SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K/A
(AMENDMENT NO. 1)
/X/ Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 For the fiscal year ended December 31, 2001
OR
/ / Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from _______________ to _____________
COMMISSION FILE NUMBER 0-13972
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PENN TREATY AMERICAN CORPORATION
3440 Lehigh Street, Allentown, PA 18103
(610) 965-2222
INCORPORATED IN PENNSYLVANIA I.R.S. EMPLOYER ID NO.
23-1664166
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Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.10
par value
Securities registered pursuant to Section 12(g) of the Act: None
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 18, 2002 was $106,909,908.
The number of shares outstanding on the Registrant's common stock, par value
$.10 per share, as of March 18, 2002 was 19,367,737.
Documents Incorporated By Reference:
(1) Proxy Statement for the 2001 Annual Meeting of Shareholders - Part III (2)
Other documents incorporated by reference on this report are listed in the
Exhibit Index.
***** EXPLANATORY NOTE *****
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IN OCTOBER 2002, THE COMPANY FILED A PRELIMINARY PROXY STATEMENT WITH THE
SECURITIES AND EXCHANGE COMMISSION. THE COMMISSION DETERMINED TO REVIEW THE
PRELIMINARY PROXY AND THE REFERENCED ANNUAL REPORT ON FORM 10-K FOR THE PERIOD
ENDED DECEMBER 31, 2001 AND THE QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD
ENDED JUNE 30, 2002. WE BELIEVE THE REVIEW WAS UNDERTAKEN AS A RESULT OF THE
COMMISSION'S NORMAL REVIEW PROCESS.
AS A RESULT OF THE REVIEW, THE COMMISSION REQUESTED, AND THE COMPANY AGREED, TO
CLARIFY CERTAIN LANGUAGE IN ITS FILINGS. IN RESPONSE, THE COMPANY HAS FILED THE
ATTACHED FORM 10-K/A FOR THE PERIOD ENDED DECEMBER 31, 2001.
NO CHANGES TO NET INCOME HAVE OCCURRED AS A RESULT OF THE REVIEW OR THIS FILING.
PART I
Item 1. Business
(a) Penn Treaty American Corporation
We are a leading provider of long-term care insurance in the United States. We
market our products primarily to older persons in the states in which we are
licensed through independent insurance agents. Our principal products are
individual, defined benefit accident and health insurance policies covering
long-term skilled, intermediate and custodial nursing home and home health care.
Our policies are designed to make the administration of claims simple, quick and
sensitive to the needs of our policyholders. We also own insurance agencies that
sell senior-market insurance products underwritten by other insurers and us.
We are among the largest writers of individual long-term care insurance in terms
of annualized premiums. We sold 26,474 long-term care policies in 2001,
representing $47 million of annualized premiums. At December 31, 2001, we had
242,644 long-term care insurance policies in-force, representing $351 million of
annualized premiums. Our total premiums were $350 million in 2001, representing
a compound annual growth rate of 22.7% from $102.4 million in 1995. We market
our products primarily through the independent agency channel, which we believe
to be effective in distributing long-term care insurance.
We introduced our first long-term nursing home insurance product in 1972 and our
first home health care insurance product in 1983, and we have developed a record
of innovation in long-term care insurance products. Since 1994, we have
introduced several new products designed to meet the changing needs of our
customers, including the following:
- The Independent Living policy, which provides coverage over the full
term of the policy for home care services furnished by unlicensed
homemakers or companions, as well as licensed care providers;
- The Personal Freedom policy, which provides comprehensive coverage for
nursing home and home health care;
- The Assisted Living policy, which is a nursing home plan that provides
enhanced benefits and includes a home health care rider; and
- The Secured Risk Nursing Facility and Post Acute Recovery policies,
which provide limited benefits to higher risk insureds.
In addition, available policy riders include an automatic annual benefit
increase, benefits for adult day-care centers and a return of premium benefit.
Although nursing home and home health care policies accounted for 95.3% of our
total annualized premiums in-force as of December 31, 2001, we also market and
sell life, disability, Medicare supplement, other hospital care insurance
products and a group plan, which offers long-term care coverage to groups on a
guaranteed issue basis.
Effective December 31, 2001, we entered a reinsurance transaction to reinsure,
on a quota share basis, substantially all of our respective long-term care
insurance policies then in-force. The agreement was entered with Centre
Solutions (Bermuda) Limited, which is rated A- by A.M. Best. The agreement,
which is subject to certain coverage limitations, meets the requirements to
qualify as reinsurance for statutory accounting, but not for generally accepted
accounting principles. The initial premium of the treaties is approximately
$619,000,000, comprised of $563,000,000 of debt and equity securities
transferred subsequent to December 31, 2001, and $56,000,000 held as funds due
to the reinsurer. The initial premium and future cash flows from the reinsured
policies, less claims payments, ceding commissions and risk charges, will be
credited to a notional experience account, which is held for our benefit in the
event of commutation and recapture on or after December 31, 2007. The notional
experience account balance will receive an investment credit based upon the
total return of a series of benchmark indices and hedges, which are designed to
closely match the duration of our reserve liabilities.
THE LONG-TERM CARE INSURANCE INDUSTRY
The long-term care insurance market has grown rapidly in recent years. According
to studies by Conning & Co. and LifePlans, Inc., the long-term care insurance
market experienced a compound average growth rate of 20.1% from 1994 to 1999,
rising from approximately $1.7 billion of net written premiums in 1994 to
approximately $4.2 billion of net written premiums in 1999. We expect this
growth to continue based on the projected demographics of the United States
population, the rising costs of health care and a regulatory environment that
supports the use of private long-term care insurance.
The population of senior citizens (over age 65) in the U.S. is projected to grow
from the current estimated level of approximately 35 million to approximately 70
million by 2030, according to a 1996 U.S. Census Bureau report. Furthermore,
health and medical technologies are improving life expectancy and, by extension,
increasing the number of people requiring some form of long-term care. According
to a 1999 report by Conning & Co., market penetration of long-term care
insurance products in the over-65 age group ranges from 5% to 7%. The size of
the target population and the lack of penetration of the existing market
indicate a substantial growth opportunity for companies providing long-term care
insurance products.
We believe that the rising cost of nursing home and home health care services
makes long-term care insurance an attractive means to pay for these services.
According to a 1998 report by the U.S. Healthcare Financing Administration, the
combined cost of home health care and nursing home care was $20.0 billion in
1980. By 1996, this cost had risen to $108.7 billion. In addition, recent and
proposed tax legislation encourages individuals to use private insurance for
long-term care needs through tax incentives at both the federal and state
levels.
OUR STRATEGY
We seek to enhance shareholder value by strengthening our position as a leader
in providing long-term care insurance. We intend to accomplish this goal through
the following strategies:
Recommencing sales in all states. During 2001, we ceased new sales in the
majority of states in which we are licensed to sell new insurance policies. This
action resulted from a concern that our statutory surplus would continue to
decline from new sales during a period in which we were formulating our
Corrective Action Plan with the Pennsylvania Insurance Department. Since our
Corrective Action Plan was approved in February 2002, we have recommenced sales
in 26 states. We are actively working with all states in order to recommence
sales in all jurisdictions. See "Management's Discussion and Analysis -
Liquidity and Capital Resources."
Refinancing our long-term debt. We have $74,750,000 of convertible debt that
matures in December 2003. We do not expect that our debt will be converted into
shares of common stock at that time. Therefore, we intend to seek refinancing
alternatives that will extend the maturity of the debt and provide favorable
terms to our shareholders.
Developing and qualifying new products with state insurance regulatory
authorities. We have sold long-term care insurance for over 29 years. As an
innovator in nursing home and home health care insurance, we have introduced
many new policies over the years, including four new products in the last five
years. By continually discussing long-term care needs with our agency force and
policyholders, we are able to design new products and to offer what we believe
to be the most complete benefit features in the industry. The development of new
products enables us to generate new business, maintain proper pricing levels and
provide advancements in the benefits we offer. We intend to continue to develop
new insurance products designed to meet the needs of senior citizens and their
families.
Increasing the size and productivity of our network of independent agents. We
have significantly increased the number of agents who sell products for us and
have focused our efforts on states that have larger concentrations of older
individuals. We have successfully increased our number of licensed agents from
approximately 13,000 in 1995 to approximately 49,000 at December 31, 2001. We
intend to continue to recruit agents and we believe that we will be able to
continue to expand our business. Approximately one-third of our agents write new
business for us each year.
Utilizing Internet strategies. We have developed a proprietary agent sales
system for long-term care insurance, LTCWorks!, which enables agents to sell
products utilizing downloadable software. We believe that LTCWorks! increases
the potential distribution of our products by enhancing agents' ability to
present the products, assist policyholders in the application process and submit
applications over the Internet. LTCWorks! provides agents who specialize in the
regular sale of long-term care insurance products with a unique and easy to use
sales tool and enables agents who are less familiar with long-term care
insurance to present it when they are discussing other products such as life
insurance or annuities.
Developing third-party administration contracts. We believe that our surplus and
parent company liquidity can be supplemented by providing administrative
services to other long-term care providers and self-funded plans. We believe
that our experience in long-term care affords us opportunities to develop these
relationships.
Introducing group products. In 2000, we began actively marketing our new group
policy, which we anticipate will generate additional premium revenue from a
younger policyholder base. Group products allow us to penetrate an additional
market for the sale of long-term care insurance. We pursue large and small
groups, and offer supplemental coverage on an individually underwritten basis to
group members and their families. We currently market our group products
primarily through agents who market products to individuals. However, we are in
the process of developing a network of agents who generally sell other group
products, and who often have existing relationships with employer groups, to
market our group products. As of December 31, 2001, premiums in-force for our
group products were approximately $4.0 million, covering 3,256 individuals. We
believe our group products present an opportunity to significantly increase the
number of policies in-force without paying significantly increased commissions.
RISK FACTORS
Certain statements made by us, in this filing, may be considered forward-looking
within the meaning of the Private Securities Litigation Reform Act of 1995.
Although we believe that our expectations are based on reasonable assumptions
within the bounds of our knowledge of our business and operations, there can
be no assurance that our actual results of operations will not differ materially
from our expectations. Factors which could cause actual results to differ from
expectations include:
WE MAY BE UNABLE TO SERVICE AND REPAY OUR DEBT OBLIGATIONS IF OUR SUBSIDIARIES
CANNOT PAY SUFFICIENT DIVIDENDS OR MAKE OTHER CASH PAYMENTS TO US AND WE MAY BE
UNABLE TO REFINANCE OUR DEBT ON FAVORABLE TERMS AS NECESSARY.
We are an insurance holding company whose assets principally consist of the
capital stock of our operating subsidiaries. Our ability to redeem, repurchase
or make interest payments on our outstanding debt is dependent upon the ability
of our subsidiaries to pay cash dividends or make other cash payments to us. Our
insurance subsidiaries are subject to state laws and regulations and an order of
the Pennsylvania Insurance Department, which restrict their ability to pay
dividends and make other payments to us. We cannot assure you that we will be
able to service and repay our debt obligations through their maturity in
December 2003. We do not expect our subsidiaries to have sufficient dividend
capability to enable us to repay our 6.25% Convertible Subordinated Notes of
$74,750,000 due December 2003. If these notes are not converted into common
stock, we will have to refinance them. We cannot assure you that we will be able
to refinance the notes on favorable terms.
WE COULD SUFFER A LOSS IF OUR PREMIUM RATES ARE NOT ADEQUATE AND WE MAY BE
REQUIRED TO REFUND OR REDUCE PREMIUMS IF OUR PREMIUM RATES ARE DETERMINED TO BE
TOO HIGH.
We set our premiums based on facts and circumstances known at the time and on
assumptions about numerous variables, including the actuarial probability of a
policyholder incurring a claim, the severity and duration of the claim and the
mortality rate of our policyholder base, the persistency or renewal of our
policies in-force and the interest rate which we expect to earn on the
investment of premiums. In setting premiums, we consider historical claims
information, industry statistics and other factors. If our actual experience
proves to be less favorable than we assumed and we are unable to raise our
premium rates, our net income may decrease. We generally cannot raise our
premiums in any state unless we first obtain the approval of the insurance
regulator in that state. We have filed and are preparing to file rate increases
on the majority of our products. We cannot assure you that we will be able to
obtain approval for premium rate increases from existing requests or requests
filed in the future. If we are unable to raise our premium rates because we fail
to obtain approval for a rate increase in one or more states, our net income may
decrease.
If we are successful in obtaining regulatory approval to raise premium rates,
the increased premiums may reduce our sales and cause policyholders to let their
policies lapse. Increased lapsation would reduce our premium income and would
require us to expense fully the deferred policy costs relating to lapsed
policies in the period in which those policies lapse, reducing our net income in
that period. Our reinsurance coverage may also be reduced if we fail to obtain
required rate increases.
Insurance regulators also require us to maintain certain minimum statutory loss
ratios on the policies that we sell. We must pay out, on average, a certain
minimum percentage of premiums as benefits to policyholders. State regulations
also mandate the manner in which insurance companies may compute loss ratios and
the manner in which compliance is measured and enforced. If our policies are not
in compliance with state mandated minimum loss ratios, state regulators may
require us to reduce or refund premiums.
OUR RESERVES FOR FUTURE POLICY BENEFITS AND CLAIMS MAY BE INADEQUATE, REQUIRING
US TO INCREASE LIABILITIES AND RESULTING IN REDUCED NET INCOME AND BOOK VALUE.
We calculate and maintain reserves for the estimated future payment of claims to
our policyholders using the same actuarial assumptions that we use to set our
premiums. Establishing reserves is an uncertain process, and we cannot assure
you that actual claims expense will not materially exceed our reserves and have
a material adverse effect on our results of operations and financial condition.
Our net income depends significantly upon the extent to which our actual claims
experience is consistent with the assumptions we used in setting our reserves
and pricing our policies. If our assumptions with respect to future claims are
incorrect, and our reserves are insufficient to cover our actual losses and
expenses, we would suffer an increase in liabilities resulting in reduced net
income.
Claims experience can differ from our expectations due to numerous factors,
including mortality rates, duration of care and type of care utilized. Due to
the inherent uncertainty in establishing reserves, it has been necessary in the
past for us to increase the estimated future liabilities reflected in our
reserves for claims and policy expenses. In 1999, we added approximately $4.1
million to our claim reserves for 1998 and prior claim incurrals, in 2000, we
added approximately $6.6 million to our claim reserves for 1999 and prior claim
incurrals, and in 2001, we added approximately $8.8 million to our claim
reserves for 2000 and prior claim incurrals. Our additions to prior year
incurrals in 2001 resulted from a continuance study performed by our consulting
actuary. We also increased claim reserves in 2001 by $1.6 million as a result of
utilizing a lower interest rate for the purpose of discounting our future
liabilities. Over time, it may continue to be necessary for us to increase our
reserves.
New insurance products, such as our Independent Living, Assisted Living and
Personal Freedom policies, entail a greater risk of unanticipated claims than
products which have more extensive historical claims data, such as long-term
nursing home care insurance. We believe that individuals may be more inclined to
use home health care than nursing home care, which is generally only considered
after all other possibilities have been exhausted. Accordingly, we believe that
home health care policies entail a greater risk of wide variations in claims
experience than nursing home insurance. Because we have relatively limited
claims experience with these products, we may incur higher than expected losses
and expenses and may be required to adjust our reserve levels with respect to
these products.
WE MAY RECOGNIZE A DISPROPORTIONATE AMOUNT OF POLICY COSTS IN ONE FINANCIAL
REPORTING PERIOD IF OUR ESTIMATES WITH RESPECT TO THE DURATION OF OUR POLICIES
ARE INACCURATE.
We recognize policy costs over the life of each policy we sell. These costs
include all expenses that are directly related to, and vary with, the
acquisition of the policy, including commission, underwriting and other policy
issue expenses. We use the same actuarial assumptions used to compute premiums
and reserves to determine the period over which to amortize policy costs.
Upon the occurrence of an unanticipated termination of a policy, we must fully
expense deferred acquisition costs associated with the terminated policy. If
actual experience adversely differs from our actuarial assumptions or if
policies are terminated early by the insured or by us, we would recognize a
disproportionate amount of policy expenses at one time, which would negatively
affect our net income for that period.
Annually, we determine if the future profitability of current in-force policies
is sufficient to support our remaining deferred acquisition cost amount. This
determination may include assumptions regarding the current need and future
implementation of premium rate increases. We believe that we need certain rate
increases in order to generate sufficient profitability to offset our current
deferred acquisition costs. In the event that profits are considered
insufficient to fully support the deferred acquisition costs, or if we are
unable to obtain anticipated premium rate increases, we would impair the value
of our deferred acquisition expense asset and would recognize a disproportionate
amount of policy expenses at one time, which would negatively affect our net
income for that period.
WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY WITH INSURERS WHO HAVE GREATER
FINANCIAL RESOURCES OR HIGHER FINANCIAL STRENGTH RATINGS.
We sell our products in highly competitive markets. We compete with large
national insurers, smaller regional insurers and specialty insurers. Many
insurers are larger and have greater resources and higher financial strength
ratings than we do. In addition, we are subject to competition from insurers
with broader product lines. We also may be subject, from time to time, to new
competition resulting from changes in Medicare benefits, as well as from
additional private insurance carriers introducing products similar to those
offered by us. Also, the removal of regulatory barriers (including as a result
of the Gramm-Leach-Bliley Financial Services Modernization Act of 1999) might
result in new competitors entering the long-term care insurance business. These
new competitors may include diversified financial services companies that have
greater financial resources than we do and that have other competitive
advantages, such as large customer bases and extensive branch networks for
distribution.
WE MAY SUFFER REDUCED INCOME IF GOVERNMENTAL AUTHORITIES CHANGE THE REGULATIONS
APPLICABLE TO THE INSURANCE INDUSTRY.
We are licensed to do business as an insurance company in a number of states and
are subject to comprehensive regulation by the insurance regulatory authorities
of those states. The primary purpose of such regulation is to protect
policyholders, not shareholders. The laws of the various states establish
insurance departments with broad powers with respect to such things as licensing
companies to transact business, licensing agents, prescribing accounting
principles and practices, admitting statutory assets, mandating certain
insurance benefits, regulating premium rates, approving policy forms, regulating
unfair trade, market conduct and claims practices, establishing statutory
reserve requirements and solvency standards, limiting dividends, restricting
certain transactions between affiliates and regulating the types, amounts and
statutory valuation of investments.
State insurance regulators and the National Association of Insurance
Commissioners ("NAIC") continually reexamine existing laws and regulations, and
may impose changes in the future that materially adversely affect our business,
results of operations and financial condition. In particular, rate rollback
legislation and legislation to control premiums, policy terminations and other
policy terms may affect the amount we may charge for insurance premiums. In
addition, some state legislatures have discussed and implemented proposals to
limit rate increases on long-term care insurance products. Because insurance
premiums are our primary source of income, our net income may be negatively
affected by any of these changes. Many states are now disallowing coverage
exclusions incurred as a result of war or terrorist acts. We have proactively
removed these exclusions in some states, but cannot be certain that our
financial results would not be adversely affected by such acts.
Proposals currently pending in the U.S. Congress may affect our income. These
include the implementation of minimum consumer protection standards for
inclusion in all long-term care policies, including: guaranteed premium rates;
protection against inflation; limitations on waiting periods for pre-existing
conditions; setting standards for sales practices for long-term care insurance;
and guaranteed consumer access to information about insurers, including lapse
and replacement rates for policies and the percentage of claims denied.
Enactment of any of these proposals could adversely affect our net income. In
addition, recent federal financial services legislation requires states to adopt
laws for the protection of consumer privacy. Compliance with various existing
and pending privacy requirements also could result in significant additional
costs to us.
WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY IF WE CANNOT RECRUIT AND RETAIN
INSURANCE AGENTS.
We distribute our products principally through independent agents whom we
recruit and train to market and sell our products. We also engage marketing
general agents from time to time to recruit independent agents and develop
networks of agents in various states. We compete vigorously with other insurance
companies for productive independent agents, primarily on the basis of our
financial position, support services, compensation and product features. We may
not be able to continue to attract and retain independent agents to sell our
products, especially if we are unable to restore our capital and surplus and
improve our financial strength ratings. Our business and ability to compete
would suffer if we are unable to recruit and retain insurance agents and if we
lose the services provided by our marketing agents.
OUR BUSINESS IS CONCENTRATED IN A FEW STATES.
Historically, our business has been concentrated in a few states. Over the past
four fiscal years, approximately half of our premiums were from sales of
policies in California, Florida and Pennsylvania. Increased competition, changes
in economic conditions, legislation or regulations, rating agency downgrades,
statutory surplus deficiencies or the loss of our ability to write business due
to regulatory intervention in any of these states could significantly affect our
results of operations or prospects. In 2001, we voluntarily ceased new sales in
these states as a result of our subsidiary's statutory surplus position. We
recommenced sales in Pennsylvania in February 2002 and petitioned Florida and
California for reentry. Until the necessary approvals are received, we are
unable to sell new policies in these states. As a result of not selling policies
in these states, or if we fail to recommence sales in other states, our
financial condition may be materially adversely affected.
DECLINES IN THE VALUE OR THE YIELDS ON OUR INVESTMENT PORTFOLIO AND SIGNIFICANT
DEFAULTS IN OUR INVESTMENT PORTFOLIO MAY ADVERSELY AFFECT OUR NET INCOME.
Income from our investment portfolio is a significant element of our overall net
income. If our investments do not perform well, we would have reduced net income
and could suffer a net loss. We are susceptible to changes in market rates when
cash flows from maturing investments are reinvested at prevailing market rates.
Accordingly, a prolonged decrease in interest rates or in equity security prices
or an increase in defaults on our investments could adversely affect our net
income.
Effective December 31, 2001, we entered a reinsurance agreement to reinsure, on
a quota share basis, substantially all of our long-term care insurance policies
in-force. The transaction resulted in the transfer of debt and equity securities
of approximately $563,000,000 to the reinsurer and a funds withheld balance of
$56,000,000. The agreement provides us the opportunity to commute on or, after
December 31, 2007. The reinsurer will maintain a notional experience account,
which reflects the initial premium paid, future premiums collected net of
claims, expenses and accumulated investment earnings. The notional experience
account balance will receive an investment credit based upon the total return of
a series of benchmark indices and hedges, which are designed to closely match
the duration of reserve liabilities. Periodic changes in the market values of
the benchmark indices and hedges will be recorded in our financial statements as
investment gains or losses in the period in which they occur. As a result, we
will likely experience volatility in our future financial statements.
In addition, we depend in part on income from our investment portfolio to fund
our reserves for future policy claims and benefits. In establishing the level of
our reserves, we make assumptions about the performance of our investments. If
our investment income or the capital gains in our portfolio are lower than
expected, we may have to increase our reserves, which could adversely affect our
net income.
Our new reinsurance agreement is subject to an aggregate limit of liability,
which is a function of certain factors and which may be reduced as a result of
our inability to obtain certain rate increases.
Our new reinsurance agreement with Centre Solutions (Bermuda) Limited, effective
December 31, 2001, is subject to certain coverage limitations and aggregate
limit of liability, which is a function of certain factors and which may be
reduced as a result of our inability to obtain rate increases. This limit of
liability is subject to certain events such as material breach of the covenants
of the agreement, regulatory risk of changes in regulation or law and our
inability to achieve rate increases deemed necessary by the provisions of the
agreement.
All references to this reinsurance agreement or to Centre Solutions (Bermuda)
Limited throughout this filing and the attached Financial Statements are
intended to contain this statement of risk.
OUR REINSURERS MAY NOT SATISFY THEIR OBLIGATIONS TO US.
We obtain reinsurance from unaffiliated reinsurers on most of our policies to
increase the number and size of the policies we may underwrite and reduce the
risk to which we are exposed. Although reinsurance makes the reinsurer liable to
us to the extent the risk is transferred to the reinsurer, it does not relieve
us of our liability to our policyholders. Accordingly, we bear credit risk with
respect to our reinsurers. We cannot assure you that our reinsurers will pay all
of our reinsurance claims or that they will pay our reinsurance claims on a
timely basis.
Our Corrective Action Plan, as approved by the Pennsylvania Insurance
Department, will result in a strengthening of our statutory reserves. A
component of the Corrective Action Plan is a reinsurance agreement. If the
reinsurer does not honor our agreement, if the limit of liability is reduced as
a result of limitations and / or conditions contained in the reinsurance
agreement, or if the agreement is cancelled, our statutory surplus would be
materially adversely affected.
WE MAY NOT COMMUTE OUR NEW REINSURANCE TRANSACTION ON DECEMBER 31, 2007 AND MAY
INCUR INCREASED EXPENSES BY NOT COMMUTING.
Effective December 31, 2001, we entered a reinsurance transaction with an
unaffiliated reinsurer for substantially all of our long-term care insurance
policies then in-force. This agreement contains commutation provisions and
allows us to recapture the reserve liabilities and the current experience
account balance as of December 31, 2007 or on December 31 of any year
thereafter.
If we choose not to or are unable to commute the agreement as planned, our
financial results would likely suffer a materially adverse impact due to an
escalation of the charges paid to the reinsurer after December 31, 2007.
Additionally, our reinsurance agreement contains significant covenants and
conditions that, if breached, could result in a significant loss, requiring a
payment of $2.5 million per quarter from the period of the breach through
December 31, 2007. Any breach of the reinsurance agreement may also result in
the immediate recapture of the reinsured business, which would have a material
adverse effect on our subsidiaries' statutory surplus. Management has also
completed an assessment of its ability to avoid any breach through 2002 and
believes that it will remain compliant. The reinsurer has been granted warrants
to acquire convertible preferred stock in the event we do not commute the
agreements that, if converted, would represent an additional 20 percent of the
common stock then outstanding.
WE MAY BE AFFECTED BY OUR FINANCIAL STRENGTH RATINGS DUE TO HIGHLY COMPETITIVE
MARKETS.
Our ability to expand and to attract new business is affected by the financial
strength ratings assigned to our insurance company subsidiaries by A.M. Best
Company, Inc. and Standard & Poor's Insurance Rating Services, two independent
insurance industry rating agencies. A.M. Best's ratings for the industry range
from "A++ (superior)" to "F (in liquidation)." Standard & Poor's ratings range
from "AAA (extremely strong)" to "CC (extremely weak)." Some companies are
unrated. A.M. Best and Standard & Poor's insurance company ratings are based
upon factors of concern to policyholders and insurance agents and are not
directed toward the protection of investors. Our subsidiaries that are rated
have A.M. Best ratings of "B- (fair)" and Standard & Poor's ratings of "B-
(weak)."
Certain distributors will not sell our group products unless we have a financial
strength rating of at least an "A-." The inability of our subsidiaries to obtain
higher A.M. Best or Standard & Poor's ratings could adversely affect the sales
of our products if customers favor policies of competitors with better ratings.
In addition, the recent downgrades and further downgrades in our ratings may
cause our policyholders to allow their existing policies to lapse. Increased
lapsation would reduce our premium income and would also cause us to expense
fully the deferred policy costs relating to lapsed policies in the period in
which those policies lapsed, thereby reducing our capital and surplus.
Downgrades to our ratings may also lead some independent agents to sell fewer of
our products or to cease selling our policies altogether.
WE MAY NOT HAVE ENOUGH CAPITAL AND SURPLUS TO CONTINUE TO GROW.
Our continued growth is dependent upon our ability to continue to fund expansion
of our markets and our network of agents while at the same time maintaining
required minimum statutory levels of capital and surplus to support such growth.
Our new business growth typically results in net losses on a statutory basis
during the early years of a policy, due primarily to differences in accounting
practices between statutory accounting principles and generally accepted
accounting principles. The resultant reduction in statutory surplus, or surplus
strain, can limit our ability to generate new business due to statutory
restrictions on premium to surplus ratios and required statutory surplus
parameters. If we cannot generate sufficient statutory surplus to maintain
minimum statutory requirements through increased statutory profitability,
reinsurance or other capital generating alternatives, we will be limited in our
ability to generate additional premium from new business growth, which would
result in lower net income under generally accepted accounting principles, or,
in the event that our statutory surplus is not sufficient to meet minimum state
premium to surplus and risk based capital ratios, we could be prohibited from
generating additional premium revenue.
