**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

# **FORM 10-Q**

 

| **ý****  Quarterly  Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                     |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                   |
| **For the quarterly period ended June 30,  2003**                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                   |
| **or**                                                                                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                   |
| **o****  Transition  Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                         |
|                                                                                                                                                                                                                                                                                                   |
| **for the transition period from                         to                       ** |
|                                                                                                                                                                                                                                                                                                   |
| **Commission file number 0-13972**                                                                                                                                                                                                                                                                     |

 

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| **PENN TREATY AMERICAN CORPORATION**         |
|----------------------------------------------|
| **3440 Lehigh  Street, Allentown, PA 18103** |
| **(610) 965-2222**                           |
|                                         |
| Incorporated in **Pennsylvania**             |   | I.R.S. Employer ID No. |
|                                         |   | **23-1664166** |

 

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Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. YES ýNO o

 

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the ExchangeAct).   Yes o   No ý

 

The number of shares outstanding of the Registrant’scommon stock, par value $.10 per share, as of August 7, 2003was 21,069,735.

 

 

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# **PART I**                                                                                                    FINANCIAL INFORMATION

** **

**Item 1.**FinancialStatements

 

Penn Treaty American Corporation is one of the leading providers oflong-term nursing home and home health care insurance. Our unauditedConsolidated Balance Sheets, Statements of Income and Comprehensive Income andStatements of Cash Flows and Notes thereto required under this item arecontained on pages 3 through 18 of this report. Our financial statementsrepresent the consolidation of our operations and those of our subsidiaries:Penn Treaty Network America Insurance Company, American Network InsuranceCompany, American Independent Network Insurance Company of New York, PennTreaty (Bermuda) Ltd., United Insurance Group Agency, Inc., Network InsuranceSenior Health Division and Senior Financial Consultants Company, which areunderwriters and marketers of long-term care insurance, Medicare supplement andother senior-market products.

 

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PENNTREATY AMERICAN CORPORATION AND SUBSIDIARIES

ConsolidatedBalance Sheets

(amountsin thousands, except per share data)

 
|                                                                                                                             |   | **June 30,  2003** |      | **December 31,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|------------------------|--------|
|                                                                                                                             |   | **(unaudited)**    |      |                   |   |
| ASSETS                                                                                                                           |   |               |      |                   |   |
| Investments:                                                                                                                     |   |               |      |                   |   |
| Bonds, available for sale at market (cost of $60,895 and $26,775,  respectively) (1)                                             |   | $                  | 63,348    |                   | $      | 28,454 |   |
| Policy loans                                                                                                                     |   | 288                |      | 238                    |   |
| Total investments                                                                                                                |   | 63,636             |      | 28,692                 |   |
| Cash and cash equivalents (1)                                                                                                    |   | 10,031             |      | 29,206                 |   |
| Property and equipment, at cost, less accumulated depreciation of  $8,785 and $7,925, respectively                               |   | 14,928             |      | 13,611                 |   |
| Unamortized deferred policy acquisition costs                                                                                    |   | 166,163            |      | 171,357                |   |
| Receivables from agents, less allowance for uncollectable amounts of  $312 and $119, respectively                                |   | 1,528              |      | 1,654                  |   |
| Accrued investment income                                                                                                        |   | 889                |      | 414                    |   |
| Goodwill                                                                                                                         |   | 20,360             |      | 20,360                 |   |
| Receivable from reinsurers                                                                                                       |   | 25,633             |      | 26,218                 |   |
| Corporate owned life insurance                                                                                                   |   | 58,901             |      | 57,773                 |   |
| Experience account due from reinsurer                                                                                            |   | 791,853            |      | 708,982                |   |
| Other assets                                                                                                                     |   | 19,135             |      | 21,933                 |   |
|                                                                                                                             |   |               |      |                   |   |
| Total assets                                                                                                                     |   | $                  | 1,173,057 |                   | $      | 1,080,200 |   |
| LIABILITIES                                                                                                                      |   |               |      |                   |   |
| Policy reserves:                                                                                                                 |   |               |      |                   |   |
| Accident and health                                                                                                              |   | $                  | 483,952   |                   | $      | 464,318 |   |
| Life                                                                                                                             |   | 12,706             |      | 12,553                 |   |
| Claim reserves                                                                                                                   |   | 339,742            |      | 329,944                |   |
| Accounts payable and other liabilities                                                                                           |   | 18,289             |      | 18,859                 |   |
| Long-term debt, less discount of $1,930 and $0, respectively                                                                     |   | 97,672             |      | 76,245                 |   |
| Preferred interest on early conversion                                                                                           |   | 1,950              |      | —                 |   |
| Deferred income taxes                                                                                                            |   | 36,624             |      | 23,101                 |   |
| Total liabilities                                                                                                                |   | 990,935            |      | 925,020                |   |
| Commitments and contingencies                                                                                                    |   | —             |      | —                 |   |
| SHAREHOLDERS’  EQUITY                                                                                                       |   |               |      |                   |   |
| Preferred stock, par value $1.00; 5,000 shares authorized, none  outstanding                                                     |   | —             |      | —                 |   |
| Common stock, par value $.10; 150,000 and 40,000 shares authorized,  respectively; 20,490 and 20,340 shares issued, respectively |   | 2,049              |      | 2,034                  |   |
| Additional paid-in capital                                                                                                       |   | 97,308             |      | 97,058                 |   |
| Accumulated other comprehensive income                                                                                           |   | 1,595              |      | 1,090                  |   |
| Retained earnings                                                                                                                |   | 87,875             |      | 61,703                 |   |
|                                                                                                                             |   | 188,827            |      | 161,885                |   |
| Less 915 common shares held in treasury, at cost                                                                                 |   | (6,705             | )         | (6,705                 | )      |
|                                                                                                                             |   | 182,122            |      | 155,180                |   |
| Total liabilities and shareholders’ equity                                                                                  |   | $                  | 1,173,057 |                   | $      | 1,080,200 |   |

 

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(1)  Cash andinvestments of $23,902 and $22,022, respectively, are restricted as to use.

See accompanying notes toconsolidated financial statements.

 

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PENNTREATY AMERICAN CORPORATION AND SUBSIDIARIES

ConsolidatedStatements of Income and Comprehensive Income

(unaudited)

(amountsin thousands, except per share data)

 
|                                                                                                          |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|---------------------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                                                                          |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| Revenues:                                                                                                     |   |                            |   |                          |   |   |   |   |   |
| Premium revenue                                                                                               |   | $                               | 78,707 |                          | $      | 83,906 |   | $ | 162,285 |   | $ | 168,142 |   |
| Net investment income                                                                                         |   | 10,572                          |   | 10,172                        |   | 20,919 |   | 19,707 |   |
| Net realized capital gains                                                                                    |   | 170                             |   | 41                            |   | 249 |   | 14,564 |   |
| Market gain (loss) on notional experience account                                                             |   | 38,964                          |   | 19,951                        |   | 43,266 |   | (6,002 | ) |
| Change in preferred interest on early conversion liability                                                    |   | 148                             |   | —                        |   | 87 |   | — |   |
| Other income                                                                                                  |   | 2,181                           |   | 2,392                         |   | 4,444 |   | 5,162 |   |
|                                                                                                          |   | 130,742                         |   | 116,462                       |   | 231,250 |   | 201,573 |   |
| Benefits and expenses:                                                                                        |   |                            |   |                          |   |   |   |   |   |
| Benefits to policyholders                                                                                     |   | 60,873                          |   | 62,515                        |   | 125,040 |   | 142,702 |   |
| Commissions                                                                                                   |   | 10,260                          |   | 11,677                        |   | 20,964 |   | 24,507 |   |
| Net policy acquisition costs amortized                                                                        |   | 2,140                           |   | 7,777                         |   | 5,194 |   | 4,451 |   |
| General and administrative expense                                                                            |   | 17,364                          |   | 10,873                        |   | 30,104 |   | 21,585 |   |
| Expense and risk charges on reinsurance                                                                       |   | 2,769                           |   | 3,577                         |   | 5,537 |   | 7,154 |   |
| Excise tax expense                                                                                            |   | 386                             |   | 792                           |   | 1,175 |   | 1,373 |   |
| Interest expense                                                                                              |   | 1,926                           |   | 1,194                         |   | 3,582 |   | 2,390 |   |
|                                                                                                          |   | 95,718                          |   | 98,405                        |   | 191,596 |   | 204,162 |   |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Income (loss) before federal income taxes and cumulative effect of  change in accounting principle            |   | 35,024                          |   | 18,057                        |   | 39,654 |   | (2,589 | ) |
| Federal income tax provision (benefit)                                                                        |   | 11,908                          |   | 6,139                         |   | 13,482 |   | (880 | ) |
| Net income (loss) before cumulative effect of change in accounting  principle                                 |   | 23,116                          |   | 11,918                        |   | 26,172 |   | (1,709 | ) |
| Cumulative effect of change in accounting principle                                                           |   | —                          |   | —                        |   | — |   | (5,151 | ) |
| Net income (loss)                                                                                             |   | 23,116                          |   | 11,918                        |   | 26,172 |   | (6,860 | ) |
| Other comprehensive income (loss):                                                                            |   |                            |   |                          |   |   |   |   |   |
| Unrealized holding gain (loss) arising during period                                                          |   | 930                             |   | 92                            |   | 1,023 |   | (542 | ) |
| Income tax (provision) benefit from unrealized holdings                                                       |   | (326                            | )      | (31                           | )      | (357 | ) | 184 |   |
| Reclassification of gains included in net income (loss)                                                       |   | (170                            | )      | (41                           | )      | (249 | ) | (14,564 | ) |
| Income tax provision from reclassification adjustment                                                         |   | 60                              |   | 14                            |   | 87 |   | 4,952 |   |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Comprehensive income (loss)                                                                                   |   | $                               | 23,610 |                          | $      | 11,952 |   | $ | 26,676 |   | $ | (16,830 | ) |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Basic earnings per share from net income (loss) before cumulative  effect of change in accounting principle   |   | $                               | 1.18   |                          | $      | 0.62 |   | $ | 1.34 |   | $ | (0.09 | ) |
| Basic earnings per share from net income (loss)                                                               |   | $                               | 1.18   |                          | $      | 0.62 |   | $ | 1.34 |   | $ | (0.36 | ) |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Diluted earnings per share from net income (loss) before cumulative  effect of change in accounting principle |   | $                               | 0.32   |                          | $      | 0.57 |   | $ | 0.43 |   | $ | (0.09 | ) |
| Diluted earnings per share from net income (loss)                                                             |   | $                               | 0.32   |                          | $      | 0.57 |   | $ | 0.43 |   | $ | (0.36 | ) |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Weighted average number of shares outstanding                                                                 |   | 19,520                          |   | 19,349                        |   | 19,480 |   | 19,102 |   |
| Weighted average number of shares and share equivalents                                                       |   | 75,952                          |   | 22,372                        |   | 65,999 |   | 19,102 |   |

 

See accompanying notes toconsolidated financial statements.

 

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PENNTREATY AMERICAN CORPORATION AND SUBSIDIARIES

ConsolidatedStatements of Cash Flows

(unaudited)

(amountsin thousands)

 
|                                                                        |   | **Six Months Ended June 30,** |   |
|-----------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                        |   | **2003**                      |   | **2002** |   |
| Cash flow from operating activities:                                        |   |                          |   |   |   |
| Net income (loss)                                                           |   | $                             | 26,172 |   | $ | (6,860 | ) |
| Adjustments to reconcile net income (loss) to cash provided by  operations: |   |                          |   |   |   |
| Amortization of intangible assets                                           |   | 379                           |   | 388 |   |
| Cumulative effect of change in accounting principle                         |   | —                        |   | 5,151 |   |
| Amortization of deferred reinsurance premium                                |   | 1,322                         |   | 1,320 |   |
| Amortization of discount on long-term debt                                  |   | 108                           |   | — |   |
| Gain on preferred interest on early conversion                              |   | (87                           | )      | — |   |
| Policy acquisition costs, net                                               |   | 5,194                         |   | 4,451 |   |
| Deferred income taxes                                                       |   | 13,251                        |   | (1,165 | ) |
| Depreciation expense                                                        |   | 860                           |   | 850 |   |
| Net realized capital gains                                                  |   | (249                          | )      | (14,564 | ) |
| Increase (decrease) due to change in:                                       |   |                          |   |   |   |
| Receivables from agents                                                     |   | (67                           | )      | 862 |   |
| Receivable from reinsurers                                                  |   | 1,452                         |   | 3,577 |   |
| Notional experience account due from reinsurer                              |   | (54,814                       | )      | (5,436 | ) |
| Claim reserves                                                              |   | 9,798                         |   | 17,993 |   |
| Policy reserves                                                             |   | 18,920                        |   | 34,032 |   |
| Accounts payable and other liabilities                                      |   | (570                          | )      | (7,861 | ) |
| Federal income taxes recoverable                                            |   | —                        |   | 700 |   |
| Accrued investment income                                                   |   | (475                          | )      | 7,530 |   |
| Other, net                                                                  |   | 1,497                         |   | (1,370 | ) |
|                                                                        |   |                          |   |   |   |
| Cash provided by operations                                                 |   | 22,691                        |   | 39,598 |   |
|                                                                        |   |                          |   |   |   |
| Cash flow from investing activities:                                        |   |                          |   |   |   |
| Proceeds from sales of bonds                                                |   | 11,632                        |   | 469,473 |   |
| Proceeds from sales of equity securities                                    |   | —                        |   | 9,547 |   |
| Proceeds from maturities of bonds                                           |   | 869                           |   | 3,572 |   |
| Purchase of bonds                                                           |   | (46,419                       | )      | (20,164 | ) |
| Purchase of equity securities                                               |   | —                        |   | (20 | ) |
| Increase in corporate owned life insurance                                  |   | (1,128                        | )      | (1,743 | ) |
| Deposits to notional experience account due from reinsurer                  |   | (28,057                       | )      | (589,013 | ) |
| Acquisition of property and equipment                                       |   | (2,177                        | )      | (550 | ) |
|                                                                        |   |                          |   |   |   |
| Cash used in investing                                                      |   | (65,280                       | )      | (128,898 | ) |
|                                                                        |   |                          |   |   |   |
| Cash flow from financing activities:                                        |   |                          |   |   |   |
| Proceeds from stock offering                                                |   | —                        |   | 2,352 |   |
| Issuance of long-term debt                                                  |   | 32,421                        |   | — |   |
| Repayment of long-term debt                                                 |   | (9,007                        | )      | (2,902 | ) |
|                                                                        |   |                          |   |   |   |
| Cash provided by (used in) financing                                        |   | 23,414                        |   | (550 | ) |
| Decrease in cash and cash equivalents                                       |   | (19,175                       | )      | (89,850 | ) |
|                                                                        |   |                          |   |   |   |
| Cash balances:                                                              |   |                          |   |   |   |
| Beginning of period                                                         |   | 29,206                        |   | 114,600 |   |
|                                                                        |   |                          |   |   |   |
| End of period                                                               |   | $                             | 10,031 |   | $ | 24,750 |   |

 

See accompanying notes toconsolidated financial statements.

