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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1995
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File No. 0-15972
PENN TREATY AMERICAN CORPORATION
--------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-1664166
- ------------ ----------
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
3440 Lehigh Street
Allentown, Pennsylvania 18103
- ----------------------- -----
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code (610) 965-2222
--------------
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- ---------------------
None Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value
----------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days. YES X NO
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 22, 1996 was $90,562,924.
The number of shares outstanding of the registrant's common stock as
of March 22, 1996 was 6,990,084.
Documents Incorporated By Reference:
(1) Proxy Statement for the 1996 Annual Meeting of Shareholders -
Part III
PART I
------
Item 1. Business
- ------ --------
(a) General
-------
Penn Treaty American Corporation is primarily engaged in providing
long-term nursing home and home health care insurance to persons age 65 and
over. An originator of long-term nursing home care insurance products for
twenty years, Penn Treaty is the second largest insurance carrier whose
operations are primarily focused on long-term care insurance. Its policies are
marketed nationally through independent insurance agents. The Company
underwrites its insurance products through two of its subsidiaries, Penn Treaty
Life Insurance Company,("PTLIC") and Network America Life Insurance Company
("Network America"). As of December 31, 1995, long-term nursing home care and
home health care policies accounted for approximately 93% of the Company's total
annualized premiums in force.
The Company's principal products are individual fixed, defined benefit
accident and health insurance policies covering long-term skilled, intermediate
and custodial nursing home care, home health care, hospital care and policies
that supplement Medicare benefits. In 1993, the Company introduced life
insurance products designed specifically for individuals age 65 and over. In
later 1994, the Company introduced an Independent Living policy which provides
coverage over the full term of the policy for services furnished by a homemaker
or companion who is not a qualified or licensed care provider. Available policy
riders allow insureds to tailor their policies and include an automatic annual
benefit increase, benefits for adult day-care centers and a return of premium
benefit. Policies are designed to make the administration of claims simple,
quick and sensitive to the needs of senior citizens.
Long-Term Care Industry
Long-term care insurance policies were first introduced in the 1970's.
Significant sales of these policies commenced in the mid 1980's. Typical early
policies provided limited nursing home coverage for a limited benefit period and
were subject to certain restrictions such as prior hospitalization and a
certificate of medical necessity. As awareness of the long-term care needs of
senior citizens has grown, the long-term care insurance industry has responded
with more diverse insurance offerings to provide needed benefits in a cost-
effective fashion. Requirements for prior hospitalization and medical necessity
are no longer standard and benefit periods have been extended up to the life of
the insured. Coverages for custodial care and home health care are now offered
by many insurers.
3
A survey conducted by a national industry organization estimated that the
number of long-term care policies in force grew from 815,000 in 1987 to
approximately 3,420,000 by the end of 1993. While the number of policies sold
has grown an average of more than 27% annually since 1987, this same survey
indicated that only 6% of the population age 65 and over is covered by long-term
care insurance.
The emphasis on long-term care insurance has evolved primarily as a result
of the aging of society, increasing life expectancies and the escalating cost of
care. According to a 1992 survey of the U.S. Bureau of the Census, by the year
2050 the population age 65 and over is expected to grow to approximately 98
million, or more than three times the 1990 figure, while the population age 85
and over is expected to grow to 26 million, or more than eight times the 1990
figure. Another study has suggested that at age 65 a person has a 43% chance of
being confined to a nursing home during some time in his or her life. The cost
of care has also increased significantly. It has been estimated by the U.S.
Census Bureau that from 1980 to 1990, the cost of care for Medicaid nursing home
residents increased from $8.7 billion to $21.5 billion.
Other factors causing growth of the long-term care insurance industry
include the lack of suitable alternatives for financing long-term care. There
are four primary alternatives to long-term care insurance: government programs
such as Medicare and Medicaid, personal assets, dependence on family members and
life insurance. Medicare offers only limited coverage of the cost of long-term
care. Medicaid is the single largest source of financing for nursing home care
in the U.S. However, since eligibility for Medicaid requires that its
recipients have a very small amount of assets or income, many individuals are
forced to deplete their assets in order to become eligible.
Among the options available to individuals depending upon their personal
assets to finance the cost of long-term care are annuities, home equity
conversions ("HECs") and life insurance policies. Annuities generally are a
marginal alternative because it is difficult to predict when annuity funds will
be needed, HECs have not been used extensively to date and many elderly people
may not have adequate life insurance coverage to generate significant cash
values to finance the costs of long-term care.
Strategy
The Company's objective is to strengthen its position as a leader in
providing long-term care insurance to persons age 65 and over. To meet this
objective and to continue to increase profitability, the Company is implementing
the following strategies:
4
Expanding its market share in states in which it currently operates: The
Company is presently licensed in 44 states and the District of Columbia and
currently writes policies in 38 states and the District of Columbia. The
Company's business is generated primarily in Florida, Pennsylvania, Virginia,
California, Illinois, Ohio, Arizona and Missouri. The Company holds restricted
licenses in Connecticut, Minnesota, New Hampshire and North Carolina and is not
currently licensed in Kansas, Maine, Massachusetts, New Jersey, New York and
West Virginia. The Company intends to expand its business operations in states
in which it is currently licensed through increased marketing efforts, continued
agent recruitment and the introduction of new products, including some types of
group insurance. See "Business - Marketing and Expansion."
Entering states in which it is not currently licensed, either through
acquisition or application: The Company regularly evaluates potential
acquisition opportunities and often makes inquiries to determine whether
potential acquisition candidates might be interested in being acquired by the
Company. The Company periodically enters into negotiations with respect to such
potential acquisition opportunities. On March 15, 1996, the Company signed an
agreement with Health Insurance of Vermont, Inc. ("HIVT") providing that the
Company will acquire HIVT by means of a statutory merger with a subsidiary of
the Company. Completion of the merger is subject to approval of regulatory
authorities, and to certain other conditions. HIVT is licensed to conduct
business in 46 states, including New Jersey, West Virginia, Kansas, Maine and
Massachusetts. Upon completion of the merger the Company would be licensed in
all states with the exception of New York. The Company currently has a license
application pending in New York.
Developing and qualifying new products with state insurance regulatory
authorities: The Company has been an originator in the field of long-term care
insurance for twenty years. The Company recently introduced an Independent
Living policy which provides coverage over the full term of the policy for
services furnished by a homemaker or companion who is not a qualified or
licensed care provider. The Company has received approval of this product in all
states in which the Company is currently writing policies, with the exception of
Arkansas, California, Delaware, Indiana, Rhode Island and South Carolina. The
Company intends to continue to develop new insurance products designed to meet
the needs of senior citizens and their families.
Expanding its network of independent agents: The Company has significantly
increased the number of producing agents (agents who produce premiums for the
Company on new policies) selling its policies by focusing its efforts on certain
geographic areas of the country which have larger concentrations of individuals
65 and over. The Company intends to continue to recruit agents in these states
and believes that it will be able to continue to expand its business in these
and other states.
5
Seeking to acquire blocks of in-force policies underwritten by other insurance
companies: The Company has augmented its premium revenue from time to time
through the acquisition of existing blocks of policies underwritten by other
insurance companies. The Company intends to continue to evaluate such blocks as
a means of enhancing its revenue base, provided such policies meet the Company's
underwriting standards.
Corporate Background
The Company, which is registered and approved as a holding company under
the Pennsylvania Insurance Code, was incorporated in Pennsylvania on May 13,
1965 under the name Greater Keystone Investors,Inc., and changed its name to
Penn Treaty American Corporation on March 25, 1987. PTLIC was incorporated in
Pennsylvania under the name Family Security Life Insurance Company on June 6,
1962, and its name was changed to Quaker State Life Insurance Company on
December 29, 1969, at which time it was operating under a limited insurance
company charter. Quaker State Life Insurance Company was acquired by the Company
on May 4, 1976, and its name was changed to Penn Treaty Life Insurance Company.
On July 13, 1989, PTLIC acquired all of the outstanding capital stock of AMICARE
Insurance Company (formerly Fidelity Interstate Life Insurance Company), a stock
insurance company organized and existing under the laws of Pennsylvania which
changed its name to Network America Life Insurance Company on August 1, 1989.
The Agency was incorporated in Pennsylvania on February 23, 1988 under the name
Penn Treaty Service Company. On February 29, 1988, the Agency acquired, among
other assets, the rights to renewal commissions on a certain block of PTLIC's
existing in-force policies from Cher-Britt Agency,Inc., and an option to
purchase the rights to renewal commissions on a certain block of PTLIC's
existing policies from Cher-Britt Insurance Agency,Inc., an affiliated company
of Cher-Britt Agency,Inc. In connection with this acquisition, on March 3, 1988,
the name of the Agency was changed to Cher-Britt Service Company. The option was
exercised on March 3, 1989. The Agency's name was changed to "Senior Financial
Consultants Company" on August 9, 1993.
(b) Insurance Products
------------------
Since 1976, the Company has developed, marketed and underwritten fixed,
defined benefit accident and health insurance policies designed to be responsive
to changes in (i)the characteristics and needs of the senior citizen market,
(ii)governmental regulations and governmental benefits available for this
population segment and (iii)the health care and long-term care industries in
general. The Company solicits input from both its independent agents and its
policyholders with respect to the changing needs of its insureds. In addition,
Company representatives regularly attend seminars to monitor significant trends
in the industry.
6
The following table sets forth, as of the dates indicated, and for each
class of policies, the annualized premiums (in thousands) in force, the
percentage of total annualized premiums, the number of policies in force, and
the average premium per policy. Policies are classified by their base coverage
but may include a rider for a different coverage. For example, if a policyholder
purchased a home health care policy with a nursing home rider, premium collected
in connection with the nursing home rider would be included in the home health
care class.
Year ended December 31,
-----------------------
1993 1994 1995
---- ---- ----
Long-term nursing home
care:
Annualized premium $57,455 77.9% $67,059 77.4% $ 77,217 70.3%
Number of policies 41,903 47,525 53,084
Average premium
per policy: $ 1,371 $ 1,411 $ 1,455
Long-term home health care:
Annualized premium $ 9,923 13.4% $11,822 13.6% $ 24,881 22.6%
Number of policies 11,113 12,637 22,967
Average premium
per policy: $ 893 $ 936 $ 1,083
Hospital care:
Annualized premiums $ 409 0.6% $ 325 0.4% $ 260 0.2%
Number of policies 1,169 953 779
Average premium
per policy $ 349 $ 341 $ 334
Medicare supplement:
Annualized premiums $ 4,268 5.8% $ 3,604 4.2% $ 3,246 3.0%
Number of policies 3,737 2,988 2,527
Average premium
per policy: $ 1,142 $ 1,206 $ 1,285
Life Insurance:
Annualized premiums $ 577 0.8% $ 2,754 3.2% $ 3,273 3.0%
Number of policies 1,239 4,012 5,270
Average premium
per policy: $ 466 $ 686 $ 621
Other insurance:
Annualized premiums $ 1,084 1.5% $ 1,064 1.2% $ 1,007 0.9%
Number of policies 7,587 6,942 6,382
Average premium
per policy: $ 143 $ 153 $ 158
------- ------ ------- ---- -------- ----
Total Annualized Premiums
in Force (1) $73,716 100% $86,628 100% $109,884 100%
======= ====== ======= ==== ======== ====
(1) Excludes credit life and credit accident and health insurance premiums in
force. Credit insurance premiums in force are calculated as the
cumulative total of one-time premiums received by the Company for policies
issued for terms of up to 120 months. Credit insurance premiums in force
for the years ended December 31, 1993, 1994 and 1995 were approximately
$1,215,500, $702,000 and $453,000, respectively.
7
Accident and Health Insurance Products. The Company offers accident and
health insurance policies in one or more of three basic classes of coverage,
consisting of benefits for (i)long-term nursing home care, (ii)long-term home
health care and (iii)individual coverage to supplement Medicare benefits.
Policies are designed to meet the accident and health insurance needs of senior
citizens and may be written for one insured, jointly for spouses or, in some
cases, for groups of individuals.
The majority of the Company's accident and health insurance policies are
written on an annual basis and provide for guaranteed renewability at then
current premium rates at the option of the insured. The insured may elect to pay
premiums on a monthly, quarterly, semi-annual or annual basis. In addition, the
Company offers an automatic payment feature that allows policyholders to have
premiums automatically withdrawn from a checking account. The Company may
increase premium rates on a particular form of policy only upon approval of the
applicable insurance regulatory authority in each state. Although the insured
may elect to pay premiums on a monthly, quarterly or semi-annual basis, as of
December 31, 1995, premiums on approximately 60% of the Company's policies in
force were paid on an annual basis. Policies lapse if and when premiums become
more than 31 days overdue; however, policies may be reinstated, if approved by
the Company, within six months after the policy lapses.
Long-Term Nursing Home Care. The Company's long-term nursing home care
policies generally provide a fixed benefit payable during periods of nursing
home confinement prescribed by a physician or necessitated by the policyholder's
cognitive impairment or inability to perform two or more activities of daily
living. These policies include built-in benefits for alternative plans of care,
waiver of premium after 90 days of benefit payments on a claim and unlimited
restoration of the policy's maximum benefit period.
The policies also provide that pre-existing conditions disclosed on the
application are covered immediately as of the effective date of the policy, and
there is no "prior hospitalization" requirement. Historically, most nursing home
policies required that a policyholder must have been discharged from a hospital
within a certain number of days prior to being confined in a nursing home. The
Company has phased out the prior hospitalization requirement on its new policies
and has made a policy rider to eliminate the prior hospitalization requirement
available to policyholders of the Company's older policies. Additionally, all
levels of nursing care, including skilled, custodial and intermediate care, are
covered and benefits continue even when the policyholder's required level of
care changes. Skilled nursing care refers to professional nursing care provided
by a medical professional (a doctor or registered or licensed
8
practical nurse) located at a licensed facility which cannot be provided by a
non-medical professional. Custodial care refers to non-medical care which does
not require professional treatment and can be provided by a non-medical
professional with minimal or no training. Intermediate nursing care is designed
to cover situations which would otherwise fall between skilled and custodial
care and includes situations in which an individual may require skilled
assistance on a sporadic basis.
The Company's current long-term nursing home care policies provide benefits
which are payable over periods ranging from one to five years and lifetime.
These policies provide for a fixed daily benefit ranging from $40 to $200 per
day. Certain of the Company's nursing home care policies provide benefits which
are payable over periods ranging from six months to five years and lifetime, and
from $800 to $5,000 per month of nursing home benefits.
Long-Term Home Health Care. The Company's home health care policies generally
provide a benefit payable on an expense-incurred basis during periods of home
care prescribed by a physician or necessitated by the policyholder's cognitive
impairment or inability to perform two or more activities of daily living. These
policies cover the services of registered nurses, licensed practical nurses,
home health aides, physical therapists, speech therapists, medical social
workers and other similar home health practitioners. Benefits are payable over
periods ranging from six months to five years and lifetime and provide for $40
to $160 per day of home benefits. Pre-existing conditions disclosed on the
application are not covered during the initial six months following the
effective date of the policy and there is no prior hospitalization requirement.
The Company's home health care policies also include built-in benefits for
waiver of premium and unlimited restoration of the policy's maximum benefit
period.
The most recent addition to the Company's long-term care product line is
its Independent Living policy. This policy was first introduced in the fourth
quarter of 1994 and is currently being marketed in those states in which the
Company has received regulatory approval. This policy provides coverage over the
full term of the policy for services furnished by a homemaker or companion
(other than a member of the insured's family) who is not a qualified or licensed
care provider ("Homemaker/Companion Services"). Homemaker/Companion Services
include cooking, shopping, housekeeping and assisting the insured with such
activities as laundry, correspondence, using the telephone and paying bills.
Historically, only limited coverage had been provided under certain of the
Company's home health care policies for Homemaker/Companion Services, typically
for a period of up to 30 days per calendar year during the term of the policy.
The Independent Living policy provides that the Company will waive the
elimination period the time at the beginning of the
9
period during which care is provided for which no benefits are available under
the policy (usually twenty days)- if the insured agrees to utilize a Case
Manager (as defined below) designated by the Company. The Case Manager is
engaged at the time a claim is submitted to prepare for the Company a written
assessment of the insured's condition and to establish a written plan of care.
The Company also encourages, but does not require, the purchase of a nursing
home care rider with its Independent Living policy. The Company believes that
the Independent Living policy, which represents a significant expansion of the
benefits previously available for Homemaker/Companion Services, is the first of
its kind.
The Company also has policies outstanding that provide benefits which are
payable over periods ranging from six months to three years and in amounts
ranging from $5.00 up to $20.00 per hour of home benefits subject to a limit of
eight hours per day. Some of these policies require prior hospitalization as a
condition to receipt of benefits.
Long-Term Care Generally. As a supplement to some of its long-term care
policies, the Company offers riders providing survivorship benefits, adult day
care benefits and an automatic annual benefit increase to help offset the
effects of inflation. The Company also offers a return of premium benefit rider
for its long-term care policies. This rider provides that after a policy has
been in force for ten years, the policyholder is entitled to a return of 80% of
all premiums paid during the ten year period less any claims paid by the
Company. If, however, claims exceed 20% of the premiums paid during the ten year
period, no return of premium is made. In addition, in most states the rider
provides for a pro-rata return of premium in the event of death or surrender
beginning in the sixth year.
The need for many of the riders offered by the Company has been eliminated
due to the incorporation of many of these benefits into the basic coverage under
the Company's newest long-term care policies. Among the built-in benefits
provided under the long-term care policies currently marketed by the Company are
hospice care and adult day care benefits, survivorship benefits, restoration of
benefits and a guaranteed upgrade option pursuant to which the policyholder may
increase the benefits available under the policy during the first two years if
no claims have been made. These policies also provide a yearly wellness benefit
(a payment made to policyholders who have not made a claim) after the first year
of the policy.