Furthermore, the insurance industry may undergo change in the future and,
accordingly, new products and methods of service may also be introduced. In
order to keep pace with any new developments, we may need to expend significant
capital to offer new products and to train our agents and employees to sell and
administer these products and services. We may also need to make significant
capital expenditures for computer systems and other technology needed to market
and administer our policies. We may not be successful in developing new products
and we may not have the funds necessary to make capital expenditures. Any
significant capital expenditures, or the failure to make necessary investments,
may have a material adverse effect on us.
LITIGATION MAY RESULT IN FINANCIAL LOSSES, HARM TO OUR REPUTATION AND DIVERT
MANAGEMENT RESOURCES.
We are regularly involved in litigation, both as a defendant and as a plaintiff.
The litigation naming us as a defendant ordinarily involves our activities as an
insurer. In recent years, many insurance companies have been named as defendants
in class actions relating to market conduct or sales practices, and other
long-term care insurance companies have been sued when they sought to implement
premium rate increases. We cannot assure you that we will not be named as a
defendant in a similar case. Current and future litigation may result in
financial losses, harm our reputation and require the dedication of significant
management resources.
The Company and certain of its key executive officers are defendants in
consolidated actions that were instituted on April 17, 2001 in the United States
District Court for the Eastern District of Pennsylvania by shareholders of the
Company, on their own behalf and on behalf of a putative class of similarly
situated shareholders who purchased shares of the Company's common stock between
July 23, 2000 through and including March 29, 2001. The consolidated amended
class action complaint seeks damages in an unspecified amount for losses
allegedly incurred as a result of misstatements and omissions allegedly
contained in the Company's periodic reports filed with the SEC, certain press
releases issued by them, and in other statements made by its officials. The
alleged misstatements and omissions relate, among other matters, to the
statutory capital and surplus position of the Company's largest subsidiary, Penn
Treaty Network America Insurance Company. On December 7, 2001, the defendants
filed a motion to dismiss the complaint, which is currently pending. The Company
believes that the complaint is without merit, and it and its executives will
continue to vigorously defend the matter.
WE ARE DEPENDENT UPON KEY PERSONNEL AND OUR OPERATIONS COULD BE AFFECTED BY THE
LOSS OF THEIR SERVICES.
Our success largely depends upon the efforts of our senior operating management,
including our chairman, chief executive officer, president and founder, Irving
Levit. The loss of the services of Mr. Levit or one or more of our key personnel
could have a material adverse effect on our operations.
OUR PRINCIPAL SHAREHOLDER AND OTHER MEMBERS OF OUR SENIOR MANAGEMENT TEAM HAVE
THE ABILITY TO EXERT SIGNIFICANT INFLUENCE OVER OUR AFFAIRS.
Mr. Levit is our principal shareholder and controls, directly or indirectly,
approximately 13% of our common stock. In addition, a majority of the members of
our board of directors are members of our senior management team. Accordingly,
Mr. Levit and other members of our senior management team have the power to
exert significant influence over our policies and affairs.
CERTAIN ANTI-TAKEOVER PROVISIONS IN STATE LAW AND OUR ARTICLES OF INCORPORATION
MAY MAKE IT MORE DIFFICULT TO ACQUIRE US AND THUS MAY DEPRESS THE MARKET PRICE
OF OUR COMMON STOCK.
Our Restated and Amended Articles of Incorporation, the Pennsylvania Business
Corporation Law of 1988, as amended, and the insurance laws of states in which
our insurance subsidiaries do business contain certain provisions which could
delay or impede the removal of incumbent directors and could make a merger,
tender offer or proxy contest involving us difficult, even if such a transaction
would be beneficial to the interests of our shareholders, or discourage a third
party from attempting to acquire control of us. In particular, the
classification of our board of directors could have the effect of delaying a
change in control. In addition, we have authorized 5,000,000 shares of preferred
stock, which we could issue without further shareholder approval and upon such
terms and conditions, and having such rights privileges and preferences, as the
board of directors may determine. We have no current plans to issue any
preferred stock. Insurance laws and regulations of Pennsylvania and New York
prohibit any person from acquiring control of us, and thus indirect control of
our insurance subsidiaries, without the prior approval of the insurance
commissioners of those states.
REDUCED LIQUIDITY AND PRICE VOLATILITY COULD RESULT IN A LOSS TO INVESTORS.
Although our common stock is listed on the New York Stock Exchange, there can be
no assurance as to the liquidity of investments in our common stock or as to the
price investors may realize upon the sale of our common stock. These prices are
determined in the marketplace and may be influenced by many factors, including
the liquidity of the market for the common stock, the market price of the common
stock, investor perception and general economic and market conditions.
CORPORATE BACKGROUND
We are registered and approved as a holding company under the Pennsylvania
Insurance Code. We were incorporated in Pennsylvania on May 13, 1965 under the
name Greater Keystone Investors, Inc. and changed our name to Penn Treaty
American Corporation on March 25, 1987. Penn Treaty Life Insurance Company
("Penn Treaty Life") 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. We acquired Quaker State
Life Insurance Company on May 4, 1976, and changed its name to Penn Treaty Life
Insurance Company. On July 13, 1989, Penn Treaty Life 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, and changed its name to Network America
Life Insurance Company on August 1, 1989.
On August 30, 1996, we consummated the acquisition of all of the issued and
outstanding capital stock of Health Insurance of Vermont, Inc., and have since
changed its name to American Network Insurance Company.
Senior Financial Consultants Company, an insurance agency that we own, was
incorporated in Pennsylvania on February 23, 1988 under the name Penn Treaty
Service Company. On February 29, 1988, it acquired, among other assets, the
rights to renewal commissions on a certain block of Penn Treaty Life'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 Penn Treaty Life'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,
we changed the name of the Agency to Cher-Britt Service Company. The option was
exercised on March 3, 1989. Its name was changed to Senior Financial Consultants
Company on August 9, 1994.
On December 31, 1997, Penn Treaty Life dividended to us its common stock
ownership of Penn Treaty Network America Insurance Company. At that time, Penn
Treaty Network America Insurance Company assumed substantially all of the
assets, liabilities and premium in-force of Penn Treaty Life through a purchase
and assumption reinsurance agreement. On December 30, 1998, we sold our common
stock interest in Penn Treaty Life to an unaffiliated insurer. All remaining
policies in-force were assumed by Penn Treaty Network America Insurance Company
through a 100% quota share agreement.
On November 25, 1998, we entered into a purchase agreement to acquire all of the
common stock of United Insurance Group Agency, Inc. ("United Insurance Group"),
a Michigan based consortium of long-term care insurance agencies. The
acquisition was effective January 1, 1999.
On December 10, 1999, we incorporated Penn Treaty (Bermuda), Ltd., a Bermuda
based reinsurer, for the purpose of reinsuring affiliated long-term insurance
contracts at a future date.
On January 1, 2000, we acquired Network Insurance Senior Health Division
("NISHD"), a Florida-based insurance agency brokerage company. NISHD was
purchased by Penn Treaty Network America Insurance Company.
(b) Insurance Products
Since 1972, we have developed, marketed and underwritten defined benefit
accident and health insurance policies designed to be responsive to changes in:
- the characteristics and needs of the senior citizen market;
- governmental regulations and governmental benefits available for senior
citizens; and
- the health care and long-term care industries in general.
As of December 31, 2001, 95.3% of our total annualized premiums in-force were
derived from long-term care policies, which include nursing home and home health
care policies. Our other lines of insurance include life, disability, Medicare
supplement and other hospital care policies and riders. We solicit input from
both our independent agents and our policyholders with respect to the changing
needs of insureds. In addition, our representatives regularly attend seminars to
monitor significant trends in the industry.
Our focus on long-term care has enabled us to gain expertise in claims and
underwriting which we have applied to product development. Through the years, we
have continued to build on our brand names by offering the independent agency
channel a series of differentiated products. We have expanded our product line
to offer both tax-qualified and non-qualified plans based on consumer demand for
both.
The following table sets forth, for each of our last three fiscal years our
annualized gross premiums by type of policy.
(annualized premiums in $000's)
Year ended December 31,
----------------------------------------------------------
2001 2000 1999
Long-term facility, home and comprehensive coverage:
Annualized premiums $ 351,268 95.0% $ 360,600 95.2% $ 313,222 94.6%
Number of policies 242,644 242,075 208,955
Average premium per policy $ 1,448 $ 1,490 $ 1,499
Disability insurance:
Annualized premiums $ 6,415 1.7% $ 6,634 1.8% $ 7,126 2.2%
Number of policies 13,226 13,502 14,963
Average premium per policy $ 485 $ 491 $ 476
Medicare supplement:
Annualized premiums $ 8,449 2.3% $ 7,314 1.9% $ 6,131 1.9%
Number of policies 8,216 7,696 5,934
Average premium per policy $ 1,028 $ 950 $ 1,033
Life insurance:
Annualized premiums $ 3,310 0.9% $ 3,785 1.0% $ 4,095 1.2%
Number of policies 5,756 6,315 6,677
Average premium per policy $ 575 $ 599 $ 613
Other insurance:
Annualized premiums $ 398 0.1% $ 609 0.2% $ 548 0.2%
Number of policies 2,459 3,900 2,968
Average premium per policy $ 162 $ 156 $ 185
Total annualized premiums in force $ 369,840 100% $ 378,942 100% $ 331,122 100%
Total Policies 272,301 273,488 239,497
We received an insurance license in 1972, which permitted us to write insurance
in 12 states. In 1974, we filed a long-term care policy offering a five-year
benefit period. Our policy was the first national plan to equally cover all
levels of care, including skilled, intermediate and custodial care, with an
extended benefit period. We began the sale of home health care riders, which pay
for licensed nurses, certified nurses' aides and home health care workers who
provide care/assistance in the policyholder's home, in 1983. This plan was the
first in the industry to include a limited benefit for homemaker companion care
provided by a friend, neighbor, relative or religious organization. We began the
use of table-based underwriting, which enables higher risk policyholders to
receive coverage at a risk-adjusted premium level, in 1986. Appropriate risk is
calculated based upon medical conditions and ability to perform daily
activities. Multiple rate classes enabled us to penetrate an untapped market in
long-term care insurance sales.
We specialize in the sale of long-term care insurance, which is generally
defined as nursing home and home health care insurance coverage.
Long-Term Nursing Home Care. Our long-term nursing home care policies generally
provide a fixed or maximum daily 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,
waivers of premiums 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, intermediate and custodial (assisted living) 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 that 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 that would otherwise fall between skilled and assisted
living care and includes situations in which an individual may require skilled
assistance on a sporadic basis.
Our current long-term nursing home care policies provide benefits that are
payable over periods ranging from one to five years, or the lifetime of the
policyholder. These policies provide for a maximum daily benefit on costs
incurred ranging from $60 to $300 per day. Our Personal Freedom policies also
provide comprehensive coverage for nursing home and home health care, offering
benefit "pools of coverage" ranging from $75,000 to $300,000, as well as
lifetime coverage.
Long-Term Home Health Care. Our 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 our currently
marketed home health care policies are payable over periods ranging from six
months to five years, or the lifetime of the policyholder, and provide from $40
to $160 per day of home benefits. Our home health care policies also include
built-in benefits for waivers of premiums after 90 days of benefit payments, and
unlimited restoration of the policy's maximum benefit period.
We currently offer the following products:
INDEPENDENT LIVING PLAN. The Independent Living Plan (offered since 1994) was
our first stand-alone home health care plan that covered all levels of care
received at home. Besides covering skilled care and care by home health aides,
this plan pays for care provided by unlicensed, unskilled homemakers. This care
includes assistance with cooking, shopping, housekeeping, laundry,
correspondence, using the telephone and paying bills. Historically, only limited
coverage had been provided under certain of our home health care policies for
homemaker care, typically for a period of up to 30 days per calendar year during
the term of the policy. This benefit is now standard in most long-term care
policies. Family members also may be reimbursed for any training costs incurred
in order to provide in-home care.
The Independent Living policy provides that we 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 management service referred by us. Newer
policies offer up to 100% of the daily benefit if a care management service is
used, versus 80% if the policyholder does not elect care management services. We
engage the care manager 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.
We have subsequently incorporated the use of care management in all of our new
home health care policies.
PERSONAL FREEDOM PLAN. Our Personal Freedom Plan (offered since 1996) is a
comprehensive plan which provides a sum of money for long-term care to be used
for either nursing facility or home health care. The plan also provides coverage
for homemaker care for insureds who are unable to perform activities of daily
living such as cooking, shopping, housekeeping, laundry, correspondence, using
the telephone, paying bills and managing medication.
When policyholders purchase this policy, with benefits ranging from $75,000 to
$300,000, as well as lifetime 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. This plan also includes an optional return of
premium/nonforfeiture benefit.
ASSISTED LIVING PLAN. The Assisted Living Plan (offered since 1996) is a
stand-alone facility care plan that provides benefits in either a traditional
nursing home setting or in an Assisted Living Facility, the setting preferred by
the majority of policyholders. This policy, coupled with an optional home health
care rider, offers benefits similar to those of the Personal Freedom Plan, but
on an elapsed time, cost incurred basis with a maximum daily benefit, cost
incurred basis, rather than a sum of money basis.
SECURED RISK PLAN. Our Secured Risk Plan (offered since 1998) offers facility
care benefits to people who would most likely not qualify for long-term care
insurance under traditional policies. Table-based underwriting allows us to
examine these substandard conditions by level of activity and independence of
the applicant. This plan offers protection to such individuals by providing
coverage for care in a nursing facility or in the insured's home if he or she
chooses the limited optional home health care benefits. Features of this plan,
as with many of our other plans, include coverage for pre-existing conditions
after six months, guaranteed renewal for life, premiums that will not increase
with age and no requirement of prior hospitalization.
POST ACUTE RECOVERY PLAN. The Post Acute Recovery Plan (offered since 1999)
provides facility and home health care benefits for up to one year after
traditional medical insurance, Medicare, Medigap or HMO services stop, thereby
providing a more affordable short-term plan. Coupled with optional home health
care benefits, this product pays for medical recovery in a facility or in the
insured's home when traditional health care coverage stops. Features of this
plan include immediate coverage (no elimination period or deductible), coverage
for pre-existing conditions after six months in most states, guaranteed renewal
and
premiums that will not increase with age. We offer a "Care Solutions" service
with this plan, in which a care manager works with the insured to design a plan
of care suited to meet his or her individual needs.
GROUP LONG-TERM CARE INSURANCE PLAN. Our group long-term care insurance plan
(offered since 2000) provides group long-term care insurance to groups formed
for purposes other than the purchase of insurance, such as an employee group, an
association or a professional organization. A 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. Group members, spouses and parents can generally
purchase supplemental coverage beyond the level paid by the group. This coverage
is offered on an individually underwritten basis.
We are currently seeking to expand our group insurance business and are
enhancing our marketing efforts towards this end. Our management considers this
area to offer significant opportunities for sales growth.
RIDERS. Our policies generally offer an optional lifetime inflation rider, which
provides for a 5% increase of the selected daily benefit amount on each
anniversary date for the lifetime of the policy. An optional nonforfeiture
shortened benefit rider, which provides the insured with the right to maintain a
portion of his or her benefit period in the event the policy lapses after being
continuously in-force for at least three years, is also available. The return of
premium benefit rider provides for a pro-rata return of premium in the event of
death or surrender beginning in the sixth year. We also offer and encourage the
purchase of home health care riders to supplement our nursing home policies and
nursing home riders to supplement our home health care policies.
Previously, we offered numerous other riders to supplement our long-term care
policies. The need, however, for many of these riders has been eliminated due to
the incorporation of many of the benefits they provided into the basic coverage
included in our newest long-term care policies. Among the built-in benefits
provided under the long-term care policies we currently market are hospice care,
adult day care, survivorship benefits and restoration of benefits.
After the enactment of the Health Insurance Portability and Accountability Act
of 1996, issues arose relating to the tax status of long-term care benefits
included as part of non-qualified plans. To permit policyholders to purchase
either the tax-qualified plan or non-qualified plan that best suits their needs,
we introduced the Pledge and Promise. The Pledge and Promise states that, if the
U.S. Congress or the Treasury Department should determine that the benefits
received on a long-term care policy are considered taxable income, we will allow
a policyholder to convert the policy to a tax-qualified policy at any time. The
Pledge and Promise further states that, if the U.S. Congress or Treasury
Department should determine that the benefits received on a non-qualified plan
will not be considered taxable income, we will allow a policyholder to convert
the policy from a tax-qualified plan to a non-qualified plan at any time prior
to its first anniversary.
(c) Marketing
MARKETS. The following chart shows premium revenues by state for each of the
states where we do business:
($000)
-------------------------------------
Year Ended December 31, Current
Year ------------------------------------- Year %
State Entered 2001 2000 1999 of Total
----- -------- --------- --------- --------- --------
Arizona 1988 $ 15,392 $ 15,677 $ 13,715 4.4%
California 1992 51,498 50,165 43,514 14.7%
Colorado 1969 4,701 3,564 2,563 1.3%
Florida 1987 65,067 71,588 63,218 18.6%
Georgia 1990 5,066 4,764 3,350 1.4%
Illinois 1990 19,525 19,748 15,970 5.6%
Iowa 1990 5,361 5,097 4,317 1.5%
Maryland 1987 3,948 3,896 3,427 1.1%
Michigan 1989 6,654 6,357 5,469 1.9%
Missouri 1990 4,061 4,391 4,297 1.2%
Nebraska 1990 4,263 4,358 3,952 1.2%
New Jersey 1996 8,374 7,856 4,707 2.4%
New York 1998 4,103 2,665 676 1.2%
North Carolina 1990 10,399 9,690 8,089 3.0%
Ohio 1989 11,880 11,935 10,149 3.4%
Pennsylvania 1972 43,126 48,692 37,661 12.3%
Texas 1990 17,847 16,105 11,879 5.1%
Virginia 1989 22,638 22,370 19,597 6.5%
Washington 1993 10,670 9,814 7,485 3.0%
All Other States(1) 35,818 38,381 28,481 10.2%
--------- --------- --------- --------
All States $ 350,391 $ 357,113 $ 292,516 100.0%
========= ========= ========= ========
----------
(1) Includes all states in which premiums comprised less than one percent of
total premiums in 2001.
Our goal is to strengthen our position as a leader in providing long-term care
insurance to senior citizens by underwriting, marketing and selling our products
throughout the United States. We focus our marketing efforts primarily in those
states where we have successfully developed networks of agents and that have the
highest concentration of individuals whose financial status and insurance needs
are compatible with our products.
AGENTS. We market our products principally through independent agents. With the
exception of agents employed by our insurance agency subsidiaries, we do not
directly employ agents but instead rely on relationships with independent agents
and their sub-agents. We provide assistance to our agents through 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 our products in
each state in which the agent and our companies are licensed. Some of our
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. We do not have
exclusive agency agreements with any of our independent agents and they are free
to sell policies of other insurance companies, including our competitors.
We generally do not impose production quotas or assign exclusive territories to
agents. The amount of insurance written for us by individual independent agents
varies. We periodically review and terminate our agency relationships with
non-producing or under-producing independent agents and agents who do not comply
with our guidelines and policies with respect to the sale of our products.
We are actively engaged in recruiting and training new agents. Sub-agents are
recruited by the independent agents and are licensed by us with the appropriate
state regulatory authorities to sell our policies. Independent agents are
generally paid higher commissions than those employed directly by insurance
companies, in part to account for the expenses of operating as an independent
agent. We believe that the commissions we pay 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. We generally permit many
of our established independent agents to collect the initial premium with the
application and remit such premium to us less the commission. New independent
agents are required to remit the full amount of initial premium with the
application. We provide assistance to our independent agents in connection with
the processing of paperwork and other administrative services.
We have developed a proprietary agent sales system for long-term care insurance,
LTCWorks!, which enables agents to sell products utilizing downloadable
software. We believe that LTCWorks! increases
the potential distribution of our products by enhancing agents' ability to
present the products, assist policyholders in the application process and submit
applications over the Internet. LTCWorks! provides agents who specialize in the
regular sale of long-term care insurance products with a unique and easy to use
sales tool and enables agents who are less familiar with long-term care
insurance to present it when they are discussing other products such as life
insurance or annuities.
MARKETING GENERAL AGENTS AND GENERAL AGENTS. We selectively utilize marketing
general agents for the purpose of recruiting independent agents and developing
networks of agents in various states. Marketing general agents receive an
override commission on business written in return for recruiting, training and
motivating the independent agents. In addition, marketing general agents may
function as general agents for us in various states. No single grouping of
agents accounted for more than 10% of our new premiums or renewal premiums
written in 2001 or 2000. One agency accounted for 16% of total premiums earned
in 1999. We acquired a division of this agency during 2000, which reduced our
reliance on this unaffiliated agency. We have not delegated any underwriting or
claims processing authority to any agents.
GROUP AND FRANCHISE INSURANCE. We have recently begun to sell group long-term
care insurance to groups formed for purposes other than the purchase of
insurance, such as an employee group, an association or a professional
organization. A 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.
Group members, spouses and parents can generally purchase supplemental coverage
beyond the level paid by the group. This coverage is offered on an individually
underwritten basis.
We currently market our group products primarily through agents who market
products to individuals. However, we are in the process of developing a network
of agents who generally sell other group products, and who often have existing
relationships with employer groups, to market our group products. As of December
31, 2001, premiums in-force for our group products were approximately $4.0
million, covering 3,256 individuals. We believe our group products present an
opportunity to significantly increase the number of policies in-force without
paying significantly increased commissions.
From time to time, we also sell franchise insurance, which is a series of
individually underwritten policies sold to an association or group. While
franchise insurance is generally presented to groups that endorse the insurance,
policies are issued to individual group members. Each application is
underwritten and issuance of policies is not guaranteed to members of the
franchise group.
(d) Administration
Underwriting
We believe that the underwriting process through which we, as an accident and
health insurance company particularly in the long-term care segment, choose to
accept or reject an applicant for insurance is critical to our success. We have
offered long-term care insurance products for nearly 30 years and we believe we
have benefited significantly from our longstanding focus on this specialized
line. Through our experience with and focus on this niche product, we have been
able to establish a system of underwriting designed to permit us to process our
new business and assess the risk presented effectively and efficiently.
Applicants for insurance must complete detailed medical questionnaires. Physical
examinations are not required for our accident and health insurance policies,
but medical records are frequently requested. All long-term care applications
are reviewed by our in-house underwriting department and all applicants are
also interviewed by members of our underwriting department via telephone. This
"personal history interview" is aimed at not only confirming the information
disclosed on the application, but also at gaining more insight into the
applicant's physical abilities, activity level and cognitive functioning. We
consider age, cognitive status and medical history, among other factors, in
deciding whether to accept an application for coverage and, if accepted, the
appropriate rate class for the applicant. 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. We
also frequently use face-to-face assessments conducted in the applicant's home
by independent subcontractors (nurse networks). This evaluation is similar to
the personal history interview in terms of obtaining medical information and
information regarding the applicant's functional abilities, and it includes an
expanded cognitive test. We also use the Minnesota Cognitive Acuity Screening
test (formerly known as Cognistat) when a question of cognitive functioning
exists and is not adequately addressed by the other underwriting tools, or when
the possibility of cognitive problems is identified by one of the other
underwriting tools. In addition to age, cognitive status and medical history,
our underwriters are concerned with the applicant's abilities to perform the
activities of daily living. Our underwriting process extends beyond current
conditions, however, and takes into account how existing health conditions are
likely to progress and to what degree the independence of the applicant is
likely to change as the applicant ages.
We use table-based underwriting, or multiple rate classifications, as a means to
accept more business while obtaining the appropriate premiums for additional
risk. Applicants are placed in different risk classes for acceptance and premium
calculation based on medical conditions and level of activity during the
application process. We currently offer Premier, Select, Standard and Secured
risk classifications. If we determine that we cannot offer the requested
coverage, we may suggest an alternative product suitable for coverage for higher
risk applicants. Accepted policies are usually issued within seven working days
from receipt of the information necessary to underwrite the application.
Pre-existing conditions disclosed on an application for new long-term nursing
home care and most home health care policies are covered immediately upon
approval of the policy. Undisclosed pre-existing conditions are covered after
six months in most states and two years in certain other states. In addition,
our 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.
In group long-term care insurance, eligibility is guaranteed to all members of
the group without an underwriting review on an individual basis. However,
supplemental coverage offered to group members and their parents and spouses is
individually underwritten. Franchise insurance is a series of individually
underwritten policies sold to the members of an association or group. The
issuance of policies is not guaranteed to individual members of the franchise
group.
In conjunction with the development of our LTCWorks! system, we developed an
underwriting credit-scoring system, which provides consistent underwriting and
rate classification for applicants with similar medical histories and
conditions.
Claims
Claims for policy benefits, except with respect to Medicare supplement and
disability claims, are processed by our claims department, which includes nurses
employed or retained as consultants. We use third party administrators to
process our Medicare supplement claims due to the large number of claims and the
small benefit amount typically paid for each claim. Beginning in 1999, we also
engaged a third party administrator to perform all administration, including
claims processing, for our disability business.
For nursing home claims, upon notification of a claim, a personal claims
assistant is assigned to review all necessary documentation, including
verification of the facility where the claimant resides. A claims examiner
verifies eligibility of the claim under the policy. Every effort is made to
facilitate the processing of the claim, recognizing that this service efficiency
provides substantial value to the policyholder and his or her family. Toward
this end, the personal claims assistant verifies the continued residence of the
policyholder in the facility each month and expedites payment of the claim.
We periodically utilize the services of "care managers" to review certain
claims, particularly those filed under home health care policies. When a claim
is filed, we may engage a 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. This review may include visiting the claimant to assess
his or her condition. The care manager assists the insured and us by ensuring
that the services provided to the insured, and the corresponding benefits paid,
are appropriate under the circumstances. The care manager then follows the
claimant's progress with periodic contact to ensure that the plan of care
continues to be appropriate and that it is adjusted if warranted by improvement
in the claimant's condition.
Home care claims require the greatest amount of diligent overview and we have
utilized care management techniques for nearly ten years. Under the terms of our
Independent Living policy, we will waive the elimination period if the insured
agrees to utilize a care manager. Newer policies offer 100% claims coverage if
the claimant uses a care manager and provide up to 80% of the daily benefit if
care manager services are not used. The majority of all of our home health care
claims in 2001 were submitted to care management. We anticipate that this usage
will continue as our business grows.
In 1999, we 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. We intend to continue to develop this
unit, as we believe it can meet many of our care management needs more
effectively and less expensively than third party vendors can.
Systems Operations
We maintain our own computer system for most aspects of our operations,
including policy issuance, billing, claims processing, commission reports,
premium production by agent (state and product) and general ledger. Critical to
our ongoing success is our ability to continue to provide the quality of service
for which we are known to our policyholders and agents. We believe that our
overall systems are an integral component in delivering that service. If we are
able to generate additional statutory capital, we intend to significantly expand
or enhance our existing system through a replacement project. The extent of the
project has not been determined, but we estimate that it would require a
substantial investment of funds and resources to replace our entire system. One
current proposal would cost approximately $4 million to $8 million over three
years.
In 2000, we entered an outsourcing agreement with a computer services vendor,
which thereby assumed responsibility for the majority of the daily operations of
our system, future program development and business continuity planning. This
vendor provides both in-house and external servicing of all existing legacy
systems and hardware. We believe that this vendor can provide better expertise
in the evolving arena of information technology than we can provide by running
our own operations.
(e) Premiums
Our long-term care policies 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, we offer an automatic payment feature that allows
policyholders to have premiums automatically withdrawn from a checking account.
Premium rates for all lines of insurance are subject to state regulation.
Premium regulations vary greatly among jurisdictions and lines of insurance.
Rates for our insurance policies are established with the assistance of our
independent actuarial consultants and reviewed by the insurance regulatory
authorities. Before a rate change can be made, the proposed change must be filed
with and, with respect to rates for individual policies, approved by the
insurance regulatory authorities in each state in which an increase is sought.
Regulators may not approve the increases we request, may approve them only with
respect to certain types of policies or may approve increases that are smaller
than those we request.
As a result of minimum statutory loss ratio standards imposed to state
regulations, the premiums on our accident and health polices are subject to
reduction and/or corrective measures in the event insurance regulatory agencies
in states where we do business determine that our loss ratios either have not
reached or will not reach required minimum levels. See "Government Regulation."
(f) Future Policy Benefits and Claims Reserves
We are required to maintain reserves equal to our probable ultimate liability
for claims and related claims expenses with respect to all policies in-force.
