-----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, UH/1shbzmk1Peeg167q0bugEjeEfuVGrmPTXxW2nczgRVgzbQYiRWDyM4B5NNaJ2 gDVEv6coQAE3FzJxxt3pyA== 0001047469-98-012480.txt : 19980331 0001047469-98-012480.hdr.sgml : 19980331 ACCESSION NUMBER: 0001047469-98-012480 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 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: SEC FILE NUMBER: 000-15972 FILM NUMBER: 98578838 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 10-K405 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, 1997 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 NASDAQ Stock Market
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, 1998 was $223,160,386. The number of shares outstanding of the registrant's common stock as of March 19, 1998 was 7,795,996. Documents Incorporated By Reference: (1) Proxy Statement for the 1998 Annual Meeting of Shareholders - Part III PART I Item 1. Business (a) General Penn Treaty American Corporation ("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") (collectively "the Insurers"). 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, 1997, long-term nursing home care and home health care policies accounted for approximately 91% of the Company's total annualized premiums in-force. On December 31, 1997, PTLIC entered an assumption reinsurance treaty with Network America, whereby Network America effectively purchased all of the premium in-force and assets and assumed all of the liabilities of PTLIC. Network America simultaneously changed its name to Penn Treaty Network America Insurance Company ("PTNA"). The Company has also filed with the Internal Revenue Service requesting a favorable ruling regarding the tax-free nature of the dividend of PTLIC common stock ownership of PTNA to the Company. Upon receipt of a favorable ruling, PTNA will become a direct subsidiary of the Company, and will no longer be a subsidiary of PTLIC. Throughout the remainder of this document, all references to Network America, whether in the present or with regard to occurences prior to December 31, 1997, are addressed as PTNA. In 1997, the Company incorporated a new direct subsidiary, American Independent Network Insurance Company of New York ("AINIC"). The Company is seeking approval from the New York Department of Insurance to license AINIC as an accident and health insurer. The Company anticipates receiving this approval in April 1998. 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. In late 1996 and throughout 1997, the Company began its introduction of its Personal Freedom policies, which provide comprehensive coverage for nursing home and home health care. The Company also introduced in late 1996 its Assisted Living policy, which, as a nursing home plan, provides enhanced benefits and includes a home health care rider. 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 4,350,000 by the end of 1995, an average of more than 23% annually since 1987. 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 2 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 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 began its introduction of its Personal Freedom policies, which provide comprehensive coverage for nursing home and home health care. The Company also introduced its Assisted Living policy, which, as a nursing home plan, provides enhanced benefits and includes a home health care rider. 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 acquisition of ANIC in 1996, 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 3 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. On December 31, 1997, PTLIC entered an assumption reinsurance treaty with Network America, whereby Network America effectively purchased all of the premium in-force, assets and liabilities of PTLIC. Network America simultaneously changed its name to Penn Treaty Network America Insurance Company. The Company has also filed with the Internal Revenue Service requesting a favorable ruling regarding the tax-free nature of the dividend of PTLIC common stock ownership of PTNA to the Company. Upon receipt of a favorable ruling, PTNA will become a direct subsidiary of the Company, and will no longer be a subsidiary of PTLIC. Senior Financial Consulatants Company, an insurance agency owned by the Company, 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, (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, 1997, approximately 91% 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. 4 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, ----------------------------------------------------------- 1995 1996 1997 ---- ---- ---- Long term nursing home care: Annualized premiums $77,217 70.3% $89,692 62.6% $121,819 67.4% Number of policies 53,084 60,874 78,137 Average premium per policy $1,455 $1,473 $1,559 Long term home health care: Annualized premiums $24,881 22.6% $38,609 26.9% $42,921 23.8% Number of policies 22,967 34,594 38,553 Average premium per policy $1,083 $1,116 $1,113 Disability insurance: Annualized premiums $0 0.0% $7,092 4.9% $7,145 4.0% Number of policies 0 16,674 46,373 Average premium per policy $0 $425 $154 Medicare supplement: Annualized premiums $3,246 3.0% $3,206 2.2% $4,248 2.4% Number of policies 2,527 2,757 4,018 Average premium per policy $1,285 $1,163 $1,057 Life insurance: Annualized premiums $3,273 3.0% $3,629 2.5% $3,567 2.0% Number of policies 5,270 6,112 6,262 Average premium per policy $621 $594 $570 Other insurance: Annualized premiums $1,267 1.2% $1,163 0.8% $1,015 0.6% Number of policies 7,161 6,509 5,827 Average premium per policy $177 $179 $174 Total annualized premiums in force (1) $109,884 100% $143,391 100% $180,715 100% Total Policies 91,009 127,520 179,170
- ------------ (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, 1995, 1996, and 1997 were approximately $453,000, $199,000 and $180,000, 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 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. 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 5 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 (in California only), and restoration of benefits. These policies also provide a yearly wellness benefit (a payment made to policyholders who have not made a claim, also available only in California), 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. All levels of nursing care, including skilled, custodial (assisted living) 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. Assisted living care generally 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 assisted living 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 also for lifetime coverage. These policies provide for a fixed daily benefit ranging from $40 to $250 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. The Company's Personal Freedom policies also provide comprehensive coverage for nursing home and home health care, offering benefit "pools of coverage" ranging from $75,000 to $250,000 total coverage, as well as lifetime coverage. 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, 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 also covering lifetime, and provide from $40 to $160 per day of home benefits. On some 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. In late 1994, the Company introduced its Independent Living policy. 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, 6 typically for a period of up to 30 days per calendar year during the term of the policy. The Company's Independent Living policies covered disclosed pre-existing conditions immediately upon policy issuance. 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 care management agency ("Care Manager") referred by the Company. The Care 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 Care Management in all of its new home health care policies. The most recent addition to the Company's long-term care product line is its Personal Freedom policy. This policy was first introduced during the fourth quarter of 1996 and is currently being marketed in those states in which regulatory approval has been received. This product is a comprehensive coverage policy, which combines long-term care and home health care insurance. When policyholders purchase this policy, with face value benefits ranging from $50,000 to unlimited coverage, they may then access up to the face amount of the policy for nursing home or home health care as needed subject to maximum daily limits. 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 six 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 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, companies 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 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. 7 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 supplement premiums represented 2.4% of the Company's annualized premiums in-force for the period ended December 31, 1997. Other Insurance. The Company also sells other insurance products including accidental death and dismemberment policies and cancer policies, of which the aggregate premiums represented 0.6% of the Company's total annualized premium in-force as of December 31, 1997. (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 1997, the Company's policies were marketed through approximately 8,000 producing agents. 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. 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 PTNA 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 PTNA in various states. In its capacity as marketing general agent and general agent, this agent accounted for 18%, 21% and 27% of the total premiums earned by the Company during 1995, 1996 and 1997, respectively. 8 General Agents. The ten independent agents accounting for the most new business premium revenue accounted for approximately 7% of the Company's new business written during 1997. No other single grouping of agents accounted for more than 10% of the Company's new premium written in 1997. 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, which is individually underwritten policies sold to an association or group. 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. 9 Markets. The following chart shows premium revenues by state for each of the states where the Company does business:
Year Ended December 31, Year ------------------------------------ State Entered (l) 1995 1996 1997 ----------- ---- ---- ---- (in thousands) Arizona 1988 $3,603 $5,284 $7,253 California 1992 9,379 17,403 23,462 Florida 1987 33,116 38,394 43,638 Georgia 1990 995 1,545 1,737 Illinois 1990 4,084 5,160 7,771 Iowa 1990 1,459 1,805 2,081 Maryland 1987 1,969 2,441 2,314 Michigan 1989 1,123 2,460 3,463 Missouri 1990 2,540 2,673 2,809 Nebraska 1990 1,222 1,538 2,130 North Carolina 1990 2,046 3,074 4,334 Ohio 1989 2,989 3,682 4,428 Pennsylvania 1972 19,680 22,056 24,420 South Dakota 1990 1,487 1,845 2,269 Texas 1990 2,887 3,550 3,809 Virginia 1989 7,903 10,532 12,426 Washington 1993 1,165 2,147 2,727 All Other States (2) 5,843 7,063 16,610 -------- -------- -------- All States $102,367 $132,652 $167,681 ======== ======== ========
- ---------- (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 1997. (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 10 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 disclosed on the application for new long-term nursing home care and most home health 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. In addition, the Company's Independent Living policies immediately cover all disclosed pre-existing conditions. 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 a physician and nurses employed or retained as consultants by the Company. The Company has historically utilized third party administrators to process its Medicare supplement claims due to the typically small benefit 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 Care Managers to review certain claims, particularly those made under home health care policies. When a claim is filed, the Company may engage the Care 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 Care 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 Care Manager. The Company estimates that approximately 95% of all new home health care claims submitted in the last year have been submitted to Care Managers. The Company anticipates that this usage will continue as both its business and the need to manage effectively the processing of claims grow. In 1997, the Company created and staffed an in-house Care Management unit. This in-house unit conducts the full range of care management services, which were previously provided exclusively by subcontractors. The Company intends to develop this unit as it believes it can meet many of its care management needs more effectively and with less expense than by relying on third party vendors. 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. Throughout 1997, the Company continued 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 the new system to be fully operational by the end of 1998. 11 The Company will continue to utilize its current system in an enhanced mode, until the more-efficient application is installed. Many computer systems are reliant upon a two-digit field in determining the year for software applications involving dates. This use of a two-digit field presents difficulty for computers and application programs in differentiating between the year 1900 and 2000. The Company is in process of replacing its computer application systems with new systems which are year 2000 compliant. The Company is also changing its current systems to a four digit date field to avoid any potential year 2000 problems prior to its conversion to new systems. The Company does not expect that year 2000 compliance will have a material impact on its financial condition or results of operations. Non-compliance could have an adverse effect on the operations of the Company. (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. 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 "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, 12 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 National Association of Insurance Commissioners ("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-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 PTNA 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 PTNA to Life and Health Insurance Company of America ("Life and Health") (A.M. Best rating B-). 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 PTNA have structured their agreement with Life and Health to require maintenance of securities in escrow for PTLIC and PTNA 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 PTNA's related statutory reserve credits as of December 31, 1997, which were approximately $459,000. The policies subject to this fronting arrangement are being marketed in six states to federal employees. Premium ceded under this agreement totaled $943,500, $882,465 and $779,162 in 1995, 1996 and 1997, respectively. In January 1991, PTNA entered into another fronting arrangement under which PTNA ceded 100% of certain whole life and deferred annuity policies to Provident Indemnity Life Insurance Company ("Provident 13 Indemnity"), (A.M. Best rating B). No new policies have been ceded under this arrangement since December 31, 1995. PTNA has structured its agreement with Provident Indemnity to require maintenance of securities in escrow for PTNA in an amount at least equal to its statutory reserve credit. The value of these escrowed securities, which consist of U.S. Government bonds, exceeds PTNA's related statutory reserve credit as of December 31, 1997 of approximately $3,700,000. 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 $14,169,000, $12,121,000 and $10,562,000 for 1995, 1996 and 1997, 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, 1997 were approximately $1,484,000. Effective January 1998, no new policies will be reinsured under this treaty. In May 1991, PTNA 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). PTNA assumed the obligations as insurer for all policies in force as of that date. PTNA received cash totaling $1,512,300, net of $513,500 as consideration for the sale. Under this agreement, PTNA assumed a reinsurance treaty under which 66% of the premiums assumed are, in turn, ceded by PTNA to a third party reinsurer. The total accident and health premiums ceded under this treaty amounted to $1,174,792 in 1995, $1,081,380 in 1996 and $1,001,730 in 1997. On December 28, 1990, PTNA entered into a reinsurance agreement with Midland Mutual Life Insurance Company (A.M. Best rating A-) under which PTNA acquired approximately 3,100 nursing home policies in 22 states with an annualized premium of approximately $3,000,000. The Company recognized $1,768,467 of premium related to this acquisition in 1995, $1,661,725 in 1996 and $1,550,667 in 1997. 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. 14 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, 1997.
