SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
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OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-22316
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Penn-America Group, Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2731409
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
420 South York Road, Hatboro, Pennsylvania 19040
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(Address of principal executive offices, including zip code)
(215) 443-3600
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such other period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No .
----- ----
At August 2, 2002, 11,584,749 shares of the registrant's common stock, $.01 par
value, were outstanding.
Page 1
Penn-America Group, Inc. and SubsidiarIES
Index
Page Number
-----------
Part I - Financial Information
Consolidated Balance Sheets - June 30, 2002 (unaudited) and
December 31, 2001 3
Consolidated Unaudited Statements of Operations - For the three
and six months ended June 30, 2002 and 2001 4
Consolidated Unaudited Statement of Stockholders' Equity -
For the six months ended June 30, 2002 5
Consolidated Unaudited Statements of Cash Flows -
For the six months ended June 30, 2002 and 2001 6
Notes to Unaudited Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Quantitative and Qualitative Disclosure About Market Risk 20
Part II - Other Information 21
Page 2
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except per share data)
June 30, December 31,
2002 2001
----------------- -----------------
ASSETS (Unaudited)
Investments:
Fixed maturities:
Available for sale, at fair value (amortized cost 2002, $176,016; 2001, $130,976) $ 182,214 $ 135,253
Held to maturity, at amortized cost (fair value 2002, $3,042; 2001, $15,317) 2,968 15,084
Equity securities, at fair value (cost 2002, $25,376; 2001, $27,770) 23,013 25,149
----------------- -----------------
Total investments 208,195 175,486
Cash 4,857 13,129
Accrued investment income 2,712 2,199
Premiums receivable 13,840 12,285
Reinsurance recoverable 25,415 25,804
Prepaid reinsurance premiums 7,206 4,241
Deferred policy acquisition costs 12,191 9,083
Capital lease, affiliate 1,622 1,666
Deferred income taxes 3,565 3,790
Income tax recoverable -- 66
Other assets 318 366
----------------- -----------------
Total assets $ 279,921 $ 248,115
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses $ 127,220 $ 119,598
Unearned premiums 58,852 41,034
Accounts payable and accrued expenses 5,640 3,800
Capitalized lease obligation, affiliate 1,499 1,570
Income tax payable 111 --
Other liabilities 1,315 1,722
----------------- -----------------
Total liabilities 194,637 167,724
----------------- -----------------
Stockholders' equity:
Preferred stock, $.01 par value; authorized 2,000,000 shares;
None issued -- --
Common stock, $.01 par value; authorized 20,000,000 shares;
issued 2002 and 2001, 15,334,185 and 15,228,351 shares, respectively;
outstanding 2002 and 2001, 11,584,185 and 11,478,351 shares, respectively 153 152
Additional paid-in capital 71,518 70,735
Accumulated other comprehensive income 2,531 1,092
Retained earnings 36,111 33,334
Treasury stock, 3,750,000 shares at cost (24,161) (24,161)
Officers' stock loans (629) (629)
Unearned compensation from restricted stock awards (239) (132)
----------------- -----------------
Total stockholders' equity 85,284 80,391
----------------- -----------------
Total liabilities and stockholders' equity $ 279,921 $ 248,115
================= =================
Page 3
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)
For the three and six months ended June 30, 2002 and 2001
(In thousands, except per share data)
Three months ended Six months ended
June 30, June 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenues
Premiums earned $ 27,234 $ 22,206 $ 50,217 $ 45,248
Net investment income 2,925 2,815 5,758
5,665
Net realized investment loss (1,093) (334) (1,345) (232)
------------ ------------ ------------ ------------
Total revenues 29,066 24,687 54,630 50,681
------------ ------------ ------------ ------------
Losses and expenses
Losses and loss adjustment expenses 17,364 15,453 32,650 32,187
Amortization of deferred policy acquisition costs 6,739 6,007 12,750 12,231
Other underwriting expenses 2,166 1,684 3,823 3,218
Corporate expenses 233 189 344 351
Interest expense 35 40 70 80
------------ ------------ ------------ ------------
Total losses and expenses 26,537 23,373 49,637 48,067
------------ ------------ ------------ ------------
Income before income tax 2,529 1,314 4,993 2,614
Income tax expense 647 320 1,325 653
------------ ------------ ------------ ------------
Net income $ 1,882 $ 994 $ 3,668 $ 1,961
============ ============ ============ ============
Net income per share
Basic $ 0.16 $ 0.09 $ 0.32 $ 0.17
Diluted $ 0.16 $ 0.09 $ 0.31 $ 0.17
Weighted average shares outstanding
Basic 11,574,913 11,407,215 11,555,944 11,387,687
Diluted 11,791,719 11,514,498 11,754,854 11,471,070
Cash dividends per share $ 0.03875 $ 0.035 $ 0.07708 $ 0.070
Page 4
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(Unaudited)
For the six months ended June 30, 2002
(In thousands, except per share data)
Unearned
Accumulated Compensation
Other From Total
Additional Compre- Officers' Restricted Stock-
Common Paid-In hensive Retained Treasury Stock Stock holders'
Stock Capital Income Earnings Stock Loans Awards Equity