Reserves, which are computed with the assistance of an independent firm of
actuarial consultants, are established for:
- claims which have been reported but not yet paid;
- claims which have been incurred but not yet reported; and
- the discounted present value of all future policy benefits less the
discounted present value of expected future premiums.
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. We compare actual experience with estimates and adjust reserves on the
basis of such comparisons.
In addition to reserves for incurred claims, reserves are also established for
future policy benefits. The policy reserves represent the discounted present
value of future obligations that are likely to arise from the policies that we
underwrite, 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 these reserves rests
on the validity of the underlying assumptions that were used to price the
products; the more important of these assumptions relate to policy lapses, loss
ratios and claim incidence rates. We review the adequacy of our deferred
acquisition costs and reserves on an annual basis, utilizing assumptions for
future expected claims and interest rates. If we determine that future gross
profits of our in-force policies are not sufficient to recover our deferred
acquisition costs, we recognize a premium deficiency and "unlock" or change our
original assumptions and reset our reserves to appropriate levels using new
assumptions. The assumptions we use to calculate reserves for claims under our
long-term care products are based on our 29 years of significant claims
experience, primarily with respect to nursing home care products, and on the
experience of the industry as a whole.
We began offering home health care coverage in 1983 and since that time have
realized a significant increase in the number of home health care policies
written. Claims experience with home health care coverage is more limited than
the available nursing home care claims experience. Our experience with
respect to the Independent Living policy, which was first offered in November
1994, and the Assisted Living and Personal Freedom policies, which were first
offered in late 1996, is more limited than our experience with skilled care
facilities. We believe that individuals may be more inclined to utilize home
health care than nursing home care, which is generally considered only after all
other possibilities have been explored. Accordingly, we believe that wide
variations in claims experience may be more likely in home health care insurance
than in nursing home insurance. Our actuarial consultants utilize both our
experience and other industry data in the computation of reserves for the home
health care product line.
In addition, newer long-term care products, developed as a result of regulation
or market conditions, may incorporate more benefits with fewer limitations or
restrictions. For instance, the Omnibus Budget Reconciliation Act of 1990
required that Medicare supplement policies provide for guaranteed renewability
and waivers of pre-existing condition coverage limitations under certain
circumstances. In addition, the NAIC has recently adopted model long-term care
policy language providing nonforfeiture benefits and a rate stabilization
standard for long-term care policies, either or both of which may be adopted by
the states in which we write policies. The fluidity in market and regulatory
forces may limit our ability to rely on historical claims experience for the
development of new premium rates and reserve allocations. See "Government
Regulation."
We use an independent firm of actuarial consultants and an in-house actuary to
assist us in pricing insurance products and establishing reserves with respect
to those products. Additionally, actuaries assist us in improving the
documentation of our reserve methodology and in determining the adequacy of our
reserves and their underlying assumptions, a process that has resulted in
certain adjustments to our reserve levels. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Overview." Although
we believe that our reserves are adequate to cover all policy liabilities, we
cannot assure you that reserves are adequate or that future claims experience
will be similar to, or accurately predicted by, our past or current claims
experience.
As of December 31, 2001 and 2000, our reserves for current claims were
$214,466,000 and $164,565,000, respectively. In 2001, we added approximately
$8.8 million to our claim reserves for 2000 and prior claim incurrals, and in
2000 we added approximately $6.6 million to our claim reserves for 1999 and
prior claim incurrals. Our additions to prior year incurrals in 2001 resulted
from a continuance study performed by our consulting actuary. We also increased
reserves in 2001 by $1.6 million as a result of utilizing a lower interest rate
for the purpose of discounting our future liabilities. Over time, it may
continue to be necessary for us to increase our claim reserves.
Policy reserves have been computed principally by the net level premium method
based upon estimated future investment yield, mortality, morbidity, withdrawals,
premium rate increases and other benefits. The following table sets forth the
composition of our policy reserves at December 31, 2001 and 2000 and the
assumptions pertinent thereto:
Amount of Policy Reserves
as of December 31,
2001 2000
--------- --------
Accident and health $ 382,660 $ 348,344
Annuities and other 131 118
Ordinary life, individual 13,255 12,947
Years of Issue Discount Rate Discount Rate
-------------- ------------- --------------
Accident and health 1976 to 1986 6.5% 7.0%
1987 6.5% 7.5%
1988 to 1991 6.5% 8.0%
1992 to 1995 6.5% 6.0%
1996 6.5% 7.0%
1997 to 2000 6.5% 6.8%
2001 6.5% 6.5%
Annuities and other 1977 to 1983 6.5% & 7.0% 6.5% & 7.0%
Ordinary life, individual 1962 to 2001 3.0% to 5.5% 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 1975-80 SOA Mortality Table
(Age Last Birthday).
In 2001, the anticipated future gross profits of our in-force long-term care
business was not sufficient to recover our deferred acquisition costs, resulting
in the recognition of an impairment charge. In connection with this, we unlocked
our prior reserve assumptions due to our determination that certain elements
were insufficient to produce adequate future coverage of claims. These
assumptions include interest rates, premium rates, shock lapses and
anti-selection of policyholder persistence.
(g) Reinsurance
As is common in the insurance industry, we purchase reinsurance to increase the
number and size of the policies we 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, we can limit our exposure to risk.
However, if a reinsurance company becomes insolvent or otherwise fails to honor
its obligations under any reinsurance agreements, we would remain fully liable
to the policyholder.
We reinsure any life insurance policy to the extent the risk on that policy
exceeds $50,000. We currently reinsure our ordinary life policies through
Reassurance Company of Hanover. We also have a reinsurance agreement with
Transamerica Occidental Life Insurance Company to reinsure term life policies
whose risk exceeds $15,000, and with Employer's Reassurance Corporation to
reinsure credit life policies whose risk exceeds $15,000.
We have ceded, through a fronting arrangement, 100% of certain whole life and
deferred annuity policies to Provident Indemnity Life Insurance Company. No new
policies have been ceded under this arrangement since December 31, 1995. We also
entered into a reinsurance agreement to cede 100% of certain life, accident,
health and Medicare supplement insurance policies to Life and Health of America.
These fronting arrangements are used when one insurer wishes to take advantage
of another insurer's ability to procure and issue policies. As the fronting
company, we remain ultimately liable to the policyholder, even though all of our
risk is reinsured. Therefore, the agreements require the maintenance of
securities in escrow for our benefit in the amount equal to our statutory
reserve credit.
We have also entered into a reinsurance agreement with Cologne Life Reinsurance
Company with respect to home health care policies with benefit periods exceeding
36 months. No new policies have been reinsured under this agreement since 1998.
We also enter into funds withheld financial reinsurance treaties, which allow us
to temporarily increase statutory surplus. However, the agreements did not
qualify for reinsurance treatment in accordance with SFAS 113 because, based on
our analysis, the agreements did not result in the reasonable possibility that
the reinsurer could realize a significant loss in the event of adverse
development. As a result, we are using deposit accounting for these agreements
and results of operations reflect only the annual fee paid to the reinsurer.
Since the contracts were funds withheld, there was no reinsurance recoverable or
payable on a GAAP basis on the balance sheet. The agreements met the
requirements to qualify for reinsurance treatment under statutory accounting
rules. We commuted all existing financial reinsurance treaties, effective
December 31, 2001, which reduced statutory surplus by approximately $20,000,000.
At December 31, 2001 and 2000, our statutory surplus was increased by $0 and
approximately $20,000,000, respectively, from financial reinsurance.
We have stop-loss reinsurance on our disability business that limits our
liability in aggregate for the life of the policy or above monthly loss amounts.
This coverage is ceded to Employer's Reassurance Corporation, Reassurance
America Life Insurance Company and Lincoln National Life Insurance Company.
Since January 1, 2000, no new policies have been ceded to Employer's Reassurance
Corporation, which has historically provided the majority of our stop-loss
reinsurance.
In 2001, we ceded substantially all of our disability policies to Assurity Life
Insurance Company on a 100% quota share basis. The reinsurer may assume
ownership of the policies as a sale upon various state and policyholder
approvals. We received a ceding allowance of approximately $5,000,000 and ceded
reserves to the reinsurer of approximately $10,300,000.
Effective December 31, 2001, we entered a reinsurance transaction to reinsure,
on a quota share basis, substantially all of our respective long-term care
insurance policies then in-force. The agreement was entered with Centre
Solutions (Bermuda) Limited, which is rated A- by A.M. Best. The agreement is
subject to certain coverage limitations, including an aggregate limit of
liability, which is a function of certain factors and which may be reduce in the
event that the rate increases that the reinsurance agreement may require are not
obtained. The agreement meets the requirements to qualify as reinsurance for
statutory accounting, but not for generally accepted accounting principles. The
initial premium of the treaties is approximately $619,000,000, comprised of
$563,000,000 of cash and qualified securities transferred subsequent to December
31, 2001, and $56,000,000 held as funds due to the reinsurer. The
initial premium and future cash flows from the reinsured policies, less claims
payments, ceding commissions and risk charges, will be credited to a notional
experience account, which is held for our benefit in the event of commutation
and recapture on or after December 31, 2007. The notional experience account
balance will receive an investment credit based upon the total return of a
series of benchmark indices and hedges, which are designed to closely match the
duration of our reserve liabilities.
Pennsylvania insurance regulations require that funds ceded for reinsurance
provided by a foreign or "unauthorized" reinsurer must be secured by funds held
in a trust account or by a letter of credit for the protection of policyholders.
We received approximately $648,000,000 in statutory reserve credits from this
transaction as of December 31, 2001, of which $619,000,000 was held by us and
$29,000,000 was backed by letters of credit, which increased our statutory
surplus by $29,000,000 as well.
The agreements contain commutation provisions and allow us to recapture the
reserve liabilities and the current experience account balance as of December
31, 2007 or on December 31 of any year thereafter. We intend to commute the
treaty on December 31, 2007; therefore, we are accounting for the agreements in
anticipation of this commutation. In the event we do not commute the agreements
on December 31, 2007, we will be subject to escalating expenses.
The following table shows our historical use of reinsurance, excluding financial
reinsurance:
Reinsurance
Recoverable
Company
A.M. Best Rating December 31, 2001 December 31, 2000
---------------- ----------------- -----------------
(in thousands)
General and Cologne Life Re of America A+ $ 10,365 $ 8,196
Assurity Life Insurance Company A- 8,403 -
Provident Indemnity Life Insurance Company NR3 4,362 4,643
Lincoln National Life Insurance Company (1) A 999 1,142
Employer's Reassurance Corporation (1) A++ 510 662
Reassure America Life Insurance Company (1) A++ 426 400
Life and Health of America B- 388 409
Transamerica Occidental Life Insurance Company A+ 30 1
Reassurance Company of Hanover A 15 11
Swiss Reassurance Life and Health America A++ 7 6
(1) We determine the amount of reinsurance recoverable in accordance with GAAP
on an aggregate basis for multiple companies that provide reinsurance on our
disability business. In order to segregate the risk by reinsurer, we have listed
the amount reported for Reassure America Life Insurance Company and Lincoln
National Life Insurance Company for reserve credits as calculated under
statutory accounting principles as of December 31, 2001 and 2000. The amounts
reported for Employer's Reassurance Corporation include the net differences
between statutory and GAAP reporting for our disability reinsurance.
(h) Investments
Management has categorized the majority of our 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 category are
reported at their current market value with net unrealized gains and losses, net
of the applicable deferred income tax effect, being added to or deducted from
the Company's total shareholders' equity on the balance sheet. As of December
31, 2001, shareholders' equity was increased by $10,583,000 due to unrealized
gains of $16,032,000 in the investment portfolio. As of December 31, 2000,
shareholders' equity was decreased by $662,000 due to unrealized losses of
$1,005,000 in the investment portfolio.
In 2001, we classified our convertible bond portfolio as trading account
investments. Changes in trading account investment market values are recorded in
our statement of operations during the period in which the change occurs, rather
than as an unrealized gain or loss recorded directly through equity. We recorded
a trading account loss in 2001 of $3,428,000, which reflects the unrealized and
realized loss of our convertible portfolio that arose during the year ended
December 31, 2001. At December 31, 2001, we had liquidated our entire trading
portfolio.
We invest in securities and other investments authorized by applicable state
laws and regulations and follow an investment policy designed to maximize yield
to the extent consistent with liquidity requirements and preservation of assets.
We generally purchase fixed income securities with the expectation of holding
them until maturity. However, we classify these securities as available for sale
and have sold securities prior to their stated maturity, at either a gain or
loss.
We attempt to match the duration and cash flows of our investments to the
liquidity requirements of our liabilities. Although we have generally met our
cash flow requirements from operations, we expect that asset / liability
management will become increasingly important as future claims payments
increase.
Our investments are managed by three external firms: Davidson Capital Management
of Wayne, Pennsylvania, First Union National Bank of Charlotte, North Carolina
and Palisade Capital Management of Fort Lee, New Jersey.
Our investments, other than convertible securities (which were classified as
trading), are recorded at their current market value, with any unrealized gains
or losses recorded through shareholders' equity in the current reporting period.
The following table sets forth the mix of our investment portfolio and the
market value by investment segment for the periods ended December 31, 2001 and
2000.
December 31, 2001 December 31, 2000
----------------- -----------------
Amortized Estimated Amortized Estimated
Cost Market Value Cost Market Value
--------- ------------ --------- ------------
(amounts in thousands)
U.S. Treasury securities
and obligations of U.S.
Government authorities
and agencies $ 164,712 $ 172,063 $ 120,691 $ 125,981
Obligations of states and
political sub-divisions 572 612 572 600
Mortgage backed securities 42,587 43,331 26,529 26,720
Debt securities issued by
foreign governments 11,954 12,089 15,817 15,549
Corporate securities 243,793 250,513 186,268 180,638
Equities 8,760 9,802 17,112 16,496
Policy Loans 181 181 142 142
--------- --------- --------- ---------
Total Investments $ 472,559 $ 488,591 $ 367,131 $ 366,126
========= ========= ========= =========
Net unrealized gain (loss) 16,032 (1,005)
--------- ---------
$ 488,591 $ 366,126
========= =========
As of December 31, 2001, 98% of our total investments were fixed income debt
securities, 40% of which were securities of the United States Government (or its
agencies or instrumentalities). The balance of our total investment portfolio
consisted substantially of publicly traded equity securities.
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, 2001. Ratings are prepared by Moody's Debt Rating Service or
Standard & Poor's Rating Services.
Rating Amount Percent
--------- -------
(in thousands)
U.S. Treasury and U.S. Agency Securities..... $ 192,024 40.1%
Aaa or AAA................................... 34,282 7.2%
Aa or AA..................................... 75,782 15.8%
A............................................ 128,852 26.9%
BBB.......................................... 34,383 7.2%
Other or Not Rated........................... 13,285 2.8%
--------- ------
Total........................................ $ 478,608 100.0%
========= ======
Our investment policy is to purchase U.S. Treasury securities, U.S. agency
securities and investment-grade municipal and corporate securities with the
highest yield to maturity available, and to have 7% to 10% of our bond
investment portfolio mature each year. Our policy also limits high-yield
investments (those rated below "BBB-") to 5% percent of our total portfolio. We
may only purchase bonds rated "B" or higher. Certain investments may be unrated
or in the process of being rated. At December 31, 2001, our investment portfolio
contained no direct investments in real estate.
During 2001, we recognized impairment losses of approximately $5,800,000, which
we deemed to be other than temporary. During 2000, we recognized impairment
losses of approximately $3,200,000. These losses have been recorded as realized
losses in the consolidated income statement.
We have historically limited our investments in equity securities. At December
31, 2001, we held common and preferred stock investments that represented 2% of
our total investments. We intend to limit our common and preferred stock
investments to 10% or less of our total investments.
The following table sets forth, for the periods indicated, certain information
concerning investment income, including dividend payments made on common and
preferred stock. The average yield
calculation does not reflect the impact upon market value of investments due to
changes in market interest rates.
Year Ended December 31,
-----------------------
2001 2000 1999
--------- --------- ---------
(in thousands, except percentages)
Average balance of investments, cash
and cash equivalents during the period,
at cost (1).............................. $ 545,404 $ 441,300 $ 392,592
Net investment income.................... 30,613 27,408 22,619
Average yield on investments ............ 5.6% 6.2% 5.8%
----------
(1) Average of average quarterly balances for all investable assets, including
bonds, equity securities, policy loans and cash; average quarterly balances are
averages of amounts at the beginning and end of the quarter.
At December 31, 2001, the duration of our bond portfolio was approximately 5.0
years. The following table sets forth the contractual maturity of our bond
portfolio, at amortized cost, by aggregate amount and as a percentage of our
bond portfolio. Actual maturities may differ from contractual maturities because
of the issuer's right to call or repay obligations, with or without call or
prepayment penalties.
Amortized Estimated
Cost Market Value
--------- ------------
Due in one year or less $ 7,969 $ 8,054
Due after one year through five years 145,916 149,582
Due after five years through ten years 234,452 244,114
Due after ten years 75,281 76,858
--------- ----------
$ 463,618 $ 478,608
========= ==========
As of December 31, 2001, we had purchased approximately $50 million of corporate
owned life insurance ("COLI") from American General Life Insurance Company of
Houston, Texas in order to fund the long-term expense of our employee benefit
programs. COLI is not recorded as an investment but is reported as its own
financial statement category.
Effective December 31, 2001, we entered a reinsurance agreement to reinsure, on
a quota share basis, substantially all of our long-term care insurance policies
in-force. The transaction resulted in the transfer of approximately $563,000,000
of cash and qualified securities to the reinsurer, representing approximately
93% of our December 31, 2001 investment and cash portfolio. The reinsurer will
maintain a notional experience account, which reflects the initial premium paid,
future premiums collected net of claims, expenses and accumulated investment
earnings. The notional experience account balance will receive an investment
credit based upon the total return from a series of benchmark indices and hedges
that are intended to match the duration of our reserve liability. Because we do
not have controlling ownership of these assets, periodic changes in the market
values of the benchmark indices and hedges will be recorded in our financial
statements in the period in which they occur. The investment credit rate
represents a total return on a benchmark portfolio, which subjects us to
potential realized losses in our investment income. As a result, we will likely
experience significant increased volatility in our future financial statements.
i) Selected Financial Information: Statutory Basis
The following table shows certain ratios derived from our insurance regulatory
filings with respect to our 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,
2001 2000 1999
------ ----- -----
Loss Ratio (1) (4) 154.4% 67.1% 70.4%
Expense ratio (2) (4) -201.3% 114.4% 44.1%
------ ----- -----
Combined loss and expense ratio -46.9% 181.5% 114.5%
Persistency (3) 88.0% 86.4% 86.7%
----------
(1) Loss ratio is defined as incurred claims and increases in policy reserves
divided by collected premiums.
(2) Expense ratio is defined as commissions and expenses incurred divided by
collected premiums.
(3) Persistency represents the percentage of premiums renewed, which we
calculate by dividing the total annual premiums in-force 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 us.
(4) The 2001, 2000 and 1999 loss ratios and expense ratios are significantly
affected by the reinsurance of approximately $408,093,000, $225,741,000 and
$90,230,000, respectively, in premium on a statutory basis under financial and
other reinsurance treaties. Reserves are accounted for as offsetting negative
benefits and negative premium, causing substantial deviation in reported ratios.
Statutory accounting practices. As long-term care insurers, our insurance
subsidiaries are required by state insurance regulation to have statutory
surplus, which is calculated differently than under GAAP, at a sufficient level
to support existing policies as well as new business growth. 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. The commissions paid to agents on new business production are
generally higher for new business than for renewing policies. Because statutory
accounting requires commissions to be expensed as paid, rapid growth in first
year business generally results in higher expense ratios.
Effective December 31, 2001, we entered a reinsurance transaction that,
according to Pennsylvania insurance regulation, required the reinsurer to
provide us with letters of credit in order for us to receive statutory reserve
and surplus credit from the reinsurance. The letters of credit were dated
subsequent to December 31, 2001, as a result of the final closing of the
agreement. In addition, the initial premium paid for the reinsurance included
investment securities carried at amortized cost but valued at market price for
purposes of the premium transfer and the experience account. The Pennsylvania
Insurance Department permitted us to receive credit of $29,000,000 for the
letters of credit, and to accrue the anticipated, yet unknown, gain of
$18,000,000 from the sale of securities at market value, in our statutory
financial results for December 31, 2001. The impact of this permitted practice
served to increase the statutory surplus of our insurance subsidiaries by
approximately $47,000,000 at December 31, 2001. Had we not been granted a
permitted practice, our statutory surplus would have been negative until the
first quarter 2002 reporting period, when a permitted practice would no longer
be required due to our receipt of the letters of credit prior to March 31, 2002.
Minimum loss ratios. Mandated loss ratios are calculated in a manner intended to
provide 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 our annual and quarterly state insurance
filings. The states in which we are 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. We
are unable to predict the impact of (1) the imposition of any changes in the
mandatory statutory loss ratios for individual or group long-term care policies
to which we may become subject, (2) any changes in the minimum loss ratios for
individual or group long-term care or Medicare supplement policies, or (3) any
change in the manner in which these minimums are computed or enforced in the
future. We have not been informed by any state that our subsidiaries do not meet
mandated minimums, and we believe we are in compliance with all such minimum
ratios. In the event the we are not in compliance with minimum statutory loss
ratios mandated
by regulatory authorities with respect to certain policies, we may be required
to reduce or refund our premiums on such policies.
(j) Insurance Industry Rating Agencies
Our subsidiaries have A.M. Best ratings of "B- (fair)" and Standard & Poor's
ratings of "B- (weak)." A.M. Best and Standard & Poor'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 range from "A++ (superior)" to "F (in
liquidation)." Standard & Poor's ratings range from "AAA (extremely strong)" to
"CC (extremely weak)." A.M. Best and Standard & Poor's ratings are based upon
factors of concern to policyholders and insurance agents and are not directed
toward the protection of investors and are not recommendations to buy, hold or
sell a security. In evaluating a company's financial and operating performance,
the rating agencies review profitability, leverage and liquidity, as well as
book of business, the adequacy and soundness of reinsurance, the quality and
estimated market value of assets, the adequacy of reserves and the experience
and competence of management.
Certain distributors will not sell our group products unless we have a financial
strength rating of at least an "A-." The inability of our subsidiaries to obtain
higher A.M. Best or Standard & Poor's ratings could adversely affect the sales
of our products if customers favor policies of competitors with better ratings.
In addition, a downgrade in our ratings may cause our policyholders to allow
their existing policies to lapse. Increased lapsation would reduce our premium
income and would also cause us to expense fully the deferred policy costs
relating to lapsed policies in the period in which those policies lapsed. Recent
downgrades or further downgrades in our ratings also may lead some independent
agents to sell less of our products or to cease selling our policies altogether.
(k) Competition
We operate in a highly competitive industry. We believe that competition is
based on a number of factors, including service, products, premiums, commission
structure, financial strength, industry ratings and name recognition. We compete
with a large number of national insurers, smaller regional insurers and
specialty insurers, many of whom have considerably greater financial resources,
higher ratings from A.M. Best and Standard and Poor's and larger networks of
agents than we do. Many insurers offer long-term care policies similar to those
we offer and utilize similar marketing techniques. In addition, we are subject
to competition from insurers with broader product lines. We also may be subject,
from time to time, to new competition resulting from changes in Medicare
benefits, as well as from additional private insurance carriers introducing
products similar to those offered by us.
We also actively compete with other insurers in attracting and retaining agents
to distribute our products. Competition for agents is based on quality of
products, commission rates, underwriting, claims service and policyholder
service. We continuously recruit and train independent agents to market and sell
our products. We also engage marketing general agents from time to time to
recruit independent agents and develop networks of agents in various states. Our
business and ability to compete may suffer if we are unable to recruit and
retain insurance agents and if we lose the services provided by our marketing
general agents.
We also compete with non-insurance financial services companies such as banks,
securities brokerage firms, investment advisors, mutual fund companies and other
financial intermediaries marketing insurance products, annuities, mutual funds
and other retirement-oriented investments. The Gramm-Leach-Bliley Financial
Services Modernization Act of 1999 ("Gramm-Leach-Bliley Act") implemented
fundamental changes in the regulation of the financial services industry,
permitting mergers that combine
commercial banks, insurers and securities firms under one holding company. The
ability of banks to affiliate with insurers may adversely affect our ability to
remain competitive.
The insurance industry may undergo further change in the future and,
accordingly, new products and methods of service may also be introduced. In
order to keep pace with any new developments, we may need to expend significant
capital to offer new products and to train our agents and employees to sell and
administer these products and services. Our ability to compete with other
insurers depends on our success in developing new products.
(l) Government Regulation
Insurance companies are subject to supervision and regulation in all states in
which they transact business. We are registered and approved as a holding
company under the Pennsylvania Insurance Code. Our insurance company
subsidiaries are chartered in the states of Pennsylvania and New York. We are
currently licensed in all states and the District of Columbia.
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 National Association of
Insurance Commissioners, 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 that can be used as guidelines for individual
states in adopting or enacting insurance legislation. While the NAIC model laws
are accorded substantial deference within the insurance industry, these laws are
not binding on insurance companies unless adopted by states, and variation from
the model laws within states is common.
The Pennsylvania Insurance Department, the New York Insurance Department and the
insurance regulators 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 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. This calculation, commonly referred to as RBC, serves
as a benchmark for the regulation of insurance company solvency by state
insurance regulators. The primary purpose of such supervision and regulation is
the protection of policyholders, not investors. See "Selected Financial
Information - Statutory Basis."
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. Certain states,
including New Jersey and New York, have adopted a minimum loss ratio of 65% for
long-term care. The states in which we are 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.
On an annual basis, the Pennsylvania Insurance Department and the New York
Insurance Department are provided with a calculation prepared by our consulting
actuaries 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, there presently are no similar
reporting requirements in the states in which we do business for such other
policies.
In December 1986, the NAIC adopted the Long-Term Care Insurance Model Act
("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 it has not enacted any such legislation
to date.
Some state legislatures have adopted proposals to limit rate increases on
long-term care insurance products. In the past, we have been generally
successful in obtaining rate increases when necessary. We currently have rate
increases on file with various state insurance departments and anticipate that
increases on other products may be required in the future. If we are unable in
the future to obtain rate increases, or in the event of legislation limiting
rate increases, we believe it would have a negative impact on our future
earnings.
In September 1996, Congress enacted the Health Insurance Portability and
Accountability Act ("HIPAA"), which permits premiums paid for eligible long-term
care insurance policies after December 31, 1996 to be treated as deductible
medical expenses for federal income tax purposes. 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
limitations on pre-existing condition exclusions, prohibitions on excluding
individuals from coverage based on health status and guaranteed renewability of
health insurance coverage. Although we offer tax-deductible policies, we will
continue to offer a variety of non-deductible policies as well. We have
long-term care policies that qualify for tax exemption under HIPAA in all states
in which we are licensed.
In 1998, the NAIC adopted the Codification of Statutory Accounting Principles
("Codification") guidance, which replaced the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting as of
January 1, 2001. The Codification provides guidance for areas where statutory
accounting has been silent and changes current statutory accounting in some
areas, including the recognition of deferred income taxes.
The Pennsylvania and New York Insurance Departments have adopted the
Codification guidance, effective January 1, 2001. The Codification guidance
serves to reduce the insurance subsidiaries' surplus, primarily due to certain
limitations on the recognition of goodwill and EDP equipment and the recognition
of other than temporary declines in investments. In 2001, our statutory surplus
was reduced by approximately $2,000 as a result of the Codification guidance.
These reductions are partially offset by certain other items, including the
recognition of deferred tax assets subject to certain limitations.
We are also subject to the insurance holding company laws of Pennsylvania and of
the other states in which we are 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 intercompany transfers of assets within the holding company
structure. The Pennsylvania Insurance Department and the New York Insurance
Department must approve the purchase of more than 10% of the outstanding shares
of our common stock by one or more parties acting in concert, and may subject
such party or parties to the reporting requirements of the insurance laws and
regulations of Pennsylvania and New York and to the prior approval and/or
reporting requirements of other jurisdictions in which we are licensed. In
addition, our officers, directors and 10% shareholders and those of our
insurance subsidiaries are subject to the reporting requirements of the
insurance laws and regulations of Pennsylvania and New York, as the case may be,
and may be subject to the prior approval and/or reporting requirements of other
jurisdictions in which they are licensed.
