicare supplement policies, pre-existing conditions are generally not covered during the six month period following the effective date of the policy. Claims. All claims for policy benefits, except with respect to Medicare supplement claims, are currently processed by the Company's claims department, which includes physicians and nurses employed or retained as consultants by the Company. From November 1, 1993 through July 31, 1994, all claims for policy benefits, including Medicare supplement claims, were processed through an unaffiliated third party administrator. In mid-1994, management decided to process all claims (except the Medicare supplement claims) through the Company's home office claims department. The Company transferred the processing of its Medicare supplement claims to a new unaffiliated third party administrator, effective March 1, 1995. The Company has historically utilized third party administrators to process its Medicare supplement claims due to the typically small amount per claim and the large number of claims. The processing of all disability claims is performed by ANIC. The Company periodically utilizes the services of unaffiliated Case Managers to review certain claims, particularly those made under home health care policies. When a claim is filed, the Company may engage the Case Manager to review the claim, including the specific health problem of the insured and the nature and extent of health care services being provided. The Case Manager assists both the Company and the insured by determining that the services provided to the insured, and the corresponding benefits paid by the Company, are appropriate under the circumstances. Under the terms of its Independent Living policy, the Company will waive the elimination period, the time at the beginning of the period during which care is provided for which no benefits are available under the policy (usually twenty days), if the insured agrees to utilize a Case Manager. The Company estimates that approximately 95% of all new home health care claims submitted in the last year have been submitted to Case Managers. The Company anticipates that this usage will continue as both its business and the need to manage effectively the processing of claims grow. Systems Operations. The Company operates and maintains its own computer system for all aspects of the Company's operations, including: policy issuance; billing; claims processing; commission reports; premium production by agent (state and product) and general ledger. During 1995, the Company commenced the installation of a new computer system, including hardware and a variety of applications software, which will enable the Company to (i) define and refine its underwriting and claims functions so that data may be analyzed more usefully, (ii) target agents and consumers more effectively and (iii) continue to manage the increasing volume of information as the Company's business grows. The Company considers an enhanced system critical to its ability to continue to provide the quality of service for which the Company has been known to its policyholders and agents. The Company is using both in-house programmers and outside consultants in installing the system, and expects portions of the new system to be fully operational during 1997. The Company will continue to utilize its current system in an enhanced mode, until a more-efficient application is installed. (e) Premiums Premium rates for all lines of insurance written by the Company are subject to state by state regulation. Premium regulations vary greatly among jurisdictions and lines of insurance. Rates for the Company's insurance policies are established by the Company's independent actuarial consultants and reviewed by the insurance regulatory authorities as part of the licensing process in the states where the Company markets its products. Before a rate change can be made, the proposed change must be filed with and approved by the insurance regulatory authorities. -10- As a result of minimum loss ratio standards imposed by state regulations, the premiums charged by the Company with respect to all of its accident and health polices are subject to reduction and/or corrective measures in the event insurance regulatory agencies in states where the Company does business determine that the Company's loss ratios either have not reached or will not reach required minimum levels. See "Business--Government Regulation". (f) Future Policy Benefits and Claims Reserves The Company is required to maintain reserves equal to the probable ultimate liability for claims and related claims expenses with respect to all policies in force. Reserves, which are computed by the Company's actuarial consultant, are established for (i) claims which have been reported but not yet paid, (ii) claims which have been incurred but not yet reported and (iii) the discounted present value of all future policy benefits less the discounted present value of expected future premiums. See Note 4 of the Notes to Consolidated Financial Statements. The amount of reserves relating to reported and unreported claims incurred is determined by periodically evaluating historical claims experience and statistical information with respect to the probable number and nature of such claims. The Company compares actual experience with estimates and adjusts its reserves on the basis of such comparisons. In addition to reserves for incurred claims, reserves are also established for future policy benefits. The policy reserve represents the discounted present value of future obligations that are likely to arise from the policies that the Company underwrites, less the discounted present value of expected future premiums on such policies. The reserve component is determined using generally accepted actuarial assumptions and methods. However, the adequacy of this reserve rests on the validity of the underlying assumptions that were used to price the Company's products; the more important of these assumptions relate to policy lapses, loss ratios and claim incidence rates. The Company's long-term care experience, most of which is based on its nursing home care products, is derived from the Company's twenty years of significant claims experience with respect to this product line, and reserves for these policies are based primarily upon this experience. The Company began offering home health care coverage in 1987, and since that time has realized a significant increase in the number of home health care policies written by the Company. The Company's claims experience with home health care coverage is more limited than is its nursing home care claims experience, and the Company's claims experience with respect to its Independent Living policy, which it first offered in November 1994, is extremely limited. The Company's claims experience to date with respect to certain of its home health care products has been characterized by a higher than expected number of claims with a longer than expected duration. Management of the Company believes that individuals may be more inclined to utilize home health care than nursing home care, which is generally a last resort to be considered only after all other possibilities have been explored. Accordingly, management believes that there is a greater potential for wide variations in claims experience in its home health care insurance than exists with respect to nursing home care insurance. The Company's actuarial consultants utilize both the Company's experience and other industry-wide data in the computation of reserves for the home health care product line. In addition, more recent long-term care products, developed as a result of regulation or market conditions, may incorporate more benefits with fewer limitations or restrictions. For instance, OBRA '90 required that Medicare supplement policies provide for guaranteed renewability and waivers of pre-existing condition coverage limitations under certain circumstances. In addition, the NAIC has recently adopted model long-term care policy language providing nonforfeiture benefits and has proposed a rate stabilization standard for long-term care policies, either or both of which may be adopted by the states in which the Company writes policies. See "Government Regulation." The fluidity in market and regulatory forces might limit the Company's ability to rely on historical claims experience for the development of new premium rates and reserve allocations. The Company employs full-time actuarial support and utilizes the services of actuarial consultants (the "Actuaries"), to price insurance products and establish reserves with respect to those products. Additionally, the actuaries assist the Company in improving the documentation of its reserve methodology, a process which has resulted in certain adjustments to the Company's reserve levels. See "Management's Discussion and Analysis of Financial Condition and Results of Operations- -11- Overview." Although management believes that the Company's reserves are adequate to cover all policy liabilities, there can be no assurance that reserves are adequate or that future claims experience will be similar to, or accurately predicted by, the Company's past or current claims experience. (g) Reinsurance As is common in the insurance industry, the Company purchases reinsurance to increase the number and size of the policies it may underwrite. Reinsurance is purchased by insurance companies to insure their liability under policies written to their insureds. By transferring, or ceding, certain amounts of premium (and the risk associated with that premium) to reinsurers, the Company can limit its exposure to risk. The Company currently reinsures any life insurance policy to the extent the risk on that policy exceeds $50,000. The Company currently reinsures its ordinary life policies through Reassurance Company of Hannover (A.M. Best rating A-). The Company also has reinsurance agreements with Life Insurance Company of North America (A.M. Best rating A+) and Transamerica Occidental Life Insurance Company (A.M. Best rating A+) to reinsure term life policies whose risk exceeds $15,000, and with Employers Reassurance Corporation (A.M. Best rating A+) to reinsure credit life policies whose risk exceeds $15,000. PTLIC and Network America have entered into a reinsurance agreement, effective in January 1994, to cede 100% of certain life, accident and health and Medicare supplement insurance policies issued by PTLIC and Network America to Life and Health Insurance Company of America ("Life and Health") (A.M. Best rating B-), an unaffiliated insurer. This arrangement, known as a "fronting" arrangement, is used when one insurer wishes to take advantage of another insurer's ability to procure and issue policies. The fronting company remains liable to the policyholder, even though all of its risk is reinsured. Because of Life and Health's A.M. Best rating, PTLIC and Network America have structured their agreement with Life and Health to require maintenance of securities in escrow for PTLIC and Network America in an amount at least equal to their statutory reserve credit. The value of these escrowed securities, which consist of U.S. government bonds, exceeded PTLIC's and Network America's related statutory and GAAP reserve credits as of December 31, 1996, which were approximately $530,000. The policies subject to this fronting arrangement are being marketed in six states to federal employees. Premium ceded under this agreement totaled $984,600, $943,500 and $882,465 in 1994, 1995 and 1996, respectively. In January 1991, Network America entered into another fronting arrangement under which Network America ceded 100% of certain whole life and deferred annuity policies to Provident Indemnity Life Insurance Company ("Provident Indemnity"), (A.M. Best rating B-), an unaffiliated insurer. No new policies have been ceded under this arrangement since December 31, 1995. As a result, Network America has structured its agreement with Provident Indemnity to require maintenance of securities in escrow for Network America in an amount at least equal to its statutory reserve credit. The value of these escrowed securities, which consist of U.S. government bonds, exceeded Network America's related statutory reserve credit as of December 31, 1996 of approximately $3,673,000, but was less than Network America's GAAP reserve credit as of December 31, 1996, which was approximately $4,825,000. The policies which are subject to this fronting agreement were intended for the funeral arrangement or "pre-need" market, and were being underwritten in 24 states (with the largest markets in California and Michigan). Total ceded life insurance in force approximated $8,018,000, $14,169,000 and $12,121,000 for 1994, 1995 and 1996, respectfully. Effective in October 1994, the Insurers entered into reinsurance agreements with Cologne Life Reinsurance Company (A.M. Best rating A+) with respect to their home health care policies with benefit periods exceeding 36 months. Under these reinsurance agreements, the Insurers are responsible for payment of claims during the first 36 months of the benefit period, and the reinsurer will reimburse the Insurers for 100% of all claims paid after such 36 month period. Total reserve credits taken related to this agreement as of December 31, 1996 were approximately $859,000. In May 1991, Network America acquired a block of long-term care business under an assumption reinsurance agreement with Providentmutual Life and Annuity Company of America (formerly known as Washington Square Life Insurance Company), an unaffiliated insurance company. Network America assumed the obligations as insurer for all policies in force as of that date. Network America received cash totaling $1,512,300, net of $513,500 as consideration for the sale. Under this agreement, Network America assumed a reinsurance treaty under which 66% of the premiums assumed are, in turn, ceded by Network America to a third party reinsurer. The total accident and health premiums ceded under this treaty amounted to $1,287,502 in 1994, $1,174,792 in 1995 and $1,081,380 in 1996. -12- On December 28, 1990, Network America entered into a reinsurance agreement with Midland Mutual Life Insurance Company (A.M. Best rating A-) under which Network America acquired approximately 3,100 nursing home policies in 22 states with an annualized premium of approximately $3,000,000. The Company recognized $1,886,790 of premium related to this acquisition in 1994, $1,768,467 in 1995 and $1,661,725 in 1996. In the event a reinsurance company becomes insolvent or otherwise fails to honor its obligations to the Company under any of its reinsurance agreements, the Company would remain fully liable to the policyholder. ANIC reinsures approximately $500,000 of premium with three Vermont licensed companies. For a discussion of the amounts reinsured by the Company, see Note 11 of the Notes to Consolidated Financial Statements. For a discussion of A.M. Best ratings, see "A. M. Best Ratings and Standard & Poor's Ratings." (h) Investments The Company invests in securities and other investments authorized by applicable state laws and regulations and follows an investment policy designed to maximize yield to the extent consistent with liquidity requirements and preservation of assets. Investments are managed by James M. Davidson & Company of Wayne, Pennsylvania and First Union National Bank of Charlotte, North Carolina. Over the past five years, the Company has been able to meet its liabilities through operations and has not had to utilize any of its investment assets. The following table shows the composition of the debt securities investment portfolio (at carrying value), excluding short-term investments, by rating as of December 31, 1996. December 31, 1996 ----------------- Rating (1) Amount Percent -------- -------- (in thousands) U.S. Treasury and U.S. Agency securities $150,196 74.6% Aaa or AAA 31,193 15.9% Aa or AA 13,889 6.9% A 4,197 2.1% Other 1,085 0.5% -------- -------- Total $201,330 100.0% ======== ======== As of December 31, 1996, over 94.7% of the Company's total investments were fixed income debt securities, 74.6% of which were securities of the United States Government (or its agencies or instrumentalities). The balance of the Company's investment portfolio consisted principally of publicly traded equity securities. As of December 31, 1996, all of the Company's bond investment portfolio consisted of investment grade securities, with substantially 100% rated "A" or better by either Moody's Debt Rating Service or Standard and Poor's Corporation. The Company's investment policy is to purchase only U.S. Treasury securities, U.S. agency securities and investment-grade municipal and corporate securities primarily with an "A" or higher rating with the highest yield to maturity available, and to have 7% to 10% of the Company's bond investment portfolio mature each year. The Company generally buys investments maturing within two to twelve years of the date of the purchase. At December 31, 1996, the average maturity of the Company's bond investment portfolio was 5.8 years and the Company's investment portfolio contained no collateralized mortgage obligations or investments in real estate. The Company has historically limited its investments in equity securities. In 1996, the Company expanded its common stock investments slightly to approximately 5.3% of its total investments. The Company intends to limit its common stock investments to 8.0% of its total investments. For additional information regarding the Company's investments, see Note 3 of the Notes to Consolidated Financial Statements. The following table sets forth for the periods indicated certain information concerning investment income. -13- Investment Portfolio 1994 1995 1996 ---- ---- ---- Year Ended December 31, ----------------------- (Dollar amounts in thousands) Average balance of investments, cash and cash equivalents during the period (1) $ 91,823 $ 125,524 $174,422 Net investment income 5,946 8,103 10,882 Average yield on investments 6.5% 6.5% 6.3% - ---------- (1) Valued at amortized cost except for common stock which is carried at market value. (i) Selected Financial Information: Statutory Basis The following table shows certain ratios derived from the Company's insurance regulatory filings with respect to the Company's accident and health policies presented in accordance with accounting principles prescribed or permitted by insurance regulatory authorities ("SAP"), which differ from the presentation under Generally Accepted Accounting Principles ("GAAP") and which also differ from the presentation under SAP for purposes of demonstrating compliance with statutorily mandated loss ratios. See Item 1, "Business--Government Regulation". Year ended December 31, ----------------------- 1994 1995 1996 ---- ---- ---- Loss ratio (1) 59.0% 56.1% 61.5% Expense ratio (2) 46.9 50.4 48.7 ------ ------ ------ Combined loss and expense ratio 105.9 106.5 110.2 Persistency (3) 75.4 77.4 79.9 - --------------- (1) Loss ratio is defined as incurred claims and increases in policy reserves divided by earned premiums. (2) Expense ratio is defined as commissions and expenses incurred divided by earned premiums. (3) Persistency represents the percentage of premiums renewed, which the Company calculates by dividing the total annual premiums at the end of each year (less first year business for that year) by the total annual premiums in force for the prior year. For purposes of this calculation, a decrease in total annual premiums in force at the end of any year would be a result of non-renewal policies, including those policies that have terminated by reason of death, lapse due to nonpayment of premiums, and/or conversion to other policies offered by the Company. The Company's loss ratio rose in 1995 and continued to rise in 1996 from the prior year's level due in part to a mandated change in reserving method wherein underwriters of long-term care products were required by the Pennsylvania Insurance Department, commencing in October 1994, to use the one-year preliminary term reserve method, instead of the two-year preliminary term method previously permitted. This change had the effect of requiring companies to establish a full annual reserve for a policy commencing at the end of the first policy year, instead of at the end of the second policy year. The increase in the persistency rate in 1996 and 1995, signifying a greater percentage of policy renewals, also caused the loss ratio to increase. This is due to the fact that as policies age, the reserves associated with such policies must be increased. Under SAP, costs associated with sales of new policies must be charged to earnings as incurred. Because these costs, together with required reserves, generally exceed first year premiums, statutory surplus may be reduced during periods of increasing first year sales. Through November 1994, the Company was able to expand its business from accumulation of statutory retained earnings and from proceeds received from the Company's Common Stock offering completed in December, 1989. In December 1994, PTLIC's capital position was strengthened by a $4,000,000 contribution from the Company. The -14- capital position of the Insurers was improved further by the contribution of $14,000,000 of the net proceeds of the 1995 public offering to the capital and surplus of the Insurers during the third quarter of 1995. In October 1996, the Company contributed an additional $5,000,000 of the offering proceeds to Network America. In December 1996, the Company contributed $20,000,000, $20,000,000 and $5,000,000 to the capital and surplus of PTLIC, Network America, and ANIC, respectively, from the proceeds of its $74,750,000 convertible subordinated debt offering in November 1996. Mandated loss ratios are calculated in a manner which provides adequate reserving for the long-term care insurance risks, using statutory lapse rates and certain assumed interest rates. The statutorily assumed interest rates differ from those used in developing reserves under GAAP. For this reason, statutory loss ratios differ from loss ratios reported under GAAP. Mandatory statutory loss ratios also differ from loss ratios reported on a current basis under SAP for purposes of the Company's annual and quarterly state insurance filings. The states in which the Company is licensed have the authority to change