In some cases, provision of benefits under the Company's long-term care
policies is reviewed by unaffiliated case management agencies ("Case Managers")
retained by the Company to control and monitor claims made. The Case Manager
reviews the claim, including the specific health problem of the insured and the
nature and
10
extent of health care services being provided. The Case Manager assists both the
Company and the insured by determining that the services provided to the
insured, and the corresponding benefits paid by the Company, are appropriate
under the circumstances.
The Company also sells a relatively small amount of group insurance. True
group insurance ("Group Insurance") may be sold by the Company through the
issuance of a Group Master Policy to a group formed for purposes other than the
purchase of insurance, such as an employee group, an association or a
professional organization. The Group Master Policy is issued to the group and
all participating members are issued certificates of insurance which describe
the benefits available under the policy. Eligibility for insurance is guaranteed
to all members of the group without an underwriting review on an individual
basis.
The Company also sells franchise insurance ("Franchise Insurance") from
time to time. While Franchise Insurance is generally presented to an employee
group, association or professional organization which endorses the insurance,
the policies are issued to individual group members. Each application is
underwritten and issuance of policies is not guaranteed to members of the
franchise group.
Medicare Supplement. The Company writes policies designed to provide coverage
to supplement benefits available under Medicare, such as payment of deductible
amounts. OBRA '90 enacted various changes in Medicare reimbursement, set more
stringent standards for Medicare supplement insurance policies and required that
states adopt these new standards by July 31, 1992. OBRA' 90 sets forth ten
federally standardized benefit plans of which the Company offers five such plans
in most states. With respect to these benefit packages, every company writing
Medicare supplement coverages must adopt at least the Basic Plan, which covers
Medicare Part A coinsurance amounts for in-patient hospitalization (without the
PartA deductible), the cost of the first three pints of blood and 20% of
allowable charges under Medicare Part B. The other nine plans provide for the
Basic Plan coverage in addition to more extensive benefits such as skilled
nursing home coinsurance amounts, the Medicare Part A deductible, the Medicare
Part B deductible, 100% of Medicare Part B Excess Charges, Foreign Travel
Emergency Care, At-Home Recovery, Extended Drug Coverage and Preventive Care.
All Medicare supplement benefit plans offered by the Company are subject to
"open enrollment" and the Company is required to issue a policy to any person
applying for Medicare supplement insurance within six months of becoming
eligible for Medicare Part B, which generally occurs within the first six months
after a person's 65th birthday.
11
Because of lower profit margins associated with the Company's Medicare
supplement products, the Company has gradually de-emphasized the marketing of
these products. Medicare supplement premiums represented 3.0% of the Company's
annualized premiums for the year ended December 31, 1995.
Life Insurance. Beginning in August 1993, the Company began to market
actively its whole life insurance products which were approved by various state
insurance authorities during 1992 and 1993. These policies have face amounts of
$2,000 to $25,000 for individuals age 50-80 years and $2,000 to $10,000 for
individuals age 80-85 years. For the convenience of the insured, the Company
offers three premium payment options for these policies: (1) monthly, quarterly,
semi-annual or annual payments paid up to age 95; (2) one-time single premium
payment; or (3) two, three and five year payment plans. These policies were
developed to be sold by the Company's agents to senior citizens so as to
complete the Company's portfolio of insurance products.
The life insurance products currently marketed by the Company have been
designed for the senior citizen market. The Company previously marketed life
insurance policies, including annual renewable term and whole life policies, to
all ages of insureds. Certain of these policies carry face amounts substantially
in excess of the limits on life insurance policies currently being written by
the Insurers. The Company reinsures any life insurance policy to the extent the
risk on the policy is in excess of $30,000. See "Reinsurance."
Other Insurance. Among the other insurance products offered by the Company
are accidental death and dismemberment policies. The Company also has cancer and
disability income policies in force, and has acquired from other insurance
companies blocks of business which include short-term nursing home care
policies.
In the past, the Company offered credit life insurance to debtors in
connection with loans or other credit transactions. This insurance would provide
benefits to (i) pay off the debtor's obligations on the loan or other credit
transaction in the event of the debtor's death or (ii) cover the monthly loan
payments in the event the debtor became disabled.
(c) Marketing and Expansion
-----------------------
The Company's goal is to underwrite, market and sell its products
throughout the United States. The Company focuses its marketing efforts
primarily in those states (i) where it has successfully developed networks of
agents and (ii) which have the highest concentration of individuals whose
financial status and insurance needs are compatible with its products.
12
Agents. The Company employs no agents directly but relies instead on
relationships with independent agents and their sub-agents. In 1995, the
Company's policies were marketed through 5,136 producing agents, an increase of
22% over the number of producing agents in 1994. The Company provides assistance
to its agents through the use of seminars, underwriting training and field
representatives who consult with agents on underwriting matters, assist agents
in research and accompany agents on marketing visits to current and prospective
policyholders.
The following table sets forth the number of producing agents in each of
the states where the Company does business:
Year ended December 31,
----------------------------------
State 1993 1994 1995
- ----- ---- ---- ----
Arizona 113 181 231
California 255 418 675
Florida 1,276 1,270 1,303
Georgia 64 77 81
Illinois 206 282 291
Iowa 56 152 85
Maryland 64 71 74
Missouri 121 48 111
Nebraska 45 61 65
North Carolina 61 92 155
Ohio 94 123 152
Pennsylvania 342 365 460
South Dakota 28 39 44
Texas 102 150 296
Virginia 168 217 312
Washington 65 74 143
All Other States (1) 363 604 658
----- ----- -----
Total 3,423 4,224 5,136
===== ===== =====
(1) Includes all states in which premiums represented one percent or less
of the Company's total premiums in 1995.
Each independent agent must be authorized by contract to sell the
Company's products in each particular state in which the agent and the Company
are licensed. Some of the Company's independent agents are large general
agencies with many sales persons (sub-agents), while others are individuals
operating as sole proprietors. Some independent agents sell multiple lines of
insurance, while others concentrate primarily or exclusively on accident and
health insurance.
13
The Company generally does not impose production quotas or assign
exclusive territories to agents. The amount of insurance written for the Company
by individual independent agents varies. The Company periodically reviews and
terminates its agency relationships with non-producing or under-producing
independent agents or agents who do not comply with the Company's guidelines and
policies with respect to the sale of its products.
The Company is actively engaged in recruiting and training new agents.
Sub-agents are recruited by the independent agents and are licensed by the
Company with the appropriate state regulatory authorities to sell the Company's
policies. Independent agents are generally paid higher commissions than those
employed directly by an insurance company, in part to account for the expenses
of operating as an independent agent. The Company believes that the commissions
it pays to independent agents are competitive with the commissions paid by other
insurance companies selling similar policies. The independent agent's right to
renewal commissions is vested and commissions are paid as long as the policy
remains in force, provided the agent continues to abide by the terms of the
contract. The Company generally permits its established independent agents to
collect the initial premium with the application and remit such premium to the
Company less the commission. New independent agents are required to remit the
full amount of initial premium with the application. The Company provides
assistance to its independent agents in connection with the processing of
paperwork and other administrative services.
The Company is continuing to develop networks of agents in its
historical markets, as well as in those states where the Company is licensed and
has recently gained product approval. In some states, the Company is utilizing
marketing general agents. In addition, the Company has developed a program
designed to attract, train and motivate agents by educating them with respect to
the Company's insurance products and operations, and is equipped to prepare and
present programs addressing specific questions or issues in response to requests
from agents or groups of agents.
Marketing General Agents. The Company selectively utilizes marketing general
agents for the purpose of recruiting independent agents and developing networks
of agents in various states. The Company has a marketing general agent for the
purpose of generating business for the Insurers in various states. This
marketing general agent receives an overriding commission on business written in
return for recruiting, training, and motivating the independent agents. In
addition, this marketing general agent functions as a general agent for the
Insurers in various states. In its capacity as marketing general agent and
general agent, this agent accounted for 21%, 20% and 18% of the total premiums
earned by the Company during 1993, 1994 and 1995, respectively.
14
General Agents. The ten independent general agents accounting for the most
new business premium revenue employed a total of approximately 1,425 producing
sub-agents and accounted for approximately 23% of the Company's new business
written during 1995. No independent general agents, other than the marketing
general agent discussed above, accounted for more than 10% of the Company's
total premium income.
No underwriting or claims processing authority has been delegated to
any agents of the Company.
Markets. The following chart shows premium revenues by state for each of the
states where the Company does business:
Year ended December 31,
Year -----------------------
State Entered(1) 1993 1994 1995
- ----- ---------- ---- ---- ----
(in thousands)
Arizona 1988 $ 1,706 $ 2,466 $ 3,603
California 1992 2,914 4,585 9,379
Florida 1987 25,902 29,372 33,116
Georgia 1990 944 1,061 995
Illinois 1990 2,690 3,185 4,084
Iowa 1990 911 945 1,459
Maryland 1987 1,574 1,775 1,969
Missouri 1990 1,676 2,156 2,540
Nebraska 1990 950 1,101 1,222
North Carolina 1990 1,241 1,643 2,046
Ohio 1989 2,074 2,476 2,989
Pennsylvania 1972 17,305 17,628 19,680
South Dakota 1990 897 1,123 1,487
Texas 1990 1,404 1,851 2,887
Virginia 1989 3,883 5,570 7,903
Washington 1993 442 648 1,165
All Other States (2) 3,468 4,250 5,843
------- ------- -------
All States $69,981 $81,835 $102,367
======= ======= ========
(1) Represents year in which the Company commenced sale of policies in each
state.
(2) Includes all states in which premiums represented one percent or less of
the Company's total premiums in 1995.
15
(d) Administration
--------------
Underwriting.
- ------------
The Company believes that the underwriting process through which an
accident and health insurance company, particularly one in the long-term care
segment, chooses to accept or reject an applicant for insurance is critical to
its success. All applications are reviewed by the Company's in-house
underwriting department and must be approved before a policy can be issued. The
Company considers age and medical history, among other factors, in deciding
whether to accept an application for coverage. With respect to medical history,
efforts are made to underwrite on the basis of the medical information listed on
the application, but an Attending Physician's Statement is often requested. In
all cases, a personal history interview is required, and a paramedic interview
is often conducted. In the event the Company determines that it cannot offer the
requested coverage, an alternative for suitable coverage for higher risk
applicants may be suggested to the agent. Accepted policies are usually issued
within seven working days from receipt of the information necessary to
underwrite the application. As noted above, while there is no individual
underwriting process for Group Insurance, the underwriting for Franchise
Insurance written by the Company is identical to that for individual policies.
In order to expedite the large volume of premiums generated from sales
of policies in Florida and the increasing volume of premiums from sales of
policies in California, the Company operates field offices in Sarasota, Florida
and Stockton, California to underwrite and issue policies. These regional
offices enable the Company to respond more effectively and efficiently to its
agents and policyholders in the southeastern and western regions of the United
States.
Applicants for insurance must respond to detailed medical
questionnaires. Physical examinations are not required for the Company's
accident and health insurance policies, but medical records are frequently
requested. Pre-existing conditions disclosed on the application for new long-
term nursing home care policies are covered immediately upon approval of the
policy by the Company's underwriting department, while undisclosed pre-existing
conditions are not covered for six months in most states and two years in
certain other states. On certain of the Company's older nursing home policy
forms and all home health care policies, pre-existing conditions disclosed on
the application are not covered during the initial six months following the
effective date of the policy and undisclosed pre-existing conditions are not
covered for up to two years. In the case of individual Medicare supplement
policies, pre-existing conditions are generally not covered during the six month
period following the effective date of the policy.
16
Claims.
------
All claims for policy benefits, except with respect to Medicare
supplement claims, are currently processed by the Company's claims department,
which includes physicians and nurses employed or retained as consultants by the
Company. From November 1, 1993 through July 31, 1994, all claims for policy
benefits, including Medicare supplement claims, were processed through an
unaffiliated third party administrator. In mid-1994, management decided to
process all claims (except the Medicare supplement claims) through the Company's
home office claims department. The Company transferred the processing of its
Medicare supplement claims to a new unaffiliated third party administrator,
effective March 1, 1995. The Company has historically utilized third party
administrators to process its Medicare supplement claims due to the typically
small amount per claim and the large number of claims.
The Company periodically utilizes the services of unaffiliated Case
Managers to review certain claims, particularly those made under home health
care policies. When a claim is filed, the Company may engage the Case Manager to
review the claim, including the specific health problem of the insured and the
nature and extent of health care services being provided. The Case Manager
assists both the Company and the insured by determining that the services
provided to the insured, and the corresponding benefits paid by the Company, are
appropriate under the circumstances. Under the terms of its Independent Living
policy, the Company will waive the elimination period, the time at the beginning
of the period during which care is provided for which no benefits are available
under the policy (usually twenty days), if the insured agrees to utilize a Case
Manager. The Company estimates that an average of 10% of all claims submitted in
the last year, including approximately one-quarter of home health care claims,
have been submitted to Case Managers. The Company's use of Case Managers has
increased steadily in recent years, and the Company anticipates that this
increase will continue as both its business and the need to manage effectively
the processing of claims grow.
Systems Operations. The Company operates and maintains its own
------------------
computer system for all aspects of the Company's operations, including: policy
issuance; billing; claims processing; commission reports; premium production by
agent (state and product) and general ledger. During 1995, the Company
contracted to purchase a new computer system which will enable the Company to
(i) define and refine its underwriting and claims functions so that data may be
analyzed more usefully, (ii) target agents and consumers more effectively and
(iii) continue to manage the increasing volume of information as the Company's
business grows. The Company considers the new system critical to its ability to
continue to provide the quality of service for which the Company has been known
to its policyholders and agents. The
17
Company is using both in-house programmers and outside consultants in
implementing the system.
(e) Premiums
--------
Premium rates for all lines of insurance written by the Company are
subject to state by state regulation. Premium regulations vary greatly among
jurisdictions and lines of insurance. Rates for the Company's insurance
policies are established by the Company's independent actuarial consultant and
reviewed by the insurance regulatory authorities as part of the licensing
process in the states where the Company markets its products. Before a rate
change can be made, the proposed change must be filed with and approved by the
insurance regulatory authorities.
As a result of minimum loss ratio standards imposed by state
regulations, the premiums charged by the Company with respect to all of its
accident and health polices are subject to reduction and/or corrective measures
in the event insurance regulatory agencies in states where the Company does
business determine that the Company's loss ratios either have not reached or
will not reach required minimum levels. See "Business--Government Regulation".
(f) Future Policy Benefits and Claims Reserves
------------------------------------------
The Company is required to maintain reserves equal to the probable ultimate
liability for claims and related claims expenses with respect to all policies in
force. Reserves, which are computed by the Company's actuarial consultant, are
established for (i) claims which have been reported but not yet paid, (ii)
claims which have been incurred but not yet reported and (iii) the discounted
present value of all future policy benefits less the discounted present value of
expected future premiums. See Note 3 of the Notes to Consolidated Financial
Statements.
The amount of reserves relating to reported and unreported claims incurred
is determined by periodically evaluating historical claims experience and
statistical information with respect to the probable number and nature of such
claims. The Company compares actual experience with estimates and adjusts its
reserves on the basis of such comparisons.
In addition to reserves for incurred claims, reserves are also established
for future policy benefits. The policy reserve represents the discounted present
value of future obligations that are likely to arise from the policies that the
Company underwrites, less the discounted present value of expected future
premiums on such policies. The reserve component is determined using generally
accepted actuarial assumptions and methods. However, the adequacy of this
reserve rests on the validity of the underlying assumptions
18
that were used to price the Company's products; the more important of these
assumptions relate to policy lapses, loss ratios and claim incidence rates.
The Company's long-term care experience, most of which is based on its
nursing home care products, is derived from the Company's twenty years of
significant claims experience with respect to this product line, and reserves
for these policies are based primarily upon this experience.
The Company began offering home health care coverage in 1987. Since
1988, there has been a significant increase in the number of home health care
policies written by the Company. The Company's claims experience with home
health care coverage is more limited than is its nursing home care claims
experience, and the Company's claims experience with respect to its Independent
Living policy, which it first offered in November 1994, is extremely limited.
The Company's claims experience to date with respect to certain of its home
health care products has been characterized by a higher than expected number of
claims with a longer than expected duration. Management of the Company believes
that individuals may be more inclined to utilize home health care than nursing
home care, which is generally a last resort to be considered only after all
other possibilities have been explored. Accordingly, management believes that
there is a greater potential for volatility in claims experience in its home
health care insurance than exists with respect to nursing home care insurance.
The Company's actuarial consultant utilizes both the Company's experience and
other industry-wide data in the computation of reserves for the home health care
product line.
In addition, more recent long-term care products, developed as a
result of regulation or market conditions, may incorporate more benefits with
fewer limitations or restrictions. For instance, OBRA '90 required that Medicare
supplement policies provide for guaranteed renewability and waivers of pre-
existing condition coverage limitations under certain circumstances. In
addition, the NAIC has recently adopted model long-term care policy language
providing nonforfeiture benefits and has proposed a rate stabilization standard
for long-term care policies, either or both of which may be adopted by the
states in which the Company writes policies. See "Government Regulation." The
fluidity in market and regulatory forces might limit the Company's ability to
rely on historical claims experience for the development of new premium rates
and reserve allocations.
The Company employs full-time actuarial support and utilizes the
services of actuarial consultants (the "Actuaries"), to price insurance products
and establish reserves with respect to those products. Additionally, the
actuaries assist the Company in improving the documentation of its reserve
methodology, a process which has resulted in certain adjustments to the
Company's reserve
19
levels. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations Overview." Although management believes that the
Company's reserves are adequate to cover all policy liabilities, there can be no
assurance that reserves are adequate or that future claims experience will be
similar to, or accurately predicted by, the Company's past or current claims
experience.
(g) Reinsurance
-----------
As is common in the insurance industry, the Company purchases
reinsurance to increase the number and size of the policies it may underwrite.