Under Pennsylvania law, public utilities and their affiliates, subsidiaries,
officers and employees may not be licensed or admitted as insurers. If any
public utility or affiliate, subsidiary, officer or employee of any public
utility acquires 5% or more of the outstanding shares of our common stock, such
party may be deemed to be an affiliate, in which event our Certificate of
Authority to do business in Pennsylvania may be revoked upon a determination by
the Pennsylvania Insurance Department that such party exercises effective
control over us. Although several entities own more than 5% of our common stock,
no public utility or affiliate, subsidiary, officer or employer of any public
utility holds sufficient voting authority to exercise effective control over us.
States also restrict the dividends our insurance subsidiaries are permitted to
pay. Dividend payments will depend on profits arising from the business of our
insurance company subsidiaries, computed according to statutory formulae. Under
the insurance laws of Pennsylvania and New York, insurance companies can pay
dividends only out of surplus. In addition, Pennsylvania law requires each
insurance company to give 30 days advance notice to the Pennsylvania Insurance
Department of any planned extraordinary dividend (any dividend paid within any
twelve-month period which exceeds the greater of (1) 10% of an insurer's surplus
as shown in its most recent annual statement filed with the Insurance Department
or (2) its net gain from operations, after policyholder dividends and federal
income taxes and before realized gains or losses, shown in such statement) and
the Insurance Department may refuse to allow it to pay such extraordinary
dividends. Our Corrective Action Plan also requires the approval of the
Pennsylvania Insurance Department of all dividends. Under New York law, our New
York insurance subsidiary must give the New York Insurance Department 30 days'
advance notice of any proposed extraordinary dividend and cannot pay any
dividend if the regulator disapproves the payment during that 30-day period.
In addition, our New York insurance company must obtain the prior approval of
the New York Insurance Department before paying any dividend that, together with
all other dividends paid during the preceding twelve months, exceeds the lesser
of 10% of the insurance company's surplus as of the preceding December 31 or its
adjusted net investment income for the year ended the preceding December 31. In
2002, we received a dividend from our New York subsidiary of $651,000. The
dividend proceeds were used for parent company liquidity needs.
We believe that, other than our New York subsidiary, none of our insurance
subsidiaries are eligible to make dividend payments to the parent company in
2002.
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 our operations. In
addition, legislation enacted by Congress could impact our 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. As with any
pending legislation, it is possible that any laws finally enacted will be
substantially different from the current proposals. Accordingly, we are unable
to predict the impact of any such legislation on our business and operations.
Compliance with multiple federal and state privacy laws may affect our profits.
Congress enacted the Gramm-Leach-Bliley Financial Services Modernization Act in
November 1999. Federal agencies have adopted regulations to implement this
legislation. The Gramm-Leach-Bliley Act empowers states to adopt their own
measures to protect the privacy of consumers and customers of insurers that are
covered by the Gramm-Leach-Bliley Act, so long as those protections are at least
as stringent as those required by the Gramm-Leach-Bliley Act. If states do not
enact their own insurance privacy laws or adopt regulations, the privacy
requirements of the Gramm-Leach-Bliley Act will apply to insurers, although no
enforcement mechanism has yet been adopted for insurers. The Department of
Health and Human Services has adopted privacy rules, which will also apply to at
least some of our products. The NAIC has adopted the Insurance Information and
Privacy Model Act, but no state has yet adopted this model act. Individual state
insurance regulators have indicated that their states may adopt privacy laws or
regulations that are more stringent than the NAIC's model act and those provided
for under federal law. Compliance with different laws in states where we are
licensed could prove extremely costly.
We monitor economic and regulatory developments that have the potential to
impact our business. Recently enacted federal legislation will allow banks and
other financial organizations to have greater participation in securities and
insurance businesses. This legislation may present an increased level of
competition for sales of our products. Furthermore, the market for our products
is enhanced by the tax incentives available under current law. Any legislative
changes that lessen these incentives could negatively impact the demand for
these products.
(m) Employees
As of December 31, 2001, we had 303 full-time employees (not including
independent agents). We are not a party to any collective bargaining agreements.
ITEM 2. PROPERTIES
Our principal offices in Allentown, Pennsylvania occupy two buildings,
totaling approximately 30,000 square feet of office space in a 40,000 square
foot building and all of an 16,000 square foot building. We own both
buildings and a 2.42 acre undeveloped parcel of land located across the
street from our home offices. We also lease additional office space in
Michigan and New York.
ITEM 3. LEGAL PROCEEDINGS
Our subsidiaries are parties to various lawsuits generally arising in the normal
course of their business. We do not believe that the eventual outcome of any of
the suits to which we are party will have a material adverse effect on our
financial condition or results of operations. However, the outcome of any single
event could have a material impact upon the quarterly or annual financial
results of the period in which it occurs.
The Company and certain of our key executive officers are defendants in
consolidated actions that were instituted on April 17, 2001 in the United States
District Court for the Eastern District of Pennsylvania by shareholders of the
Company, on their own behalf and on behalf of a putative class of similarly
situated shareholders who purchased shares of the Company's common stock between
July 23, 2000 through and including March 29, 2001. The consolidated amended
class action complaint seeks damages in an unspecified amount for losses
allegedly incurred as a result of misstatements and omissions allegedly
contained in our periodic reports filed with the SEC, certain press releases
issued by us, and in other statements made by our officials. The alleged
misstatements and omissions relate, among other matters, to the statutory
capital and surplus position of our largest subsidiary, Penn Treaty Network
America Insurance Company. On December 7, 2001, the defendants filed a motion to
dismiss the complaint, which is currently pending. We believe that the complaint
is without merit, and we will continue to vigorously defend the matter.
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, 2001 to a vote of security holders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange under the symbol
"PTA." The following table indicates the high and low sale prices of our
common stock as reported on the New York Stock Exchange during the periods
indicated.
High Low
------- -------
2001
1st Quarter $ 19.75 $ 8.80
2nd Quarter $ 9.70 $ 2.15
3rd Quarter $ 4.29 $ 2.10
4th Quarter $ 6.42 $ 2.70
2000
1st Quarter $ 18.13 $ 12.25
2nd Quarter $ 19.94 $ 13.13
3rd Quarter $ 18.81 $ 14.88
4th Quarter $ 21.56 $ 15.63
We have never paid any cash dividends on our common stock and do not intend to
do so in the foreseeable future. It is our present intention to retain any
future earnings to support the continued growth of our business. Any future
payment of dividends is subject to the discretion of the board of directors and
is dependency, in part, on any dividends we may receive from our subsidiaries.
The payment of dividends by our subsidiaries is 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
financial strength ratings. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources,"
"Business--Insurance Industry Rating Agencies" and "Business--Government
Regulation."
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated statement of operations data and balance
sheet data as of and for the years ended December 31, 2001, 2000, 1999, 1998 and
1997, have been derived from our Consolidated GAAP Financial Statements.
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
(in thousands, except per share data and ratio)
Statement of Operations Data:
Revenues:
Total premiums $ 350,391 $ 357,113 $ 292,516 $ 223,692 $ 167,680
Net investment income 30,613 27,408 22,619 20,376 17,009
Net realized (losses) gains (7,795) 652 5,393 9,209 1,417
Other income 9,208 8,096 6,297 885 417
--------- --------- --------- --------- ---------
Total revenues 382,417 393,269 326,825 254,162 186,523
--------- --------- --------- --------- ---------
Benefits and expenses:
Benefits to policyholders (1) 239,155 243,571 200,328 154,300 123,865
Commissions 76,805 102,313 96,752 80,273 55,240
Net acquisition costs amortized (deferred) (2) 9,860 (43,192) (51,134) (46,915) (28,294)
Impairment of net unamortized policy
acquisition costs (3) 61,800 -- -- -- --
General and administrative expenses 49,282 49,973 40,736 26,069 20,614
Excise tax expense (4) 5,635 -- -- -- --
Loss due to impairment of property
and equipment (5) -- -- 2,799 -- --
Change in reserve for claim litigation (250) 1,000 -- -- --
Interest expense 4,999 5,134 5,187 4,809 4,804
--------- --------- --------- --------- ---------
Total benefits and expenses 447,286 358,799 294,668 218,536 176,229
--------- --------- --------- --------- ---------
(Loss) income before federal income taxes (64,869) 34,470 32,157 35,626 10,294
(Benefit) provision for federal income taxes (16,280) 11,720 10,837 11,578 2,695
--------- --------- --------- --------- ---------
Net (loss) income $ (48,589) $ 22,750 $ 21,320 $ 24,048 $ 7,599
========= ========= ========= ========= =========
Basic earnings per share $ (3.41) $ 3.13 $ 2.83 $ 3.17 $ 1.01
========= ========= ========= ========= =========
Diluted earnings per share $ (3.41) $ 2.61 $ 2.40 $ 2.64 $ 0.98
========= ========= ========= ========= =========
Weighted average shares outstanding (6) 14,248 7,279 7,533 7,577 7,540
Weighted average diluted shares outstanding (7) 14,248 9,976 10,293 10,402 7,758
Balance Sheet Data:
Total investments $ 488,591 $ 366,126 $ 373,001 $ 338,889 $ 301,787
Total assets 940,367 856,131 697,639 580,552 465,772
Total debt (8) 79,190 81,968 82,861 76,550 76,752
Shareholders' equity 192,796 188,062 158,685 157,670 132,756
Book value per share $ 10.24 $ 25.81 $ 21.81 $ 20.79 $ 17.53
GAAP Ratios:
Loss ratio 68.3% 68.2% 68.5% 69.0% 73.9%
Expense ratio (9) 59.0% 32.0% 31.3% 28.7% 31.2%
--------- --------- --------- --------- ---------
Total (10) 127.3% 100.2% 99.8% 97.7% 105.1%
========= ========= ========= ========= =========
Return on average equity (11) (25.5%) 13.1% 13.5% 16.6% 6.0%
Selected Statutory Data:
Net premiums written (12) $ (64,689) $ 130,676 $ 208,655 $ 143,806 $ 167,403
Statutory surplus (beginning of
period) $ 30,137 $ 67,070 $ 76,022 $ 67,249 $ 81,795
Ratio of net premiums written to
statutory surplus (2.2)x 1.9x 2.7x 2.1x 2.0x
Notes to Selected Financial Data (in thousands)
(1) In 1997, we added approximately $12,000 to our reserves as a result of our
reassessment of assumptions utilized in the actuarial determination of our
claims reserves. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
(2) Effective September 10, 2001, we discontinued the sale, nationally, of all
new long-term care insurance policies until our Corrective Action Plan was
completed and approved by the Pennsylvania Insurance Department. As a result, we
did not defer the costs associated with new policy issuance and recognized only
the amortization of existing deferred acquisition costs. In addition, we
recognized approximately $10,000 in additional amortization expense when we
unlocked our factors during the second quarter of 2001. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(3) Effective December 31, 2001, we entered a reinsurance agreement for
substantially all of our long-term care insurance policies. The agreement
requires us to pay an annual expense and risk charge to the reinsurer in the
event we later commute the agreement. As a result of these anticipated charges,
we determined to impair the value of our net unamortized policy acquisition
costs by $61,500.
(4) As a result of our December 31, 2001 reinsurance agreement with a foreign
reinsurer, we must pay federal excise tax of 1% on all ceded premium. The 2001
expense represents excise taxes due for premiums transferred at the inception of
the contract.
(5) During 1999, we discontinued the implementation of a new computer system,
for which we had previously capitalized $2,799 of licensing, consulting and
software costs. When we decided not to use this system, its value became fully
impaired. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
(6) On May 25, 2001, we issued approximately 11,047 new common shares of our
common stock, for net proceeds of $25,726, through an investor rights offering.
(7) Diluted shares outstanding includes shares issuable upon the conversion of
our convertible debt and exercise of options outstanding, except in 2001, for
which the inclusion of such shares would be anti-dilutive.
(8) In 1996, we issued $74,750 in convertible debt, due December 2003. In 1999,
we purchased an agency for cash and a note for $7,167 payable in installments
through January 2002. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
(9) Expense ratios exclude the impact of reduced commissions and increased
general and administrative expenses resulting from the 1999 and 2000
acquisitions of our agency subsidiaries. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
(10) We measure our combined ratio as the total of all expenses, including
benefits to policyholders, related to policies in-force divided by premium
revenue. This ratio provides an indication of the portion of premium revenue
that is devoted to the coverage of policyholder related expenses. We depend upon
our investment returns to offset the amounts by which our combined ratio is
greater than 100%. In 2001, reduced premium revenue, the impairment of our DAC
asset in the fourth quarter (see Note 3) and the
payment of excise taxes on the initial premium for our new reinsurance agreement
(see Note 4) increased our combined ratio above what it otherwise would have
been.
(11) Return on equity, which is the ratio of net income or losses to average
shareholders' equity, measures the current period return provided to
shareholders on invested equity. New or existing shareholders could be dissuaded
from future investment in our common stock if they are not satisfied with return
on equity.
(12) Under statutory accounting principles, ceded reserves are accounted for as
offsetting negative benefits and negative premium. Our 2001, 2000 and 1999
premium is reduced by $408,093, $225,741 and $90,230, respectively from
reinsurance transactions.
Quarterly Data
Our unaudited quarterly data for each quarter of 2001 and 2000 has been derived
from unaudited financial statements and include all adjustments, consisting only
of normal recurring accruals, which we consider necessary for a fair
presentation of the results of operations for these periods. Such quarterly
operating results are not necessarily indicative of our future results of
operations.
The following table presents unaudited quarterly data for each quarter of 2001
and 2000.
2001
---------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
(in thousands, except per share data and ratios)
Total premiums $ 96,019 $ 90,039 $ 80,588 $ 83,745
Net investment income 6,725 7,185 8,571 8,132
Net realized capital gains and losses and
other income (889) 3,476 728 (1,902)
--------- --------- --------- ---------
Total revenues 101,855 100,700 89,887 89,975
--------- --------- --------- ---------
Benefits to policyholders (1) 72,137 60,235 47,220 59,563
Commissions and expenses 37,372 33,793 27,999 32,308
Net acquisition costs amortized (deferred) (5,397) 1,750 7,255 68,052
--------- --------- --------- ---------
Net (loss) income $ (2,336) $ 2,430 $ 4,075 $ (52,759)
========= ========= ========= =========
Net (loss) income per share (basic) $ (0.32) $ 0.20 $ 0.22 $ (2.80)
Net (loss) income per share (diluted) $ (0.32) $ 0.20 $ 0.22 $ (2.80)
GAAP loss ratio 75.1% 66.9% 58.6% 71.1%
GAAP expense ratio (excluding interest)(1) 33.3% 39.5% 43.7% 119.8%
--------- --------- --------- ---------
Total 108.4% 106.4% 102.3% 191.0%
========= ========= ========= =========
2000
---------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
(in thousands, except per share data and ratios)
Total premiums $ 86,038 $ 86,825 $ 91,963 $ 92,287
Net investment income 6,161 6,636 6,874 7,737
Net realized capital gains and losses and
other income 4,293 808 2,886 761
--------- --------- --------- ---------
Total revenues 96,492 94,269 95,352 94,401
--------- --------- --------- ---------
Benefits to policyholders 59,911 59,488 61,120 63,052
Commissions and expenses 37,859 38,347 38,167 38,913
Net acquisition costs deferred (10,890) (12,090) (9,111) (11,101)
--------- --------- --------- ---------
Net income $ 5,491 $ 4,788 $ 6,776 $ 5,696
========= ========= ========= =========
Net income per share (basic) $ 0.75 $ 0.66 $ 0.93 $ 0.78
Net income per share (diluted) $ 0.64 $ 0.56 $ 0.76 $ 0.65
GAAP loss ratio 69.6% 68.5% 66.5% 68.3%
GAAP expense ratio (excluding interest) 31.3% 30.2% 31.6% 30.1%
--------- --------- --------- ---------
Total 101.0% 98.8% 98.1% 98.5%
========= ========= ========= =========
(1) Effective December 31, 2001, we entered a reinsurance agreement for
substantially all of our long-term care insurance policies. We owe an annual
expense and risk charge to the reinsurer to be paid upon commutation of the
agreement. As a result of these anticipated charges, we impaired the value of
our net unamortized policy acquisition costs by $61,500 in the fourth quarter of
2001. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following table sets forth the components of our condensed statements of
operations for the years ended December 31, 2001, 2000 and 1999, expressed as a
percentage of total revenues.
Year Ended December 31,
----------------------------
2001 2000 1999
----- ----- -----
Statement of Operations Data:
Revenues:
Total premiums 91.6% 90.8% 89.5%
Net investment income 8.0% 6.9% 6.9%
Net realized (losses) gains -2.0% 0.2% 1.7%
Other income 2.4% 2.1% 1.9%
----- ----- -----
Total revenues 100.0% 100.0% 100.0%
----- ----- -----
Benefits and expenses:
Benefits to policyholders 62.5% 61.9% 61.3%
Commissions 20.1% 26.0% 29.6%
Net policy acquisition costs
amortized (deferred) 18.7% -11.0% -15.6%
General and administrative expense 14.3% 13.0% 13.3%
Interest expense 1.4% 1.3% 1.6%
----- ----- -----
Total benefits and expenses 117.0% 91.2% 90.2%
----- ----- -----
(Loss) income before federal income taxes -17.0% 8.8% 9.8%
(Benefit) provision for federal income taxes -4.3% 3.0% 3.3%
----- ----- -----
Net (loss) income -12.7% 5.8% 6.5%
===== ===== =====
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview (amounts in thousands)
Our principal products are individual, defined benefit accident and health
insurance policies that consist of nursing home care, home health care, Medicare
supplement, life and long-term disability insurance. We experienced significant
reductions in new premium sales during 2001 due to the cessation of new business
generation in all states and as a result of market concerns regarding our
insurance subsidiaries' statutory surplus. Under our Corrective Action Plan,
which was recently approved by the Pennsylvania Insurance Department (the
"Department"), we intend to limit new business growth to levels that will allow
us to maintain sufficient statutory surplus. Our underwriting practices rely
upon the base of experience that we have developed in over 29 years of providing
nursing home care insurance, as well as upon available industry and actuarial
information. As the home health care market has developed, we have encouraged
our customers to purchase both nursing home and home health care coverage, thus
providing our insureds with enhanced protection and broadening our policy base.
Our insurance subsidiaries are subject to the insurance laws and regulations of
the states in which they are licensed to write insurance. These laws and
regulations govern matters such as payment of dividends, settlement of claims
and loss ratios. State regulatory authorities must approve premiums charged for
insurance products. In addition, our insurance subsidiaries are required to
establish and maintain reserves with respect to reported and incurred but not
reported losses, as well as estimated future benefits payable under our
insurance policies. These reserves must, at a minimum, comply with mandated
standards. Our reserves are certified annually by our consulting actuary as to
standards required by the insurance departments for our domiciliary state and
for the other states in which we conduct business. We believe we maintained
adequate reserves as mandated by each state in which we are currently writing
business at December 31, 2001. For a description of current regulatory matters
affecting our insurance subsidiaries, see "Liquidity and Capital Resources -
Subsidiary Operations."
Our results of operations are affected significantly by the following other
factors:
Level of required reserves for policies in-force. Our insurance policies are
accounted for as SFAS 60 long
duration contracts. As a result, there are two components of policyholder
liabilities. The first is a policy reserve liability as required by SFAS 60
for future policyholder benefits, represented by the present value of future
benefits less future premium collection. These reserves are calculated based
on assumptions that include estimates for mortality, morbidity, interest
rates, premium rate increases and policy persistency. The assumptions are
consistent with industry experience and historical results, as modified for
our own experience.
The second is a reserve for incurred, either reported or not yet reported,
policy and contract claims, which represents the benefits for current claims.
The amount of reserves relating to reported and unreported claims incurred is
determined by periodically evaluating statistical information with respect to
the number and nature of historical claims. We compare actual experience with
estimates and adjust our reserves on the basis of such comparisons to the extent
that our analysis suggests that an adverse development is likely to continue or
occur in future periods.
Additions to, or reductions in, reserves are recognized in our current
consolidated statements of operations and comprehensive income as expense or
income, respectively, through benefits to policyholders and are a material
component of our net income or loss. A portion of premium collected in each
period is set aside to establish reserves for future policy benefits.
Establishing reserves is based upon current assumptions and we cannot assure
you that actual claims expense will not differ materially from the claims
expense anticipated by the assumptions used in the establishment of reserves.
Any variance from these assumptions could affect our profitability in future
periods.
Policy premium levels. We attempt to set premium levels to maximize
profitability. Premium levels on new products, as well as rate increases on
existing products, are subject to government review and regulation.
Deferred policy acquisition costs. In connection with the sale of our insurance
policies, we defer and amortize a portion of the policy acquisition costs over
the related premium paying periods of the life of the policy. These costs
include all expenses that are directly related to, and vary with, the
acquisition of the policy, including commissions, underwriting and other policy
issue expenses. The amortization of deferred policy acquisition costs ("DAC") is
determined using the same projected actuarial assumptions used in computing
policy reserves. DAC can be affected by unanticipated terminations of policies
because, upon such terminations, we are required to expense fully the DAC
associated with the terminated policies.
With the assistance of our consulting actuary, we reviewed the appropriateness
and recoverability of DAC. We determined that we require premium rate increases
on a majority of our existing products in order to fully recover our present DAC
from future profits. We recognized a DAC impairment loss of $61,800 during 2001
primarily as a result of the additional cost projected for our new reinsurance
agreement, including investment management fees, excise taxes and expense and
risk charges. In the event that premium rate increases cannot be obtained as
needed, our DAC would be further impaired and we would incur an expense in the
amount of the impairment. See "Net Policy Acquisition Costs Deferred."
Investment income. Our investment portfolio consisted primarily of investment
grade fixed income securities. Income generated from this portfolio is largely
dependent upon prevailing levels of interest rates. Due to the duration of our
investments (approximately 5.0 years), investment interest income does not
immediately reflect changes in market interest rates. In connection with our
reinsurance agreement with Centre, we transferred substantially all of our
investment portfolio to the reinsurer as the initial premium payment. The
initial and future premium for the reinsured policies, less claims payments,
ceding commissions and risk charges, is credited to a notional experience
account, the balance of which
also receives an investment credit. The notional experience account balance
represents an amount to be paid to us in the event of commutation of the
agreement.
Lapsation and persistency. Factors that affect our results of operations include
lapsation and persistency, both of which relate to the renewal of insurance
policies. Lapsation is the termination of a policy by non-renewal. Lapsation is
automatic if and when premiums become more than 31 days overdue although, in
some cases, a lapsed policy may be reinstated within six months. Persistency
represents the percentage of premiums renewed, which we calculate by dividing
the total annual premiums at the end of each year (less first year premiums 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 the result of non-renewal of policies, including
policies that have terminated by reason of death, lapsed due to nonpayment of
premiums and/or been converted to other policies we offered. First year premiums
are premiums covering the first twelve months a policy is in-force. Renewal
premiums are premiums covering all subsequent periods.
Policies renew or lapse for a variety of reasons, both internal and external. We
believe that our efforts to address policyholder concerns or questions help to
ensure policy renewals. We work closely with our licensed agents, who play an
integral role in policy persistency and policyholder communication.
Economic cycles can influence a policyholder's ability to continue the
payment of insurance premiums when due. We believe that publicity regarding
newly enacted Federal and state tax legislation allowing medical deductions
for certain long-term care insurance premiums has raised public awareness of
the escalating costs of long-term care and the value provided to the consumer
of long-term care insurance. The ratings assigned to our insurance
subsidiaries by independent rating agencies also influence consumer decisions.
Lapsation and persistency can both positively and adversely impact future
earnings. Reduced lapses and higher persistency generally result in higher
renewal premiums and lower amortization of deferred acquisition costs, but may
lead to increased claims in future periods. Higher lapsation can result in
reduced premium collection and a greater percentage of higher-risk
policyholders, but requires us to fully expense deferred acquisition costs
relating to lapsed policies in the period in which policies lapse.
RESULTS OF OPERATIONS
TWELVE MONTHS ENDED DECEMBER 31, 2001 AND 2000 (AMOUNTS IN THOUSANDS)
Premiums. Total premium revenue earned in the twelve month period ended December
31, 2001, including long-term care, disability, life and Medicare supplement,
decreased 1.9% to $350,391, compared to $357,113 in the twelve month period
ended December 31, 2000. Total premium in the 2001 period was reduced by $10,009
as a result of premium ceded for the reinsurance of our disability product line.
Total first year premiums earned in 2001 decreased 54.5% to $44,539, compared to
$97,888 in 2000. First year long-term care premiums earned in 2001 decreased
56.0% to $42,135, compared to $95,693 in 2000. We experienced significant
reductions in new premium sales due to the cessation of new business generation
in all states during the third and fourth quarters and as a result of the
market's concerns regarding our insurance subsidiaries' statutory surplus.
Effective September 10, 2001, we discontinued the sale, nationally, of all new
long-term care insurance policies until our Corrective Action Plan was completed
and approved by the Department. This decision resulted from our concern about
further depletion of statutory surplus from new sales prior to the
completion and approval of the Corrective Action Plan and from increasing
concern regarding our financial status expressed by many states in which we are
licensed to conduct business. Under our Corrective Action Plan, we intend to
limit future new business growth to levels that will allow us to maintain
sufficient statutory surplus. See "Liquidity and Capital Resources." Since the
approval of our Corrective Action Plan on February 12, 2002, we have recommenced
sales in 26 states and are continuing efforts to recommence in all states upon
individual state approvals.
Total renewal premiums earned in 2001 increased 18.0% to $305,852, compared to
$259,225 in 2000. Renewal long-term care premiums earned in 2001 increased 18.7%
to $290,632, compared to $244,945 in 2000. This increase reflects renewals of a
larger base of in-force policies, as well as a continued increase in
policyholder persistency.
Net investment income. Net investment income earned during 2001 increased 11.7%
to $30,613, from $27,408 for 2000. Management attributes this growth to an
increase in invested assets, which resulted from premium receipts and from the
investment of additional funds generated from the exercise of rights to purchase
shares of our common stock distributed to our shareholders and holders of our
Subordinated Notes. Our average yield on invested assets at cost, including cash
and cash equivalents, was 5.6% in 2001, compared to 6.2% in 2000. The average
yield is lower due to reduced market rates for reinvesting of maturing
investments and due to higher cash balances held during 2001.
The total return of the Lehman Brothers US Aggregate Bond Index was 8.44% and
11.63% for 2001 and 2000, respectively. Including the effect of realized and
unrealized capital gains and losses and trading account results arising during
the period, the total return of our fixed income portfolio was 8.92% and 8.83%
in the 2001 and 2000 periods, respectively. While the performance in the 2001
was similar to the total return of the Lehman Brothers US Aggregate Bond Index,
our 2000 performance was below the benchmark index due primarily to significant
declines in the market value of three bonds during the year, totaling
approximately $5,100.
Net realized capital gains and trading account activity. During 2001, we
recognized capital losses of $4,367, compared to capital gains of $652 in 2000.
The results of both years were recorded due to realized gains and losses from
our normal investment management operations and from impairment losses of
approximately $5,800 in 2001 and $3,200 in 2000 on equity and debt securities,
which we deemed to be other than temporary. At December 31, 2001, we entered a
reinsurance agreement for which a substantial portion of our investment
portfolio was later ceded as the initial premium for this agreement. As a result
of this intended transfer or sale of assets, we determined that all gross
unrealized losses on our debt and equities securities would not be recovered and
therefore were deemed other than temporary impairments. We recognized a loss of
$3,867 from this determination.
We classified our convertible bond portfolio as trading account investments as a
result of Statement of Financial Accounting Standards No. 133 "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"). Changes in
trading account investment market values are recorded in our statement of
operations during the period in which the change occurs, rather than as an
unrealized gain or loss recorded directly through equity. Therefore, we recorded
a trading account loss in 2001 of $3,428, which reflects the unrealized and
realized loss of our convertible portfolio that arose during the year ended
December 31, 2001. We sold all of our convertible bond investments during 2001.
Other income. We recorded $9,208 in other income during 2001, up from $8,096 in
2000. The increase is attributable to an increase of commissions earned by
United Insurance Group on sales of insurance products underwritten by
unaffiliated insurers and to income generated from corporate owned life
insurance policies.