December 31, 1997 ------------------- Rating Amount Percent ------ ------- (Dollar amounts in thousands) U.S. Treasury and U.S. Agency securities $167,856 60.3% Aaa or AAA 43,888 15.8% Aa or AA 28,471 10.2% A 35,566 13.1% Other 1,367 0.5% -------- ------ Total $278,148 100.0% ======== ======
As of December 31, 1997, over 92.2% of the Company's total investments were fixed income debt securities, 60.3% 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, 1997, substantially 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 12 years of the date of the purchase. At December 31, 1997, 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 1997, the Company expanded its common stock investments to approximately 7.8% of its total investments. During March 1998, the Company sold its entire equity securities portfolio, or approximately $21,000,000 of invested assets. From this sale, the Company recognized an approximate $6,5000,000 capital gain, which is reportable in the first quarter of 1998. The Company intends to limit its common stock investments to 10% 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.
Investment Portfolio 1995 1996 1997 -------- -------- -------- Year Ended December 31, ----------------------- (Dollar amounts in thousands) Average balance of investments, cash and cash equivalents during the period (at cost) $125,524 $174,422 $284,323 Net investment income 8,103 10,982 17,009 Average yield on investments 6.5% 6.3% 6.0%
The Company's declining yield is reflective of lower market interest rates, increased equity securities investments, and increased purchases of tax-exempt investments. 15 (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 "Government Regulation".
Year ended December 31, ----------------------- 1995 1996 1997 ---- ---- ---- Loss ratio (1) 56.1% 61.5% 70.9% Expense ratio (2) 50.4 48.7 57.9 ----- ----- ----- Combined loss and expense ratio 106.5 110.2 128.8 Persistency (3) 77.4 79.9 83.1
--------------- (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 and 1997 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 1997, 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. In addition, the Company added approximately $12,000,000 to this reserve as a result of its reassessment of assumptions utilized in the actuarial determination of reserves for current claims liabilities and incurred but unreported liabilities for nursing home and home health care claims. The Company reviewed the assumptions underlying its reserves in connection with its recent employment of a new long-term care consulting actuary. The review encompassed certain actuarial assumptions related to the Company's products' benefit utilization and duration. 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 capital position of the Insurers was improved further by the contribution of $14,000,000 of the net proceeds of a public offering of common stock 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 PTNA. In December 1996, the Company contributed $20,000,000, $20,000,000 and $5,000,000 to the capital and surplus of PTLIC, PTNA, and ANIC, respectively, from the proceeds of its $74,750,000 convertible subordinated debt offering in November 1996. 16 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 PTNA 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 PTNA 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, where the Company has formed a subsidiary and is seeking approval to operate as an insurer. 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 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 17 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 PTNA for the five year period ended December 31, 1994 and had no recommendations for either PTLIC or PTNA. 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 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 18 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 1993. As of December 31, 1997, the risk-based capital of PTLIC, PTNA and ANIC were 659% , 682%, and 329% 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. The Company believes that its new policies are in compliance with the Model Act. 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 PTNA 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 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 19 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 returned 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. The Company is in compliance with all such regulations. 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 for the Internal Revenue Service. 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. Periodically, 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 enacted by 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. 20 (m) Employees As of December 31, 1997, the Company had approximately 253 full-time employees (not including independent agents), 168 of whom are employed in the Company's home office. Of those employees in the Company's home office, 34 are employed in various administrative services, 28 in sales, 34 in underwriting, 18 in accounting, nine in compliance, 25 in claims, 16 in an executive capacity, and four in systems. The Company had approximately 36 full-time employees employed in the Florida field office as of December 31, 1997. Of the Florida employees, 27 are employed in underwriting and administrative services and nine are employed in marketing. As of December 31, 1997, the Company had 24 employees in its California office and had 25 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 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. The warehouse is currently used for storage and houses the Company's printing equipment. 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, 1997 to a vote of security holders. 21 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 NASDAQ Stock Market ("NASDAQ") under the symbol PTAC. The transfer agent and registrar for the Company's Common Stock is First Union National Bank of Charlotte, North Carolina. As of March 19, 1998 the Company had 7,795,996 shares of Common Stock outstanding, held by approximately 429 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 ---- --- 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 1997 First Quarter 29 1/2 24 3/4 Second Quarter 30 7/8 23 7/8 Third Quarter 35 1/2 29 1/2 Fourth Quarter 34 1/2 28 3/4
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 PTNA. The payment of dividends by PTLIC, ANIC and PTNA, 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 and Standard & Poor's. 22 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, 1993, 1994, 1995, 1996 and 1997, 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, ----------------------------------------------------------------- 1993 1994 1995 1996 1997 --------- --------- --------- --------- --------- (in thousands, except per share data and ratios) Statement of Operations Data: Revenues: Accident and health: First year premiums $ 25,836 $ 26,968 $ 36,770 $ 46,346 $ 55,348 Renewal premiums 43,615 52,237 62,402 80,311 108,794 Life: First year premiums 361 2,149 1,701 1,457 1,056 Renewal premiums 169 481 1,494 2,077 2,483 --------- --------- --------- --------- --------- Total premiums 69,981 81,835 102,367 130,192 167,681 Investment income, net 4,979 5,946 8,103 10,982 17,009 Net realized gains (losses) 182 8 46 20 1,417 Other income 321 305 347 342 417 --------- --------- --------- --------- --------- Total revenues 75,463 88,094 110,863 141,536 186,524 Benefits and expenses: Benefits to policyhholders 40,829 48,757 64,879 83,993 123,865 First year commissions 16,722 19,365 26,223 30,772 37,834 Renewal commissions 7,060 7,866 10,128 12,533 17,406 Net acquisition costs deferred (2) (6,640) (7,643) (15,303) (19,043) (28,294) General and administrative expenses 9,350 10,262 12,171 15,648 20,614 Interest expense 184 162 327 625 4,804 --------- --------- --------- --------- --------- Total benefits and expenses 67,505 78,769 98,425 124,529 176,230 --------- --------- --------- --------- --------- Income before federal income taxes 7,958 9,325 12,438 17,008 10,294 Provision for federal income taxes 2,137 2,562 3,609 4,847 2,695 --------- --------- --------- --------- --------- Net income $ 5,821 $ 6,763 $ 8,829 $ 12,161 $ 7,599 ========= ========= ========= ========= ========= Basic earnings per share (1) $ 1.24 $ 1.45 $ 1.53 $ 1.70 $ 1.01 ========= ========= ========= ========= ========= Diluted earnings per share (1) $ 1.24 $ 1.44 $ 1.51 $ 1.66 $ 0.98 ========= ========= ========= ========= ========= Weighted average shares outstanding (3) 4,689 4,669 5,772 7,165 7,540 Diluted shares outstanding (1) 4,697 4,687 5,842 7,528 7,758 GAAP Ratios: Loss ratios 58.3% 59.5% 63.4% 64.5% 73.9% Expense ratio 38.1% 36.7% 32.8% 31.1% 31.2% --------- --------- --------- --------- --------- Total 96.4% 96.2% 96.2% 95.6% 105.1% ========= ========= ========= ========= ========= Selected Statutory Data: Net premiums written $ 69,898 $ 81,878 $ 102,145 $ 133,950 $ 167,403 Statutory surplus (beginning of period) $ 12,301 $ 17,256 $ 21,067 $ 38,148 $ 81,795 Ratio of net premiums written to statutory surplus 5.7x 4.7x 4.8x 3.5x 2.0x Balance Sheet Data: Total investments $ 77,891 $ 91,490 $ 144,928 $ 212,662 $ 301,786 Total assets 136,948 164,346 237,744 386,768 465,770 Total debt 2,516 6,372 2,206 77,115 76,752 Total liabilities 85,599 108,903 140,637 267,861 333,015 Shareholders' equity (4) 51,349 55,444 97,107 118,907 132,775 Book value per share (3)(4) $ 11.00 $ 11.87 $ 13.93 $ 15.83 $ 17.53
23 (1) The Company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share," which requires retroactive restatement of basic and diluted earnings per share. (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. For a discussion of the impact of this change on shareholders' equity, see "Management's Discussion and Analysis of Financial Condition-Liquidity and Capital Resources." 24 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, 1995, 1996 and 1997, expressed as a percentage of total revenues.
Year Ended December 31, ------------------------------ 1995 1996 1997 ----- ----- ----- Statement of Operations Data: Revenues: Accident and health: First year premiums 33.2% 32.7% 29.7% Renewal premiums 56.3% 56.7% 58.3% Life: First year premiums 1.5% 1.0% 0.6% Renewal premiums 1.3% 1.5% 1.3% ----- ----- ----- Total premiums 92.3% 91.9% 89.9% Investment income, net 7.4% 7.9% 9.1% Net realized gains (losses) 0.0% 0.0% 0.8% Other income 0.3% 0.2% 0.2% ----- ----- ----- Total revenues 100.0% 100.0% 100.0% Benefits and expenses: Benefits to policyholders 58.5% 59.3% 66.4% First year commissions 23.7% 21.7% 20.3% Renewal commissions 9.1% 8.9% 9.3% Net policy acquisition costs deferred -13.8% -13.5% -15.2% General and administrative expense 11.0% 11.1% 11.1% Interest expense 0.3% 0.4% 2.6% ----- ----- ----- Total benefits and expenses 88.8% 88.0% 94.5% ----- ----- ----- Income before federal income taxes 11.2% 12.0% 5.5% Provision for federal income taxes 3.2% 3.4% 1.4% ----- ----- ----- Net income 8.0% 8.6% 4.1% ===== ===== =====
25 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 1996, the Company introduced its Personal Freedom Plan and Assisted Living Plan. Both plans are designed to provide comprehensive nursing home and home health care coverage. Long-term nursing home care and home health care policies accounted for approximately 91% of the Company's total annualized premiums in force as of December 31, 1997 and approximately 82% of its consolidated revenues for 1997. 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. However, 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. 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. As of December 31, 26 1997, approximately 7.8% of the Company's invested assets were committed to high quality large capitalization common stocks. During March, 1998, the Company sold its entire equity securities portfolio, or approximately $21,000,000 of invested assets. From this sale, the Company recognized an approximate $6,500,000 capital gain, which will be included in its first quarter 1998 results. 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. 27 Results of Operations Quarterly Data The unaudited quarterly data for the Company for each quarter of 1996 and 1997 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 1996 and 1997.