Reinsurance is purchased by insurance companies to insure their liability under
policies written to their insureds. By transferring, or ceding, certain amounts
of premium (and the risk associated with that premium) to reinsurers, the
Company can limit its exposure to risk. The Company currently reinsures any life
insurance policy to the extent the risk on that policy exceeds $30,000. The
Company currently reinsures its ordinary life policies through Reassurance
Company of Hannover (A.M. Best rating A-). The Company also has reinsurance
agreements with Life Insurance Company of North America (A.M. Best rating A+)
and Transamerica Occidental Life Insurance Company (A.M. Best rating A+) to
reinsure term life policies whose risk exceeds $15,000, and with Employers
Reassurance Corporation (A.M. Best rating A+) to reinsure credit life policies
whose risk exceeds $15,000.
PTLIC and Network America have entered into a reinsurance agreement,
effective in January 1994, to cede 100% of certain life, accident and health and
Medicare supplement insurance policies issued by PTLIC and Network America to
Life and Health Insurance Company of America ("Life and Health") (A.M. Best
rating C++), a third party insurer. This arrangement, known as a "fronting"
arrangement, is used when one insurer wishes to take advantage of another
insurer's ability to procure and issue policies. The fronting company remains
liable to the policyholder, even though all of its risk is reinsured. Because of
Life and Health's A.M. Best rating, the Insurers have structured their agreement
with Life and Health to require maintenance of securities in escrow for the
Insurers in an amount at least equal to their statutory reserve credit. The
value of these escrowed securities, which consist of U.S. government bonds,
exceeded the Insurers' related statutory and GAAP reserve credits as of December
31, 1995, which were approximately $662,000. The policies subject to this
fronting arrangement are being marketed in thirteen states to federal employees.
Premium ceded under this agreement totalled $984,600 and $943,500 in 1994 and
1995, respectively.
In January 1991, Network America entered into another fronting
agreement under which Network America ceded 100% of certain whole life and
deferred annuity policies to Provident Indemnity Life
20
Insurance Company ("Provident Indemnity"), a third party insurer. Provident
Indemnity has been assigned an A.M. Best rating of NA-9 (Company Request) which,
according to A.M. Best, is assigned to companies eligible for letter ratings but
which request that their letter ratings not be published because they disagree
with the A.M. Best rating. As a result, Network America has structured its
agreement with Provident Indemnity to require maintenance of securities in
escrow for Network America in an amount at least equal to its statutory reserve
credit. The value of these escrowed securities, which consist of U.S. government
bonds, exceeded Network America's related statutory reserve credit as of
December 31, 1995 of approximately $3,469,000, but was less than Network
America's GAAP reserve credit as of December 31, 1995, which was approximately
$4,400,000. The policies which are subject to this fronting agreement are
intended for the funeral arrangement or "pre-need" market, and are being
underwritten in 24 states (with the largest markets in California and Michigan).
Total ceded life insurance in force approximated $8,018,000 and $14,169,000 at
December 31, 1994 and 1995, respectively.
Effective in October 1994, the Insurers entered into reinsurance
agreements with Cologne Life Reinsurance Company (A.M. Best rating A+) with
respect to their home health care policies with benefit periods exceeding 36
months. Under these reinsurance agreements, the Insurers are responsible for
payment of claims during the first 36 months of the benefit period, and the
reinsurer will reimburse the Insurers for 100% of all claims paid after such 36
month period. Total reserve credits taken related to this agreement as of
December 31, 1995 were approximately $391,000.
In May 1991, Network America acquired a block of long-term care
business under an assumption reinsurance agreement with Providentmutual Life and
Annuity Company of America (formerly known as Washington Square Life Insurance
Company), an unaffiliated insurance company. Network America assumed the
obligations as insurer for all policies in force as of that date. Network
America received cash totalling $1,512,300, net of $513,500 as consideration for
the sale. Under this agreement, Network America assumed a reinsurance treaty
under which 66% of the premiums assumed are, in turn, ceded by Network America
to a third party reinsurer. The total accident and health premiums ceded under
this treaty amounted to $1,345,488 in 1993, $1,287,502 in 1994 and $1,174,792 in
1995.
On December 28, 1990, Network America entered into a reinsurance
agreement with Midland Mutual Life Insurance Company (A.M. Best rating A-) under
which Network America acquired approximately 3,100 nursing home policies in 22
states with an annualized premium of approximately $3,000,000. The Company
recognized $2,102,491 of premium related to this acquisition in 1993, $1,886,790
in 1994 and $1,768,467 in 1995.
21
In the event a reinsurance company becomes insolvent or otherwise
fails to honor its obligations to the Company under any of its reinsurance
agreements, the Company would remain fully liable to the policyholder.
For a discussion of the amounts reinsured by the Company, see Note 10
of the Notes to Consolidated Financial Statements. For a discussion of A.M. Best
ratings, see "A. M. Best Ratings."
(h) Investments
-----------
The Company invests in securities and other investments authorized by
applicable state laws and regulations and follows an investment policy designed
to maximize yield to the extent consistent with liquidity requirements and
preservation of assets. Investments are managed by James M. Davidson & Company
of Wayne, Pennsylvania. Over the past five years, the Company has been able to
meet its liabilities through operations and has not had to utilize any of its
investment assets.
The following table shows the composition of the debt securities
investment portfolio (at carrying value), excluding short-term investments, by
rating as of December 31, 1995.
December 31, 1995
-----------------
Rating (1)
Amount Percent
------------- -----
(in thousands)
U.S. Treasury and U.S. Agency securities $107,161 75.3%
Aaa or AAA 12,866 9.0%
Aa or AA 17,626 12.4%
A 4,590 3.3%
-------- ------
Total $142,243 100.0%
======== ======
___________
(1) Ratings assigned by Moody's Investors Services, Inc. or Standard and Poor's
Corporation.
As of December 31, 1995, over 98.1% of the Company's total investments were
fixed income debt securities, 75.3% of which were securities of the United
States Government (or its agencies or instrumentalities). The balance of the
Company's investment portfolio consisted principally of publicly traded equity
securities. As of December 31, 1995, all of the Company's bond investment
portfolio consisted of investment grade securities, with 100% rated "A" or
better by either Moody's Debt Rating Service or Standard and Poor's Corporation.
The Company's investment policy is to purchase only U.S. Treasury securities,
U.S. agency securities and investment-grade municipal and corporate securities
primarily
22
with an "A" or higher rating with the highest yield to maturity available, and
to have 7% to 10% of the Company's bond investment portfolio mature each year.
The Company generally buys investments maturing within two to twelve years of
the date of the purchase. At December 31, 1995, the average maturity of the
Company's bond investment portfolio was 6.4 years and the Company's investment
portfolio contained no collateralized mortgage obligations or investments in
real estate. The Company has historically limited its investments in equity
securities. In 1995, the Company expanded its common stock investments slightly
to approximately 2.0% of its total investments. The Company intends to limit
its common stock investments to 5.0% of its total investments. For additional
information regarding the Company's investments, see Note 2 of the Notes to
Consolidated Financial Statements.
The following table sets forth for the periods indicated certain
information concerning investment income.
Investment Portfolio 1993 1994 1995
---- ---- ----
Year Ended December 31,
-----------------------
(Dollar amounts in thousands)
Average balance of investments, cash and
cash equivalents during the period (1) $73,420 $91,823 $125,524
Net investment income 4,979 5,946 8,103
Average yield on investments 6.8% 6.5% 6.5%
___________
(1) Valued at amortized costs except for common stock which is carried at market
value.
(i) Selected Financial Information: Statutory Basis
------------------------------------------------
The following table shows certain ratios derived from the Company's
insurance regulatory filings with respect to the Company's accident and health
policies presented in accordance with accounting principles prescribed or
permitted by insurance regulatory authorities ("SAP"), which differ from the
presentation under Generally Accepted Accounting Principles ("GAAP") and which
also differ from the presentation under SAP for purposes of demonstrating
compliance with statutorily mandated loss ratios. See Item 1, "Business--
Government Regulation".
23
Year ended December 31,
-----------------------
1993 1994 1995
---- ---- ----
Loss ratio (1) 51.0% 59.0% 56.1%
Expense ratio (2) 50.7 46.9 50.4
----- ----- -----
Combined loss and
expense ratio 101.7 105.9 106.5
Persistency (3) 70.0 75.4 77.4
_______________
(1) Loss ratio is defined as incurred claims and increases in policy reserves
divided by earned premiums.
(2) Expense ratio is defined as commissions and expenses incurred divided by
earned premiums.
(3) Persistency represents the percentage of premiums renewed, which the
Company calculates by dividing the total annual premiums at the end of each
year (less first year business for that year) by the total annual premiums
in force for the prior year. For purposes of this calculation, a decrease
in total annual premiums in force at the end of any year would be a result
of non-renewal policies, including those policies that have terminated by
reason of death, lapse due to nonpayment of premiums, and/or conversion to
other policies offered by the Company.
The Company's loss ratio rose in 1994 and continued to rise in 1995 from
the prior year's level due in part to a mandated change in reserving method
wherein underwriters of long-term care products were required by the
Pennsylvania Insurance Department, commencing in October 1994, to use the one-
year preliminary term reserve method, instead of the two-year preliminary term
method previously permitted. This change had the effect of requiring companies
to establish a full annual reserve for a policy commencing at the end of the
first policy year, instead of at the end of the second policy year. The increase
in the persistency rate in 1995 and 1994, signifying a greater percentage of
policy renewals, also caused the loss ratio to increase. This is due to the fact
that as policies age, the reserves associated with such policies must be
increased.
Under SAP, costs associated with sales of new policies must be charged to
earnings as incurred. Because these costs, together with required reserves,
generally exceed first year premiums, statutory surplus may be reduced during
periods of increasing first year sales. Through November 1994, the Company was
able to expand its business from accumulation of statutory retained earnings and
from proceeds received from the Company's Common Stock offering completed in
December, 1989. In December 1994, PTLIC's capital position was strengthened by
a $4,000,000 contribution from the
24
Company. The capital position of the Insurers was improved further by the
contribution of $14,000,000 of the net proceeds of the recent public offering to
the capital and surplus of the Insurers during the third quarter of 1995.
Mandated loss ratios are calculated in a manner which provides adequate
reserving for the long-term care insurance risks, using statutory lapse rates
and certain assumed interest rates. The statutorily assumed interest rates
differ from those used in developing reserves under GAAP. For this reason,
statutory loss ratios differ from loss ratios reported under GAAP. Mandatory
statutory loss ratios also differ from loss ratios reported on a current basis
under SAP for purposes of the Company's annual and quarterly state insurance
filings. The states in which the Company is licensed have the authority to
change these minimum ratios and to change the manner in which these ratios are
computed and the manner in which compliance with these ratios is measured and
enforced. The Company is unable to predict the impact of (i) the imposition of
any changes in the mandatory statutory loss ratios for individual or group long-
term care policies to which the Company may become subject, (ii) any changes in
the minimum loss ratios for individual or group long-term care or Medicare
supplement policies, or (iii) any change in the manner in which these minimums
are computed or enforced in the future. The Company has not been informed by any
state that it does not meet mandated minimums, and the Company believes it is in
compliance with all such minimum ratios. In the event the Company is not in
compliance with minimum statutory loss ratios mandated by regulatory authorities
with respect to certain policies, the Company may be required to reduce or
refund its premiums on such policies.
(j) A.M. Best's Rating
------------------
PTLIC and NALIC received a rating of "B+" in A.M. Best's Insurance
Reports Life/Health 1995, Edition. A.M. Best's ratings are based on a
comparative analysis of the financial condition and operating performance for
the prior year of the companies rated, as determined by their publicly available
reports. A.M. Best's classifications are A++ and A+ (superior), A and A-
(excellent), B++ and B+ (very good), B and B- (good), C++ and C+ (fair), and C
and C- (marginal), D (below minimum standards), E (under state supervision) and
F (in liquidation). A.M. Best's ratings are based upon factors of concern to
policyholders and insurance agents and are not directed toward the protection of
investors.
(k) Competition
-----------
The Company operates in a highly competitive industry. Many of its
competitors have considerably greater financial resources and
25
higher ratings from A.M. Best than the Company. A large number of insurance
companies are licensed to sell accident and health insurance, including
substantially all of the major companies selling life insurance. Many of these
companies sell a significant volume of accident and health insurance (either
comprehensive policies, supplemental policies or both).
In addition to the multiple-line companies which sell accident and health
insurance as a relatively minor portion of their business, there are many
insurers concentrating in the accident and health field. Many of these insurers
offer policies generally similar to those of the Company, in some cases through
similar marketing techniques. Some accident and health insurers concentrate
primarily on policies which provide comprehensive basic health benefits. By
contrast, the Company's policies generally provide benefits of fixed dollar
amounts for periods of nursing home confinement and for home health care
services. The Company also competes with voluntary and cooperative plans which
pay hospitalization and medical expenses. In addition, the Company faces
competition from various health maintenance organizations which offer individual
Medicare supplement coverage to persons eligible to receive Medicare.
Furthermore, in recent years, the number of companies offering products
comparable to those of the Company has substantially increased and many private
insurance carriers and members of the Blue Cross/Blue Shield Association have
introduced or are expected to introduce comparable products. In addition, long-
term care policies are offered by some of these competitors at rates, including
group rates, which are lower than those offered by the Company.
(l) Government Regulation
---------------------
Insurance companies are subject to supervision and regulation in all states
in which they transact business. The Company is registered and approved as a
holding company under the Pennsylvania Insurance Code. PTLIC and Network America
are chartered and licensed in Pennsylvania as stock life insurance companies. On
a combined basis with its direct and indirect insurance subsidiaries, the
Company is currently licensed in all states except Kansas, Maine, Massachusetts,
New Jersey, New York and West Virginia.
The extent of regulation of insurance companies varies, but generally
derives from state statutes which delegate regulatory, supervisory and
administrative authority to state insurance departments. Although many states'
insurance laws and regulations are based on models developed by the NAIC and are
therefore similar, variations among the laws and regulations of different states
are common.
26
The NAIC is a voluntary association of all of the state insurance
commissioners in the United States. The primary function of the NAIC is to
develop model laws on key insurance regulatory issues which can be used as
guidelines for individual states in adopting or enacting insurance legislation.
While the NAIC model laws are accorded substantial deference within the
insurance industry, these laws are not binding on insurance companies unless
adopted by the state, and variations from the model laws within the states is
common. Indications that the Company or the Insurers meet or exceed NAIC
standards do not necessarily mean that the Company or the Insurers have complied
with applicable regulations in all states.
The Pennsylvania Department of Insurance (the "Department"), and insurance
regulatory authorities in other jurisdictions, have broad administrative and
enforcement powers relating to the granting, suspending and revoking of licenses
to transact insurance business, the licensing of agents, the regulation of
premium rates and trade practices, the content of advertising material, the form
and content of insurance policies and financial statements and the nature of
permitted investments. In addition, regulators have the power to require
insurance companies to maintain certain deposits, capital, surplus and reserve
levels calculated in accordance with prescribed statutory standards. The primary
purpose of such supervision and regulation is the protection of policyholders,
not shareholders.
The Company also is subject to the insurance holding company laws of the
other states in which it is licensed to do business. These laws generally
require insurance holding companies and their subsidiary insurers to register
and file certain reports, including information concerning their capital
structure, ownership, financial condition and general business operations.
Further, states often require prior regulatory approval of changes in control of
an insurer and of intercorporate transfers of assets within the holding company
structure. The purchase of more than 10% of the outstanding shares of Common
Stock by one or more parties acting in concert requires the prior approval of
the Department, and may subject such party or parties to the reporting
requirements of the insurance laws and regulations of Pennsylvania and to the
prior approval and/or reporting requirements of other jurisdictions in which the
Company is licensed. In addition, officers, directors and 10% shareholders of
insurance companies, such as the Insurers, are subject to the reporting
requirements of the insurance laws and regulations of Pennsylvania and may be
subject to the prior approval and/or reporting requirements of other
jurisdictions in which the Company is licensed.
Under Pennsylvania law, lending institutions, public utilities, bank
holding companies, savings and loan companies, and their affiliates,
subsidiaries, officers and employees may not be licensed or admitted as
insurers. If any of the foregoing entities
27
or individuals (or any such entity and its affiliates, subsidiaries, officers
and employees in the aggregate) acquires 5% or more of the outstanding shares of
Common Stock, such party may be deemed to be an affiliate, in which event the
Company's Certificate of Authority to do business in Pennsylvania may be revoked
upon a determination by the Department that such party exercises effective
control over the Company.
State insurance regulators typically have the power to inspect and examine
insurers, in order to ensure that insurers are adhering to all regulatory
requirements. During 1995 the Department completed its examination of both
Insurers for the five year period ended December 31, 1994. Both companies were
found to be in compliance with applicable Pennsylvania regulations. PTLIC and/or
Network America have been examined from time to time by other state insurance
regulators and in each case have been found to be in compliance with applicable
state regulations. The Company believes that its deposit, capital, surplus
and reserve levels currently meet or exceed all applicable regulatory
requirements.
The Company is also subject to state imposed mandatory annual audits by
independent certified public accountants. These audits are conducted by the
Company's independent public accounting firm in conjunction with its annual
audit of the Company's financial statements.
In addition to conducting examinations, the Department also conducts
separate market conduct examinations. These examinations focus on an insurer's
claims practices, policyholder complaints, policy forms, advertising practices
and other marketing aspects. The Department completed a market conduct
examination of PTLIC in April 1990 and acknowledged that the Company had
implemented all recommendations made by the Department to its satisfaction.