Benefits to policyholders. Total benefits to policyholders in 2001 decreased
1.8% to $239,115, compared to $243,571 in 2000. Our loss ratio, or policyholder
benefits to premiums, was 68.3% in 2001, compared to 68.2% in 2000.
We review the adequacy of our deferred acquisition costs on an annual basis,
utilizing assumptions for future expected claims and interest rates. If we
determine that the future gross profits of our in-force policies are not
sufficient to recover our deferred acquisition costs, we recognize a premium
deficiency and "unlock" (or change) our original assumptions and reset our
reserves to appropriate levels using new assumptions. During the second quarter
of 2001, we performed a DAC recoverability analysis on our existing business,
utilizing our most current assumptions. Upon the completion of the analysis, we
determined to record an impairment charge of approximately $300 and utilized the
new assumptions in the establishment of our current DAC and policy benefit
reserves, in accordance with SFAS 60. This reset of DAC and reserves resulted in
a decrease of approximately $7,600 to reserves and a decrease to DAC of
approximately $7,900, representing 2% and 4% of the respective balances. The
resultant net GAAP liability (reserves less DAC) is $300 higher than before the
impairment charge. We believe that the new levels of DAC and reserves more
appropriately represent the future anticipated development of both accounts.
Claims experience can differ from our expectations due to numerous factors,
including mortality rates, duration of care and type of care utilized. When we
experience adverse deviation from our estimates, we typically seek premium rate
increases that are sufficient to offset future deviation. During 2001, we filed
premium rate increases on the majority of our policy forms in a majority of
states. These rate increases were sought as a result of higher claims
expectations and policyholder persistency than existed at the time of the
original form filings. The assumptions used in requesting and supporting the
premium rate increase filings are consistent with those incorporated in our
newest policy form offerings. We have been generally successful in the past in
obtaining state insurance department approvals for increases. If we are
unsuccessful in obtaining rate increases when deemed necessary, or if we do not
pursue rate increases when actual claims experience exceeds our expectations, we
could suffer a financial loss.
Due to the utilization of assumptions in establishing reserves, it has been
necessary in the past for us to increase the estimated liabilities reflected in
our reserves for claims and policy expenses. In the year in which a claim is
first incurred, we establish policy and contract claims reserves that are
actuarially determined to be the present value of all future payments required
for that claim. We assume that our current reserve amount and interest income
earned on invested assets will be sufficient to make all future payments. We
evaluate our prior year assumptions by reviewing the development of reserves for
the prior period. This amount of $17,477 and $13,427, in 2001 and 2000,
respectively, includes imputed interest from prior year-end reserve balances
plus adjustments to reflect actual versus estimated claims experience. These
adjustments (particularly when calculated as a percentage of the prior year-end
reserve balance) provide a relative measure of deviation in actual performance
as compared to our initial assumptions.
The adjustments to reserves for claims incurred in prior periods are primarily
attributable to claims incurred from our long-term care insurance policies,
which represent approximately 95% of our premium in-force.
We evaluate the assumptions utilized at the time the claim is incurred compared
to our most current assumptions. In 2001, two factors affected the reserves we
held for claims incurred in prior years. (1) Excluding $7,050 from the effect of
imputed interest, we added $8,845 to our claim reserves for 2000 and prior claim
incurrals. Prior to 2001, we based our expectations on claim continuance
patterns determined from our historical claims payments. In 2001, we engaged a
new consulting actuary that provided us with additional industry data to
incorporate in our revised continuance expectations (the probability that a
claim in one duration will continue to another). Our analysis of this
supplemental data suggested that we would recognize higher future payments on
currently incurred claims than was previously anticipated. As a result, we
lengthened our continuance tables for claim durations beyond the third year, and
increased our reserves held for claims incurred to record this liability. We
believe that our experience for claims in the first, second and third duration
was consistent with industry data and, therefore, did not alter this portion of
our continuance tables. (2) In 2001, we reduced the discount rate used in the
establishment of reserves to appropriately reflect the current investment rate
earned on assets supporting this liability. As a result, reserves for claims
incurred in prior years was increased $1,582.
In 2000, excluding the effect of $6,863 from imputed interest, we added $6,565
for claims incurred in prior years. While this increase in reserves for prior
year incurred claims of 4.8% does not reflect a material variance from our
expectations, we believe that the increases were attributable to the method we
employed for determining incurred but not reported claims ("IBNR"). This method
sought to project a ratio of incurred claims to earned premium based upon
historic experience and current trends. The actual number and type of claims
that were ultimately reported to us exceeded the amount of IBNR that we had
recorded at the original estimated date.
The establishment of reserves for claims liabilities incorporates assumptions
regarding the duration of claims, lag in reporting of claims, and interest
discount rates. We periodically reevaluate these assumptions based upon actual
results. Although we believe that our current reserves accurately reflect our
most recent assumptions, continued adverse claims experience could result in
additional future increases. Adverse development of our claim reserves, however,
will not generally be known until future payments occur or other evidence exists
to cause us to change our assumptions. As a result, we could experience positive
or negative deviation from the established reserves, which would impact our
results of operations.
Commissions. Commissions to agents decreased 24.9% to $76,805 in 2001, compared
to $102,313 in 2000.
First year commissions on accident and health business in 2001 decreased 54.9%
to $29,371, compared to $65,117 in 2000, due to the decrease in first year
accident and health premiums. The mix of policyholder issue ages for new
business affects the percentage of commissions paid for new business due to our
age-scaled commission rates. Generally, sales to younger policyholders result in
a higher commission percentage. The ratio of first year accident and health
commissions to first year accident and health premiums was 67.4% in 2001 and
67.1% in 2000.
Renewal commissions on accident and health business in 2001 increased 25.8% to
$49,536, compared to $39,390 in 2000, consistent with the increase in renewal
premiums discussed above. The ratio of renewal accident and health commissions
to renewal accident and health premiums was 16.3% in 2001 and 15.7% in 2000,
which varies as a result of the weighting of policies written by agents with
differing contracts.
During 2001 and 2000, we reduced commission expense, as an intercompany
elimination, by netting $3,706 and $4,923, respectively, from override
commissions that affiliated insurers paid to our subsidiary agencies. The
reduction in commission overrides earned by these agencies in 2001 resulted from
our suspension of new sales in all states at varying times throughout 2001.
Net policy acquisition costs amortized (deferred) and impairment of DAC. The net
deferred policy acquisition costs in 2001 decreased 22.8% to a net amortization
of $9,860, compared to net deferrals of $43,192 in 2000.
Deferred costs typically include all costs that are directly related to, and
vary with, the acquisition of policies. These costs include the variable portion
of commissions, which are defined as the first year commission rate less
ultimate renewal commission rates, and variable general and administrative
expenses related to policy underwriting. Deferred costs are amortized over the
life of the policy based upon actuarial assumptions, including persistency of
policies in-force. In the event a policy lapses prematurely due to death or
termination of coverage, the remaining unamortized portion of the deferred
amount is immediately recognized as expense in the current period.
The amortization of deferred costs is generally offset largely by the deferral
of costs associated with new premiums generation. Lower new premium sales during
2001 produced significantly less expense deferral to offset amortized costs.
During 2001, with the assistance of our consulting actuary, we completed an
analysis to determine if existing policy reserves and policy and contract claim
reserves, together with the present value of future gross premiums, would be
sufficient to (1) cover the present value of future benefits to be paid to
policyholders and settlement and maintenance costs and (2) recover unamortized
deferred policy acquisition costs, referred to as recoverability analysis. We
determined that we would require premium rate increases on certain of our
existing products in order to fully recover our present deferred acquisition
cost asset from future profits. We perform the recoverability analysis each
quarter. During the second quarter we recognized an impairment charge of $300 as
a result of this analysis. Effective December 31, 2001, we entered a reinsurance
agreement for substantially all of our long-term care insurance policies. The
reinsurance agreement includes an annual expense and risk charges. These
additional expense and risk charges reduced our anticipated future gross profits
and resulted in a further impairment of our deferred policy acquisition cost
asset of $61,500. We also amortized approximately $10,000 more of deferred
acquisition cost asset during 2001 due to changing our future assumptions. "See
Premiums."
When an impairment occurs, the historical assumptions utilized in the
establishment of the reserves and DAC are "unlocked" and based on current
assumptions. Changes in policy reserves and unamortized deferred policy
acquisition costs will be based on these revised assumptions in future periods.
In determining the impairment, we evaluated future claims expectations, premium
rates and our ability to obtain future rate increases, persistency and expense
projections.
General and administrative expenses. General and administrative expenses in 2001
decreased 1.4% to $49,282, compared to $49,973 in 2000. The amounts for the
years ended 2001 and 2000, respectively, include $6,591 and $8,138 related to
United Insurance Group. The ratio of total general and administrative expenses,
excluding United Insurance Group expense, to premium revenues was 12.2% in 2001,
compared to 11.7% in 2000.
General and administrative expenses were increased during 2001 as a result of
supplemental accounting and actuarial fees, legal fees, depreciation expenses
and the recognition of $434 of compensation expense related to the variable
treatment of options granted to employees. The compensation expense represents
the December 31, 2001 market value of our common stock in excess of the grant
price of the options. Throughout 2001 we took certain actions to reduce costs,
including staff eliminations, marketing reductions and overhead eliminations. We
believe that if we remain unable to write new policies in states where we have
ceased new production, we will need to decrease production expenses further.
As a result of our December 31, 2001 reinsurance agreement with a foreign
reinsurer, we must pay federal excise tax of 1% on all ceded premium. At
December 31, 2001, we accrued $5,635 of excise tax, which represents the total
amount due for the transfer of premium at the inception of the agreement. This
amount was paid in the first quarter 2002.
Reserve for claim litigation. In the second quarter 2000, a jury awarded
compensatory damages of $24 and punitive damages of $2,000 in favor of the
plaintiff in a disputed claim case against one of our subsidiaries. We
subsequently appealed the decision. During the second quarter 2001, we agreed to
settle the claim for $750 rather than pursuing the appeal process.
Provision for Federal income taxes. Our provision for Federal income taxes for
2001 decreased 276.8% to a tax benefit of $16,280, compared to a tax provision
of $11,720 for 2000 as a result of net losses in 2001. During 2001, we
determined that the net operating loss carryforward attributable to our non-life
parent may be impaired due to the life subsidiary's inability to utilize these
losses within the allowed future periods. As a result, we recognized a valuation
allowance of $5,775 to our deferred tax asset in 2001.
Comprehensive income. During 2001, our investment portfolio generated pre-tax,
unrealized gains of $11,606, compared to $10,350 in 2000. After accounting for
deferred taxes from these gains, shareholders' equity decreased by $37,345 from
comprehensive losses during 2001, compared to comprehensive income of $29,151 in
2000.
Twelve Months Ended December 31, 2000 and 1999 (amounts in thousands)
Premiums. Total premiums earned in the twelve month period ended December 31,
2000, including long-term care, disability, life and Medicare supplement,
increased 22.1% to $357,113, compared to $292,516 in the twelve month period
ended December 31, 1999.
First year long-term care premiums earned in 2000 increased 1.8% to $95,693,
compared to $93,957 in 1999. We attribute our growth to continued improvements
in product offerings, which competitively meet the needs of the long-term care
marketplace, and growth from expansion into new states, such as New
Jersey, Connecticut and New York. In addition, we introduced our group plan,
which offers long-term care insurance to group members on a guaranteed
acceptance basis. Group plan sales accounted for approximately $4,000 in 2000
first year premium. We believe that our growth was otherwise hampered during
2000 as a result of the introduction of higher priced products in many states
and unfavorable press reports regarding the long-term care industry and our
company as a market leader.
Renewal premiums earned in 2000 increased 33.5% to $259,225, compared to
$194,243 in 1999. Renewal long-term care premiums earned in 2000 increased 35.3%
to $244,945, compared to $181,010 in 1999. This increase reflects renewals of a
larger base of in-force policies and policyholder persistency, which remained
constant at approximately 87%, as well as rate increases.
Net investment income. Net investment income earned for 2000 increased 21.2% to
$27,408, from $22,619 for 1999. Management attributes this growth to an increase
in invested assets as a result of higher established reserves. Investment income
was reduced, however, by our use of $6,000 of invested cash for the acquisition
of Network Insurance Senior Health Division on January 1, 2000. Our average
yield on invested assets at cost, including cash and cash equivalents, was 6.2%
in 2000, compared to 5.8% in 1999. Average yields generally increased due to
cash from maturing bonds invested at higher rates. These yields are reduced as a
result of investments in equity securities, which generate low or no dividend
yields.
Net realized capital gains. During 2000, we recognized capital gains of $652,
compared to gains of $5,393 in 1999. Capital gains and losses are generally
recorded as a result of our normal investment management operations. At December
31, 2000, however, we realized a capital loss of $3,200 by marking the cost
basis of one of our bonds to its current market value. The issuer of this bond
declared bankruptcy,
which prompted the bond's impairment. In 1999, we recognized capital gains to
offset expenses of approximately $2,800 as a result of the impairment of certain
of our fixed assets as discussed below.
Other income. We recorded $8,096 in other income during 2000, up from $6,297 in
1999. The increase is attributable to the partial settlement of a previously
disclosed lawsuit, the details of which are confidential in accordance with the
settlement agreement, and to income generated from corporate owned life
insurance policies.
Benefits to policyholders. Total benefits to policyholders in 2000 increased
21.6% to $243,571, compared to $200,328 in 1999. Our loss ratio, or policyholder
benefits to premiums, was 68.2% in 2000, compared to 68.5% in 1999. This ratio
is expected to grow as new business premiums as a percentage of total premiums
decreases.
Claims experience can differ from our expectations due to numerous factors,
including mortality rates, duration of care and type of care utilized. When we
experience adverse deviation from our estimates, we typically seek premium rate
increases that we estimate will be sufficient to offset future deviation. We
have been generally successful in the past in obtaining state insurance
department approvals for increases.
Policyholder benefits include additions to reserves and claims payments for
policyholders' incurring claims in the current and prior years. In 2000, we paid
$37,864 related to current year incurrals and $85,153 related to claims incurred
in 1999 and prior years. In 1999, we paid $25,145 for current year claims and
$69,887 related to prior year incurrals. Paid claims as a percentage of premiums
were 34.4% in 2000, compared to 32.5% in 1999. This ratio increased as a result
of aging policies and a reduction in new premium as a percentage of total
premium reduction.
In the year in which a claim is first incurred, we establish reserves that are
actuarially determined to be the present value of all future payments required
for that claim. We assume that our current reserve amount and interest income
earned on invested reserves will be sufficient to make all future payments. We
measure the validity of our prior year assumptions by reviewing the development
of reserves for the prior period (i.e., incurred from prior years). This amount,
$13,427 and $9,231 in 2000 and 1999, respectively, includes imputed interest
from prior year-end reserve balances of $6,863 and $5,085, respectively, plus
adjustments to reflect actual versus estimated claims experience. These
adjustments, particularly as a percentage of the prior year-end reserve balance,
yield a relative measure of deviation in actual performance to our initial
assumptions. In 2000, we added approximately $6,600 or 4.8% of prior year-end
reserves to our claim reserves for 1999 and prior claim incurrals. In 1999, we
added approximately $4,100 or 3.9% of prior year-end reserves to our claim
reserves for 1998 and prior claim incurrals.
Commissions. Commissions to agents increased 5.7% to $102,313 in 2000, compared
to $96,752 in 1999.
First year commissions on accident and health business in 2000 decreased .6% to
$65,117, compared to $65,538 in 1999, due primarily to the lack of commissions
paid for our new group policies. The ratio of first year accident and health
commissions to first year accident and health premiums was 67.1% in 2000 and
69.4% in 1999, which also reflects the lack of group product commissions. The
mix of policyholder issue ages for new business affects the overall percentage
of commissions paid for new business due to our age-scaled commission rates.
Generally, sales to younger policyholders have a higher commission percentage.
Renewal commissions on accident and health business in 2000 increased 32.5% to
$39,390 compared to $29,736 in 1999, consistent with the increase in renewal
premiums discussed above. The ratio of renewal accident and health commissions
to renewal accident and health premiums was 15.7% in 2000 and 16.0%
in 1999. This ratio fluctuates in relation to the age of the policies in-force
and the rates of commissions paid to the producing agents.
Commission expense during 2000 was reduced by the netting, as an intercompany
elimination, of $4,923 from override commissions paid to our insurance agency
subsidiaries by affiliated insurers. During 1999, commissions were reduced by
$2,593. In 2000, override commission reductions included approximately $1,991
from the insurance agency that we purchased in January 2000.
Net policy acquisition costs deferred. The net deferred policy acquisition costs
in 2000 decreased 15.5% to $43,192, compared to $51,134 in 1999.
Although new premiums increased in 2000, lower first year commissions from our
group product line resulted in lower deferred acquisition costs. In addition,
amortization of previously deferred costs offsets a greater portion of the
current period deferral, especially when new premium growth slows, as has been
the case in 2000.
General and administrative expenses. General and administrative expenses in 2000
increased 22.7% to $49,973, compared to $40,736 in 1999. In 2000 and 1999
general and administrative expenses included $8,138 and $7,748, respectively,
related to United Insurance Group. Generally, costs such as premium taxes and
salaries related to business processing increase proportionately to premium
growth. Management believes that current cost savings initiatives, such as
remote office consolidation and outsourcing of certain administrative functions,
has helped to contain the level of our expenses. 2000 expenses increased due to
the depreciation of capitalized costs for new internal software development,
legal expenses and sales promotion expense. General and administrative expenses
as a percentage of premiums (excluding United Insurance Group and goodwill
amortization related to its purchase) were 11.8% in 2000, compared to 11.3% in
1999.
Loss due to impairment of property and equipment. During 1999, we discontinued
the implementation of a new computer system. At June 30, 1999, we had
capitalized $2,799 of expenditures related to this project, including licensing
costs and fees paid to outside parties for system development and
implementation. As the system was not yet in service, none of these costs had
previously been depreciated. When we decided not to use these fixed assets,
their value became fully impaired and we recognized the entire amount as current
period expense.
In conjunction with our decision to discontinue our implementation of this
computer system, we filed suit against the software manufacturer and several
consultants, alleging misrepresentations regarding the system's capabilities and
ability to meet our expectations. We received $1,119 in settlement of a portion
of the lawsuit in 2000. In 2001, we received settlement in our favor of $357
from two additional parties who acted as consultants on the project.
Reserve for claim litigation. In the second quarter 2000, a jury awarded
compensatory damages of $24 and punitive damages of $2,000 in favor of the
plaintiff in a disputed claim case against one of our subsidiaries. We
subsequently appealed the decision. During the second quarter 2001, we agreed to
settle the claim for $750 rather than pursuing the appeal process.
Provision for Federal income taxes. Our provision for Federal income taxes for
2000 increased 8.1% to $11,720, compared to $10,837 for 1999. The effective tax
rates of 34.0% and 33.7% in 2000 and 1999, respectively, are at or below the
normal Federal corporate rate as a result of credits from our investments in
tax-exempt bonds and corporate owned life insurance and dividends we receive
that are partially exempt from taxation and are partially offset by
non-deductible goodwill amortization and other non-deductible expenses.
Comprehensive income. During 2000, our investment portfolio generated pre-tax
unrealized gains of $10,350, compared to 1999 unrealized losses of $18,009.
After accounting for deferred taxes from these gains, shareholders' equity
increased by $29,151 from comprehensive income during 2000, compared to
comprehensive income of $5,875 in 1999.
LIQUIDITY AND CAPITAL RESOURCES (AMOUNTS IN THOUSANDS)
Our consolidated liquidity requirements have historically been created and met
from the operations of our insurance subsidiaries, from our agency subsidiaries
and from funds raised in the capital markets. Our primary sources of cash are
premiums, investment income and maturities of investments. We have obtained, and
may in the future obtain, cash through public offerings of our common stock,
other capital markets activities or debt instruments. Our primary uses of cash
are policy acquisition costs (principally commissions), payments to
policyholders, investment purchases and general and administrative expenses.
Our 2000 Report of Independent Accountants contained a going concern opinion
resulting from uncertainty regarding parent company liquidity and insurance
subsidiary statutory surplus. Our 2001 Report of Independent Accountants does
not contain a going concern opinion because of the steps that we have taken to
improve parent company liquidity and insurance subsidiary statutory surplus,
including the approval of our Corrective Action Plan with the Pennsylvania
Insurance Department, our reinsurance agreement with Centre Solutions (Bermuda)
Limited (see "Subsidiary Operations") and the public and private placement of
additional shares of our Common Stock (see "Parent Company Operations").
However, we cannot make assurances that parent company liquidity and insurance
subsidiary statutory surplus will not cause uncertainty with respect to our
ability to continue as a going concern without additional resources in the
future. See "Parent Company Operations."
In 2001, our cash decreased by $1,996, primarily from funds used to purchase
bonds and equity securities of $263,388. Our cash was primarily increased by
proceeds from the sale and maturity of investment securities of $128,881. These
sources of funds were supplemented with $111,277 from operations and $25,726
generated from exercise of rights to purchase shares of our common stock
distributed to our shareholders and holders of our Subordinated Notes.
In 2000, our cash increased by $99,249, primarily due to the maturity and sale
of $250,765 of our bond and equity securities portfolio. These sources of funds
were supplemented with $92,415 from operations. The major source of cash from
operations was premium revenue used to fund reserve additions of $116,227. The
primary uses of cash during 2000 were the purchase of $233,539 in bonds and
equity securities, $102,313 paid as agent commissions and $6,000 used to
purchase Network Insurance Senior Health Division.
In 1999, our cash decreased $21,055, primarily due to $192,990 used to purchase
bonds and equity securities, $4,999 used to purchase our common stock, which is
held as treasury stock, and $9,194 used to purchase United Insurance Group. Cash
was provided primarily from the maturity and sale of $140,892 in bonds and
equity securities. These sources of funds were supplemented with $50,533 from
operations. The major provider of cash from operations was premium revenue used
to fund reserve additions of $104,610.
We invest in securities and other investments authorized by applicable state
laws and regulations and follow an investment policy designed to maximize yield
to the extent consistent with liquidity requirements and preservation of assets.
At December 31, 2001, the market value of our bond portfolio represented 103.2%
of our cost, compared to 99.9% at December 31, 2000, with a current unrealized
gain of $14,990 at December 31, 2001, compared to an unrealized loss of $389 at
December 31, 2000. The
market value of our equity portfolio exceeded cost by $1,042 at December 31,
2001, but was below cost by $616 at December 31, 2000.
At December 31, 2001 and December 31, 2000, the average maturity of our bond
portfolio was 7.1 and 7.2 years, respectively.
SUBSIDIARY OPERATIONS
Our insurance subsidiaries are regulated by various state insurance departments.
In its ongoing effort to improve solvency regulation, the NAIC has adopted
Risk-Based Capital ("RBC") requirements for insurance companies to evaluate the
adequacy of statutory capital and surplus in relation to investment and
insurance risks, such as asset quality, mortality and morbidity, asset and
liability matching, benefit and loss reserve adequacy, and other business
factors. The RBC formula is used by state insurance regulators as an early
warning tool to identify, for the purpose of initiating regulatory action,
insurance companies that potentially are inadequately capitalized. In addition,
the formula defines minimum capital standards that an insurer must maintain.
Regulatory compliance is determined by a ratio of the enterprise's regulatory
Total Adjusted Capital, to its Authorized Control Level RBC, as defined by the
NAIC. Companies below specific trigger points or ratios are classified within
certain levels, each of which may require specific corrective action depending
upon the insurer's state of domicile.
Our insurance subsidiaries, Penn Treaty, American Network and American
Independent (representing approximately 92%, 6% and 2% of our in-force
premium, respectively) are each required to hold statutory surplus that is
above a certain required level. If the statutory surplus of any of our
Pennsylvania subsidiaries falls below such level, the Department would be
required to place such subsidiary under regulatory control, leading to
rehabilitation or liquidation. At December 31, 2000, Penn Treaty had Total
Adjusted Capital at the Regulatory Action level. As a result, it was required
to file a Corrective Action Plan (the "Plan") with the insurance commissioner.
Subsequent to December 31, 2001, the Department approved the Plan. As a
primary component of the Plan, effective December 31, 2001, Penn Treaty and
American Network entered a reinsurance transaction to reinsure, on a quota
share basis, substantially all of our respective long-term care insurance
policies then in-force. The agreement was entered with Centre Solutions
(Bermuda) Limited, which is rated A- by A.M. Best. The agreement, which is
subject to certain coverage limitations, meets the requirements to qualify as
reinsurance for statutory accounting, but not for generally accepted
accounting principles. The initial premium of the treaties is approximately
$619,000, comprised of $563,000 of cash and qualified securities transferred
subsequent to December 31, 2001, and $56,000 as funds held due to the
reinsurer. The initial premium and future cash flows from the reinsured
policies, less claims payments, ceding commissions and risk charges, will be
credited to a notional experience account, which is held for our benefit in
the event of commutation and recapture on or after December 31, 2007. The
notional experience account balance will receive an investment credit based
upon the total return of a series of benchmark indices and hedges that are
intended to match the duration of our reserve liability.
The agreement contains commutation provisions and allows us to recapture the
reserve liabilities and the current experience account balance as of December
31, 2007 or on December 31 of any year thereafter. If we choose not to or are
unable to commute the agreement as planned, our financial results would likely
suffer a materially adverse impact due to an escalation of the charges paid to
the reinsurer. Additionally, our reinsurance provisions contain significant
covenants and conditions that, if breached, could result in a significant loss,
requiring a payment of $2.5 million per quarter from the period of the breach
through December 31, 2007. Any breach of the reinsurance agreement may also
result in the immediate recapture
of the reinsured business, which would have a material adverse effect on our
subsidiaries' statutory surplus. Management has completed an assessment of its
ability to avoid any breach through 2002 and believes that it will remain
compliant. In addition, the reinsurer has been granted warrants to acquire
convertible preferred stock in the event we do not commute the agreements that,
if converted, would represent an additional 20 percent of the common stock then
outstanding.
Pennsylvania insurance regulations require that funds ceded for reinsurance
provided by a foreign or "unauthorized" reinsurer must be secured by funds held
in a trust account or by a letter of credit for the protection of policyholders.
We received approximately $648,000 in statutory reserve credits from this
transaction as of December 31, 2001, of which $619,000 was held by us and
$29,000 was backed by letters of credit, which increased our statutory surplus
by $29,000 as well. As a result, our subsidiary's RBC ratio at December 31, 2001
was substantially above the required statutory minimum, as well as above
recommended or trigger levels.
The initial premium paid for the reinsurance (in February 2002) included
investment securities carried at amortized cost but valued at market price for
purposes of the premium transfer and the experience account. The Pennsylvania
Insurance Department permitted us to receive credit of $29,000 for the letters
of credit, and to accrue the anticipated, yet unknown, gain of $18,000 from the
sale of securities at market value, in our statutory financial results for
December 31, 2001. The impact of this permitted practice served to increase the
statutory surplus of our insurance subsidiaries by approximately $47,000 at
December 31, 2001. Had we not been granted a permitted practice, our statutory
surplus would have been negative. Upon finalization of the reinsurance
agreement, transfer of funds and establishment of appropriate letters of credit
in the first quarter of 2002, the permitted practices are not expected to be
required.
The Plan requires our subsidiary to comply with certain other agreements at the
direction of the Department, including, but not limited to:
- new investments are limited to NAIC 1 or 2 rated securities.
- affiliated transactions are limited and require Department approval.
- an agreement to increase statutory reserves (which is the responsibility
of the reinsurer) by an additional $100,000 throughout 2002-2004, such that
our policy reserves will be based on new, current claims assumptions and
will not include any rate increases. These claim assumptions are applied to
all policies, regardless of issue year and are assumed to have been present
since the policy was first issued.
Our subsidiary insurers will be subject to continued surplus strain as a result
of new business as well as a reduced level of premium to support our general and
administrative expenses. We believe that our surplus will continue to be
sufficient and that our RBC ratio at December 31, 2002 will be above the NAIC
Company Action Level. We expect to seek other sources of additional capital to
supplement our statutory surplus.
Effective September 10, 2001, we determined to discontinue the sale nationally
of all new long-term care insurance policies until the Plan was approved by the
Department. The decision resulted from our concern about further depletion of
statutory surplus from new sales prior to the completion and approval of the
Plan and from increasing concern regarding our status by many states in which we
are licensed to conduct business. The form of our cessation varied by state,
ranging from no action to certificate suspensions.