 

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##### **PENN TREATYAMERICAN CORPORATION**

##### **NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

##### **June 30, 2003**

(unaudited)

(amounts in thousands, except per share data)

 

The Consolidated Financial Statements should be read in conjunctionwith these Notes and with the Notes to Consolidated Financial Statementsincluded in the Annual Report on Form 10-K for the year ended December 31, 2002of Penn Treaty American Corporation (the “Company”).  Certain amounts in the June 30, 2002 and December 31, 2002financial statements have been reclassified to conform to the presentation inthe June 30, 2003 financial statements.

 

In the opinion of management, the summarized financial informationreflects all adjustments (consisting only of normal recurring adjustments) thatare necessary for a fair presentation of the financial position and results ofoperations, comprehensive income and cash flows for the interim periods.

 

1.                                       NewAccounting Principles:

 

In May 2003,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No.150, “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity” (“SFAS No. 150”).  SFAS No. 150 specifies thatinstruments within its scope embody obligations of the issuer and that,therefore, the issuer must classify them as liabilities.  SFAS No. 150 represents phase one of theFASB’s broader project on (1) distinguishing between liability and equityinstruments and (2) accounting for instruments that have characteristics ofboth types of instruments.  SFAS No. 150covers a limited number of instruments that are to be classified as liabilitiesand is effective at the beginning of the first interim period beginning afterJune 15, 2003.  The adoption of SFAS No.150 is not expected to have a material impact on the Company’s consolidatedfinancial statements.

 

In April 2003,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No.149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities” (“SFAS No. 149”).  SFAS No. 149 amends and clarifies SFAS No. 133 to improvefinancial accounting and reporting for derivative instruments and hedgingactivities.  To ensure that contractswith comparable characteristics are accounted for similarly, SFAS No. 149clarifies the circumstances under which a contract with an initial netinvestment meets the characteristics of a derivative, clarifies when aderivative contains a financing component, and amends the definition of“underlying” and certain other existing pronouncements.  SFAS No. 149 is effective for contractsentered into or modified and for hedging relationships designated after June30, 2003, except that certain provisions relating to forward purchases andsales of when-issued securities or other securities that do not yet existshould be applied to both existing contracts and new contracts entered into afterJune 30, 2003.  The adoption of SFAS No.149 is not expected to have a material impact on the Company’s consolidatedfinancial statements.

 

In December 2002, the FASB issued Statement ofFinancial Accounting Standards No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure” (“SFAS No. 148”), which amendsStatement of Financial Accounting Standards Statement No. 123, “Accounting forStock-Based Compensation” (“SFAS No. 123”). The objective of SFAS No. 148 is toprovide alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation. SFASNo. 148 does not change the provisions of SFAS No. 123 that permit entities tocontinue to apply the intrinsic value method of Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees” 

 

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(“APB No. 25”). Inaddition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 torequire prominent disclosures in both annual and interim financial statementsabout the method of accounting for stock-based employee compensation and theeffect of the method used on reported results. The Company continues tomaintain its accounting for stock-based compensation in accordance with APB No.25, but has adopted the disclosure provisions of SFAS No. 148.

 

The following table reflects net income, basic anddiluted earnings per share as reported and pro-forma as if the Company hadadopted the fair value based method of accounting for its stock-based employeecompensation awards:

 
|                                                                                                                                                |   | **Three Months Ended June 30, ,** |   | **Six Months Ended June 30** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|------------------------------|--------|
|                                                                                                                                                |   | **2003**                          |   | **2002**                     |   | **2003** |   | **2002** |   |
|                                                                                                                                                |   |                              |   |                         |   |   |   |   |   |
| Net income, as reported                                                                                                                             |   | $                                 | 23,116 |                         | $      | 11,918 |   | $ | 26,172 |   | $ | (6,860 | ) |
| Add:  Stock-based employee  compensation expense (income) included in reported net income, net of related  tax effects                         |   | —                            |   | (135                         | )      | — |   | (240 | ) |
| Deduct:  Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |   | (53                               | )      | (11                          | )      | (63 | ) | (156 | ) |
| Pro forma net income                                                                                                                                |   | $                                 | 23,063 |                         | $      | 11,772 |   | $ | 26,109 |   | $ | (7,256 | ) |
|                                                                                                                                                |   |                              |   |                         |   |   |   |   |   |
| Earnings per share:                                                                                                                                 |   |                              |   |                         |   |   |   |   |   |
| Basic - as reported                                                                                                                                 |   | $                                 | 1.18   |                         | $      | 0.62 |   | $ | 1.34 |   | $ | (0.36 | ) |
| Basic - pro forma                                                                                                                                   |   | $                                 | 1.18   |                         | $      | 0.61 |   | $ | 1.34 |   | $ | (0.38 | ) |
| Diluted - as reported                                                                                                                               |   | $                                 | 0.32   |                         | $      | 0.57 |   | $ | 0.43 |   | $ | (0.36 | ) |
| Diluted - pro forma                                                                                                                                 |   | $                                 | 0.32   |                         | $      | 0.56 |   | $ | 0.43 |   | $ | (0.38 | ) |

 

Statement of Financial Accounting Standards No. 142,“Goodwill and Other Intangible Assets” (“SFAS No. 142”), primarily addressesthe accounting for goodwill and intangible assets subsequent to theiracquisition. The Company adopted SFAS No. 142 on January 1, 2002 and ceasedamortizing goodwill at that time. During the second quarter of 2002, theCompany completed an impairment analysis of goodwill, in accordance with SFASNo. 142. The Company’s goodwill was recorded as a result of its purchase of itsagencies and its insurance subsidiaries. As part of its evaluation, the Companycompleted numerous steps in determining the recoverability of its goodwill. Thefirst required step was the measurement of total enterprise fair value versusbook value. Because the Company’s fair market value, as measured by its stockprice, was below book value at January 1, 2002, goodwill was next evaluatedat a reporting unit level, which included its insurance agencies and insurancesubsidiaries.

 

Upon completion of this evaluation, the Companydetermined that the goodwill associated with the agency purchases was fullyrecoverable. The deficiency of current market value to book value wasattributed to the insurance subsidiary values. As a result, the Companydetermined that the goodwill associated with its insurance subsidiaries wasimpaired and recognized an impairment loss of $5,151 from its transitionalimpairment test of goodwill, which it recorded as a cumulative effect of changein accounting principle. The impairment has been recorded effective January 1,2002.  Management has completed anassessment of other intangible assets and has determined to continue toamortize these assets so as to closely match the future profit emergence fromthese assets.

 

In January 2003, the FASBissued FASB Interpretation No. 46, “Consolidation of Variable InterestEntities, an Interpretation of Accounting Research Bulletin No. 51” (“FIN No.

 

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46”). FIN No. 46 requiresexisting, unconsolidated variable interest entities to be consolidated by theirprimary beneficiaries if the entities do not effectively disperse risks amongparties involved. FIN No. 46 applies immediately to variable interest entitiescreated after January 31, 2003, and to variable interest entities in which anenterprise obtains an interest after that date. It applies in the first fiscalyear or interim period beginning after June 15, 2003, for variable interestentities in which an enterprise holds a variable interest that it acquiredbefore February 1, 2003. FIN No. 46 applies to public enterprises as of thebeginning of the applicable interim or annual period.  FIN No. 46 may be applied prospectively with a cumulative-effectadjustment as of the date on which it is first applied or by restatingpreviously issued financial statements for one or more years with acumulative-effect adjustment as of the beginning of the first year restated.The implementation of FIN No. 46 did not have a material impact on theCompany’s consolidated financial statements.

 

2.                                     RegulatoryDevelopments:

 

*Pennsylvania Corrective Action Plan*

 

The Company’s Pennsylvania insurance subsidiaries are required to holdstatutory surplus that is, at a minimum, above a calculated authorized controllevel at which the Pennsylvania Insurance Department (the “Department”) mayplace them under regulatory control, leading to rehabilitation or liquidation.At December 31, 2000, Penn Treaty Network America Insurance Company (“PTNA”),the Company’s primary insurance subsidiary, that represented 94% of its directpremium, had statutory surplus which while above the authorized control level, wasat an amount that required PTNA to file a Corrective Action Plan (the “Plan”)with the insurance commissioner.  Inaddition, American Network Insurance Company (“ANIC”), which is owned 100% byPTNA, is also subject to the provisions of the Plan.

 

On February 12, 2002, the Department approved the Plan which, amongother things:

 

a)              required the Company toenter into a reinsurance agreement with Centre Solutions (Bermuda) Limited (the“2001 Centre Agreement”) for substantially all of its existing business atDecember 31, 2001  (See Note 3 —Reinsurance Agreements);

b)             limits new investments tothose rated by the National Association of Insurance Commissioners (“NAIC”) as1 or 2;

c)              limits and requiresDepartment approval for affiliated transactions; and

d)             requires a $125,000 increasein statutory reserves over a three-year period, of which a $33,000****increaseremains to be made throughout 2003 and 2004.

 

The 2001 Centre Agreement is accounted for as reinsurance for statutoryaccounting purposes, but does not qualify as reinsurance under generallyaccepted accounting principles (“GAAP”) (See Note 3). As the agreement istreated as reinsurance for statutory accounting purposes, it results in theceding (or removal) of substantially all of PTNA’s and ANIC’s policy reserveand claim reserve liabilities for statutory accounting purposes. Furthermore,subject to certain limitations, any adverse development of the 2001 and priorpolicy and claim reserves, including the $125,000 of reserve increasesmentioned above, is ceded to the reinsurer and is not reflected on PTNA’s orANIC’s statutory financial statements.

 

The agreement is subject to certain coverage limitations, including anaggregate limit of liability that is a function of certain factors and that maybe reduced in the event that the premium rate increases that the reinsuranceagreement may require are not obtained. The Company is required to performannual comparisons of its actual to expected claims experience. If the Companyhas reason to believe, whether from this analysis or other availableinformation, that at least a 5% premium rate increase is necessary, the Companyis obligated to file and obtain such premium rate increases in order to complywith the requirements of the agreement. If the 

 

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Company does not file and obtain such premium rate increases, theaggregate limit of liability would be reduced by 50% of the premium amount thatwould have otherwise been received.

 

In the event the statutory policy and claim reserves for the reinsuredpolicies ultimately exceed the limit of liability established in thereinsurance agreement, either as a result of additions to reserves orreductions in the amount of the reinsurer’s limit of liability, PTNA or ANIC wouldhave to retain any reserve liabilities in excess of the limit of liability,which could have a materially adverse impact upon their statutory surplus.

 

The estimation of policy reserves for statutory accounting purposesdiffers from that utilized in GAAP. For statutory accounting purposes, theassumptions utilized and the methodology applied may be at the discretion ofthe Department in its interpretation of its regulations. As noted above, aspart of the Plan, the Department has provided the Company with guidelines forestablishing its statutory policy reserves. Because PTNA and ANIC have limitedstatutory capital and the 2001 Centre Agreement has a limit of liability, anychanges in the Department’s interpretation or view of how the Company’s insurancesubsidiaries determine their statutory policy reserves could have a materialadverse impact on PTNA or ANIC, possibly resulting in regulatory control orliquidation.

 

*New Policy Sales*

 

The Company is licensed and receives renewal premium revenue from policyholdersin all states, but is currently prohibited from issuing new policies in 14states. In March 2003, the Company agreed on terms for the recommencement ofsales in California, which is pending subject to certain conditions. Californiarepresented approximately 14% of the Company’s premium revenue for the sixmonths ended June 30, 2003. The Company is approved for sales in Florida andPennsylvania (subject to Corrective Action Plans), which accounted forapproximately 18% and 11% respectively, of the Company’s premium revenue forthe six months ended June 30, 2003. No other state’s sales accounted for morethan 10% of the Company’s premium revenue for the period ended June 30, 2003.

 

3.                                     ReinsuranceAgreements:

 

*2001Centre Agreement*

 

As a primary component ofthe Plan, effective December 31, 2001, the Company entered the 2001 CentreAgreement to reinsure, on a quota share basis, substantially all of itsrespective long-term care insurance policies then in-force.

 

This agreement does not qualify for reinsurance treatment in accordancewith GAAP because it does not result in the reasonable possibility that thereinsurer may realize a significant loss. This is due to a number of factorsrelated to the agreement, including experience refund provisions, expense andrisk charges due to the reinsurer and the aggregate limit of liability.Accordingly, the contract is being accounted for in accordance with depositaccounting for reinsurance contracts. However, this agreement meets therequirements to qualify for reinsurance treatment under statutory accountingrules.

 

The initial premium paid under the agreement was approximately$619,000, comprised of $563,000 in cash and qualified securities transferred inFebruary 2002, and $56,000 in funds held due to the reinsurer. The initialpremium and future cash flows from the reinsured policies, less claimspayments, ceding commissions and risk charges, are credited to a notionalexperience account, which is held for the Company’s benefit in the event ofcommutation and recapture on or after December 31, 2007. The notionalexperience account balance receives an investment credit based upon the totalreturn from a series of benchmark indices and derivative hedges that are

 

9

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intended to match the duration of the Company’s reserve liability.

 

The notional experience account represents a hybridinstrument, containing both a fixed debt host contract and an embeddedderivative. The economic characteristics and risks of the embedded derivativeinstrument are not clearly and closely related to the economic characteristicsand risks of the fixed debt host contract. The Company is accounting for theinvestment credit received on the notional experience account as follows:

 

a)              The fixed debt host yields a fixed returnbased on the yield to maturity of the underlying benchmark indices. The returnon the fixed debt host is reported as investment income in the Statements ofIncome and Comprehensive Income.

b)             The change in fair value of the embeddedderivative represents the percentage change in the underlying indices appliedto the notional experience account, similar to that of an unrealized gain/losson a bond. The change in the fair value of the embedded derivative is reportedas market gain (loss) on notional experience account in the Statements ofIncome and Comprehensive Income.

 

The benchmark indices are comprised of US treasury strips, agencies andinvestment grade corporate bonds, with weightings of approximately 25%, 15% and60%, respectively, and have a duration of approximately 11 years. The hybridinstrument subjects the Company to significant volatility as the estimatedvalue of the embedded derivative is highly sensitive to changes in interestrates. A 100 basis point increase in interest rates would reduce the currentnotional experience account balance by approximately $79,000.

 

For the periods ended June 30, 2003 and 2002, respectively, thenotional experience account activity was as follows:

 
|                                          |   | **Three Months Ended June 30,** |    | **Six Months Ended June 30,** |   |
|-----------------------------------------------|--------|---------------------------------|---------|-------------------------------|--------|
|                                          |   | **2003**                        |    | **2002**                      |   | **2003** |   | **2002** |   |
|                                          |   |                            |    |                          |   |   |   |   |   |
| Beginning balance                             |   | $                               | 734,037 |                          | $      | 552,967 |   | $ | 708,982 |   | $ | — |   |
| Initial premium                               |   | —                          |    | —                        |   | — |   | 563,300 |   |
| Premiums, net of claims and ceding allowance: |   | 11,737                          |    | 15,358                        |   | 25,492 |   | 25,712 |   |
| Investment credit:                            |   |                            |    |                          |   |   |   |   |   |
| Investment income                             |   | 10,123                          |    | 9,750                         |   | 20,005 |   | 18,593 |   |
| Market gain(loss)                             |   | 38,964                          |    | 19,951                        |   | 43,266 |   | (6,002 | ) |
| Expense and risk charges                      |   | (2,769                          | )       | (3,577                        | )      | (5,537 | ) | (7,154 | ) |
| Broker/Custodian/Trustee fees                 |   | (239                            | )       | —                        |   | (355 | ) | — |   |
| Ending balance                                |   | $                               | 791,853 |                          | $      | 594,449 |   | $ | 791,853 |   | $ | 594,449 |   |

 

The reinsurance agreement contains commutation provisions and allowsthe Company to recapture the reserve liabilities and the current notionalexperience account balance as of December 31, 2007, or on December 31 of anyyear thereafter. The Company intends, but is not required, to commute theagreement on December 31, 2007. In the event the Company does not commute theagreement on December 31, 2007, the expense and risk charges applied to thenotional experience account will increase significantly. Additionally, thereinsurance provisions contain covenants and conditions that, if breached, mayresult in the immediate commutation of the agreement and the payment of $2,500per quarter from the period of the breach through December 31, 2007.