In recent years, there has been considerable legislative and regulatory
activity, at both the state and federal levels, with regard to long-term care
and Medicare supplement insurance. There is extensive federal and state
regulation applicable to the form and content of Medicare supplement policies,
including requirements for specified minimum benefits and loss ratios and
requirements relating to agent compensation and the sales practices of agents
and companies. For example, Pennsylvania, which had previously enacted
regulations governing Medicare supplement insurance, recently promulgated
regulations governing long-term care insurance. These regulations are effective
for policies written on or after February 8, 1995, and impact, affect and/or
regulate areas including permissible policy practices and provisions, lapse
provisions, required disclosure provisions, post-claims underwriting, minimum
standards for home health and community care benefits, inflation protection
provisions, application forms and replacement coverage, reporting requirements,
reserve standards, loss ratios, filings for out-of-state group policies,
marketing
28
standards, agent recommendations, pre-existing condition limitations, coverage
outlines, allowable shoppers guides and permitted compensation arrangements.
Most states mandate minimum benefit standards and loss ratios for long-term
care insurance policies and for other accident and health insurance policies.
Most states have adopted the NAIC's proposed standard minimum loss ratios of 65%
for individual Medicare supplement policies and 75% for group Medicare
supplement policies. A significant number of states, including Pennsylvania and
Florida, also have adopted the NAIC's proposed minimum loss ratio of 60% for
both individual and group long-term care insurance policies. The states in which
the Company is licensed have the authority to change these minimum ratios, the
manner in which these ratios are computed and the manner in which compliance
with these ratios is measured and enforced.
The Department is provided, on an annual basis, with a calculation prepared
by the Company's independent consulting actuary regarding compliance with
required minimum loss ratios for Medicare supplement and credit policies. This
report is made available to all states. Although certain other policies (e.g.,
nursing home and hospital care policies) also have specific mandated loss ratio
standards, at the present there typically are no similar reporting requirements
in the states in which the Company does business for such other policies.
The NAIC has developed new minimum capital and surplus requirements
utilizing certain risk-based factors associated with various types of assets,
credit, underwriting and other business risks. The Company did not experience
any problems meeting these new requirements when they took effect in 1993. As of
December 31, 1995, the risk-based capital of PTLIC and Network America were 614%
and 440%, respectively, of authorized control level capital.
In December 1986, the NAIC adopted the Long-Term Care Insurance Model Act
(the "Model Act"), which was adopted to promote the availability of long-term
care insurance policies, to protect applicants for such insurance and to
facilitate flexibility and innovation in the development of long-term care
coverage. The Model Act establishes standards for long-term care insurance,
including provisions relating to disclosure and performance standards for long-
term care insurers, incontestability periods, nonforfeiture benefits,
severability, penalties and administrative procedures. Model regulations were
also developed by the NAIC to implement the Model Act. As of January 1995, 43
states had adopted the Model Act or substantially similar legislation. Some
states have also adopted standards relating to agent compensation for long-term
care insurance. In addition, from time to time, the federal government has
considered adopting standards for long-term care insurance policies, but has not
enacted any such legislation to date.
29
States also restrict the dividends the Insurers are permitted to pay.
Dividend payments will depend on profits arising from the business of the
Insurers, computed according to statutory formulae. In addition, Pennsylvania
law requires each Insurer to furnish the Department 30 days advance notice of
any planned extraordinary dividend (any dividend paid within any twelve-month
period which exceeds the greater of (i) 10% of that Insurer's surplus as shown
in its most recent annual statement filed with the Department or (ii) that
Insurer's net gain from operations, after policyholder dividends and federal
income taxes and before realized gains or losses, shown in such statement) and
the Department may refuse to allow that Insurer to pay such dividends.
OBRA '90 enacted various changes in Medicare reimbursement and set new
standards for Medicare supplement insurance policies. Among the changes in
reimbursement are (i) an increase in the premium paid by participants under Part
B and (ii) an extension until September 30, 1995 of the authority of the
Medicare program to use data provided by the Social Security Administration and
the Internal Revenue Service to improve collection in Medicare secondary payor
cases. Among the new standards for Medicare supplement insurance policies are
those requiring (i) guaranteed renewability, (ii) mandatory state reporting on
the implementation and enforcement of Medicare supplement policy standards,
(iii) the obtaining of statements by insurers from purchasers as to whether they
are already covered by another Medicare supplement policy or by Medicaid and
(iv) a waiver of pre-existing condition coverage limitations for policies that
replace existing policies.
During 1993, the NAIC adopted model language that requires long-term care
policies to include a nonforfeiture benefit. The mandated inclusion of a
nonforfeiture benefit is intended to protect policyholders against the lapse (or
cancellation) of policies without some value returning to the policyholder.
During 1994, the NAIC adopted a standard calling for "rate stabilization" of
long-term care policies. Some states, such as Florida, have adopted regulations
which require long-term care policies to include nonforfeiture provisions. Other
states, such as California, have adopted regulations which require long-term
care policies to include provisions allowing insureds to obtain protection
against the effects of inflation. Adoption of nonforfeiture benefits would
increase the price of long-term care policies, while rate stabilization
provisions limit the Company's ability to adjust to adverse loss experiences.
From time to time, the federal government has considered adopting a
national health insurance program. Although it does not appear that the federal
government will enact an omnibus health care reform law in the near future, the
passage of such a program could have a material impact upon the Company's
operations. In addition, legislation currently pending in Congress could impact
the Company's business. Among the proposals are the implementation
30
of certain minimum consumer protection standards for inclusion in all long-term
care policies, including guaranteed renewability, protection against inflation
and limitations on waiting periods for pre-existing conditions. These proposals
would also prohibit "high pressure" sales tactics in connection with long-term
care insurance and would guarantee consumers access to information regarding
insurers, including lapse and replacement rates for policies and the percentage
of claims denied. Other pending legislation would permit premiums paid for long-
term care insurance to be treated as deductible medical expenses, with the
amount of the deduction increasing with the age of the taxpayer. As with any
pending legislation, it is possible that any laws finally enacted will be
substantially different than the current proposals. Accordingly, the Company is
unable to predict the impact of any such legislation on its business and
operations.
(m) Employees
---------
As of December 31, 1995, the Company had approximately 174 full-time
employees (not including independent agents), 128 of whom are employed in the
Company's home office. Of those employees in the Company's home office, 29 are
employed in various administrative services, 19 in sales, 27 in underwriting, 16
in accounting, 7 in compliance, 12 in claims, 14 in an executive capacity, and
4 in systems. The Company had approximately 31 full-time employees employed in
the Florida field office as of December 31, 1995. Of the Florida employees, 21
are employed in underwriting and administrative services and 10 are employed in
marketing. The Company has 15 employees in its California office. The Company
is not a party to any collective bargaining agreements and believes that its
relationship with its employees is good.
Item 2. Properties
- ------ ----------
The Company's main offices occupy approximately 25,500 square feet of
office space in a 40,000 square foot building located in Allentown, Pennsylvania
which the Company acquired in September 1988 and which is subject to a mortgage
in the amount of $2,060,069. The Company currently leases out approximately
10,500 square feet of this building to third parties. The Company also rents
approximately 5,516 square feet of office space in Sarasota, Florida, and 1,000
square feet of office space in Stockton, California, which are used as field
offices.
The Company owns a 2.42 acre parcel of land located across the street
from its home office held as a possible site for future expansion or relocation
of its home office. The Company has received the zoning and other approvals
necessary to develop this property.
31
Item 3. Legal Proceedings
- ------ -----------------
The Insurers are parties to various lawsuits generally arising in the
normal course of their insurance business. The Company does not believe that
the eventual outcome of any suit to which either of the Insurers is currently a
party will have a material effect on the financial condition or results of
operations of the Company.
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, 1995 to a vote of security holders.
PART II
-------
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
- ------ ---------------------------------------------------------------------
The Common Stock of the Company is traded in the over-the-counter
market and is included on the National Market System of the National Association
of Securities Dealers, Inc. Automated Quotation System ("NASDAQ") under the
symbol PTAC. The transfer agent and registrar for the Company's Common Stock is
Registrar and Transfer Company of Cranford, New Jersey.
As of March 22, 1996 the Company had 6,990,084 shares of Common Stock
outstanding, held by approximately 200 stockholders of record. This latter
number was derived from the Company's shareholder records, and does not include
beneficial owners of the Company's Common Stock whose shares are held in the
names of various dealers, clearing agencies, banks, brokers, and other
fiduciaries.
32
The range of high and low sale prices, as reported by NASDAQ, for the
Company's Common Stock for the periods indicated below, is as follows:
High Low
------ ------
1994
First Quarter 10 8
Second Quarter 9 7/8 8 5/8
Third Quarter 10 5/8 9
Fourth Quarter 11 9 5/8
1995
First Quarter 12 1/8 9 5/8
Second Quarter 13 11 3/8
Third Quarter 14 3/4 11 7/8
Fourth Quarter 16 1/2 13
The Company has never paid any cash dividends on its Common Stock and
does not intend to do so in the foreseeable future. It is the present intention
of the Company to retain any future earnings to support the continued growth of
the Company's business. Any future payment of dividends by the Company is
subject to the discretion of the Board of Directors and is dependent, in part,
on any dividends it may receive as the sole shareholder of PTLIC and the Agency,
and which PTLIC may in turn receive as the sole shareholder of Network America.
The payment of dividends by PTLIC and Network America, respectively, is in turn
dependent on a number of factors, including their respective earnings and
financial condition, business needs and capital and surplus requirements, and is
also subject to certain regulatory restrictions and the effect that such payment
would have on their ratings by A.M. Best Company. See Item 1, "Business--A.M.
Best's Rating" and Item 1, "Business--Government Regulation".
Item 6. Selected Financial Data
- ------ -----------------------
The following selected consolidated statement of operations data and
balance sheet data of the Company as of and for the years ended December 31,
1991, 1992, 1993, 1994 and 1995, have been derived from the Consolidated GAAP
Financial Statements of the Company which have been audited by Coopers and
Lybrand L.L.P., independent accountants.
33
Year Ended December 31,
-----------------------
1991 (1) 1992 (1) 1993 1994 1995
-------- -------- ---- ---- ----
(in thousands, except per share data and ratios)
Statement of Operations
Data:
Revenues:
Accident and health:
First year premiums $ 20,926 $ 22,477 $ 25,836 $ 26,968 $ 36,770
Renewal premiums 30,654 37,507 43,615 52,237 62,402
Life:
First year premiums 1 4 361 2,149 1,701
Renewal premiums 342 248 169 481 1,494
-------- -------- -------- -------- --------
Total premiums 51,923 60,236 69,981 81,835 102,367
Investment income, net 3,844 4,398 4,979 5,946 8,103
Net realized gains
(losses) (5) 173 182 8 46
Other income 356 371 321 305 347
-------- -------- -------- -------- --------
Total revenues 56,118 65,178 75,463 88,094 110,863
-------- -------- -------- -------- --------
Benefits and expenses:
Benefits to policyholders 25,031 34,285 40,829 48,757 64,879
First year commissions 12,922 14,282 16,722 19,365 26,223
Renewal commissions 5,946 6,004 7,060 7,866 10,128
Net acquisition costs
deferred (2) (5,663) (5,832) (6,640) (7,643) (15,303)
General and
administrative expense 8,105 8,511 9,350 10,262 12,171
Interest expense 237 192 184 162 327
-------- -------- -------- -------- --------
Total benefits and
expenses 46,578 57,442 67,505 78,769 98,425
-------- -------- -------- -------- --------
Income before federal
income taxes 9,540 7,736 7,958 9,325 12,438
Provision for federal
income taxes 2,845 2,436 2,137 2,562 3,609
Net income $ 6,695 $ 5,300 $ 5,821 $ 6,763 $ 8,829
======== ======== ======== ======== ========
Net income per share (3) $ 1.42 $ 1.12 $ 1.24 $ 1.45 $ 1.53
======== ======== ======== ======== ========
Weighted average shares
outstanding (3) 4,705 4,732 4,689 4,669 5,772
GAAP Ratios:
Loss ratios 48.2% 56.9% 58.3% 59.5% 63.4%
Expense ratio 41.5 38.4 38.1 36.7 32.8
-------- -------- -------- -------- --------
Total 89.7% 95.3% 96.4% 96.2% 96.2%
Selected Statutory Data:
Net premiums written $ 52,290 $ 60,385 $ 69,898 $ 81,878 $102,145
Statutory surplus
(beginning of
period) $ 8,595 $ 10,688 $ 12,301 $ 17,256 $ 21,067
Ratio of net premiums
written to
statutory surplus 6.1x 5.6x 5.7x 4.7x 4.8x
Balance Sheet Data:
Total investments $ 52,515 $ 60,685 $ 77,981 $ 91,490 $144,928
Total assets 92,466 115,699 136,948 164,346 237,744
Total debt 2,384 2,625 2,516 6,372 2,206
Total liabilities 51,941 69,327 85,599 108,903 140,637
Shareholders' equity (4) 40,525 46,070 51,349 55,444 97,107
Book value per share
(3)(4) $ 8.61 $ 9.72 $ 11.00 $ 11.87 $ 13.93
34
________________________
(1) Restated to reflect adoption of Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes," as of January 1, 1990. The effect of
adoption is as follows:
1991 1992
---- ----
Net income (reduction) addition $180,000 $(116,000)
Net income per share (reduction) addition $ .04 $ (.02)
(2) For a discussion of policy acquisition costs, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations".
(3) Adjusted to give effect to a 50% stock dividend on the Common Stock declared
on April 19, 1995, payable to shareholders of record on May 3, 1995 and
distributed on May 15, 1995.
(4) The Company adopted Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," on
January 1, 1994. The cumulative effect of this adoption was an increase on
January 1, 1994 in shareholders' equity of $3,529,000 to reflect the net
unrealized gain (net of $1,512,000 in deferred income taxes) on investment
securities classified as available for sale. As of December 31, 1994,
shareholders' equity was decreased by $2,714,000 due to unrealized losses of
$4,112,000 in the Company's investment portfolio. As of December 31, 1995,
shareholders' equity was increased by $4,056,000 due to gains of $6,146,000
in the Company's investment portfolio. These increases were caused
primarily by decreases in interest rates.
35
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- ------ -----------------------------------------------------------------------
of Operations
-------------
The following table sets forth the components of the Company's condensed
statements of operations for the years ended December 31, 1993, 1994 and 1995,
expressed as a percentage of total revenues.
Year Ended December 31,
-----------------------
1993 1994 1995
----- ----- -----
Revenues:
Accident and health:
First year premiums 34.2% 30.6% 33.2%
Renewal premiums 57.8% 59.3% 56.3%
Life:
First year premiums 0.5% 2.4% 1.5%
Renewal premiums 0.3% 0.6% 1.3%
Investment income, net 6.6% 6.8% 7.3%
Net realized gains 0.2% 0.0% 0.1%
Other income 0.4% 0.3% 0.3%
----- ----- -----
Total revenues 100.0% 100.0% 100.0%
Benefits and expenses:
Benefits to policyholders 54.1% 55.3% 58.5%
First year commissions 22.2% 22.0% 23.7%
Renewal commissions 9.4% 8.9% 9.1%
Net acquisition costs deferred (8.8) (8.6) (13.8)
General and administrative
expenses 12.4% 11.6% 11.0%
Interest expense 0.2% 0.2% 0.2%
----- ----- -----
Total benefits and
expenses 89.5% 89.4% 88.7%
----- ----- -----
Income before Federal
income taxes 10.5% 10.6% 11.3%
Provision for Federal
income taxes 2.8% 2.9% 3.3%
----- ----- -----
Net Income 7.7% 7.7% 8.0%
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Penn Treaty develops and markets insurance products designed for individuals
primarily age 65 and over. The Company's principal products are individual
fixed, defined benefit accident and health insurance policies covering long-term
skilled, intermediate and custodial nursing home care, home health care,
hospital care and policies that supplement Medicare benefits. The Company's
underwriting practices rely upon the base of experience which it has developed
over twenty years of providing nursing home care insurance, as well as upon
available industry and actuarial information. During recent years, the Company
has expanded its insurance products to include home health care insurance
policies, an important segment of the Company's business and of the accident and
health insurance industry nationwide. As the home health care
36
market has developed, the Company has encouraged the purchase of both nursing
home care and home health care coverage, and has introduced new life insurance
products as well, thus providing policyholders with enhanced protection while
broadening the Company's policy base. In late 1994, the Company introduced an
Independent Living policy which provides coverage over the full term of the
policy for services furnished by a homemaker or companion who is not a qualified
or licensed care provider. In 1995, long-term nursing home care and home health
care policies accounted for approximately 93% of the Company's annualized
premiums in force and nearly 87% of its consolidated revenues.
The Company and the Insurers are subject to the insurance laws and regulations
of each state in which they are licensed to write insurance. These laws and
regulations govern matters such as payment of dividends, settlement of claims
and loss ratios. Premiums charged for insurance products must be approved by
state regulatory authorities. In addition, the Company and the Insurers are
required to establish and maintain reserves with respect to reported and
incurred but not reported losses, as well as estimated future benefits payable
under the Company's insurance policies. These reserves must, at a minimum,
comply with mandated standards.
The Company's results of operations are affected significantly by the following
factors:
Level of required reserves for policies in force. The amount of reserves
relating to reported and unreported claims incurred is determined by
periodically evaluating historical claims experience and statistical information
with respect to the probable number and nature of such claims. Claim reserves
reflect actual experience through the most recent time period and policy
reserves reflect expectations of claims related to a block of business over its
entire life. The Company compares actual experience with estimates and adjusts
its reserves on the basis of such comparisons. Revisions to reserves are
reflected in the Company's results of operations through benefits to
policyholders expense.
Policy premium levels. The Company attempts to set premium levels to ensure
profitability, subject to the constraints of competitive market conditions and
state regulatory approvals.
Deferred acquisition costs. In connection with the sale of its insurance
policies, the Company defers and amortizes a portion of the policy acquisition
costs over the related premium paying periods of the life of the policy. These
costs include all expenses directly related to the acquisition of the policy,
including commissions, underwriting and other policy issue expenses. The
amortization of deferred acquisition costs is determined using the same
projected actuarial assumptions used in computing policy reserves. Deferred
acquisition costs can be affected by unanticipated termination of policies
because, upon such
37
unanticipated termination, the Company is required to expense fully the deferred
acquisition costs associated with the terminated policy.