Upon the approval by the Department of the Plan in February 2002, we recommenced
new sales in 23 states. We have since recommenced sales in 3 additional states.
We are actively working with all states in order to recommence sales in all
remaining jurisdictions.
The majority of our insurance subsidiaries' cash flow results from our existing
long-term care policies, which will be ceded to the reinsurer under this
agreement. Our subsidiaries' ability to meet additional liquidity needs and
fixed expenses in the future is highly dependent upon our ability to issue new
policies and to control expense growth.
We have historically utilized financial reinsurance arrangements to mitigate the
surplus strain caused by the new business growth. As a result of these
arrangements, Penn Treaty Network America's ("PTNA") 2000 statutory surplus was
increased by $19,841. These arrangements are designed to be paid over a
relatively short period of time. As a result of these repayment provisions and
our commutation of all existing treaties during 2001, all of the surplus benefit
derived from the financial reinsurance treaties reversed during fiscal 2001.
Our new reinsurance agreement meets the requirements necessary to qualify as
reinsurance for statutory accounting. Since it does not have an accelerated
repayment provision, we do not consider it to be financial reinsurance. The
agreement does not create a material probability of loss for the reinsurer, and
accordingly does not qualify for reinsurance under generally accepted accounting
principles and is not reflected as such in our financial statements.
The agreement contains commutation provisions and allows us to recapture the
reserve liabilities and the current experience account balance as of December
31, 2007 or on December 31 of each any thereafter. We have an intent and desire
to commute the treaty on December 31, 2007 and we are accounting for the
agreement in anticipation of this commutation. In the event we do not commute
the agreement on December 31, 2007, we will be subject to escalating expenses.
Our future growth is dependent upon our ability to continue to expand our
historical markets, retain and expand our network of agents and effectively
market our products and our ability to fund our marketing and expansion while
maintaining minimum statutory levels of capital and surplus required to support
such growth. Under the insurance laws of Pennsylvania and New York, where our
insurance subsidiaries are domiciled, insurance companies can pay dividends only
out of earned surplus. In addition, under Pennsylvania law, our Pennsylvania
insurance subsidiaries (including our primary insurance subsidiary) must give
the Pennsylvania Insurance Department at least 30 days' advance notice of any
proposed "extraordinary dividend" and cannot pay such a dividend if the
Insurance Department disapproves the payment during that 30-day period. For
purposes of that provision, an extraordinary dividend is a dividend that,
together with all other dividends paid during the preceding twelve months,
exceeds the greater of 10% of the insurance company's surplus as shown on the
company's last annual statement filed with the Insurance Department or its
statutory net income as shown on that annual statement. Statutory earnings are
generally lower than earnings reported in accordance with generally accepted
accounting principles due to the immediate or accelerated recognition of all
costs associated with premium growth and benefit reserves. Additionally, the
Plan requires the Department to approve all dividend requests, regardless of
statutory allowances.
Under New York law, our New York insurance subsidiary must give the New York
Insurance Department 30 days' advance notice of any proposed dividend and cannot
pay any dividend if the regulator disapproves the payment during that 30-day
period. In addition, our New York insurance company must obtain the prior
approval of the Insurance Department before paying any dividend that, together
with all other dividends paid during the preceding twelve months, exceeds the
lesser of 10% of the insurance company's surplus as of the preceding December 31
or its adjusted net investment income for the year
ended the preceding December 31. During 2002, we received a dividend from our
New York subsidiary of $651.
Our subsidiaries' debt currently consists primarily of a mortgage note in the
amount of approximately $1,581 that was issued by a former subsidiary and
assumed by us when that subsidiary was sold. The mortgage note is currently
amortized over 15 years, and has a balloon payment due on the remaining
outstanding balance in December 2003. Although the note carries a variable
interest rate, we have entered into an amortizing swap agreement with the same
bank with a nominal amount equal to the outstanding debt, which has the effect
of converting the note to a fixed rate of interest of 6.85%.
PARENT COMPANY OPERATIONS
(DOLLARS IN THOUSANDS)
We are a non-insurer that directly controls 100% of the voting stock of our
insurance company subsidiaries. If we are unable to meet our financial
obligations, become insolvent or discontinue operations, the financial condition
and results of operations of our insurance company subsidiaries could be
materially affected.
On April 27, 2001, we distributed rights to our shareholders and holders of our
6.25% convertible subordinated notes due 2003 ("Rights Offering") for the
purpose of raising new equity capital. Pursuant to the Rights Offering, holders
of our common stock and holders of our convertible subordinated notes received
rights to purchase 11,547 newly issued shares of common stock at a set price of
$2.40 per share. The Rights Offering was completed on May 25, 2001 and generated
net proceeds of $25,726 in additional equity capital. We contributed $18,000 of
the net proceeds to the statutory capital of our subsidiaries.
Parent company debt currently consists of $74,750 of 6.25% Convertible
Subordinated Notes due 2003, as well as an installment note in the amount of
$2,858 issued in connection with the purchase of United Insurance Group. The
convertible subordinated notes, issued in November 1996, are convertible into
common stock at $28.44 per share until maturity in December 2003. At maturity,
to the extent that the convertible subordinated notes have not been converted
into common stock, we will have to repay their entire principal amount in cash.
The convertible subordinated notes carry a fixed interest coupon of 6.25%,
payable semi-annually. Because we do not have sufficient cash flow to retire the
debt upon maturity, and the conversion price of $28.44 per share is not likely
to be met, we expect that we will need to refinance our 6.25% Convertible
Subordinate Notes on or before maturity in 2003. The terms of any such
refinancing are not yet known, or if refinancing is achievable. We cannot give
assurance that these terms will not be materially adverse to our existing
shareholders' interests.
On January 1, 1999, we purchased all of the common stock of United Insurance
Group, a Michigan based consortium of long-term care insurance agencies, for
$18,192. As part of the purchase, we issued a note payable for $8,078, which was
in the form of a three-year zero-coupon installment note. The installment note,
after discounting for imputed interest, was recorded as a note payable of
$7,167, and had an outstanding balance of $2,858 at December 31, 2001. The
remainder of the purchase was paid in cash. The total outstanding balance of the
note was repaid in January 2002.
Our total debt and financing obligations through 2006 are as follows:
Lease
Debt Commitments Total
----
2002 $ 2,978 $ 547 $ 3,525
2003 76,212 433 76,645
2004 - 344 344
2005 - 252 252
2006 - 18 18
-------- ------- --------
Total $ 79,190 $ 1,594 $ 80,784
======== ======= ========
Amounts subsequent to 2006 are immaterial.
In December 1999, we contributed $1,000 to initially capitalize another
subsidiary, which concurrently lent us $750 in exchange for a demand note, which
is still outstanding.
At December 31, 1999, we had a $3,000 line of credit from a bank, which was
unused. The line of credit was not renewed by the bank at December 31, 2000.
As part of our reinsurance agreement, effective December 31, 2001, the reinsurer
was granted four tranches of warrants to purchase non-voting shares of
convertible preferred stock. The first three tranches of convertible preferred
stock are exercisable through December 31, 2007 at common stock equivalent
prices ranging from $4.00 to $12.00 per share if converted. If exercised for
cash, at the reinsurer's option, the warrants could yield additional capital and
liquidity of approximately $20,000 and would represent, if converted, of
approximately 15% of the outstanding shares of our common stock. If the
agreement is not commuted on or after December 31, 2007, the reinsurer may
exercise the fourth tranche of warrants for common stock equivalent prices of
$2.00 per share if converted, potentially generating additional capital of
$12,000, representing an additional 20% of the then outstanding common stock. No
assurance can be given that the reinsurer will exercise any or all of the
warrants granted.
Cash flow needs of the parent company primarily include interest payments on
outstanding debt and limited operating expenses. The funding is primarily
derived from the operating cash flow of our agency subsidiary operations and
dividends from the insurance subsidiaries. However, as noted above, the dividend
capabilities of the insurance subsidiaries are limited and the only insurance
company that can pay dividends is American Independent Network Insurance Company
of New York. While we intend to sell this insurance subsidiary in order to
generate additional parent company liquidity, we cannot assure that this will be
accomplished during 2002. In the event the sale is not completed, we may need to
rely upon the dividend capabilities of our agency subsidiaries to meet current
liquidity needs. These sources of funds, however, are expected to be
insufficient to meet our future needs beyond June 30, 2003, including the
repayment of $74.8 million of long-term debt in December 2003.
In March 2002, we completed an equity placement of 500 shares of unregistered
common stock for net proceeds of approximately $2,400. The equity placement
included current and new institutional investors, with shares offered at $4.65.
The offering price was a 10 percent discount to the 30-day average price prior
to the issuance. We have agreed to file a registration statement with the
Securities and Exchange Commission on or before June 5, 2002 to register these
shares for resale. The proceeds of the equity placement are expected to provide
sufficient additional liquidity to the parent company to meet our debt
obligations prior to the maturity of the convertible debt in 2003. The proceeds,
together with currently available cash sources, are not sufficient to meet the
December 2003 final interest requirement of the debt or to retire the debt upon
maturity.
Our liquidity projections, while based upon our best estimates and containing
excess margin for our estimated needs, may not be sufficient to meet our
obligations throughout 2003. We cannot assure that we
will not need additional funding in the event that our liquidity projections are
insufficient to meet our future cash needs.
New Accounting Principles (in thousands)
Effective January 1, 2001, we adopted SFAS No. 133, which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
"derivatives") and for hedging activities. SFAS No. 133 requires an entity to
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value.
In accordance with SFAS No. 133, which we transferred its convertible bond
portfolio from the available for sale category to the trading category. Theses
bonds were sold during December 2001.
We are party to an interest rate swap agreement, which converts its mortgage
loan from a variable rate to a fixed rate instrument. We determined that the
swap qualifies as a cash-flow hedge. The notional amount of the swap is
approximately $1,600. The effects have been determined to be immaterial to the
financial statements.
Our involvement with derivative instruments and transactions is primarily to
mitigate its own risk and is not considered speculative in nature.
In June 2001, the Financial Accounting Standards Board ("FASB") issued two
Statements of Financial Accounting Standards ("SFAS"). SFAS No. 141, "Business
Combinations" requires usage of the purchase method for all business
combinations initiated after June 30, 2001, and prohibits the use of the pooling
of interests method of accounting for business combinations. The provisions of
SFAS No. 141 relating to the application of the purchase method are generally
effective for business combinations completed after June 30, 2001. Such
provisions include guidance on the identification of the acquiring entity, the
recognition of intangible assets other than goodwill acquired in a business
combination and the accounting for negative goodwill. The transition provisions
of SFAS No. 141 require an analysis of goodwill, acquired in purchase business
combinations prior to July 1, 2001, to identify and reclassify separately
identifiable intangible assets currently recorded as goodwill.
SFAS No. 142, "Goodwill and Other Intangible Assets," primarily addresses the
accounting for goodwill and intangible assets subsequent to their acquisition.
We will adopt SFAS No. 142 on January 1, 2002 and will cease amortizing goodwill
at that time. All goodwill recognized in our consolidated balance sheet at
January 1, 2002 will be assigned to one or more reporting units. Goodwill in
each reporting unit will be tested for impairment by June 30, 2002. Any
impairment loss recognized as a result of this transitional impairment test of
goodwill will be reported as the cumulative effect of a change in accounting
principle. Our book value is currently in excess of our market value, which will
require an analysis of the goodwill at the reporting unit level. Management has
not yet completed this analysis to determine the extent of impairment, if any.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(DOLLARS IN THOUSANDS)
We invest in securities and other investments authorized by applicable state
laws and regulations and follow an investment policy designed to maximize yield
to the extent consistent with liquidity requirements and preservation of assets.
A significant portion of assets and liabilities are financial instruments, which
are subject to the market risk of potential losses from adverse changes in
market rates and prices. Our primary market risk exposures relate to interest
rate risk on fixed rate domestic medium-term instruments and, to a lesser
extent, domestic short-term and long-term instruments. We have established
strategies, asset quality standards, asset allocations and other relevant
criteria for our portfolio to manage our exposure to market risk.
We currently have an interest rate swap on our mortgage, which is used as a
hedge to convert the mortgage to a fixed interest rate. We believe that, since
the notional amount of the swap is amortized at the same rate as the underlying
mortgage and both financial instruments are with the same bank, no credit or
financial risk is carried with the swap.
Our financial instruments are held for purposes other than trading. Our
portfolio does not contain any significant concentrations in single issuers
(other than U.S. treasury and agency obligations), industry segments or
geographic regions.
We urge caution in evaluating overall market risk from the information below.
Actual results could differ materially because the information was developed
using estimates and assumptions as described below, and because insurance
liabilities and reinsurance receivables are excluded in the hypothetical effects
(insurance liabilities represent 81.6% of total liabilities and reinsurance
receivables on unpaid losses represent 2.7% of total assets). Long-term debt,
although not carried at fair value, is included in the hypothetical effect
calculation.
The hypothetical effects of changes in market rates or prices on the fair values
of financial instruments as of December 31, 2001, excluding insurance
liabilities and reinsurance receivables on unpaid losses because such insurance
related assets and liabilities are not carried at fair value, would have been as
follows:
If interest rates had increased by 100 basis points at December 31, 2001, there
would have been a decrease of approximately $17,408 in the net fair value of our
investment portfolio less our long-term debt and the related swap agreement. A
200 basis point increase in market rates at December 31, 2001 would have
resulted in a decrease of approximately $33,472 in the net fair value. If
interest rates had decreased by 100 and 200 basis points, there would have been
a net increase of approximately $18,887 and $39,406, respectively, in the net
fair value of our total investments and debt.
If interest rates had increased by 100 basis points at December 31, 2000, there
would have been a decrease of approximately $15,674 in the net fair value of our
investment portfolio less our long-term debt and the related swap agreement. The
change in fair value was determined by estimating the present value of future
cash flows using models that measure the change in net present values arising
from selected hypothetical changes in market interest rate. A 200 basis point
increase in market rates at December 31, 2000 would have resulted in a decrease
of approximately $30,035 in the net fair value. If interest rates had decreased
by 100 and 200 basis points, there would have been a net increase of
approximately $17,123 and $35,847, respectively, in the net fair value of our
total investments and debt.
We hold certain mortgage and asset backed securities as part of our investment
portfolio. The fair value of these instruments may react in a convex or
non-linear fashion when subjected to interest rate increases or decreases. The
anticipated cash flows of these instruments may differ from expectations in
changing interest rate environments, resulting in duration drift or a varying
nature of predicted time-weighted present values of cash flows. The result of
unpredicted cash flows from these investments could cause the above hypothetical
estimates to change. However, we believe that the minimal amount we have
invested
in these instruments and their broadly defined payment parameters sufficiently
outweigh the cost of computer models necessary to accurately predict the
possible impact on our investment income of hypothetical effects of changes in
market rates or prices on the fair values of financial instruments as of
December 31, 2001.
Effective December 31, 2001, we entered a reinsurance agreement to reinsure, on
a quota share basis, substantially all of our long-term care insurance policies
in-force. The transaction resulted in the transfer of debt and equity securities
of approximately $563,000 to the reinsurer. The agreements provide us the
opportunity to commute and recapture after December 31, 2007. To that end, the
reinsurer will maintain a notional experience account for our benefit only in
the event of commutation and recapture, which reflects the initial premium paid,
future premiums collected net of claims, expenses and accumulated investment
earnings. The notional experience account balance will receive an investment
credit based upon the total return of a series of benchmark indices and hedges
that are designed to closely match the duration of reserve liabilities. As a
result, we will likely experience significant volatility in our future financial
statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Refer to Consolidated Financial Statements and notes thereto attached to this
report.
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 our Definitive Proxy Statement for the Annual
Meeting of Shareholders to be held in May 2002.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from our Definitive Proxy Statement for the Annual
Meeting of Shareholders to be held in May 2002. See Exhibits 10.1, 10.2, 10.11
and 10.17.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from our Definitive Proxy Statement for the Annual
Meeting of Shareholders to be held in May 2002.
ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS
Incorporated by reference from our Definitive Proxy Statement for the Annual
Meeting of Shareholders to be held in May 2002.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULE AND REPORTS
(a) The following documents are filed as a part of this report.
(1) Financial Statements.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Pages
-----
Report of Independent Accountants F-2
Financial Statements:
Consolidated Balance Sheets as of December 31,
2001 and 2000 F-3
Consolidated Statements of Income and Comprehensive Income
for the Years Ended December 31, 2001, 2000 and 1999 F-4
Consolidated Statements of Shareholders' Equity
for the Years Ended December 31, 2001,
2000 and 1999 F-5
Consolidated Statements of Cash Flows for the
Years Ended December 31, 2001, 2000 and 1999 F-6
Notes to Consolidated Financial Statements F-7
Financial Pages (F) 1
Report of Independent Accountants
To the Board of Directors and Shareholders of Penn Treaty American Corporation
Allentown, Pennsylvania
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income and comprehensive income, of shareholders'
equity and of cash flows present fairly, in all material respects, the financial
position of Penn Treaty American Corporation and Subsidiaries (the "Company") at
December 31, 2001 and 2000, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States of
America. 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 of these statements in
accordance with auditing standards generally accepted in the United States of
America, which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
------------------------------
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
April 1, 2002
Financial Pages (F) 2
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
as of December 31, 2001 and 2000
(amounts in thousands)
ASSETS 2001 2000
--------- ---------
Investments:
Bonds, available for sale at market (amortized cost of
$463,618 and $349,877, respectively) $ 478,608 $ 349,488
Equity securities at market (cost of $8,760 and $17,112, respectively) 9,802 16,496
Policy loans 181 142
--------- ---------
Total investments 488,591 366,126
Cash and cash equivalents 114,600 116,596
Property and equipment, at cost, less accumulated depreciation of
$6,594 and $5,162, respectively 12,783 12,467
Unamortized deferred policy acquisition costs 180,052 251,711
Receivables from agents, less allowance for
uncollectable amounts of $199 2,190 3,333
Accrued investment income 7,907 6,214
Federal income tax recoverable 4,406 3,671
Goodwill less accumulated amortization of $4,607 and $3,314, respectively 25,771 27,064
Present value of future profits acquired 1,937 2,352
Receivable from reinsurers 25,594 16,131
Corporate owned life insurance 54,478 41,628
Other assets 22,058 8,838
--------- ---------
Total assets $ 940,367 $ 856,131
========= =========
LIABILITIES
Policy reserves:
Accident and health $ 382,660 $ 348,344
Life 13,386 13,065
Policy and contract claims 214,466 164,565
Accounts payable and other liabilities 19,422 14,706
Long-term debt 79,190 81,968
Deferred income tax liability 38,447 45,421
--------- ---------
Total liabilities 747,571 668,069
--------- ---------
Commitments and contingencies (Note 11)
SHAREHOLDERS' EQUITY
Preferred stock, par value $1.00; 5,000 shares authorized, none outstanding -- --
Common stock, par value $.10; 40,000 and 25,000 shares authorized,
19,750 and 8,202 shares issued and outstanding at December 31, 2001
and 2000, respectively 1,975 820
Additional paid-in capital 94,802 53,879
Accumulated other comprehensive income (loss) 10,583 (662)
Retained earnings 92,141 140,730
--------- ---------
199,501 194,767
Less 915 common shares held in treasury, at cost (6,705) (6,705)
--------- ---------
192,796 188,062
--------- ---------
Total liabilities and shareholders' equity $ 940,367 $ 856,131
========= =========
See accompanying notes to consolidated financial statements
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
for the Years Ended December 31, 2001, 2000 and 1999
(amounts in thousands)
2001 2000 1999
--------- --------- ---------
Revenues:
Premium revenue $ 350,391 $ 357,113 $ 292,516
Net investment income 30,613 27,408 22,619
Net realized capital (losses) gains (4,367) 652 5,393
Trading account losses (3,428) -- --
Other income 9,208 8,096 6,297
--------- --------- ---------
382,417 393,269 326,825
Benefits and expenses:
Benefits to policyholders 239,155 243,571 200,328
Commissions 76,805 102,313 96,752
Net policy acquisition costs amortized (deferred) 9,860 (43,192) (51,134)
Impairment of unamortized policy acquisition costs 61,800 -- --
General and administrative expenses 49,282 49,973 40,736
Excise tax expense 5,635 -- --
Loss due to impairment of property and equipment -- -- 2,799
Loss due to change in reserve for claim litigation (250) 1,000 --
Interest expense 4,999 5,134 5,187
--------- --------- ---------
447,286 358,799 294,668
--------- --------- ---------
(Loss) income before federal income taxes (64,869) 34,470 32,157
(Benefit) provision for federal income taxes (16,280) 11,720 10,837
--------- --------- ---------
Net (loss) income $ (48,589) $ 22,750 $ 21,320
========= ========= =========
Other comprehensive income:
Unrealized holding gain (loss) arising during period 11,606 10,350 (18,009)
Income tax (expense) benefit from unrealized holdings (3,946) (3,519) 6,123
Reclassification of gain (loss) included in net income 5,432 (652) (5,393)
Income tax (expense) benefit from reclassification (1,847) 222 1,834
--------- --------- ---------
Comprehensive (loss) income $ (37,344) $ 29,151 $ 5,875
========= ========= =========
Basic earnings per share $ (3.41) $ 3.13 $ 2.83
Diluted earnings per share $ (3.41) $ 2.61 $ 2.40
Weighted average number of shares outstanding 14,248 7,279 7,533
Weighted average number of shares outstanding
(Diluted) 14,248 9,976 10,293
See accompanying notes to consolidated financial statements
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
for the Years Ended December 31, 2001, 2000 and 1999
(amounts in thousands)
Accumulated
Common Stock Additional Other Total
------------ Paid-In Comprehensive Retained Treasury Shareholders'
Shares Amount Capital Income (Loss) Earnings Stock Equity
------ ------ -------- ------------- ------------ -------- -------------
Balance, December 31, 1998 8,189 $ 819 $ 53,516 $ 8,381 $ 96,660 $ (1,706) $ 157,670
Net income 21,320 21,320
Other comprehensive loss (15,445) (15,445)
Treasury stock purchase (4,999) (4,999)
Option-based compensation 108 108
Exercised options proceeds 2 31 31
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
Balance, December 31, 1999 8,191 819 53,655 (7,064) 117,980 (6,705) 158,685
Net income 22,750 22,750
Other comprehensive income 6,402 6,402
Option-based compensation 86 86
Exercised options proceeds 11 1 138 139
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
Balance, December 31, 2000 8,202 820 53,879 (662) 140,730 (6,705) 188,062
Net loss (48,589) (48,589)
Other comprehensive income 11,245 11,245
Option-based compensation 485 485
Rights offering proceeds 11,547 1,155 24,571 25,726
Warrants issued 15,855 15,855
Exercised options proceeds 1 12 12
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Balance, December 31, 2001 19,750 $ 1,975 $ 94,802 $ 10,583 $ 92,141 $ (6,705) $ 192,796
===============================================================================
See accompanying notes to consolidated financial statements.
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the Years Ended December 31,
(amounts in thousands)
2001 2000 1999
--------- --------- ---------
Net cash flow from operating activities:
Net (loss) income $ (48,589) $ 22,750 $ 21,320
Adjustments to reconcile net (loss) income to cash
provided by operations:
Amortization of intangible assets 2,068 2,068 1,765
Policy acquisition costs, net 71,660 (43,192) (51,134)
Deferred income tax (benefit) provision (12,767) 8,675 8,860
Depreciation expense 1,409 1,275 996
Net realized capital gains (losses) 7,795 (652) (5,393)
Loss on disposal of property and equipment -- 137 2,799
Increase (decrease) due to change in:
Receivables from agents 1,143 (620) (347)
Receivable from reinsurers (9,463) (1,061) (2,782)
Policy and contract claims 49,901 27,031 31,867
Policy reserves 34,637 89,196 72,743
Accounts payable and other liabilities 4,716 1,819 2,959
Federal income taxes recoverable (735) (2,055) 178
Accrued investment income (1,693) (296) (1,029)
Net proceeds from purchases and sales of trading account 21,285 -- --
Other, net (10,090) (12,660) (32,269)
--------- --------- ---------
Cash provided by operations 111,277 92,415 50,533
--------- --------- ---------
Cash flow from investing activities:
Net cash from purchase of subsidiary -- (6,000) (9,194)
Proceeds from sales of bonds 107,296 207,906 108,003
Proceeds from sales of equity securities 2,699 30,163 25,572
Maturities of investments 18,886 12,696 7,317
Purchase of bonds (258,343) (205,213) (168,430)
Purchase of equity securities (5,045) (28,326) (24,560)
Acquisition of property and equipment (1,726) (3,637) (4,472)
--------- --------- ---------
Cash (used in) provided by investing (136,233) 7,589 (65,764)
--------- --------- ---------
Cash flow from financing activities:
Purchase of treasury stock -- -- (4,999)
Net proceeds from stock offering 25,726 -- --
Proceeds from exercise of stock options 12 138 31
Repayments of long-term debt (2,778) (893) (856)
--------- --------- ---------
Cash provided by (used in) financing 22,960 (755) (5,824)
--------- --------- ---------
(Decrease) increase in cash and cash equivalents (1,996) 99,249 (21,055)
Cash balances:
Beginning of period 116,596 17,347 38,402
--------- --------- ---------
End of period $ 114,600 $ 116,596 $ 17,347
========= ========= =========
Acquisition of subsidiary with note payable $ -- $ -- $ 7,167
========= ========= =========
See accompanying notes to consolidated financial statements
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES Notes to Consolidated
Financial Statements (amounts in thousands, except per share information)
1. Basis of Presentation:
The accompanying consolidated financial statements of Penn Treaty American
Corporation and its Subsidiaries (the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and include Penn Treaty Network America Insurance Company
("PTNA"), American Network Insurance Company ("ANIC"), American Independent
Network Insurance Company of New York ("AIN"), Penn Treaty (Bermuda), Ltd.
("PTB"), United Insurance Group Agency, Inc. ("UIG"), Network Insurance Senior
Health Division ("NISHD") and Senior Financial Consultants Company ("SFCC").
Significant intercompany transactions and balances have been eliminated in
consolidation. Certain prior year amounts have been reclassified to conform to
the current year presentation.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent liabilities and the reported
amounts of revenues and expenses. Actual results could differ from those
estimates.
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 independent agents and managing general agents.
The Company operates its home office in Allentown, Pennsylvania, and has
satellite offices in Michigan and New York, whose principal functions are to
market and underwrite new business. The Company is licensed in all states. Sales
in Florida, California and Pennsylvania accounted for 19%, 15% and 12%,
respectively, of the Company's premiums for the year ended December 31, 2001. No
other state sales accounted for more than 10% of the Company's premiums for the
year ended December 31, 2001.
2. Summary of Significant Accounting Policies:
Investments:
Management categorizes the majority 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.
Effective January 1, 2001, in accordance with Statement of Financial Accounting
Standard No. 133 "Accounting for Derivative Instruments and Hedging Activities"
("SFAS No. 133"), the Company transferred its convertible bond portfolio, which
contained embedded derivatives, from the available for sale category of
investments to the trading category. Realized gains and losses and changes in
unrealized gains and losses for the trading portfolio are recorded in current
operations. The unrealized loss at the time of the transfer was $1,064. During
2001, we sold our entire convertible bond portfolio.
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.
Debt and equity securities are regularly evaluated to determine if market values
below amortized cost are as a result of credit quality, performance or general
market decline. If market value declines are determined to be other than
temporary, the amortized cost is adjusted to the market value of the security,
with the loss recognized in the current period.
Purchases and sales of securities are recorded on a trade-date basis. Interest
income is recorded on the accrual basis. Dividends are recorded on the
ex-dividend date.
The Company is subject to interest rate risk to the extent that its investment
portfolio cash flows are not matched to its insurance liabilities. Management
believes it manages this risk through monitoring cash flows and actuarial
assumptions regarding the timing of future insurance liabilities.
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 $55,812,
$37,681 and $26,956 for the years ended December 31, 2001, 2000 and 1999,
respectively. Recoverability of deferred acquisition costs is dependent upon the
Company's ability to obtain future rate increases and certain other factors. The
ability to obtain these increases is subject to regulatory approval, and is not
guaranteed.