--------- -------- -------- -------- -------- -------- -------- ---------
Balance at December 31, 2001 $ 152 $ 70,735 $ 1,092 $ 33,334 $(24,161) $ (629) $ (132) $ 80,391
Net income -- -- -- 3,668 -- -- -- 3,668
Other comprehensive income:
net unrealized gain on investments,
net of tax and reclassification
adjustment -- -- 1,439 -- -- -- -- 1,439
--------
Comprehensive income 5,107
--------
Issuance of common stock 1 783 -- -- -- -- -- 784
Unearned compensation from
restricted stock awards issued -- -- -- -- -- -- (155) (155)
Amortization of compensation expense from
restricted stock awards issued -- -- -- -- -- -- 48 48
Cash dividends paid ($0.07708 per share) -- -- -- (891) -- -- -- (891)
-------- -------- -------- -------- -------- -------- -------- --------
Balance at June 30, 2002 $ 153 $ 71,518 $ 2,531 $ 36,111 $(24,161) $ (629) $ (239) $ 85,284
======== ======== ======== ======== ======== ======== ======== ========
Page 5
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
For the six months ended June 30, 2002 and 2001
(In thousands)
Six months ended June 30,
---------------------------
2002 2001
-------- --------
Cash flows from operating activities:
Net income $ 3,668 $ 1,961
Adjustments to reconcile net income to net cash provided (used) by
operating activities:
Amortization and depreciation expense (185) 18
Net realized investment loss 1,345 232
Deferred income tax (516) (273)
Net increase (decrease) in premiums receivable, prepaid reinsurance
premiums and unearned premiums 13,298 (5,485)
Net increase in unpaid losses and loss adjustment expenses
and reinsurance recoverable 8,011 540
Accrued investment income (513) 24
Deferred policy acquisition costs (3,108) 1,097
Income tax recoverable/payable 177 926
Other assets 11 (109)
Accounts payable and accrued expenses 1,840 21
Other liabilities 82 (365)
-------- --------
Net cash provided (used) by operating activities 24,110 (1,413)
-------- --------
Cash flows from investing activities:
Purchases of equity securities -- (2,065)
Purchases of fixed maturities available for sale (54,296) (17,547)
Proceeds from sales of equity securities 1,000 1,375
Proceeds from sales and maturities of fixed maturities available for sale 9,451 15,865
Proceeds from maturities and calls of fixed maturities held to maturity 12,130 2,000
-------- --------
Net cash used by investing activities (31,715) (372)
-------- --------
Cash flows from financing activities:
Issuance of common stock 295 358
Officers' stock loans -- (109)
Principal payments on capital lease obligations, affiliate (71) (62)
Dividends paid (891) (797)
-------- --------
Net cash used by financing activities (667) (610)
-------- --------
Decrease in cash (8,272) (2,395)
Cash, beginning of period 13,129 11,425
-------- --------
Cash, end of period $ 4,857 $ 9,030
======== ========
Page 6
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Note 1 - Organization and Basis of Presentation
Penn-America Group, Inc. ("PAGI") is an insurance holding company.
Approximately 40% of the outstanding common stock of PAGI was owned by Penn
Independent Corporation ("Penn Independent") at June 30, 2002. The accompanying
financial statements include the accounts of PAGI and its wholly owned
subsidiary, Penn-America Insurance Company ("Penn-America") and its wholly owned
subsidiary, Penn-Star Insurance Company ("Penn-Star"), (collectively the
"Company").
The Company markets and underwrites general liability, commercial
property and multi-peril insurance for small businesses located primarily in
small towns and suburban and rural areas. The Company can write business in all
fifty states and the District of Columbia on both an admitted and non-admitted
basis.
The accompanying interim condensed unaudited consolidated financial
statements and notes have been prepared in accordance with accounting principles
generally accepted in the United States ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and notes required
by GAAP for complete financial statements. In the opinion of management, all
adjustments (consisting of normal and recurring adjustments) considered
necessary for a fair presentation of results for the interim periods have been
included. All significant intercompany accounts and transactions have been
eliminated in consolidation. It is suggested that these interim condensed
unaudited consolidated financial statements and related notes be read in
conjunction with the financial statements and related notes in the Company's
2001 Annual Report which was incorporated by reference into the Company's Form
10-K for the year ended December 31, 2001. The Company's results of operations
for interim periods are not necessarily indicative of the results to be expected
for the entire year.
Note 2 - Reinsurance
Premiums earned are presented net of amounts ceded to reinsurers of
$4.1 million and $3.0 million for the three months ended June 30, 2002 and 2001,
respectively. Losses and loss adjustment expenses are presented net of amounts
ceded to reinsurers of $1.1 million and $0.7 million for the three months ended
June 30, 2002 and 2001, respectively.
Premiums earned are net of amounts ceded to reinsurers of $7.2 million
and $6.0 million for the six months ended June 30, 2002 and 2001, respectively.
Losses and loss adjustment expenses are net of amounts ceded to reinsurers of
$2.8 million and $3.4 million for the six months ended June 30, 2002 and 2001,
respectively.