The number of years a policy has been in effect. Claims costs tend to be
higher on policies which have been in force for a longer period of time. As the
policy ages, it is more likely that the insured will have need for services
covered by the policy. On the other hand, the longer the policy is in effect,
the more premium the Company will receive.
Investment income. The Company's investment portfolio consists primarily of
high-grade fixed income securities. Income generated from this portfolio is
largely dependent upon prevailing levels of interest rates. A small percentage
of the Company's investment portfolio (1.8%) is committed to high quality large
capitalization common-stocks.
Other factors which affect the Company's results of operations are lapsation
and persistency, both of which relate to the renewal of insurance policies, and
first year compared to renewal premiums. Lapsation is the termination of a
policy by nonrenewal and, pursuant to the Company's policy, is automatic if and
when premiums become more than 31 days overdue; however, policies may be
reinstated, if approved by the Company, within six months after the policy
lapses. Conversely, persistency represents the percentage of premiums renewed,
which the Company calculates by dividing the total annual premiums at the end of
each year (less first year business for that year) by the total annual premiums
in force for the prior year. For purposes of this calculation, a decrease in
total annual premiums in force at the end of any year would be a result of non-
renewal of policies, including those policies that have terminated by reason of
death, lapse due to nonpayment of premiums, and/or conversion to other policies
offered by the Company. First year premiums are premiums covering the first
twelve months a policy is in force. Renewal premiums are premiums covering all
subsequent periods.
Quarterly Data
The unaudited quarterly data for the Company for each quarter of 1994 and 1995
have been derived from unaudited financial statements and include all
adjustments, consisting only of normal recurring accruals, which the Company
considers necessary for a fair presentation of the results of operations for
these periods. Such quarterly operating results are not necessarily indicative
of the Company's future results of operations. The GAAP loss ratio for the
fourth quarter of 1994 was 67.9% compared to 56.7% for the first nine months of
1994. The primary cause of this increase was an increase in policy reserves
resulting from improved documentation of the Company's reserve system, which was
undertaken following the engagement of the new actuarial consultant in the
38
third quarter of 1993. The effect of this increase was partially offset by an
increase in deferred acquisition costs in the fourth quarter of 1994, as
reflected by an improvement in the expense ratio, due primarily to the increase
in new life insurance policies written in 1994 for which deferred acquisition
costs were first established in the fourth quarter of 1994.
39
The following table presents unaudited quarterly data for the Company for each
quarter of 1994 and 1995.
1994
--------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- ----------- ---------- ----------
(in thousands, except per share data and ratios)
Accident and health
premiums $19,382 $19,505 $19,861 $20,456
Life premiums 738 594 633 665
------- ------- ------- -------
Total premiums 20,120 20,099 20,494 21,121
Investment income, net 1,369 1,434 1,515 1,628
Net realized capital gains
and losses and
other income 88 59 75 91
------- ------- ------- -------
Total revenues 21,577 21,592 22,084 22,840
Benefits to policyholders 11,228 11,343 11,856 14,331
Commissions 6,690 7,080 6,460 7,001
Net acquisition costs
deferred (1,288) (1,889) (1,027) (3,439)
Net income $ 1,693 $ 1,700 $ 1,644 $ 1,726
Net income per share $ .36 $ .37 $ .35 $ .37
======= ======= ======= =======
GAAP loss ratio 55.8% 56.4% 57.8% 67.9%
GAAP expense ratio 39.3 38.8 39.3 29.7
------- ------- ------- -------
Total 95.1% 95.2% 97.1% 97.6%
1995
----------------------------------------------
First Second Third Fourth
Quarter(1) Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share data and ratios)
Accident and health
premiums $22,562 24,895 25,510 26,205
Life Premiums 846 795 746 808
------- ------- ------- -------
Total premiums 23,408 25,690 26,256 27,013
Investment income, net 1,682 1,807 2,177 2,436
Net realized gains and
other income 74 71 128 121
------- ------- ------- -------
Total revenues 25,164 27,568 28,561 29,570
Benefits to policyholders 14,699 16,412 16,387 17,381
Commissions 7,400 9,371 9,261 10,319
Net acquisition costs
deferred (2,425) (4,200) (3,509) (5,169)
Net income $ 1,842 1,963 2,343 2,681
Net income per share $ .39 $ .42 $ .35 $ .37
======= ======= ======= =======
GAAP loss ratio 62.8% 63.9% 62.4% 64.3%
GAAP expense ratio 33.4 32.5 33.6 31.6
------- ------- ------- -------
Total 96.2% 96.4% 96.0% 95.9%
- -------------------------
(1) Adjusted to give effect to a 50% stock dividend on the Common Stock
declared on April 19, 1995, payable to shareholders of record on May 3,
1995 and distributed on May 15, 1995.
Years Ended December 31, 1995 and 1994:
Accident and Health Premiums. First year accident and health premiums
earned by the Company in 1995, including long-term care and Medicare supplement,
increased 36.3% to $36,769,835, compared to $26,967,973 in 1994.
40
First year long-term care premiums earned by the Company in 1995 increased
36.9% to $36,507,436, compared to $26,669,960 in the same period in 1994. This
increase was attributable to increased sales of home health care policies, which
increased to $14,560,437 in 1995 from $4,771,366 in 1994 and continued strong
sales of nursing home care policies, which increased from $21,898,594 in 1994 to
$21,946,999 in 1995. These results reflect increasing market demand for the
Company's home health care policies relative to its nursing home policies and
the Company's marketing focus on its home health care Independent Living policy
first introduced in the fourth quarter of 1994. Independent Living policy sales
were $10,643,354 in 1995. First year Medicare supplement premiums earned by
the Company in 1995 decreased 12.0% to $262,399, compared to $298,013 in 1994.
This decrease was due to the Company's continued de-emphasis of its Medicare
supplement products because of lower profit margins associated with this line of
business.
Renewal accident and health premiums earned by the Company in 1995,
including long-term care and Medicare supplement, increased 19.5% to
$62,402,068, compared to $52,236,980 in 1994.
Renewal long-term care premiums earned by the Company in 1995 increased
21.6% to $59,624,488, compared to $49,054,157 in 1994. This increase reflects
renewal of a larger base of in-force policies as well as the effect of rate
increases the Company received in various states. The Company believes that
this increase also reflects an increase in persistency which increased from
75.4% in 1994 to 77.4% in 1995. Renewal Medicare supplement premiums earned by
the Company in 1995 decreased 12.7% to $2,777,580, compared to $3,182,823 in
1994, consistent with the Company's de-emphasis in marketing this product
discussed above.
Life Premiums. First year life premiums earned by the Company in 1995
decreased 20.9% to $1,700,549, compared to $2,149,039 in 1994. This change was
attributable to record sales of the Company's life insurance products during
1994, particularly in the first quarter of 1994 resulting from the Company's
focused marketing efforts in late 1993 and early 1994 related to the
introduction of these new products. Since the first quarter of 1994, first year
life premiums have been negatively impacted by the Company's utilization of
stricter underwriting standards.
Renewal life premiums earned by the Company in 1995 increased 210.7% to
$1,494,153, compared to $480,842 in 1994. This increase was primarily the
result of renewal of first year policies written in 1993 and 1994.
Net Investment Income. Net investment income earned by the Company in 1995
increased 36.3% to $8,102,809, compared to $5,946,034 in 1994. This increase
was primarily the result of growth in the Company's investment assets due to
continued premium growth during 1995 and proceeds of $22,065,000 from the
Company's
41
public offering in July, 1995. Refer to "Liquidity and Capital Resources" for a
discussion of the public offering. The average yield on the Company's
investments was 6.5% in 1995 compared to 6.5% in 1994.
Benefits to Policyholders. Accident and health benefits to policyholders
in 1995 increased 33.0% to $63,175,068, compared to $47,497,004 in 1994. The
Company's accident and health loss ratio (the ratio of benefits to policyholders
to total accident and health premiums) was 63.7% in 1995, compared to 60.0% in
1994. This increase in loss ratio was due to (i) refinement of actuarial data
used to calculate return of premium benefits and (ii) modification of
assumptions used to reflect benefit payment frequency. The refinement of
actuarial data and modification of assumptions were recommended by the Company's
actuarial consultant. Reserves are increased on the anniversary date of the
policy.
Life benefits to policyholders increased to $1,704,207 from $1,260,480 in
1994. The life loss ratio was 53.3% in 1995, compared to 47.9% in 1994. These
increases in benefits and the Company's life loss ratio are a result of the sale
of the Company's new life insurance products which were introduced in late 1993.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition
costs in 1995 increased 100.2% to $15,303,161 compared to $7,642,875 in 1994,
consistent with the growth of the Company's business. This deferral is net of
amortization, which decreases or increases as the Company's actual persistency
is better or worse than the persistency assumed for reserving purposes. The
Company believes that amortization decreased in 1995 relative to 1994 as a
result of better persistency.
General and Administrative Expenses. General and administrative expenses
increased 18.6% to $12,170,913, compared to $10,262,410 in 1994. This increase
was due to increases in marketing and underwriting costs associated with the
introduction of a new product and increased sales. The ratio of general and
administrative expenses to total revenues was 11.0% in 1995 compared to 11.6% in
1994, due to the Company's ability to control these expenses.
First Year Commissions. First year commissions on accident and health
business increased 40.7% to $24,897,878, compared to $17,694,410 in 1994. The
ratio of first year accident and health commissions to first year accident and
health premiums was 67.7% in 1995 compared to 65.6% in 1994. The increase in
the ratio is a result of a decrease in the average age of the insured covered by
new business, which results in a higher agent commission.
First year commissions on life business decreased to $1,325,521, compared
to $1,670,785 in 1994, corresponding to a decrease in first year life premiums.
The ratio of first year life
42
commissions to first year life premiums was 78.0% in 1995 compared to 77.8% in
1994, reflecting a commission structure which varies with the premium payment
terms of policies.
Renewal Commissions. Renewal commissions on accident and health business
increased 27.1% to $9,964,110, compared to $7,840,877 in 1994, consistent with
the increase in renewal premium discussed above. The ratio of renewal accident
and health commissions to renewal accident and health premiums was 16.0% in 1995
compared to 15.0% in 1994. This ratio fluctuates in relation to the age of the
policies in-force and the rates of commissions paid to agents.
Provision for Federal Income Taxes. The provision for federal income taxes
recorded by the Company in 1995 increased 40.9% to $3,609,000, compared to
$2,562,000 in 1994. The effective tax rate increased to 29.0% in 1995 from
27.5% in 1994. The Company's effective tax rate was below the normal federal
corporate rate as a result of credits from the small life insurance company
deduction as well as the Company's investments in tax-exempt bonds.
Years Ended December 31, 1994 and 1993:
Accident and Health Premiums. First year accident and health premiums
earned by the Company in 1994, including long-term care and Medicare supplement,
increased 4.4% to $26,967,973, compared to $25,836,521 in 1993.
First year long-term care premiums earned by the Company in 1994 increased
5.3% to $26,669,960, compared to $25,328,748 in 1993. This increase reflects
growth in new business in California and other states. The Company believes
that new business growth was moderated, in part, by consumer concerns regarding
the proposed federal health care legislation. First year Medicare supplement
premiums earned by the Company in 1994 decreased 41.3% to $298,013, compared to
$507,773 in 1993. This decrease was due to the Company's gradual de-emphasis of
its Medicare supplement products because of lower profit margins associated with
this line of business.
Renewal accident and health premiums earned by the Company in 1994,
including long-term care and Medicare supplement, increased 19.8% to
$52,236,980, compared to $43,614,746 in 1993.
Renewal long-term care premiums earned by the Company in 1994 increased
22.3% to $49,054,157, compared to $40,095,519 in 1993. This reflects increases
in premiums from policies written in previous years which were enhanced by an
improvement in persistency from 70.0% in 1993 to 75.4% in 1994 and, to a lesser
extent, the effect of rate increases the Company received in various states.
Renewal medicare supplement premiums earned by the Company in 1994 decreased
9.6% to $3,182,823, compared to $3,519,227 in 1993,
43
consistent with the Company's de-emphasis in marketing this product discussed
above.
Life Premiums. First year life premiums earned by the Company in 1994
increased to $2,149,039, compared to $360,601 in 1993. This increase was the
result of sales for the first full year of the Company's new life insurance
products introduced in August 1993. Sales were enhanced during 1994 as
additional states granted regulatory approvals of these new products.
Renewal life premiums earned by the Company in 1994 increased 183.7% to
$480,842, compared to $169,486 in 1993. This increase was the result of the
increase in life premiums from policies introduced in 1993.
Net Investment Income. Net investment income earned by the Company in 1994
increased 19.4% to $5,946,034, compared to $4,979,068 in 1993. This increase
was primarily the result of growth in the Company's investment assets due to
continued premium growth during 1994. The average yield on the Company's
investments was 6.5% in 1994 compared to 6.8% in 1993.
Benefits to Policyholders. Accident and health benefits to policyholders
in 1994 increased 17.2% to $47,497,004, compared to $40,535,046 in 1993,
consistent with the growth in business. The Company's accident and health loss
ratio was 60.0% in 1994 compared to 58.4% in 1993. This increase was due to (i)
refinement of actuarial data used to reflect policy benefit terms and (ii) the
increase in claim reserves inherent in the Company's business as it matures,
offset in part by a corresponding decrease in policy reserves. There are timing
differences between these components of the loss ratio, as the claim reserve
reflects actual experience through the most recent quarter, while the policy
reserve reflects expectations regarding the block of business over its entire
life.
Life benefits to policyholders increased to $1,260,480 from $293,621 in
1993. The life loss ratio was 47.9% in 1994, compared to 55.4% in 1993. The
increase in benefits was due to increased sales of the new life products
discussed above. The life loss ratio decreased as a result of a change in the
life insurance product mix, reflecting the introduction of new life products
discussed above.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition
costs in 1994 increased 15.1% to $7,642,875 compared to $6,639,551 in 1993,
consistent with the growth of the Company's business. This deferral is net of
amortization, which decreases or increases as the Company's actual persistency
is better or worse than the persistency assumed for reserving purposes.
44
General and Administrative Expenses. General and administrative expenses
increased 9.8% to $10,262,410, compared to $9,349,746 in 1993. This increase
was due to increases in personnel and underwriting costs as a result of
increases in new business and utilization of stricter underwriting standards.
The ratio of general and administrative expenses to total revenues was 11.6 % in
1994 compared to 12.4% in 1993, due to the Company's ability to control these
expenses.
First Year Commissions. First year commissions on accident and health
business increased 7.7% to $17,694,410, compared to $16,433,432 in 1993. The
ratio of first year accident and health commissions to first year accident and
health premiums was 65.6% in 1994 compared to 63.6% in 1993. This increase is a
result of a decrease in the average age of the insured covered by new business,
which results in a higher agent commission.
First year commissions on life business increased to $1,670,785, compared
to $288,038 in 1993. The ratio of first year life commissions to first year
life premiums was 77.8% in 1994 compared to 80.0% in 1993, reflecting a
commission structure which varies with the premium payment terms of policies.
The increase in commissions paid is consistent with the growth of life premiums.
Renewal Commissions. Renewal commissions on accident and health business
increased 11.1% to $7,840,877, compared to $7,057,477 in 1993. The increases in
commissions are consistent with the growth of the business in previous years.
The ratio of renewal accident and health commissions to renewal accident and
health premiums was 15.0% in 1994 compared to 16.0% in 1993. This ratio
decrease reflects lapsation of older policies which paid a higher renewal
commission rate, and premium rate increases which do not require additional
commissions.
Provision for Federal Income Taxes. The provision for federal income taxes
recorded by the Company in 1994 increased 19.9% to $2,562,000, compared to
$2,137,000 in 1993. The effective tax rate increased to 27.5% in 1994 from
26.9% in 1993. The Company's effective tax rate was below the normal federal
corporate rate as a result of credits from the small life insurance company
deduction as well as the Company's investments in tax-exempt bonds.
Changes in Accounting Principles. In the first quarter of 1993
--------------------------------
the Company retroactively adopted Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" (SFAS 109). Under the asset and
liability method provided for by SFAS 109, deferred tax assets and liabilities
are recognized for the tax consequences of temporary differences between the
financial statement carrying amounts and the tax basis of existing assets and
liabilities by applying enacted statutory tax rates.
45
In 1993, the Company adopted Statement of Financial Accounting
Standards No. 113 (SFAS No. 113), "Accounting and Reporting of Short-Duration
and Long-Duration Contracts." This Statement established the conditions a
reinsurance contract must meet in order to be accounted for as such. In
addition, it eliminates the industry practice of reporting financial statement
items, net of the effects of reinsurance. SFAS 113 did not impact the Company's
results of operations, other than the financial statement presentation.
In May 1993, the Financial Accounting Standards Board issued SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities." Refer
to "Liquidity and Capital Resources" for discussion of adoption.
New Accounting Principles. In October 1995, Statement of Financial
--------------------------
Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based
Compensation," was issued. SFAS No. 123, which is effective January 1, 1996,
provides an alternative method of accounting for stock-based compensation
arrangements, based on fair value of the stock-based compensation determined by
an option pricing model utilizing various assumptions regarding the underlying
attributes of the options and the Company's stock. The accounting under SFAS
No. 123 differs from the existing method of accounting for stock-based
compensation which is provided in Accounting Principles Board Opinion No. 25
(APB No. 25), "Accounting for Stock Issued to Employees." The Financial
Accounting Standards Board encourages entities to adopt the fair value based
method, but does not require the adoption of this method. For those entities
that continue to apply APB 25, pro forma disclosure of the effects, if adopted,
of SFAS No. 123 on net income and earnings per share would be required in the
1996 financial statements. The Company will continue to apply APB No. 25 and,
therefore, there will be no impact on the financial position and results of
operation.