 

The Company’s current modeling and actuarial projections suggest thatit is likely to be able to commute the agreement, as planned, on December 31,2007. In order to commute the agreement, PTNA’s and ANIC’s statutory surplusfollowing commutation must be sufficient to 

 

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support the reacquired business in compliance with all statutoryrequirements. Upon commutation, the Company will receive cash or other liquidassets equaling the value of the notional experience account from thereinsurer. The Company would also record the necessary reserves for thebusiness in PTNA’s and ANIC’s statutory financial statements. Accordingly, theCompany’s ability to commute the agreement is highly dependent upon the valueof the notional experience account exceeding the level of required statutoryreserves recorded upon commutation. As of June 30, 2003, the statutory basisreserve liabilities of $928,795 exceeded the combination of the notionalexperience account value and funds held due to the reinsurer of $848,689.  Based upon the Company's current modelingand actuarial projections, management expects the value of the notional experienceaccount to exceed the reserve liabilities at December 31, 2007. In addition tothe performance of the reinsured policies from now through 2007, the notionalexperience account value is susceptible to market interest rate changes. Amarket interest rate increase of 100 basis points could reduce the value of thecurrent notional experience account by approximately $79,000 and jeopardize theCompany’s ability to commute as planned. As the intended commutation dateapproaches, the sensitivity of the notional experience account to market interestrate movement will decline as the duration of the benchmark indices becomesshorter; however, the amount of assets susceptible to such interest sensitivitywill continue to grow as additional net cash flows are added to the notionalexperience account balance prior to commutation.

 

As part of the reinsurance agreement, the reinsurer was granted fourtranches of warrants to purchase shares of non-voting convertible preferredstock. The first three tranches of warrants are exercisable through December 31,2007 at common stock equivalent prices ranging from $4.00 to $12.00 per share.If exercised and converted, the convertible preferred stock would representapproximately 15% of the then outstanding shares of our common stock on a fullydiluted basis. If the agreement is not commuted on December 31, 2007, thereinsurer may exercise the fourth tranche of convertible preferred stockpurchase warrants at a common stock equivalent price of $2.00 per share, andthe convertible preferred stock would represent, if converted, an additional20% of the then outstanding common stock on a fully diluted basis.

 

The warrants are part of the consideration for the reinsurance contractand are recognized as reinsurance premiums over the anticipated life of thecontract, which is six years. The warrants were valued at the issuance dateusing a Black-Scholes model with the following assumptions: 6.0 years expectedlife, volatility of 70.9% and a risk free interest rate of 4.74%. The $15,855value of the warrants was recorded as a deferred premium as of December 31,2001. Of the original $15,855 value, $661 of deferred premium was amortizedduring each of the three months ended June 30, 2003 and 2002 and $1,322****ofdeferred premium was amortized during each of the six months ended June 30,2003 and 2002.  The unamortized value ofthe warrants at June 30, 2003 and December 31, 2002 is $11,891 and $13,213,respectively.  These amounts areincluded in other assets on the Consolidated Balance Sheets.

 

As a result of the Company’s intention to commute, it considered onlythe expense and risk charges anticipated prior to the commutation date in itsmost recent unamortized deferred acquisition costs (“DAC”) recoverabilityanalyses and has not recorded the potential of future escalating charges. Inaddition, the Company is recognizing the additional consideration of enteringinto the agreement, represented by the fair value of the warrants granted tothe reinsurer, over the period of time to the expected commutation date.

 

In the event the Company determines that commutation of the reinsuranceagreement on December 31, 2007 is unlikely, but likely at some future date, itwill include additional annual reinsurer expense and risk charges in its DACrecoverability analysis. As a result, it could impair the value of its DACasset and record the impairment in its financial statements at that time.However, the Company currently believes that PTNA and ANIC will have sufficientstatutory capital and surplus to commute the agreement on December 31, 2007 orthat sufficient alternatives, such as additional capital issuance or newreinsurance opportunities, will be 

 

11

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available to enable it to commute the agreement on December 31, 2007.

 

*2002 Centre Agreement*

 

The 2001 Centre Agreement granted the reinsurer an option toparticipate in reinsuring new business sales on a quota share basis. In August2002, the reinsurer exercised its option to reinsure up to 50% of future sales,subject to a limitation of the reinsurer’s risk. The reinsurer may continuethis level of participation on the first $100,000 in new policy premium issuedafter January 1, 2002. The final agreement, which was entered into in December2002, further provides the reinsurer the option to reinsure a portion of thenext $1,000,000 in newly issued long-term care annual insurance premium,subject to maximum quota share amounts of up to 40% as additional policies arewritten.

 

This agreement does not qualify for reinsurance treatment in accordancewith GAAP because it does not result in the reasonable possibility that thereinsurer may realize a significant loss. This is due to an aggregate limit ofliability that reduces the likelihood of the reinsurer realizing a significantloss on the agreement. Accordingly, the contract is being accounted for inaccordance with deposit accounting for reinsurance contracts. However, thisagreement meets the requirements to qualify for reinsurance treatment understatutory accounting rules.

 

 

4.                                     Contingencies:

 

*Litigation*

 

The Company and certain of its key executive officersare defendants in consolidated actions that were instituted on April 17, 2001in the United States District Court for the Eastern District of Pennsylvania byits shareholders, on their own behalf and on behalf of a putative class ofsimilarly situated shareholders who purchased shares of the Company’s commonstock from July 23, 2000 through and including March 29, 2001. The consolidatedamended class action complaint seeks damages in an unspecified amount forlosses allegedly incurred as a result of misstatements and omissions allegedlycontained in the Company’s periodic reports filed with the SEC, certain pressreleases issued by the Company, and in other statements made by the Company’s officials.The alleged misstatements and omissions relate, among other matters, to thestatutory capital and surplus position of its largest subsidiary, PTNA. On July1, 2002, the defendants filed an answer to the complaint, denying allliability.  Plaintiffs filed a motion for class certification on August15, 2002, which is currently pending. On February 26, 2003, the parties reachedan agreement in principle to settle the litigation for $2,300, to be paidentirely by the Company’s directors’ and officers’ liability insurancecarrier.  The settlement remains subject to documentation and courtapproval.

 

The Company and its subsidiary, PTNA, are defendantsin an action in the Fifth Judicial Circuit of the State of Florida in and forMarion County, Civil Division.  Plaintiffs filed this matter on January10, 2003 in Florida State court, on behalf of themselves and a class ofsimilarly situated Florida long-term care policyholders. The Company removedthis case from the Florida State court to United States District Court, MiddleDistrict of Florida, Ocala Division. Plaintiffs’ motion to remand the case to Florida State Court was grantedon June 25, 2003. Plaintiffs claim wrongdoing in connection with the sale oflong-term care insurance policies to the Plaintiffs and 

 

12

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the Class. Plaintiffsallege claims for reformation, breach of fiduciary duty, breach of the impliedduty of good faith and fair dealing, negligent misrepresentation, fraudulentmisrepresentation, and restitution. The Company has filed motions to dismissfor failure to state a claim, lack of personal jurisdiction against theCompany, and to strike certain allegations of the complaint as irrelevant andimproper.  A hearing on these motions has been scheduled for October 9,2003.  While the Company cannot predictthe outcome of this case, it could have a material adverse impact upon itsfinancial condition and results of operations. However, the Company believesthat the complaint is without merit and intends to continue to defend thematter vigorously.

 

The Company and two of its subsidiaries, PTNA andSenior Financial Consultants Company, are defendants in an action instituted onJune 5, 2002 in the United States District Court for the Eastern District ofPennsylvania by National Healthcare Services, Inc. The complaint seekscompensatory damages in excess of $150 and punitive damages in excess of $5,000for an alleged breach of contract and misappropriation. The claims arise out ofa joint venture related to the AllRisk Healthcare program, which was marketedfirst by PTNA and then later by Senior Financial Consultants Company. Thedefendants have denied the allegations of the complaint and will continue todefend the matter vigorously. While the Company cannot predict the outcome ofthis case, the Company believes that any resolution of this action will nothave a material impact on its financial condition or results of operations.

 

The Company’s subsidiaries are parties to variousother lawsuits generally arising in the normal course of their business. TheCompany does not believe that the eventual outcome of any of the other suits towhich it is a party will have a material adverse effect on its financialcondition or results of operations. However, the outcome of any single eventcould have a material impact upon the quarterly or annual financial results ofthe period in which it occurs.

 

*Reinsurance*

 

PTNA is a party to a reinsurance agreement to cede therisk of certain home health care claims that extend beyond 36 months.Reinsurance recoverables related to this treaty were $10,306 and $10,175 atJune 30, 2003 and December 31, 2002, respectively. The reinsurer has notifiedPTNA that it believes that the Company is in breach of its current agreement asa result of entering the 2001 Centre Agreement without the prior writtenapproval of the reinsurer. PTNA has contested this assertion of breach and iscontinuing discussions with the reinsurer to reach an equitable resolution.   The ultimate resolution of this disputecannot be determined at this time.

 

5.                                     Investments:

 

Management hascategorized all of its investment securities as available for sale because theymay be sold in response to changes in interest rates, prepayments and similarfactors. Investments in this category are reported at their current marketvalue, with net unrealized gains and losses, net of the applicable deferredincome tax effect, being added to or deducted from the Company’s totalshareholders’ equity on the balance sheet. As of June 30, 2003, shareholders’equity was increased by $1,595 due to unrealized gains of $2,453 in theinvestment portfolio. As of December 31, 2002, shareholders’ equity wasincreased by $1,090 due to unrealized gains of $1,679 in the investment portfolio.

 

The amortized cost andestimated market value of the Company’s available for sale investment portfolioas of June 30, 2003 and December 31, 2002 are as follows:

 

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|                                                                                  |   | **June 30, 2003**   |   | **December 31, 2002**       |   |
|---------------------------------------------------------------------------------------|--------|---------------------|--------|-----------------------------|--------|
|                                                                                  |   | **Amortized  Cost** |   | **Estimated  Market Value** |   | **Amortized  Cost** |   | **Estimated  Market Value** |   |
| U.S. Treasury securities and obligations of U.S. Government  authorities and agencies |   | $                   | 29,160 |                        | $      | 30,493 |   | $ | 15,689 |   | $ | 16,861 |   |
|                                                                                  |   |                |   |                        |   |   |   |   |   |
| Mortgage backed securities                                                            |   | 2,644               |   | 2,730                       |   | 1,603 |   | 1,681 |   |
|                                                                                  |   |                |   |                        |   |   |   |   |   |
| Debt securities issued by foreign governments                                         |   | 625                 |   | 616                         |   | 205 |   | 216 |   |
|                                                                                  |   |                |   |                        |   |   |   |   |   |
| Corporate securities                                                                  |   | 28,466              |   | 29,509                      |   | 9,278 |   | 9,696 |   |
|                                                                                  |   |                |   |                        |   |   |   |   |   |
| Policy loans                                                                          |   | 288                 |   | 288                         |   | 238 |   | 238 |   |
|                                                                                  |   |                |   |                        |   |   |   |   |   |
| Total investments                                                                     |   | $                   | 61,183 |                        | $      | 63,636 |   | $ | 27,013 |   | $ | 28,692 |   |
|                                                                                  |   |                |   |                        |   |   |   |   |   |
| Net unrealized gain                                                                   |   | $                   | 2,453  |                        |   |   | $ | 1,679 |   |   |   |

 

The majority of the Company’s investment portfolio was transferred tothe reinsurer as part of the initial premium paid for the 2001 CentreAgreement. The reinsurer maintains a notional experience account for theCompany’s benefit in the event of future commutation of the reinsuranceagreement. The Company receives an investment credit equal to the total returnof a series of benchmark indices and derivative hedges. The notional experienceaccount balance at June 30, 2003 and December 31, 2002 was $791,853 and$708,982, respectively (See Note 3).

 

Pursuant to certain statutory licensing requirements, as of June 30,2003 and December 31, 2002, the Company had on deposit bonds with an estimatedmarket value aggregating $10,812 and $10,848, respectively in InsuranceDepartment special deposit accounts. The Company is not permitted to remove thebonds from these accounts without approval of the regulatory authority.

 

The Company maintains assets in a trust account under a reinsuranceagreement with an unaffiliated insurer. The Company is required to hold assets equal to 102% of the reserves, or$13,090 and $11,174 at June 30, 2003 and December 31, 2002,respectively, for the policies assumed under this agreement. At both June 30,2003 and December 31, 2002, the market value of the assets in trust exceededthe required amount.

 

6.                                     Reconciliationof Earnings Per Share:

 

A reconciliation of thenumerator and denominator of the basic earnings per share computation to thenumerator and denominator of the diluted earnings per share computationfollows. Basic earnings per share excludes dilution and is computed by dividingincome available to common shareholders by the weighted average number ofcommon shares outstanding for the period. Diluted earnings per share reflectsthe potential dilution that could occur if securities or other contracts toissue common stock were exercised or converted into common stock. The Companycurrently has outstanding $98,163 of convertible, subordinated notes due 2008(see Note 8), which are convertible prior to maturity into common shares at$1.75 per share.  The effect of theconversion of these shares is included for purposes of calculating dilutedearnings per share.  Anti-dilutiveeffects are not included.