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 (basic) $ 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%
1997 -------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (in thousands, except per share data and ratios) Accident and health premiums $ 38,816 $ 40,081 $ 41,533 $ 43,712 Life premiums 894 981 908 756 Total premiums 39,710 41,062 42,441 44,468 Investment income, net 3,893 4,103 4,585 4,428 Net realized capital gains and losses and other income 128.8 212 900 593.3 Total revenues 43,732 45,377 47,926 49,489 Benefits to policyholders 25,303 31,556 29,510 37,495 Commissions & expenses 17,874 18,624 19,491 19,865 Net policy acquisition costs deferred (5,492) (11,282) (8,187) (3,333) Net income $ 3,448 $ 3,730 $ 4,173 ($ 3,749) Net income per share (basic) $ 0.46 $ 0.50 $ 0.55 -$0.50 GAAP loss ratio 63.7% 76.8% 69.5% 84.3% GAAP expense ratio 34.2 20.8 29.4 39.9 Total 97.9% 97.6% 98.9% 124.2%
28 Twelve Months Ended December 31, 1997 and 1996 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, 1997, increased 22.8% to $54,135,630, compared to $44,071,649 in 1996. First year long-term care premiums in 1997 increased 21.3% to $52,747,317, compared to $43,478,707 in 1996. The Company attributes its growth to continued improvements in product offerings, which competitively meet the needs of the long term care marketplace. In addition, the Company actively recruits and trains agents to sell its products. Management believes that it is no longer relevant to measure separate growth for nursing home and home health care policies given the Company's sale of comprehensive coverage plans and plans with attached riders. First year Medicare supplement premiums earned by the Company in 1997 increased to $1,388,313 from $592,083 in 1996. The Company uses Medicare supplement products as a marketing tool to compliment its other long-term care offerings. Renewal accident and health premiums earned by the Company in 1997 increased 28.5% to $103,184,695, compared to $80,311,319 in 1996. Renewal long-term care premiums in 1997 increased 29.5% to $100,673,867, compared to $77,734,271 in 1996. This increase reflects higher persistency and growth of in-force premiums. Renewal Medicare supplement premiums earned by the Company in 1997 decreased 2.6% to $2,510,828, compared to $2,577,048 in 1996. 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 $6,821,784 during 1997, up from $2,274,442 recognized in 1996. Due to the accounting of the ANIC acquisition as a purchase, only four months of 1996 income and expense were recognized by the Company. Life Premiums. First year life premiums earned by the Company decreased 27.5% to $1,055,873, in 1997, compared to $1,457,044 in 1996. The Company's life business has remained stable as the Company is focusing its marketing efforts on its long-term care products. Renewal life premiums in 1997 increased to $2,482,542, compared to $2,077,325 in 1996. This increase was primarily the result of renewals of first-year policies written in 1996. Net Investment Income. Net investment income earned by the Company for 1997 increased 54.9% to $17,008,955 from $10,982,131 for 1996. This increase was primarily the result of growth in the Company's investment assets due to continued premium growth, and additional funds of approximately $72,000,000 obtained from the issuance of convertible debt late in 1996. The Company recognized $1,416,659, of capital gains in 1997 due primarily to its desire to bolster investment earnings, which are reduced by the Company's investments in equity securities. Fixed income levels are lower from dividends received rather than interest from bonds. During March 1998, the Company sold its entire equity securities portfolio, or approximately $21,000,000 of invested assets. From this sale, the Company recognized an approximate $6,5000,000 capital gain, which is reportable in the first quarter of 1998. Benefits to Policyholders. Benefits to policyholders in 1997 increased 47.5% to $123,865,143, compared to $83,993,132 in 1996, including ANIC expenses of $2,846,272. Accident and health benefits to policyholders in 1997 increased 45.3% to $118,942,408 compared to $81,860,045 in 1996. The Company's accident and health loss ratio was 75.6% in 1997, compared to 64.9% in 1996. The increase in the Company's loss ratio is attributable in part to the impact of improved persistancy upon the reserves held for future anticipated losses. In addition, the Company added approximately $12,000,000 to this reserve as a result of its reassessment of assumptions utilized in the actuarial determination of reserves for current claims liabilities and incurred but unreported liabilities for nursing home and home health care claims. The Company reviewed the assumptions underlying its reserves in connection with its recent employment of a new long-term care consulting actuary. The review encompassed certain actuarial assumptions related to the Company's products' benefit utilization and duration. During 1997, expenses for care management services of approximately $1,041,000 were classified as benefits to policyholders. The Company utilizes care management services in order to attempt to reduce overall claims expense. In 1996, the Company included approximately $450,000 of care management expenses as general and administrative expenses. Had this expense been classified as benefits to policyholders during 1996, the total 1996 loss ratio would have increased by .35% of premiums to 64.9%. The ANIC loss ratio was 41.7% in 1997 and 47.4% in 1996. 29 Life benefits to policyholders, including paid claims and reserve increases, in 1997 decreased to $2,076,463, compared to $2,133,087 for 1996. The life loss ratio was 58.7% in 1997, compared to 60.4% in 1996. Commissions. Commissions to agents increased 27.6% to $55,240,438 in 1997 compared to $43,305,148 in 1996. Included are ANIC commissions on long-term disability policies, which generated $1,251,476 of expenses in 1997. First year commissions on accident and health business in 1997, excluding ANIC, increased 23.9% to $36,240,021, compared to $29,243,102 in 1996, 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 66.9% in 1997 and 66.4% in 1996. First year commissions on life business in 1997 decreased 18.9% to $878,961, compared to $1,083,892 in 1996, directly reflecting the Company's reduction in first year life premiums. The ratio of first year life commissions to first year life premiums was 83.2% in 1997 compared to 74.4% in 1996 due to an increase in single premium policies sold. Renewal commissions on accident and health business in 1997 increased 34.7% to $16,580,473, compared to $12,312,521 in 1996, 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 16.1% in 1997 and 15.4% in 1996. 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 1997 increased 48.6% to $28,294,358 compared to $19,042,509 in 1996, primarily due to an increase in policyholder persistency used in the establishment of deferred acquisition cost reserve factors. The result of higher persistency incorporated into reserve factors is lengthier amortization of expenses and reduced net expenses in earlier periods. 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 1997 increased 31.7% to $20,613,908, compared to $15,647,715 in 1996. ANIC expenses accounted for $2,317,068 in 1997, which includes the amortization of goodwill and the present value of future profits. In addition, the Company recognized approximately $400,000 in non-recurring settlement charges in 1997 due to the consolidation of certain ANIC operations at the Company headquarters. The settlement charges stemmed from severance costs, contract terminations and movement of operations. General and administrative expenses, excluding goodwill and convertible debt cost amortization, as a percentage of revenues were 11.9% in 1997, compared to 12.5% in 1996, which is due in part to the inclusion of approximately $450,000 of care management expenses in general and administrative expense in 1996 (.39% of premiums). Economies of scale achieved in 1997 were offset by ANIC consolidation charges and additional actuarial, compliance and legal fees associated with the duplicate filings of tax qualified plans in many states. Net Income. Net income of $7,598,580 (including a contribution of $2,013,569 from ANIC) for 1997 was $4,561,767 or 37.5% below 1996 income of $12,160,347. Net income includes income tax provisions of $2,695,435 and $4,847,000, for the 1997 and 1996 periods, respectively. Income before federal income taxes decreased in 1997 by $6,713,332 or 39.5% to $10,294,015. This decrease was primarily attributable to the addition of approximately $12,000,000 to the Company's pending claim reserves as discussed in "Benefits to Policyholders." The Company made a 1997 provision for federal income taxes of $2,695,435 reflecting an effective rate of 26.2%, as compared to an effective 1996 tax rate of 28.5%. 30 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 policyholders 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 Care Manager. See "Business-Claims." Management believes that this acceleration of reported claims was completely recognized by the end of 1996. During 1996, expenses for care management services of approximately $450,000 were classified as general and administrative expenses. The Company utilizes care management services in order to reduce overall 31 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. Life benefits to policyholders in 1996 increased to $2,133,087, compared to $1,704,207 for 1995. The life loss ratio was 60.4% in 1996, compared to 53.3% 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 care 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 care 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%. 32 New Accounting Principles In February 1997, the Financial Accounting Standards Board ("FASB") 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." SFAS 128 prescribes that for all financial statements with effective dates after December 31, 1997, 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. Prior year per share amounts must also be restated if applicable. Basic earnings per share for 1995 and 1996 are unaffected by this change, however, diluted earnings per share are reported for 1995, which was not previously reported. Also, diluted earnings per share for 1996 is increased $.02 from previously reported fully diluted earnings per share due to the use of the average market price of Company shares in utilizing the treasury stock methodology to account for the dilutive nature of outstanding stock options. SFAS 128, however, prescribes that if the components of diluted earnings per share are anti-dilutive, then diluted earnings per share will not differ from basic earnings per share. In 1997, the Company reported basic and diluted earnings per share of $1.01 and $.98, respectively. Since the exclusion of the impact of interest expense from the Company's convertible debt would be anti-dilutive, the future anticipated conversion of the debt into additional shares is not included in the calculation of diluted earnings per share. The Company anticipates that approximately 2,600,000 additional shares will be issued in the future for the conversion of debt. However, the Company also expects that approximately $3,550,000 of annual after-tax interest expense due to this convertible debt would be excluded from the diluted earnings per share calculation. The FASB recently issued Statement 130, "Reporting Comprehensive Income," which requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. While not mandating a specific financial statement format, Statement 130 requires that an amount representing total comprehensive income be reported for fiscal years beginning after December 15, 1997. 33 Restatement for earlier years is required for comparative purposes. The Company anticipates no material effect on its financial condition or results of operations due to the adoption of Statement 130. The FASB also issued Statement 131, "Disclosures about Segments of an Enterprise and Related Information." This Statement, which supersedes Statement 14, Financial Reporting for Segments of a Business Enterprise, changes the way public companies report information about segments. The Statement, which is based on the management approach to segment reporting, includes requirements to report selected segment information quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues. The Statement is effective for periods beginning after December 15, 1997. Restatement for earlier years is required for comparative purposes unless impracticable. Statement 131 need not be applied to interim periods in the initial year; however, in subsequent years, interim period information must be presented on a comparative basis. The Company believes that the adoption of Statement 131 will not have a material impact on its financial condition or results of operations. In 1998, the FASB issued Statement 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revises employers disclosures about pension and other postretirement benefits. The Company expects that the adoption of Statement 132 will have no material impact on its financial condition or results of operations. Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments" (SOP 97-3) was issued by the American Institute of Certified Public Accountants in December 1997 and provides guidance for determining when an insurance or other enterprise should recognize a liability for guaranty-fund assessments and guidance for measuring the liability. The statement is effective for 1999 financial statements with early adoption permitted. The Company does not expect adoption of this statement to have a material effect on its financial position or results of operations. Impact of the Year 2000 on Information Systems. Many computer systems are reliant upon a two-digit field in determining the year for software applications involving dates. This use of a two-digit field presents difficulty for computers and application programs in differentiating between the year 1900 and 2000. The Company is in process of replacing its computer application systems with new systems which are year 2000 compliant. The Company is also changing its current systems to a four digit date field to avoid any potential year 2000 problems prior to its conversion to new systems. The Company does not expect that year 2000 compliance will have a material impact on its financial condition or results of operations. Non-compliance could have an adverse effect on the operations of the Company. 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, investment income and maturities of investments. 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." 34 The Company's cash flows are attributable to cash provided by operations, cash used in investing, and cash provided by financing. The Company's cash decreased by approximately $40,000,000 in 1997 primarily due to the purchase of approximately $134,000,000 in bonds, which more than offset cash from operations and approximately $44,000,000 in proceeds from the sale of bonds. The major provider of cash from operations was additions to reserves of approximately $59,000,000 in 1997. Cash increased in 1996 by approximately $43,000,000, which was primarily due to approximately $72,000,000 in proceeds from the Company's convertible debt issuance. This increase, coupled with approximately $31,000,000 provided by operations, was more than sufficient to provide for approximately $93,000,000 of bond and equity purchases in 1996. Cash increased in 1995 by approximately $2,000,000, primarily due to approximately $26,000,000 provided by the Company's common stock offering. These funds and cash from operations of approximately $24,000,000 were used to purchase approximately $54,000,000 in bonds. 