Impact of Increases in Cost of Medical Care. Increases in the cost of
-------------------------------------------
medical care tend to increase the need for insurance. Many policyholders who
once had adequate insurance coverage increased their insurance coverage to
provide the same relative financial benefit and protection. The increases in
medical costs lead to accident and health policies requiring higher benefits and
an increased need for the products. Consequently, the Company offers riders to
its insurance policies which provide for increases in policyholder benefits each
year in the amount of 5% compounded annually on the anniversary date of the
policy for 20 years or to age 85, whichever occurs first, or for the lifetime of
the policyholder, as is mandated in certain states.
The adequacy of premium rates in relation to the level of health
claims is constantly monitored by the Company and, where
46
appropriate, premium rates on such policies are increased as policy benefits
increase. Failure to make such increases commensurate with health care cost
increases may result in a loss from health insurance operations.
Liquidity and Capital Resources. The Company's consolidated liquidity
-------------------------------
requirements have historically been created and met from the operations of the
Insurers. The Company's primary sources of cash are premiums and investment
income. The primary uses of cash are policy acquisition costs (principally
commissions), payments to policyholders, investment purchases and general and
administrative expenses.
The Company invests in securities and other investments authorized by
applicable state laws and regulations and follows an investment policy designed
to maximize yield to the extent consistent with liquidity requirements and
preservation of assets. At December 31, 1995, the average maturity of the
Company's bond portfolio was 6.4 years, and its market value exceeded cost by
4.1% or $5,642,566. At December 31, 1994, the average maturity of the Company's
portfolios was 6.9 years and its market value was below cost by 4.4% or
approximately $4,165,000. The Company's equity portfolio exceeded costs by
$503,083 or 23.9% in 1995 and $52,780 or 6.0% in 1994.
On December 28, 1994, the Company entered into an agreement with
CoreStates Bank, N.A., whereby a loan was extended to the Company in an amount
of $4,000,000. The proceeds of the loan were contributed to the surplus of
PTLIC in the form of cash to strengthen its overall capital position. The
Company repaid this loan as required by the loan agreement, with a portion of
the proceeds of the Company's recent public offering of 2,300,000 shares of
common stock. The public offering was consummated on July 6, 1995 and the
Company realized net proceeds of $26,165,000, including the proceeds from the
exercise of the underwriters' over-allotment option.
On January 1, 1994, the Company adopted SFAS 115. The cumulative
effect of adoption of SFAS 115 was an increase in shareholders' equity of
$3,528,512, net of taxes, for unrealized gains of $5,040,731 in the investment
securities available for sale portfolio. During the year ended December 31,
1994, the Company experienced a decrease in unrealized gains of $9,205,393. As
of December 31, 1995, shareholders' equity was increased by $4,055,788 due to
unrealized gains of $6,145,649 in the investment portfolio. As of December 31,
1994 shareholders' equity was decreased by $2,713,842 due to unrealized losses
of $4,111,882 in the investment portfolio.
The capital position of the Insurers was improved by the contribution
of $14,000,000 of the net proceeds of the recent public offering to the capital
and surplus of the Insurers during
47
the third quarter of 1995. During 1994, the Company contributed $4,000,000 in
cash to PTLIC. During 1993, the Company contributed $2,000,000 in bonds to the
Insurers. The Company believes that the Insurers' capital and surplus presently
meets or exceeds the requirements in all jurisdictions in which they each are
licensed.
The Company's continued growth is dependent upon its ability to (i)
continue marketing efforts to expand its historical markets, (ii) continue to
expand its network of agents and effectively market its products in states where
the Insurers are currently licensed and (iii) fund such marketing and expansion
while at the same time maintaining minimum statutory levels of capital and
surplus required to support such growth. Management believes that the funds
necessary to accomplish the foregoing, including funds required to maintain
adequate levels of statutory surplus in the Insurers, can be met for at least
the next 24 months by funds generated from the Company's recent public offering
and from operations.
The long-term care insurance industry is a subject of pending
legislation in Congress which, in its present form, provides for a number of
modifications of existing law, including the tax deductibility of long-term care
insurance premiums and the implementation of minimum consumer protection
standards to be included in all long-term care insurance policies. See
"Government Regulation." There can be no assurance that such legislation will
be enacted or, if enacted, that the current proposals will be included.
The Company regularly evaluates potential acquisition opportunities
and often makes preliminary inquiries to determine whether potential acquisition
candidates might by interested in being acquired by the Company. The Company
periodically enters into negotiations with respect to such potential acquisition
opportunities. On March 15, 1996, the Company signed an agreement with Health
Insurance of Vermont, Inc. ("HIVT") providing that the Company will acquire HIVT
by means of a statutory merger with a subsidiary of the Company. Completion of
the merger is subject to approval of regulatory authorities, and to certain
other conditions. HIVT is licensed to conduct business in 46 states, including
New Jersey, West Virginia, Kansas, Maine and Massachusetts. Upon completion of
the merger the Company would be licensed in all states with the exception of New
York. The Company currently has a license application pending in New York.
In the event the Company (i) fails to maintain minimum loss ratios
calculated in accordance with statutory guidelines, (ii) fails to meet other
requirements mandated and enforced by regulatory authorities, (iii) has adverse
claim experience in the future, (iv) is unable to obtain additional financing to
support future growth, or (v) the economy continues to effect the buying
48
power of senior citizens, the Company's results of operations, liquidity and
capital resources could be adversely affected.
Item 8. Financial Statements and Supplementary Data
- ------ -------------------------------------------
49
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
REPORT ON AUDITS OF
CONSOLIDATED FINANCIAL STATEMENTS
as of December 31, 1995 and 1994 and
for the years ended
December 31, 1995, 1994 and 1993
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Pages
-----
Report of Independent Accountants 2
Financial Statements:
Consolidated Balance Sheets at December 31,
1995 and 1994 3
Consolidated Statements of Operations for the
years ended December 31, 1995, 1994 and 1993 4
Consolidated Statements of Changes in Shareholders'
Equity for the years ended December 31, 1995,
1994 and 1993 5
Consolidated Statements of Cash Flows for the
years ended December 31, 1995, 1994 and 1993 6
Notes to Consolidated Financial Statements 7 - 24
1
Report of Independent Accountants
To the Board of Directors of
Penn Treaty American Corporation
Allentown, Pennsylvania
We have audited the accompanying consolidated balance sheets of Penn Treaty
American Corporation and Subsidiaries as of December 31, 1995 and 1994, and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Penn Treaty
American Corporation and Subsidiaries as of December 31, 1995 and 1994, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1995, in conformity with generally
accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for investments in 1994.
/s/ Coopers & Lybrand L.L.P.
COOPERS & LYBRAND L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 6, 1996
2
PENN TREATY AMERICAN CORPORATION AND
SUBSIDIARIES
Consolidated Balance Sheets
as of December 31, 1995 and 1994
ASSETS 1995 1994
---- ----
Investments:
Bonds, available for sale at market (amortized cost
$136,600,775 and $94,660,452, respectively) $ 142,243,341 $ 90,495,790
Equity securities at market value (cost $2,102,529 and
$880,507, respectively) 2,605,612 933,287
Policy loans 79,404 61,315
------------- -------------
Total investments 144,928,357 91,490,392
Cash and cash equivalents 8,661,061 7,226,769
Property and equipment, at cost, less accumulated
depreciation of $1,854,065 and $1,752,474, respectively 5,740,353 4,874,132
Unamortized deferred policy acquisition costs 63,133,759 47,830,598
Receivables from agents, less allowance for uncollectible
amounts of $231,226 for 1995 and 1994 1,275,481 1,148,564
Accrued investment income 2,436,435 1,627,734
Cost in excess of fair value of net assets acquired, less accumulated
amortization of $231,826 and $196,066, respectively 1,197,574 1,233,334
Receivable from reinsurers 7,730,828 6,525,247
Federal income tax refundable - 481,799
Other assets 2,420,422 1,907,822
------------- -------------
Total assets $ 237,744,270 $ 164,346,391
============= =============
LIABILITIES 1995 1994
---- ----
Policy reserves:
Accident and health $ 62,007,433 $ 43,140,978
Life and annuity 7,116,848 5,861,581
Unearned premium reserves 26,503 52,336
Policy and contract claims 50,206,608 41,344,428
Accounts payable and other liabilities 2,681,499 2,138,290
Mortgage and other debt 2,206,117 6,372,209
Federal income taxes payable 183,249 -
Deferred income taxes 16,208,959 9,993,026
------------- -------------
Total liabilities 140,637,216 108,902,850
------------- -------------
Commitments and contingencies (Note 9)
SHAREHOLDERS' EQUITY*
Preferred stock, par value $1.00; 5,000,000 shares
authorized, none outstanding - -
Common stock, par value $.10; 10,000,000 shares authorized,
7,576,913 and 5,276,913 shares issued, respectively 757,691 527,691
Additional paid-in capital 41,146,594 15,311,594
Unrealized appreciation (depreciation), net of deferred taxes 4,055,788 (2,713,842)
Retained earnings 52,852,855 44,023,972
------------- -------------
98,612,928 57,149,415
Less 605,629 of common shares held in treasury, at cost (1,705,874) (1,705,874)
------------- -------------
97,107,054 55,443,541
------------- -------------
Total liabilities and shareholders' equity $ 237,744,270 $ 164,346,391
============= =============
* Restated to reflect a 50% stock dividend, see Note 13.
See accompanying notes to consolidated financial statements.
3
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
for the years ended December 31, 1995, 1994 and 1993
1995 1994 1993
---- ---- ----
Revenues:
Accident and health premiums $ 99,171,903 $ 79,204,953 $ 69,451,267
Life premiums 3,194,702 2,629,881 530,087
------------ ------------ ------------
102,366,605 81,834,834 69,981,354
Net investment income 8,102,809 5,946,034 4,979,068
Net realized capital gains 46,431 8,335 182,203
Other income 347,113 304,823 320,054
------------ ------------ ------------
110,862,958 88,094,026 75,462,679
------------ ------------ ------------
Benefits and expenses:
Benefits to policyholders 64,879,275 48,757,484 40,828,667
Commissions 36,351,140 27,230,679 23,782,238
Net policy acquisition costs deferred (15,303,161) (7,642,875) (6,639,551)
General and administrative expense 12,170,913 10,262,410 9,349,746
Interest expense 326,908 161,527 183,222
------------ ------------ ------------
98,425,075 78,769,225 67,504,322
------------ ------------ ------------
Income before Federal income taxes 12,437,883 9,324,801 7,958,357
Provision for Federal income taxes 3,609,000 2,562,000 2,137,000
------------ ------------ ------------
Net income $ 8,828,883 $ 6,762,801 $ 5,821,357
============ ============ ============
Earnings per share $ 1.53 $ 1.45* $ 1.24*
============ ============ ============
Weighted average number of shares
outstanding 5,771,558 4,668,834* 4,689,152*
============ ============ ============
* Restated to reflect a 50% stock dividend, see Note 13.
See accompanying notes to
consolidated financial statements.
4
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1995, 1994* and 1993*
Unrealized
Appreciation
(Depreciation)
Common Stock Additional Net of Total
---------------------- Paid-in Deferred Retained Treasury Shareholders'
Shares Amount Capital Taxes Earnings Stock Equity
---------- ---------- ------------ -------------- ------------ ------------ -----------------
Balance, December 31, 1992 3,514,124 $ 351,412 $ 15,448,271 $ 80,002 $ 31,439,814 $ (1,249,200) $ 46,070,299
Retroactive recognition of
May 15, 1995 stock dividend 1,755,692 175,569 (175,569) - - - -
Proceeds from exercise of options 2,496 250 12,230 - - - 12,480
Acquisition of treasury stock
(75,000 shares) - - - - - (456,250) (456,250)
Net income - - - - 5,821,357 - 5,821,357
Change in net unrealized
depreciation of equity
securities - - - 98,549 - - (98,549)
--------- ---------- ------------ -------------- ------------ ------------ -------------
Balance, December 31, 1993 5,272,312 527,231 15,284,932 (18,547) 37,261,171 (1,705,450) 51,349,337
Initial adoption of SFAS No. 115 - - - 3,528,500 - - 3,528,500
Proceeds from exercise of options 4,601 460 26,662 - - - 27,122
Acquisition of treasury stock
(42 shares) - - - - - (424) (424)
Net income - - - - 6,762,801 - 6,762,801
Change in net unrealized
depreciation - - - (6,223,795) - - (6,223,795)
--------- ---------- ------------ -------------- ------------ ------------ -------------
Balance, December 31, 1994 5,276,913 527,691 15,311,594 (2,713,842) 44,023,972 (1,705,874) (55,443,541)
Proceeds from public offering 2,300,000 230,000 25,835,000 - - - 26,065,000
Net income - - - - 8,828,883 - 8,828,883
Change in net unrealized
appreciation - - - 6,769,630 - - 6,769,630
--------- ---------- ------------ -------------- ------------ ------------ -------------
Balance, December 31, 1995 7,576,913 $ 757,691 $ 41,146,594 $ 4,055,788 $ 52,852,855 $ (1,705,874) $ 97,107,054
========= ========== ============ ============== ============ ============ =============
* Restated to reflect a 50% stock dividend, see Note 13.
See accompanying notes to consolidated financial statements.
5
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
for the years ended December 31, 1995, 1994 and 1993
1995 1994 1993
---- ---- ----
Cash flows from operations:
Net income $ 8,828,883 $ 6,762,801 $ 5,821,357
Adjustments to reconcile net income
to net cash provided by operations:
Amortization of intangible assets 35,760 348,260 415,482
Policy acquisition costs, net (15,303,161) (7,642,875) (6,639,551)
Deferred income taxes 2,726,032 1,779,620 320,463
Depreciation expense 353,589 342,246 343,510
Net realized capital gains (46,431) (8,335) (182,203)
Changes in:
Receivables from agents (126,917) 84,183 218,201
Receivable from reinsurers (1,205,581) (1,052,417) (450,231)
Policy and contract claims 8,862,180 9,130,004 6,458,102
Policy and unearned premium reserves 20,097,887 9,815,820 9,481,956
Accounts payable and other liabilities 543,209 179,541 27,298
Federal income taxes recoverable 481,799 (481,799) -
Federal income taxes payable 183,249 (67,102) (164,898)
Accrued investment income (808,701) (340,910) (204,983)
Other, net (512,600) (330,353) (136,146)
------------ ------------ ------------
Net cash provided by operations 24,109,197 18,518,684 15,308,357
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from sales of bonds 5,356,956 4,671,988 11,882,435
Proceeds from sales of equity securities - 1,451,329 1,836,279
Maturities and calls of bonds 5,421,112 4,246,278 4,502,963
Purchase of bonds (52,690,049) (27,956,095) (32,621,564)
Purchase of equity securities (1,222,022) - (2,856,156)
Acquisition of property and equipment (1,219,810) (372,511) (105,718)
------------ ------------ ------------
Cash used in investing activities (44,353,813) (17,959,011) (17,361,761)
------------ ------------ ------------
Cash flows from financing activities:
Net proceeds of public offering 26,065,000 - -
Proceeds from exercise of options - 27,122 12,480
Repayment of mortgages and other debt (4,166,092) (143,505) (109,467)
Purchase of treasury stock - (424) (456,250)
Proceeds from note payable - 4,000,000 -
------------ ------------ ------------
Cash provided by (used in)
financing activities 21,898,908 3,883,193 (553,237)
------------ ------------ ------------
Increase (decrease) in cash
and cash equivalents 1,654,292 4,442,866 (2,606,641)
Cash and cash equivalents balances:
Beginning of year 7,226,769 2,783,903 5,390,544
------------ ------------ ------------
End of year $ 8,881,061 $ 7,226,769 $ 2,783,903
============ ============ ============
Supplemental disclosures of cash flow
information:
Cash paid during the year for interest $ 327,205 $ 163,414 $ 183,816
Cash paid during the year for Federal
income taxes $ 217,920 $ 1,331,281 $ 1,981,435
See accompanying notes to
consolidated financial statements.
6
PENN TREATY AMERICAN CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies:
Basis of Presentation:
The accompanying consolidated financial statements of Penn Treaty American
Corporation and its Subsidiaries (the Company) have been prepared in
accordance with generally accepted accounting principles (GAAP) and include
Penn Treaty Life Insurance Company (PTLIC), Senior Financial Consultants
Company and Network America Life Insurance Company (Network America). All
significant intercompany transactions and balances have been eliminated in
consolidation. Certain prior year amounts have been reclassified to conform
with the current year presentation.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent liabilities
as of December 31, 1995 and 1994 and the reported amounts of revenues and
expenses during 1995, 1994 and 1993. Actual results could differ from those
estimates.
Nature of Operations:
The Company sells both accident and health and life insurance through its
wholly-owned subsidiaries. The Company's principal lines of business are
long-term care products and home health care products. The Company
distributes its products principally through managing general agents and
independent agents. The Company operates its home office in Allentown,
Pennsylvania and has satellite offices in California and Florida, whose
principal functions are to market and underwrite new business. The Company
is licensed to operate in 44 states. State regulatory authorities have
powers relating to granting and revoking licenses to transact business, the
licensing of agents, the regulation of premium rates and trade practices,
the form and content of insurance policies, the content of advertising
material, financial statements and the nature of permitted practices. Sales
in 11 states accounted for approximately 87% of the Company's premiums for
the year ended December 31, 1995.
7
Notes to Consolidated Financial Statements, Continued
1. Summary of Significant Accounting Policies, continued:
Investments:
On January 1, 1994, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities" ("SFAS No. 115"). SFAS No. 115 requires all
entities to allocate their investments among three categories as
applicable: (1) trading, (2) available for sale, and (3) held to maturity.
Management categorized all of its investment securities as available for
sale since they may be sold in response to changes in interest rates,
prepayments, and similar factors. Investments in this classification are
reported at the current market value with net unrealized gains or losses,
net of the applicable deferred income tax effect, being added to or
deducted from the Company's total shareholders' equity on the balance
sheet.