 

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|                                                                                                          |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|---------------------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                                                                          |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
| Net income (loss) before cumulative effect of change in accounting  principle                                 |   | $                               | 23,116 |                          | $      | 11,918 |   | $ | 26,172 |   | $ | (1,709 | ) |
| Weighted average common shares outstanding                                                                    |   | 19,520                          |   | 19,349                        |   | 19,480 |   | 19,102 |   |
| Basic earnings per share from net income (loss) before cumulative  effect of change in accounting principle   |   | $                               | 1.18   |                          | $      | 0.62 |   | $ | 1.34 |   | $ | (0.09 | ) |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Net income (loss) before cumulative effect of change in accounting  principle                                 |   | $                               | 23,116 |                          | $      | 11,918 |   | $ | 26,172 |   | $ | (1,709 | ) |
| Cumulative effect of change in accounting principle                                                           |   | —                          |   | —                        |   | — |   | (5,151 | ) |
| Net income (loss)                                                                                             |   | $                               | 23,116 |                          | $      | 11,918 |   | $ | 26,172 |   | $ | (6,860 | ) |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Basic earnings per share from net income (loss)                                                               |   | $                               | 1.18   |                          | $      | 0.62 |   | $ | 1.34 |   | $ | (0.36 | ) |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Adjustments net of tax:                                                                                       |   |                            |   |                          |   |   |   |   |   |
| Interest expense on convertible debt                                                                          |   | $                               | 1,158  |                          | $      | 771 |   | $ | 2,168 |   | $ | — |   |
| Amortization of debt offering costs                                                                           |   | 89                              |   | 60                            |   | 145 |   | — |   |
| Diluted net income (loss) before cumulative effect of change in  accounting principle                         |   | $                               | 24,363 |                          | $      | 12,749 |   | $ | 28,485 |   | $ | (1,709 | ) |
| Diluted net income (loss)                                                                                     |   | $                               | 24,363 |                          | $      | 12,749 |   | $ | 28,485 |   | $ | (6,860 | ) |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Weighted average common shares outstanding                                                                    |   | 19,520                          |   | 19,349                        |   | 19,480 |   | 19,102 |   |
| Common stock equivalents due to dilutive effect of stock  options/warrants                                    |   | 13                              |   | 395                           |   | 10 |   | — |   |
| Shares converted from convertible debt                                                                        |   | 56,419                          |   | 2,628                         |   | 46,509 |   | — |   |
| Total outstanding shares for diluted earnings per share computation                                           |   | 75,952                          |   | 22,372                        |   | 65,999 |   | 19,102 |   |
|                                                                                                          |   |                            |   |                          |   |   |   |   |   |
| Diluted earnings per share from net income (loss) before cumulative  effect of change in accounting principle |   | $                               | 0.32   |                          | $      | 0.57 |   | $ | 0.43 |   | $ | (0.09 | ) |
| Diluted earnings per share from net income (loss)                                                             |   | $                               | 0.32   |                          | $      | 0.57 |   | $ | 0.43 |   | $ | (0.36 | ) |

 

Securities that couldpotentially dilute basic earnings per share in the future that were notincluded in the computation of diluted earnings per share were 41,540 and14,588 at June 30, 2003 and December 31, 2002, respectively, because to do sowould have been anti-dilutive. These securities include options, warrants (seeNote 3) and convertible debt securities (see Note 8) that have exercise pricesabove the current period market price or the inclusion of which would result ina lower net loss per share.

 

15

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7.                                     EquityPlacement:

 

In March 2002, the Company completed a private placement of 510 sharesof common stock for net proceeds of $2,352. The common stock was sold toseveral institutional investors at $4.65 per share, a 10 percent discount tothe 30-day average price of the Company’s common stock prior to the issuance ofthe new shares. The proceeds of the private placement provided additionalliquidity to the parent company to meet its current year debt serviceobligations.

 

Throughout 2002 and 2003, the Company issued shares ofits common stock to its financial advisor as compensation for its assistance invarious capital markets transactions. The dates, number of shares and compensation expense as a result of theissuances were:

 
| **Date**     |   | **Shares** |   | **Compensation** |   |
|--------------|--------|------------|--------|------------------|--------|
|         |   |       |   |             |   |
| April 2002   |   | 60         |   | $                | 325    |   |
| October 2002 |   | 20         |   | 68               |   |
| January 2003 |   | 20         |   | 34               |   |
| May 2003     |   | 100        |   | 175              |   |
|              |        |            |        |                  |        |  |

 

8.                                       Long-TermDebt:

 

During the first quarter of 2003, the Company issued $32,421 in 6.25%convertible subordinated notes due 2008 (the “2008 Notes”).  The primary terms of the 2008 Notes are:

 

1.               the 2008 Notes can be converted by theholder into shares of the Company’s common stock at $1.75 per share;

2.               the 2008 notes may not be called by theCompany or forced to convert into shares of common stock prior toOctober 2005;

3.               after October 2005, the 2008 Notes willmandatorily convert into shares of the Company’s common stock if at any timethereafter the average market price for fifteen trading days of the commonstock exceeds $1.93; and,

4.               holders of the 2008 Notes are entitledto convert their notes into shares of the Company’s common stock beforeOctober 2005 and receive a discounted amount of interest that they wouldhave otherwise received until October 2005. The Company may elect to pay this interest in cash or in newly issuedshares of common stock priced at a 10% discount to the then fair market valueof traded shares.

 

In conjunction with the issuance of the new 2008 Notes, the Companymodified the terms of its existing $65,793 of 2008 Notes to make them identicalto those of the new 2008 Notes.

 

In June 2003, the Company called and paid the entire obligation relatedto its remaining $8,957 of its 6.25% convertible subordinated notes due2003.  In addition, holders of $51 of2008 Notes elected to convert their notes in June 2003 in exchange for 29shares of common stock.  Subsequent toJune 30, 2003, holders of approximately $2,600 elected to convert their 2008Notes in exchange for approximately 1,500 shares of common stock.

 

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As noted above, holders of the 2008 Notes are entitled toconvert their notes into shares of the Company’s common stock before October2005 and receive a discounted amount of interest that they would have otherwisereceived until that date.  The Companymay elect to pay this interest in cash or in newly issued shares of commonstock priced at a 10% discount to the then fair market value of tradedshares.  The Company has determined thatthis feature is an embedded derivative as defined in Statement of FinancialAccounting Standards No. 133 “Accounting for Derivative Instruments and HedgingActivities.”  This embedded derivativeis not clearly and closely related to the host contract, the 2008 Notes,because it could at least double the investor’s initial rate of return on thehost contract and could also result in a rate of return that is at least twicewhat otherwise would be the market return for a contract that has the sameterms as the host contract and that involves a debtor with a similar creditquality.

 

As a result ofthis determination, the Company concluded that the embedded derivative shouldbe separately valued and bifurcated from the host contract, the 2008 Notes,upon the date that the option was granted. At each balance sheet date, the embedded derivative must be recorded atfair value, with any change in fair value recognized in currentoperations.  Additionally, due to thebifurcation of the embedded derivative from the host contract, the Company’slong-term debt is recorded at a discounted amount in the Consolidated BalanceSheet.  This discount will be amortizedthrough October 2008 using the effective interest method and an adjustedeffective yield of 6.69%.

 

The Companydetermined that the fair value of the embedded derivative as of the date thatthe option was granted was $2,038.  Thisamount was separately classified as preferred interest on early conversion inthe Consolidated Balance Sheets.  As ofJune 30, 2003, the Company adjusted the embedded derivative to its then fairvalue of $1,950 by recognizing a gain of $148 and $87****for the three months and sixmonths ended June 30, 2003.  The Companyalso recorded $75 and $108 of additional interest expense during the threemonths and six months ended June 30, 2003, due to the amortization of thediscount on the long-term debt.

 

In determiningthe fair value of the embedded derivative, the Company makes certainassumptions, including the future volatility and liquidity of the Company’scommon stock.  If actual experiencedeviates from current assumptions, the Company may be subject to significantvolatility in future periods.

 

Principal payment of the Company’s long-term debt outstanding at June30, 2003, including the Company’s current mortgage outstanding is as follows:

 
|   |   | **Debt** |   |
|--------|--------|----------|--------|
| 2003   |   | $        | 1,439  |   |
| 2004   |   | —   |   |
| 2005   |   | —   |   |
| 2006   |   | —   |   |
| 2007   |   | —   |   |
| 2008   |   | 98,163   |   |
| Total  |   | $        | 99,602 |   |

 

9.                                       RetirementBenefits:

 

On April 29, 2003, the Company announced that its Board of Directorshad approved certain changes in the management of the Company to implement thesuccession plan initiated in 2002.  OnMay 23, 2003, in connection with the succession plan, Irving Levit stepped down

 

17

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as Chairman of the Board of Directors and Chief ExecutiveOfficer but will continue as a member of the Board of Directors.  In addition, the Company and Mr. Levit haveentered into a consulting and retirement agreement.

 

The significant terms of the agreement are as follows:

 

a)              Mr. Levit will assume the newposition of Founding Chairman.

b)             The Company will pay Mr.Levit or his spouse, until the later of his death or the death of his spouse, aretirement benefit of $100 per year and health and welfare benefits comparableto those the Company offers to its executives from time to time.

c)              Mr. Levit will continue toprovide certain services to the Company for a period of up to two years, inexchange for which the Company will pay him an annual retainer of $100.

 

The employee benefit plans established under thisagreement are unfunded.  The Companyutilizes an independent actuary to calculate the total benefit obligation forpension and other benefits related to these plans.  As of June 30, 2003, the total benefit obligation recognized bythe Company was $1,764.  The Companywill recognize $99 in interest costs on these plans for the year ended December31, 2003.

 

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**Item 2.**Management’sDiscussion and Analysis of Financial Condition and Results of Operations. (amountsin thousands, except per share data)

 

*Overview*

 

Our principal productsare individual, defined benefit accident and health insurance policies thatconsist of nursing home care, home health care and Medicare supplement. Weexperienced significant reductions in new premium sales beginning in 2001 dueto the cessation of new business generation in all states and as a result ofmarket concerns regarding our Pennsylvania insurance subsidiaries’ statutorysurplus. Under our Corrective Action Plan (the “Plan”), which was approved bythe Pennsylvania Insurance Department (the “Department”) in February 2002, werecommenced sales in certain states, but intend to limit new business growth tolevels that will allow us to maintain sufficient statutory surplus.

 

Our insurance subsidiaries are subject to the insurance laws andregulations of the states in which they are licensed to write insurance. Theselaws and regulations govern matters such as payment of dividends, settlement ofclaims and loss ratios. State regulatory authorities must approve premiumscharged for insurance products. In addition, our insurance subsidiaries arerequired to establish and maintain reserves with respect to reported andincurred but not reported claims, as well as estimated future benefits payableunder our insurance policies. These reserves must, at a minimum, comply withmandated standards. Our reserves are certified annually by our consultingactuary as to standards required by the insurance departments for ourdomiciliary states and for the other states in which we conduct business. Webelieve we maintained adequate reserves as mandated by each state in which weare currently writing business at June 30, 2003. For a description of currentregulatory matters affecting our insurance subsidiaries, see *“Liquidityand Capital Resources - Subsidiary Operations.”*

 

Our financial condition and results of operations are affectedsignificantly by the following factors:

 

*Level of required reserves for policies in-force*.Our insurance policies are accounted for as long duration contracts. As aresult, there are two components of policyholder liabilities. The first is apolicy reserve liability for future policyholder benefits, represented by thepresent value of future benefits less a portion of future premium collection.These reserves are calculated based on assumptions that include estimates formortality, morbidity, interest rates, premium rate increases and policypersistency. The assumptions are based on our past experience, industry experienceand current trends.

 

The second is a reserve for incurred, either reported or not yetreported, policy claims. The amount of reserves relating to reported andunreported claims incurred is determined by periodically evaluating statisticalinformation with respect to the number and nature of historical claims. Wecompare actual experience with estimates and adjust our reserves in the currentperiod on the basis of such comparisons to the extent that our analysissuggests that the estimates utilized differ from actual experience.

 

Additions to, or reductions in, reserves are recognized in our currentConsolidated Statements of Income and Comprehensive Income as expense orincome, respectively, through benefits to policyholders and are a materialcomponent of our net income or loss. A portion of premium collected in eachperiod is set aside to establish reserves for future policy benefits. Reservesare established based upon current assumptions and we cannot assure you thatactual experience will not differ materially from the assumptions used in theestablishment of our reserves. Any variance from these assumptions could affectour profitability in future periods.

 

*Deferred policy acquisition costs*. Inconnection with the sale of our insurance policies, 

 

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we defer and amortize a portion of the policy acquisition costs overthe related premium paying periods for the life of the policy. These costsinclude all expenses that are directly related to, and vary with, theacquisition of the policy, including commissions, underwriting and other policyissue expenses. The amortization of deferred policy acquisition costs (“DAC”)is determined using the same projected actuarial assumptions used in computingpolicy reserves. DAC can be affected by unanticipated terminations of policiesbecause, upon such terminations, we are required to expense fully the DACassociated with the terminated policies. In addition, the assumptionsunderlying DAC and our policy benefit reserves are periodically reviewed andupdated to reflect current assumptions, including planned premium rateincreases. In the event planned premium rate increases are not achieved, wecould recognize an impairment of our DAC in the future.  Whenever we determine that our DAC is notfully recoverable, we impair the carrying value of our DAC through an expenseto our Consolidated Statements of Income and Comprehensive Income.

 

*Policy premium levels*. We attempt to setpremium levels to maintain planned profit margins. Premium levels on newproducts, as well as rate increases on existing products, are subject togovernment review and regulation.  Wemay be limited in our ability to gain approval for premium rate increases suchthat future profit margins could be reduced or prior losses may not berecouped.

 

*Investment income and notional experience account*. Our investment portfolio, excluding ournotional experience account, consists primarily of investment grade fixedincome securities. Income generated from this portfolio is largely dependentupon prevailing levels of interest rates. Due to the duration of ourinvestments (approximately 3.4 years), investment income does not immediatelyreflect changes in market interest rates.

 

In connection with our2001 reinsurance agreement with Centre Solutions (Bermuda) Limited (the “2001Centre Agreement”) (see “*Liquidity and Capital Resources*”), wetransferred substantially all of our investment portfolio to the reinsurer asthe initial premium payment. The initial and future premium for the reinsuredpolicies, less claims payments, ceding commissions and risk charges, iscredited to a notional experience account, the balance of which also receivesan investment credit based upon the total market return of a series of benchmarkindices and derivative hedges. The notional experience account balancerepresents an amount to be paid to us in the event of commutation of theagreement. We believe that the notional experience account represents a hybridinstrument, containing both a fixed debt host contract and an embeddedderivative. The economic characteristics and risks of the embedded derivativeinstrument are not clearly and closely related to the economic characteristicsand risks of the fixed debt host contract. We are accounting for the investmentcredit received on the notional experience account as follows:

 

a)              The fixed debt host yields a fixed return based uponthe yield to maturity of the underlying benchmark indices. The return on thefixed debt host is reported as investment income in the Statements of Incomeand Comprehensive Income.

b)             The change in fair value of the embedded derivativerepresents the percentage change in the underlying indices applied to thenotional experience account, similar to that of an unrealized gain/loss on abond. The change in the fair value of the embedded derivative is reported asmarket gain (loss) on notional experience account in the Statements of Incomeand Comprehensive Income.

 

As a result, our resultsof operations are subject to significant volatility. Recorded market valuegains or losses, although recognized in current earnings, are expected to bepartially offset in future periods from the receipt of the most recent marketinterest rates for all subsequent periods. The benchmark indices are comprisedof U.S. Treasury strips, agencies and investment grade corporate bonds, withweightings of approximately 25%, 15% and 60%, respectively, and have a 

 

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duration of approximately 11 years.

 

*Lapsation and persistency*. Our financial condition and results of operationsmay be effected by lapsation and persistency, both of which relate to therenewal of insurance policies. Lapsation is the termination of a policy bynon-renewal. Lapsation is automatic if and when premiums become more than 31days overdue, although, in some cases, a lapsed policy may be reinstated withinsix months. Persistency represents the percentage of policies renewed, which wecalculate by dividing the total number of policies in-force at the end of eachyear (less new policies added during the year) by the total number of policiesin-force at the end of the prior year. Prior to December 31, 2002, we calculated persistency by dividing thetotal annual premiums at the end of each year (less first year premiums forthat year) by the total annual premiums in-force for the prior year. Forpurposes of these calculations, a decrease in total policies in-force or theannual premiums in-force at the end of any year would be the result ofnon-renewal of policies, including policies that have terminated by reason ofdeath, lapsed due to nonpayment of premiums and/or have been converted to otherpolicies we offered. The calculation was changed at December 31, 2002 due tothe impact of rate increases on the annual premiums in-force at the end ofDecember 31, 2002.  We believe thatusing the number of policies in-force will provide a more accurate measure ofpersistency and will continue to utilize that method of calculation in thefuture.