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. At December 31, 1997, the average maturity of the Company's bond portfolio was 5.8 years, and its market value represented approximately 102.5% of its cost, with a current unrealized gain of $6,832,967. Its equity portfolio exceeded cost by $5,042,112 at December 31, 1997. The Company's equity portfolio exceeded cost by $1,604,604 in 1996 and $503,083 in 1995. On December 31, 1996, the average maturity of the Company's bond portfolio was 5.3 years, and its market value exceeded its cost by approximately $1,821,387 or .9% of its cost. On December 31, 1995, the average maturity of the Company's portfolio was 6.4 years and its market value exceeded cost by 4.1% or approximately $5,643,000. In July 1995, the Company consummated a public offering of 2,300,000 shares of common stock, from which it realized net proceeds of approximately $22,000,000, including the proceeds from the exercise of the underwriters' over-allotment option. As of December 31, 1997, shareholders' equity was increased by $7,837,550 due to unrealized gains of $11,875,079 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. 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. 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. 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. The capital position of PTLIC and PTNA was 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 PTNA 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 PTNA. In December, 1996, the Company contributed $20,000,000, $20,000,000, and $5,000,000 to the surplus of PTLIC, PTNA and ANIC, respectively, from the proceeds of the convertible subordinated debt. The remaining funds were retained at the parent level in order to service the future interest payments on the debt. 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 consists of the Insurers and a non-insurer parent company, Penn Treaty American Corporation ("the Parent"). The Parent directly or indirectly controls 100% of the voting stock of the 35 subsidiary insurers. In the event the Parent is unable to meet its financial obligations, becomes insolvent, or discontinues operations, the Insurers' financial condition and results of operations could be materially affected. The Parent currently has the obligation of making semi-annual interest payments attributable to the Company's convertible debt. In that the dividend ability of the subsidiaries is restricted, the Parent must rely on its own liquidity and cash flows to make all required interest installments. Management believes that the Parent holds sufficient liquid funds to meet its obligations for the foreseeable future. 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 its most recent stock offering, the Company's issuance of convertible subordinated debt 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. SOME OF THE INFORMATION PRESENTED IN THIS FILING CONSTITUTE FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SEUCRITIES LITIGATION REFORM ACT OF 1995. ALTHOUGH THE COMPANY BELEIVES THAT ITS EXPECTATIONS ARE BASED ON REASONABLE ASSUMPTIONS WITHIN THE BOUNDS OF ITS KNOWLEDGE OF ITS BUSINESS AND OPERATIONS, THERE CAN BE NO ASSURANCE THAT ACTUAL RESULTS OF THE COMPANY'S OPERATIONS WILL NOT DIFFER MATERIALLY FROM ITS EXPECTATIONS. FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER FROM EXPECTATIONS INCLUDE, AMONG OTHERS, THE ADEQUACY OF THE COMPANY'S LOSS RESERVES, THE COMPANY'S ABILITY TO QUALIFY NEW INSURANCE PRODUCTS, THE COMPANY'S ABILITY TO COMPLY WITH GOVERNMENT REGULATIONS, THE ABILITY OF SENIOR CITIZENS TO PURCHASE THE COMPANY'S PRODUCTS IN LIGHT OF THE INCREASING COSTS OF HEALTH CARE AND THE COMPANY'S ABILITY TO EXPAND ITS NETWORK OF PRODUCTIVE INDEPENDENT AGENTS. 36 Item 7A. Quantatative and Qualitative Disclosures Amount Market Risks Not applicable. Item 8. Financial Statements and Supplementary Data 37 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Pages ----- Report of Independent Accountants F-2 Financial Statements: Consolidated Balance Sheets as of December 31, 1997 and 1996 F-3 Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995 F-4 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995 F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 F-6 Notes to Consolidated Financial Statements F-7-F-24 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, 1997 and 1996, 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, 1997. 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, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. 2400 Eleven Penn Center Philadelphia, Pennsylvania March 11, 1998 F-2 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets as of December 31, 1997 and 1996
1997 1996 ---- ---- ASSETS Investments: Bonds, available for sale at market, (amortized cost $271,315,125 and $199,508,579, respectively) $ 278,148,092 $ 201,329,966 Equity securities at market value, (cost of $18,511,470 and $9,642,912, respectively) 23,553,582 11,247,516 Policy loans 84,757 84,232 ------------- ------------- Total investments 301,786,431 212,661,714 Cash and cash equivalents 11,240,925 51,612,067 Property and equipment, at cost, less accumulated depreciation of $2,399,107 and $2,205,407, respectively 8,752,509 8,092,028 Unamortized deferred policy acquisition costs 110,470,626 82,176,268 Receivables from agents, less allowance for uncollectable amounts of $130,000 and $231,000, respectively 1,106,908 1,543,382 Accrued investment income 4,112,114 3,581,077 Federal income tax recoverable 1,181,709 175,219 Cost in excess of fair value of net assets acquired, less accumulated amortization of $715,913 and $389,203, respectively 6,661,630 6,042,786 Present value of future profits acquired 3,596,667 4,011,668 Receivable from reinsurers 10,542,275 10,105,654 Other assets 6,318,292 6,766,129 ------------- ------------- Total assets $ 465,770,086 $ 386,767,992 ============= ============= LIABILITIES Policy reserves: Accident and health $ 139,962,685 $ 101,119,912 Life 8,116,565 8,523,267 Policy and contract claims 78,141,574 57,539,380 Accounts payable and other liabilities 6,192,353 4,768,441 Long-term debt 76,752,063 77,114,592 Deferred income taxes 23,849,502 18,795,316 ------------- ------------- Total liabilities 333,014,742 267,860,908 ------------- ------------- 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; 25,000,000 and 10,000,000 shares authorized, 8,177,529 and 8,116,464 shares issued 817,752 811,646 Additional paid-in capital 53,194,134 52,526,956 Net unrealized appreciation of securities 7,837,550 2,261,154 Retained earnings 72,611,782 65,013,202 ------------- ------------- 134,461,218 120,612,958 Less 605,629 common shares held in treasury, at cost (1,705,874) (1,705,874) ------------- ------------- 132,755,344 118,907,084 ------------- ------------- Total liabilities and shareholders' equity $ 465,770,086 $ 386,767,992 ============= =============
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, 1997, 1996 and 1995
1997 1996 1995 ---- ---- ---- Revenue: Accident and health premiums $ 164,142,109 $ 126,657,410 $ 99,171,903 Life premiums 3,538,415 3,534,369 3,194,702 ------------- ------------- ------------- 167,680,524 130,191,779 102,366,605 Net investment income 17,008,955 10,982,131 8,102,809 Net realized capital gains 1,416,659 19,960 46,431 Other income 416,935 342,388 347,113 ------------- ------------- ------------- 186,523,073 141,536,258 110,862,958 Benefits and expenses: Benefits to policyholders 123,865,143 83,993,132 64,879,275 Commissions 55,240,438 43,305,148 36,351,140 Net policy acquisition costs deferred (28,294,358) (19,042,509) (15,303,161) General and administrative expenses 20,613,908 15,647,715 12,170,913 Interest expense 4,803,927 625,425 326,908 ------------- ------------- ------------- 176,229,058 124,528,911 98,425,075 ------------- ------------- ------------- Income before federal income taxes 10,294,015 17,007,347 12,437,883 Provision for federal income taxes 2,695,435 4,847,000 3,609,000 ------------- ------------- ------------- Net Income $ 7,598,580 $ 12,160,347 $ 8,828,883 ===================================================== Basic earnings per share $ 1.01 $ 1.70 $ 1.53 Diluted earnings per share $ 0.98 $ 1.66 $ 1.51 Weighted average number of shares outstanding 7,540,354 7,164,782 5,771,558 Weighted average number of shares outstanding (Diluted) 7,757,936 7,528,071 5,841,901
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, 1997, 1996 and 1995
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, 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 acquisi- tion 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 Net income 7,598,580 7,598,580 Change in net unrealized gains on investments 5,576,396 5,576,396 Exercised options proceeds 61,065 6,106 667,178 673,284 -------------------------------------------------------------------------------------------------- Balance, December 31, 1997 8,177,529 $ 817,752 $ 53,194,134 $ 7,837,550 $72,611,782 $(1,705,874) $132,755,344 ==================================================================================================
See accompanying notes to consolidated financial statements. F-5 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ---- ---- ---- Net cash flow from operating activities: Net income $ 7,598,580 $ 12,160,347 $ 8,828,883 Adjustments to reconcile net income to cash provided by operations: Amortization of intangible assets 693,164 325,987 35,760 Deferred income taxes 2,181,497 3,095,000 2,726,032 Depreciation expense 467,848 375,092 353,589 Net realized capital (gains) losses (1,416,659) (19,960) (46,431) Increase (decrease) due to change in: Receivables from agents 436,474 (267,901) (126,917) Receivable from reinsurers (436,621) (904,238) (1,205,581) Policy acquisition costs, net (28,294,358) (19,042,509) (15,303,161) Policy and contract claims 20,602,194 6,885,661 8,862,180 Policy reserves 38,436,071 29,844,074 20,097,887 Accounts payable and other liabilities 1,423,912 1,207,846 543,209 Federal income tax recoverable (1,006,490) (175,219) 481,799 Federal income tax payable -- (183,249) 183,249 Accrued investment income (531,037) (963,477) (808,701) Other, net (458,610) (1,070,083) (512,600) ------------- ------------- ------------- Cash provided by operations 39,695,965 31,267,371 24,109,197 Cash flow from (used in) investing activities: Acquisition of business, net of cash received -- (1,218,204) -- Proceeds from sales of bonds 44,080,109 16,684,028 5,356,956 Proceeds from sales of equity securities 3,436,251 303,560 -- Maturities of investments 18,862,880 18,571,559 5,421,112 Purchase of bonds (134,198,812) (85,092,419) (53,912,071) Purchase of equity securities (11,429,961) (7,953,520) -- Acquisition of property and equipment (1,128,329) (2,110,844) (1,219,810) ------------- ------------- ------------- Cash used in investing (80,377,862) (60,815,840) (44,353,813) Cash flow from (used in) financing activities: Proceeds from stock offering -- -- 26,065,000 Proceeds from convertible debt offering -- 72,207,500 -- Proceeds from excercise of stock options 673,284 563,500 -- Repayments of long-term debt (362,529) (491,525) (4,166,092) ------------- ------------- ------------- Cash provided by financing 310,755 72,279,475 21,898,908 ------------- ------------- ------------- (Decrease) increase in cash and cash equivalents (40,371,142) 42,731,006 1,654,292 Cash balances: Beginning of period 51,612,067 8,881,061 7,226,769 ------------- ------------- ------------- End of period $ 11,240,925 $ 51,612,067 $ 8,881,061 ===================================================== Supplemental disclosures of cash flow information: Cash paid during the year for interest $ 4,795,321 $ 161,102 $ 327,205 Cash paid during the year for federal income taxes $ 1,200,000 $ 2,109,955 $ 217,920 Non-cash investing activities: Common stock issued for business acquisition $ -- $ 10,870,815 $ -- Purchase of block of renewal commission through installment note $ -- $ 650,000 $ --
See accompanying notes to consolidated financial statements. F-6 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), Penn Treaty Network America 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. In 1997, the Company incorporated a new subsidiary, American Independent Network Insurance Company of New York (AINIC), which it intends to license as an insurer in 1998. On December 31, 1997, PTLIC entered an assumption reinsurance treaty with Network America (formerly Network America Life Insurance Company), whereby Network America effectively purchased all of the premium in-force, assets and liabilities of PTLIC. Network America simultaneously changed its name to Penn Treaty Network America Insurance Company (PTNA). The Company has also filed with the Internal Revenue Service requesting a favorable ruling regarding the tax-free nature of the dividending of PTLIC common stock ownership of PTNA to the Company. Upon acceptance of a favorable ruling, PTNA will become a direct subsidiary of the Company, and will no longer be a direct subsidiary of PTLIC. 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 Florida, Pennsylvania, and California accounted for approximately 26%, 15% and 14%, respectively, of the Company's premiums for the year ended December 31, 1997. No other state sales accounted for more than 10% of the Company's premiums for the year ended December 31, 1997. F-7 Investments: The Company accounts for its investments according to 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. As of December 31, 1996, shareholders' equity was increased by approximately $2,261,000 due to net unrealized gains of approximately $3,426,000 in the investment portfolio. As of December 31, 1997 shareholders' equity was increased by approximately $7,838,000 due to net unrealized gains of approximately $11,875,000. 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 $11,977,144, $13,678,181, and $11,720,966 for the years ended December 31, 1997, 1996, and 1995, 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. 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. F-8 Present Value of Future Profits Acquired: The present value of future profits of ANIC's acquired business is being amortized over the life of the insurance business acquired. During 1997 and 1996, approximately $415,000 and $138,000 was amortized to expense, respectively. 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) an estimate, based upon prior experience, for accident and health claims reported, and incurred but unreported losses; (2) the actual in force amounts for reported life claims and an estimate of incurred but unreported claims. 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. F-9 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. In late 1996, the Company began marketing its Personal Freedom policy, a comprehensive nursing home and home health care product, and its Assisted Living policy, a revised nursing home with attached home health care rider policy. Because of the Company's relatively limited claims experience with these products, the Company may incur higher than expected loss ratios and may be required to adjust further its reserve levels with respect to these products. 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, the long duration of claims, and industry practice for long-term care policies. Benefits are payable over periods ranging from six months to five years, and are also available for lifetime coverage. These liabilites are discounted using an assumed rate of 6.75% for 1997, 7% for 1996, 6% for 1995, 1994, 1993 and 1992 claims and 8% for claims in 1991 and prior. New Accounting Principles: In February 1997, the Financial Accounting Standards Board ("FASB") 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." SFAS 128 prescribes that for all financial statements with effective dates after December 31, 1997, 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. Prior year per share amounts must also be restated if applicable. Basic earnings per share for 1995 and 1996 are unaffected by this change, however, diluted earnings per share are reported for 1995, which was not previously reported. Also, diluted earnings per share for 1996 is increased $.02 from previously reported fully diluted earnings per share due to the use of the average market price of Company shares in utilizing the treasury stock methodology to account for the dilutive nature of outstanding stock options. A reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation follows. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
