**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 March 31,  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  ý  NO  o

 

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

 

The number of shares outstanding of the Registrant’s common stock, parvalue $.10 per share, as of May 19, 2003 was 19,445,741.

 

 

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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.

 

2

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PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

(amounts in thousands, except per share data)

 
|                                                                                                                              |   | **March 31,  2003** |      | **December 31,  2002** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|------------------------|------------|
|                                                                                                                              |   | **(unaudited)**     |      |                   | ** ** |
| ASSETS                                                                                                                            |   |                |      |                   |       |
|                                                                                                                              |   |                |      |                   |       |
| Investments:                                                                                                                      |   |                |      |                   |       |
| Bonds,  available for sale at market (cost of $51,986 and $26,775, respectively)(1)                                               |   | $                   | 53,679    |                   | $          | 28,454 |   |
| Policy  loans                                                                                                                     |   | 267                 |      | 238                    |       |
| Total  investments                                                                                                                |   | 53,946              |      | 28,692                 |       |
| Cash  and cash equivalents(1)                                                                                                     |   | 35,570              |      | 29,206                 |       |
| Property  and equipment, at cost, less accumulated depreciation of $8,365 and $7,925,  respectively                               |   | 14,294              |      | 13,611                 |       |
| Unamortized  deferred policy acquisition costs                                                                                    |   | 168,304             |      | 171,357                |       |
| Receivables  from agents, less allowance for uncollectable amounts of $228 and $119,  respectively                                |   | 1,530               |      | 1,654                  |       |
| Accrued  investment income                                                                                                        |   | 782                 |      | 414                    |       |
| Goodwill                                                                                                                          |   | 20,360              |      | 20,360                 |       |
| Receivable  from reinsurers                                                                                                       |   | 25,460              |      | 26,218                 |       |
| Corporate  owned life insurance                                                                                                   |   | 58,387              |      | 57,773                 |       |
| Experience  account due from reinsurer                                                                                            |   | 734,037             |      | 708,982                |       |
| Other  assets                                                                                                                     |   | 22,709              |      | 21,933                 |       |
| Total  assets                                                                                                                     |   | $                   | 1,135,379 |                   | $          | 1,080,200 |   |
|                                                                                                                              |   |                |      |                   |       |
| LIABILITIES                                                                                                                       |   |                |      |                   |       |
|                                                                                                                              |   |                |      |                   |       |
| Policy  reserves:                                                                                                                 |   |                |      |                   |       |
| Accident  and health                                                                                                              |   | $                   | 470,879   |                   | $          | 464,318 |   |
| Life                                                                                                                              |   | 12,704              |      | 12,553                 |       |
| Claim  reserves                                                                                                                   |   | 338,596             |      | 329,944                |       |
| Accounts  payable and other liabilities                                                                                           |   | 21,503              |      | 18,859                 |       |
| Long–term  debt, less discount of $2,005 and $0, respectively                                                                |   | 106,637             |      | 76,245                 |       |
| Preferred  interest on early conversion                                                                                           |   | 2,099               |      | —                 |       |
| Deferred  income taxes                                                                                                            |   | 24,680              |      | 23,101                 |       |
| Total  liabilities                                                                                                                |   | 977,098             |      | 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;  20,360 and 20,340 shares issued, respectively |   | 2,036               |      | 2,034                  |       |
| Additional  paid-in capital                                                                                                       |   | 97,090              |      | 97,058                 |       |
| Accumulated  other comprehensive income                                                                                           |   | 1,100               |      | 1,090                  |       |
| Retained  earnings                                                                                                                |   | 64,760              |      | 61,703                 |       |
|                                                                                                                              |   | 164,986             |      | 161,885                |       |
| Less  915 common shares held in treasury, at cost                                                                                 |   | (6,705              | )         | (6,705                 | )          |
|                                                                                                                              |   | 158,281             |      | 155,180                |       |
| Total  liabilities and shareholders’ equity                                                                                  |   | $                   | 1,135,379 |                   | $          | 1,080,200 |   |

 

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(1)  Cash and investments of $22,681 and $22,022,respectively, are restricted as to use.

 

Seeaccompanying notes to consolidated financial statements.

 

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PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income and ComprehensiveIncome

(unaudited)

(amounts in thousands, except per share data)