Note 3 - Comprehensive Income
Accumulated other comprehensive income consists solely of unrealized
gains or losses on investment securities net of applicable income tax expense or
benefit and reclassification adjustments. Comprehensive income was $4.3 million
for the three months ended June 30, 2002 compared with $0.8 million for the
three months ended June 30, 2001. Comprehensive income was $5.1 million and $2.4
million for the six months ended June 30, 2002 and 2001, respectively.
Page 7
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 4 - Income Per Share
Income per share for the three and six months ended June 30, 2002 and
2001 is computed by dividing net income by the basic and diluted weighted
average number of common shares outstanding during the respective periods. The
following table is a reconciliation of the numerators and denominators of the
basic and diluted income per share computations:
(in thousands, except per share data) Three months ended June 30, Six months ended June 30,
------------------------------ ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Basic per share computation:
Net income $ 1,882 $ 994 $ 3,668 $1 ,961
Weighted average common shares (1) 11,574,913 11,407,215 11,555,944 11,387,687
----------- ----------- ----------- -----------
Basic net income per share (1) $ 0.16 $ 0.09 $ 0.32 $ 0.17
=========== =========== =========== ===========
Diluted per share computation:
Net income $ 1,882 $ 994 $ 3,668 $ 1,961
Weighted average common shares (1) 11,574,913 11,407,215 11,555,944 11,387,687
Additional shares outstanding after the assumed
assumed exercise of stock options by
applying the treasury stock method (1) 216,806 107,283 198,910 83,383
----------- ----------- ----------- -----------
Total shares (1)a 11,791,719 11,514,498 11,754,854 11,471,070
=========== =========== =========== ===========
Diluted net income per share (1)a $ 0.16 $ 0.09 $ 0.31 $ 0.17
=========== =========== =========== ===========
(1) Adjusted to reflect a three-for-two stock split effected on May 9, 2002.
Page 8
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 5 - Retroactive Adjustment for Stock Split
The common stock issued and outstanding and treasury stock at December
31, 2001 have been restated to reflect the three-for-two stock split announced
on April 11, 2002 and distributed on May 9, 2002. Accordingly, the balance sheet
values for common stock and additional paid-in capital have been adjusted for
the effect of the stock split. This adjustment resulted in a $51,000 increase in
common stock and a $51,000 decrease in additional paid-in capital. The following
table illustrates share information on a pre stock split and a post stock split
basis as of December 31, 2001:
Pre Stock Split Post Stock Split
Basis Basis
--------------- ----------------
Common stock issued 10,152,234 15,228,351
Common stock outstanding 7,652,234 11,478,351
Treasury stock 2,500,000 3,750,000
Note 6- Segment Information
The Company had two reportable segments: non-standard personal
automobile and commercial lines. These segments were managed separately because
they had different customers, pricing and expense structures. The Company exited
the non-standard personal automobile business in 1999 and announced that it
would run-off its remaining portfolio of such business. The Company will
continue to report on this segment separately until the amounts relating to the
non-standard personal automobile business become immaterial to the financial
statements presented. The Company does not allocate assets between segments
because assets are reviewed in total by management for decision-making purposes.
The accounting policies of the segments are the same as those more
fully described in the summary of significant accounting policies in Note 1 of
the Company's 2001 Annual Report, which was incorporated by reference into the
Company's 2001 Form 10-K. The Company evaluates segment results based on profit
or loss from operating activities. Segment profits or losses from operations are
pre-tax and do not include unallocated expenses but do include investment income
attributable to insurance transactions. Segment profit or loss therefore
excludes federal income taxes, unallocated expenses and investment income
attributable to equity.
Page 9
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
The following is a summary of the Company's segment revenues, expenses and
profit:
(in thousands) Three months ended June 30, 2002
--------------------------------
Personal
Commercial Automobile Total
-------------------------------------------
Premiums earned $ 27,234 $ -- $ 27,234
Net investment income and net realized investment
loss from insurance operations 1,002 -- 1,002
-------------------------------------------
Total segment revenues 28,236 -- 28,236
-------------------------------------------
Segment losses and loss adjustment expenses 17,364 -- 17,364
Segment expenses 7,913 -- 7,913
-------------------------------------------
Total segment expenses 25,277 -- 25,277
-------------------------------------------
Segment income $ 2,959 $ -- $ 2,959
-------------------------------------------
Plus unallocated items:
Net investment income from equity 830
Unallocated expenses (1,260)
Income tax expense (647)
--------
Net income $ 1,882
========
(in thousands) Three months ended June 30, 2001
--------------------------------
Personal
Commercial Automobile Total
-------------------------------------------
Premiums earned $ 22,200 $ 6 $ 22,206
Net investment income and net realized investment
loss from insurance operations 1,568 71 1,639
-------------------------------------------
Total segment revenues 23,768 77 23,845
-------------------------------------------
Segment losses and loss adjustment expenses 15,750 (297) 15,453
Segment expenses 6,558 5 6,563
-------------------------------------------
Total segment expenses 22,308 (292) 22,016
-------------------------------------------
Segment income $ 1,460 $ 369 $ 1,829
-------------------------------------------
Plus unallocated items:
Net investment income from equity 842
Unallocated expenses (1,357)
Income tax expense (320)
--------
Net income $ 994
========
Total segment revenue of $28,236,000 and $23,845,000 plus unallocated net
investment income from equity of $830,000 and $842,000 equals total Company
revenues of $29,066,000 and $24,687,000 for the three months ended June 30, 2002
and 2001, respectively.