these minimum ratios and to change the manner in which these ratios are computed and the manner in which compliance with these ratios is measured and enforced. The Company is unable to predict the impact of (i) the imposition of any changes in the mandatory statutory loss ratios for individual or group long-term care policies to which the Company may become subject, (ii) any changes in the minimum loss ratios for individual or group long-term care or Medicare supplement policies, or (iii) any change in the manner in which these minimums are computed or enforced in the future. The Company has not been informed by any state that it does not meet mandated minimums, and the Company believes it is in compliance with all such minimum ratios. In the event the Company is not in compliance with minimum statutory loss ratios mandated by regulatory authorities with respect to certain policies, the Company may be required to reduce or refund its premiums on such policies. (j) A.M. Best's Rating and Standard & Poor's Rating The Insurers rating with A.M. Best is "B++ (very good)." A.M. Best's ratings are based on a comparative analysis of the financial condition and operating performance for the prior year of the companies rated, as determined by their publicly available reports. A.M. Best's classifications are A++ and A+ (superior), A and A- (excellent), B++ and B+ (very good), B and B-(good), C++ and C+ (fair), and C and C- (marginal), D (below minimum standards), E (under state supervision) and F (in liquidation). A.M. Best's ratings are based upon factors of concern to policyholders and insurance agents and are not directed toward the protection of investors. In evaluating a company's financial and operating performance, the rating agencies review the company's profitability, leverage and liquidity as well as the company's book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its reserves and the experience and competency of its management. PTLIC and Network America also have a Standard & Poor's claims paying ability rating of "A- (good)," which falls within the most secure range (AAA to BBB). ANIC is not rated by Standard & Poor's. (k) Competition The Company operates in a highly competitive industry. Many of its competitors have considerably greater financial resources, higher ratings from A.M. Best and larger networks of agents than the Company. Many insurers offer long-term care policies similar to those offered by the Company and utilize similar marketing techniques. The Company actively competes with these insurers in attracting and retaining agents by offering competitive products and commission rates and quality underwriting, claims service and policyholder service. (l) Government Regulation Insurance companies are subject to supervision and regulation in all states in which they transact business. The Company is registered and approved as a holding company under the Pennsylvania Insurance Code. PTLIC and Network America are chartered and licensed in Pennsylvania as stock life insurance companies. ANIC is chartered and licensed in Vermont as a stock accident and health insurance company. On a combined basis with its direct and indirect insurance subsidiaries, the Company is currently licensed in all states except New York. The extent of regulation of insurance companies varies, but generally derives from state statutes which delegate regulatory, supervisory and administrative authority to state insurance departments. Although many states' insurance laws and -15- regulations are based on models developed by the NAIC and are therefore similar, variations among the laws and regulations of different states are common. The NAIC is a voluntary association of all of the state insurance commissioners in the United States. The primary function of the NAIC is to develop model laws on key insurance regulatory issues which can be used as guidelines for individual states in adopting or enacting insurance legislation. While the NAIC model laws are accorded substantial deference within the insurance industry, these laws are not binding on insurance companies unless adopted by the state, and variations from the model laws within the states is common. The Pennsylvania Department, the Vermont Department of Banking, Insurance, Securities and Health Care Administration (the "Vermont Department") and insurance regulatory authorities in other jurisdictions, have broad administrative and enforcement powers relating to the granting, suspending and revoking of licenses to transact insurance business, the licensing of agents, the regulation of premium rates and trade practices, the content of advertising material, the form and content of insurance policies and financial statements and the nature of permitted investments. In addition, regulators have the power to require insurance companies to maintain certain deposits, capital, surplus and reserve levels calculated in accordance with prescribed statutory standards. The Company believes that its deposit, capital, surplus and reserve levels currently meet or exceed all applicable regulatory requirements. The primary purpose of such supervision and regulation is the protection of policyholders, not investors. The Company also is subject to the insurance holding company laws of Pennsylvania and of the other states in which it is licensed to do business. These laws generally require insurance holding companies and their subsidiary insurers to register and file certain reports, including information concerning their capital structure, ownership, financial condition and general business operations. Further, states often require prior regulatory approval of changes in control of an insurer and of intercorporate transfers of assets within the holding company structure. The purchase of more than 10% of the outstanding shares of Common Stock by one or more parties acting in concert requires the prior approval of the Pennsylvania and Vermont Departments, and may subject such party or parties to the reporting requirements of the insurance laws and regulations of Pennsylvania and Vermont and to the prior approval and/or reporting requirements of other jurisdictions in which the Company is licensed. In addition, officers, directors and 10% shareholders of insurance companies, such as the Insurers, are subject to the reporting requirements of the insurance laws and regulations of Pennsylvania and Vermont, as the case may be, and may be subject to the prior approval and/or reporting requirements of other jurisdictions in which the Company is licensed. Under Pennsylvania law, lending institutions, public utilities, bank holding companies, savings and loan companies, and their affiliates, subsidiaries, officers and employees may not be licensed or admitted as insurers. If any of the foregoing entities or individuals (or any such entity and its affiliates, subsidiaries, officers and employees in the aggregate) acquires 5% or more of the outstanding shares of Common Stock, such party may be deemed to be an affiliate, in which event the Company's Certificate of Authority to do business in Pennsylvania may be revoked upon a determination by the Department that such party exercises effective control over the Company. As part of their routine regulatory, oversight process state insurance regulators periodically conduct detailed examinations of the books, records and operations of insurers. During 1995, the Pennsylvania Department completed its examination of PTLIC and Network America for the five year period ended December 31, 1994 and had no recommendations for either PTLIC or Network America. During 1995, the Vermont Department completed its examination of ANIC for the three year period ended December 31, 1994 and had no material recommendations. In addition to conducting these examinations, state insurance regulatory authorities from time to time also conduct separate market conduct examinations. These examinations focus on an insurer's claims practices, policyholder complaints, policy forms, advertising practices and other marketing aspects. In recent years, there has been considerable legislative and regulatory activity, at both the state and federal levels, with regard to long-term care and Medicare supplement insurance. There is extensive federal and state regulation applicable to the form and content of Medicare supplement policies, including requirements for specified minimum benefits and loss ratios and requirements relating to agent compensation and the sales practices of agents and companies. For example, Pennsylvania, which had previously enacted regulations governing Medicare supplement insurance, recently promulgated regulations -16- governing long-term care insurance. These regulations are effective for policies written on or after February 8, 1995, and impact, affect and/or regulate areas including permissible policy practices and provisions, lapse provisions, required disclosure provisions, post-claims underwriting, minimum standards for home health and community care benefits, inflation protection provisions, application forms and replacement coverage, reporting requirements, reserve standards, loss ratios, filings for out-of-state group policies, marketing standards, agent recommendations, pre-existing condition limitations, coverage outlines, allowable shoppers guides and permitted compensation arrangements. Most states mandate minimum benefit standards and loss ratios for long-term care insurance policies and for other accident and health insurance policies. Most states have adopted the NAIC's proposed standard minimum loss ratios of 65% for individual Medicare supplement policies and 75% for group Medicare supplement policies. A significant number of states, including Pennsylvania and Florida, also have adopted the NAIC's proposed minimum loss ratio of 60% for both individual and group long-term care insurance policies. The states in which the Company is licensed have the authority to change these minimum ratios, the manner in which these ratios are computed and the manner in which compliance with these ratios is measured and enforced. The Department is provided, on an annual basis, with a calculation prepared by the Company's independent consulting actuary regarding compliance with required minimum loss ratios for Medicare supplement and credit policies. This report is made available to all states. Although certain other policies (e.g., nursing home and hospital care policies) also have specific mandated loss ratio standards, at the present there typically are no similar reporting requirements in the states in which the Company does business for such other policies. The NAIC has developed minimum capital and surplus requirements utilizing certain risk-based factors associated with various types of assets, credit, underwriting and other business risks. The Company did not experience any problems meeting these requirements when they took effect in 1994. As of December 31, 1996, the risk-based capital of PTLIC, Network America and ANIC were 900% , 1,082%, and 767% respectively, of authorized control level capital. In December 1986, the NAIC adopted the Long-Term Care Insurance Model Act (the "Model Act"), which was adopted to promote the availability of long-term care insurance policies, to protect applicants for such insurance and to facilitate flexibility and innovation in the development of long-term care coverage. The Model Act establishes standards for long-term care insurance, including provisions relating to disclosure and performance standards for long-term care insurers, incontestability periods, nonforfeiture benefits, severability, penalties and administrative procedures. Model regulations were also developed by the NAIC to implement the Model Act. Some states have also adopted standards relating to agent compensation for long-term care insurance. In addition, from time to time, the federal government has considered adopting standards for long-term care insurance policies, but has not enacted any such legislation to date. States also restrict the dividends the Company's insurance subsidiaries are permitted to pay. Dividend payments will depend on profits arising from the business of the Insurers, computed according to statutory formulae. In addition, Pennsylvania law requires PTLIC and Network America to furnish the Pennsylvania Department 30 days advance notice of any planned extraordinary dividend (any dividend paid within any twelve-month period which exceeds the greater of (i) 10% of its surplus as shown in its most recent annual statement filed with the Pennsylvania Department or (ii) its net gain from operations, after policyholder dividends and federal income taxes and before realized gains or losses, shown in such statement) and the Pennsylvania Department may refuse to allow it to pay such extraordinary dividends. Under Vermont insurance law, ANIC is also required to furnish 30 days advance written notice of an extraordinary dividend to the Vermont Department which may disapprove the dividend. Vermont law defines an extraordinary dividend as a dividend in excess of the lesser of (i) the net earnings of the company during the preceding calendar year plus net income not paid out as dividends during the prior two calendar years and (ii) 10% of the capital surplus of the company, determined as of the immediately preceding December 31. OBRA '90 enacted various changes in Medicare reimbursement and set new standards for Medicare supplement insurance policies. Among the changes in reimbursement are (i) an increase in the premium paid by participants under Part B and (ii) an extension until September 30, 1995 of the authority of the Medicare program to use data provided by the Social Security Administration and the Internal Revenue Service to improve collection in Medicare secondary payor cases. Among -17- the new standards for Medicare supplement insurance policies are those requiring (i) guaranteed renewability, (ii) mandatory state reporting on the implementation and enforcement of Medicare supplement policy standards, (iii) the obtaining of statements by insurers from purchasers as to whether they are already covered by another Medicare supplement policy or by Medicaid and (iv) a waiver of pre-existing condition coverage limitations for policies that replace existing policies. During 1993, the NAIC adopted model language that requires long-term care policies to include a nonforfeiture benefit. The mandated inclusion of a nonforfeiture benefit is intended to protect policyholders against the lapse (or cancellation) of policies without some value returning to the policyholder. Issuers of long-term care insurance policies are subject to a tax if they fail to meet certain requirements set forth in the long-term care insurance model regulations and the long-term care insurance model act as promulgated by the NAIC (January 1993). The amount of the tax is $100 per insured for each day any of the requirements are not met with respect to each qualified long-term care insurance contract. During 1994, the NAIC adopted a standard calling for "rate stabilization" of long-term care policies. Some states, such as Florida, have adopted regulations which require long-term care policies to include nonforfeiture provisions. Other states, such as California, have adopted regulations which require long-term care policies to include provisions allowing insureds to obtain protection against the effects of inflation. Adoption of nonforfeiture benefits would increase the price of long-term care policies, while rate stabilization provisions limit the Company's ability to adjust to adverse loss experiences. In September 1996, Congress enacted the Health Insurance Portability and Accountability Act of 1996 ("the Act") which permits premiums paid for eligible long-term care insurance policies after December 31, 1996 to be treated as deductible medical expenses. The deduction is limited to a specified dollar amount ranging from $200 to $2,500, with the amount of the deduction increasing with the age of the taxpayer. In order to qualify for the deduction the insurance contract must, among other things, provide for (i) limitations on pre-existing condition exclusions, (ii) prohibitions on excluding individuals from coverage based on health status, and (iii) guaranteed renewability of health insurance coverage. Although the Company intends to offer tax deductible policies, it will continue to offer a variety of non-deductible policies as well. The Company has filed long-term care policies which qualify for tax exemption under the Act in all states in which it is licensed. From time to time, the federal government has considered adopting a national health insurance program. Although it does not appear that the federal government will enact an omnibus health care reform law in the near future, the passage of such a program could have a material impact upon the Company's operations. In addition, legislation currently pending in Congress could impact the Company's business. Among the proposals are the implementation of certain minimum consumer protection standards for inclusion in all long-term care policies, including guaranteed renewability, protection against inflation and limitations on waiting periods for pre-existing conditions. These proposals would also prohibit "high pressure" sales tactics in connection with long-term care insurance and would guarantee consumers access to information regarding insurers, including lapse and replacement rates for policies and the percentage of claims denied. Other pending legislation would permit premiums paid for long-term care insurance to be treated as deductible medical expenses, with the amount of the deduction increasing with the age of the taxpayer. As with any pending legislation, it is possible that any laws finally enacted will be substantially different than the current proposals. Accordingly, the Company is unable to predict the impact of any such legislation on its business and operations. (m) Employees As of December 31, 1996, the Company had approximately 235 full-time employees (not including independent agents), 148 of whom are employed in the Company's home office. Of those employees in the Company's home office, 31 are employed in various administrative services, 21 in sales, 31 in underwriting, 17 in accounting, 7 in compliance, 21 in claims, 16 in an executive capacity, and 4 in systems. The Company had approximately 32 full-time employees employed in the Florida field office as of December 31, 1996. Of the Florida employees, 24 are employed in underwriting and administrative services and 8 are employed in marketing. As of December 31, 1996, the Company has 20 employees in its California office and has 35 employees in its Vermont office. The Company is not a party to any collective bargaining agreements and believes that its relationship with its employees is good. Item 2. Properties -18- The Company's principal offices in Allentown, Pennsylvania, occupy approximately 25,500 square feet of office space in a 40,000 square foot building, owned by the Company. The Company also leases additional office space in Florida and California, and owns office space in Vermont. The Company owns a 2.42 acre parcel of land and a warehouse, both located across the street from its home office for future use. Item 3. Legal Proceedings The Insurers are parties to various lawsuits generally arising in the normal course of business. The Company does not believe that the eventual outcome of any such suit will have a material effect on its financial condition or results of operations. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted during the fourth quarter of the fiscal year ended December 31, 1996 to a vote of security holders. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Common Stock of the Company is traded in the over-the-counter market and is included on the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation System ("NASDAQ") under the symbol PTAC. Until March 24, 1997, the transfer agent and registrar for the Company's Common Stock is Registrar and Transfer Company of Cranford, New Jersey. Effective March 24, 1997, First Union National Bank of Charlotte, North Carolina will become the transfer agent and registrar for the Company's Common Stock. As of March 19, 1997 the Company had 7,518,080 shares of Common Stock outstanding, held by approximately 430 stockholders of record. This latter number was derived from the Company's shareholder records, and does not include beneficial owners of the Company's Common Stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers, and other fiduciaries. The range of high and low sale prices, as reported by NASDAQ, for the Company's Common Stock for the periods indicated below, is as follows: High Low ---- --- 1995 First Quarter 12 1/8 9 3/4 Second Quarter 13 11 3/8 Third Quarter 14 3/4 11 7/8 Fourth Quarter 16 1/2 13 1996 First Quarter 19 15 1/4 Second Quarter 21 1/2 18 1/2 Third Quarter 24 3/4 17 Fourth Quarter 26 22 1/2 -19- The Company has never paid any cash dividends on its Common Stock and does not intend to do so in the foreseeable future. It is the present intention of the Company to retain any future earnings to support the continued growth of the Company's business. Any future payment of dividends by the Company is subject to the discretion of the Board of Directors and is dependent, in part, on any dividends it may receive as the sole shareholder of PTLIC, ANIC and the Agency, and which PTLIC may in turn receive as the sole shareholder of Network America. The payment of dividends by PTLIC, ANIC and Network America, respectively, is in turn dependent on a number of factors, including their respective earnings and financial condition, business needs and capital and surplus requirements, and is also subject to certain regulatory restrictions and the effect that such payment would have on their ratings by A.M. Best Company. See Item 1, "Business--A.M. Best's Rating and Standard & Poor's Rating" and Item 1, "Business--Government Regulation". -20- Item 6. Selected Financial Data The following selected consolidated statement of operations data and balance sheet data of the Company as of and for the years ended December 31, 1992, 1993, 1994, 1995 and 1996, have been derived from the Consolidated GAAP Financial Statements of the Company, which have been audited by Coopers and Lybrand L.L.P., independent accountants.