 
|                                                                                                           |   | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                                                           |   | **2003**                         |       | **2002** |   |
| Revenues:                                                                                                      |   |                             |       |   |   |
| Premium  revenue                                                                                               |   | $                                | 83,578     |   | $ | 84,236 |   |
| Net  investment income                                                                                         |   | 10,347                           |       | 9,535 |   |
| Net  realized capital gains                                                                                    |   | 79                               |       | 14,523 |   |
| Market  gain (loss) on notional experience account                                                             |   | 4,302                            |       | (25,953 | ) |
| Loss  on preferred interest on early conversion                                                                |   | (61                              | )          | — |   |
| Other  income                                                                                                  |   | 2,263                            |       | 2,770 |   |
|                                                                                                           |   | 100,508                          |       | 85,111 |   |
| Benefits  and expenses:                                                                                        |   |                             |       |   |   |
| Benefits  to policyholders                                                                                     |   | 64,167                           |       | 80,187 |   |
| Commissions                                                                                                    |   | 10,704                           |       | 12,830 |   |
| Net  policy acquisition costs amortized (deferred)                                                             |   | 3,054                            |       | (3,326 | ) |
| General  and administrative expense                                                                            |   | 12,740                           |       | 10,712 |   |
| Expense  and risk charges on reinsurance                                                                       |   | 2,768                            |       | 3,577 |   |
| Excise  tax expense                                                                                            |   | 789                              |       | 581 |   |
| Interest  expense                                                                                              |   | 1,656                            |       | 1,196 |   |
|                                                                                                           |   | 95,878                           |       | 105,757 |   |
|                                                                                                           |   |                             |       |   |   |
| Income  (loss) before federal income taxes and cumulative effect of change in  accounting principle            |   | 4,630                            |       | (20,646 | ) |
|                                                                                                           |   |                             |       |   |   |
| Federal  income tax provision (benefit)                                                                        |   | 1,574                            |       | (7,020 | ) |
| Net  income (loss) before cumulative effect of change in accounting principle                                  |   | 3,056                            |       | (13,626 | ) |
| Cumulative  effect of change in accounting principle                                                           |   | —                           |       | (5,151 | ) |
| Net  income (loss)                                                                                             |   | 3,056                            |       | (18,777 | ) |
|                                                                                                           |   |                             |       |   |   |
| Other  comprehensive income (loss):                                                                            |   |                             |       |   |   |
| Unrealized  holding gain (loss) arising during period                                                          |   | 93                               |       | (634 | ) |
| Income  tax (provision) benefit from unrealized holdings                                                       |   | (32                              | )          | 216 |   |
| Reclassification  of gains included in net income (loss)                                                       |   | (79                              | )          | (14,523 | ) |
| Income  tax provision from reclassification adjustment                                                         |   | 28                               |       | 4,938 |   |
|                                                                                                           |   |                             |       |   |   |
| Comprehensive  income (loss)                                                                                   |   | $                                | 3,066      |   | $ | (28,780 | ) |
|                                                                                                           |   |                             |       |   |   |
| Basic  earnings per share from net income (loss) before cumulative effect of change  in accounting principle   |   | $                                | 0.16       |   | $ | (0.72 | ) |
| Basic  earnings per share from net income (loss)                                                               |   | $                                | 0.16       |   | $ | (1.00 | ) |
|                                                                                                           |   |                             |       |   |   |
| Diluted  earnings per share from net income (loss) before cumulative effect of change  in accounting principle |   | $                                | 0.07       |   | $ | (0.72 | ) |
| Diluted  earnings per share from net income (loss)                                                             |   | $                                | 0.07       |   | $ | (1.00 | ) |
|                                                                                                           |   |                             |       |   |   |
| Weighted  average number of shares outstanding                                                                 |   | 19,439                           |       | 18,853 |   |
| Weighted  average number of shares and share equivalents                                                       |   | 55,931                           |       | 18,853 |   |

 

See accompanying notes to consolidated financialstatements.

 

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PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

(amounts in thousands)

 
|                                                                        |   | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                        |   | **2003**                         |       | **2002** | ** ** |
| Cash  flow from operating activities:                                       |   |                             |       |   |   |
| Net  income (loss)                                                          |   | $                                | 3,056      |   | $ | (18,777 | ) |
| Adjustments  to reconcile net income (loss) to cash provided by operations: |   |                             |       |   |   |
| Amortization  of intangible assets                                          |   | 175                              |       | 194 |   |
| Cumulative  effect of change in accounting principle                        |   | —                           |       | 5,151 |   |
| Amortization  of deferred reinsurance premium                               |   | 660                              |       | 660 |   |
| Amortization  of discount on long-term debt                                 |   | 33                               |       | — |   |
| Loss  on preferred interest on early conversion                             |   | 61                               |       | — |   |
| Policy  acquisition costs, net                                              |   | 3,053                            |       | (3,326 | ) |
| Deferred  income taxes                                                      |   | 1,574                            |       | (6,605 | ) |
| Depreciation  expense                                                       |   | 440                              |       | 398 |   |
| Net  realized capital gains                                                 |   | (79                              | )          | (14,523 | ) |
| Increase  (decrease) due to change in:                                      |   |                             |       |   |   |
| Receivables  from agents                                                    |   | 15                               |       | 633 |   |
| Receivable  from reinsurers                                                 |   | 1,339                            |       | (3,003 | ) |
| Notional  experience account due from reinsurer                             |   | (10,731                          | )          | 20,687 |   |
| Claim  reserves                                                             |   | 8,652                            |       | 14,669 |   |
| Policy  reserves                                                            |   | 6,131                            |       | 24,589 |   |
| Accounts  payable and other liabilities                                     |   | 2,644                            |       | (3,593 | ) |
| Accrued  investment income                                                  |   | (368                             | )          | 7,521 |   |
| Other,  net                                                                 |   | (1,464                           | )          | (753 | ) |
|                                                                        |   |                             |       |   |   |
| Cash  provided by operations                                                |   | 15,191                           |       | 23,922 |   |
|                                                                        |   |                             |       |   |   |
| Cash  flow from investing activities:                                       |   |                             |       |   |   |
| Proceeds  from sales of bonds                                               |   | 3,394                            |       | 466,677 |   |
| Proceeds  from sales of equity securities                                   |   | —                           |       | 9,547 |   |
| Proceeds  from maturities of bonds                                          |   | 566                              |       | 2,571 |   |
| Purchase  of bonds                                                          |   | (29,123                          | )          | (12,888 | ) |
| Purchase  of equity securities                                              |   | —                           |       | (20 | ) |
| Increase  in corporate owned life insurance                                 |   | (614                             | )          | (862 | ) |
| Deposits  to notional experience account due from reinsurer                 |   | (14,324                          | )          | (573,654 | ) |
| Acquisition  of property and equipment                                      |   | (1,123                           | )          | (330 | ) |
|                                                                        |   |                             |       |   |   |
| Cash  used in investing                                                     |   | (41,224                          | )          | (108,959 | ) |
|                                                                        |   |                             |       |   |   |
| Cash  flow from financing activities:                                       |   |                             |       |   |   |
| Proceeds  from stock offering                                               |   | —                           |       | 228 |   |
| Issuance  (repayment) of long-term debt                                     |   | 32,397                           |       | (2,880 | ) |
|                                                                        |   |                             |       |   |   |
| Cash  provided by (used in) financing                                       |   | 32,397                           |       | (2,652 | ) |
| Increase  (decrease) in cash and cash equivalents                           |   | 6,364                            |       | (87,689 | ) |
| Cash  balances:                                                             |   |                             |       |   |   |
| Beginning  of period                                                        |   | 29,206                           |       | 114,600 |   |
|                                                                        |   |                             |       |   |   |
| End  of period                                                              |   | $                                | 35,570     |   | $ | 26,911 |   |