Page 10
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
The following is a summary of the Company's segment revenues, expenses and
profit:
(in thousands) Six months ended June 30, 2002
------------------------------
Personal
Commercial Automobile Total
-------------------------------------------
Premiums earned $ 50,217 $ -- $ 50,217
Net investment income and net realized investment
loss from insurance operations 2,439 -- 2,439
-------------------------------------------
Total segment revenues 52,656 -- 52,656
-------------------------------------------
Segment losses and loss adjustment expenses 32,650 -- 32,650
Segment expenses 14,234 -- 14,234
-------------------------------------------
Total segment expenses 46,884 -- 46,884
-------------------------------------------
Segment income $ 5,772 $ -- $ 5,772
-------------------------------------------
Plus unallocated items:
Net investment income from equity 1,974
Unallocated expenses (2,753)
Income tax expense (1,325)
--------
Net income $ 3,668
========
(in thousands) Six months ended June 30, 2001
------------------------------
Personal
Commercial Automobile Total
-------------------------------------------
Premiums earned $ 45,226 $ 22 $ 45,248
Net investment income and net realized investment
loss from insurance operations 3,434 155 3,589
-------------------------------------------
Total segment revenues 48,660 177 48,837
-------------------------------------------
Segment losses and loss adjustment expenses 33,680 (1,493) 32,187
Segment expenses 13,149 10 13,159
-------------------------------------------
Total segment expenses 46,829 (1,483) 45,346
-------------------------------------------
Segment income $ 1,831 $ 1,660 $ 3,491
-------------------------------------------
Plus unallocated items:
Net investment income from equity 1,844
Unallocated expenses (2,721)
Income tax expense (653)
--------
Net income $ 1,961
========
Total segment revenue of $52,656,000 and $48,837,000 plus unallocated net
investment income from equity of $1,974,000 and $1,844,000 equals total Company
revenues of $54,630,000 and $50,681,000 for the six months ended June 30, 2002
and 2001, respectively.
Page 11
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 7- Equity Offering
On June 27, 2002, PAGI filed a registration statement with the Securities and
Exchange Commission relating to a proposed offering of 4,000,000 shares of its
common stock. Until the registration statement is effective, these securities
may not be sold nor may offers to buy be accepted. The intended use of the net
proceeds of this offering are to support the Company's operations, including
contributing capital to the insurance subsidiaries and capitalizing new
insurance subsidiaries to support the growth in business, and for working
capital and other general corporate purposes.
Page 12
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations
Results of Operations
Three Months Ended June 30, 2002 and 2001
Premiums earned were $27.2 million for the three months ended June 30,
2002 compared to $22.2 million for the three months ended June 30, 2001. The
Company previously announced that it was exiting both commercial automobile and
non-standard personal automobile lines of business. Premiums earned for these
exited lines of business decreased $1.5 million, or 99.5%, for the three months
ended June 30, 2002 compared to the three months ended June 30, 2001. The
Company's core commercial lines premiums earned (excluding exited lines of
business) increased $6.5 million, or 31.3%, attributable to the increase in net
written premiums for the three months ended June 30, 2002 as compared to the
same period of 2001.
Gross written premiums increased 91.8% for the three months ended June
30, 2002 to $45.2 million compared to $23.6 million for the three months ended
June 30, 2001. This increase was attributable to rate increases, strong growth
in new business and higher average exposures per policy.
Net written premiums increased 85.5% for the three months ended June
30, 2002 to $38.7 million compared to $20.9 million for the three months ended
June 30, 2001. The increase in net written premiums is consistent with the
increase in gross written premiums, but was partially offset by higher
reinsurance costs.
Net investment income was $2.9 million for the three months ended June
30, 2002 compared to $2.8 million for the same period of last year. While
average invested assets increased 13.9% for the second quarter of 2002 due to
improved operating cash flows, the average investment yield on fixed-income
securities was lower in the second quarter of 2002 than in the second quarter of
2001. Also, interest rates on overnight cash balances were lower during the
second quarter of 2002 compared to the second quarter of 2001.
Net realized investment loss was $1.1 million for the three months
ended June 30, 2002 compared to $0.3 million for the three months ended June 30,
2001. The net realized investment loss for the three months ended June 30, 2002
included an other-than-temporary impairment write-down of $1.1 million on the
Company's equity investment in exchange-traded funds.
Losses and loss adjustment expenses increased 12.4% to $17.4 million
for the three months ended June 30, 2002 from $15.5 million for the three months
ended June 30, 2001. The loss ratio for the three months ended June 30, 2002 was
63.8 compared to 69.6 for the three months ended June 30, 2001. The loss ratio
is calculated by dividing losses and loss adjustment expenses by premiums
earned. The improvement in the loss ratio is primarily attributable to rate
increases implemented in 2001 and 2002 and exiting of the commercial automobile
line of business.