Year Ended December 31, -------------------------------------------------------------------------- 1992 (1) 1993 1994 1995 1996 ---------- ---------- ---------- ---------- ---------- (in thousands, except per share data and ratios) Statement of Operations Data: Revenues: Accident and health: First year premiums $ 22,477 $ 25,836 $ 26,968 $ 36,770 $ 46,346 Renewal premiums 37,507 43,615 52,237 62,402 80,311 Life: First year premiums 4 361 2,149 1,701 1,457 Renewal premiums 248 169 481 1,494 2,077 ---------- ---------- ---------- ---------- ---------- Total premiums 60,236 69,981 81,835 102,367 130,192 Investment income, net 4,398 4,979 5,946 8,103 10,982 Net realized gains (losses) 173 182 8 46 20 Other income 371 321 305 347 342 ---------- ---------- ---------- ---------- ---------- Total revenues 65,178 75,463 88,094 110,863 141,536 Benefits and expenses: Benefits to policyholders 34,285 40,829 48,757 64,879 83,993 First year commissions 14,282 16,722 19,365 26,223 30,772 Renewal commissions 6,004 7,060 7,866 10,128 12,533 Net policy acquisition costs deferred (2) (5,832) (6,640) (7,643) (15,303) (19,043) General and administrative expense 8,511 9,350 10,262 12,171 15,648 Interest expense 192 184 162 327 625 ---------- ---------- ---------- ---------- ---------- Total benefits and expenses 57,442 67,505 78,769 98,425 124,529 ---------- ---------- ---------- ---------- ---------- Income before federal income taxes 7,736 7,958 9,325 12,438 17,007 Provision for federal income taxes 2,436 2,137 2,562 3,609 4,847 ---------- ---------- ---------- ---------- ---------- Net income $ 5,300 $ 5,821 $ 6,763 $ 8,829 $ 12,160 ========== ========== ========== ========== ========== Net income per share (3) $ 1.12 $ 1.24 $ 1.45 $ 1.53 $ 1.70 ========== ========== ========== ========== ========== Fully diluted net income per share -- -- -- -- $ 1.64 Weighted average shares outstanding 4,732 4,689 4,669 5,772 7,165 Fully diluted shares outstanding -- -- -- -- 7,608 GAAP Ratios: Loss ratios 56.9% 58.3% 59.5% 63.4% 64.5% Expense ratio 38.4 38.1 36.7 32.8 31.1 ---------- ---------- ---------- ---------- ---------- Total 95.3% 96.4% 96.2% 96.2% 95.6% Selected Statutory Data: Net premiums written $ 60,385 $ 69,898 $ 81,878 $ 102,145 $ 133,950 Statutory surplus (beginning of period) $ 10,688 $ 12,301 $ 17,256 $ 21,067 $ 38,148 Ratio of net premiums written to statutory surplus 5.6x 5.7x 4.7x 4.8x 3.5x Balance Sheet Data: Total investments $ 60,685 $ 77,981 $ 91,490 $ 144,928 $ 212,662 Total assets 115,699 136,948 164,346 237,744 386,768 Total debt 2,625 2,516 6,372 2,206 77,115 Total liabilities 69,327 85,599 108,903 140,637 267,861 Shareholders' equity (4) 46,070 51,349 55,444 97,107 118,907 Book value per share (3)(4) $ 9.72 $ 11.00 $ 11.87 $ 13.93 $ 15.83
- ------------------------ -21- (1) Restated to reflect adoption of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," as of January 1, 1990. The effect of adoption is as follows: 1992 ---- Net income (reduction) $ (116,000) Net income per share (reduction) $ (.02) (2) For a discussion of policy acquisition costs, see "Management's Discussion and Analysis of Financial Condition and Results of Operations". (3) Adjusted to give effect to a 50% stock dividend on the Common Stock declared on April 19, 1995, payable to shareholders of record on May 3, 1995 and distributed on May 15, 1995. (4) The Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," on January 1, 1994. The cumulative effect of this adoption was an increase on January 1, 1994 in shareholders' equity of $3,529,000 to reflect the net unrealized gain (net of $1,512,000 in deferred income taxes) on investment securities classified as available for sale. As of December 31, 1995, shareholders' equity was increased by $4,056,000 due to unrealized gains of $6,146,000 in the Company's investment portfolio. As of December 31, 1996, shareholders' equity was increased by $2,261,000 due to unrealized gains of $3,426,000 in the Company's investment portfolio. These increases were caused primarily by decreases in interest rates since the date of purchase of the debt securities in the Company's portfolio. -22- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table sets forth the components of the Company's condensed statements of operations for the years ended December 31, 1994, 1995 and 1996, expressed as a percentage of total revenues.
Year Ended December 31, ------------------------------ 1994 1995 1996 ------ ------ ------ Statement of Operations Data: Revenues: Accident and health: First year premiums 30.6% 33.2% 32.7% Renewal premiums 59.3% 56.3% 56.7% Life: First year premiums 2.4% 1.5% 1.0% Renewal premiums 0.5% 1.3% 1.5% ------ ------ ------ Total premiums 92.9% 92.3% 92.0% Investment income, net 6.7% 7.3% 7.8% Net realized gains (losses) 0.0% 0.1% 0.0% Other income 0.3% 0.3% 0.2% ------ ------ ------ Total revenues 100.0% 100.0% 100.0% Benefits and expenses: Benefits to policyholders 55.3% 58.5% 59.3% First year commissions 22.0% 23.7% 21.7% Renewal commissions 8.9% 9.1% 8.9% Net policy acquisition costs deferred (8.7%) (13.8%) (13.5%) General and administrative expense 11.6% 11.0% 11.1% Interest expense 0.2% 0.3% 0.4% ------ ------ ------ Total benefits and expenses 89.4% 88.8% 87.9% ------ ------ ------ Income before federal income taxes 10.6% 11.2% 12.0% Provision for federal income taxes 2.9% 3.2% 3.4% ------ ------ ------ Net income 7.7% 8.0% 8.6% ====== ====== ======
-23- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The Company develops and markets insurance products primarily designed for individuals age 65 and over. The Company's principal products are individual fixed, defined benefit accident and health insurance policies which consist of nursing home care, home health care, Medicare supplement and long-term disability insurance. The Company's underwriting practices rely upon the base of experience which it has developed over twenty years of providing nursing home care insurance, as well as upon available industry and actuarial information. As the home health care market has developed, the Company has encouraged the purchase of both nursing home care and home health care coverage, and has introduced new life insurance products as well, thus providing policyholders with enhanced protection while broadening the Company's policy base. In late 1994, the Company introduced its Independent Living policy which provides coverage over the full term of the policy for services furnished by a homemaker or companion who is not a qualified or licensed care provider. Long-term nursing home care and home health care policies accounted for approximately 90% of the Company's total annualized premiums in force as of December 31, 1996 and approximately 86% of its consolidated revenues for 1996. The Company and its insurance subsidiaries are subject to the insurance laws and regulations of each state in which they are licensed to write insurance. These laws and regulations govern matters such as payment of dividends, settlement of claims and loss ratios. Premiums charged for insurance products must be approved by state regulatory authorities. In addition, the Company and its insurance subsidiaries are required to establish and maintain reserves with respect to reported and incurred but not reported losses, as well as estimated future benefits payable under the Company's insurance policies. These reserves must, at a minimum, comply with mandated standards. The Company's results of operations are affected significantly by the following factors: Level of required reserves for policies in force. The amount of reserves relating to reported and unreported claims incurred is determined by periodically evaluating historical claims experience and statistical information with respect to the probable number and nature of such claims. Claim reserves reflect actual experience through the most recent time period and policy reserves reflect expectations of claims related to a block of business over its entire life. The Company compares actual experience with estimates and adjusts its reserves on the basis of such comparisons. Revisions to reserves are reflected in the Company's results of operations through benefits to policyholders expense. Policy premium levels. The Company attempts to set premium levels to ensure profitability, subject to the constraints of competitive market conditions and state regulatory approvals. Deferred acquisition costs. In connection with the sale of its insurance policies, the Company defers and amortizes a portion of the policy acquisition costs over the related premium paying periods of the life of the policy. These costs include all expenses directly related to the acquisition of the policy, including commissions, underwriting and other policy issue expenses. The amortization of deferred acquisition costs is determined using the same projected actuarial assumptions used in computing policy reserves. Deferred acquisition costs can be affected by unanticipated termination of policies because, upon such unanticipated termination, the Company is required to expense fully the deferred acquisition costs associated with the terminated policy. The number of years a policy has been in effect. Claims costs tend to be higher on policies which have been in force for a longer period of time. As the policy ages, it is more likely that the insured will have need for services covered by the policy. On the other hand, the longer the policy is in effect, the more premium the Company will receive. Investment income. The Company's investment portfolio consists primarily of high-grade fixed income securities. Income generated from this portfolio is largely dependent upon prevailing levels of interest rates. As of December 31, 1996, approximately 5.3% of the Company's investment portfolio was committed to high quality large capitalization common stocks. Due to the longevity of the Company's investment portfolio duration (approximately 4 years), investment interest income does not immediately reflect changes in market interest rates. However, the Company is susceptible to changes in market rates when cash flows from maturing investments are reinvested at prevailing market rates. -24- Other factors which affect the Company's results of operations are lapsation and persistency, both of which relate to the renewal of insurance policies, and first year compared to renewal premiums. Lapsation is the termination of a policy by nonrenewal and, pursuant to the Company's policy, is automatic if and when premiums become more than 31 days overdue; however, policies may be reinstated, if approved by the Company, within six months after the policy lapses. Persistency represents the percentage of premiums renewed, which the Company calculates by dividing the total annual premiums at the end of each year (less first year business for that year) by the total annual premiums in force for the prior year. For purposes of this calculation, a decrease in total annual premiums in force at the end of any year would be a result of non-renewal of policies, including those policies that have terminated by reason of death, lapse due to nonpayment of premiums, and/or conversion to other policies offered by the Company. First year premiums are premiums covering the first twelve months a policy is in force. Renewal premiums are premiums covering all subsequent periods. -25- Results of Operations Quarterly Data The unaudited quarterly data for the Company for each quarter of 1995 and 1996 have been derived from unaudited financial statements and include all adjustments, consisting only of normal recurring accruals, which the Company considers necessary for a fair presentation of the results of operations for these periods. Such quarterly operating results are not necessarily indicative of the Company's future results of operations. The following table presents unaudited quarterly data for the Company for each quarter of 1995 and 1996.
1995 ------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (in thousands, except per share data and ratios) Accident and health premiums $ 22,562 $ 24,895 $ 25,509 $ 26,205 Life premiums 846 795 746 807 Total premiums 23,408 25,691 26,256 27,013 Investment income, net 1,683 1,807 2,177 2,436 Net realized capital gains and losses and other income 74 71 128 121 Total revenues 25,165 27,568 28,561 29,570 Benefits to policyholders 14,699 16,412 16,387 17,381 Commissions & expenses 10,117 12,448 12,295 13,663 Net policy acquisition costs deferred (2,425) (4,200) (3,509) (5,169) Net income $ 1,842 $ 1,963 $ 2,343 $ 2,681 Net income per share (primary) $ 0.39 $ 0.42 $ 0.35 $ 0.37 GAAP loss ratio 62.8% 63.9% 62.4% 64.3% GAAP expense ratio 33.4 32.5 33.6 31.6 Total 96.2% 96.4% 96.0% 95.9% 1996 ------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (in thousands, except per share data and ratios) Accident and health premiums $ 29,524 $ 31,344 $ 31,511 $ 34,279 Life premiums 946 866 874 848 Total premiums 30,470 32,210 32,385 35,127 Investment income, net 2,386 2,505 2,602 3,489 Net realized capital gains and losses and other income 137 137 88 0 Total revenues 32,993 34,853 35,075 38,616 Benefits to policyholders 19,787 21,832 20,161 22,213 Commissions & expenses 13,493 14,171 14,509 16,780 Net policy acquisition costs deferred (4,170) (5,303) (4,054) (5,516) Net income $ 2,693 $ 2,883 $ 3,098 $ 3,487 Net income per share (primary) $ 0.39 $ 0.41 $ 0.43 $ 0.46 GAAP loss ratio 64.9% 67.8% 62.3% 63.2% GAAP expense ratio 30.7 27.6 32.4 33.5 Total 95.6% 95.4% 94.7% 96.7%
-26- Twelve Months Ended December 31, 1996 and 1995 Accident and Health Premiums. First year accident and health premiums earned by the Company, excluding the contribution of ANIC, in the twelve month period ended December 31, 1996, increased 19.9% to $44,071,649, compared to $36,769,835 in 1995. First year long-term care premiums in 1996 increased 19.1% to $43,478,707, compared to $36,507,436 in 1995. This increase was primarily attributable to increased sales of home health care policies, which increased to $19,866,692 for 1996 from $14,560,437 for 1995. Premiums from sales of nursing home care policies increased from $21,946,999 in 1995 to $23,612,015 in 1996. Management believes that the increase in the sale of home health care policies reflects the continued growth in the home health care market. Management further believes that the lower increase in the sale of nursing home policies primarily resulted from nursing home policies increasingly being sold as riders to home care policies as opposed to separate stand-alone policies. First year Medicare supplement premiums earned by the Company in 1996 increased to $592,083 from $262,399 in 1995. The Company places reduced emphasis upon this product due to reduced profitability caused by regulation. Renewal accident and health premiums earned by the Company in 1996 increased 28.7% to $80,311,319, compared to $62,402,068 in 1995. Renewal long-term care premiums in 1996 increased 30.4% to $77,734,271, compared to $59,624,488 in 1995. This increase reflects higher persistency and growth of in-force premiums. Renewal Medicare supplement premiums earned by the Company in 1996 decreased 7.2% to $2,577,048, compared to $2,777,580 in 1995. This trend is consistent with the Company's decision not to actively pursue Medicare supplement business. In addition, ANIC, which the Company acquired on August 30, 1996, generated accident and health premiums, comprised primarily of long-term disability coverage, of $2,274,442 during 1996. Life Premiums. First year life premiums earned by the Company decreased 14.3% to $1,457,044, in 1996, compared to $1,700,549 in 1995. The Company's life business has remained stable as the Company is focusing its marketing efforts on its Independent Living policy and its other long-term care products. Renewal life premiums in 1996 increased to $2,077,325, compared to $1,494,153 in 1995. This increase was primarily the result of renewals of first-year policies written in 1995. In order to enhance the marketability of certain products, the Company has recently emphasized offering new policy holders a monthly premium payment plan. The Company believes that the lower monthly payment is more attractive than the historical larger annual premium payment and that offering the monthly payment option enables it to sell more policies. However, because the Company records premiums when due, and a higher percentage of new policy holders opted for the monthly payment option in 1996 compared with 1995, management believes that it has experienced a delay in premium recognition of approximately $5,000,000 throughout 1996. Net Investment Income. Net investment income earned by the Company for 1996 increased 35.5% to $10,982,131 from $8,102,809 for 1995. This increase was primarily the result of growth in the Company's investment assets due to continued premium growth, additional funds of approximately $22,000,000 from the Company's public offering in July 1995, and additional funds of approximately $72,000,000 obtained from the issuance of convertible debt late in 1996. Benefits to Policyholders. Benefits to policyholders in 1996 increased 29.5% to $83,993,132, including ANIC expenses of $1,078,073, compared to $64,879,275 in 1995. Accident and health benefits to policyholders in 1996 increased 29.6% to $81,860,045 compared to $63,175,068 in 1995. The Company's accident and health loss ratio was 64.9% in 1996, compared to 63.7% in 1995. This increase in loss ratio was due, in part, to the increase in premium and policies of the Company's Independent Living policy which is reserved for at a higher rate, and also to improved persistency. In addition, management believes that claims were reported more quickly throughout 1996 due to the Company's offer to waive a policy elimination period if the insured agreed to utilize a Case Manager. See "Business-Claims." Management believes that this acceleration of reported claims was completely recognized by the end of 1996. During 1996, expenses for case management services of approximately $450,000 were classified as general and administrative expenses. The Company utilizes case management services in order to reduce overall claims expense. Had this expense been classified as Benefits to Policyholders, the total 1996 loss ratio would have increased by .35% of premiums to 64.9% compared to 63.4% in 1995. -27- Life benefits to policyholders in 1996 increased to $1,154,868, compared to $1,032,224 for 1995. The life loss ratio was 32.7% in 1996, compared to 32.3% in 1995. This increase relates to the maturing of the life products that the Company first introduced in 1993. Commissions. Commissions to agents increased 19.1% to $43,305,148 in 1996 compared to $36,351,140 in 1995. Included are ANIC commissions on long-term disability policies, which generated $445,084 of expenses in 1996. For the Company, excluding ANIC, first year commissions on accident and health business in 1996 increased 17.4% to $29,243,102, compared to $24,897,878 in 1995, corresponding to the increase in first year accident and health premiums. The ratio of first year accident and health commissions to first year accident and health premiums was 66.4% in 1996 and 67.7% in 1995. First year commissions on life business in 1996 decreased 18.2% to $1,083,892, compared to $1,325,521 in 1995, directly reflecting the Company's reduction in first year life premiums. The ratio of first year life commissions to first year life premiums was 74.4% in 1996 compared to 78.0% in 1995. Renewal commissions on accident and health business in 1996 increased 23.6% to $12,312,521, compared to $9,964,110 in 1995, remaining consistent with the increase in renewal premiums discussed above. The ratio of renewal accident and health commissions to renewal accident and health premiums was 15.4% in 1996 and 16.0% in 1995. This ratio fluctuates in relation to the age of the policies in force and the rates of commissions paid to the producing agents. Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs in 1996 increased 24.4% to $19,042,509 compared to $15,303,161 in 1995, consistent with the growth of the Company's business. This deferral is net of amortization, which decreases or increases as the Company's actual persistency is higher or lower than the persistency assumed for reserving purposes. The deferral of policy acquisition costs has remained consistent with the growth of premiums, and the growth in amortization of policy acquisition costs has been modified by improved persistency. General and Administrative Expenses. General and administrative expenses in 1996 increased 28.6% to $15,647,715, compared to $12,170,913 in 1995. ANIC expenses accounted for $928,385 in 1996, which includes the amortization of goodwill and the present value of future profits. Without the ANIC increase in expenses, general and administrative costs would have increased 20.9%. This amount also includes an additional $450,000 of case management charges, which will be reported as policyholder benefits in subsequent years. General and administrative expenses as a percentage of revenues were 11.1% in 1996, compared to 11.0% in 1995, which is due to the additional costs of ANIC and case management. Net Income. Net income of $12,160,347 (including a contribution of $299,354 from ANIC) for 1996 was $3,331,464 or 37.7% above 1995 income of $8,828,883. Net income includes income tax provisions of $4,847,000 and $3,609,000, for 1996 and 1995 period, respectively. Income before federal income taxes increased in 1996 by $4,569,464 or 36.7% to $17,007,347. This increase was primarily attributable to the continuing growth of premiums earned. The Company made a 1996 provision for federal income taxes of 4,847,000 or 28.5%, as compared to an effective 1995 tax provision rate of 29.0%. Years Ended December 31, 1995 and 1994 Accident and Health Premiums. First year accident and health premiums earned by the Company in 1995, including long-term care and Medicare supplement, increased 36.3% to $36,769,835, compared to $26,967,973 in 1994. First year long-term care premiums earned by the Company in 1995 increased 36.9% to $36,507,436, compared to $26,669,960 in the same period in 1994. This increase was attributable to increased sales of home health care policies, which increased to $14,560,437 in 1995 from $4,771,366 in 1994 and continued strong sales of nursing home care policies, which increased from $21,898,594 in 1994 to $21,946,999 in 1995. These results reflect increasing market demand for the Company's home health care policies relative to its nursing home policies and the Company's marketing focus on its home health care Independent Living policy first introduced in the fourth quarter of 1994. Independent Living policy sales were $10,643,354 in 1995. First year Medicare supplement premiums earned by the Company in 1995 decreased 12.0% to $262,399, compared to $298,013 in 1994. This decrease was due to the Company's continued de-emphasis of its Medicare supplement products because of lower profit margins associated with this line of business. -28- Renewal accident and health premiums earned by the Company in 1995, including long-term care and Medicare supplement, increased 19.5% to $62,402,068, compared to $52,236,980 in 1994. Renewal long-term care premiums earned by the Company in 1995 increased 21.6% to $59,624,488, compared to $49,054,157 in 1994. This increase reflects renewal of a larger base of in-force policies as well as the effect of rate increases the Company received in various states. The Company believes that this increase also reflects an increase in persistency which increased from 75.4% in 1994 to 77.4% in 1995. Renewal Medicare supplement premiums earned by the Company in 1995 decreased 12.7% to $2,777,580, compared to $3,182,823 in 1994, consistent with the Company's de-emphasis in marketing this product discussed above. Life Premiums. First year life premiums earned by the Company in 1995 decreased 20.9% to $1,700,549, compared to $2,149,039 in 1994. This change was attributable to record sales of the Company's life insurance products during 1994, particularly in the first quarter of 1994 resulting from the Company's focused marketing efforts in late 1993 and early 1994 related to the introduction of these new products. Since the first quarter of 1994, first year life premiums have been negatively impacted by the Company's utilization of stricter underwriting standards. Renewal life premiums earned by the Company in 1995 increased 210.7% to $1,494,153, compared to $480,842 in 1994. This increase was primarily the result of renewal of first year policies written in 1993 and 1994. Net Investment Income. Net investment income earned by the Company in 1995 increased 36.3% to $8,102,809, compared to $5,946,034 in 1994. This increase was primarily the result of growth in the Company's investment assets due to continued premium growth during 1995 and proceeds of approximately $22,000,000 from the Company's public offering in July 1995. See "-Liquidity and Capital Resources" below for a discussion of the public offering. The average yield on the Company's investments was 6.5% in 1995 and in 1994. Benefits to Policyholders. Accident and health benefits to policyholders in 1995 increased 33.0% to $63,175,068, compared to $47,497,004 in 1994. The Company's accident and health loss ratio (the ratio of benefits to policyholders to total accident and health premiums) was 63.7% in 1995, compared to 60.0% in 1994. This increase in loss ratio was due to (i) refinement of actuarial data used to calculate return of premium benefits and (ii) modification of assumptions used to reflect benefit payment frequency. The refinement of actuarial data and modification of assumptions were recommended by the Company's actuarial consultant. Reserves are increased on the anniversary date of the policy. Life benefits to policyholders increased to $1,704,207 from $1,260,480 in 1994. The life loss ratio was 53.3% in 1995, compared to 47.9% in 1994. These increases in benefits and the Company's life loss ratio are a result of the sale of the Company's new life insurance products which were introduced in late 1993. Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs in 1995 increased 100.2% to $15,303,161 compared to $7,642,875 in 1994, consistent with the growth of the Company's business. This deferral is net of amortization, which decreases or increases as the Company's actual persistency is higher or lower than the persistency assumed for reserving purposes. The Company believes that amortization decreased in 1995 relative to 1994 as a result of higher persistency. General and Administrative Expenses. General and administrative expenses increased 18.6% to $12,170,913, compared to $10,262,410 in 1994. This increase was due to increases in marketing and underwriting costs associated with the introduction of a new product and increased sales. The ratio of general and administrative expenses to total revenues was 11.0% in 1995 compared to 11.6% in 1994, due to the Company's ability to control these expenses. First Year Commissions. First year commissions on accident and health business increased 40.7% to $24,897,878, compared to $17,694,410 in 1994. The ratio of first year accident and health commissions to first year accident and health premiums was 67.7% in 1995 compared to 65.6% in 1994. The increase in the ratio is a result of a decrease in the average age of the insured covered by new business, which results in a higher agent commission. -29- First year commissions on life business decreased to $1,325,521, compared to $1,670,785 in 1994, corresponding to a decrease in first year life premiums. The ratio of first year life commissions to first year life premiums was 78.0% in 1995 compared to 77.8% in 1994, reflecting a commission structure which varies with the premium payment terms of policies. Renewal Commissions. Renewal commissions on accident and health business increased 27.1% to $9,964,110, compared to $7,840,877 in 1994, consistent with the increase in renewal premium discussed above. The ratio of renewal accident and health commissions to renewal accident and health premiums was 16.0% in 1995, compared to 15.0% in 1994. This ratio fluctuates in relation to the age of the policies in force and the rates of commissions paid to agents. Provision for Federal Income Taxes. The provision for federal income taxes recorded by the Company in 1995 increased 40.9% to $3,609,000, compared to $2,562,000 in 1994. The effective tax rate increased to 29.0% in 1995 from 27.5% in 1994. The Company's effective tax rate was below the normal federal corporate rate as a result of credits from the small life insurance company deduction as well as the Company's investments in tax-exempt bonds. Changes in Accounting Principles In the first quarter of 1993, the Company retroactively adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under the asset and liability method provided for by SFAS 109, deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities by applying enacted statutory tax rates. In 1993, the Company adopted Statement of Financial Accounting Standards No. 113, "Accounting and Reporting of Short-Duration and Long-Duration Contracts" ("SFAS 113"). SFAS 113 established the conditions a reinsurance contract must meet in order to be accounted for as such. In addition, it eliminated the industry practice of reporting financial statement items, net of the effects of reinsurance. SFAS 113 did not impact the Company's results of operations, other than the financial statement presentation. New Accounting Principles On January 1, 1996, Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123") became effective. SFAS 123 provides an alternative method of accounting for stock-based compensation arrangements, based on the fair value of the stock-based compensation determined by an option pricing model utilizing various assumptions regarding the underlying attributes of the options and the Company's common stock. The accounting under SFAS 123 differs from the existing method of accounting for stock-based compensation which is provided in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB 25"). The Financial Accounting Standards Board encourages entities to adopt the fair value based method, but does not require the adoption of this method. For those entities that continue to apply APB 25, pro forma disclosure of the effects, if adopted, of SFAS 123 on net income and earnings per share is required in the 1996 financial statements. The Company has adopted the disclosure-only provisions of SFAS 123 and applies APB 25 in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. See Note 9 of the consolidated financial statements for full disclosure under SFAS 123. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 establishes standards for computing and presenting earnings per share, and simplifies the standards for computing earnings per share previously found in Accounting Principles Board Opinion No. 15, "Earnings per Share." Primary and fully diluted earnings per share will be replaced with basic and diluted earnings per share, and these amounts are required to be shown on the face of the income statement. In addition, 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 will be required. 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 reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. This Statement is effective for financial statements issued for periods ending after December 15, 1997, and requires restatement of all prior-period earnings per share data presented. Management has not determined the impact that SFAS 128 may have on the Financial Statements. Impact of Increases in Cost of Medical Care Increases in the cost of medical care tend to increase the need for insurance. Many policyholders who once had adequate insurance coverage increased their insurance coverage to provide the same relative financial benefit and protection. The increases in medical costs lead to accident and health policies requiring higher benefits and an increased need for the products. Consequently, the Company offers riders to its insurance policies which provide for increases in policyholder benefits each year in the amount of 5% compounded annually on the anniversary date of the policy for 20 years or to age 85, whichever occurs first, or for the lifetime of the policyholder, as is mandated in certain states. -30- The adequacy of premium rates in relation to the level of health claims is constantly monitored by the Company and, where appropriate, premium rates on such policies are increased as policy benefits increase. Failure to make such increases commensurate with health care cost increases may result in a loss from health insurance operations. Liquidity and Capital Resources The Company's consolidated liquidity requirements have historically been created and met from the operations of its insurance subsidiaries. The Company's primary sources of cash are premiums and investment income. The Company has provided, and may continue to provide, cash through public offerings of its common stock, capital markets activities or debt instruments. The primary uses of cash are policy acquisition costs (principally commissions), payments to policyholders, investment purchases and general and administrative expenses. Statutory requirements allow insurers to pay dividends only from statutory earnings as approved by the state insurance commissioner. Statutory earnings are generally lower than publicly-reported earnings due to the immediate or accelerated recognition of all costs associated with premium growth and benefit reserves. The Company has not and does not intend to pay shareholder dividends in the near future due to these requirements, choosing to retain statutory surplus to support continued premium growth. See "Dividend Policy" and "Business-Government Regulation." The Company invests in securities and other investments authorized by applicable state laws and regulations and follows an investment policy designed to maximize yield to the extent consistent with liquidity requirements and preservation of assets. On December 31, 1995, the average maturity of the Company's bond portfolio was 6.4 years, and its market value exceeded cost by 4.1% or approximately $5,643,000. On December 31, 1994, the average maturity of the Company's portfolio was 6.9 years and its market value was below cost by 4.4% or approximately $4,165,000. The Company's equity portfolio exceeded cost by $503,083 or 23.9% in 1995 and $52,780 or 6.0% in 1994. At December 31, 1996, the average maturity of the Company's bond portfolio was 5.8 years, and its market value represented approximately 100.9% of its cost, with a current unrealized gain of $1,821,387. Its equity portfolio exceeded cost by $1,604,604 at December 31, 1996. In December 1994, a loan was extended to the Company by a bank in the amount of $4,000,000. The proceeds of the loan were contributed to the surplus of PTLIC in the form of cash to strengthen its overall capital position. The Company repaid this loan as required by the loan agreement, with a portion of the proceeds of the Company's public offering of 2,300,000 shares of Common Stock. The public offering was consummated on July 6, 1995, and the Company realized net proceeds of approximately $22,000,000, including the proceeds from the exercise of the underwriters' over-allotment option. On January 1, 1994, the Company adopted SFAS 115. The cumulative effect of adoption of SFAS 115 was an increase in shareholders' equity of $3,528,512, net of taxes, for unrealized gains of $5,040,731 in the investment securities available for sale portfolio. During the year ended December 31, 1994, the Company experienced a decrease in unrealized gains of $9,205,393. As of December 31, 1994, shareholders' equity was decreased by $2,713,842 due to unrealized losses of $4,111,882 in the investment portfolio. As of December 31, 1995, shareholders' equity was increased by $4,055,788 due to unrealized gains of $6,145,649 in the investment portfolio. As of December 31, 1996, shareholders' equity was increased by $2,261,154 due to unrealized gains of $3,425,991 in the investment portfolio. During 1993, the Company contributed $2,000,000 in bonds to PTLIC and Network America. During 1994, the Company contributed $4,000,000 in cash to PTLIC. The capital position of PTLIC and Network America was further improved by the contribution of $14,000,000 of the net proceeds of the public offering in 1995 to the capital and surplus of PTLIC and Network America during the third quarter of 1995. In November 1996, the Company contributed an additional $5,000,000 of the net proceeds of the public offering in July 1995 to Network America. The Company believes that its insurance subsidiaries' capital and surplus presently meet or exceed the requirements in all jurisdictions in which they are licensed. The Company's debt currently consists primarily of a mortgage note in the approximate amount of $2,000,000 and $74,750,000 in convertible subordinated debt. The convertible debt, issued in November 1996, is convertible at $28.44 per share until November 2003. The debt carries a fixed interest coupon of 6.25%, payable semi-annually. The mortgage note is currently amortized over 12 years, and has a balloon payment due on the remaining outstanding balance in September 1998. -31- Although the note carries a variable interest rate, the Company has entered into an amortizing swap agreement with the same bank, with a notional amount equal to the outstanding debt, which has the effect of converting the note to a fixed rate of interest. In December, 1996, the Company contributed $20,000,000, $20,000,000, and $5,000,000 to the surplus of PTLIC, Network America, and ANIC, respectively, from the proceeds of the convertible subordinated debt. The remaining approximately $27,000,000 in proceeds from the debt offering were retained at the parent in order to meet the interest service requirements of the debt. If the debt is not converted to common shares of the Company prior to December 2, 2003, the Company will be required to pay an aggregate of $32,703,125 in interest. The Company believes that it has retained sufficient funds to make these payments. The $74,750,000 balance of the debt is expected to convert to shares of common stock of the Company by design of the debt offering. However, in the event of maturity of the debt without conversion, the Company would be required to refinance the debt in order to meet its repayment obligations. The Company's continued growth is dependent upon its ability to (i) continue marketing efforts to expand its historical markets, (ii) continue to expand its network of agents and effectively market its products in states where its insurance subsidiaries are currently licensed and (iii) fund such marketing and expansion while at the same time maintaining minimum statutory levels of capital and surplus required to support such growth. Management believes that the funds necessary to accomplish the foregoing, including funds required to maintain adequate levels of statutory surplus in the Company's insurance subsidiaries can be met for the foreseeable future by funds generated from this offering, the Company's public offering in 1995 and from operations. In the event (i) the Company fails to maintain minimum loss ratios calculated in accordance with statutory guidelines, (ii) the Company fails to meet other requirements mandated and enforced by regulatory authorities, (iii) the Company has adverse claims experience in the future, (iv) the Company is unable to obtain additional financing to support future growth, or (v) the economy continues to effect the buying powers of senior citizens, the Company's results of operations, liquidity and capital resources could be adversely affected. Certain statements made by the Company may be considered to be forward looking. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance actual results will not differ significantly from its expectations. Item 8. Financial Statements and Supplementary Data -32- PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS as of December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGES --------- Report of Independent Accountants...................................................... F-2 Financial Statements: Consolidated Balance Sheets as of December 31, 1996 and 1995......................... F-3 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994............................................................................... F-4 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994................................................... F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994................................................................................. F-6-7 Notes to Consolidated Financial Statements........................................... F-8-22
F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of Penn Treaty American Corporation Allentown, Pennsylvania We have audited the accompanying consolidated balance sheets of Penn Treaty American Corporation and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Penn Treaty American Corporation and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. 2400 Eleven Penn Center Philadelphia, Pennsylvania March 5, 1997 F-2 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets as of December 31, 1996 and 1995