In accordance with SFAS No. 115, prior period financial statements have not
been restated to reflect the change in accounting principle. The cumulative
effect of adopting SFAS No. 115 as of January 1, 1994 was an increase in
the balance of shareholders' equity of $3,528,500 to reflect the net
unrealized gain (net of $1,512,000 in deferred income taxes) on investment
securities classified as available for sale. As of December 31, 1994,
shareholders' equity was decreased by $2,714,000 due to net unrealized
losses of $4,112,000 in the investment portfolio. As of December 31, 1995
shareholders' equity was increased by $4,056,000 due to net unrealized
gains of $6,146,000.
Realized investment gains and losses, including provisions for market
declines considered to be other than temporary, are included in income.
Gains and losses on sales of investment securities are computed on the
specific identification method.
Policy loans are stated at the aggregate unpaid principal balance.
Unamortized Deferred Policy Acquisition Costs:
The costs primarily related to and varying with the acquisition of new
business, principally commissions, underwriting and policy issue expenses,
have been deferred. These deferred costs are amortized over the related
premium-paying periods utilizing the same projected premium assumptions
used in computing reserves for future policy benefits. Net policy
acquisition costs deferred, on the consolidated statements of operations,
are net of amortization of $6,859,194, $7,010,329, and $6,567,642 for the
years ended December 31, 1995, 1994, and 1993, respectively.
Property and Equipment:
Property and equipment are stated at cost, less accumulated depreciation
and amortization. Expenditures for improvements which materially increase
the estimated useful life of the asset are capitalized. Expenditures for
repairs and maintenance are charged to operations as incurred. Depreciation
is provided principally on a straight-line basis over the related asset's
estimated life. Upon sale or retirement, the cost of the asset and the
related accumulated depreciation are removed from the accounts and the
resulting gain or loss, if any, is included in operations.
Cash and Cash Equivalents:
Cash and cash equivalents include highly liquid debt instruments purchased
with a maturity of three months or less
8
Notes to Consolidated Financial Statements, Continued
1. Summary of Significant Accounting Policies, continued:
Cost in Excess of Fair Value of Net Assets Acquired:
The costs in excess of fair value of net assets acquired are being
amortized to expense on a straight-line basis over a 40-year period.
Other Assets:
Other assets consist primarily of due and unpaid insurance premiums.
Income Taxes:
Deferred income taxes relate principally to temporary differences in
reporting policy acquisition costs and policy reserves for financial
statement and income tax purposes.
Premium Recognition:
Premiums on accident and health insurance, the majority of which is
guaranteed renewable, and life insurance are recognized when due. Premiums
on credit life and credit accident and health insurance are reported as
earned in proportion to the amount at risk over the contract term.
Estimates of premiums due but not yet collected are accrued.
Policy Reserves and Policy and Contract Claims:
The Company establishes liabilities to reflect the impact of level renewal
premiums and the increasing risks of claims losses as policyholders age.
The present value of estimated future policy benefits to be paid to or on
behalf of policyholders less the present value of estimated future net
premiums to be collected from policyholders is accrued when premium revenue
is recognized. Those estimates are based on assumptions, such as estimates
of expected investment yield, mortality, morbidity, withdrawals and
expenses, applicable at the time insurance contracts are made, including a
provision for the risk of adverse deviation. These reserves differ from
policy and contract claims, which are recognized when insured events occur.
Policy and contract claims include amounts representing: (1) the actual in
force amounts for reported life claims and an estimate of incurred but
unreported claims; (2) an estimate, based upon prior experience, for
accident and health claims reported, and incurred but unreported losses.
The methods for making such estimates and establishing the resulting
liabilities are continually reviewed and updated and any adjustments
resulting therefrom are reflected in earnings currently.
The establishment of appropriate reserves is an inherently uncertain
process, and there can be no assurance that the ultimate liability will not
materially exceed the Company's claim and policy reserves and have a
material adverse effect on the Company's results of operations and
financial condition. Due to the inherent uncertainty of estimating
reserves, it has been necessary, and may over time continue to be
necessary, to revise estimated future liabilities as reflected in the
Company's policy reserves and policy and contract claims .
9
Notes to Consolidated Financial Statements, Continued
1. Summary of Significant Accounting Policies, continued:
Policy Reserves and Policy and Contract Claims, continued:
In late 1994, the Company began marketing its Independent Living policy, a
home health care insurance product which provides coverage over the full
term of the policy for services furnished by a homemaker or companion who
is not a qualified or licensed care provider. Because of the Company's
relatively limited claims experience with this product, the Company may
incur higher than expected loss ratios and may be required to adjust
further its reserve levels with respect to this product.
The Company discounts all policy and contract claims which involve fixed
periodic payments extending beyond one year. This is consistent with the
method allowed for statutory reporting and the long duration of claims, as
well as industry practice for long-term care policies. Benefits are payable
over periods ranging from six months to five years and lifetime.
The liability for reported accident and health claims for which payments
will be made over an extended period has been discounted using an assumed
rate of 7% for 1995 and 1994 claims, 6% for 1993 and 1992 claims and 8% for
claims 1991 and prior.
Earnings Per Share:
Primary earnings per share amounts have been computed by dividing the
applicable amounts by the weighted average common shares outstanding.
2. Investments and Financial Instruments:
Net investment income is applicable to the following investments:
1995 1994 1993
---- ---- ----
Bonds $7,756,571 $5,798,152 $4,895,470
Equity securities 27,920 32,833 53,420
Cash and short-term
investments 480,274 260,853 168,185
---------- ---------- ----------
Investment income 8,264,765 6,091,838 5,117,075
Investment expense (161,956) (145,804) (138,007)
---------- ---------- ----------
Net investment income $8,102,809 $5,946,034 $4,979,068
========== ========== ==========
10
Notes to Consolidated Financial Statements, Continued
2. Investments and Financial Instruments, continued:
The amortized cost and estimated market value of investments in debt
securities as of December 31, 1995 and 1994 are as follows:
December 31, 1995
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
-------------- ------------- ------------- -------------
U.S. Treasury securities
and obligations of U.S.
Government corporations
and agencies $ 103,119,270 $ 4,124,815 $ (83,244) $ 107,160,841
Obligations of states and
political subdivisions 24,952,467 1,194,533 - 26,147,000
Debt securities issued by
foreign governments 449,055 33,945 (2,500) 480,500
Corporate securities 5,619,499 227,415 (26,914) 5,820,000
Other debt securities 2,460,484 174,516 - 2,635,000
-------------- ------------- ------------- -------------
Total bonds $ 136,600,775 $ 5,755,224 $ (112,658) $ 142,243,341
============== ============= ============= =============
December 31, 1994
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
-------------- ------------- ------------- -------------
U.S. Treasury securities
and obligations of U.S.
Government corporations
and agencies $ 63,954,663 $ 334,723 $(3,119,096) $ 61,170,290
Obligations of states and
political subdivisions 22,946,937 33,283 (975,220) 22,005,000
Debt securities issued by
foreign governments 448,853 7,147 (4,500) 451,500
Corporate securities 5,816,128 18,542 (365,670) 5,469,000
Other debt securities 1,493,871 - (93,871) 1,400,000
-------------- ------------- ------------- -------------
Total bonds $ 94,660,452 $ 393,695 $(4,558,357) $ 90,495,790
============== ============= ============= =============
11
Notes to Consolidated Financial Statements, Continued
2. Investments and Financial Instruments, continued:
The amortized cost and estimated market value of debt securities at
December 31, 1995 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.
Estimated
Amortized Market
Cost Value
--------- ---------
Due in one year or less $ 2,551,702 $ 2,573,700
Due after one year through
five years 52,338,763 54,119,000
Due after five years through
ten years 72,716,048 75,868,000
Due after ten years 8,994,262 9,682,641
------------ ------------
$136,600,775 $142,243,341
============ ============
Gross proceeds and realized gains and losses on the sales of debt
securities, excluding calls, were as follows:
Gross Gross
Realized Realized
Year Proceeds Gains Losses
---- -------- -------- --------
1995 $ 5,356,956 $ 53,648 $ 7,500
1994 4,671,988 48,170 -
1993 11,882,435 108,683 37,117
Gross proceeds and realized gains and losses on the sales of equity
securities were as follows:
Gross Gross
Realized Realized
Year Proceeds Gains Losses
---- -------- -------- --------
1995 - - -
1994 $1,451,329 $ 23,388 $163,334
1993 1,836,279 273,638 167,589
12
Notes to Consolidated Financial Statements, Continued
2. Investments and Financial Instruments, continued:
Gross unrealized gains (losses) pertaining to equity securities were as
follows:
Gross Gross Estimated
Year Ended Original Unrealized Unrealized Market
December 31 Cost Gains Losses Value
----------- -------- ---------- ---------- ---------
1995 $2,102,529 $561,509 $ (58,426) $2,605,612
1994 880,507 135,651 (82,871) 933,287
1993 2,471,785 122,857 (149,404) 2,445,238
The Company's bond investment portfolio is entirely comprised of investment
grade securities at December 31, 1995. Securities are classified as
"investment grade" by utilizing ratings furnished by independent bond
rating agencies.
Pursuant to certain statutory licensing requirements, as of December 31,
1995, the Company had on deposit bonds aggregating $4,850,404 in insurance
department safekeeping accounts. The Company is not permitted to remove the
bonds from these accounts without approval of the regulatory authority.
The Company has a mortgage and other debt outstanding as of December 31,
1995. Management believes that the book value of these financial
instruments approximates their fair values since both instruments carry
interest rates which approximate market.
13
Notes to Consolidated Financial Statements, Continued
3. 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, 1995 and 1994 and the assumptions pertinent thereto are
presented below:
Amount of Policy Reserves
as of December 31,
--------------------------
1995 1994
---- ----
Accident and health $62,007,433 $43,140,978
----------- -----------
Annuities and other $ 365,651 $ 283,157
=========== ===========
Ordinary life, individual $ 6,753,197 $ 5,578,424
----------- -----------
Years of Issue Discount Rate
-------------- -------------
Accident and health 1976 to 1986 7.0%
1987 7.5%
1988 to 1991 8.0%
1992 to 1995 6.0%
Annuities and other 1977 to 1983 6.5% and 7.0%
Ordinary life, individual 1962 to 1995 3.0% to 5.5%
Basis of Assumption
-------------------
Accident and health Morbidity and withdrawals based on actual
and projected experience.
Annuities and other Primarily funds on deposit inclusive of
accrued interest.
Ordinary life, individual Mortality based on 1955-60 Intercompany
Mortality Table Combined Select and
Ultimate.
14
Notes to Consolidated Financial Statements, Continued
3. Policy Reserves and Claims, continued:
Policy and contract claims include approximately $38,150,000 and
$31,096,000 at December 31, 1995 and 1994, respectively, that are
discounted at varying interest rates. The amount of discount was $2,044,000
and $1,633,000 at December 31, 1995 and 1994, respectively.
Total reserves, including policy and contract claims, reported to statutory
authorities were approximately $3,077,000 and $1,612,000 less than those
recorded for GAAP as of December 31, 1995 and 1994, respectively.
Activity in policy and contract claims is summarized as follows:
1995 1994
---- ----
Balance at January 1 $41,344,428 $32,214,424
Less reinsurance recoverables 1,198,897 1,126,985
----------- -----------
Net balance at January 1 40,145,531 31,087,439
----------- -----------
Incurred related to:
Current year 43,599,323 37,760,665
Prior years 2,047,708 2,157,252
----------- -----------
Total incurred 45,647,031 39,917,917
----------- -----------
Paid related to:
Current year 11,867,015 10,443,530
Prior years 25,295,146 20,416,295
----------- -----------
Total paid 37,162,161 30,859,825
----------- -----------
Net balance at December 31 48,630,401 40,145,531
Plus reinsurance recoverables 1,576,207 1,198,897
----------- -----------
Balance at December 31 $50,206,608 $41,344,428
=========== ===========
The amounts related to prior years' incurral of claims reflects the
accretion of interest due to the discounting of pending claim reserves as
well as adjustments to reflect actual versus estimated claims experience.
15
Notes to Consolidated Financial Statements, Continued
4. Mortgage and Other Debt:
Mortgage and other debt at December 31, 1995 and 1994 are as follows:
1995 1994
---- ----
Mortgage loan with interest rate fixed at 6.6%
for three years effective September 15,
1993 and monthly payment of $20,103
based on a twenty year amortization
schedule with a balloon payment due
September 14, 1998; collateralized by
property with depreciated cost of
$2,700,968 and $2,771,508 as of
December 31, 1995 and 1994, respectively $2,060,069 $2,173,326
Revolving line of credit with a fixed rate of 8.85%
for 6 months, effective December 31,
1994, thereafter the interest rate reverts to
prime plus one; monthly payments are
interest only through March 31, 1996. The
line of credit was paid in full and terminated
in July 1995. - 4,000,000
Capital lease 146,048 198,883
---------- ----------
$2,206,117 $6,372,209
========== ==========
Maturities of mortgage and other debt are as follows:
1996 $ 165,765
1997 203,906
1998 1,836,446
----------
$2,206,117
==========
16
Notes to Consolidated Financial Statements, Continued
5. Federal Income Taxes:
The provision for Federal income taxes for the years ended December 31
consisted of:
1995 1994 1993
---- ---- ----
Current $ 882,968 $ 782,380 $1,816,537
Deferred 2,726,032 1,779,620 320,463
----------- ---------- ----------
$ 3,609,000 $2,562,000 $2,137,000
=========== ========== ==========
Deferred income taxes result from temporary differences between the
recognition of certain expenses for tax and financial statement purposes.
The sources of these differences and the approximate tax effect are as
follows for the years ended December 31:
1995 1994
---- ----
Deferred policy acquisition costs $15,896,021 $11,786,210
Policy reserves (2,627,583) (1,108,675)
Premiums due and unpaid 592,225 453,836
Other 256,775 259,695
Unrealized (depreciation) appreciation
on investments 2,089,521 (1,398,040)
----------- -----------
Total deferred income taxes $16,206,959 $ 9,993,026
=========== ===========
A reconciliation of the income tax provision computed using the Federal
income tax rate of 34% to income before Federal income taxes is as follows:
1995 1994 1993
---- ---- ----
Computed Federal income tax
provision at statutory rate $4,289,000 $3,170,000 $2,706,000
Small life insurance company
deduction (577,000) (579,000) (431,000)
Tax-exempt interest income (431,000) (325,000) (159,000)
Other 328,000 296,000 21,000
---------- ---------- ----------
$3,609,000 $2,562,000 $2,137,000
========== ========== ==========
17
Notes to Consolidated Financial Statements, Continued
5. Federal Income Taxes, continued:
At December 31, 1995, the accumulated earnings of the Company for Federal
income tax purposes included $1,055,873 of "Policyholders' Surplus", a
special memorandum tax account. This memorandum account balance has not
been currently taxed, but income taxes computed at then-current rates will
become payable if surplus is distributed. Provisions of the Deficit
Reduction Act of 1984 (the "Act") do not permit further additions to the
"Policyholders' Surplus" account. "Shareholders' Surplus" represents an
accumulation of taxable income (net of tax thereon) plus the dividends
received deduction, tax-exempt interest, and certain other special
deductions as provided by the Act. At December 31, 1995, the combined
balance in the "Shareholders' Surplus" account amounted to approximately
$19,145,000. There is no present intention to make distributions in excess
of "Shareholders' Surplus."
6. Regulatory Restrictions:
The Company's insurance subsidiaries (PTLIC and Network America) are
required by insurance laws and regulations to maintain minimum capital and
surplus. At December 31, 1995 and 1994, both subsidiaries' capital and
surplus exceed the minimum required capital and surplus in all states in
which they are licensed to conduct business.
Under Pennsylvania insurance law, dividends may be paid from PTLIC or
Network America only from statutory profits of earned surplus and require
Insurance Department approval if the dividend is in excess of the greater
of 10% of surplus or net statutory income of the prior year.
Net income and capital and surplus as reported in accordance with statutory
accounting principles for the Company's insurance subsidiaries are as
follows:
1995 1994 1993
---- ---- ----
Net income (loss) $ 839,491 $ (97,230) $ 2,323,145
----------- ----------- -----------
Capital and surplus $32,291,981 $21,067,123 $17,256,471
The National Association of Insurance Commissioners (NAIC) has established
risk-based capital standards that life and health insurers and reinsurers
must meet. In concept, risk-based capital standards are designed to measure
the acceptable amount of capital an insurer should have based on the
inherent and specific risks of each insurer. Insurers failing to meet their
benchmark capital level may be subject to scrutiny by the insurer's
domiciled insurance department and, ultimately, rehabilitation or
liquidation. Based on the NAIC's currently adopted standards, the Company
has capital and surplus in excess of the required levels. The differences
in statutory net income compared to GAAP are primarily due to the immediate
expensing of acquisition costs and deferred income taxes. Due to these
differences, under statutory accounting there is a net loss and decrease in
surplus, called surplus strain, in years of high growth. The surplus needed
to sustain growth must be raised externally or from profits from existing
business. In 1995, the Company received permission to include $3,287,501 of
this surplus strain, related to a new required valuation method, as a
charge to surplus.
18
Notes to Consolidated Financial Statements, Continued
7. Pension Plan:
The Company maintains a defined contribution pension plan covering
substantially all employees. The Company contributes 3% of each eligible
employee's annual covered payroll to the plan. All contributions are
subject to limitations imposed by the Internal Revenue Code on retirement
plans and Section 401(k) plans.
The Company's contributions become 20% vested after two years of service
and are vested ratably over seven years, at which point all contributions
are fully vested. Pension expense was $55,000, $70,000, and $60,000 for the
years ended December 31, 1995, 1994 and 1993, respectively.