 

Policies renew or lapse for a variety of reasons, both internal andexternal. We believe that our efforts to address policyholder concerns orquestions help to ensure policy renewals. We work closely with our licensedagents, who play an integral role in policy persistency and policyholdercommunication.

 

Economic cycles can influence a policyholder’s ability to continue thepayment of insurance premiums when due. We believe that publicity regardingFederal and state tax legislation allowing medical deductions for certainlong-term care insurance premiums has raised public awareness of the escalatingcosts of long-term care and the value provided to the consumer by long-termcare insurance. The ratings assigned to our insurance subsidiaries byindependent rating agencies also influence consumer decisions.

 

Lapsation and persistency can both positively and adversely affectfuture earnings. Reduced lapsation and higher persistency generally result inhigher renewal premiums and lower amortization of DAC, but may lead toincreased claims in future periods. Higher lapsation can result in reducedpremium collection, a greater percentage of higher-risk policyholders, andaccelerated expensing of DAC. However, higher lapsation may also lead todecreased claims in future periods.

 

###### *Results ofOperations*

 

**Three Months EndedJune 30, 2003 and 2002**

 

*Premiums*. Effective September 10, 2001, we determinedto discontinue the sale nationally of all new long-term care insurance policiesuntil the Plan was completed and approved by the Department. This decisionresulted from our concern about further depletion of statutory surplus from newpolicy sales prior to the completion and approval of the Plan and fromincreasing concern with respect to the status of the Plan expressed by manystates in which we are licensed to conduct business. Upon the Department’sapproval of the Plan in February 2002, we recommenced new policy sales in 23states, including Pennsylvania. We have now recommenced new policy sales in 13additional states.  These 36 statesrepresented approximately 71% in aggregate of our total premium revenue in the2003 quarter.  In March, we agreed uponterms for the recommencement of sales in California, which is pending subjectto certain conditions, which we believe will be satisfied during the fourthquarter of 2003. California represented 14% of our premium revenue in the 2003quarter. We are actively working 

 

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withthe remaining states to recommence new policy sales in all jurisdictions.

 

Totalpremium revenue earned in the three month period ended June 30, 2003 (the “2003quarter”), including long-term care, disability, life and Medicare supplement,decreased 6.2% to $78,707, compared to $83,906 in the same period in 2002 (the“2002 quarter”).

 

Totalfirst year premium revenue in the 2003 quarter increased 32.7% to $1,693,compared to $1,276 in the 2002 quarter. First year long-term care premiumrevenue in the 2003 quarter increased 41.4% to $1,471, compared to $1,040 inthe 2002 quarter.   We anticipate thatfirst year premium revenue will continue to increase as independent agents thatsold our policies prior to the cessation of sales are reengaged and independentagents that had not previously sold our policies are recruited.  In addition to this increase in states inwhich we have recommenced sales, we anticipate that we will recommence sales inadditional states in which we are currently not writing new business.

 

Totalrenewal premium revenue in the 2003 quarter decreased 6.8% to $77,014 comparedto $82,630 in the 2002 quarter. Renewal long-term care premium revenue in the2003 quarter decreased 7.2% to $74,218, compared to $79,974 in the 2002quarter. We may continue to experience reduced renewal premium revenue in thefuture, primarily driven by the reduced level of new premium revenue in recentprior periods as discussed above and the lapsation of existing policies.

 

*Net investment income.* Net investment income earned for the 2003quarter increased 3.9% to $10,572, from $10,172 for the 2002 quarter.

 

Asa result of our 2001 Centre Agreement, substantially all of our investableassets from business written prior to December 31, 2001, were transferred tothe reinsurer. The reinsurer maintains a notional experience account on ourbehalf in the event that the reinsurance agreement is later commuted. Asdiscussed above in “*Overview*,” the notional experience accountis credited with an investment credit equal to the most recent yield tomaturity on a series of benchmark indices and derivative hedges, which aredesigned to closely match the duration of our liabilities.

 

Our average yield on invested assets at cost,including cash and cash equivalents, was 5.02% and 6.55% in the 2003 and 2002quarters, respectively. The investment income component of our notionalexperience account investment credit generated $10,123 and $9,750 in the 2003and 2002 quarters, respectively.  Theyield on our notional experience account was 5.53% and 7.02% in the 2003 and2002 quarters, respectively. The decrease in our average yield is due to adecline in market interest rates which has the greatest impact on our notionalexperience account.  The notionalexperience account yields a fixed return based upon the yield to maturity ofthe underlying benchmark indices, which are comprised of U.S. Treasury strips,agencies and investment grade corporate bonds, with weightings of approximately25%, 15% and 60%, respectively, and have a duration of approximately 11 years.

 

*Market gain on notional experienceaccount*. We recordeda market gain on our notional experience account balance of $38,964 in the 2003quarter compared to a market gain of $19,951 in the 2002 quarter.

 

Asdiscussed in “*Overview*” and *“Net investment income”* above, thereinsurer maintains a notional experience account for our benefit in the eventof future recapture of the reinsured business. The notional experience accountreceives an investment credit based upon the total return of a series ofbenchmark indices and derivative hedges, which are designed to closely matchthe duration of our reserve liabilities. Periodic changes in the market valuesof the benchmark indices and derivative hedges are recorded in our financialstatements as a realized gain or loss in the period in which they occur. Thenotional experience account is susceptible to 

 

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marketinterest rate changes.  As a result, ourfuture financial statements are subject to significant volatility.  During both the 2003 and 2002 quarters,market interest rates decreased, leading to a market gain on the notionalexperience account. Subsequent to June 30, 2003, there has been an increase inmarket rates, which we believe if sustained, will generate a market loss on thenotional experience account.

 

*Other income*. We recorded $2,181 inother income during the 2003 quarter, down from $2,392 in the 2002 quarter. Thedecrease is attributable primarily to a decrease of approximately $350 in theincome generated from our ownership of corporate owned life insurance policies.

 

*Benefits to policyholders*. Total benefits to policyholders in the 2003quarter decreased 2.6% to $60,873, compared to $62,515 in the 2002 quarter. Ourloss ratio, or policyholder benefits to premium revenue, was 77.3% in the 2003quarter, compared to 74.3% in the 2002 quarter.

 

Claimsexperience can differ from our expectations due to numerous factors, includingmortality rates, duration of care and type of care utilized. When we experiencedeviation from our estimates, we typically seek premium rate increases that aresufficient to offset future deviation. In 2001 and 2002, we filed for premiumrate increases on the majority of our policies in-force. These rate increaseswere necessary because we expected higher loss ratios as a result of higherclaims expectations than existed at the time of the original premium ratefilings. We have filed additional premium rate increases on many policiesin-force as result of new claim assumptions we established in the third quarterof 2002.  We have been generallysuccessful in the past in obtaining state insurance department approvals forincreases. If we are unsuccessful in obtaining the recently filed or futurerate increases when deemed necessary, or if we do not pursue rate increaseswhen actual claims experience exceeds our expectations, we would suffer afinancial loss.

 

Historically, we have observed variations throughout theyear in the payment or incurrals of new claims.  Management employs seasonal assumptions throughout the year,based upon observed historical trends, in the establishment of its claimreserves so that it can more consistently monitor loss ratio variances from itsexpectations based upon other significant factors such as claims duration andincidence.  We reduced our claimsreserves by approximately $4,650 and $7,579, as of June 30, 2003 and 2002respectively, to reflect this seasonal variation.

 

In July 2003, following an internal review of historic home health careclaims and external consultant guidance, we implemented new claims adjudicationprocedures for family member and private caregiver services. We estimate thatthese new protocols, which include increased in-home assessments and additionalplan of care structure, will decrease future benefit payments on currentclaims. As a result, we have reduced our claims reserves in the 2003 quarter byapproximately $5,200 to reflect our best estimate of the impact of our newclaims adjudication procedures. 

 

Our policy reserves, whichare held for policyholders not currently on claim, are highly dependent uponseveral factors, including policyholder persistency and the mix of policieswith varying benefit amounts or types. We project the growth of our policy reserves based upon the current andprojected mix of policies in-force. Variances from our expectations result from future changes in this mixthat differ from our assumptions.

 

As a result of premium rateincreases implemented during the 2002 quarter, our persistency declined in the2002 quarter compared to the first quarter of 2002.  This decline, or “shock lapse,” was within the bounds of ourexpectations and served to reduce benefit reserves by approximately $5,000during the 2002 quarter.  Managementbelieves that shock lapses are generally not preferable to policy persistencein that the lapsing policyholders are assumed to be healthier and lowerrisks.  Also, while recognizing acurrent period income benefit from the release of reserves, future periodrevenues are reduced as a result of lapsation. No significant rate increases were implemented during the 2003 quarter.

 

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*Commissions*. Commissions to agents decreased 12.1% to$10,260 in the 2003 quarter, compared to $11,677 in the 2002 quarter.

 

Firstyear commissions on accident and health business in the 2003 quarter increased26.1% to $907, compared to $719 in the 2002 quarter, due to the increase infirst year accident and health premium revenue. The ratio of first yearaccident and health commissions to first year accident and health premiumrevenue was 53.6% in the 2003 quarter and 56.3% in the 2002 quarter. The firstyear commission ratio for both the 2003 and 2002 quarters is lower than thefirst year commission ratio prior to the cessation of sales in 2001 due to theincreased portion of premium revenue attributable to the sale of our SecuredRisk, Medicare Supplement and franchise group policies. All of these policiespay a lower commission as a percentage of premium revenue to agents than our individuallong-term care policies.   We believethat sales of theses policies as a percentage of new sales are likely to remainat this level as we recommence sales in many states.  Other long-term care policy sales have declined as a result ofour lower financial ratings with A.M. Best and Standard and Poor’s ratingservices and continued consumer and agent concerns regarding our financialstrength.

 

Renewalcommissions on accident and health business in the 2003 quarter decreased 15.6%to $9,903, compared to $11,734 in the 2002 quarter, due to the decrease inrenewal accident and health premium revenue. The ratio of renewal accident andhealth commissions to renewal accident and health premiums was 13.0% in the2003 quarter and 14.3% in the 2002 quarter. We have implemented premium rateincreases on a majority of policies written prior to December 31, 2001.  We do not pay commissions on the additionalpremium collected as a result of a rate increase, which reduces the ratio ofrenewal commissions to renewal premium revenue.

 

*Net policy acquisition costsamortized*.  The net policy acquisition costs amortizedin the 2003 quarter decreased to $2,140, compared to $7,777 in the 2002quarter.

 

Deferredcosts are typically all costs that are directly related to, and vary with, theacquisition of new premiums. The deferred costs include the variable portion ofcommissions, which are defined as the first year commissions less ultimaterenewal commissions, and variable general and administrative expenses relatedto policy sales, underwriting and issuance. Deferred costs are amortized overthe life of the policy based on actuarial assumptions, including persistency ofpolicies in-force. In the event a policy lapses prematurely due to death ortermination of coverage, the remaining unamortized portion of the deferredamount is immediately recognized as expense in the current period.

 

The net amortization ofdeferred policy acquisition costs is affected by new business generation,imputed interest on prior reserves and policy persistency. The amortization ofdeferred costs is generally offset largely by the deferral of costs associatedwith new premium generation. However, lower new premium revenue throughout 2002and continuing through the 2003 quarter produced significantly less expensedeferral to offset amortized costs. In addition, during the 2002 quarter,higher policyholder lapses (as noted under “*Premiums*”), resulted in increasedamortization of deferred policy acquisition costs.

 

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*General and administrativeexpenses*. General andadministrative expenses in the 2003 quarter increased 59.7% to $17,364,compared to $10,873 in the 2002 quarter. The ratio of total general andadministrative expenses to premium revenues was 22.1% in the 2003 quarter,compared to 12.1% in the 2002 quarter.

 

Duringthe 2003 quarter, we recorded expense of approximately $2,500 related to theinitial recognition of future retirement benefits payable to our formerchairman and severance related expenses for certain managers whose positionswill be eliminated during the third quarter of 2003.  Management estimates that it will recognize future annual savingsrelated to the salaries and benefits related to these positions ofapproximately $900.

 

Duringthe 2003 quarter, we incurred additional expenses of approximately $1,000related to the recommencement of new sales in certain key states as compared tothe 2002 quarter.  Salaries and employeebenefits increased approximately $1,100 in the 2003 quarter compared to the2002 quarter.  This increase is due tosalary increases, increased health insurance premiums, the addition ofemployees in the marketing, actuarial and accounting functions, and the accrualof bonuses for executives and employees. Legal expenses increased approximately $350 in the 2003 quarter comparedto the 2002 quarter due to costs associated with premium rate increaselitigation.  The expenses related to ourinformation system replacement project, which started after the 2002 quarter,were approximately $200.

 

Oneof our agency subsidiaries has expanded its regional office structure in orderto increase its ability to sell additional new long-term care policies that weand other companies offer.  As a resultof the staffing and initial capitalization of these offices, as well as salespromotion expenses, we incurred approximately $600 of additional expense in the2003 quarter.  We anticipate that theseexpenses will eventually be offset by additional revenue.

 

Webelieve that we currently have substantial capacity for premium growth at ourcurrent staff levels, print inventories and other expense categories.  We also believe that our current expenselevels represent the minimum requirements necessary to reengage new salesterritories, design competitive product lines and properly underwrite newpolicy applications. However, we believe that if we remain unable to write newbusiness in certain states where we have ceased new production, or if we areunable to use our existing staff and infrastructure capacity to generateadditional premium revenue, we will need to decrease production expenses, whichcould result in decisions to reduce our staff or other operating functions.

 

**Six Months Ended June30, 2003 and 2002**

 

*Premiums*. Total premium revenue earned in the sixmonth period ended June 30, 2003 (the “2003 period”), including long-term care,disability, life and Medicare supplement, decreased 3.5% to $162,285, comparedto $168,142 in the same period in 2002 (the “2002 period”).

 

Totalfirst year premium revenue in the 2003 period decreased 8.9% to $3,235,compared to $3,551 in the 2002 period. First year long-term care premiumrevenue in the 2003 period decreased 8.9% to $2,803, compared to $3,077 in the2002 quarter.   We anticipate that firstyear premium revenue will begin to increase as independent agents that sold ourpolicies prior to the cessation of sales are reengaged and independent agentsthat had not previously sold our policies are recruited.  In addition to this increase in states inwhich we have recommenced sales, we anticipate that we will recommence sales inadditional states in which we are currently not writing new business.

 

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Totalrenewal premium revenue in the 2003 period decreased 3.4% to $159,050 comparedto $164,591 in the 2002 period. Renewal long-term care premium revenue in the2003 period decreased 3.8% to $153,125, compared to $159,250 in the 2002period. We may continue to experience reduced renewal premium revenue in thefuture, primarily driven by the reduced level of new premium revenue in recentprior periods as discussed above and the lapsation of existing policies.

 

*Net investment income.* Net investment income earned for the 2003period increased 6.2% to $20,919, from $19,707 for the 2002 period.