For the Periods Ended December 31, ------------------------------------------------- 1997 1996 1995 ---- ---- ---- Net income $7,598,580 $12,160,347 $8,828,883 Weighted average common shares outstanding 7,540,354 7,164,782 5,771,558 Basic earnings per share $1.01 $1.70 $1.53 ================================================= Net income $7,598,580 $12,160,347 $8,828,883 Adjustments net of tax: Interest expense on convertible debt - 320,314 - Amortization of debt offering costs - 22,964 - ------------------------------------------------- Diluted net income $7,598,580 $12,503,625 $8,828,883 ================================================= Weighted average common shares outstanding 7,540,354 7,164,782 5,771,558 Common stock equivalents due to dilutive effect of stock options 217,582 144,261 70,343 Shares converted from convertible debt - 219,028 - ------------------------------------------------- Total outstanding shares for fully diluted earnings per share computation 7,757,936 7,528,071 5,841,901 Diluted earnings per share $0.98 $1.66 $1.51 =================================================
F-10 SFAS 128, however, prescribes that if the components of diluted earnings per share are anti-dilutive, then diluted earnings per share will not differ from basic earnings per share. In 1997, the Company reported basic and diluted earnings per share of $1.01 and $.98, respectively. Since the exclusion of the impact of interest expense from the Company's convertible debt would be anti-dilutive, the future anticipated conversion of the debt into additional shares is not included in the calculation of diluted earnings per share. The Company anticipates that approximately 2,600,000 additional shares will be issued in the future for the conversion of debt. However, the Company also expects that approximately $3,550,000 of annual after-tax interest expense due to this convertible debt would be excluded from the diluted earnings per share calculation. The FASB recently issued Statement 130, "Reporting Comprehensive Income," which requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. While not mandating a specific financial statement format, Statement 130 requires that an amount representing total comprehensive income be reported for fiscal years beginning after December 15, 1997. Restatement for earlier years is required for comparative purposes. The Company anticipates no material effect on its financial condition or results of operations due to the adoption of Statement 130. The FASB also issued Statement 131, "Disclosures about Segments of an Enterprise and Related Information." This Statement, which supersedes Statement 14, Financial Reporting for Segments of a Business Enterprise, changes the way public companies report information about segments. The Statement, which is based on the management approach to segment reporting, includes requirements to report selected segment information quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues. The Statement is effective for periods beginning after December 15, 1997. Restatement for earlier years is required for comparative purposes unless impracticable. Statement 131 need not be applied to interim periods in the initial year; however, in subsequent years, interim period information must be presented on a comparative basis. The Company believes that the adoption of Statement 131 will not have a material impact on its financial condition or results of operations. In 1998, the FASB issued Statement 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revises employers disclosures about pension and other postretirement benefits. The Company expects that the adoption of Statement 132 will have no material impact on its financial condition or results of operations. Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance- Related Assessments" (SOP 97-3) was issued by the American Institute of Certified Public Accountants in December 1997 and provides guidance for determining when an insurance or other enterprise should recognize a liability for guaranty-fund assessments and guidance for measuring the liability. The statement is effective for 1999 financial statements with early adoption permitted. The Company does not expect adoption of this statement to have a material effect on its financial position or results of operations. 2. Acquisitions of Businesses On August 30, 1996, the Company acquired ANIC. Pursuant to the merger, ANIC shareholders received stock consideration consisting of 472,644 shares of the Company's common stock and F-11 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. For 1997 and the four-month period ended December 31, 1996, ANIC generated premiums of $6,821,784 and $2,274,442, respectively, and net income of $2,828,413 and $299,354, respectively. The acquisition was accounted for as a purchase. In connection with this purchase, the Company recognized goodwill in the amount of $5,298,134, 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 $280,290 and $251,108 of commission income in 1997 and 1996, respectively, from this acquisition. 3. Investments and Financial Instruments: The Company's bond investment portfolio is comprised primarily of investment grade securities at December 31, 1997. Securities are classified as "investment grade" by utilizing ratings furnished by independent bond rating agencies. The amortized cost and estimated market value of investments in debt securities as of December 31, 1997 and 1996 are as follows:
December 31, 1997 ------------------------------------------------------------------------ Amortized Gross Unrealized Gross Unrealized Estimated Cost Gains Losses Market Value ---- ----- ------ ------------ U.S. Treasury securities and obligations of U.S Government authorities and agencies $163,276,895 $4,669,734 ($90,220) $167,856,409 Obligations of states and political sub-divisions 30,514,705 1,637,627 0 32,152,332 Debt securities issued by foreign governments 204,552 448 (77) 204,923 Corporate securities 77,318,973 872,019 (256,564) 77,934,428 ------------------------------------------------------------------------ $271,315,125 $7,179,828 ($346,861) $278,148,092 ======================================================================== 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 ========================================================================
F-12 The amortized cost and estimated market value of debt securities at December 31, 1997 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 $9,250,256 $9,294,500 Due after one year through five years 99,187,482 99,781,548 Due after five years through ten years 128,161,921 133,334,241 Due after ten years 34,715,466 35,737,803 ------------- -------------- $271,315,125 $278,148,092 ============= ==============
Gross proceeds and realized gains and losses on the sales of debt securities, excluding calls, were as follows:
Gross Gross Realized Realized Proceeds Gains Losses -------- ----- ------ 1997 $44,080,109 $ 787,356 $ 256,475 1996 $16,684,028 $ 145,371 $ 15,834 1995 $ 5,356,956 $ 53,648 $ 7,500
Gross proceeds and realized gains and losses on the sales of equity securities were as follows:
Gross Gross Realized Realized Proceeds Gains Losses -------- ----- ------ 1997 $ 3,436,251 $ 963,714 $ 88,869 1996 $ 303,560 $ 11,178 $ 122,157 1995 $ -- $ -- $ --
Gross unrealized gains (losses) pertaining to equity securities were as follows:
Gross Gross Estimated Original Realized Realized Market Cost Gains Losses Value ----------- -------------- ------------- -------------- 1997 $18,511,470 $5,361,106 $(318,994) $ 23,553,582 1996 9,642,912 1,171,865 (113,261) 11,247,516 1995 2,102,529 561,509 (58,426) 2,605,612
Net investment income is applicable to the following investments:
1997 1996 1995 ---- ---- ---- Bonds $16,025,290 $10,262,611 $7,756,571 Equity securities 339,577 92,358 27,920 Cash and short-term investments 946,044 796,319 480,274 --------------------------------------- Investment income 17,310,911 11,151,288 8,264,765 Investment expense (301,956) (169,157) (161,956) --------------------------------------- Net investment income $17,008,955 $10,982,131 $8,102,809 =======================================
Pursuant to certain statutory licensing requirements, as of December 31, 1997, the Company had on deposit bonds aggregating $8,043,843 in insurance department safekeeping accounts. The Company is not permitted to remove the bonds from these accounts without approval of the regulatory authority. F-13 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, 1997 and 1996 and the assumptions pertinent thereto are presented below:
Amount of Policy Reserves as of December 31, 1997 1996 ---- ---- Accident and health $139,962,685 $101,119,912 Annuities and other 140,999 339,910 Ordinary life, individual 7,975,566 8,183,357 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% 1997 6.8% Annuities and other 1977 to 1983 6.5% & 7.0% Ordinary life, individual 1962 to 1997 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 $65,143,000 and $45,300,000 at December 31, 1997 and 1996, respectively, that are discounted at varying interest rates. The amount of discount was $4,101,000 and $3,618,000 at December 31, 1997 and 1996, respectively. Total reserves, including policy and contract claims, reported to statutory authorities were approximately $7,652,000 and $3,510,000 less than those recorded for GAAP as of December 31, 1997 and 1996, respectively. F-14 Activity in policy and contract claims is summarized as follows:
1997 1996 ---- ---- Balance at January 1 $57,539,380 $50,206,608 Less reinsurance recoverables 1,277,942 1,576,207 ----------- ----------- Net balance at January 1 56,261,438 48,630,401 Incurred related to: Current year 70,520,327 52,128,679 Prior years 14,433,152 3,099,034 ----------- ----------- Total incurred 84,953,479 55,227,713 Paid related to: Current year 22,194,682 15,894,011 Prior years 43,528,989 32,149,776 ----------- ----------- Total paid 65,723,671 48,043,787 Reserves purchased from ANIC -- 447,111 Net balance at December 31 75,491,246 56,261,438 Plus reinsurance recoverables 2,650,328 1,277,942 ----------- ----------- Balance at December 31 $78,141,574 $57,539,380 ============================
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. In 1997, the Company added to claim reserves as a result of its reassessment of assumptions utilized in the actuarial determination of reserves for current claims liabilities and incurred but unreported liabilities for nursing home and home health care claims. The Company reviewed the assumptions underlying its reserves in connection with its recent employment of a new long-term care consulting actuary. The review encompassed certain actuarial assumptions related to the Company's products' benefit utilization and duration. F-15 5. Long-Term Debt: Long-term debt, at December 31, 1997 and 1996 is as follows:
1997 1996 ---- ---- 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 $74,750,000 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 $2,559,888 and $2,630,429 as of December 31, 1997 and 1996, respectively. 1,839,563 1,951,176 Installment note for purchase of block of renewal commissions in January 1996, payable over two years with interest accrued at 7%. 162,500 325,000 Capital lease 0 88,416 ----------- ----------- $76,752,063 $77,114,592 =========== ===========
Maturities of mortgage and other debt are as follows: 1998 $ 2,002,063 1999 -- 2000 -- 2001 -- 2002 -- Thereafter 74,750,000 ---------- $76,752,063 ===========
F-16 6. Federal Income Taxes: The provision for Federal income taxes for the years ended December 31 consisted of:
1997 1996 1995 ---- ---- ---- Current $ 513,938 $1,752,000 $ 882,968 Deferred 2,181,497 3,095,000 2,726,032 --------- --------- --------- $2,695,435 $4,847,000 $3,609,000 ========== ========== ==========
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. Management believes the existing net deductible temporary differences are realizable on a more likely than not basis. The sources of these differences and the approximate tax effect are as follows for the years ended December 31:
1997 1996 ---- ---- Net operating loss carryforward $ 2,658,493 $ -- Policy reserves 8,044,121 4,690,679 Alternative minimum tax carryforward 39,901 599,000 ------------- ------------ Total deferred tax assets $ 10,742,515 $ 5,289,679 ============= ============ Deferred policy acquisition costs $ (28,141,592) $(20,677,263) Present value of future profits acquired (1,222,867) (1,344,700) Premiums due and unpaid (952,032) (829,600) Other (238,000) (68,595) Unrealized appreciation on investments (4,037,526) (1,164,837) ------------- ------------ Total deferred income taxes $ (34,592,017) $(24,084,995) ============= ============ Net deferred income tax asset (liability) $ (23,849,502) $(18,795,316) ============= ============
The Company has net operation loss carry-forwards of approximately $7,8000,000, which, if unused, will expire in 2012. 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:
1997 1996 1995 ---- ---- ---- Computed Federal income tax (benefit) provision at statutory rate $3,499,965 $5,782,000 $4,289,000 Small life insurance company deduction (0) (560,000) (577,000) Tax-exempt interest income (500,988) (478,000) (431,000) Other (303,542) 103,000 328,000 ---------- ---------- ---------- $2,695,435 $4,847,000 $3,609,000 ========== ========== ==========
At December 31, 1997, the accumulated earnings of the Company for Federal income tax purposes included $1,452,589 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" 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, 1997, the combined balance in the "Shareholders' Surplus" account amounted to approximately $25,771,000. There is no present intention to make distributions in excess of "Shareholders' Surplus." F-17 7. Regulatory Restrictions: The Company's insurance subsidiaries (PTLIC, PTNA, and ANIC) are required by insurance laws and regulations to maintain minimum capital and surplus. At December 31, 1997 and 1996, 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, PTNA 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. No dividendes have been declared or paid in 1997, 1996, or 1995. Net income and capital and surplus as reported in accordance with statutory accounting principles for the Company's insurance subsidiaries are as follows:
1997 1996 1995 ---- ---- ---- Net income (loss) $(10,287,275) $(4,512,941) $839,491 Capital and surplus $73,399,828 $81,794,728 $32,291,981
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, reserving methodologies, 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. Expense for this pension plan was $30,000 and $55,000 for the years ended December 31, 1996 and 1995, respectively. 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 F-18 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 related to this 401(k) plan was $93,152 and $36,000 for the years ended December 31, 1997 and 1996, respectively. 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 1997 or 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 1997 or 1996 contribution expense for this plan. Upon the termination of the plan, the Company completed an actuarial review of its liability to plan participants. As a result of this review, the Company recognized approximately $125,000 of reduced expense in 1997 due to the overaccrual of its liability upon the purchase of ANIC in 1996. 9. Stock Option Plans: At December 31, 1997, 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 SFAS No. 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.