1996 1995 -------------- -------------- ASSETS Investments: Bonds, available for sale at market, (amortized cost $199,508,579 and $136,600,775, respectively)................................... $ 201,329,966 $ 142,243,341 Equity securities at market value, (cost of $9,642,912 and $2,102,529, respectively).................... 11,247,516 2,605,612 Policy loans.................................................... 84,232 79,404 -------------- -------------- Total investments............................................. 212,661,714 144,928,357 Cash and cash equivalents......................................... 51,612,067 8,881,061 Property and equipment, at cost, less accumulated depreciation of $2,205,407 and $1,854,065, respectively......... 8,092,028 5,740,353 Unamortized deferred policy acquisition costs..................... 82,176,268 63,133,759 Receivables from agents, less allowance for uncollectable amounts of $231,226 and $231,226, respectively.... 1,543,382 1,275,481 Accrued investment income......................................... 3,581,077 2,436,435 Federal income tax recoverable.................................... 175,219 -- Cost in excess of fair value of net assets acquired, less accumulated amortization of $324,203 and $231,826, respectively 6,042,786 1,197,574 Present value of future profits acquired.......................... 4,011,668 -- Receivable from reinsurers........................................ 10,105,654 7,730,828 Other assets...................................................... 6,766,129 2,420,422 -------------- -------------- Total assets.................................................. $ 386,767,992 $ 237,744,270 -------------- -------------- -------------- -------------- LIABILITIES Policy reserves: Accident and health............................................. $ 101,107,697 $ 62,007,433 Life............................................................ 8,523,267 7,118,848 Unearned premium reserve.......................................... 12,215 26,503 Policy and contract claims........................................ 57,539,380 50,206,608 Accounts payable and other liabilities............................ 4,768,441 2,681,499 Long-term debt.................................................... 77,114,592 2,206,117 Federal income taxes payable...................................... -- 183,249 Deferred income taxes............................................. 18,795,316 16,206,959 -------------- -------------- Total liabilities............................................. 267,860,908 140,637,216 -------------- -------------- Commitments and contingencies (Note 10) SHAREHOLDERS' EQUITY Preferred stock, par value $1.00; 5,000,000 shares authorized, none outstanding............................. -- -- Common stock, par value $.10; 10,000,000 shares authorized, 8,116,464 and 7,576,913 shares issued....... 811,646 757,691 Additional paid-in capital........................................ 52,526,956 41,146,594 Net unrealized appreciation of securities......................... 2,261,154 4,055,788 Retained earnings................................................. 65,013,202 52,852,855 -------------- -------------- 120,612,958 98,812,928 Less 605,629 common shares held in treasury, at cost.............. (1,705,874) (1,705,874) -------------- -------------- 118,907,084 97,107,054 -------------- -------------- Total liabilities and shareholders' equity.................... $ 386,767,992 $ 237,744,270 -------------- -------------- -------------- --------------
See accompanying notes to consolidated financial statements. F-3 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994
1996 1995 1994 -------------- ------------- ------------- Revenue: Accident and health premiums.................................. $ 126,657,410 $ 99,171,903 $ 79,204,953 Life premiums................................................. 3,534,369 3,194,702 2,629,881 -------------- ------------- ------------- 130,191,779 102,366,605 81,834,834 Net investment income......................................... 10,982,131 8,102,809 5,946,034 Net realized capital gains.................................... 19,960 46,431 8,335 Other income.................................................. 342,388 347,113 304,823 -------------- ------------- ------------- 141,536,258 110,862,958 88,094,026 Benefits and expenses: Benefits to policyholders..................................... 83,993,132 64,879,275 48,757,484 Commissions................................................... 43,305,148 36,351,140 27,230,679 Net policy acquisition costs deferred......................... (19,042,509) (15,303,161) (7,642,875) General and administrative expense............................ 15,647,715 12,170,913 10,262,410 Interest expense.............................................. 625,425 326,908 161,527 -------------- ------------- ------------- 124,528,911 98,425,075 78,769,225 -------------- ------------- ------------- Income before federal income taxes............................. 17,007,347 12,437,883 9,324,801 Provision for federal income taxes............................. 4,847,000 3,609,000 2,562,000 -------------- ------------- ------------- Net Income................................................... $ 12,160,347 $ 8,828,883 $ 6,762,801 -------------- ------------- ------------- -------------- ------------- ------------- Primary earnings per share..................................... $ 1.70 $ 1.53 $ 1.45 Fully diluted earnings per share............................... $ 1.64 -- -- Weighted average number of shares outstanding.................. 7,164,782 5,771,558 4,668,834 Weighted average number of shares outstanding (fully diluted)............................................. 7,614,321 -- --
See accompanying notes to consolidated financial statements. F-4 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994
UNREALIZED APPRECIATION (DEPRECIATION) COMMON STOCK ADDITIONAL NET OF TOTAL ------------------------ PAID-IN DEFERRED RETAINED TREASURY SHAREHOLDERS' SHARES AMOUNT CAPITAL TAXES EARNINGS STOCK EQUITY ----------- ----------- ------------- ------------- ------------- -------------- -------------- Balance, December 31, 1993....... 5,272,312 $ 527,231 $ 15,284,932 $ (18,547) $ 37,261,171 $ (1,705,450) $ 51,349,337 Initial adoption of SFAS 115.... 3,528,500 3,528,500 Exercised options proceeds....... 4,601 460 26,662 27,122 Treasury stock acquisition.... (424) (424) Net income....... 6,762,801 6,762,801 Change in net unrealized gains on investments.... (6,223,795) (6,223,795) ----------- ----------- ------------- ------------- ------------- -------------- -------------- Balance, December 31, 1994....... 5,276,913 527,691 15,311,594 (2,713,842) 44,023,972 (1,705,874) 55,443,541 Net income....... 8,828,883 8,828,883 Proceeds from public offering....... 2,300,000 230,000 25,835,000 26,065,000 Change in net unrealized loss on investments.... 6,769,630 6,769,630 ----------- ----------- ------------- ------------- ------------- -------------- -------------- Balance, December 31, 1995....... 7,576,913 757,691 41,146,594 4,055,788 52,852,855 (1,705,874) 97,107,054 Net income....... 12,160,347 12,160,347 Shares issued for the acquisition of Health Insurance of Vermont........ 472,644 47,264 10,823,553 10,870,817 Change in net unrealized gains on investments.... (1,794,634) (1,794,634) Exercised options proceeds....... 66,907 6,691 556,809 563,500 ----------- ----------- ------------- ------------- ------------- -------------- -------------- Balance, December 31, 1996....... 8,116,464 $ 811,646 $ 52,526,956 $ 2,261,154 $ 65,013,202 $ (1,705,874) $ 118,907,084 ----------- ----------- ------------- ------------- ------------- -------------- -------------- ----------- ----------- ------------- ------------- ------------- -------------- --------------
See accompanying notes to consolidated financial statements. F-5 PENN TREATY AMERICAN CORPORATION Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994
1996 1995 1994 ------------- ------------- ------------- Net cash flow from operating activities: Net income........................................................... $ 12,160,347 $ 8,828,883 $ 6,762,801 Adjustments to reconcile net income to cash provided by operations: Amortization of intangible assets.................................. 325,987 35,760 348,260 Policy acquisition costs, net...................................... (19,042,509) (15,303,161) (7,642,875) Deferred income taxes.............................................. 3,095,000 2,726,032 1,779,620 Depreciation expense............................................... 375,092 353,589 342,246 Net realized capital (gains) losses................................ (19,960) (46,431) (8,335) Increase (decrease) due to change in: Receivables from agents............................................ (267,901) (126,917) 84,183 Receivable from reinsurers......................................... (904,238) (1,205,581) (1,052,417) Policy and contract claims......................................... 6,885,661 8,862,180 9,130,004 Policy and unearned premium reserves............................... 29,844,074 20,097,887 9,815,820 Accounts payable and other liabilities............................. 1,207,846 543,209 179,541 Federal income taxes recoverable................................... (175,219) 481,799 (481,799) Federal income tax payable......................................... (183,249) 183,249 (67,102) Accrued investment income.......................................... (963,477) (808,701) (340,910) Other, net......................................................... (1,070,083) (512,600) (330,353) ------------- ------------- ------------- Cash provided by operations...................................... 31,267,371 24,109,197 18,518,684 Cash flow used in investing activities: Acquisition of business, net of cash received...................... (1,218,204) -- -- Proceeds from sales of bonds....................................... 16,684,028 5,356,956 4,671,988 Proceeds from sales of equity securities........................... 303,560 -- 1,451,329 Maturities and call of bonds....................................... 18,571,559 5,421,112 4,246,278 Purchase of bonds.................................................. (85,092,419) (52,690,049) (27,956,095) Purchase of equity securities...................................... (7,953,520) (1,222,022) -- Acquisition of property and equipment.............................. (2,110,844) (1,219,810) (372,511) ------------- ------------- ------------- Cash used in investing........................................... (60,815,840) (44,353,813) (17,959,011) Cash flow from financing activities: Proceeds from stock offering....................................... -- 26,065,000 -- Proceeds from convertible debt offering............................ 72,207,500 -- -- Proceeds from exercise of stock options............................ 563,500 -- 27,122 Repayments of mortgages and other debts............................ (491,525) (4,166,092) (143,505) Proceeds from note payable......................................... -- -- 4,000,000 Purchase of treasury stock......................................... -- -- (424) ------------- ------------- ------------- Cash provided by financing....................................... 72,279,475 21,898,908 3,883,193 ------------- ------------- ------------- Increase in cash and cash equivalents................................ 42,731,006 1,654,292 4,442,866 Cash balances: Beginning of period................................................ 8,881,061 7,226,769 2,783,903 ------------- ------------- ------------- End of period...................................................... $ 51,612,067 $ 8,881,061 $ 7,226,769 ------------- ------------- ------------- ------------- ------------- -------------
F-6
1996 1995 1994 ------------- ------------- ------------- Supplemental disclosures of cash flow information: Cash paid during the year for interest............................. $ 161,102 $ 327,205 $ 163,414 Cash paid during the year for federal income taxes................. $ 2,109,955 $ 217,920 $ 1,331,281 Non-cash investing activities: Common stock issued for business acquisition....................... $ 10,870,817 $ -- $ -- Purchase of block of renewal commission through installment note... $ 650,000 $ -- $ --
See accompanying notes to consolidated financial statements. F-7 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies: Basis of Presentation: The accompanying consolidated financial statements of Penn Treaty American Corporation and its Subsidiaries (the Company) have been prepared in accordance with generally accepted accounting principles (GAAP) and include Penn Treaty Life Insurance Company (PTLIC),Network America Life Insurance Company (Network America), American Network Insurance Company (ANIC) and Senior Financial Consultants Company. All significant intercompany transactions and balances have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform with the current year presentation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates. The Company is subject to interest rate risk to the extent its investment portfolio cash flows are not matched to its insurance liabilities. Management believes it manages this risk through modeling of the cash flows under reasonable scenarios. Nature of Operations: The Company sells accident and health, life and disability insurance through its wholly-owned subsidiaries. The Company's principal lines of business are long-term care products and home health care products. The Company distributes its products principally through managing general agents and independent agents. The Company operates its home office in Allentown, Pennsylvania and has satellite offices in California, Florida and Vermont, whose principal functions are to market and underwrite new business. State regulatory authorities have powers relating to granting and revoking licenses to transact business, the licensing of agents, the regulation of premium rates and trade practices, the form and content of insurance policies, the content of advertising material, financial statements and the nature of permitted practices. The Company is licensed to operate in 49 states. Sales in seven states accounted for approximately 73% of the Company's premiums for the year ended December 31, 1996. Investments: On January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115"). SFAS No. 115 requires all entities to allocate their investments among three categories as applicable: (1) trading, (2) available for sale, and (3) held to maturity. Management categorized all of its investment securities as available for sale since they may be sold in response to changes in interest rates, prepayments, and similar factors. Investments in this classification are reported at the current market value with net unrealized gains or losses, net of the applicable deferred income tax effect, being added to or deducted from the Company's total shareholders' equity on the balance sheet. F-8 The cumulative effect of adopting SFAS No. 115 as of January 1, 1994 was an increase in the balance of shareholders' equity of approximately $3,528,500 to reflect the net unrealized gain (net of approximately $1,512,000 in deferred income taxes) on investment securities classified as available for sale. As of December 31, 1995, shareholders' equity was increased by approximately $4,056,000 due to net unrealized gains of approximately $6,146,000 in the investment portfolio. As of December 31, 1996 shareholders' equity was increased by approximately $2,261,000 due to net unrealized gains of approximately $3,426,000. Realized investment gains and losses, including provisions for market declines considered to be other than temporary, are included in income. Gains and losses on sales of investment securities are computed on the specific identification method. Policy loans are stated at the aggregate unpaid principal balance. Unamortized Deferred Policy Acquisition Costs: The costs primarily related to and varying with the acquisition of new business, principally commissions, underwriting and policy issue expenses, have been deferred. These deferred costs are amortized over the related premium-paying periods utilizing the same projected premium assumptions used in computing reserves for future policy benefits. Net policy acquisition costs deferred, on the consolidated statements of operations, are net of amortization of $13,678,181, $11,720,966, and $13,012,937 for the years ended December 31, 1996, 1995, and 1994, respectively. Property and Equipment: Property and equipment are stated at cost, less accumulated depreciation and amortization. Expenditures for improvements which materially increase the estimated useful life of the asset are capitalized. Expenditures for repairs and maintenance are charged to operations as incurred. Depreciation is provided principally on a straight-line basis over the related asset's estimated life. Upon sale or retirement, the cost of the asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss, if any, is included in operations. During 1996, the Company capitalized approximately $1,500,000 in computer software expenses. Cash and Cash Equivalents: Cash and cash equivalents include highly liquid debt instruments purchased with a maturity of three months or less. Cost in Excess of Fair Value of Net Assets Acquired: The costs in excess of fair value of net assets acquired (goodwill) for acquisitions made under purchase accounting methods are being amortized to expense on a straight-line basis over a 10 to 40-year range. Present Value of Future Profits Acquired: The present value of all anticipated future profits of ANIC's acquired business is being amortized over the life of insurance business acquired. During 1996, approximately $138,000 was amortized to expense. F-9 Other Assets: Other assets consist primarily of due and unpaid insurance premiums and unamortized debt offering costs. Income Taxes: Deferred income taxes relate principally to temporary differences in reporting policy acquisition costs and policy reserves for financial statement and income tax purposes. Deferred income tax assets and liabilities have been recorded for temporary differences between the reported amounts of assets and liabilities in the accompanying financial statements and those in the Company's income tax return. Premium Recognition: Premiums on accident and health insurance, the majority of which is guaranteed renewable, and life insurance are recognized when due. Estimates of premiums due but not yet collected are accrued. Policy Reserves and Policy and Contract Claims: The Company establishes liabilities to reflect the impact of level renewal premiums and the increasing risks of claims losses as policyholders age. The present value of estimated future policy benefits to be paid to or on behalf of policyholders less the present value of estimated future net premiums to be collected from policyholders is accrued when premium revenue is recognized. Those estimates are based on assumptions, such as estimates of expected investment yield, mortality, morbidity, withdrawals and expenses, applicable at the time insurance contracts are made, including a provision for the risk of adverse deviation. These reserves differ from policy and contract claims, which are recognized when insured events occur. Policy and contract claims include amounts representing: (1) the actual in force amounts for reported life claims and an estimate of incurred but unreported claims; (2) an estimate, based upon prior experience, for accident and health claims reported, and incurred but unreported losses. The methods for making such estimates and establishing the resulting liabilities are continually reviewed and updated and any adjustments resulting therefrom are reflected in earnings currently. The establishment of appropriate reserves is an inherently uncertain process, and there can be no assurance that the ultimate liability will not materially exceed the Company's claim and policy reserves and have a material adverse effect on the Company's results of operations and financial condition. Due to the inherent uncertainty of estimating reserves, it has been necessary, and may over time continue to be necessary, to revise estimated future liabilities as reflected in the Company's policy reserves and policy and contract claims. In late 1994, the Company began marketing its Independent Living policy, a home health care insurance product which provides coverage over the full term of the policy for services furnished by a homemaker or companion who is not a qualified or licensed care provider. Because of the Company's relatively limited claims experience with this product, the Company may incur higher than expected F-10 loss ratios and may be required to adjust further its reserve levels with respect to this product. The Company discounts all policy and contract claims which involve fixed periodic payments extending beyond one year. This is consistent with the method allowed for statutory reporting and the long duration of claims, as well as industry practice for long-term care policies. Benefits are payable over periods ranging from six months to five years and lifetime. These liabilites are discounted using an assumed rate of 7% for 1996, 1995 and 1994 claims, 6% for 1993 and 1992 claims and 8% for claims in 1991 and prior. Earnings Per Share: Primary earnings per share amounts have been computed by dividing the applicable amounts by the weighted average common shares outstanding. Due to the issuance of the convertible debt, the Company calculated fully diluted earnings per share in 1996. Prior to 1996, the impact of the outstanding options was non-dilutive. Fully diluted earnings per share amounts have been computed by dividing the applicable net income amounts, as adjusted assuming all convertible debt had converted to common shares, by the weighted average common shares outstanding, as adjusted assuming all convertible debt had converted to common shares, and including the impact of all outstanding options as accounted for using the treasury stock methodology. New Accounting Principle: In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 establishes standards for computing and presenting earnings per share, and simplifies the standards for computing earnings per share previously found in Accounting Principles Board Opinion No. 15, "Earnings per Share." Primary and fully diluted earnings per share will be replaced with basic and diluted earnings per share, and these amounts are required to be shown on the face of the income statement. In addition, 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 is required. 