Amortization of deferred policy acquisition costs (ADAC) increased
12.2% to $6.7 million for the three months ended June 30, 2002 from $6.0 million
for the three months ended June 30, 2001 primarily due to the growth in premiums
earned. This increase was partially offset by a decline in the ratio of ADAC to
premiums earned of 24.7 for the three months ended June 30, 2002 compared to
27.1 for the three months ended June 30, 2001. The improvement in this ratio was
attributable to the Company writing a larger portion of its business on a
non-admitted basis, which is not subject to premium tax expense and has a lower
overall commission rate.
Page 13
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Other underwriting expenses increased 28.6% to $2.2 million for the
three months ended June 30, 2002 from $1.7 million for the three months ended
June 30, 2001. This increase is mainly attributable to increases in salary and
benefit expenses associated with the hiring of additional underwriting and
marketing personnel.
The overall GAAP combined ratio, which is the sum of the loss and
expense ratios, decreased to 96.5 for the three months ended June 30, 2002 from
104.2 for the three months ended June 30, 2001. This improvement was primarily
due to the decrease in the loss ratio to 63.8 in 2002 compared to 69.6 in 2001.
The expense ratio decreased to 32.7 for the three months ended June 30, 2002
from 34.6 for the three months ended June 30, 2001. The expense ratio is
calculated by dividing the sum of ADAC and other underwriting expenses by
premiums earned. The GAAP combined ratio is a standard measure of underwriting
profitability used throughout the property and casualty insurance industry. A
ratio below 100.0 generally indicates profitable underwriting results.
The factors described above resulted in net income for the three months
ended June 30, 2002 of $1.9 million or $0.16 per share (basic and diluted)
compared to net income of $1.0 million or $0.09 per share (basic and diluted)
for the three months ended June 30, 2001.
Six Months Ended June 30, 2002 and 2001
Premiums earned were $50.2 million for the six months ended June 30,
2002 compared to $45.2 million for the six months ended June 30, 2001. The
Company previously announced that it was exiting both commercial automobile and
non-standard personal automobile lines of business. Premiums earned for these
exited lines of business decreased $3.6 million, or 99.6%, for the six months
ended June 30, 2002 compared to the six months ended June 30, 2001. The
Company's core commercial lines premiums earned (excluding exited lines of
business) increased $8.6 million, or 20.6%, attributable to the increase in net
written premiums for the six months ended June 30, 2002 as compared to the same
period of 2001.
Gross written premiums increased 58.8% for the six months ended June
30, 2002 to $75.3 million compared to $47.4 million for the six months ended
June 30, 2001. This increase was attributable to rate increases, strong growth
in new business and higher average exposures per policy.
Net written premiums increased 55.2% for the six months ended June 30,
2002 to $65.1 million compared to $41.9 million for the six months ended June
30, 2001. The increase in net written premiums is consistent with the increase
in gross written premiums, but was partially offset by higher reinsurance costs.
Net investment income was $5.8 million for the six months ended June
30, 2002 compared to $5.7 million for the same period of last year. While
average invested assets increased 10.7% for the six months ended June 30, 2002
due to improved operating cash flows, the average investment yield on
fixed-income securities was lower in 2002 than for the six months ended June 30,
2001. Also, interest rates on overnight cash balances were lower during the six
months ended June 30, 2002 compared to the same period of 2001.
Net realized investment loss was $1.3 million for the six months ended
June 30, 2002 compared to $0.2 million for the six months ended June 30, 2001.
The current period included an other-than-temporary impairment write-down of
$1.3 million on the Company's equity investments in exchange-traded funds.
Page 14
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Losses and loss adjustment expenses increased 1.4% to $32.7 million
for the six months ended June 30, 2002 from $32.2 million for the six months
ended June 30, 2001. The loss ratio for the six months ended June 30, 2002 was
65.0 compared to 71.1 for the six months ended June 30, 2001. This improvement
is attributable to rate increases implemented in 2001 and 2002 and exiting of
the commercial automobile line of business.
Amortization of deferred policy acquisition costs (ADAC) increased 4.2%
to $12.8 million for the six months ended June 30, 2002 from $12.2 million for
the six months ended June 30, 2001 primarily due to the growth in premiums
earned. This increase was partially offset by a decline in the ratio of ADAC to
premiums earned of 25.4 for the six months ended June 30, 2002 compared to 27.0
for the six months ended June 30, 2001. The improvement in this ratio was
attributable to the Company writing a larger portion of its business on a
non-admitted basis, which is not subject to premium tax expense and has a lower
overall commission rate.
Other underwriting expenses increased 18.8% to $3.8 million for the six
months ended June 30, 2002 from $3.2 million for the six months ended June 30,
2001. This increase is mainly attributable to increases in salary and benefit
expenses associated with the hiring of additional underwriting and marketing
personnel.
The overall GAAP combined ratio for the Company decreased to 98.0 for
the six months ended June 30, 2002, from 105.2 for the six months ended June 30,
2001, primarily due to the decrease in the loss ratio to 65.0 in 2002 compared
to 71.1 in 2001. The expense ratio was 33.0 for the six months ended June 30,
2002 and 34.1 for the six months ended June 30, 2001.