 

Our average yield on invested assets at cost,including cash and cash equivalents, was 5.11% and 6.48% in the 2003 and 2002periods, respectively. The investment income component of our notionalexperience account investment credit generated $20,002 and $18,593 in the 2003and 2002 periods, respectively.  Theyield on our notional experience account was 5.65% and 6.69% in the 2003 and2002 periods, respectively. The decrease in our average yield is due to adecline in market interest rates which has the greatest impact on our notionalexperience account.  The notionalexperience account yields a fixed return based upon the yield to maturity ofthe underlying benchmark indices, which are comprised of U.S. Treasury strips,agencies and investment grade corporate bonds with weightings of approximately25%, 15% and 60%, respectively, and have a duration of approximately 11 years.

 

*Net realized capital gains*. During the 2003 period, we recognized capital gainsof $249 compared to $14,564 in the 2002 period. The capital gains in the 2003period were recorded as a result of our normal investment managementoperations.  The gains recognized in the2002 period resulted from the transfer of substantially all of our investedassets to our reinsurer. 

 

*Market gain (loss) on notionalexperience account*.We recorded a market gain on our notional experience account balance of $43,266in the 2003 period compared to a market loss of $6,002 in the 2002 period.  The notional experience account issusceptible to market interest rate changes. As a result, our future financial results are subject to significantvolatility.  During the 2003 periodmarket rates decreased, leading to a market gain on the notional experience ascompared to the 2002 period in which market rates increased. Subsequent to June30, 2003, there has been an increase in market interest rates, which we believeif sustained, will generate a market loss on the notional experience account.

 

*Other income*. We recorded $4,444 inother income during the 2003 period, down from $5,162 in the 2002 quarter. Thedecrease is attributable primarily to a decrease of approximately $600 in theincome generated from our ownership of corporate owned life insurance policies.  In addition, net commission payments earnedby our agency subsidiaries were $200 less in the 2003 period than in the 2002period, primarily as a result of the payment of overwrite commissions to newlyemployed branch managers.  Overwritecommissions represent a portion of commission income paid to managers forrecruiting sales agents that write new policies.

 

*Benefits to policyholders*. Total benefits to policyholders in the 2003period decreased 12.4% to $125,040, compared to $142,702 in the 2002 period.Our loss ratio, or policyholder benefits to premium revenue, was 77.05% in the2003 period, compared to 84.9% in the 2002 period.

 

Historically, we have observed variations throughout theyear in the payment or incurrals of new claims.  Management employs seasonal assumptions throughout the year,based upon observed historical trends, in the establishment of its claimreserves so that it can more consistently monitor loss ratio variances from itsexpectations based upon other significant factors such as claims duration and incidence.  We reduced our claims reserves byapproximately $4,650 and $7,579 as of June 30, 2003 and 2002 respectively, toreflect this seasonal variation.

 

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In July, 2003, following an internal review of historichome health care claims and external consultant guidance, we implemented newclaims adjudication procedures for family member and private caregiverservices.  We estimate that these newprotocols, which include increased in-home assessments and additional plan ofcare structure, will decrease future benefit payments on current claims. As aresult, we have reduced our claims reserves in the 2003 period by approximately$5,200 to reflect our best estimate of the impact of our new claims adjudicationprocedures. 

 

During the first quarter of 2002, the composition of ouraggregate policyholder base changed.  Asa result, our policyholder base included more policies with inflationprotection, shorter elimination periods and type of care protection than we hadpreviously seen.  This change incomposition resulted in a higher loss ratio in the 2002 period as compared tothe 2003 period.

 

*Commissions*. Commissions to agents decreased 14.5% to$20,964 in the 2003 period, compared to $24,507 in the 2002 period.

 

Firstyear commissions on accident and health business in the 2003 period decreased22.4% to $1,687, compared to $2,175 in the 2002 period, primarily due to thedecrease in first year accident and health premium revenue. The ratio of firstyear accident and health commissions to first year accident and health premiumrevenue was 52.1% in the 2003 period and 61.3% in the 2002 period. The firstyear commission ratio for both the 2003 and 2002 periods is lower than thefirst year commission ratio prior to the cessation of sales in 2001 due to theincreased sale of our Secured Risk, Medicare Supplement and franchise grouppolicies as a percentage of new sales. All of these policies pay a lowercommission as a percentage of premium revenue to agents than our individuallong-term care policies.   We believethat sales of these policies as a percentage of new sales are likely to remainat this level as we recommence sales in many states.  We believe that the sale of long-term care policies has declinedas a result of our lower financial ratings with A.M. Best and Standard andPoor’s rating services and continued consumer and agent concerns regarding ourfinancial strength.

 

Renewalcommissions on accident and health business in the 2003 period decreased 15.1%to $20,372, compared to $23,982 in the 2002 period, due to the decrease inrenewal accident and health premium revenue. The ratio of renewal accident andhealth commissions to renewal accident and health premiums was 12.9% in the2003 period and 14.7% in the 2002 period. We have implemented premium rateincreases on a majority of policies written prior to December 31, 2001.  We do not pay commissions on the additionalpremium collected as a result of a rate increase, which reduces the ratio ofrenewal commissions to renewal premium revenue.

 

*Net policyacquisition costs amortized*.  The net policy acquisitioncosts amortized in the 2003 period increased to $5,194, compared to $4,451 inthe 2002 period.

 

Deferredcosts are typically all costs that are directly related to, and vary with, theacquisition of new premiums. The deferred costs include the variable portion ofcommissions, which are defined as the first year commissions less ultimaterenewal commissions, and variable general and administrative expenses relatedto policy sales, underwriting and issuance. Deferred costs are amortized overthe life of the policy based on actuarial assumptions, including persistency ofpolicies in-force. In the event a policy lapses prematurely due to death ortermination of coverage, the remaining unamortized portion of the deferredamount is immediately recognized as expense in the current period.

 

The net amortization ofdeferred policy acquisition costs is affected by new business generation,imputed interest on prior reserves and policy persistency. The amortization ofdeferred costs is generally offset largely by the deferral of costs associatedwith new premium generation. However, lower new premium revenue throughout 2002and continuing through the 2003 quarter produced significantly less expensedeferral to offset amortized costs.

 

*General and administrativeexpenses*. General andadministrative expenses in the 2003 period increased 39.5% to $30,104, comparedto $21,585 in the 2002 period. The ratio of total general and administrativeexpenses to premium revenues was 18.6% in the 2003 period, compared to 12.2% inthe 2002 period.

 

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Duringthe 2003 period, we recorded expense of approximately $2,500 related to theinitial recognition of future retirement benefits payable to our formerchairman and severance related expenses for certain managers whoseresponsibilities will be eliminated during the third quarter of 2003.  Management estimates that it will recognizefuture annual savings related to the salaries and benefits related to thesepositions of approximately $900.

 

Duringthe 2003 period, we incurred additional expenses of approximately $1,550related to the recommencement of new sales in certain key states as compared tothe 2002 period.  Salaries and employeebenefits increased approximately $1,700 in the 2003 period compared to the 2002period.  This increase is due to salaryincreases, increased health insurance premiums, the addition of employees inthe marketing, actuarial and accounting functions, and the accrual of bonusesfor executives and employees.  Legalexpenses increased approximately $750 in the 2003 period compared to the 2002period due to costs associated with premium rate increase litigation.  The expenses related to our informationsystem replacement project which started after the 2002 period, wereapproximately $400.

 

Oneof our agency subsidiaries has expanded its regional office structure in orderto increase its ability to sell additional new long-term care policies that weand other companies offer.  As a resultof the staffing and initial capitalization of these offices, we incurredapproximately $900 of additional expense in the 2003 period.  We anticipate that these expenses willeventually be offset by additional revenue, and that these offices will beprofitable within the next several quarters.

 

Webelieve that we currently have substantial capacity for premium growth at ourcurrent staff levels, print inventories and other expense categories.  We also believe that our current expenselevels represent the minimum requirements necessary to reengage new salesterritories, design competitive product lines and properly underwrite newpolicy applications. However, we believe that if we remain unable to write newbusiness in certain states where we have ceased new production, or if we areunable to use our existing staff and infrastructure capacity to generateadditional premium revenue, we will need to decrease production expenses, whichcould result in decisions to reduce our staff or other operating functions.

 

 

***Liquidity and Capital Resources***

 

Ourconsolidated liquidity requirements have historically been met from theoperations of our insurance subsidiaries, from our agency subsidiaries and fromfunds raised in the capital markets. Our primary sources of cash from normaloperations are premiums, investment income and maturities of investments. Wehave obtained, and may in the future obtain, cash through public and privateofferings of our common stock, the exercise of stock options and warrants andother capital markets activities including the sale or exchange of debtinstruments.  Our primary uses of cashare policy acquisition costs (principally commissions), payments topolicyholders, investment purchases and general and administrative expenses.

 

Inthe 2003 period, our cash flows were attributable to cash provided byoperations, cash used in investing and cash provided by financing. Our cashdecreased $19,175 in the 2003 period primarily due to payments made to ourreinsurer of $28,057 and the purchase of $46,419 in bonds. In the 2003 period,our cash was also decreased as a result of the repayment of approximately$9,000 of convertible subordinated notes due 2003.  Our cash was increased during the period due primarily to $32,421in additional funds generated from the issuance of convertible subordinateddebt. This was supplemented by $20,691 from operations. The major 

 

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sourceof cash from operations was premium received.

 

Inthe 2002 period, our cash flows were attributable to cash provided byoperations, cash used in investing and cash provided by financing.  Our cash decreased $89,850 in the 2002period primarily due to payments made to our reinsurer of $589,013 and from thepurchase of $20,184 in bonds and equity securities.  Cash was provided primarily from the maturity and sale of$482,592 in bonds and equity securities. These sources of funds were supplemented by $39,598 from operations.  The major source of cash from operations waspremium received.

 

We invest in securities and other investments authorized by applicablestate laws and regulations and follow an investment policy designed to maximizeyield to the extent consistent with liquidity requirements and preservation ofassets. As of June 30, 2003, shareholders’ equity was increased by $1,595 dueto unrealized gains of $2,453 in the investment portfolio. As of December 31,2002, shareholders’ equity was increased by $1,090 due to unrealized gains of$1,679 in the investment portfolio.

 

###### *Parent companyoperations*

 

The parent company is a non-insurer that directly controls 100% of thevoting stock of our insurance subsidiaries. If we are unable to meet ourfinancial obligations, become insolvent or discontinue operations, thefinancial condition and results of operations of our insurance subsidiariescould be materially affected.

 

We have successfully engaged in capital markets activities, includingissuance of both debt and equity capital, over the past two years to fund ourliquidity and subsidiary capital needs. These activities have included:

 

1)  In March 2002, we completeda private placement of 510 shares of common stock for net proceeds of $2,352.The common stock was sold to several then existing and new institutionalinvestors, at $4.65 per share. The offering price was a 10 percent discount tothe 30-day average price of our common stock prior to the issuance of the newshares.

 

2)  In September 2002, wecommenced an offer of up to $74,750 in aggregate principal amount of 6.25%convertible subordinated notes due 2008 (the “2008 Notes”) in exchange for upto all of our then outstanding 6.25% convertible subordinated notes due 2003(the “2003 Notes”). Under the terms of the exchange offer, the 2008 Notes wouldhave terms similar to the 2003 Notes but mature in October 2008 and beconvertible into shares of our common stock at a conversion price of$5.31.  We exchanged approximately$65,793 of the 2003 Notes for 2008 Notes.

 

3)  In December 2002, wecommenced the sale of additional 2008 Notes. During the 2003 period, we completed the sale of 2008 Notes and receivedproceeds of $32,421. We used $16,000 of the proceeds to satisfy the premium to surplusrequirements of our voluntary consent order with the Florida InsuranceDepartment. We used the remaining proceeds to supplement parent liquidity, tocall and pay the entire obligation on our remaining 2003 Notes of $8,957 andfor general working capital purposes.

 

The primary terms of the 2008 Notes are:

 

1.               the 2008 Notes can be converted by theholder into shares of our common stock at $1.75 per share;

2.               the 2008 notes may not be called by usor forced to convert into shares of our stock prior to October 2005;

3.               after October 2005, the 2008 Notes willmandatorily convert into shares of our common stock if at any time thereafterthe average market price for fifteen trading days of the common stock exceeds$1.93; and,

4.               holders of the 2008 Notes are entitledto convert their notes into shares of our common stock before October 2005and receive a discounted amount of interest that they would have otherwisereceived until October 2005.  We mayelect to pay this interest in cash or in newly issued shares of common stockpriced at a 10% discount to the then fair market value of traded shares.

 

In conjunction with the issuance of the new 2008 Notes, we modified theterms of our existing $65,793 of 2008 Notes to make them identical to those ofthe new 2008 Notes.

 

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4)  Holders of $51 of 2008 Noteselected to convert their notes in June 2003 in exchange for 29 shares of commonstock.  Subsequent to June 30, 2003,holders of approximately $2,500 elected to convert their 2008 Notes in exchangefor approximately 1,420 shares of common stock.

 

In order to accomplish the foregoing, we engaged a financial advisor toassist us in these capital markets efforts.   Throughout 2002 and 2003, we provided shares of common stock to ourfinancial advisor as compensation for its assistance in various capital marketstransactions.  The dates, number ofshares and compensation expense recorded as a result of the issuances were:

 
| **Date**     |   | **Shares** |   | **Compensation** |   |
|--------------|--------|------------|--------|------------------|--------|
|         |   |       |   |             |   |
| April 2002   |   | 60         |   | $                | 325    |   |
| October 2002 |   | 20         |   | 68               |   |
| January 2003 |   | 20         |   | 34               |   |
| May 2003     |   | 100        |   | 175              |   |
|              |        |            |        |                  |        |  |

 

At June 30, 2003, our total principal payment and lease obligationsthrough 2008 were as follows:

 
|   |   | **Lease** |   |
|--------|--------|-----------|--------|
|   |   | **Debt**  |   | **Obligations** |   | **Total** |   |
| 2003   |   | $         | 1,439  |   | $ | 258 |   | $ | 1,697 |   |
| 2004   |   | —    |   | 252 |   | 252 |   |
| 2005   |   | —    |   | 18 |   | 18 |   |
| 2006   |   | —    |   | 18 |   | 18 |   |
| 2007   |   | —    |   | 18 |   | 18 |   |
| 2008   |   | 98,163    |   | 18 |   | 98,181 |   |
| Total  |   | $         | 99,602 |   | $ | 582 |   | $ | 100,184 |   |

 

Thedebt obligation in 2003 is a $1,439 mortgage obligation of our subsidiary,which is due in December 2003.  Weintend to make this payment using currently available funds at our subsidiary.Other amounts due after 2008 are immaterial.

 

Theparent company’s cash flow needs primarily include interest payments onoutstanding debt and operating expenses. The funding is primarily derived fromthe operating cash flow of our agency subsidiary operations and dividends fromthe insurance subsidiaries. However, the dividend capabilities of the insurancesubsidiaries are limited and we may need to rely upon the dividend capabilitiesof our agency subsidiaries to meet current liquidity needs. Our current cash onhand and these sources of funds are expected to be sufficient to meet ourliquidity needs through at least March 2004, but may be insufficient to meetour interest payments thereafter. If our available funds are insufficient tomeet any interest payments, we will need to raise additional capital to fullysatisfy parent company liquidity needs, including interest payments on our 2008Notes in April and October of 2004.  Wewill also need to raise additional capital to further service our 2008 Notesand provide for other parent company liquidity needs after 2004.