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 reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. This Statement is effective for financial statements issued for periods ending after December 15, 1997, and requires restatement of all prior-period earnings per share data presented. Management has not determined the impact that SFAS 128 may have on the financial statements. 2. Acquisitions of Businesses On August 30, 1996, the Company acquired Health Insurance of Vermont. The resultant wholly-owned subsidiary of the Company was incorporated under the laws of the state of Vermont as ANIC. Pursuant to the merger, HIVT shareholders received stock consideration consisting of 472,644 shares of the Company's common stock and cash consideration of $2,200,380. Using the market value of the Company's common stock at the date of closing, the value of the shares of Company common stock issued on the merger was $10,870,817. As of December 31, 1996, ANIC had a total of 16,674 disability policies in-force and approximately $7,092,000 of in-force annualized premiums. For the four-month period ended December 31, 1996, ANIC generated premiums of $2,274,442 and net income of $299,354. The acquisition was accounted for as a purchase. F-11 In connection with this purchase, the Company recognized goodwill in the amount of $4,294,947, which is being amortized, straight-line, over a 25 year period. The operating results of ANIC have been included in the consolidated statement of income from the date of acquisition. Consolidated pro forma net income and earnings per share would not have been materially different from the reported amounts for fiscal 1996 and 1995. On January 29, 1996, the Company acquired the rights to all renewal commissions on a block of in-force policies and sub-agent contracts from a marketing general agent. This agreement includes insurance policies of PTLIC and other unaffiliated insurance companies. The cost of the acquisition was $650,000. The Company recognized $251,108 of net commission income in 1996 from this acquisition. 3. Investments and Financial Instruments: Net investment income is applicable to the following investments:
1996 1995 1994 ------------- ------------ ------------ Bonds............................ $10,262,611 $7,756,571 $5,798,152 Equity securities................ 92,358 27,920 32,833 Cash and short-term investments.. 796,319 480,274 260,853 ------------- ------------ ------------ Investment income................ 11,151,288 8,264,765 6,091,838 Investment expense............... (169,157) (161,956) (145,804) ------------- ------------ ------------ Net investment income............ $10,982,131 $8,102,809 $5,946,034 ------------- ------------ ------------ ------------- ------------ ------------
F-12 The amortized cost and estimated market value of investments in debt securities as of December 31, 1996 and 1995 are as follows:
DECEMBER 31, 1996 ------------------------------------------------------------------ AMORTIZED GROSS UNREALIZED GROSS UNREALIZED ESTIMATED COST GAINS LOSSES MARKET VALUE ------------ ---------------- ---------------- -------------- U.S. Treasury securities and obligations of U.S Government authorities and agencies.................. $149,354,655 $2,116,948 ($1,275,588) $150,196,015 Obligations of states and political sub-divisions....... 30,460,952 1,076,049 0 31,537,001 Debt securities issued by foreign governments........... 424,275 21,725 (750) 445,250 Corporate securities........... 19,068,114 61,013 (169,427) 18,959,700 Other debt securities.......... 200,583 0 (8,583) 192,000 -------------- ---------------- ---------------- -------------- $199,508,579 $3,275,735 ($1,454,348) $201,329,966 -------------- ---------------- ---------------- -------------- -------------- ---------------- ---------------- --------------
DECEMBER 31, 1995 --------------------------------------------------------------- AMORTIZED GROSS UNREALIZED GROSS UNREALIZED ESTIMATED COST GAINS LOSSES MARKET VALUE -------------- ---------------- ---------------- -------------- U.S. Treasury securities and obligations of U.S Government authorities and agencies................... $103,119,270 $4,124,815 ($83,244) $107,160,841 Obligations of states and political sub-divisions........ 24,952,467 1,194,533 0 26,147,000 Debt securities issued by foreign governments............ 449,055 33,945 (2,500) 480,500 Corporate securities............ 5,619,499 227,415 (26,914) 5,820,000 Other debt securities........... 2,460,484 174,516 0 2,635,000 -------------- ---------------- ---------------- -------------- $136,600,775 $5,755,224 ($112,658) $142,243,341 -------------- ---------------- ---------------- -------------- -------------- ---------------- ---------------- --------------
F-13 The amortized cost and estimated market value of debt securities at December 31, 1996 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
AMORTIZED ESTIMATED COST MARKET VALUE ------------- -------------- Due in one year or less.................... $ 8,230,765 $ 8,249,250 Due after one year through five years...... 68,303,224 69,318,518 Due after five years through ten years..... 109,308,468 109,758,700 Due after ten years........................ 13,666,122 14,003,498 -------------- -------------- $199,508,579 $201,329,966 -------------- -------------- -------------- -------------- F-14
Gross proceeds and realized gains and losses on the sales of debt securities, excluding calls, were as follows:
GROSS GROSS REALIZED REALIZED YEAR ENDED DECEMBER 31, PROCEEDS GAINS LOSSES - ------------------------- ------------- ---------- --------- 1996............. $16,684,028 $145,371 $15,834 1995............. 5,356,956 53,648 7,500 1994............. 4,671,988 48,170 --
Gross proceeds and realized gains and losses on the sales of equity securities were as follows:
GROSS GROSS REALIZED REALIZED YEAR ENDED DECEMBER 31, PROCEEDS GAINS LOSSES - ------------------------- ---------- --------- ---------- 1996............. $ 303,560 $ 12,580 $ 122,157 1995............. -- -- -- 1994............. 1,451,329 23,388 163,334
Gross unrealized gains (losses) pertaining to equity securities were as follows:
GROSS GROSS ORIGINAL UNREALIZED UNREALIZED ESTIMATED YEAR ENDED DECEMBER 31, COST GAINS LOSSES MARKET VALUE - ------------------------- ------------ ------------ ----------- ------------- 1996............. $ 9,642,912 $ 1,717,865 ($ 113,261) $ 11,247,516 1995............. 2,102,529 561,509 (58,426) 2,605,612 1994............. 880,507 135,651 (82,871) 933,287
The Company's bond investment portfolio is comprised primarily of investment grade securities at December 31, 1996. Securities are classified as "investment grade" by utilizing ratings furnished by independent bond rating agencies. Pursuant to certain statutory licensing requirements, as of December 31, 1996, the Company had on deposit bonds aggregating $8,029,732 in insurance department safekeeping accounts. The Company is not permitted to remove the bonds from these accounts without approval of the regulatory authority. F-15 4. Policy Reserves and Claims: Policy reserves have been computed principally by the net level premium method based upon estimated future investment yield, mortality, morbidity, withdrawals and other benefits. The composition of the policy reserves at December 31, 1996 and 1995 and the assumptions pertinent thereto are presented below:
AMOUNT OF POLICY RESERVES AS OF DECEMBER 31, ----------------------------- 1996 1995 -------------- ------------- Accident and health........................................... $ 101,107,697 $ 62,007,433 Annuities and other........................................... 339,910 365,651 Ordinary life, individual..................................... 8,183,357 6,753,197
YEARS OF ISSUE DISCOUNT RATE -------------- ------------- Accident and health........................................... 1976 to 1986 7.0% 1987 7.5% 1988 to 1991 8.0% 1992 to 1995 6.0% 1996 7.0% Annuities and other........................................... 1977 to 1983 6.5% & 7.0% Ordinary life, individual..................................... 1962 to 1996 3.0% to 5.5%
BASIS OF ASSUMPTION - ------------------- Accident and health....................... Morbidity and withdrawals based on actual and projected experience. Annuities and other....................... Primarily funds on deposit inclusive of accrued interest. Ordinary life, individual................. Mortality based on 1955-60 Intercompany Mortality Table Combined Select and Ultimate.
Policy and contract claims include approximately $45,300,000 and $38,150,000 at December 31, 1996 and 1995, respectively, that are discounted at varying interest rates. The amount of discount was $3,618,000 and $2,044,000 at December 31, 1996 and 1995, respectively. Total reserves, including policy and contract claims, reported to statutory authorities were approximately $3,510,000 and $3,077,000 less than those recorded for GAAP as of December 31, 1996 and 1995, respectively. F-16 Activity in policy and contract claims is summarized as follows:
1996 1995 ------------- ------------- Balance at January 1........................................... $ 50,206,608 $ 41,344,428 Less reinsurance recoverables.................................. 1,576,207 1,198,897 ------------- ------------- Net balance at January 1....................................... 48,630,401 40,145,531 Incurred related to: Current year................................................. 52,128,679 43,599,323 Prior years.................................................. 3,099,034 2,047,708 ------------- ------------- Total incurred............................................. 55,227,713 45,647,031 Paid related to: Current year................................................. 15,894,011 11,867,015 Prior years.................................................. 32,149,776 25,295,146 ------------- ------------- Total paid................................................. 48,043,787 37,162,161 Reserves assumed in acquisition................................ 447,111 -- Net balance at December 31..................................... 56,261,438 48,630,401 Plus reinsurance recoverables................................ 1,277,942 1,576,207 ------------- ------------- Balance at December 31....................................... $ 57,539,380 $ 50,206,608 ------------- ------------- ------------- -------------
The amounts related to prior years' incurral of claims reflects the accretion of interest due to the discounting of pending claim reserves as well as adjustments to reflect actual versus estimated claims experience. 5. Long-Term Debt: Long-term debt, at December 31, 1996 and 1995 are as follows: 1996 1995 ---- ---- Convertible, subordinated debt issued in November 1996, with semi-annual coupon of 6.25% annual percentage rate. Debt is callable after December 2, 1999 at declining redemption values and matures in 2003. Prior to maturity, the debt is convertible to shares of the Company's common stock at $28.44. $74,750,000 $ 0 Mortgage loan with interest rate fixed for two years at 7.3% effective September 1996, which repriced from 6.6% in 1995. Although carrying a variable rate, the loan has an effective fixed rate due to an offsetting swap with the same institution. Current monthly payment of $20,103 based on a twelve year amortization schedule with a balloon payment due September 14, 1998; collateralized by property with depreciated cost of $2,630,429 and $2,700,968 as of December 31, 1996 and 1995, respectively. 1,951,176 2,060,069 Installment note for purchase of block of renewal commissions in January 1996, payable over two years with interest accrued at 7% 325,000 0 Capital lease 88,416 146,048 ----------- ---------- $77,114,592 $2,206,117 ----------- ---------- ----------- ---------- F-17 Maturities of mortgage and other debt are as follows: 1997.............. $ 367,002 1998.............. 1,997,590 1999.............. -- 2000.............. -- 2001.............. -- Thereafter........ 74,750,000 ---------- $77,114,592 ----------- ----------- 6. Federal Income Taxes: The provision for Federal income taxes for the years ended December 31 consisted of:
1996 1995 1994 ------------ ------------ ------------ Current................................................................. $ 1,752,000 $ 882,968 $ 782,380 Deferred................................................................ 3,095,000 2,726,032 1,779,620 ------------ ------------ ------------ $ 4,847,000 $ 3,609,000 $ 2,562,000 ------------ ------------ ------------ ------------ ------------ ------------
Deferred income tax assets and liabilities have been recorded for temporary differences, between the reported amounts of assets and liabilities in the accompanying financial statements and those in the Company's income tax return. The sources of these differences and the approximate tax effect are as follows for the years ended December 31: 1996 1995 ----------- ---------- Deferred policy acquisition costs....... $20,677,263 $15,896,021 Policy reserves......................... (4,690,679) (2,627,583) Present value of future profits acquired.............................. 1,344,700 -- Premiums due and unpaid................. 829,600 592,225 Alternative minimum tax carryforward.... (599,000) -- Other................................... 68,595 256,775 Unrealized appreciation on investments........................... 1,164,837 2,089,521 ---------- ----------- Total deferred income taxes......... $18,795,316 $16,206,959 ---------- ----------- ---------- ----------- A reconciliation of the income tax provision computed using the Federal income tax rate of 34% to income before Federal income taxes is as follows:
1996 1995 1994 ------------ ----------- ------------ Computed Federal income tax provision at statutory rate................. $5,782,000 $4,289,000 $3,170,000 Small life insurance company deduction.................................. (560,000) (577,000) (579,000) Tax-exempt interest income.............................................. (478,000) (431,000) (325,000) Other................................................................... 103,000 328,000 296,000 ---------- ---------- ---------- $4,847,000 $3,609,000 $2,562,000 ---------- ---------- ---------- ---------- ---------- ----------
At December 31, 1996, the accumulated earnings of the Company for Federal income tax purposes included $1,055,873 of "Policyholders' Surplus", a special memorandum tax account. This memorandum account balance has not been currently taxed, but income taxes computed at then-current rates will become payable if surplus is distributed. Provisions of the Deficit Reduction Act of 1984 (the "Act") do not permit further additions to the "Policyholders' Surplus" F-18 account. "Shareholders' Surplus" represents an accumulation of taxable income (net of tax thereon) plus the dividends received deduction, tax-exempt interest, and certain other special deductions as provided by the Act. At December 31, 1996, the combined balance in the "Shareholders' Surplus" account amounted to approximately $21,470,000. There is no present intention to make distributions in excess of "Shareholders' Surplus." 7. Regulatory Restrictions: The Company's insurance subsidiaries (PTLIC, Network America, and ANIC) are required by insurance laws and regulations to maintain minimum capital and surplus. At December 31, 1996 and 1995, the subsidiaries' capital and surplus exceeded the minimum required capital and surplus in all states in which they are licensed to conduct business. Under Pennsylvania and Vermont insurance law, dividends may be paid from PTLIC, Network America or ANIC only from statutory profits of earned surplus and require Insurance Department approval if the dividend is in excess of the greater of 10% of surplus or net statutory income of the prior year. Net income and capital and surplus as reported in accordance with statutory accounting principles for the Company's insurance subsidiaries are as follows: 1996 1995 1994 ----------- ---------- ------------ Net income (loss).............. $(4,512,941) $ 839,491 $ (97,230) Capital and surplus............ $81,794,728 $32,291,981 $21,067,123 The National Association of Insurance Commissioners (NAIC) has established risk-based capital standards that life and health insurers and reinsurers must meet. In concept, risk-based capital standards are designed to measure the acceptable amount of capital an insurer should have based on the inherent and specific risks of each insurer. Insurers failing to meet their benchmark capital level may be subject to scrutiny by the insurer's domiciled insurance department and, ultimately, rehabilitation or liquidation. Based on the NAIC's currently adopted standards, the Company has capital and surplus in excess of the required levels. The differences in statutory net income compared to GAAP are primarily due to the immediate expensing of acquisition costs and deferred income taxes. Due to these differences, under statutory accounting there is a net loss and decrease in surplus, called surplus strain, in years of high growth. The surplus needed to sustain growth must be raised externally or from profits from existing business. In 1995, the Company received permission to include $3,287,501 of this surplus strain, related to a new required valuation method, as a charge to surplus. 8. Pension Plan and 401(k) Plan: Until August 1, 1996, the Company maintained a defined contribution pension plan covering substantially all employees. The Company contributed 3% of each eligible employee's annual covered payroll to the plan. All contributions were subject to limitations imposed by the Internal Revenue Code on retirement plans and Section 401(k) plans. Upon the termination of the plan on August 1, 1996, each participant became fully vested. A prorata portion of the 1996 scheduled contribution was put into the plan upon termination. Pension expense was $30,000, $55,000, and $70,000 for the years ended December 31, 1996, 1995 and 1994, respectively. F-19 On August 1, 1996, the Company adopted a 401(k) retirement plan, covering substantially all employees with one year of service. Under the plan, participating employees may contribute up to 15% of their annual salary on a pre-tax basis. The Company, under the plan, equally matches employee contributions up to the first three percent of the employee's salary. The Company and employee portion of the plan is vested immediately. The Company expense in 1996 was $36,000. The Company may elect to make a discretionary contribution to the plan, which will be contributed proportionately to each eligible employee. The Company did not make a discretionary contribution in 1996. ANIC maintained a defined benefit pension plan for all ANIC employees in 1996. This plan was subsequently terminated in 1997, with all eligible employees joining the Company's 401(k) plan. There was no 1996 contribution expense for this plan. 9. Stock Option Plans: At December 31, 1996, the Company has two stock-based compensation plans which are described below. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, ("SFAS No. 123"), and applies APB Opinion No. 25 "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. Had compensation cost for the Company's two stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of FASB Statement 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below. The effects of applying the SFAS No. 123 proforma disclosure are not indicative of future amounts.