1997 1996 1995 ---- ---- ---- Net Income As reported $7,598,580 $12,160,347 $8,828,883 Proforma $7,407,061 $12,075,410 $8,815,305 Basic Earnings Per Share As reported $1.01 $1.70 $1.53 Proforma $0.98 $1.69 $1.53 Diluted Earnings Per Share As reported $0.98 $1.66 $1.51 Proforma $0.95 $1.65 $1.51
Compensation cost is estimated using the Black-Scholes model with the following assumptions for 1995, 1996 and 1997: an expected life ranging from 5.3 to 8.3 years, volatility of 27.9% for 1995 and 1996 and 26.4% for 1997 and a risk free rate ranging from 5.71% to 6.35%. The weighted average fair value of those options granted in 1995, 1996 and 1997 was $4.98, $8.21 and $12.11, 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 1,200,000 shares of common stock. The exercise price of all options granted under F-19 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 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:
1997 1996 1995 -------------------------- ----------------------------- ---------------------------- Exercise Exercise Exercise Price Price Price Options Per Option Options Per Option Options Per Option -------------------------- ----------------------------- ---------------------------- Outstanding at beginning of year 510,108 14.84 396,015 10.88 229,914 9.52 Granted 124,850 32.61 184,800 21.03 166,100 14.13 Exercised 61,065 11.03 66,907 8.61 0 -- Canceled 0 -- 3,800 12.38 0 -- -------------- --------------- ---------------- Outstanding at end of year 573,893 19.11 510,108 14.84 396,015 10.88 ============== =============== ================ Exercisable at end of year 218,118 12.63 200,540 10.45 197,929 9.79 ============== =============== ================
Outstanding Remaining Exercisable at December Contractual at December Range of Exercise Prices 31, 1997 Life (Yrs) 31, 1997 ----------------------------------------------- 5.50 2,630 1 2,630 8.71 5,265 3 5,265 8.92 27,140 5 27,140 9.81 44,850 5 44,850 11.17 15,767 4 15,767 12.28 26,340 4 26,340 12.38 85,626 8 39,503 12.63 15,350 8 7,300 13.61 48,000 8 13,715 20.50 131,575 9 28,750 22.55 48,000 9 6,858 32.25 94,350 10 0 35.48 29,000 10 0 --------------- ---------------- 573,893 218,118 =============== ================
10. Commitments and Contingencies: F-20 Operating Lease Commitments: The total net rental expenses under all leases amounted to approximately $202,000, $174,000 and $142,000 for the years ended December 31, 1997, 1996 and 1995, 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. Line of Credit: In June 1997, the Company was given an unsecured, uncommitted line of credit from a bank for up to $3,000,000, which was unused during 1997. The line of credit is renewable annually, carries no origination or carrying fees, and if used, will carry a variable rate of interest equal to the London Interbank Offering Rate (LIBOR) plus .75% annually on the outstanding balance. 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: PTLIC and PTNA are parties to 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, 1997 and 1996 were approximately $2,912,000 and $859,000, respectively. Effective January 1, 1998, no new business is reinsured under this facility. 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 PTNA 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, 1997 and 1996 were approximately $569,000 and $530,000, respectively. PTNA is party to a Reinsurance Agreement to cede 100% of certain whole life and deferred annuity policies to be issued by PTNA 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, 1997 and 1996 were approximately $3,427,000 and $3,862,000, 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. PTNA 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, 1997 and 1996, reserve credits taken related to this treaty were approximately $1,947,000 and $1,615,000, respectively. ANIC reinsures approximately $500,000 of its risk with three reinsuring companies, all of which are authorized to do business in the State of Vermont. F-21 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, 1997 Ordinary Life Insurance In-Force $65,964,000 $16,636,000 $0 $49,328,000 Premiums: Accident and health 167,187,289 3,545,845 500,665 164,142,109 Life 4,044,650 506,235 0 3,538,415 Benefits to Policyholders: Accident and health 86,828,400 2,769,750 258,029 84,316,679 Life 1,790,296 522,694 0 1,267,602 Inc (dec) in Policy Reserves: Accident and health 37,743,083 260,451 (10,632) 37,472,000 Life (406,702) (1,215,563) 0 808,861 Commissions $56,193,489 $1,028,152 $75,100 $55,240,437 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
The Company remains contingently liable in the event that the reinsuring companies are unable to meet their obligations. 12. Transactions with Related Parties: F-22 Irv Levit Insurance Management Corporation ("IMC"), an insurance agency which is owned by the President of the Company, produced approximately $50,000, $55,000, and $62,000 of new and renewal premiums for PTLIC, for the years ended December 31, 1997, 1996 and 1995, respectively, for which it received commissions of approximately $13,000, $12,000 and $14,000, 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, 1997, 1996 and 1995, IMC commission overrides totaled approximately $534,000, $539,000, and $517,000, respectively. 13. Major Agencies: A managing general agent accounted for approximately 27%, 21% and 18% of total premiums in 1997, 1996 and 1995, 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, 1997, 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: 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. F-23 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, 1997 December 31, 1996 ---------------------------------- --------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------ ----- ------ ----- Financial assets: Investments Bonds, available for sale $278,148,092 $278,148,092 $201,329,966 $201,329,966 Equity securities 23,553,582 23,553,582 11,247,516 11,247,516 Policy loans 84,757 84,757 84,232 84,232 Cash and cash equivalents 11,240,925 11,240,925 51,612,067 51,612,067 Financial liabilities: Convertible debt $74,750,000 $58,058,252 $74,750,000 $70,518,868 Mortgage and other debt 2,002,063 2,002,063 2,364,592 2,364,592
F-24 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENT SCHEDULE
Pages ----- Report of Independent Accountants on Schedule S-2 Schedule II -- 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 11, 1998 S-2 PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES (PARENT COMPANY) Schedule II - Condensed Financial Information of Registrant Balance Sheets as of December 31, 1997 and 1996
ASSETS 1997 1996 ---- ---- Bonds, available for sale at market (amortized cost $22,675,585 and $11,399,502, respectively) $ 23,381,984 $ 11,495,000 Equity securities at market (cost $3,098,810 and $1,004,250, respectively) 3,178,812 994,500 Cash and cash equivalents 962,516 16,375,868 Investment in subsidiaries* 179,262,804 162,699,321 Other assets 4,085,960 4,408,050 ------------- ------------- Total assets $ 210,872,076 $ 195,972,739 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Long-term debt $ 74,750,000 $ 74,838,415 Accrued interest payable 389,323 447,988 Accounts payable 242,129 349,223 Deferred income taxes 267,376 29,154 Due to subsidiaries* 2,467,904 1,400,875 ------------- ------------- Total liabilities 78,116,732 77,065,655 ------------- ------------- Shareholders' equity Preferred stock, par value $1.00; 5,000,000 shares authorized, none outstanding -- -- Common stock, par value $.10; 25,000,000 and 10,000,000 shares authorized, 8,177,529 and 8,116,464 shares issued, respectively 817,752 811,646 Additional paid-in capital 53,194,134 52,526,956 Unrealized appreciation, net of deferred taxes 7,837,550 2,261,154 Retained earnings 72,611,782 65,013,202 ------------- ------------- 134,461,218 120,612,958 Less 605,629 of common shares held in treasury, at cost (1,705,874) (1,705,874) ------------- ------------- Total shareholders' equity 132,755,344 118,907,084 ------------- ------------- Total liabilities and shareholders' equity $ 210,872,076 $ 195,972,739 ============= =============
* 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 II - Condensed Financial Information of Registrant Statements of Operations for the years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ---- ---- ---- Management fees* $ 56,400 $ 56,400 $ 56,400 Investment income 1,817,912 835,714 275,342 General and administrative expense 1,295,638 274,365 410,968 Interest on Convertible Debt 4,671,875 447,988 -- ------------ ------------ ------------ Gain (loss) before equity in undistributed net earnings of subsidiaries* (4,093,201) 169,761 (79,226) Equity in undistributed net earnings of subsidiaries* 11,691,781 11,990,586 8,908,109 ------------ ------------ ------------ Net income 7,598,580 12,160,347 8,828,883 Retained earnings, beginning of year 65,013,202 52,852,855 44,023,972 ------------ ------------ ------------ Retained earnings, end of year $ 72,611,782 $ 65,013,202 $ 52,852,855 ============ ============ ============
*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 II - Condensed Financial Information of Registrant Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ---- ---- ---- Cash flows from operating activities: Net Income $ 7,598,580 $ 12,160,347 $ 8,828,883 Adjustments to reconcile net income to cash provided by (used in) operations: Equity in undistributed earnings of subsidiaries (11,691,781) (11,990,586) (8,908,109) Depreciation and amortization 425,244 113,741 99,528 Net realized (gains) losses (102,815) 5,495 (30,178) Increase (decrease) due to change in: Due to/from subsidiaries 1,067,029 440,307 302,568 Other, net 12,636 (2,631,436) (249,338) ------------ ------------ ------------ Net cash provided by (used in) operations (2,691,107) (1,902,132) 43,354 ------------ ------------ ------------ Cash flows from investing activities: Sales and maturities of investments 14,201,958 12,372,277 1,512,195 Purchase of investments (27,469,786) (17,314,915) (8,358,058) Acquisition of property and equipment (39,285) (396,882) (883,629) Contribution to subsidiary -- (53,092,644) (14,000,000) ------------ ------------ ------------ Net cash used in investing activities (13,307,113) (58,432,164) (21,729,492) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from convertible debt offering -- 74,750,000 -- Proceeds from exercise of stock options 673,284 563,500 -- Repayment of long term debt (88,416) 739,578 (4,052,835) Proceeds from public offering -- -- 26,065,000 ------------ ------------ ------------ Net cash provided by financing activities 584,868 76,053,078 22,012,165 ------------ ------------ ------------ Increase (decrease) in cash and cash equivalents (15,413,352) 15,718,782 326,027 Cash and cash equivalents balances: Beginning of year 16,375,868 657,086 331,059 ------------ ------------ ------------ End of year $ 962,516 $ 16,375,868 $ 657,086 ============ ============ ============ Supplemental disclosures of cash flow information: Cash paid during the year for interest $ 4,674,409 $ 7,768 $ 199,218 ============ ============ ============
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 1998 Annual Meeting of Shareholders. Item 11. Executive Compensation Incorporated by reference from the Company's Definitive Proxy Statement for the 1998 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 1998 Annual Meeting of Shareholders. Item 13. Certain Relationship and Related Transactions Incorporated by reference from the Company's Definitive Proxy Statement for the 1998 Annual Meeting of Shareholders. 38 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 at December 31, 1997 and 1996 ............................................................. F-3 Consolidated Statements of Operations for the years ended December 31, 1997, 1996, and 1995...................... F-4 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1997, 1996, and 1995......................................................... F-5 Consolidated Statements of Cash Flow for the years ended December 31, 1997, 1996, and 1995...................... F-6 Notes to Consolidated Financial Statements......................... F-7-F-24 (2) Financial Statement Schedule. Report of Independent Accountants on Schedule...................... S-2 Schedule II - Condensed Financial Information of Registrant................................................... S-3-S-5