The Company regularly assesses the recoverability of deferred acquisition costs
through actuarial analysis. To determine recoverability, the present value of
future premiums less future costs and claims are added to current reserve
balances. If this amount is greater than current unamortized deferred
acquisition costs, the unamortized amount is deemed recoverable. In the event
recoverability is not demonstrated, the Company reassesses the calculation using
justifiable premium rate increases. If rate increases are not received or are
deemed unjustified, the Company will expense, as impaired, the attributable
portion of the deferred asset in the current period. If the Company concludes
that the deferred acquisition costs are impaired, the Company will record
impairment loss and a reduction in the deferred acquisition cost asset. In the
event of an impairment, the Company will also evaluate its historical
assumptions utilized in establishing the policy reserves and deferred
acquisition costs and may update those assumptions to reflect current experience
(referred to as "unlocking"). The primary assumptions include persistency,
claims expectations, interest rates and rate increases.
During 2001, the Company recognized an impairment of its deferred acquisition
costs of approximately $61,800. Effective December 31, 2001, the Company entered
into a reinsurance agreement covering substantially all of its long-term care
policies (see Note 12). The reinsurance agreement requires the Company to pay
annual expense and risk charges to the reinsurer. The reduction in the
anticipated future gross profits resulting from the expenses and risk charges
was the primary factor causing the 2001 impairment of the deferred acquisition
costs.
In performing the impairment analyses, the Company included anticipated premium
rate increases. The Company has determined that it will require premium rate
increases on a majority of its existing products in order to fully recover its
present deferred policy acquisition cost asset from future profits.
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.
The following table lists the range of lives, cost and accumulated depreciation
for various asset classes:
Accumulated
Class Years Cost Depreciation
----- ------- -------- ------------
Automobiles 5 $ 370 $ 229
Equipment and Software 3 - 12 10,877 3,862
Furniture 7 - 12 1,864 1,183
Buildings 10 - 40 6,266 1,320
-------- -------
$ 19,377 $ 6,594
======== =======
Depreciation expense was $1,409, $1,275 and $996 for the years ended December
31, 2001, 2000 and 1999, respectively.
Cash and Cash Equivalents:
Cash and cash equivalents include highly liquid debt instruments purchased with
a maturity of three months or less.
Goodwill:
Goodwill is being amortized to expense on a straight-line basis over a 10- to
40-year range. During 2001, 2000 and 1999, $1,293, $1,293 and $993 were
amortized to expense, respectively.
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 each of the
years ended 2001, 2000 and 1999, $415 was amortized to expense.
At the time of purchase, the acquired ANIC premium in-force was deemed to have a
remaining average life of approximately ten years. Although amortization of
future profits will normally occur in accordance with actuarial assumptions over
the life of the policies, the Company determined to amortize this on a
straight-line basis over ten years and regularly monitors the emerging
profitability of the acquired business. The Company believes that this approach
is not materially different than if an actuarial methodology had been employed.
Impairment of Long-Lived Assets:
Long-lived assets and certain identifiable intangible assets held and used by
the Company are reviewed for impairment whenever events or circumstances
indicate that the carrying amount may not be recoverable. During 1999, the
Company determined to discontinue its planned implementation of a new computer
system. The Company expensed as fully impaired the remaining carrying value of
$2,799 for this asset.
Other Assets:
Other assets consist primarily of due and unpaid insurance premiums and
unamortized debt offering costs.
Corporate Owned Life Insurance:
During 1999, the Company purchased approximately $30,000 of corporate owned life
insurance to fund the future payment of employee benefit expenses. The Company
purchased an additional $10,000 in each of 2001 and 2000. The Company includes
the cash value of these policies, which is invested in investment grade
corporate bonds, as a separate financial statement caption. Increases in the
cash surrender value are recorded as other income.
Income Taxes:
Income taxes consist of amounts currently due plus deferred tax expense or
benefits. Deferred income tax liabilities, net of assets, 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.
Revenue Recognition:
Premiums on long duration 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.
Commission override revenue from unaffiliated insurers is included in other
income when its underlying premium is due, net of an allowance for unissued or
cancelled policies.
Policy Reserves and Policy and Contract Claims:
The Company establishes policy reserve liabilities to reflect the impact of
level renewal premiums and the increasing risks of claims losses as
policyholders age. The Company also establishes claim reserves to reflect the
liability for incurred claims.
A policy reserve liability is determined using the present value of estimated
future policy benefits to be paid to or on behalf of policyholders less the
present value of estimated future premiums to be collected from policyholders.
This liability is accrued as policy reserves and is recognized concurrent with
premium revenue. Those estimates are based on assumptions, including estimates
of expected investment yield, mortality, morbidity, withdrawals and expenses,
applicable at the time insurance contracts are effective. These reserves differ
from policy and contract claims, which are recognized when insured events occur.
Policy and contract claims include amounts comprising: (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; and (3) an estimate of future
administrative expenses, which would be incurred to adjudicate existing claims.
The methods for making such estimates and establishing the resulting liabilities
are periodically reviewed and updated and any resulting adjustments are
reflected in earnings currently.
The establishment of appropriate reserves is an inherently uncertain process and
includes estimates for amounts of benefits and length of benefit period for each
claim, 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.
The Company reviews the adequacy of its deferred acquisition costs on an annual
basis, utilizing assumptions for future expected claims and interest rates. If
the Company determines that the future gross profits of its in-force policies
are not sufficient to recover its deferred acquisition costs, the Company
recognizes a premium deficiency and "unlocks" (or changes) our historical
assumptions to match current expectations. In 2001, the Company recognized a
premium deficiency and unlocked its prior reserve assumptions. These assumptions
include interest rates, premium rates, shock lapses and anti-selection of
policyholder persistence. As a result, reserves for benefits to policyholders
was decreased by approximately $7,600 in 2001, due to anticipated premium rate
increases, which were partially offset by changes in discount rates, lapse
assumptions and future claims assumptions.
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. In 1998, the Company introduced its Secured Risk
policy, a limited benefit plan made available to higher risk applicants. 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.
Reinsurance:
The Company reports all reserve amounts gross of reinsurance. The amounts
receivable from unaffiliated reinsurers are reported as receivable from
reinsurers.
The Company uses deposit accounting for reinsurance agreements that do not meet
the risk transfer criteria in SFAS 113.
Accounts Payable and Other Liabilities:
Accounts payable and other liabilities consist primarily of amounts payable to
agents and vendors and deferred income items. During 2001, the Company reinsured
its disability policies with an unaffiliated insurer, for which it received a
ceding commission of approximately $5,000. This deferred ceding commission will
be recognized as income over the remaining life of the policies. As a result the
Company recognized $319 of income in 2001.
Earnings Per Share:
A reconciliation of the numerator and denominator of the basic earnings per
share computation to the numerator and denominator of the diluted earnings per
share computation follows. Basic earnings per share excludes dilution and is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. Anti-dilutive effects are not included.
For the Periods Ended December 31,
----------------------------------------
2001 2000 1999
---- ---- ----
Net (loss) income $ (48,589) $ 22,750 $ 21,320
Weighted average common shares outstanding 14,248 7,279 7,533
---------------------------------------
Basic earnings per share $ (3.41) $ 3.13 $ 2.83
=======================================
Net (loss) income $ (48,589) $ 22,750 $ 21,320
Adjustments net of tax:
Interest expense on convertible debt - 3,084 3,098
Amortization of debt offering costs - 240 241
---------------------------------------
Diluted net (loss) income $ (48,589) $ 26,074 $ 24,659
---------------------------------------
Weighted average common shares outstanding 14,248 7,279 7,533
Common stock equivalents due to dilutive
effect of stock options - 69 132
Shares converted from convertible debt - 2,628 2,628
---------------------------------------
Total outstanding shares for fully diluted earnings
per share computation 14,248 9,976 10,293
---------------------------------------
Diluted earnings per share $ (3.41) $ 2.61 $ 2.40
=======================================
New Accounting Principles:
Effective January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as "derivatives") and for hedging
activities. SFAS No. 133 requires an entity to recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value.
In accordance with SFAS No. 133, the Company transferred its convertible bond
portfolio from the available for sale category to the trading category. All of
its convertible bonds were sold during 2001.
The Company is party to an interest rate swap agreement, which converts its
mortgage loan from a variable rate to a fixed rate instrument. The Company
determined that the swap qualifies as a cash-flow hedge. The notional amount of
the swap is approximately $1,600. The effects have been determined to be
immaterial to the financial statements.
The Company's involvement with derivative instruments and transactions is
primarily to mitigate its own risk and is not considered speculative in nature.
In June 2001, the Financial Accounting Standards Board ("FASB") issued two
Statements of Financial Accounting Standards ("SFAS"). SFAS No. 141, "Business
Combinations," requires usage of the purchase method for all business
combinations initiated after June 30, 2001, and prohibits the usage of the
pooling of interests method of accounting for business combinations. The
provisions of SFAS No. 141 relating to the application of the purchase method
are generally effective for business combinations completed after June 30, 2001.
Such provisions include guidance on the identification of the acquiring entity,
the recognition of intangible assets other than goodwill acquired in a business
combination and the accounting for negative goodwill. The transition provisions
of SFAS No. 141 require an analysis of goodwill acquired in purchase business
combinations prior to July 1, 2001 to identify and reclassify separately
identifiable intangible assets currently recorded as goodwill.
SFAS No. 142, "Goodwill and Other Intangible Assets," primarily addresses the
accounting for goodwill and intangible assets subsequent to their acquisition.
The Company will adopt SFAS No. 142 on January 1, 2002 and will cease amortizing
goodwill at that time. All goodwill recognized in the Company's consolidated
balance sheet at January 1, 2002 should be assigned to one or more reporting
units. Goodwill in each reporting unit should be tested for impairment by June
30, 2002. An impairment loss recognized as a result of a transitional impairment
test of goodwill should be reported as the cumulative effect of a change in
accounting principle.
Our book value is currently in excess of our market value, which will require an
analysis of the goodwill at the reporting unit level. Management has not yet
completed this analysis to determine the extent of impairment, if any. In 2001,
the Company amortized $1,293 of goodwill.
3. Acquisition of Businesses:
The Company purchased all of the common stock of UIG, a Michigan based
consortium of long-term care insurance agencies, for the amount of $18,192, of
which $8,078 was in the form of a three-year installment note, with the
remainder paid in cash. The acquisition was effective January 1, 1999. The
Company accounted for the acquisition as a purchase, and established $17,000 of
goodwill, which is being amortized over 25 years.
On January 10, 2000, PTNA entered a purchase agreement to acquire all of the
common stock of NISHD, a Florida brokerage insurance agency for cash of $6,000.
The acquisition was effective January 1, 2000. The Company accounted for the
acquisition as a purchase and recorded $6,000 of goodwill, which is being
amortized over 20 years. The proforma effect of consolidating the financial
results of NISHD prior to 2000 is immaterial to the Company's financial
condition or results of operations.
4. Investments and Financial Instruments:
December 31, 2001
---------------------------------------------------------
Amortized Gross Unrealized Gross Unrealized Estimated
Cost Gains Losses Market Value
-------- ---------------- ---------------- ------------
U.S. Treasury securities
and obligations of U.S
Government authorities
and agencies $ 164,712 $ 7,351 $ - $ 172,063
Mortgage backed securities 42,587 744 - 43,331
Obligations of states and
political sub-divisions 572 40 - 612
Debt securities issued by
foreign governments 11,954 135 - 12,089
Corporate securities 243,793 6,720 - 250,513
--------- -------- --------- ---------
$ 463,618 $ 14,990 $ - $ 478,608
========= ======== ========= =========
December 31, 2000
---------------------------------------------------------
Amortized Gross Unrealized Gross Unrealized Estimated
Cost Gains Losses Market Value
--------- ---------------- ---------------- ------------
U.S. Treasury securities
and obligations of U.S
Government authorities
and agencies $ 120,691 $ 5,654 $ (364) $ 125,981
Mortgage backed securities 26,529 343 (152) 26,720
Obligations of states and
political sub-divisions 572 28 - 600
Debt securities issued by
foreign governments 15,817 44 (312) 15,549
Corporate securities 186,268 2,291 (7,921) 180,638
--------- ------- --------- ---------
$ 349,877 $ 8,360 $ (8,749) $ 349,488
========= ======= ========= =========
The amortized cost and estimated market values of debt securities at December
31, 2001 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 $ 7,969 $ 8,054
Due after one year through five years 145,916 149,582
Due after five years through ten years 234,452 244,114
Due after ten years 75,281 76,858
--------- ----------
$ 463,618 $ 478,608
========= ==========
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
-------- -------- --------
2001 $158,182 $ 4,970 $ 7,697
2000 $209,229 $ 8,613 $ 9,114
1999 $108,003 $ 3,133 $ 1,492
Gross proceeds and realized gains and losses on the sales of equity securities
were as follows:
Gross Gross
Realized Realized
Proceeds Gains Losses
-------- -------- --------
2001 $ 20,026 $ 1,055 $ 6,123
2000 $ 30,163 $ 4,241 $ 3,088
1999 $ 25,572 $ 4,848 $ 1,073
At December 31, 2000, the Company reduced its cost basis on a bond, whose issuer
had declared bankruptcy, to its market value, realizing an impairment charge of
approximately $3,200. In 2001, the Company reduced its cost basis of equity
securities by approximately $5,800 as a result of differences deemed other than
temporary. During 2001, we recognized capital losses of $4,367, compared to
capital gains of $652 in 2000. The results in both years were recorded as a
result of realized gains and losses from our normal investment management
operations and impairment losses.
At December 31, 2001, the Company entered a reinsurance agreement for which
substantially all of its investment portfolio was later ceded as the initial
premium for this agreement. As a result of this intended transfer or sale of
assets, the Company determined that all gross unrealized losses on its debt and
equities securities likely would not be recovered and were therefore deemed
other than temporary impairments. The Company recognized a loss of $3,867 from
this determination.
Gross unrealized gains and losses pertaining to equity securities were as
follows:
Gross Gross
Original Unrealized Unrealized Estimated
Cost Gains Losses Market Value
-------- ---------- ---------- ------------
2001 $ 8,760 $ 1,042 $ -- $ 9,802
2000 $17,112 $ 1,758 $(2,374) $16,496
1999 $17,853 $ 2,579 $(1,269) $19,163
Net investment income is applicable to the following investments:
2001 2000 1999
-------- -------- --------
Bonds $ 28,157 $ 25,777 $ 21,460
Equity securities 519 665 482
Cash and short-term investments 3,167 1,751 1,432
-------- -------- --------
Investment income 31,843 28,193 23,374
Investment expense (1,230) (785) (755)
-------- -------- --------
Net investment income $ 30,613 $ 27,408 $ 22,619
======== ======== ========
Pursuant to certain statutory licensing requirements, as of December 31, 2001,
the Company had on deposit bonds aggregating $8,453 (fair value) in insurance
department safekeeping accounts. The Company is not permitted to remove the
bonds from these accounts without approval of the regulatory authority.
5. 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, 2001
and 2000 and the assumptions pertinent thereto are presented below:
Amount of Policy Reserves
as of December 31,
---------------------------
2001 2000
---- ----
Accident and health $ 382,660 $ 348,344
Annuities and other 131 118
Ordinary life, individual 13,255 12,947
Years of Issue Discount Rate Discount Rate
Accident and health 1976 to 1986 6.5% 7.0%
1987 6.5% 7.5%
1988 to 1991 6.5% 8.0%
1992 to 1995 6.5% 6.0%
1996 6.5% 7.0%
1997 to 2000 6.5% 6.8%
2001 6.5% 6.5%
Annuities and other 1977 to 1983 6.5% & 7.0% 6.5% & 7.0%
Ordinary life, individual 1962 to 2001 3.0% to 5.5% 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 1975-80 SOA Mortality Table(Age
Last Birthday).
Financial Pages (F) 15
Activity in policy and contract claims is summarized as follows:
2001 2000 1999
---- ---- ----
Balance at January 1 $ 164,565 $ 137,534 $105,667
less reinsurance recoverable 5,454 3,917 3,335
--------- --------- --------
Net balance at January 1 159,111 133,617 102,332
Incurred related to:
Current year 193,552 135,084 117,086
Prior years 17,477 13,427 9,231
--------- --------- --------
Total incurred 211,029 148,511 126,317
Paid related to:
Current year 73,726 37,864 25,145
Prior years 90,836 85,153 69,887
--------- --------- --------
Total paid 164,562 123,017 95,032
Net balance at December 31 205,578 159,111 133,617
plus reinsurance recoverable 8,888 5,454 3,917
--------- --------- --------
Balance at December 31 $ 214,466 $ 164,565 $137,534
========= ========= ========
In the year in which a claim is first incurred, the Company establishes reserves
that are actuarially determined to be the present value of all future payments
required for that claim. It assumes that its current reserve amount and interest
income earned on invested assets will be sufficient to make all future payments.
The Company evaluates its prior year assumptions by reviewing the development of
reserves for the prior period (i.e. incurred from prior years). This amount
includes imputed interest from prior year-end reserve balances plus adjustments
to reflect actual versus estimated claims experience. These adjustments
(particularly when calculated as a percentage of the prior year-end reserve
balance) provide a relative measure of deviation in actual performance as
compared to its initial assumptions.
In 2001, excluding the effect of imputed interest, the Company added
approximately $8,800 to its claim reserves for 2000 and prior claim incurrals,
and in 2000, it added approximately $6,600 to its claim reserves for 1999 and
prior claim incurrals. The additions to prior year incurrals in 2001 resulted
from a continuance study performed by its consulting actuary. In 2001, the
Company also increased claim reserves by an additional $1,600 as a result of
utilizing a lower interest rate for the purpose of discounting its future
liabilities. The Company also increased its claim reserves approximately $5,600
during 2001 by increasing its loss adjustment expense reserve, which is
established for the funding of administrative costs associated with the payment
of current claims. Over time, it may continue to be necessary for the Company to
increase its reserves.
6. Long-Term Debt:
Long-term debt at December 31, 2001 and 2000 is as follows:
2001 2000
---- ----
Convertible, subordinated debt issued in November 1996, with a semi-annual
coupon of 6.25% annual percentage rate. Debt is callable after December 2, 1999
at declining redemption values and matures in December 2003. Prior to maturity,
the debt is convertible to shares of the Company's common stock at $28.44 per
share. $74,750 $74,750
Mortgage loan with interest rate fixed for five years at 6.85% effective
September 1998, which was repriced from 7.3% in 1997. Although carrying a
variable rate of LIBOR + 90 basis points, the loan has an effective fixed rate
due to an offsetting swap with the same institution. Current monthly payment of
$16 based on a fifteen year amortization schedule with a balloon payment due
September 2003; collateralized by property with depreciated cost of $2,361 and
$2,352 as of December 31, 2001 and 2000, respectively. 1,582 1,664
Installment note for purchase of UIG, due January 2002, payable in annual
installments at 0% interest. (imputed at 6%) 2,858 5,554
------- -------
$79,190 $81,968
======= =======
Principal repayment of mortgage and other debt are due as follows:
2002 $ 2,978
2003 76,212
--------
$ 79,190
========
7. FEDERAL INCOME TAXES:
The (benefit) provision for federal income taxes for the years ended December 31
consisted of:
2001 2000 1999
-------- -------- --------
Current $ (3,503) $ 3,045 $ 1,974
Deferred (12,777) 8,675 8,863
-------- -------- --------
$(16,280) $ 11,720 $ 10,837
======== ======== ========
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:
2001 2000
-------- --------
Net operating loss carryforward $ 22,102 $ 3,080
Excise tax 1,972 -
Policy reserves - 18,841
Unrealized losses on investments - 352
Other than temporary decline
in market value 3,187 1,150
Other - 612
Valuation allowance (5,775) -
-------- --------
Total deferred tax assets $ 21,486 $ 24,035
======== ========
Deferred policy acquisition costs $(36,822) $(67,533)
Present value of future profits acquired (678) (823)
Premiums due and unpaid (767) (1,100)
Unrealized gains on investments (5,451) -
Policy reserves (13,830) -
Other (2,385) -
-------- --------
Total deferred income liabilities $(59,933) $(69,456)
======== ========
Net deferred income tax $(38,447) $(45,421)
======== ========
The Company has net operating loss carryforwards of approximately $16,300, which
have been generated by taxable losses at the parent company, and if unused will
expire between 2018 and 2021. The parent company's net operating loss
carryforwards can be utilized by the Company's insurance subsidiaries subject to
the lesser of subsidiary taxable income or 34% of the current aggregate
carryforward amount. During 2001, the Company established a valuation allowance
of $5,775 against these parent company net operating loss carryforwards. In
addition, the Company has net operating loss carryforwards of approximately
$48,000, which have been generated by taxable losses at the Company's life
subsidiaries, and if unused, will expire on 2016.
A reconciliation of the income tax (benefit) provision computed using the
federal income tax rate to the (benefit) provision for federal income taxes is
as follows:
2001 2000 1999
-------- -------- --------
Computed federal income tax (benefit)
provision at statutory rate $(22,704) $ 12,065 $ 10,933
Valuation allowance 5,775 -- --
Small life insurance company
deduction (363) -- (120)
Tax-exempt income (1,147) (585) (96)
Other 2,159 240 120
-------- -------- --------
$(16,280) $ 11,720 $ 10,837
======== ======== ========
At December 31, 2001, the accumulated earnings of the Company for Federal income
tax purposes included $1,451 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 do not permit
further additions to the "Policyholders' Surplus" account.
8. Statutory Information:
The insurance subsidiaries prepare their statutory financial statements in
accordance with accounting practices prescribed or permitted by the insurance
department of the state of domicile. Net income and capital and surplus as
reported in accordance with statutory accounting principles for the Company's
insurance subsidiaries are as follows:
2001 2000 1999
---- ---- ----
Net loss $(32,222) $(28,984) $ (6,826)
Capital and surplus $ 17,807 $ 29,137 $ 66,872
Total reserves, including policy and contract claims, reported to regulatory
authorities were approximately $584,949 and $212,082 less than those recorded
for GAAP as of December 31, 2001 and 2000, respectively. This difference is
primarily attributable to reinsurance agreements in force as of December 31,
2001 and 2000. For further discussion see Note 12, "Reinsurance".
The differences in statutory net loss compared to GAAP net (loss) income are
primarily due to the immediate expensing of acquisition costs, as well as
differing reserving methodologies and treatment of
reinsurance and deferred income taxes. Due to the differences in expensing of
acquisition costs and reserving methodologies, under statutory accounting there
is generally a net loss and a corresponding decrease in surplus, referred to as
surplus strain, during periods of growth.
Effective December 31, 2001, the Company entered a reinsurance transaction that,
according to Pennsylvania insurance regulation, required the reinsurer to
provide it with letters of credit in order for the Company to receive statutory
reserve and surplus credit from the reinsurance. The letters of credit were
dated subsequent to December 31, 2001, as a result of the final closing of the
agreement. In addition, the initial premium paid for the reinsurance included
investment securities carried at amortized cost on the statutory financial
statements, but valued at market value for purposes of the premium transfer. The
Pennsylvania Insurance Department permitted the Company to receive credit of
$29,000 for the letters of credit, and to accrue the anticipated, yet unknown,
gain of $18,000 from the sale of securities at market value, in its statutory
financial results for December 31, 2001. The impact of this permitted practice
served to increase the statutory surplus of the Company's insurance subsidiaries
by approximately $47,000 at December 31, 2001. Had the Company not been granted
a permitted practice, its statutory surplus would have been negative. Upon
finalization of the reinsurance agreement, transfer of funds and establishment
of appropriate Letters of Credit, in the first quarter of 2002 the permitted
practices are not expected to be required.
The Company's insurance subsidiaries are regulated by various state insurance
departments. In its ongoing effort to improve solvency regulation, the National
Association of Insurance Commissioners ("NAIC") has adopted Risk-Based Capital
("RBC") requirements for insurance companies to evaluate the adequacy of
statutory capital and surplus in relation to investment and insurance risks,
such as asset quality, mortality and morbidity, asset and liability matching,
benefit and loss reserve adequacy and other business factors. The RBC formula is
used by state insurance regulators as an early warning tool to identify, for the
purpose of initiating regulatory action, insurance companies that potentially
are inadequately capitalized. In addition, the formula defines minimum capital
standards, which an insurer must maintain. Regulatory compliance is determined
by a ratio of the enterprise's regulatory Total Adjusted Capital, to its
Authorized Control Level RBC, as defined by the NAIC. Companies below specific
trigger points or ratios are classified within certain levels, each of which may
require specific corrective action depending upon the insurer's state of
domicile.
The Company's subsidiaries are required to hold statutory surplus that is, at a
minimum, above a calculated authorized control level at which the Pennsylvania
Insurance Department (the "Department") may required to place its subsidiary
under regulatory control, leading to rehabilitation or liquidation. Insurers are
obligated to hold additional statutory surplus above the authorized control
level. At December 31, 2000, the Company's primary insurance subsidiary,
representing 94% of our direct premium, had Total Adjusted Capital at the
regulatory action level. As a result, it was required to file a Corrective
Action Plan (the "Plan") with insurance commissioner.
Subsequent to December 31, 2001, the Department approved the Plan. As a primary
component of the Plan, effective December 31, 2001, the Company entered a
reinsurance transaction to reinsure, on a quota share basis, substantially all
of its respective long-term care insurance policies then in-force. The
agreement, which is subject to certain coverage limitations, including an
aggregate limit of liability, which is a function of certain factors and which
may be reduced in the event that rate increases are not obtained. The agreement
meets the requirements to qualify as reinsurance for statutory accounting, but
not for generally accepted accounting principles.
Pennsylvania insurance regulations require that funds ceded for reinsurance
provided by a foreign or "unauthorized" reinsurer must be secured by funds held
in a trust account or by a letter of credit for the protection of policyholders.
The Company received approximately $648,000 in reserve credits from this
transaction as of December 31, 2001, of which the Company held $619,000 and
$29,000 was backed by letters of credit, which increased the Company's statutory
surplus by $29,000 as well. As a result, its subsidiary's RBC ratio at December
31, 2001 was substantially above the required statutory minimum, as well as
above recommended or trigger levels.
The Plan requires the Company's subsidiary to comply with certain other
agreements at the direction of the Department, including, but not limited to:
- new investments are limited to NAIC 1 or 2 rated securities.
- affiliated transactions are limited and require Department approval.
- an agreement to increase statutory reserves the reinsurance agreement has
the capacity to accommodate this increase by an additional $100,000 throughout
2002-2004, such that its policy reserves will be based on new, current claims
assumptions and will not include any rate increases. These claim assumptions are
applied to all policies, regardless of issue year and are assumed to have been
present since the policy was first issued.
States restrict the dividends the Company's insurance subsidiaries are permitted
to pay. Dividend payments will depend on profits arising from the business of
its insurance company subsidiaries, computed according to statutory formulae.
Under the insurance laws of Pennsylvania and New York, insurance companies can
pay dividends only out of surplus. In addition, Pennsylvania law requires each
insurance company to give 30 days advance notice to the Pennsylvania Insurance
Department of any planned extraordinary dividend (any dividend paid within any
twelve-month period which exceeds the greater of (1) 10% of an insurer's surplus
as shown in its most recent annual statement filed with the Insurance Department
or (2) its net gain from operations, after policyholder dividends and federal
income taxes and before realized gains or losses, shown in such statement) and
the Insurance Department may refuse to allow it to pay such extraordinary
dividends. The Company's Corrective Action Plan also requires the approval of
the Pennsylvania Insurance Department of all dividends. Under New York law, the
Company's New York insurance subsidiary must give the New York Insurance
Department 30 days' advance notice of any proposed extraordinary dividend and
cannot pay any dividend if the regulator disapproves the payment during that
30-day period.
In addition, the Company's New York insurance company must obtain the prior
approval of the New York Insurance Department before paying any dividend that,
together with all other dividends paid during the preceding twelve months,
exceeds the lesser of 10% of the insurance company's surplus as of the preceding
December 31 or its adjusted net investment income for the year ended the
preceding December 31. In 2002, the Company received a dividend from our New
York subsidiary of $651,000. The dividend proceeds were used for parent company
liquidity needs.
In 1998, the NAIC adopted the Codification of Statutory Accounting Principles
("Codification") guidance, which replaced the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting as of
January 1, 2001. The Codification provides guidance for areas where statutory
accounting has been silent and changes current statutory accounting in some
areas, including the recognition of deferred income taxes.