1996 1995 ------------- ------------ Net Income............................... As reported $12,160,347 $ 8,828,883 Proforma $12,017,629 $ 8,801,727 Primary Earnings Per Share............... As reported $ 1.70 $ 1.53 Proforma $ 1.68 $ 1.53 Fully Diluted Earnings Per Share......... As reported $ 1.64 $ 1.50 Proforma $ 1.62 $ 1.49
Compensation cost is estimated using the Black-Scholes model with the following assumptions for both 1995 and 1996: an expected life ranging from 5.3 to 8.3 years, volatility of 27.9% and a risk free rate ranging from 6.21% to 6.35%. The weighted average fair value of those options granted in 1995 and 1996 was $4.98 and $8.21, respectively. No compensation expense is calculated for those options granted prior to 1995. The Company has an Incentive Stock Option Plan which provides for the granting of options to purchase up to 600,000 shares of common stock. The exercise price of all options granted under the plan may not be less than the fair market value of the shares on the date of grant (110% of fair market value in the case of any person who holds more than 10% of the combined voting power of all classes of outstanding stock). The maximum allowable term of each option is ten F-20 years (five years in the case of holders of more than 10% of the combined voting power of all classes of outstanding stock), and the options become exercisable in four equal, annual installments commencing one year from the option grant date. Effective May, 1995, the Company adopted a Participating Agent Stock Option Plan which provides for the granting of options to purchase up to 300,000 shares of common stock. The exercise price of all options granted under the plan may not be less than the fair market value of the shares on the date of grant. The maximum allowable term of each option is ten years, and the options become exercisable in four equal, annual installments commencing one year from the option grant date. The following is a summary of the Company's option activity, including grants, exercises, forfeitures and average price information:
1996 1995 1994 ---------------------- ------------------------ ------------------------ EXERCISE EXERCISE EXERCISE PRICE PRICE PRICE OPTIONS PER OPTION OPTIONS PER OPTION OPTIONS PER OPTION --------- ----------- --------- ------------- --------- ------------- Outstanding at beginning of year.................... 396,015 10.88 229,915 9.52 235,752 9.45 Granted............................................. 184,800 21.03 166,100 14.13 0 -- Exercised........................................... 66,907 8.42 0 -- 4,501 5.89 Canceled............................................ 3,800 12.38 0 -- 1,236 10.04 Outstanding at end of year.......................... 510,108 14.84 396,016 10.88 229,915 9.52 Exercisable at end of year.......................... 200,540 -- 197,929 -- 148,698 --
OUTSTANDING REMAINING EXERCISABLE AT DECEMBER CONTRACTUAL AT DECEMBER RANGE OF EXERCISE PRICES 31, 1996 LIFE (YRS) 31, 1996 - ------------------------- ----------- ----------------- ----------- 5.00............. 818 1 818 5.50............. 2,632 1 2,632 7.92............. 7,020 2 7,020 8.71............. 5,265 4 5,265 8.92............. 45,042 5 45,042 9.81............. 44,850 5 44,850 11.17............ 39,116 4 39,115 12.28............ 26,340 4 26,340 12.38............ 91,325 8 18,575 12.63............ 16,100 8 4,025 13.61............ 48,000 8 6,858 20.50............ 135,600 9 0 22.55............ 48,000 9 0 510,108 200,540 F-21 10. Commitments and Contingencies: Operating Lease Commitments: The total net rental expenses under all leases amounted to approximately $174,000, $142,000 and $148,000 for the years ended December 31, 1996, 1995 and 1994, respectively. During May 1987, the Company assigned its rights and interests in a land lease to a third party for $175,000. The agreement indemnifies the Company against any further liability with respect to future lease payments. The Company remains contingently liable to the lessor under the original deed of lease for rental payments of $16,080 per year, the amount being adjustable based upon changes in the consumer price index since 1987, through the year 2063. Litigation: The Company is a defendant in various lawsuits arising in the ordinary course of business. In the opinion of management, the resolution of these lawsuits will not have a significant effect on the financial condition or results of operations of the Company. 11. Reinsurance: Effective October, 1994, PTLIC and Network America entered into reinsurance agreements to cede 100% of benefits exceeding 36 months on certain home health care policies. Total reserve credits taken related to this agreement as of December 31, 1996 and 1995 were approximately $859,000 and $391,000, respectively. The Company currently reinsures with unaffiliated companies any life insurance policy to the extent the risk on that policy exceeds $50,000. Effective January, 1994, PTLIC and Network America entered reinsurance agreements to cede 100% of certain life, accident and health and Medicare supplement insurance to a third party insurer. Total reserve credits taken related to this agreement as of December 31, 1996 and 1995 were approximately $530,000 and $662,000, respectively. Network America is party to a Reinsurance Agreement to cede 100% of certain whole life and deferred annuity policies to be issued by Network America to a third party insurer. These policies are intended for the funeral arrangement or "pre-need" market. Total reserve credits taken related to this agreement as of December 31, 1996 and 1995 were approximately $3,862,000 and $3,735,000, respectively. The third party reinsurer maintains securities at least equal to the statutory reserve credit in escrow with a bank. Effective January 1, 1996, this Agreement was modified, and as a result, no new business is reinsured under this facility. Network America is party to a coinsurance agreement on a previously acquired block of long term care business whereby 66% is ceded to a third party. At December 31, 1996 and 1995, reserve credits taken related to this treaty were approximately $1,615,000 and $2,130,000, respectively. ANIC reinsures approximately $500,00 of its risk with three reinsuring companies, all of which are authorized to do business in the State of Vermont. F-22 The Company has assumed and ceded reinsurance on certain life and accident and health contracts under various agreements. The tables below highlight the amounts shown in the accompanying consolidated statements of operations which are net of reinsurance activity:
ASSUMED GROSS CEDED TO FROM OTHER NET AMOUNT OTHER COMPANIES COMPANIES AMOUNT ------------- ---------------- ----------- ------------- December 31, 1996 Ordinary Life Insurance In-Force.................... $ 66,932,000 $ 18,004,000 $ 0 $ 48,928,000 Premiums: Accident and health............................... 130,551,727 4,438,137 543,820 126,657,410 Life.............................................. 4,146,768 612,399 0 3,534,369 Benefits to Policyholders: Accident and health............................... 54,823,330 1,169,942 419,457 54,072,845 Life.............................................. 1,631,715 476,847 0 1,154,868 Inc (dec) in Policy Reserves: Accident and health............................... 28,567,856 763,605 (17,051) 27,787,200 Life.............................................. 1,404,419 426,200 0 978,219 Commissions......................................... $ 44,770,782 $ 1,547,207 $ 81,573 $ 43,305,148 December 31, 1995 Ordinary Life Insurance In-Force.................... $ 63,653,000 $ 19,977,000 $ 0 $ 43,676,000 Premiums: Accident and health............................... 101,103,823 2,512,930 581,010 99,171,903 Life.............................................. 4,815,878 1,621,176 0 3,194,702 Benefits to Policyholders: Accident and health............................... 46,073,992 1,542,816 83,631 44,614,807 Life.............................................. 1,511,812 479,588 0 1,032,224 Inc (dec) in Policy Reserves: Accident and health............................... 18,569,195 (3,107) (12,041) 18,560,261 Life.............................................. 1,257,267 585,284 0 671,983 Commissions......................................... $ 37,542,304 $ 1,278,316 $ 87,152 $ 36,351,140 December 31, 1994 Ordinary Life Insurance In-Force.................... $ 46,666,000 $ 13,880,000 $ 0 $ 32,786,000 Premiums: Accident and health............................... 80,870,772 2,270,819 605,000 79,204,953 Life.............................................. 4,011,607 1,381,726 0 2,629,881 Benefits to Policyholders: Accident and health............................... 39,865,707 1,181,485 852,801 39,537,023 Life.............................................. 788,369 407,475 0 380,894 Inc (dec) in Policy Reserves: Accident and health............................... 8,393,090 249,249 (183,860) 7,959,981 Life.............................................. 1,657,464 777,878 0 879,586 Commissions......................................... $ 27,976,116 $ 836,187 $ 90,750 $ 27,230,679
The Company remains contingently liable in the event that the reinsuring companies are unable to meet their obligations. F-23 12. Transactions with Related Parties: Irv Levit Insurance Management Corporation ("IMC"), an insurance agency which is owned by the President of the Company, produced approximately $55,000, $62,000, and $65,000 of new and renewal premiums for PTLIC, for the years ended December 31, 1996, 1995 and 1994, respectively, for which it received commissions of approximately $12,000, $14,000 and $15,000, respectively. IMC also received commission overrides on business written for PTLIC by certain agents, principally general agents who were IMC agents prior to January 1979 and any of their sub-agents hired prior and subsequent to January 1979. For the years ended December 31, 1996, 1995 and 1994, IMC commission overrides totaled approximately $539,000, $517,000, and $520,000, respectively. 13. Major Agencies: A managing general agent accounted for approximately 21%, 18% and 20% of total premiums in 1996, 1995 and 1994, respectively. 14. Concentrations of Credit Risk: Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and investments. The Company places its cash and cash equivalents and investments with high quality financial institutions, and attempts to limit the amount of credit exposure to any one institution. However, at December 31, 1996, and at other times during the year, amounts in any one institution exceeded the Federal Deposit Insurance Corporation limits. 15. Stock Dividend On April 19, 1995, the Board of Directors of the Company declared a 50% stock dividend payable to shareholders of record on May 3, 1995. The dividend was distributed on May 15, 1995. Certain amounts comprising shareholders' equity in these financial statements, weighted average shares outstanding and earnings per share have been restated to reflect this dividend. 16. Fair Value of Financial Instruments Fair values are based on estimates using present value or other valuation techniques where quoted market prices are not available. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The fair value amounts presented do not purport to represent and should not be considered representative of the underlying value of the Company. The methods and assumptions used to estimate the fair values of each class of the financial instruments described below are as follows: F-24 Investments--The fair value of fixed maturities and equity securities are based on quoted market prices. It is not practicable to determine the fair value of policy loans since such loans are not separately transferable and are often repaid by reductions to benefits and surrenders. Cash and cash equivalents--The statement value approximates fair value. Long-term debt--The statement value approximates the fair value of mortgage debt and capitalized leases, since the instruments carry interest rates which approximate market value. The convertible, subordinated debt, as a publicly traded instrument, has a readily accessible fair market value, and, as such is reported at that value.