 

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Ouranticipated cash needs for the remainder of 2003 are as follows:

 
| Debt interest payments                      |   | $   | 3,000  |   |
|---------------------------------------------|--------|-----|--------|--------|
| Other parent expenses, net of reimbursement |   | 200 |   |
|                                        |   | $   | 3,200  |   |

 

Ouranticipated sources to meet our 2003 obligations are:

 
| Cash and investments on hand |   | $     | 2,700  |   |
|------------------------------|--------|-------|--------|--------|
| Subsidiary sources           |   | 1,500 |   |
|                         |   | $     | 4,200  |   |

 

There can be no assurance that we will be able to access the capitalmarkets to raise funds necessary to meet our future obligations.

 

*Subsidiaryoperations*

 

Ourinsurance subsidiaries are regulated by various state insurance departments.The National Association of Insurance Commissioners (“NAIC”) has Risk-BasedCapital (“RBC”) requirements for insurance companies to evaluate the adequacyof statutory capital and surplus in relation to investment and insurance risks,such as asset quality, mortality and morbidity, asset and liability matching,benefit and loss reserve adequacy, and other business factors. The RBC formulais used by state insurance regulators as an early warning tool to identify, forthe purpose of initiating regulatory action, insurance companies that potentiallyare inadequately capitalized. In addition, the formula defines minimum capitalstandards that an insurer must maintain. Regulatory compliance is determined bya ratio of the enterprise’s regulatory Total Adjusted Capital to its AuthorizedControl Level RBC, as defined by the NAIC. Companies below specific triggerpoints or ratios are classified within certain levels, each of which mayrequire specific corrective action depending upon the insurer’s state ofdomicile.

 

Ourinsurance subsidiaries, PTNA, American Network Insurance Company (“ANIC”), andAmerican Independent Network Insurance Company of New York (“AmericanIndependent”) (representing approximately 94%, 5% and 1% of our direct in-forcepremium, respectively) are required to hold statutory surplus that is above acertain required level. At December 31, 2000, PTNA had Total AdjustedCapital at the Regulatory Action level, which required it to file a Plan withthe Department.

 

OnFebruary 12, 2002, the Department approved the Plan. As a primary component ofthe Plan, effective December 31, 2001, PTNA and ANIC entered a reinsurancetransaction to reinsure, on a quota share basis, substantially all of ourlong-term care insurance policies then in-force. The agreement is subject tocertain coverage limitations, including an aggregate limit of liability that isa function of certain factors and that may be reduced in the event that therate increases that the reinsurance agreement may require are not obtained. Weare required to perform annual comparisons of our actual to expected claimsexperience. If we have reason to believe, whether from this analysis or otheravailable information, that at least a 5% premium rate increase is necessary,we are obligated to file and obtain such premium rate increases in order tocomply with the requirements of the agreement. If we do not file and obtainsuch premium rate increases, our aggregate limit of liability would be reducedby 50% of the premium amount that would have otherwise been received.

 

Thisagreement does not qualify for reinsurance treatment in accordance with GAAPbecause the agreement does not result in the reasonable possibility that thereinsurer may realize a significant loss. This is due to a number of factorsrelated to the agreement, including experience refund provisions, the expenseand risk charges credited to the notional experience account by the reinsurerand the aggregate limit of liability. However, this agreement meets therequirements to qualify for reinsurance treatment under statutory accountingrules.

 

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Theinitial premium paid under the reinsurance agreement was approximately$619,000, comprised of $563,000 in cash and qualified securities transferred inFebruary 2002, and $56,000 in funds held due to the reinsurer. The initialpremium and future cash flows from the reinsured policies, less claimspayments, ceding commissions and risk charges, are credited to a notionalexperience account, which is held for our benefit in the event of commutationand recapture on or after December 31, 2007. The notional experienceaccount balance receives an investment credit based upon the total return froma series of benchmark indices and derivative hedges that are intended to matchthe duration of our reserve liability.

 

Ourcurrent modeling and actuarial projections suggest that we are likely to beable to commute the agreement, as planned, on December 31, 2007. In order tocommute the agreement, our statutory capital following commutation must be sufficientto support the reacquired business in compliance with all statutoryrequirements. Upon commutation, we would receive cash or other liquid assetsequaling the market value of our notional experience account from thereinsurer. We would also record the necessary reserves for the business in ourstatutory financial statements. Our ability to commute the agreement is highlydependent upon the market value of the notional experience account exceedingthe level of required reserves to be established. As of June 30, 2003, thestatutory basis reserve liabilities of $928,795 exceed the notional experienceaccount value of $848,689.  Based uponour current modeling and actuarial projections, management expects the value ofthe notional experience account to exceed the reserve liabilities at December31, 2007.  In addition to theperformance of the reinsured policies from now until 2007, the notionalexperience account value is susceptible to market interest rate changes. Amarket interest rate increase of 100 basis points could reduce the market valueof the current notional experience account by approximately $79,000 andjeopardize our ability to commute as planned. As we approach the intendedcommutation date, the sensitivity of our notional experience account to marketinterest rate movement will decline as the duration of the benchmark indicesbecomes shorter, however the amount of assets susceptible to such interestsensitivity will continue to grow as additional net cash flows are added to theexperience account balance prior to commutation. When we become highlyconfident of our ability to support the reinsured policies, we will notify thereinsurer of our intention to commute the agreement on December 31, 2007. Thereinsurer has agreed to fix the market value of the experience account at thattime, and to then invest the assets in a manner that we request in order tominimize short term volatility.

 

Aspart of our reinsurance agreement, effective December 31, 2001, the reinsurerwas granted four tranches of warrants to purchase shares of non-votingconvertible preferred stock. The first three tranches of warrants areexercisable through December 31, 2007 at common stock equivalent prices rangingfrom $4.00 to $12.00 per share. If exercised and converted, the convertiblepreferred stock would represent approximately 15% of the then outstandingshares of our common stock on a fully diluted basis. If the agreement is notcommuted on December 31, 2007, the reinsurer may exercise the fourth tranche ofconvertible preferred stock purchase warrants at a common stock equivalentprice of $2.00 per share, and if converted would represent an additional 20% ofthe then outstanding common stock on a fully diluted basis.  

 

Asa result of our intention to commute, we assessed only the expense and riskcredits anticipated prior to the commutation date in our most recent DACrecoverability analyses and are not recording the potential of futureescalating charges in our current financial statements. In addition, we arerecognizing the additional consideration of entering into the agreement,represented by the fair value of the warrants granted to the reinsurer, overthe period of time to the expected commutation date.

 

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Inthe event we determine that commutation of the reinsurance agreement isunlikely on December 31, 2007, but likely at some future date, we will includeadditional annual expense risk charge credits against our notional experienceaccount in our DAC recoverability analysis. As a result, we could impair thevalue of our DAC asset and record the impairment in our financial statements.However, we currently believe that we will have sufficient statutory capitaland surplus to commute the reinsurance agreement on December 31, 2007 or thatsufficient alternatives, such as additional capital issuance or new reinsuranceopportunities, are available to enable us to commute the agreement as planned.

 

Thereinsurance agreement also granted the reinsurer an option to participate inreinsuring new business sales on a quota share basis. In August 2002, thereinsurer exercised its option to reinsure up to 50% of future sales, subjectto a limitation on the reinsurer’s risk. The reinsurer may continue this levelof participation on the next $100,000 in new policy premium issued afterJanuary 1, 2002. The final agreement, which was entered into in December 2002,further provides the reinsurer with an option to reinsure a portion of the next$1,000,000 in newly issued long-term care annual insurance premium, subject tomaximum quota share amounts of up to 40% as additional policies are written.

 

Thisagreement does not qualify for reinsurance treatment in accordance with GAAPbecause, based on our analysis, the agreement does not result in the reasonablepossibility that the reinsurer may realize a significant loss. This is due toan aggregate limit of liability that reduces the likelihood of the reinsurerrealizing a significant loss on the agreement. However, this agreement meets therequirements to qualify for reinsurance treatment under statutory accountingrules.

 

InFebruary 2003, the reinsurer notified us that it may, for reasons unrelated tous, discontinue its quota share reinsurance of new long-term care insurancepolicies issued on or after September 1, 2003. Our separate agreement with thereinsurer to reinsure existing policies issued prior to December 31, 2001 willbe unaffected by any determination made by the reinsurer regarding newly issuedpolicies.  To date, the reinsurer hasnot provided us with official notification that it intends to discontinue theagreement.

 

Inaddition to the requirement to enter into the 2001 Centre Agreement, the Plan,among other things:

 

a)              Limits new investments tothose rated by the National Association of Insurance Commissioners (“NAIC”) as1 or 2.

b)             Limits and requires Department approval foraffiliated transactions.

c)              Requires a $125,000 increase in statutoryreserves over a three-year period, of which a $33,000 increase remains to bemade throughout 2003 and 2004.

 

EffectiveSeptember 10, 2001, we determined to discontinue the sale nationally of all newlong-term care insurance policies until the Plan was approved by theDepartment. The decision resulted from our concern about further depletion ofstatutory surplus from new sales prior to the completion and approval of thePlan and from increasing concern regarding our status by many states in whichwe are licensed to conduct business. The form of our cessation varied by state,ranging from no action to certificate suspensions.

 

Uponthe Department’s approval of the Plan in February 2002, we recommenced newpolicy sales in 23 states, including Pennsylvania. We have now recommenced newpolicy sales in 13 additional states. These 36 states represented approximately 71% of our premium revenue inthe 2003 period. We are actively working with the remaining states torecommence new policy sales in all jurisdictions. We have recently agreed uponterms for the recommencement of sales in 

 

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California,which represented approximately 14% of our premium revenue during the 2003period.  Recommencement of sales ispending subject to the completion of certain conditions, which we believe willbe satisfied during the fourth quarter of 2003.

 

Themajority of our insurance subsidiaries’ cash flow results from our existinglong-term care policies, which have been ceded to the reinsurer under thisagreement. Our subsidiaries’ ability to meet additional liquidity needs andcover fixed expenses in the future is highly dependent upon our ability toissue new policies and to control expense growth. Our future growth and newpolicy issuance is dependent upon our ability to continue to expand ourhistorical markets, retain and expand our network of agents and effectivelymarket our products and fund our marketing and expansion while maintainingminimum statutory levels of capital and surplus required to support suchgrowth.

 

Underthe insurance laws of Pennsylvania and New York, where our insurancesubsidiaries are domiciled, insurance companies can pay ordinary dividends onlyout of earned surplus. In addition, under Pennsylvania and New York law,insurance subsidiaries must give the Department and the New York InsuranceDepartment at least 30 days’ advance notice of any proposed “extraordinarydividend” and cannot pay such a dividend if the Department disapproves thepayment during that 30-day period. For purposes of Pennsylvania law, anextraordinary dividend is a dividend that, together with all other dividendspaid during the preceding twelve months, exceeds the greater of 10% of theinsurance company’s surplus as shown on the company’s last annual statementfiled with Department or its statutory net income as shown on that annualstatement. Statutory earnings are generally lower than earnings reported inaccordance with generally accepted accounting principles due to the immediateor accelerated recognition of all costs associated with premium growth and benefitreserves. For purposes of New York law, approval must be obtained for anydividend that, together with all other dividends paid during the precedingtwelve months, exceeds the lesser of 10% of the insurance company’s surplus asof the preceding December 31 or its adjusted net investment income for the yearended the preceding December 31. Additionally, the Plan requires the Department to approve all dividendsmade by PTNA, regardless of normal statutory requirements for allowabledividends. We believe that the Department is unlikely to approve any dividendin the foreseeable future as a result of PTNA’s current statutory surplusposition. Although not stipulated in the Plan, this requirement is likely tocontinue until such time as PTNA meets normal statutory allowances, includingreported net income and positive cumulative earned surplus. We do not expectthat this will occur in the foreseeable future.

 

PTNAand ANIC have not paid any dividends to the parent company for the past threeyears and are unlikely in the foreseeable future to be able to make dividendpayments due to insufficient statutory surplus and anticipated earnings.  However, American Independent is not subjectto the Plan and was permitted by New York statute to make a dividend payment tothe parent company of $651 in 2002.

 

Oursubsidiaries’ debt currently consists primarily of a mortgage note in theamount of $1,439 that was issued by a former subsidiary and assumed by us whenthat subsidiary was sold. The mortgage note is currently amortized over 15years, and has a balloon payment due on the remaining outstanding balance inDecember 2003. Although the note carries a variable interest rate, we haveentered into an amortizing swap agreement with the same bank with a nominalamount equal to the outstanding debt, which has the effect of converting thenote to a fixed rate of interest of 6.85%.** **Weintend to pay off the outstanding balance of the note with available cash atour subsidiary.

 

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***NewAccounting Principles***

*(amounts in thousands)*

 

In May 2003,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of Both Liabilities and Equity” (“SFAS No. 150”).  SFAS No. 150 specifies that instrumentswithin its scope embody obligations of the issuer and that, therefore, theissuer must classify them as liabilities. SFAS No. 150 represents phase one of the FASB’s broader project on (1) distinguishingbetween liability and equity instruments and (2) accounting for instrumentsthat have characteristics of both types of instruments.  SFAS No. 150 covers a limited number ofinstruments that are to be classified as liabilities and is effective at thebeginning of the first interim period beginning after June 15, 2003.  The adoption of SFAS No. 150 is not expectedto have a material impact on our consolidated financial statements.

 

Statement of FinancialAccounting Standards No. 142, “Goodwill and Other Intangible Assets,” (“SFASNo. 142”) primarily addresses the accounting for goodwill and intangible assetssubsequent to their acquisition. We adopted SFAS No. 142 on January 1, 2002 andceased amortizing goodwill at that time. During the second quarter 2002, wecompleted an impairment analysis of goodwill, in accordance with SFAS No. 142.Our goodwill was recorded as a result of the purchase of our agencies and ourinsurance subsidiaries. As part of our evaluation, we completed numerous stepsin determining the recoverability of our goodwill. The first required step wasthe measurement of total enterprise fair value versus book value. Because ourfair market value, as measured by our stock price, was below book value atJanuary 1, 2002, goodwill was next evaluated at a reporting unit level, whichis comprised of our insurance agencies and insurance subsidiaries.

 

Upon completion of ourevaluation, we determined that the goodwill associated with the agencypurchases was fully recoverable. The deficiency of current market value to bookvalue was attributed to the insurance subsidiary values. As a result, wedetermined that the goodwill associated with our insurance subsidiaries wasimpaired and recognized an impairment loss of $5,151 from our transitionalimpairment test of goodwill, which we recorded as a cumulative effect of changein accounting principle. The impairment has been recorded effective January 1,2002.  Management has completed anassessment of other intangible assets and has determined to continue toamortize these assets so as to closely match the future profit emergence fromthese assets

 

In December 2002, the FASBissued Statement of Financial Accounting Standards No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure” (“SFAS No. 148”), whichamends Statement of Financial Accounting Standards Statement No. 123,“Accounting for Stock-Based Compensation” (“SFAS No. 123”). The objective ofSFAS No. 148 is to provide alternative methods of transition for a voluntary changeto the fair value based method of accounting for stock-based employeecompensation. SFAS No. 148 does not change the provisions of SFAS No. 123 thatpermit entities to continue to apply the intrinsic value method of AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees”(“APB No. 25”). In addition, this Statement amends the disclosure requirementsof SFAS No. 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results. We continueto maintain our accounting for stock-based compensation in accordance with APBNo. 25, but have adopted the disclosure provisions of SFAS No. 148.