The Pennsylvania and New York Insurance Departments have adopted the
Codification guidance, effective January 1, 2001. The Codification guidance
serves to reduce the insurance subsidiaries' surplus, primarily due to certain
limitations on the recognition of goodwill and EDP equipment and the recognition
of other than temporary declines in investments. In 2001, the Company's
statutory surplus was reduced by approximately $2,000 as a result of the
Codification guidance. These reductions are
partially offset by certain other items, including the recognition of deferred
tax assets subject to certain limitations.
9. 401(k) Retirement Plan:
The Company has a 401(k) retirement plan, covering substantially all employees
with at least one year of service. Under the plan, participating employees may
contribute up to 15% of their annual salary on a pre-tax basis. The Company,
under the plan, equally matches employee contributions up to the first 3% of the
employee's salary. The Company and employee portion of the plan is vested
immediately. The Company's expense related to this 401(k) plan was $167, $147
and $129 for the years ended December 31, 2001, 2000 and 1999, 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 2001, 2000 or 1999.
10. Stock Option Plans:
At December 31, 2001, the Company had three stock-based compensation plans,
which are described below. For 2000 and 1999, and for certain options granted in
2001, the Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), and applies APB Opinion No. 25 "Accounting for
Stock Issued to Employees," ("APB Opinion No. 25") and related Interpretations
in accounting for its plans. Accordingly, the Company is not required to
recognize compensation expense when the exercise price is equal to, or greater
than, the fair market value at the date of grant.
The Company's 1987 Employee Incentive Stock Option Plan provided for the
granting of options to purchase up to 1,200 shares of common stock. This plan
expired in 1997 and was subsequently replaced by the 1998 Employee Non-Qualified
Incentive Stock Option Plan ("1998 Plan"). The 1998 Plan allows for the grant of
options to purchase up to 600 shares of common stock. No new options may be
granted under the 1987 Plan. The term of each option granted in 2001 is ten
years.
Effective May 1995, the Company adopted a Participating Agent Stock Option Plan
which provides for the granting of options to purchase up to 300 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 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. SFAS No. 123
requires that the fair value of options granted to non-employees (agents) be
recognized as compensation expense over the estimated life of the option.
Options were granted to agents in 1997, 1996 and 1995. No agent options were
granted in 2001, 2000, 1999 or 1998. The Company recognized $51, $86 and $108 of
compensation expense in 2001, 2000 and 1999, respectively as a result of these
grants.
During 2001, the Company granted 566 replacement options to its employees for
all existing options granted under its existing fixed option plans. As a result,
these options are now subject to the variable accounting provisions of APB
Opinion No. 25 until exercised, forfeited or cancelled. The Company recorded
compensation expense of $434 in 2001 related to these variable options,
representing the intrinsic value of the stock options at the reporting date to
the extent the fair value exceeded the exercise price of the employee options at
the grant date. In addition, 30 options were granted to a new senior executive
in 2001.
Had compensation cost for the Company's employee 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 (loss) income and earnings per share would have
been reduced to the pro forma amounts indicated below.
Compensation cost is estimated using an option-pricing model with the following
assumptions for new options granted to employees in 2001, 2000 and 1999. In
2001, options were valued with an expected life of 5.3 years, volatility of
70.9% and a risk free rate of 4.9%. The weighted average fair value of options
granted in 2001 was $1.71. In 2000, options were valued with an expected life of
5.3 years, volatility of 28.3% and a risk free rate of 4.8%. The weighted
average fair value of options granted in 2000 was $6.80. No options were granted
in 1999. The Company's net income and earnings per share results would have been
reduced to the pro forma amounts indicated below for the years ended December
31, 2001, 2000 and 1999, respectively.
2001 2000 1999
---- ---- ----
Net Income As reported $ (48,589) $ 22,750 $ 21,320
Pro forma $ (49,133) $ 22,325 $ 21,030
Basic Earnings Per Share As reported $ (3.41) $ 3.13 $ 2.83
Pro forma $ (3.41) $ 3.07 $ 2.79
Diluted Earnings Per Share As reported $ (3.41) $ 2.61 $ 2.40
Pro forma $ (3.41) $ 2.57 $ 2.37
Financial Pages (F) 21
The following is a summary of the Company's option activity, including grants,
exercises, forfeitures and weighted average price information:
2001 2000 1999
-------------------------- -------------------------- ------------------------
Exercise Exercise Exercise
Price Price Price
Options Per Option Options Per Option Options Per Option
--------- ----------- ---------- ------------- ---------- -----------
Outstanding at beginning of year 685 $ 19.59 552 $ 19.64 554 $ 19.62
Granted 596 $ 6.96 155 $ 19.25 0 $ -
Exercised 1 $ 12.45 11 $ 12.56 2 $ 13.38
Forfeitures 632 $ 18.79 11 $ 24.44 0 $ -
--------- ------- ----- ------- ------ -------
Outstanding at end of year 648 $ 8.48 685 $ 19.59 552 $ 19.64
========= ======= ===== ======= ====== =======
Exercisable at end of year 88 $ 17.99 457 $ 18.15 404 $ 16.20
========= ======= ===== ======= ====== =======
Outstanding Remaining Exercisable
at December Contractual at December
Range of Exercise Prices 31, 2001 Life (Yrs) 31, 2001
------------------------ -------------------------------------------------------
3.40 -- 4.72 206 10 13
5.19 -- 7.82 258 10 18
8.60 -- 12.38 103 10 4
12.63 -- 32.25 81 7 53
------------------------------------------------------
648 10 88
======================================================
11. Commitments and Contingencies:
Operating Lease Commitments:
The total net rental expenses under all leases amounted to approximately $561,
$688 and $629 for the years ended December 31, 2001, 2000 and 1999,
respectively.
The Company's required payments due under non-cancelable leases in each of the
next five years are as follows:
Years Amounts
----- -------
2002 $ 433
2003 344
2004 252
2005 18
2006 18
-------
$ 1,065
Amounts after 2006 are immaterial.
During May 1987, the Company assigned its rights and interests in a land lease
to a third party for $175. 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 per year, the amount being adjustable based upon changes in the
consumer price index since 1987, through the year 2063.
Letters of Credit:
At December 31, 2001, the Company received letters of credit of $29,000 to
receive statutory reserve credit and statutory surplus credit for its new quota
share reinsurance agreement. As part of the Company's financial reinsurance
agreements in effect at December 31, 2000 and 1999, it received an unsecured
letter of credit from a bank for $5,000 and $20,000, respectively, which served
to allow the Company to receive statutory reserve credit for its financial
reinsurance with state insurance departments at each of those dates.
Litigation:
The Company's subsidiaries are parties to various lawsuits generally arising in
the normal course of their business. The Company does not believe that the
eventual outcome of any of the suits to which it is party will have a material
adverse effect on its financial condition or results of operations. However, the
outcome of any single event could have a material impact upon the quarterly or
annual financial results of the period in which it occurs.
The Company and certain of its key executive officers are defendants in
consolidated actions that were instituted on April 17, 2001 in the United States
District Court for the Eastern District of Pennsylvania by shareholders of the
Company, on their own behalf and on behalf of a putative class of similarly
situated shareholders who purchased shares of the Company's common stock between
July 23, 2000 through and including March 29, 2001. The consolidated amended
class action complaint seeks damages in an unspecified amount for losses
allegedly incurred as a result of misstatements and omissions allegedly
contained in the Company's periodic reports filed with the SEC, certain press
releases issued by the Company, and in other statements made by its officials.
The alleged misstatements and omissions relate, among other matters, to the
statutory capital and surplus position of the Company's largest subsidiary,
PTNA. On December 7, 2001, the defendants filed a motion to dismiss the
complaint, which is currently pending. The Company believes that the complaint
is without merit, and it and its executives will continue to vigorously defend
the matter.
12. REINSURANCE:
The Company currently reinsures with unaffiliated companies any life insurance
policy to the extent the risk on that policy exceeds $50.
Effective January 1994, PTNA entered into a reinsurance agreement 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, 2001, 2000 and 1999 were approximately $388, $409 and $456
respectively.
PTNA is party to a reinsurance agreement to cede 100% of certain whole life and
deferred annuity policies issued by PTNA to a third party insurer. These
policies are intended for the funeral arrangement or "pre-need" market. Total
reinsurance recoverables taken related to this agreement as of December 31, 2001
and 2000 were approximately $4,362 and $4,643, respectively. The third party
reinsurer is required to maintain 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 a party to a reinsurance agreement to cede certain home health care
claims beyond 36 months. Reinsurance recoverables related to this treaty were
$7,726 and $6,054 at December 31, 2001 and 2000, respectively.
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, 2001
and 2000 reinsurance recoverables taken related to this treaty were
approximately $2,639 and $2,142, respectively.
Effective December 31, 2000 and 1999, PTNA entered separate funds withheld
financial reinsurance agreements with unaffiliated reinsurers. Under the
agreements, PTNA ceded the claims risk of a material portion of its long-term
care policies. The agreements did not qualify for reinsurance treatment in
accordance with SFAS 113 because, based on the Company's analysis, the
agreements did not result in the reasonable possibility that the reinsurer could
realize a significant loss in the event of adverse development. As a result, the
Company is using deposit accounting for these agreements and results of
operations reflect only the non-refundable annual fee owed to the reinsurer.
Since the contracts were executed as funds withheld, there was no reinsurance
recoverable or payable on a GAAP basis on the balance sheet. The agreements met
the requirements to qualify for reinsurance treatment under statutory accounting
rules. As a result of these agreements, 2000 statutory surplus was increased by
$19,841. During 2001, both agreements were commuted, resulting in a reduction of
statutory surplus of approximately $20,000.
Effective December 31, 2001, the Company entered a reinsurance transaction to
reinsure, on a quota share basis, substantially all of its long-term care
insurance policies then in force. The initial premium of the treaty resulted in
the transfer of approximately $563,000 in cash and marketable securities
subsequent to December 31, 2001, and $56,000 as funds held due to the reinsurer.
The initial premium and future cash flows of the reinsured policies, less claims
payments, ceding commissions and risk charges, will be credited to a notional
experience account, which is held for the Company's benefit in the event of
commutation and recapture following December 31, 2007. The Company will also
receive an investment credit on the experience account balance, which is based
upon the total return from a series of benchmark indices and hedges that are
intended to match the duration of the reserve liability.
This agreement does not qualify for reinsurance treatment in accordance with
SFAS 113 because, based on the Company's analysis, the agreement does not result
in the reasonable possibility that the reinsurer may realize a significant loss.
As a result, the Company is using deposit accounting for this agreement. The
agreement contains a number of provision that reduce the risk to the reinsurer
including the experience refund provisions, expense and risk charges due to the
reinsurer and the aggregate limit of liability. This agreement meets the
requirements to qualify for reinsurance treatment under statutory accounting
rules.
The agreement contains commutation provisions and allows the Company to
recapture the reserve liabilities and the current experience account balance as
of December 31, 2007, or on December 31 of any year thereafter. The Company
intends to commute the treaty on December 31, 2007; therefore, it is accounting
for the agreements in anticipation of this commutation. In the event the Company
does not commute the agreements on December 31, 2007, it will be subject to
escalating expenses. Additionally, the reinsurance provisions contain covenants
and conditions that, if breached, may result in the immediate commutation of the
agreement and the payment of $2.5 million per quarter from the period of the
breach through December 31, 2007. These covenants include, but are not limited
to, material breach and insolvency.
As part of the agreement, the reinsurer was granted four tranches of warrants to
purchase non-voting shares of convertible preferred stock. The first three
tranches of convertible preferred stock are exercisable through December 31,
2007 at common stock equivalent prices ranging from $4.00 to $12.00 per share if
converted. If exercised for cash, at the reinsurer's option, the warrants could
yield additional capital and liquidity of approximately $20,000 and would
represent ownership of approximately 15% of the outstanding shares of our common
stock. If the agreement is not commuted following December 31, 2007, the
reinsurer may exercise the fourth tranche of warrants for common stock
equivalent prices of $2.00 per share if converted, potentially generating
additional capital of $12,000, representing an additional 20% of the then
outstanding common stock. The reinsurer is under no obligation to exercise any
of the warrants.
The warrants are part of the consideration and will be recognized as premium
over the anticipated life of the contract. The warrants are valued using a
Black-Scholes model with the following assumptions: 6.0 years expected life,
volatility of 70.9% and a risk free rate of 4.74%. The $15,855 value of the
warrants is recorded as a deferred premium and will be amortized to expense over
the anticipated six years of the agreement.
In 2001, ANIC ceded substantially all of its disability policies to an
unaffiliated insurer on a quota share basis. The insurer may assume ownership of
the policies as a sale upon various state and policyholder approvals. At
December 31, 2001, reinsurance recoverables related to this treaty were $10,338.
The Company remains liable in the event that the reinsuring companies are unable
to meet their obligations.
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 income and
comprehensive income, which are net of reinsurance activity:
Ceded to Assumed
Gross Other from Other Net
Amount Companies Companies Amount
-------------- -------------- -------------- --------------
December 31, 2001
Ordinary life insurance
In-force $ 52,322 $ 10,543 $ 0 $ 41,779
Premiums:
Accident and health 355,574 13,760 5,749 347,563
Life 3,586 759 1 2,828
Benefits to policyholders:
Accident and health 211,849 3,935 1,153 209,067
Life 2,356 394 0 1,962
Inc in policy reserves:
Accident and health 32,019 7,244 2,656 27,431
Life 1,515 820 0 695
Commissions $ 76,095 $ 1,178 $ 1,888 $ 76,805
December 31, 2000
Ordinary life insurance
In-force $ 58,907 $ 12,675 $ 0 $ 46,232
Premiums:
Accident and health 352,534 3,010 4,512 354,036
Life 3,304 228 1 3,077
Benefits to policyholders:
Accident and health 164,728 2,346 713 163,095
Life 2,469 441 0 2,028
Inc (dec) in policy reserves:
Accident and health 76,514 77 1,053 77,490
Life 931 (27) 0 958
Commissions $ 100,681 $ 255 $ 1,887 $ 102,313
December 31, 1999
Ordinary life insurance
In-force $ 61,522 $ 14,009 $ 0 $ 47,513
Premiums:
Accident and health 289,396 2,935 2,738 289,199
Life 3,664 348 1 3,317
Benefits to policyholders:
Accident and health 133,188 2,265 161 131,084
Life 2,117 14 0 2,103
Inc (dec) in policy reserves:
Accident and health 65,725 360 (14) 65,351
Life 2,733 943 0 1,790
Commissions $ 95,376 $ 621 $ 1,997 $ 96,752
13. Transactions with Related Parties:
Irv Levit Insurance Management Corporation, an insurance agency which is owned
by our Chairman, Chief Executive Officer and President, produced approximately
$10, $43 and $34 of renewal premiums for some of our subsidiaries for the years
ended December 31, 2001, 2000 and 1999, respectively, for which it received
commissions of approximately $2, $10 and $8, respectively. Irv Levit Insurance
Management Corporation also received commission overrides on business written
for some of our subsidiaries by certain agents, principally general agents who
were its agents prior to January 1979 and any of their sub-agents hired prior
and subsequent to January 1979. These commission overrides totaled approximately
$544, $551 and $543 for the years ended December 31, 2001, 2000 and 1999,
respectively.
As of December 31, 2001, Palisade Capital Management owned approximately less
than 1% of our common stock. Palisade Capital Management also manages a portion
of our investment portfolio for which it received fees of $224, $231 and $170
for the years ended December 31, 2001, 2000 and 1999, respectively.
A member of the Company's board of directors is a principal in Davidson Capital
Management, which provides investment management services to the Company. The
Company paid this firm $462, $300 and $242 during the years ended December 31,
2001, 2000 and 1999, respectively.
A member of the Company's board of directors and the chairman of its audit
committee is a senior executive with Advest, Inc., an investment banking firm,
which has provided investment banking services in the past and that the Company
has engaged to explore financial alternatives. This firm received $475 in fees
during 2001. No fees were paid to this firm in 2000 or 1999.
A member of the Company's board of directors is a principal in U.S. Care, Inc.,
a marketing organization to which the Company paid $159 and $23 in 2001 and
2000, respectively. The Company also made a loan of $100, with interest applied
at 9%, to U.S. Care, Inc. in 2001, which is guaranteed by renewal commissions
payable to the Company in future periods.
14. Major Agency:
A managing general agent accounted for approximately 16% of total premiums in
1999. In 2000, the Company purchased a division of this managing agent, which
served to reduce the Company's dependence upon this agency. In 2001 and 2000,
the total premiums from this managing general agent accounted for less than 10%
of the Company's total premiums.
15. Concentrations of Credit Risk:
Financial instruments that 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, 2001, and at other
times during the year, amounts in any one institution exceeded the Federal
Deposit Insurance Corporation limits. The Company is also party to certain
reinsurance transactions whereby the Company remains ultimately liable for
claims exposure under ceded policies in the event the assuming reinsurer is
unable to meet its commitments due to default or insolvency.
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.
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, 2001 December 31, 2000
------------------------------- -------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------------- -------------- -------------- --------------
Financial assets:
Investments
Bonds, available for sale $ 478,608 $ 478,608 $ 349,488 $ 349,488
Equity securities 9,802 9,802 16,496 16,496
Policy loans 181 181 142 142
Cash and cash equivalents 114,600 114,600 116,596 116,596
Financial liabilities:
Convertible debt $ 74,750 $ 52,325 $ 74,750 $ 60,828
Mortgage and other debt 4,440 4,440 7,218 7,218
17. Subsequent Event:
In March 2002, the Company completed an equity placement of 510 shares of
unregistered common stock for net proceeds of approximately $2,400. The equity
placement was with several current and new institutional investors, with shares
offered at $4.65. The offering price was a 10 percent discount to the 30-day
average price prior to the issuance. The Company intends to file a registration
statement with the Securities and Exchange Commission on or before June 5, 2002.
The proceeds of the equity placement provided additional liquidity to the parent
company to meet its debt service obligations. The proceeds, together with
currently available cash sources, are not sufficient to meet the December 2003
final interest requirement of the debt or to retire the debt upon maturity.
18. Condensed Financial Statements:
The following lists the condensed financial information for the parent company
as of December 31, 2001 and 2000 and for the years ended December 31, 2001, 2000
and 1999.
Financial Pages (F) 27
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
(PARENT COMPANY)
Balance Sheets
as of December 31, 2001 and 2000
(amounts in thousands)
2001 2000
-------------- --------------
ASSETS
Bonds, available for sale at market (amortized cost $0) $ -- $ --
Equity securities at market (cost $0) -- --
Cash and cash equivalents 3,126 1,163
Investment in subsidiaries* 273,370 272,453
Other assets 1,245 1,412
-------------- --------------
Total assets $ 277,741 $ 275,028
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Long-term debt $ 77,608 $ 80,304
Accrued interest payable 651 768
Accounts payable 58 88
Due to subsidiaries* 6,628 5,806
-------------- --------------
Total liabilities 84,945 86,966
-------------- --------------
Shareholders' equity
Preferred stock, par value $1.00; 5,000 shares
authorized, none outstanding -- --
Common stock, par value $.10; 25,000 shares
authorized, 19,750 and 8,202 shares
issued, respectively 1,975 820
Additional paid-in capital 94,802 53,879
Accumulated other comprehensive income (loss) 10,583 (662)
Retained earnings 92,141 140,730
-------------- --------------
199,501 194,767
Less 915 of common shares held in treasury, at cost (6,705) (6,705)
-------------- --------------
Total shareholders' equity 192,796 188,062
-------------- --------------
Total liabilities and shareholders' equity $ 277,741 $ 275,028
============== ==============
* 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
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
(PARENT COMPANY)
Statements of Operations
for the Years Ended December 31, 2001, 2000 and 1999
(amounts in thousands)
2001 2000 1999
--------- --------- ---------
Investment and other income $ 209 $ 771 $ 300
General and administrative expense 1,165 1,159 1,379
Loss due to impairment of property
and equipment -- -- 2,799
Interest expense 4,888 4,717 4,672
--------- --------- ---------
Loss before equity in undistributed net
earnings of subsidiaries* (5,844) (5,105) (8,550)
Equity in undistributed net (losses)
earnings of subsidiaries* (42,745) 27,855 29,870
--------- --------- ---------
Net (loss) income (48,589) 22,750 21,320
Retained earnings, beginning of year 140,730 117,980 96,660
--------- --------- ---------
Retained earnings, end of year $ 92,141 $ 140,730 $ 117,980
========= ========= =========
* 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
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES
(PARENT COMPANY)
Statements of Cash Flows
for the Years Ended December 31, 2001, 2000 and 1999
(amounts in thousands)
2001 2000 1999
------------ ------------ ------------
Cash flows from operating activities:
Net (loss) income $ (48,589) $ 22,750 $ 21,320
Adjustments to reconcile net (loss) income
to cash used in operations:
Equity in undistributed earnings of subsidiaries 42,745 (27,855) (29,870)
Depreciation and amortization 437 491 397
Net realized losses -- 130 48
Loss due to impairment of property and equipment -- -- 2,799
Increase (decrease) due to change in:
Due to/from subsidiaries 822 575 2,672
Other, net (469) 99 (515)
------------ ------------ ------------
Net cash used in operations (5,054) (3,810) (3,149)
------------ ------------ ------------
Cash flows from investing activities:
Cash purchase of subsidiary -- -- (10,113)
Sales and maturities of investments -- 5,494 4,063
Purchase of investments -- (874) (3,406)
Acquisition of property and equipment (25) (50) (1,614)
------------ ------------ ------------
Net cash (used in) provided by investing activities (25) 4,570 (11,070)
------------ ------------ ------------
Cash flows from financing activities:
Contribution to subsidiary (18,000) -- (1,000)
Dividend from subsidiary 2,000 -- 1,039
Proceeds from exercise of stock options 12 139 31
Proceeds from note payable to subsidiary -- -- 750
Repayment of mortgages and other borrowings (2,696) (818) (794)
Proceeds from rights offering 25,726 -- --
------------ ------------ ------------
Net cash provided by (used in) financing activities 7,042 (679) 26
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents 1,963 81 (14,193)
Cash and cash equivalents balances:
Beginning of year 1,163 1,082 15,275
------------ ------------ ------------
End of year $ 3,126 $ 1,163 $ 1,082
============ ============ ============
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 4,843 $ 4,863 $ 4,887
============ ============ ============
Acquisition of subsidiary with note payable $ -- $ -- $ 7,167
============ ============ ============
The condensed financial information should be read in
conjunction with the Penn Treaty American Corporation and
Subsidiaries consolidated statements and notes thereto
(2) 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 1987 Employee Incentive Stock Option Plan
(incorporated by reference to Exhibit 99.1 to Registrant's Registration
Statement on Form S-8, No. 333-89927, filed on October 29, 1999.
10.2 Penn Treaty American Corporation 1995 Participating Agent Stock Option
Plan. (incorporated by reference to Exhibit 10.2 to Registrant's Annual Report
on Form 10-K for the year ended December 31, 1997.
10.3 Penn Treaty American Corporation Employees' Pension Plan. *
10.4 Penn Treaty American Corporation 1998 Employee Incentive Stock Option Plan
(incorporated by reference to Exhibit 99.1 to Registrant's Registration
Statement on Form S-8, No. 333-89927, filed on October 29, 1999.
10.5 Form of General Agent's Contract of Network America Life Insurance Company.
****
10.6 Form of Managing General Agency Agreement. ****
10.7 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. ***
10.8 Commission Supplement to General Agent's Contract dated December 7, 1993
between Network America Life Insurance Company and Network Insurance. ****
10.9 Mortgage in the amount of $2,450,000 dated September 13, 1988 between Penn
Treaty Life Insurance Company and Merchants Bank, N.A. **
10.10 AMENDMENTS TO MORTGAGE DATED SEPTEMBER 24, 1991,
OCTOBER 13, 1992 AND SEPTEMBER 2, 1993. ****
10.11 Loan and Security Agreement by and between Penn Treaty American
Corporation and CoreStates Bank, N.A. dated December 28, 1994.****
-original-page 50-
10.12 Form of Investment Counseling Agreement dated May 3, 1995 between Penn
Treaty American Corporation and James M. Davidson & Company. ****
10.13 Form of Assumption and Reinsurance Agreement dated December 22, 1997,
between Penn Treaty Life Insurance Company and Network America Life Insurance
Company. ***
10.14 Quota Share Reinsurance Agreement between Penn Treaty Network America and
London Life International.
10.15 Form of Change of Control Agreements with Executives. ***
10.16 Penn Treaty American Corporation 1998 Incentive Stock Option Plan. ***
10.17 Employment Contract with Executive Vice President. ***
10.48 Change of Control Employment Agreement. ******
10.49 Change of Control Employment Agreement. ******
10.50 Employment Agreement. ******
10.60 Reinsurance and Warrant Agreements by Centre Solutions (Bermuda)
Limited, filed on Form 8-K.++
11. Earnings Per Share. See Notes to Consolidated Financial
Statements, "Note 1."
21. Subsidiaries of the Registrant. ****
23. Consent of PricewaterhouseCoopers, LLP
(b) Reports on Form 8-K:
We filed no reports on Form 8-K during the quarter ended December 31, 2001.
* Incorporated by reference to the Registrant's Registration Statement on Form
S-1 dated May 12, 1987, as amended.
** Incorporated by reference to the Registrant's Registration Statement on Form
S-1 dated November 17, 1989, as amended.
*** Incorporated by reference to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1998.
**** Incorporated by reference to the Registrant's Registration Statement on
Form S-1 dated June 30, 1995, as amended.
***** Incorporated by reference to the Registrant's Registration Statement on
Form S-3 dated February 19, 1999.
++ Incorporated by reference to the Registrant's Statement on Form 8-K dated
February 21, 2002.
Executive Compensation Plans - see Exhibits 10.1, 10.2, 10.11 and 10.17,
10.48, 10.49, and 10.50.
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: December 24, 2002 By: /s/ Irving Levit
-------------------------------------
Irving Levit, Chairman of the Board,
Chief Executive Officer and President
(principal executive officer)
Date: December 24, 2002 By: /s/ Cameron B. Waite
-------------------------------------
Cameron B. Waite, Chief Financial Officer
(principal financial officer)
Date: December 24, 2002 By: /s/ Michael F. Grill
-------------------------------------
Michael F. Grill, Treasurer
(principal accounting officer)
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: December 24, 2002 By: /s/ Irving Levit
-------------------------------------
Irving Levit, Chairman of the Board,
Chief Executive Officer and President
Date: December 24, 2002 By: /s/ A.J. Carden
-------------------------------------
A.J. Carden, Executive Vice President and
Director
Date: December 24, 2002 By: /s/ Michael F. Grill
-------------------------------------
Michael F. Grill, Treasurer and Director
Date: December 24, 2002 By: /s/ Domenic P. Stangherlin
-------------------------------------
Domenic P. Stangherlin, Director
Date: December 24, 2002 By: /s/ Jack D. Baum
-------------------------------------
Jack D. Baum, Vice President, and Director
Date: December 24, 2002 By: /s/ Francis R. Grebe
-------------------------------------
Francis R. Grebe, Director
Date: December 24, 2002 By: /s/ Alexander M. Clark
-------------------------------------
Alexander M. Clark, Director
Date: December 24, 2002 By: /s/ Matthew Kaplan
-------------------------------------
Matthew Kaplan, Director
Date: December 24, 2002 By: /s/ James Heyer
-------------------------------------
James Heyer, Director
-original-page 52-
Date: December 24, 2002 By: /s/ Cameron B. Waite
-------------------------------------
Cameron B. Waite, Chief Financial
Officer (principal financial officer)
Date: December 24, 2002 By: /s/ Michael F. Grill
-------------------------------------
Michael F. Grill, Treasurer
(principal accounting officer)
-original-page 53-
I, Irving Levit, certify that:
1. I have reviewed this annual report on Form 10-K/A of Penn Treaty American
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
Date: December 24, 2002 /s/ Irving Levit
----------------- -------------------------------
Irving Levit
Chairman of the Board and
Chief Executive Officer
I, William W. Hunt, certify that:
1. I have reviewed this annual report on Form 10-K/A of Penn Treaty American
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
Date: December 24, 2002 /s/ William W. Hunt
----------------- ----------------------------
William W. Hunt
President and
Chief Operating Officer
I, Cameron B. Waite, certify that:
1. I have reviewed this annual report on Form 10-K/A of Penn Treaty American
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
Date: December 24, 2002 /s/ Cameron B. Waite
----------------- --------------------------------
Cameron B. Waite
Executive Vice President and
Chief Financial Officer