39 (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). 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. * 40 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. **** 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 41 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.**** 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 42 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. **** 10.33 Assumption and Reinsurance Agreement dated December 22, 1997, between Penn Treaty Life Insurance Company and Network America Life Insurance Company. 11. Statement re: computation of per share earnings. See Notes to Consolidated Financial Statements (Note 1). 21. Subsidiaries of the Registrant. **** 24. Consent of Coopers & Lybrand, L.L.P. 27.1 Financial Data Schedule 27.2 Restated Financial Data Schedule 27.3 Restated Financial Data Schedule (b) Reports on Form 8-K: The Company filed no reports on Form 8-K during the quarter ended December 31, 1997. * Incorporated by reference to the Company's Registration Statement on Form S-1 dated May 12, 1987, as amended. ** 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 43 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 26, 1998 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 26, 1998 By: /s/ Irving Levit --------------------------------------- Irving Levit, Chairman of the Board and President Date: March 26, 1998 By: /s/ A.J. Carden --------------------------------------- A.J. Carden, Executive Vice President and Director Date: March 26, 1998 By: /s/ Michael F. Grill --------------------------------------- Michael F. Grill, Treasurer and Director Date: March 26, 1998 By: /s/ Domenic P. Stangherlin --------------------------------------- Domenic P. Stangherlin, Secretary and Director Date: March 26, 1998 By: /s/ Jack D. Baum --------------------------------------- Jack D. Baum, Vice President, Marketing and Director Date: March 26, 1998 By: /s/ Emile Ilchuk --------------------------------------- Emile Ilchuk, Director Date: March 26, 1998 By: /s/ C. Mitchell Goldman --------------------------------------- C. Mitchell Goldman, Director Date: March 26, 1998 By: /s/ Glen A. Levit --------------------------------------- Glen A. Levit, Vice President, Sales and Director 44 Date: March 26, 1998 By: /s/ David B. Trindle --------------------------------------- David B. Trindle, Director 45 EX-10.33 2 EX-10.33 EXHIBIT 10.33 ASSUMPTION AND REINSURANCE AGREEMENT THIS AGREEMENT is made this 22nd day of December , 1997, to be effective as of 12:01 a.m. on December 31, 1997 (hereinafter the "Effective Date") subject to the written prior approval of the Insurance Commissioner of the Commonwealth of Pennsylvania, by and between Penn Treaty Life Insurance Company (hereinafter "Ceding Company"), a Pennsylvania stock life insurance company wholly owned by Penn Treaty American Corporation, and Network America Life Insurance Company (hereinafter "Reinsuring Company"), a Pennsylvania stock life insurance company wholly owned by Penn Treaty Life Insurance Company, all with offices at 3440 Lehigh Street, Allentown, Pennsylvania. RECITALS WHEREAS, the Parties are life insurance companies, domiciled in, duly organized and existing under the laws of the Commonwealth of Pennsylvania, and both are qualified to do business in Pennsylvania and licensed to issue policies of insurance in Pennsylvania; and, WHEREAS, the Ceding Company is a direct wholly-owned subsidiary and the Reinsuring Company is an indirect wholly-owned subsidiary, respectively of Penn Treaty American Corporation, a Pennsylvania corporation, and insurance holding company ("Penn Treaty"); and WHEREAS, the Boards of Directors of each of the Ceding Company, the Reinsuring Company and Penn Treaty have determined that the business of the Ceding Company and the Reinsuring Company can be conducted more efficiently as a single entity and therefore deem it desirable and in the best interests of each of the corporations that the asset and liability transfer and insurance policy ceding and reinsurance and transfer actions set forth in this Agreement be effectuated; and WHEREAS, it is the intention of the parties hereto that the Ceding Company shall cede and transfer to the Reinsuring Company and the Reinsuring Company shall reinsure or assume from the Ceding Company all of the insurance policies of the Ceding Company as more specifically described and listed on Exhibit "A", which is attached hereto and made a part hereof, as of the Effective Date of this Agreement; and WHEREAS, as of the Effective Date, the principal assets of the Ceding Company shall consist of the insurance licenses currently held by it along with adequate levels of capital and surplus required to maintain such licenses. NOW THEREFORE, in consideration of the foregoing and of the mutual agreements, covenants and conditions herein contained, the Parties, intending to be legally bound, agree as follows: 1. POLICIES CEDED AND REINSURED AND OTHER LIABILITIES TRANSFERRED AND ASSUMED. 1.1 Policies Ceded and Reinsured. The Ceding Company hereby assigns, sets over and transfers to the Reinsuring Company, as of the Effective Date, all of its rights, title and interest in the insurance policies as stated and described in Exhibit "A", in force as of the Effective Date (hereinafter referred to as "Reinsured Policies"). The Reinsuring Company hereby purchases and assumes as direct insurance all of the contractual obligations and rights with respect to the Reinsured Policies with the same force and effect as if such policies had been issued by the Reinsuring Company. 1.2 Purchase Price for Reinsured Policies. At the Effective Date, the Reinsuring Company will assume the policies ceded in exchange for an amount equal to the existing reserves of the Ceding Company of approximately one hundred fifteen million dollars ($115,000,000). 1.3 Reserves and Other Liabilities Transferred. The Ceding Company agrees to transfer to the Reinsuring Company, at the Effective Date with respect to the reinsured policies, the gross Unearned Premium Reserve, the Additional Contract Reserve and the Claim Reserve, established by the Ceding Company and calculated as of December 31, 1997. 1.4 Claim Payments. The Ceding Company shall retain the administrative and financial responsibility for all claims with respect to the Reinsured Policies on or before the Effective Date. The Reinsuring Company shall be financially and administratively responsible for all claims with respect to the Reinsured Policies after the Effective Date. 1.5 Reinsurance. The Ceding Company is a party to a reinsurance agreement with an external reinsurer, which provides reinsurance for certain of its policies which reinsurance agreement is attached hereto as Exhibit "B". To the extent permitted by law and by the terms of the reinsurance agreement, the Ceding Company hereby assigns and delegates to the Reinsuring Company, as of the Effective Date, all of its rights, duties and obligations under said reinsurance agreement. The Reinsuring Company hereby agrees to accept said assignment and delegation. 1.6 Transfer of Future Premium and Cash. Premiums as yet due and unpaid, reported or otherwise for the existing business or additions thereto, as well as new business in transit as of the Effective Date with respect to the reinsured policies will also be reinsured and belong to the Reinsuring Company. The Ceding Company shall transfer, convey, assign and pay over to the Reinsuring Company all cash received after the Effective Date allocable to the risk reinsured by the Reinsuring Company with respect to the Reinsured Policies as of the Effective Date. 1.7 Premium Taxes. The Reinsuring company accepts liability for all taxes incurred in connection with the premiums received with respect to the Reinsured Policies after the Effective Date. 1.8 Future Premiums, Claims, Coverages and Solicitation of New Business. (a) The Ceding Company and the Reinsuring Company agree that after the Effective Date the Reinsuring Company shall be entitled to collect all future premiums, and the Reinsuring Company shall be obligated to pay commissions, taxes and claims and other contractual obligations with respect to the Reinsured Policies, as if it were the original insurer, and the Reinsuring Company assumes the rights, obligations and privileges of the Ceding Company with respect to the Reinsured Policies as its own. (b) After the Effective Date, the Reinsuring Company is entitled to change premiums and to modify or cancel coverages and policies subject to policy provisions and applicable Pennsylvania statutes. (c) After the effective date of the Reinsured Policies the Reinsuring Company is further entitled to negotiate, appoint or cancel agency and administrative agreements at its sole discretion with respect to solicitation of new business. (d) The Ceding Company shall cooperate with the Reinsuring Company prior to and after the Effective Date to make such changes and take such other actions as needed to effectuate the provisions of this Section 1.8. 2. ASSUMPTION CERTIFICATE The Reinsuring Company shall deliver to each policyholder of the Reinsured Policies covered by this Agreement an Assumption Certificate in a form agreeable to applicable insurance departments. Delivery of these materials shall be made by U.S. Mail and shall take place not later than sixty (60) days after the Effective Date or the receipt of all required regulatory approvals, whichever is later. 3. AGENTS COMMISSIONS The Reinsuring Company shall be responsible for and agrees to pay all commissions on all premiums collected on Reinsured Policies after the Effective Date. All agents of the Ceding Company, either by individual state approval or by relicensing shall become agents of the Reinsuring Company, and all commissions shall be protected. The Reinsuring Company's liability hereunder, however, shall be limited to the rates of compensation specified in those agreements between the Ceding Company and its agents of record on the Reinsured Policies, (including vested terminated agents) or as amended by mutual agreement between the Reinsuring Company and the Ceding Company's agents. 4. SALE OF OTHER ASSETS AND TRANSFER OF LIABILITIES. 