The factors described above resulted in net income for the six months
ended June 30, 2002 of $3.7 million or $0.32 per basic share and $0.31 per
diluted share compared to net income of $2.0 million or $0.17 per share (basic
and diluted) for the six months ended June 30, 2001.
Critical Accounting Estimates
The Company is liable for losses and loss adjustment expenses under the
terms of the insurance policies it writes. In many cases, several years may
lapse between the occurrence of an insured loss, the reporting of the loss and
the payment of that loss. The Company reflects its liability for the ultimate
payment of all incurred losses and loss adjustment expenses by establishing loss
and loss adjustment expense reserves as balance sheet liabilities for both
reported and unreported claims.
When a claim involving a probable loss is reported, the Company
establishes a case reserve for the estimated amount of its ultimate loss. The
estimate of the amount of the ultimate loss is based upon factors such as:
o the type of loss,
o the jurisdiction of the occurrence,
o our knowledge of the circumstances surrounding the claim,
o the severity of injury or damage,
o the potential for ultimate exposure, and
o policy provisions relating to the claim.
Page 15
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The Company determines loss adjustment expenses via a formula method
that estimates loss adjustment expenses as a percentage of expected indemnity
losses based on historical patterns adjusted to current experience.
In addition to case reserves, the Company establishes reserves on an
aggregate basis to provide for incurred but not reported losses and loss
adjustment expenses, commonly referred to as "IBNR". To establish reserves for
INBR, the Company must estimate the ultimate liability based primarily on past
experience. The Company applies a variety of traditional actuarial techniques to
estimate its ultimate liability. The techniques recognize, among other factors:
o the Company's and the industry's experience,
o historical trends in reserving patterns and loss payments,
o the impact of claim inflation,
o the pending level of unpaid claims,
o the cost of claim settlements,
o the line of business mix, and
o the economic environment in which property and casualty insurance
companies operate.
The Company continually reviews these estimates and, based on new
developments and information, the Company includes adjustments of the probable
ultimate liability in the operating results for the periods in which the
adjustments are made. In general, initial reserves are based upon the actuarial
and underwriting data utilized to set pricing levels and are reviewed as
additional information, including claims experience, becomes available. The
establishment of loss and loss adjustment expense reserves makes no provision
for the broadening of coverage by legislative action or judicial interpretation
or for the extraordinary future emergence of new types of losses not
sufficiently represented in our historical experience, or which cannot yet be
quantified. The Company regularly analyzes its reserves and reviews pricing and
reserving methodologies so that future adjustments to prior year reserves can be
minimized. However, given the complexity of this process, reserves will require
continual updates and the ultimate liability may be higher or lower than
previously indicated. The Company does not discount its loss reserves.
During the first six months of 2002, there were no material adjustments to prior
year reserves.
Liquidity and Capital Resources
Penn-America Group, Inc. (PAGI) is a holding company, the principal
asset of which is the common stock of Penn-America Insurance Company. The
principal source of cash for the payment of dividends to PAGI's stockholders and
PAGI operating expenses is dividends from Penn-America Insurance Company.
Penn-America Insurance Company's principal sources of funds are underwriting
operations, investment income and proceeds from sales and redemptions of
investments. Funds are used by Penn-America Insurance Company and Penn-Star
Insurance Company principally to pay claims and operating expenses, to purchase
investments and to make dividend payments to PAGI. PAGI's future liquidity is
dependant on the ability of Penn-America Insurance Company to pay dividends.
Page 16
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Penn-America Insurance Company and Penn-Star Insurance Company are
restricted by statute as to the amount of dividends that they may pay without
the prior approval from the Pennsylvania Insurance Department. Penn-America
Insurance Company may pay dividends to PAGI without advance regulatory approval
only from unassigned surplus and only to the extent that all dividends in the
past twelve months do not exceed the greater of 10% of total statutory
policyholders' surplus, or statutory net income for the prior year. Using these
criteria, the available ordinary dividend payable by Penn-America Insurance
Company to PAGI for 2002 is $6,473,325. No ordinary dividends have been paid to
PAGI during the six months ended June 30, 2002. Ordinary dividends paid by
Penn-America Insurance Company to PAGI in 2001 were $1.6 million.
Penn-America Insurance Company provides strong incentives to its
general agents to produce profitable business through a contingent profit
commission structure that is tied directly to underwriting profitability.
Payment of these contingent profit commissions has been through the issuance of
PAGI common stock and cash. In 2002, PAGI issued 62,836 shares of its common
stock at an average value of $7.79 per share as part of the payment of the 2001
contingent profit commission due to the general agents of Penn-America Insurance
Company.