8. Stock Option Plans:
The Company has an Incentive Stock Option Plan which provides for the
granting of options to purchase up to 600,000 shares of common stock. The
exercise price of all options granted under the plan may not be less than
the fair market value of the shares on the date of grant (110% of fair
market value in the case of any person who holds more than 10% of the
combined voting power of all classes of outstanding stock). The maximum
allowable term of each option is ten years (five years in the case of
holders of more than 10% of the combined voting power of all classes of
outstanding stock), and the options become exercisable in four equal,
annual installments commencing one year from the option grant date.
Effective May, 1995, the Company adopted a Participating Agent Stock Option
Plan which provides for the granting of options to purchase up to 300,000
shares of common stock. The exercise price of all options granted under the
plan may not be less than the fair market value of the shares on the date
of grant. The maximum allowable term of each option is ten years, and the
options become exercisable in four equal, annual installments commencing
one year from the option grant date.
19
Notes to Consolidated Financial Statements, Continued
8. Stock Option Plans, continued:
The Stock Option Plan Committees have granted options to eligible employees
and agents as follows:
Number of Shares
Year Ended December 31,
Option -----------------------------
Price 1995 1994 1993
----- ---- ---- ----
Outstanding at January 1 - 229,916 235,754 249,008
Granted (canceled or exercised)
during the year $ 3.50 - (2,106) -
3.85 - - -
5.00 - - (2,496)
5.50 - - -
7.92 - (2,496) -
8.71 - - -
8.92 - (618) (5,379)
9.81 - - -
11.17 - (618) (5,379)
12.29 - - -
12.38 102,000 - -
12.63 16,100 - -
13.61 48,000 - -
------- ------- -------
Total outstanding $3.50 - $13.61 396,016 229,916 235,754
------- ------- -------
Portion exercisable at end of period 197,927 148,696 104,526
------- ------- -------
Since the inception of the plan, 43,775 options have been exercised and
20,886 options have been canceled.
In October 1995, Statement of Financial Accounting Standards No. 123 (SFAS
No. 123), "Accounting for Stock-Based Compensation," was issued. SFAS No.
123, which is effective January 1, 1996, provides an alternative method of
accounting for stock-based compensation arrangements, based on fair value
of the stock-based compensation determined by an option pricing model
utilizing various assumptions regarding the underlying attributes of the
options and the Company's stock. The accounting under SFAS No. 123 differs
from the existing method of accounting for stock-based compensation which
is provided in Accounting Principles Board Opinion No. 25 (APB No. 25),
"Accounting for Stock Issued to Employees." The Financial Accounting
Standards Board encourages entities to adopt the fair value based method,
but does not require the adoption of this method. For those entities that
continue to apply APB 25, pro forma disclosure of the effects, if adopted,
of SFAS No. 123 on net income and earnings per share would be required in
the 1996 financial statements. The Company will continue to apply APB No.
25 and, therefore, there will be no impact on the financial position and
results of operation.
20
Notes to Consolidated Financial Statements, Continued
9. Commitments and Contingencies:
Operating Lease Commitments:
The total net rental expenses under all leases amounted to approximately
$142,000, $148,000 and $129,000 for the years ended December 31, 1995, 1994
and 1993, respectively.
During May 1987, the Company assigned its rights and interests in a land
lease to a third party for $175,000. The agreement indemnifies the Company
against any further liability with respect to future lease payments. The
Company remains contingently liable to the lessor under the original deed
of lease for rental payments of $16,080 per year, the amount being
adjustable based upon changes in the consumer price index since 1987,
through the year 2063.
Litigation:
The Company is a defendant in various lawsuits arising in the ordinary
course of business. In the opinion of management, the resolution of these
lawsuits will not have a significant effect on the financial condition or
results of operations of the Company.
10. Reinsurance:
Effective October, 1994, PTLIC and Network America entered into reinsurance
agreements to cede 100% of benefits exceeding 36 months on certain home
health care policies. Total reserve credits taken related to this agreement
as of December 31, 1995 were approximately $391,000. There were no reserve
credits taken in 1994.
The Company currently reinsures with unaffiliated companies any life
insurance policy to the extent the risk on that policy exceeds $30,000.
Effective January, 1994, PTLIC and Network America entered reinsurance
agreements to cede 100% of certain life, accident and health and medicare
supplement insurance to a third party insurer. Total reserve credits taken
related to this agreement as of December 31, 1995 and 1994 were
approximately $662,000 and $520,000, respectively.
Network America is party to a Reinsurance Agreement to cede 100% of certain
whole life and deferred annuity policies to be issued by Network America to
a third party insurer. These policies are intended for the funeral
arrangement or "pre-need" market. Total reserve credits taken related to
this agreement as of December 31, 1995 and 1994 were approximately
$3,735,000 and $3,131,000, respectively. The third party reinsurer
maintains securities at least equal to the statutory reserve credit in
escrow with a bank.
21
Notes to Consolidated Financial Statements, Continued
10. Reinsurance, continued:
Network America is party to a coinsurance agreement on a previously
acquired block of long term care business whereby 66% is ceded to a third
party. At December 31, 1995 and 1994, reserve credits taken related to this
treaty were approximately $2,130,000 and $1,581,000, respectively.
The Company has assumed and ceded reinsurance on certain life and accident
and health contracts under various agreements. The tables below highlight
the amounts shown in the accompanying consolidated statements of operations
which are net of reinsurance activity:
Assumed
Gross Ceded to from Other Net
December 31, 1995 Amount Other Companies Companies Amount
----------------- ------ --------------- --------- ------
Ordinary Life Insurance
In-Force $ 63,653,000 $19,977,000 - $43,676,000
Premiums:
Accident and Health 101,103,823 2,512,930 $581,010 99,171,903
Life 4,815,878 1,621,176 - 3,194,702
Benefits to Policyholders:
Accident and Health 46,073,992 1,542,816 83,631 44,614,807
Life 1,511,812 479,588 - 1,032,224
Increase (decrease) in Policy
Reserves:
Accident and health 18,569,195 (3,107) (12,041) 18,560,261
Life 1,257,267 585,284 - 671,983
Commissions 37,542,304 1,278,316 87,152 36,351,140
Assumed
Gross Ceded to from Other Net
December 31, 1994 Amount Other Companies Companies Amount
----------------- ------ --------------- --------- ------
Ordinary Life Insurance
In-Force $46,666,000 $13,880,000 - $32,786,000
Premiums:
Accident and health 80,870,772 2,270,819 $605,000 79,204,953
Life 4,011,607 1,381,726 - 2,629,881
Benefits to Policyholders:
Accident and health 39,865,707 1,181,485 852,801 39,537,023
Life 788,369 407,475 - 380,894
Increase (decrease) in Policy
Reserves:
Accident and health 8,393,090 249,249 (183,860) 7,959,981
Life 1,657,464 777,878 - 879,586
Commissions 27,976,116 836,187 90,750 27,230,679
22
Notes to Consolidated Financial Statements, Continued
10. Reinsurance, continued:
Assumed
Gross Ceded to from Other Net
December 31, 1994 Amount Other Companies Companies Amount
----------------- ------ --------------- --------- ------
Ordinary Life Insurance
In-Force $20,947,000 $5,674,000 - $15,273,000
Premiums:
Accident and health 70,108,234 1,347,510 $690,543 69,451,267
Life 1,943,556 1,413,469 - 530,087
Benefits to Policyholders:
Accident and health 32,263,288 720,501 322,430 31,865,217
Life 467,935 374,745 - 93,190
Increase in Policy Reserves:
Accident and health 8,696,519 85,902 59,212 8,669,829
Life 933,999 733,568 - 200,431
Commissions 24,185,687 507,030 103,581 23,782,238
The Company remains contingently liable in the event that the reinsuring
companies are unable to meet their obligations.
11. Transactions with Related Parties:
Irv Levit Insurance Management Corporation ("IMC"), an insurance agency
which is owned by the President of the Company, produced approximately
$62,000, $65,000, and $72,000 of new and renewal premiums for PTLIC, for
the years ended December 31, 1995, 1994 and 1993, respectively, for which
it received commissions of approximately $14,000, $15,000 and $17,000,
respectively.
IMC also received commission overrides on business written for PTLIC by
certain agents, principally general agents who were IMC agents prior to
January 1979 and any of their sub-agents hired prior and subsequent to
January 1979. For the years ended December 31, 1995, 1994 and 1993, IMC
commission overrides totalled approximately $517,000, $520,000, and
$495,000, respectively.
12. Major Agencies:
A managing general agent accounted for approximately 18%, 20% and 21% of
total premiums in 1995, 1994 and 1993, respectively.
23
Notes to Consolidated Financial Statements, Continued
13. Stock Dividend:
On April 19, 1995, the Board of Directors of the Company declared a 50%
stock dividend payable to the shareholders of record on May 3, 1995. The
dividend was distributed on May 15, 1995. Certain amounts comprising
shareholders' equity in these financial statements, weighted average shares
outstanding and earnings per share have been restated to reflect this
dividend.
14. Concentrations of Credit Risk:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents and investments. The Company places its cash and cash
equivalents and investments with high quality financial institutions, and
attempts to limit the amount of credit exposure to any one institution.
However, at December 31, 1995, and at other times during the year, amounts
in any one institution exceeded the Federal Deposit Insurance Corporation
limits.
15. Subsequent Event:
On March 12, 1996, the Company entered into an Agreement and Plan of Merger
with Health Insurance of Vermont, Inc. (HIVT). Per the terms of this
agreement, each share of HIVT common stock shall be converted into shares
of Penn Treaty American Corporation common stock (based on the average
closing bid price for an agreed-upon period prior to the merger date) plus
$4.00 of per share cash consideration. Total consideration paid in stock
and cash will be approximately $11,002,000. This merger is subject to the
approval of HIVT shareholder and regulatory authorities.
For the year ended December 31, 1995, HIVT had premium income and net
income of $6,284,099 and $190,494, respectively. As of December 31, 1995,
HIVT had shareholders' equity of $8,719,980.
The Company believes that this transaction will give them immediate access
to do business in New Jersey, West Virginia, Kansas, Maine, and
Massachusetts. The Company would then be licensed in the entire United
States with the exception of New York. The merger will also expand the
Company's agency force by the 2,500 life and health agents currently
licensed with HIVT.
24
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------- ---------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
- ------- --------------------------------------------------
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1996 Annual Meeting of Shareholders.
Item 11. Executive Compensation
- ------- ----------------------
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1996 Annual Meeting of Shareholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------- --------------------------------------------------------------
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1996 Annual Meeting of Shareholders.
Item 13. Certain Relationship and Related Transactions
- ------- ---------------------------------------------
Incorporated by reference from the Company's Definitive Proxy
Statement for the 1996 Annual Meeting of Shareholders.
PART IV
-------
Item 14. Exhibits, Financial Statements, Schedule and Reports on Form 8-K
- ------- ----------------------------------------------------------------
(a) The following documents are filed as a part of this report.
(1) Financial Statements.
Pages
-----
Report of Independent Accountants........................... F-2
Consolidated Balance Sheets at December 31, 1995 and 1994
........................................................ F-3
Consolidated Statements of Operations for the years
ended December 31, 1995, 1994, and 1993.................. F-4
Consolidated Statements of Shareholders'
Equity for the years ended December 31, 1995, 1994, and
1993..................................................... F-5
Consolidated Statements of Cash Flow for the years
ended December 31, 1995, 1994, and 1993.................. F-6
Notes to Consolidated Financial Statements.................. F-7-F-24
(2) Financial Statement Schedules.
Report of Independent Accountants on Schedule............... S-2
Schedule III - Condensed Financial Information of
Registrant............................................... S-3-S-5
(3) Exhibits.
3.1 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. *
10.1 Penn Treaty American Corporation Employee Incentive Stock
Option Plan. *
10.2 Penn Treaty American Corporation Agent Stock Option
Plan. ****
10.3 Penn Treaty American Corporation Employees' Pension
Plan. *
10.4 Reinsurance Treaty between Penn Treaty Life Insurance
Company and NRG America Life Reassurance Corp. *
10.5 Assumption Agreement dated May 12, 1994 between Reassurance
Company of Hannover and Penn Treaty Life Insurance
Company. ****
10.6 Reinsurance Agreement between Penn Treaty Life Insurance
Company and Life Insurance Company of North America,
effective as of June 1, 1976. *
10.7 Personal Accident Quota Share issued to Penn Treaty Life
Insurance Company by American Accident Reinsurance Group,
effective as of November 23, 1982. *
10.8 Credit Life Quota Share Reinsurance Agreement between Penn
Treaty Life Insurance Company and The Centennial Life
Insurance Company, effective as of August 15, 1977. *
10.9 Treaty Endorsement replace The Centennial Life Insurance
Company with Puritan Life Insurance Company, effective June
1, 1986.****
10.10 Endorsement replacing Puritan Life Insurance Company
with Employers Reassurance Corporation, effective as of
December 31, 1986. ****
10.11 Reinsurance Agreement between Washington Square Life
Insurance Company and Cologne Life Insurance Company,
effective March 1, 1987. ****
10.12 Reinsurance Agreements between Penn Treaty Life
Insurance Company and Cologne Life Reinsurance Company,
effective October 1, 1994. ****
10.13 Reinsurance Agreements between Network America Life
Insurance Company and Cologne Life Reinsurance Company,
effective October 1, 1994. ****
10.14 Reinsurance Agreement between Penn Treaty Life Insurance
Company and Transamerica Occidental Life Insurance
Company, effective April 1, 1988. ****
10.15 Reinsurance Agreement between Network America Life
Insurance Company and Provident Indemnity Life Insurance
Company, effective January 1, 1991, as amended on
November 30, 1993. ****
10.16 Quota Share Reinsurance Agreement between Network
America Life Insurance Company and Life and Health
Insurance Company of America, effective December 1,
1994.****
10.17 Reinsurance Agreement between Penn Treaty Life Insurance
Company and Reassurance Company of Hannover, effective
January 1, 1995.****
10.18 Administrative Services Agreement between Network
America Life Insurance Company and Midland Mutual Life
Insurance Company, effective June 25, 1991.****
10.19 Administration and Agency Agreements between Penn Treaty
Life Insurance Company, Network America Life Insurance
Company and Tower Insurance Services, Inc. effective
December 1, 1993, relating to the Quota Share
Reinsurance Agreement between Network America Life
Insurance Company and Life and Health Insurance Company
of America, effective December 1, 1994. ****
10.20 Form of General Agent's Contract of Penn Treaty life
Insurance Company. ****
10.21 Form of General Agent's Contract of Network America Life
Insurance Company.****
10.22 Form of Managing General Agency Agreement.****
10.23 Regional General Agents' Contract dated August 1, 1971
between Penn Treaty Life Insurance Company and Irving
Levit of the Irv Levit Insurance Management Corporation,
as amended on August 15, 1971, May 26, 1976 and June 16,
1987, and
by an undated override commissions schedule. ***
10.24 Managing General Agent's Contract dated March 10, 1988
between Penn Treaty Life Insurance Company and Ameri-
Life and Health Services, Inc.****
10.25 Commission Supplement to General Agent's Contract dated
December 7, 1993 between Network America Life Insurance
Company and Network Insurance.****
10.26 Administrative Services Agreement dated February 14,
1995 between national Benefits Corporation and penn
Treaty Life Insurance Company and Network America Life
Insurance Company. ****
10.27 Mortgage in the amount of $2,450,000 dated September 13,
1988 between Penn Treaty Life Insurance Company and
merchants Bank, N.A. **
10.28 Amendments to Mortgage dated September 24, 1991, October
13, 1992 and September 2, 1993. ****
10.29 Loan and Security Agreement by and between Penn Treaty
American Corporation and CoreStates Bank, N.A. dated
December 28, 1994.****
10.30 Investment Counseling Agreement dated May 3, 1995
between Penn Treaty American Corporation and James M.
Davidson & Company.****
10.31 Investment Counseling Agreement dated May 3, 1995
between Penn Treaty Life Insurance Company and James M.
Davidson & Co.****
10.32 Investment Counseling Agreement dated May 3, 1995
between Network America Life Insurance Company and James
M. Davidson & Company. ****
11. Statement re: computation of per share earnings.
21. Subsidiaries of the Registrant. ****
23.1 Consent of Coopers & Lybrand, L.L.P.
- ---------------------
* Incorporated by reference to the Company's Registration Statement on
Form S-1 dated May 12, 1987, as amended.
** Incorporated by reference to the Company's Registration Statement on
Form S-1 dated November 17, 1989, as amended.
*** Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1989.
**** Incorporated by reference to the Company's Registration Statement on
Form S-1 dated June 30, 1995, as amended.
Executive Compensation Plans - see Exhibits 10.1 and 10.2
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PENN TREATY AMERICAN CORPORATION
Date: March 25, 1996 By:/s/ Irving Levit
----------------------------------
Irving Levit, Chairman of the
Board and President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 25, 1996 By: /s/ Irving Levit
-----------------------------
Irving Levit, Chairman of the
Board and President
Date: March 25, 1996 By: /s/ A.J. Carden
-----------------------------
A.J. Carden, Executive Vice
President and Director
Date: March 25, 1996 By: /s/ Michael F. Grill
-----------------------------
Michael F. Grill, Treasurer
and Director
Date: March 25, 1996 By: /s/ Domenic P. Stangherlin
-----------------------------
Domenic P. Stangherlin,
Secretary and Director
Date: March 25, 1996 By: /s/ Jack D. Baum
-----------------------------
Jack D. Baum, Vice President,
Marketing and Director
Date: March 25, 1996 By: /s/ Emile Ilchuk
-----------------------------
Emile Ilchuk, Director
Date: March 25, 1996 By: /s/ C. Mitchell Goldman
-----------------------------
C. Mitchell Goldman, Director
Date: March 25, 1996 By: /s/ Stuart H. Shapiro
-----------------------------
Stuart H. Shapiro, M.D.
Director
Date: March 25, 1996 By: /s/ Glen A. Levit
-----------------------------
Glen A. Levit
Director