4.1 Assets Purchased. In addition to the ceding and transfer of the Reinsured Policies, as of the Effective Date the Ceding Company shall sell, transfer, convey, grant, assign and deliver to the Reinsuring company, and the Reinsuring Company shall purchase, accept, acquire and receive from the Ceding Company all of the Right, title and interest in and to the following specific assets of the Ceding Company, constituting substantially all assets of the Ceding Company, tangible or intangible, real or personal, including, without limitation, the following described assets owned and used by the Ceding Company (collectively, the "Purchased Assets"): (a) all real property, equipment, business machines, computers, telephone systems, automobiles, furniture, furnishings and other tangible personal property of the Ceding Company including, without limitation, that listed in Schedule 4.1(a) hereto; (b) all claims and rights under the contracts and real and personal property leases of the Ceding Company listed in Schedule 4.1(b) (c) all sales literature, promotional material and other general files and printed forms used by the Ceding Company; (d) all goodwill, trademarks, service marks and trade names used by the Ceding Company, whether arising under common law or state or federal trademark law (including, without limitation, the name "Penn Treaty" when used in connection with the Reinsured Policies), provided that the Reinsured Company hereby grants the Ceding Company the right to use its name, and associated logos, with respect to its continued corporate existence. (e) all right, title and interest of the Ceding Company in and to policyholder lists and other mailing lists of the Ceding Company, and all computer tapes, printouts and other data with respect to such policyholder and mailing lists; (f) any and all prepaid expenses and deposits of the Ceding Company as of the Effective Date, including any lease deposits; (g) all inventory and supplies of the Ceding Company; (h) all rights to leasehold improvements and fixtures; and (i) all payroll records for all employees of the Ceding Company and of Penn Treaty in the possession and control of the Ceding Company and all pension plan assets under the management and control of the Ceding Company. The "Purchased Assets" shall include, without limitation, all properties and assets of the Ceding Company as reflected in the 1996 Financial Statements of the Ceding Company and all properties and assets acquired by the Ceding Company after January 1, 1997, except those properties and assets disposed of thereafter in the ordinary course of business and except for the "Retained Assets" as defined below. The Parties hereby agree that the value of the Purchased Assets shall be determined as of December 31, 1997 in full compliance with all statutory accounting principles as audited by Coopers & Lybrand, L.L.P.. The purchase price for the Purchased Assets shall be allocated among the Purchased Assets as listed on Exhibit "C". 4.2 Retained Assets. Notwithstanding the provisions of Section 4.1 hereof, the following described assets of the Ceding Company shall not be acquired by the Reinsuring Company, shall not constitute "Purchased Assets" and shall be defined herein as the "Retained Assets": (a) all insurance licenses issued to Penn Treaty Life Insurance Company as set forth in Schedule 4.2(a) attached hereto; (b) use of the name "Penn Treaty Life Insurance Company" together with the logos of the Ceding Company, whether arising under common law or state or federal trademark law; (c) the Ceding Company's bank accounts, deposit accounts or similar accounts; (d) the Ceding Company's corporate minute books and records, general ledgers and books of original entry, tax returns and tax records, financial statements, any books or records relating to the Ceding Company's general corporate affairs, the corporate seal of the Ceding Company and any other records, reports or documentation relating to the Retained Assets; and (e) shares of the capital stock of the Ceding Company. 4.3 Assumption of Certain Liabilities. As of and after the Effective Date, the Reinsuring Company shall assume and agree to perform and discharge, when due, all obligations and liabilities of the Ceding Company of every kind or character related to the Purchased Assets. 4.4 Transfer of Network America Capital Stock. Upon receipt of a favorable Internal Revenue Service opinion regarding the tax-free nature of this transaction, the Ceding Company shall dividend all 239,933 shares of Common Stock, par value $6.25 per share (the "Common Stock"), of the Reinsuring Company then held by the Ceding Company to Penn Treaty. At that time, each Director of the Ceding Company shall transfer the one share of Common Stock of the Reinsuring Company then held by such Director as a director qualifying share to Penn Treaty. As a result of such transfers, as of that date, the Reinsuring Company shall become a direct, wholly-owned subsidiary of Penn Treaty. 5. GOVERNING LAW This Agreement shall be governed by, and construed in accordance with the laws of the Commonwealth of Pennsylvania, without regard to principles of conflicts of laws. 6. INADVERTENT ERRORS OR OMISSIONS No inadvertent errors or omissions made by either the Ceding Company or the Reinsuring Company shall relieve the other party of liability, provided such errors or omissions are corrected as soon as possible. 7. CLAIMS AGAINST CEDING COMPANY In the event an insured under one of the Reinsured Policies covered under this Agreement or a policyowner, his beneficiary, legal representative, or any one acting on his behalf makes any claim, demand or commences any action or suit based on a fact, or alleged set of circumstances, arising subsequent to the Effective Date (whether groundless or otherwise) against the Ceding Company, its shareholders, directors, officers, employees, and agents (collectively the "Indemnified Party") in connection with any of the Reinsured Policies, the Reinsuring Company agrees it will indemnify and hold harmless the Indemnified Party from and against all liabilities, losses, damages, costs, and charges (including counsel fees and all other expenses) of every nature and character as the same may arise or be made against or incurred by the Indemnified Party. The Reinsuring Company is permitted to control the defense of any such claim, demand, action or suit. 8. RECAPTURE The Ceding Company shall have no right to recapture the Reinsured Policies, or have any claim to the business added to such policies after the Effective Date. 9. APPROVAL OF REGULATORY AUTHORITIES This Agreement shall be void and of no effect if it is deemed invalid or contrary to the laws of Pennsylvania by a formal ruling issued by the Insurance Commissioner of the Commonwealth of Pennsylvania or any other insurance department prior to the Effective Date. 10. MISCELLANEOUS 10.1 The parties hereto bind and oblige themselves to do such further acts, matters and deeds and to execute any and all such further and additional instruments and agreements as may be found necessary or expedient to carry this Agreement into full effect. 10.2 All of these terms and provisions of this Agreement shall be binding upon and inure to the benefit of and be enforceable by the respective successors and assigns of the Ceding Company and the Reinsuring Company. 10.3 The Agreement may be executed simultaneously in any number of counterparts, each of which shall be deemed an original and all of which shall constitute one and the same Agreement. 10.4 The titles to the various Sections hereof are inserted solely for convenience or reference and are not a part of, nor shall they be used to construe any term or provision of this Agreement. 10.5 The provisions hereof are independent of and separable from each other, and no provision shall be affected or rendered invalid or unenforceable by virtue of the fact that for any reason any other or others of them may be invalid or unenforceable in whole or in part. 10.6 This Agreement and all schedules and exhibits hereto constitute the entire understanding between the parties hereto as to the subject matter hereof and cannot be modified, amended or supplemented except in writing and signed by the parties hereto. prior to the Effective Time, the Parties may agree to terminate this Agreement in such manner as may be agreed by them in writing. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their respective officers and their respective corporate seals have been affixed on the Effective Date. (CORPORATE SEAL) NETWORK AMERICA LIFE INSURANCE COMPANY Attest: By: ---------------------- ----------------------------------- Sandra Kotsch Glen A. Levit Assistant Secretary Title: President (CORPORATE SEAL) PENN TREATY LIFE INSURANCE COMPANY Attest: By: ---------------------- ----------------------------------- Sandra Kotsch A. J. Carden Assistant Secretary Title: Executive Vice President and Chief Operating Officer EX-24 3 EX-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 11, 1998 on our audits of the consolidated financial statements and financial statement schedule of Penn Treaty American Corporation as of December 31, 1997 and 1996 and for the years ended December 31, 1997, 1996 and 1995, which reports are included in this Annual Report on Form 10-K. Coopers & Lybrand, L.L.P. 2400 Eleven Penn Center Philadelphia, Pennsylvania March 30, 1998 EX-27.1 4 EX-27-1 FINANCIAL DATA SCHEDULE
7 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 278,148,092 0 0 23,553,582 0 0 301,786,431 11,240,925 10,542,275 110,470,626 464,991,723 148,079,250 0 78,141,574 0 76,752,063 0 0 817,752 131,937,592 464,991,723 167,680,524 17,008,955 1,416,659 416,935 126,196,536 (28,294,358) 78,326,880 10,294,015 2,695,435 7,598,580 0 0 0 7,598,580 1.01 0.98 0 0 0 0 0 0 0
EX-27.2 5 EX-27-2 FINANCIAL DATA SCHEDULE
7 YEAR YEAR 3-MOS 6-MOS 9-MOS DEC-31-1995 DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 JAN-01-1995 JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 DEC-31-1995 DEC-31-1996 MAR-31-1996 JUN-30-1996 SEP-30-1996 142,243,341 201,329,966 146,747,870 149,128,011 167,883,832 0 0 0 0 0 0 0 0 0 0 2,605,612 11,247,516 3,515,637 4,465,444 6,401,816 0 0 0 0 0 0 0 0 0 0 144,928,357 212,661,714 150,343,074 153,675,087 174,367,109 8,881,061 51,612,067 8,349,672 9,994,740 9,258,285 7,730,828 10,105,654 8,042,085 8,165,459 9,972,221 63,133,759 82,176,268 67,303,615 72,606,338 76,742,702 237,744,270 386,767,992 247,985,132 261,429,689 297,272,542 69,126,281 109,643,179 76,135,370 83,755,892 101,083,744 0 0 30,719 30,719 511,610 50,206,608 57,539,380 53,075,354 53,712,452 57,716,263 0 0 0 0 0 2,206,117 77,114,592 2,165,672 2,124,856 2,082,926 0 0 0 0 0 0 0 0 0 0 757,691 811,646 759,571 761,488 811,100 96,349,363 118,095,438 96,515,913 98,481,245 113,377,473 237,744,270 386,767,992 247,985,132 261,429,689 297,272,542 102,366,605 130,191,779 30,469,894 62,680,135 95,064,729 8,102,809 10,982,131 2,386,069 4,891,163 7,493,143 46,431 19,900 51,221 92,883 92,665 347,113 342,388 85,750 181,292 269,929 64,879,275 83,993,132 19,786,654 41,618,439 61,779,767 (15,303,161) (19,042,509) (4,169,856) (9,472,579) (13,526,533) 48,848,961 59,578,288 13,528,802 27,733,623 42,279,465 12,437,883 17,007,347 3,847,334 7,956,990 12,387,767 3,609,000 4,847,000 1,154,000 2,390,000 3,714,276 8,828,883 12,160,347 2,693,334 5,575,990 8,673,491 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 8,828,883 12,160,347 2,693,334 5,575,990 8,673,491 1.53 1.70 0.39 0.80 1.23 1.51 1.66 0.38 0.78 1.21 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
EX-27.3 6 EX-27-3 FINANCIAL DATA SCHEDULE
7 3-MOS 6-MOS 9-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 JAN-01-1997 JAN-01-1997 JAN-01-1997 MAR-31-1997 JUN-30-1997 SEP-30-1997 241,698,092 252,133,844 265,181,218 0 0 0 0 0 0 15,117,310 19,659,352 20,436,337 0 0 0 0 0 0 256,896,046 271,874,945 285,700,611 14,512,008 13,476,392 13,431,655 10,216,937 10,524,465 10,592,802 87,668,685 98,951,544 107,137,660 399,658,356 426,302,696 449,112,643 119,117,683 132,615,179 143,807,005 12,215 9,283 9,283 58,406,726 62,263,501 63,728,975 0 0 0 76,925,396 76,898,245 76,860,589 0 0 0 0 0 0 812,370 815,358 815,858 118,297,609 126,613,926 133,381,077 399,658,356 426,302,696 449,112,643 39,709,888 80,772,181 123,212,211 3,893,298 7,996,505 12,581,291 49,762 160,623 935,125 78,966 180,080 305,105 25,330,614 56,887,015 86,369,820 (5,492,417) (16,775,276) (24,961,392) 19,077,348 38,890,305 59,573,964 4,816,369 10,107,345 16,051,340 1,397,000 2,957,838 4,703,380 3,419,369 7,149,507 11,347,960 0 0 0 0 0 0 0 0 0 3,419,369 7,149,507 11,347,960 0.45 0.95 1.51 0.42 0.86 1.35 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
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