Penn-America Insurance Company and Penn-Star Insurance Company are
required by law to maintain a certain minimum level of policyholders' surplus on
a statutory accounting basis. Policyholders' surplus is calculated by
subtracting total liabilities from total assets. The National Association of
Insurance Commissioners adopted risk-based capital standards designed to
identify property and casualty insurers that may be inadequately capitalized
based on inherent risks of each insurer's assets and liabilities and its mix of
net written premiums. Insurers falling below a calculated threshold may be
subject to varying degrees of regulatory action. As of December 31, 2001, the
policyholders' surplus of Penn-America Insurance Company and Penn-Star Insurance
Company was in excess of the prescribed risk-based capital requirements.
Penn-America Insurance Company's policyholders' surplus at December 31, 2001 was
$64,733,251 and its regulatory action level was $17,124,648. Penn-Star Insurance
Company's policyholders' surplus at December 31, 2001 was $33,389,965 and its
regulatory action level was $5,675,459.
Net cash provided by operating activities was $24.1 million for the
six months ended June 30, 2002 compared to net cash used by operating activities
of $1.4 million for the six months ended June 30, 2001. This improvement is
mostly attributable to the increase in net written premiums combined with a
decrease in paid losses.
Net cash used by investing activities was $31.7 million for the six
months ended June 30, 2002, compared to $0.4 million for the six months ended
June 30, 2001. This increase is mostly attributable to the improved operating
cash flows noted above that were used to purchase fixed maturities available for
sale.
Net cash used by financing activities was $0.7 million for the six
months ended June 30, 2002, compared to $0.6 million for the six months ended
June 30, 2001. This increase is mostly attributable to an increase in dividend
payments made in the first six months of 2002 compared to the same period of
2001.
On June 27, 2002, PAGI filed a registration statement with the
Securities and Exchange Commission relating to a proposed offering of 4,000,000
shares of its common stock. Until the registration statement is effective, these
securities may not be sold nor may offers to buy be accepted. The intended use
of the net proceeds of this offering are to support the Company's operations,
including contributing capital to the
Page 17
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
insurance subsidiaries and capitalizing new insurance subsidiaries to support
the growth in business, and for working capital and other general corporate
purposes.
Investment Portfolio
The Company seeks to maintain sufficient liquidity from operations,
investing and financing activities to meet its anticipated insurance obligations
and operating and capital expenditure needs. The Company's investment strategy
emphasizes quality, liquidity and diversification, as well as total return. With
respect to liquidity, the Company considers liability durations, specifically
related to loss reserves, when determining desired investment maturities. In
addition, maturities have been staggered to produce cash flows for loss payments
and reinvestment opportunities. At June 30, 2002, the Company held a total of
$213.1 million in cash and investments. Of this amount, cash represented $4.9
million, equity securities represented $23.0 million, and fixed-income
securities represented $185.2 million.
The Company's cash and investments portfolio mix as of June 30, 2002
was as follows:
Fixed income:
U.S. Treasury securities and obligations of U.S. government agencies 8%
Corporate securities 34%
Mortgage-backed securities 6%
Other structured securities 22%
Municipal securities 17%
-----
Total fixed income 87%
Cash and short-term 2%
Preferred stock 8%
Common stock 3%
-----
100%
=====
The Company's fixed-income portfolio of $185.2 million was 87% of the
total cash and investments as of June 30, 2002. Approximately 90% of these
securities were rated "A" or better by Standard & Poor's or Moody's. Equity
securities, which consist of preferred stocks and common stocks (comprised
exclusively of exchange traded funds), were $23.0 million or 11% of total cash
and investments as of June 30, 2002.
As of June 30, 2002, our investment portfolio contained corporate
fixed-income and preferred stock securities with a market value of $88.2
million. A summary of these securities by industry segment is as follows:
Financial institutions 40%
Technology 13%
Communications 12%
Industrial 9%
Consumer, non-cyclical 9%
Consumer, cyclical 5%
Basic materials 5%
All other 7%
-----
100%
=====
Page 18
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
As of June 30, 2002, the investment portfolio contained $61.0 million
of mortgage-backed, asset-backed and collateralized mortgage obligations. All of
these securities were rated "AA-" or better and 80% were rated "AAA" by Standard
& Poor's or Moody's. These securities are publicly traded, and have market
values obtained from an independent pricing service. Changes in estimated cash
flows due to changes in prepayment assumptions from the original purchase
assumptions are revised based on current interest rates and the economic
environment. The Company had no derivative financial instruments, real estate or
mortgages in the investment portfolio as of June 30, 2002. The quality of the
fixed-income portfolio as of June 30, 2002 was as follows:
"AAA" 47%
"AA" 21%
"A" 23%
"BBB" 8%
Below "BBB" 1%
-----
100%
=====
The Company regularly evaluates its investment portfolio to identify
other-than-temporary impairments of individual securities. The Company considers
many factors in determining if an other-than-temporary impairment exists,
including the length of time and extent to which the market value of the
security has been less than cost, the financial condition and near-term
prospects of the issuer of the security and the Company's ability and
willingness to hold the security until the market value is expected to recover.
The table below summarizes individual securities held by the Company as
of June 30, 2002 with unrealized losses that: (1) were in excess of 15% of the
security's June 30, 2002 book value and greater than $150,000; and (2) have been
in an unrealized loss position continuously for at least six months prior to
June 30, 2002. The table illustrates the hypothetical effect on future net
income per share, utilizing diluted weighted average shares outstanding for the
six months ended June 30, 2002, if management subsequently determines that the
unrealized losses are other-than-temporary. There would be no effect on
stockholders' equity.