DECEMBER 31, 1996 DECEMBER 31, 1995 ------------------------------ ------------------------------ CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE -------------- -------------- -------------- -------------- Financial assets: Investments Bonds, available for sale.................. $ 201,329,966 $ 201,329,966 $ 142,243,341 $ 142,243,341 Equity securities.......................... 11,247,516 11,247,516 2,605,612 2,605,612 Policy loans............................... 84,232 84,232 79,404 79,404 Cash and cash equivalents.................... 51,612,067 51,612,067 8,881,061 8,881,061 Financial liabilities: Convertible debt............................. $ 74,750,000 $ 69,132,948 $ -- $ -- Mortgage and other debt...................... 2,364,592 2,364,592 2,206,117 2,206,117
F-25 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENT SCHEDULE
PAGES ---------- Report of Independent Accountants on Schedule..................................... S-2 Schedule III--Condensed Financial Information of Registrant....................... S-3--S-5
S-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of Penn Treaty American Corporation Allentown, Pennsylvania Our report on the consolidated financial statements of Penn Treaty American Corporation and Subsidiaries is included on page F-2 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page S-1 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. 2400 Eleven Penn Center Philadelphia, Pennsylvania March 5, 1997 S-2 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES (PARENT COMPANY) Schedule III--Condensed Financial Information of Registrant Balance Sheets as of December 31, 1996 and 1995
1996 1995 -------------- ------------- ASSETS Bonds, available for sale at market (amortized cost $11,399,502 and $7,472,848, respectively)................... $11,495,000 $7,681,000 Equity securities at market (cost $1,004,250 and $0, respectively)............................................... 994,500 -- Cash and cash equivalents..................................... 16,375,868 657,086 Investment in subsidiaries*................................... 162,699,321 88,459,123 Other assets.................................................. 4,408,050 1,487,233 -------------- ------------- Total assets.............................................. $ 195,972,739 $ 98,284,442 -------------- ------------- -------------- ------------- LIABILITIES AND SHAREHOLDERS' EQUITY Long-term debt................................................ $74,838,415 $146,048 Accounts payable and other liabilities........................ 797,211 -- Deferred income taxes......................................... 29,154 70,772 Due to subsidiaries*.......................................... 1,400,875 960,568 -------------- ------------- Total liabilities......................................... 77,065,655 1,177,388 -------------- ------------- Shareholders' equity Preferred stock, par value $1.00; 5,000,000 shares authorized, none outstanding............................. -- -- Common stock, par value $.10; 10,000,000 shares authorized, 8,116,464 and 7,576,913 shares issued, respectively...... 811,646 757,691 Additional paid-in capital................................. 52,526,956 41,146,594 Unrealized appreciation, net of deferred taxes............. 2,261,154 4,055,788 Retained earnings.......................................... 65,013,202 52,852,855 -------------- ------------- 120,612,958 98,812,928 Less 605,629 of common shares held in treasury, at cost.... (1,705,874) (1,705,874) -------------- ------------- Total shareholders' equity............................... 118,907,084 97,107,054 -------------- ------------- Total liabilities and shareholders' equity............... $ 195,972,739 $ 98,284,442 -------------- ------------- -------------- -------------
* Eliminated in consolidation. The condensed financial information should be read in conjunction with the Penn Treaty American Corporation and Subsidiaries consolidated statements and notes thereto. S-3 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES (PARENT COMPANY) Schedule III-Condensed Financial Information of Registrant Statements of Operations for the years ended December 31, 1996, 1995 and 1994
1996 1995 1994 ------------- ------------- ------------- Management fees*.................................................... $56,400 $56,400 $56,400 Investment income................................................... 835,714 275,342 93,762 General and administrative expense.................................. 266,597 410,968 365,806 Interest expense.................................................... 455,756 -- -- ------------ ---------- ---------- Gain (loss) before equity in undistributed net earnings of subsidiaries*..................................................... 169,761 (79,226) (215,644) Equity in undistributed net earnings of subsidiaries*............... 11,990,586 8,908,109 6,978,445 ------------- ------------- ------------- Net income.......................................................... 12,160,347 8,828,883 6,762,801 Retained earnings, beginning of year................................ 52,852,855 44,023,972 37,261,171 ------------- ------------- ------------- Retained earnings, end of year...................................... $65,013,202 $52,852,855 $44,023,972 ------------- ------------- ------------- ------------- ------------- -------------
* Eliminated in consolidation. The condensed financial information should be read in conjunction with the Penn Treaty American Corporation and Subsidiaries consolidated statements and notes thereto. S-4 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES (PARENT COMPANY) Schedule III-Condensed Financial Information of Registrant Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994
1996 1995 1994 ------------ ----------- ----------- Cash flows from operating activities: Net Income...................................... $ 12,160,347 $ 8,828,883 $ 6,762,801 Adjustments to reconcile net income to cash provided by operations: Equity in undistributed earnings of subsidiaries................................ (12,289,940) (8,908,109) (6,978,445) Depreciation and amortization................. 113,741 99,528 87,290 Net realized (gains) losses................... 5,495 (30,178) -- Increase (decrease) due to change in: Due to/from subsidiaries.................... 440,307 302,568 -- Accounts payable and other liabilities...... 797,211 -- -- Other, net.................................. (138,086) (249,338) 309,295 ------------ ------------ ----------- Net cash provided by operations........... 1,089,075 43,354 180,941 Cash flows used in investing activities: Acquisition of business......................... (2,200,380) -- -- Sales and maturities of investments............. 12,372,277 1,512,195 -- Purchase of investments......................... (17,308,676) (8,358,058) -- Acquisition of property and equipment........... (396,882) (883,629) (122,172) Contribution to subsidiary...................... (50,550,000) (14,000,000) (4,000,000) ------------ ------------ ----------- Net cash used in investing activities..... (58,083,661) (21,729,492) (4,122,172) Cash flows from financing activities: Proceeds from convertible debt offering......... 72,207,500 -- -- Proceeds from exercise of stock options......... 563,500 -- -- Repayment of mortgages and other borrowings..... (57,632) (4,052,835) (48,436) Proceeds from public offering................... -- 26,065,000 27,122 Purchase of treasury stock...................... -- -- (424) Proceeds from new debt.......................... -- -- 4,000,000 ------------ ------------ ----------- Net cash provided by financing activities. 72,713,368 22,012,165 3,978,262 ------------ ------------ ----------- Increase in cash and cash equivalents..... 15,718,782 326,027 37,031 Cash and cash equivalents balances: Beginning of year............................... 657,086 331,059 294,028 ------------ ------------ ----------- End of year..................................... $ 16,375,868 $ 657,086 $ 331,059 ------------ ------------ ----------- ------------ ------------ ----------- Supplemental disclosures of cash flow information: Cash paid during the year for interest.......... $ 7,768 $ 199,218 $ 16,964 Non-cash investing activities: Common stock issued for business................ $ 10,870,817 -- --
The condensed financial information should be read in conjunction with the Penn Treaty American Corporation and Subsidiaries consolidated statements and notes thereto. S-5 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant Incorporated by reference from the Company's Definitive Proxy Statement for the 1996 Annual Meeting of Shareholders. Item 11. Executive Compensation Incorporated by reference from the Company's Definitive Proxy Statement for the 1996 Annual Meeting of Shareholders. Item 12. Security Ownership of Certain Beneficial Owners and Management Incorporated by reference from the Company's Definitive Proxy Statement for the 1996 Annual Meeting of Shareholders. Item 13. Certain Relationship and Related Transactions Incorporated by reference from the Company's Definitive Proxy Statement for the 1996 Annual Meeting of Shareholders. 33 PART IV Item 14. Exhibits, Financial Statements, Schedule and Reports on Form 8-K (a) The following documents are filed as a part of this report. (1) Financial Statements.
PAGES -------- Report of Independent Accountants.................................. F-2 Consolidated Balance Sheets as of December 31, 1996 and 1995....... F-3 Consolidated Statements of Operations for the years ended December 31, 1996, 1995, and 1994................................ F-4 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, 1995, and 1994.......................... F-5 Consolidated Statements of Cash Flow for the years ended December 31, 1996, 1995, and 1994......................................... F-6-F-7 Notes to Consolidated Financial Statements......................... F-8-F-25 (2) Financial Statement Schedules. Report of Independent Accountants on Schedule...................... S-2 Schedule III--Condensed Financial Information of Registrant........ S-3-S-5
34 (3) Exhibits. 3.1 Restated and Amended Articles of Incorporation of Penn Treaty American Corporation. **** 3.1(b) Amendment to Restated and Amended Articles of Incorporation of Penn Treaty American Corporation. ***** 3.2 Amended and Restated By-laws of Penn Treaty American Corporation, as amended. ***** 4. Form of Penn Treaty American Corporation Common Stock Certificate. * 4.1 Indenture dated as of November 26, 1996 between Penn Treaty American Corporation and First Union National Bank, as trustee (including forms of Notes) (incorporated by reference to Exhibit 4.1 to Penn Treaty American Corporation's current report on Form 8-K filed on December 6, 1996). 4.3 Registration Rights Agreement dated as of November 26, 1996 by and among Penn Treaty American Corporation and Bear Stearns and Company, Inc. and Advest Inc. (incorporated by reference to Exhibit 4.3 to Penn Treaty American Corporation's current report on Form 8-K filed on December 6, 1996). 4.4 Form of Public Notes ***** 10.1 Penn Treaty American Corporation Employee Incentive Stock Option Plan. * 10.2 Penn Treaty American Corporation Agent Stock Option Plan. **** 10.3 Penn Treaty American Corporation Employees' Pension Plan. * 10.4 Reinsurance Treaty between Penn Treaty Life Insurance Company and NRG America Life Reassurance Corp. * 10.5 Assumption Agreement dated May 12, 1994 between Reassurance Company of Hannover and Penn Treaty Life Insurance Company. **** 10.6 Reinsurance Agreement between Penn Treaty Life Insurance Company and Life Insurance Company of North America, effective as of June 1, 1976. * 10.7 Personal Accident Quota Share issued to Penn Treaty Life Insurance Company by American Accident Reinsurance Group, effective as of November 23, 1982. * 10.8 Credit Life Quota Share Reinsurance Agreement between Penn Treaty Life Insurance Company and The Centennial Life Insurance Company, effective as of August 15, 1977. * 10.9 Treaty Endorsement replace The Centennial Life Insurance Company with Puritan Life Insurance Company, effective June 1, 1986. **** 10.10 Endorsement replacing Puritan Life Insurance Company with Employers Reassurance Corporation, effective as of December 31, 1986. **** 10.11 Reinsurance Agreement between Washington Square Life Insurance Company and Cologne Life Insurance Company, effective March 1, 1987. **** 10.12 Reinsurance Agreements between Penn Treaty Life Insurance Company and Cologne Life Reinsurance Company, effective October 1, 1994. **** 10.13 Reinsurance Agreements between Network America Life Insurance Company and Cologne Life Reinsurance Company, effective October 1, 1994. **** 35 10.14 Reinsurance Agreement between Penn Treaty Life Insurance Company and Transamerica Occidental Life Insurance Company, effective April 1, 1988. **** 10.15 Reinsurance Agreement between Network America Life Insurance Company and Provident Indemnity Life Insurance Company, effective January 1, 1991, as amended on November 30, 1993. **** 10.16 Quota Share Reinsurance Agreement between Network America Life Insurance Company and Life and Health Insurance Company of America, effective December 1, 1994. **** 10.17 Reinsurance Agreement between Penn Treaty Life Insurance Company and Reassurance Company of Hannover, effective January 1, 1995. **** 10.18 Administrative Services Agreement between Network America Life Insurance Company and Midland Mutual Life Insurance Company, effective June 25, 1991. **** 10.19 Administration and Agency Agreements between Penn Treaty Life Insurance Company, Network America Life Insurance Company and Tower Insurance Services, Inc. effective December 1, 1993, relating to the Quota Share Reinsurance Agreement between Network America Life Insurance Company and Life and Health Insurance Company of America, effective December 1, 1994. **** 10.20 Form of General Agent's Contract of Penn Treaty life Insurance Company. **** 10.21 Form of General Agent's Contract of Network America Life Insurance Company. **** 10.22 Form of Managing General Agency Agreement. **** 10.23 Regional General Agents' Contract dated August 1, 1971 between Penn Treaty Life Insurance Company and Irving Levit of the Irv Levit Insurance Management Corporation, as amended on August 15, 1971, May 26, 1976 and June 16, 1987, and by an undated override commissions schedule. *** 10.24 Managing General Agent's Contract dated March 10, 1988 between Penn Treaty Life Insurance Company and Ameri-Life and Health Services, Inc. **** 10.25 Commission Supplement to General Agent's Contract dated December 7, 1993 between Network America Life Insurance Company and Network Insurance. **** 36 10.26 Administrative Services Agreement dated February 14, 1995 between National Benefits Corporation and Penn Treaty Life Insurance Company and Network America Life Insurance Company. **** 10.27 Mortgage in the amount of $2,450,000 dated September 13, 1988 between Penn Treaty Life Insurance Company and Merchants Bank, N.A. ** 10.28 Amendments to Mortgage dated September 24, 1991, October 13, 1992 and September 2, 1993. **** 10.29 Loan and Security Agreement by and between Penn Treaty American Corporation and CoreStates Bank, N.A. dated December 28, 1994. **** 10.30 Investment Counseling Agreement dated May 3, 1995 between Penn Treaty American Corporation and James M. Davidson & Company. **** 10.31 Investment Counseling Agreement dated May 3, 1995 between Penn Treaty Life Insurance Company and James M. Davidson & Co. **** 10.32 Investment Counseling Agreement dated May 3, 1995 between Network America Life Insurance Company and James M. Davidson & Company. **** 11. Statement re: computation of per share earnings. 21. Subsidiaries of the Registrant. **** 24. Consent of Coopers & Lybrand, L.L.P. 27. Financial Data Schedule (b) Reports on Form 8-K:
The Company filed three reports on Form 8-K during the quarter ended December 31, 1996. On November 26, 1996, the Company filed a current report on Form 8-K pursuant to Item 5 of that form. No financial statements were filed as part of that report. On December 6, 1996, the Company filed a current report on Form 8-K pursuant to Item 5 of that form. No financial statements were filed as part of that report. On December 13, 1996, the Company filed a current report on Form 8-K pursuant to Item 5 and Item 7 of that form. No financial statements were filed as part of that report. * Incorporated by reference to the Company's Registration Statement on Form S-1 dated May 12, 1987, as amended. 37 ** Incorporated by reference to the Company's Registration Statement on Form S-1 dated November 17, 1989, as amended. *** Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989. **** Incorporated by reference to the Company's Registration Statement on Form S-1 dated June 30, 1995, as amended. ***** Incorporated by reference to the Company's Registration Statement on Form S-3 dated February 20, 1997. Executive Compensation Plans--see Exhibits 10.1 and 10.2 38 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PENN TREATY AMERICAN CORPORATION Date: March 25, 1997 By: /s/ Irving Levit -------------------------------- Irving Levit, Chairman of the Board and President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: March 25, 1997 By: /s/ Irving Levit -------------------------------- Irving Levit, Chairman of the Board and President Date: March 25, 1997 By: /s/ A.J. Carden -------------------------------- A.J. Carden, Executive Vice President and Director Date: March 25, 1997 By: /s/ Michael F. Grill -------------------------------- Michael F. Grill, Treasurer and Director Date: March 25, 1997 By: /s/ Domenic P. Stangherlin -------------------------------- Domenic P. Stangherlin, Secretary and Director Date: March 25, 1997 By: /s/ Jack D. Baum -------------------------------- Jack D. Baum, Vice President, Marketing and Director Date: March 25, 1997 By: /s/ Emile Ilchuk Emile -------------------------------- Ilchuk, Director Date: March 25, 1997 By: /s/ C. Mitchell Goldman -------------------------------- C. Mitchell Goldman, Director Date: March 25, 1997 By: /s/ Glen A. Levit -------------------------------- Glen A. Levit, Vice President, Sales and Director Date: March 25, 1997 By: /s/ John W. Mahoney -------------------------------- John W. Mahoney, Vice President, ANIC and Director 39 EX-11 2 EXHIBIT 11 Exhibit 11 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS for the years ended December 31, 1996, 1995 and 1994
1996 1995 1994 ------------ ----------- ----------- Net income.................................................. $ 12,160,347 $ 8,828,883 $ 6,762,801 Weighted average common shares outstanding.................. 7,164,782 5771558 4668834 Primary earnings per share.................................. $ 1.70 1.53 1.45 Net income.................................................. $ 12,160,347 -- -- Adjustments net of tax: Interest expense on convertible debt...................... 320,311 -- -- Amortization of debt offering costs....................... 21,642 -- -- ------------ Fully diluted net income.................................... 12,502,300 -- -- Weighted average common shares outstanding.................. 7,164,782 -- -- Common stock equivalents due to dilutive effect of stock options................................... 224,314 -- -- Shares converted from convertible debt...................... 219,028 -- -- ------------ Total outstanding shares for fully diluted earnings per share computation..................................... 7,608,124 -- -- Fully diluted earnings per share............................ $ 1.64 -- --
EX-24 3 EXHIBIT 24 Exhibit 24 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of Penn Treaty American Corporation on Form S-8 (File No. 33-38330) of our reports dated March 5, 1997 on our audits of the consolidated financial statements and financial statement schedule of Penn Treaty American Corporation as of December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994, which reports are included in this Annual Report on Form 10-K. 2400 Eleven Penn Center Philadelphia, Pennsylvania March 26, 1997 EX-27 4 EXHIBIT 27
7 12-MOS 12-MOS DEC-31-1996 DEC-31-1995 JAN-01-1996 JAN-01-1995 DEC-31-1996 DEC-31-1995 201,329,996 142,243,341 0 0 0 0 11,247,516 2,605,612 0 0 0 0 212,661,714 144,928,357 51,612,067 8,881,061 10,105,654 7,730,828 82,176,268 63,133,759 386,767,992 237,744,270 57,539,380 50,206,608 12,215 26,503 109,630,964 69,126,281 0 0 77,114,592 2,206,117 0 0 0 0 811,646 757,691 118,095,438 96,349,363 386,767,992 237,744,270 130,191,779 102,366,605 10,982,131 8,102,809 19,960 46,431 342,388 347,113 83,993,132 64,879,275 (19,042,509) (15,303,161) 59,578,288 48,848,961 17,007,347 12,437,883 4,847,000 3,609,000 12,160,347 8,828,883 0 0 0 0 0 0 12,160,347 8,828,883 1.70 1.53 1.64 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
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