 

InJanuary 2003, the FASB issued FASB Interpretation No. 46, “Consolidation ofVariable Interest Entities, an Interpretation of Accounting Research BulletinNo. 51” (“FIN No. 46”). FIN No. 46 requires existing unconsolidated variableinterest entities to be consolidated by 

 

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theirprimary beneficiaries if the entities do not effectively disperse risks amongparties involved. FIN No. 46 applies immediately to variable interest entitiescreated after January 31, 2003, and to variable interest entities in which anenterprise obtains an interest after that date. It applies in the first fiscalyear or interim period beginning after June 15, 2003 to variable interestentities in which an enterprise holds a variable interest that it acquiredbefore February 1, 2003. FIN No. 46 applies to public enterprises as of thebeginning of the applicable interim or annual period.  FIN No. 46 may be applied prospectively with a cumulative-effectadjustment as of the date on which it is first applied or by restatingpreviously issued financial statements for one or more years with acumulative-effect adjustment as of the beginning of the first year restated.The implementation of FIN No. 46 is not expected to have a material impact onour consolidated financial statements.

 

***Forward Looking Statements***

 

Certain statements made byus may be considered forward looking within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Although we believe that ourexpectations are based upon reasonable assumptions within the bounds of ourknowledge of our business and operations, there can be no assurance that actualresults of our operations will not differ materially from our expectations. Aninvestment in PTA securities includes certain risks, which may be specific tous or to the long-term care insurance industry. Factors which could causeactual results to differ from expectations include, among others, our abilityto comply with the Corrective Action Plan, the Florida Consent Order, theorders or directives of other states in which we do business or any specialprovisions imposed by states in connection with the resumption of writing newbusiness, our ability to commute our reinsurance agreement and to recapture ourreinsured policies and accumulated notional experience account balance, whetherour Corrective Action Plan will be accepted and approved by all states, ourability to meet our future risk-based capital goals, the adverse financialimpact of suspending new business sales, our ability to raise adequate capitalto meet regulatory requirements and to support anticipated growth, our abilityto refinance, convert or repay our 2008 convertible notes, the cost associatedwith recommencing new business sales, liquidity needs and debt obligations, theadequacy of our loss reserves and the recoverability of our DAC asset, ourability to sell insurance products in certain states, including California, ourability to resume generating new business in all states, our ability to complywith government regulations and the requirements which may be imposed by stateregulators as a result of our capital and surplus levels, the ability of seniorcitizens to purchase our products in light of the increasing costs of healthcare, our ability to defend ourself against adverse litigation, and our abilityto recapture, expand and retain our network of productive independent agents,especially in light of the suspension of new business.

 

**Item 3.**Quantitative and Qualitative DisclosuresAbout Market Risk****(amounts in thousands)

 

Weinvest in securities and other investments authorized by applicable state lawsand regulations and follow an investment policy designed to maximize yield tothe extent consistent with liquidity requirements and preservation of assets. Asignificant portion of assets and liabilities are financial instruments, whichare subject to the market risk of potential losses from adverse changes inmarket rates and prices. Our primary market risk exposures relate to interestrate risk on our notional experience account and fixed rate domesticmedium-term instruments and, to a lesser extent, domestic short-term andlong-term instruments. We have established strategies, asset quality standards,asset allocations and other relevant criteria for our portfolio to manage ourexposure to market risk.  We currentlyhave an interest rate swap on our mortgage, which is used as a hedge to convertthe mortgage to a fixed interest rate. We believe that, since the notionalamount of the swap is amortized at the same rate as the underlying mortgage andboth financial instruments are with the same bank, no credit risk is carriedwith the swap.

 

Ourfinancial instruments are held for purposes other than trading. Our portfoliodoes not contain any significant concentrations in single issuers (other thanU.S. treasury and agency obligations), industry segments or geographic regions.However, our notional experience account 

 

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balance, which representssubstantially all of our investable assets at June 30, 2003, is with onereinsurer. Although sufficient assets to support our statutory reserveliabilities are secured by trust accounts and irrevocable letters of creditwith major United States financial institutions, the accumulated profits of ourreinsured business are susceptible to significant credit risk of the reinsurer.

 

Weurge caution in evaluating overall market risk from the information below.Actual results could differ materially because the information was developedusing estimates and assumptions as described below, and because insuranceliabilities and reinsurance receivables are excluded in the hypotheticaleffects (insurance liabilities represent 84.4% of total liabilities). Long-termdebt, although not carried at fair value, is included in the hypotheticaleffect calculation.

 

Thehypothetical effects of changes in market rates or prices on the fair values ofour financial instruments (including our notional experience account balance,as discussed below) as of June 30, 2003, excluding insurance liabilities andreinsurance receivables on unpaid losses because such insurance related assetsand liabilities are not carried at fair value, would have been as follows:

 

Ifinterest rates had increased by 100 basis points at June 30, 2003, there wouldhave been a decrease of approximately $75,000 in the net fair value of ourinvestment portfolio less our long-term debt and the related swap agreement. A200 basis point increase in market rates at June 30, 2003 would have resultedin a decrease of approximately $142,000 in the net fair value. If interestrates had decreased by 100 and 200 basis points, there would have been a netincrease of approximately $84,000 and $179,000, respectively, in the net fairvalue of our total investments and debt.

 

Effective December 31, 2001,we entered a reinsurance agreement to reinsure, on a quota share basis,substantially all of our long-term care insurance policies in-force. Thetransaction resulted in the transfer of debt and equity securities ofapproximately $563,000 to the reinsurer. The agreement provides us with theopportunity to commute and recapture after December 31, 2007. To that end, thereinsurer will maintain a notional experience account for our benefit only inthe event of commutation and recapture, which reflects the initial premiumpaid, future premiums collected net of claims, expenses and accumulatedinvestment earnings. The notional experience account balance will receive aninvestment credit based upon the total return of a series of benchmark indicesand hedges that are designed to closely match the duration of reserveliabilities. As a result, we will likely experience significant volatility inour future financial statements.

 

Our ability tocommute the agreement is highly dependent upon the market value of the notionalexperience account exceeding the level of required reserves to be established.In addition to the performance of the reinsured policies from now until 2007,the notional experience account value is susceptible to market interest ratechanges. A market interest rate increase of 100 basis points could reduce themarket value of the current notional experience account by approximately$79,000 and jeopardize our ability to commute as planned. As we approach theintended commutation date, the sensitivity of our notional experience accountto market interest rate movement will decline as the duration of the benchmarkindices becomes shorter, however the amount of assets susceptible to suchinterest sensitivity will continue to grow as additional net cash flows areadded to the notional experience account balance prior to commutation. Weintend to give notice to the reinsurer of our intention to commute on December31, 2007 at such time as we are highly confident of our ability to support thereacquired policies. The reinsurer has agreed to fix the market value of thenotional experience account at that time, and to then invest the assets in amanner that we request in order to minimize short term volatility.

 

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We hold certain mortgageand asset backed securities as part of our investment portfolio. The fair valueof these instruments may react in a convex or non-linear fashion when subjectedto interest rate increases or decreases. The anticipated cash flows of these instruments may differ fromexpectations in changing interest rate environments, resulting in durationdrift or a varying nature of predicted time-weighted present values of cashflows. The result of unpredicted cash flows from these investments could causethe above hypothetical estimates to change. However, we believe that theminimal amount we have invested in these instruments and their broadly definedpayment parameters sufficiently outweigh the cost of computer models necessaryto accurately predict the possible impact on our investment income ofhypothetical effects of changes in market rates or prices on the fair values offinancial instruments as of June 30, 2003.

 

**Item 4. **Controls andProcedures

 

The Company carried out an evaluation of the effectiveness of itsdisclosure controls and procedures within 90 days prior to the filing date ofthis report. This evaluation was carried out under the supervision and with theparticipation of the Company’s management, including the Company’s Presidentand Chief Executive Officer and the Company’s Executive Vice President andChief Financial Officer. Based upon that evaluation, the Company’s Presidentand Chief Executive Officer and the Company’s Executive Vice President andChief Financial Officer concluded that the Company’s disclosure controls andprocedures are effective. There have not been any significant changes in theCompany’s internal controls, or in other factors which could significantlyaffect internal controls subsequent to the date the Company carried out itsevaluation, or any corrective actions with regard to significant deficienciesand material weaknesses.

 

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# **PART II OTHER INFORMATION**

# ** **

**Item 1.**LegalProceedings****(amounts in thousands)

 

OurCompany and certain of our key executive officers are defendants inconsolidated actions that were instituted on April 17, 2001 in the UnitedStates District Court for the Eastern District of Pennsylvania by ourshareholders, on their own behalf and on behalf of a putative class ofsimilarly situated shareholders who purchased shares of our common stock fromJuly 23, 2000 through and including March 29, 2001. The consolidated amendedclass action complaint seeks damages in an unspecified amount for lossesallegedly incurred as a result of misstatements and omissions allegedlycontained in our periodic reports filed with the SEC, certain press releasesissued by us, and in other statements made by our officials. The allegedmisstatements and omissions relate, among other matters, to the statutorycapital and surplus position of our largest subsidiary, Penn Treaty NetworkAmerica Insurance Company. On July 1, 2002, the defendants filed an answer tothe complaint, denying all liability. Plaintiffs filed a motion for class certification on August 15, 2002,which is currently pending. On February 26, 2003, the parties reached anagreement in principle to settle the litigation for $2,300, to be paid entirelyby our directors and officers liability insurance carrier. The settlementremains subject to documentation and court approval.

 

Our Company and itssubsidiary, PTNA, are defendants in an action in the Fifth Judicial Circuit ofthe State of Florida in and for Marion County, Civil Division.  Plaintiffsfiled this matter on January 10, 2003 in Florida State court, on behalf ofthemselves and a class of similarly situated Florida long-term carepolicyholders. We removed this case from the Florida State court to UnitedStates District Court, Middle District of Florida, Ocala Division.  Plaintiffs’ motion to remand the case toFlorida State Court was granted on June 25, 2003. Plaintiffs claim wrongdoingin connection with the sale of long-term care insurance policies to thePlaintiffs and the Class. Plaintiffs allege claims for reformation, breach offiduciary duty, breach of the implied duty of good faith and fair dealing,negligent misrepresentation, fraudulent misrepresentation, and restitution. Wehave filed motions to dismiss for failure to state a claim, lack of personaljurisdiction against the Company, and to strike certain allegations of thecomplaint as irrelevant and improper.  A hearing on these motions has beenscheduled for October 9, 2003.  While wecannot predict the outcome of this case, it could have a material adverseimpact upon our financial condition and results of operations. However, webelieve that the complaint is without merit and intend to continue to defendthe matter vigorously.

 

Our Company and two ofour subsidiaries, Penn Treaty Network America Insurance Company and SeniorFinancial Consultants Company, are defendants in an action instituted on June5, 2002 in the United States District Court for the Eastern District ofPennsylvania by National Healthcare Services, Inc. The complaint seekscompensatory damages in excess of $150 and punitive damages in excess of $5,000for an alleged breach of contract and misappropriation.  The claims arise out of a joint venture relatedto the AllRisk Healthcare program, which was marketed first by Penn TreatyNetwork America Insurance Company and then later by Senior FinancialConsultants Company. The defendants have denied the allegations of thecomplaint and will continue to defend the matter vigorously.

 

Our subsidiaries are parties to various other lawsuits generallyarising in the normal course of their business. We do not believe that theeventual outcome of any of the other suits to which we are a party will have amaterial adverse effect on our financial condition or results of operations.However, the outcome of any single event could have a material impact upon thequarterly or annual financial results of the period in which it occurs.

 

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**Item 2.**Changesin Securities

 

In May 2003, we issued 120,000 shares of common stock as compensationto Philadelphia Brokerage Corporation, our financial advisor, in a privateplacement.

 

**Item 3.**DefaultsUpon Senior Securities

 

Not Applicable

 

**Item 4.**Submissionof Matters to a Vote of Security Holders

 

The Company’sAnnual Meeting of Shareholders was held on May 23, 2003.  At this meeting, the following matters werevoted upon by the shareholders, receiving the number of affirmative, negativeand withheld votes, as well as abstentions and broker non-votes, set forthbelow each matter.

 

1.               Toelect three persons to the Company’s Board of Directors as Class I Directors toserve until the 2006 Annual Meeting of Shareholders and until their successorsare elected and have been qualified.

 
|                          |   | **For**    |   | **Against** |   | **Abstentions** |   | **Broker  Non-Votes** |   |
|-------------------------------|--------|------------|--------|-------------|--------|-----------------|--------|-----------------------|--------|
| a)   William W. Hunt     |   | 18,174,117 |   | 0           |   | 220,732         |   |                  | 0      |   |
| b)   Irving Levit        |   | 17,333,061 |   | 0           |   | 1,061,788       |   |                  | 0      |   |
| c)   Domenic Stangherlin |   | 18,169,961 |   | 0           |   | 224,888         |   |                  | 0      |   |

 

2.               Toratify the selection of PricewaterhouseCoopers LLP as the independent publicaccountants for the Company and its subsidiaries for the year ending December31, 2003.
| **For**    |   | **Against** |   | **Abstentions** |   | **Broker  Non-Votes** |   |
|------------|--------|-------------|--------|-----------------|--------|-----------------------|--------|
| 18,334,683 |   | 17,565      |   | 42,601          |   | 0                     |   |

 

3.               Totransact other business that properly comes before the Annual Meeting, or anyadjournments or postponements.

 
| **For**    |   | **Against** |   | **Abstentions** |   | **Broker  Non-Votes** |   |
|------------|--------|-------------|--------|-----------------|--------|-----------------------|--------|
| 17,537,787 |   | 709,750     |   | 147,312         |   | 0                     |   |

 

**Item 5.**OtherInformation

 

On May 23, 2003, the Company’s Board of Directors elected Gary Hindesas Chairman to succeed Irving Levit, who remains a member of the Board ofDirectors.

 

**Item 6.**Exhibitsand Reports on Form 8-K****

 

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| (a)    |   | Exhibits                                                                                                                                    |   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |   |                                                                                                                                        |
| 31.1   |   | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. |
|   |   |                                                                                                                                        |
| 31.2   |   | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. |
|   |   |                                                                                                                                        |
| 32.1   |   | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. |
|   |   |                                                                                                                                        |
| 32.2   |   | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. |

 

 

(b)                                                      Reports on Form8-K.

 
| **Date**     |   | **Item No.** |   | **Financial  Statements** |
|--------------|--------|--------------|--------|---------------------------|
| May 13, 2003 |   | 7.9          |   | No                        |
|         |   |         |   |                      |

 

SIGNATURES

 

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 theundersigned thereunto duly authorized.

 
|   |            | PENN TREATY  AMERICAN CORPORATION |
|--------|-----------------|-----------------------------------|
|   |            | Registrant                        |   |
|   |            |
|   |            |                              |
| Date:  | August 11, 2003 |                              |   | /s/ William W. Hunt |   |
|   |            |                              | William W. Hunt |   |
|   |            |                              | President and  Chief Executive Officer |   |
|   |            |                              |
| Date:  | August 11, 2003 |                              |   | /s/ Cameron B. Waite |   |
|   |            |                              | Cameron B. Waite |   |
|   |            |                              | Executive Vice President and  Chief Financial Officer |   |
|        |                 |                                   |  |  |  |  |  |  |  |  |  |

 

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