June 30, 2002
--------------------------------------------- Hypothetical Effect
Gross on Future Net
Unrealized Income Per
Security Description Book Value Market Value Loss Share (1)
-------- ----------- ---------- ------------ ---- ---------
AMEX Technology Exchange-traded fund $ 506,400 $ 333,802 $ (172,598) $ (0.01)
Anadarko Petroleum
Corporation Preferred stock 1,942,500 1,611,600 (330,900) (0.02)
HSBC USA Inc. Preferred stock 1,030,000 851,000 (179,000) (0.01)
(1) Using the diluted weighted average shares outstanding for the six months
ended June 30, 2002 and an effective tax rate of 34%.
The Company believes that the recent decline in the value of the AMEX
Technology exchange-traded-fund was a result of the volatility in the equity
markets in the second quarter of 2002 that is attributable in part,
Page 19
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
to the disclosures of recent accounting scandals. Management believes that the
prospects for recovery in this sector are good, and therefore, the decline is
temporary.
The Anadarko Petroleum Corp. and HSBC USA Inc. preferred stock
securities are rated BBB- and A+, respectively, by Standard & Poor's (both
investment grade ratings) and have consistently paid dividends since their
respective purchase dates by the Company. Management believes that the demand
for these high-yielding, tax-advantaged securities will increase as profits in
the financial services sector increase, and therefore, the decline is temporary.
Three-for-Two Stock Split
On April 11, 2002, the Company announced a three-for-two stock split to
be effected in the form of a 50% stock dividend payable to stockholders of
record as of April 25, 2002. The distribution date was May 9, 2002.
Quantitative and Qualitative Disclosures About Market Risk
The Company's market risk is the potential economic loss principally
arising from adverse changes in the market value of financial instruments. The
major components of market risk affecting the Company are interest rate risk and
equity price risk.
The Company had fixed-income and preferred stock investments with a
market value of $201.3 million at June 30, 2002 subject to interest rate risk.
The Company manages its exposure to interest rate risk through a disciplined
asset/liability matching and capital management process. In the management of
this risk, the characteristics of duration, credit and variability of cash flows
are critical elements. These risks constantly are assessed and balanced within
the context of the liability and capital position of the Company.
The Company had common equity investments with a market value of $6.9
million at June 30, 2002 subject to equity price risk. The Company attempts to
mitigate equity price risk to its common stock portfolio by investing
exclusively in exchange-traded funds (ETFs). ETFs are securities that represent
an interest in a trust that owns and holds a basket of common stocks that
replicate a major market index (such as the S&P 500 or the Dow Jones Industrial
Average) or a portion of a major market index (such as the Value Component of
the S&P). Since these securities represent an interest in the equity capital
markets as a whole, or a sub-sector thereof, they are a diversified, index-based
exposure to common stocks. As such, the value of these ETFs will be determined
by the performance of the equity capital markets in general or of a particular
sub-sector and reduces equity price risk to a single issuer of stock.
The Company's market risk at June 30, 2002 has not materially changed
from that identified at December 31, 2001.
Page 20
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Default Upon Senior Securities - None
Item 4. Submission of Matters to a Vote by Security Holders - None
Item 5. Other Information
On June 27, 2002, PAGI filed a registration statement with the
Securities and Exchange Commission relating to a proposed offering
of 4,000,000 shares of its common stock. Until the registration
statement is effective, these securities may not be sold nor may
offers to buy be accepted. The intended use of the net proceeds of
this offering are to support the Company's operations, including
contributing capital to the insurance subsidiaries and
capitalizing new insurance subsidiaries to support the growth in
business, and for working capital and other general corporate
purposes.
Item 6. Exhibits and Reports on Form 8-K
On May 15, 2002, the Company filed a current report on Form 8-K
announcing the availability of the first quarter statements of its
insurance subsidiaries, Penn-America Insurance Company and
Penn-Star Insurance Company, on the Company's website, in hard
copy from the Company, or from the Pennsylvania Insurance
Department.
On April 11, 2002, the Company filed a current report on Form 8-K
announcing that the Board of Directors of the Company unanimously
approved a three-for-two stock split of the common stock of the
Company. The three-for-two stock split is in the form of a 50%
stock dividend, effective for stockholders of record on April 25,
2002 and was distributed on May 9, 2002.
On April 1, 2002, the Company filed a current report on Form 8-K
announcing the availability of the Combined Annual Statement of
its insurance subsidiaries, Penn-America Insurance Company and
Penn-Star Insurance Company, on the Company's website, in hard
copy from the Company, or from the Pennsylvania Insurance
Department.
Page 21
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Penn-America Group, Inc.
Date: August 7, 2002 By: /s/ Jon S. Saltzman
---------------------------- --------------------------------
Jon S. Saltzman
President and
Chief Executive Officer
By: /s/ Joseph F. Morris
--------------------------------
Joseph F. Morris
Senior Vice President,
Chief Financial Officer
and Treasurer
Page 22