 

See accompanying notes to consolidated financialstatements.

 

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

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

##### **March 31, 2003**

(unaudited)

(amounts in thousands, except per share data)

 

TheConsolidated Financial Statements should be read in conjunction with thesenotes and with the Notes to Consolidated Financial Statements included in theAnnual Report on Form 10-K for the year ended December 31, 2002 of Penn TreatyAmerican Corporation (the “Company”). Certain amounts in the March 31, 2002 andDecember 31, 2002 financial statements have been reclassified to conform to thepresentation in the March 31, 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 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 an“underlying” and certain other existing pronouncements.  SFAS No. 149 is effective for contractsentered into or modified and for hedging relationships designated after June 30,2003, except certain provisions relating to forward purchases and sales ofwhen-issued securities or other securities that do not yet exist should beapplied to both existing contracts and new contracts entered into after June30, 2003.  The adoption of SFAS No. 149is not expected to have a material impact on the Company’s financialstatements.

 

In December2002, the FASB issued Statement of Financial Accounting Standards No. 148,“Accounting for Stock-Based Compensation-Transition and Disclosure” (“SFAS No.148”), which amends Statement of Financial Accounting Standards Statement No.123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). The objectiveof SFAS No. 148 is to provide alternative methods of transition for a voluntarychange to 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, SFAS No. 148 amends the disclosure requirements ofSFAS 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. The Companycontinues to maintain its accounting for stock-based compensation in accordancewith APB No. 25, but has adopted the disclosure provisions of SFAS No. 148.

 

 

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The following table reflects net income, basic and diluted earnings pershare as reported and pro-forma as if the Company had adopted the fair valuebased method of accounting for its stock-based employee compensation awards:

 
|                                                                                                                                  |   | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                                                                                  |   | **2003**                         |       | **2002** | ** ** |
|                                                                                                                                  |   |                             |       |   |   |
| Net income (loss), as reported                                                                                                        |   | $                                | 3,056      |   | $ | (18,777 | ) |
| Stock-based employee compensation expense  (income) included in reported net income, net of related tax effects                       |   | —                           |       | (106 | ) |
| Total stock-based employee compensation expense  determined under fair value based method for all awards, net of related tax  effects |   | (10                              | )          | (145 | ) |
| Pro forma net income (loss)                                                                                                           |   | $                                | 3,046      |   | $ | (19,028 | ) |
|                                                                                                                                  |   |                             |       |   |   |
| Earnings per share:                                                                                                                   |   |                             |       |   |   |
| Basic - as reported                                                                                                                   |   | $                                | 0.16       |   | $ | (1.00 | ) |
| Basic - pro forma                                                                                                                     |   | $                                | 0.16       |   | $ | (1.01 | ) |
| Diluted - as reported                                                                                                                 |   | $                                | 0.07       |   | $ | (1.00 | ) |
| Diluted - pro forma                                                                                                                   |   | $                                | 0.07       |   | $ | (1.01 | ) |

 

Statement ofFinancial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”(“SFAS No. 142”), primarily addresses the accounting for goodwill andintangible assets subsequent to their acquisition. The Company adopted SFAS No.142 on January 1, 2002 and ceased amortizing goodwill at that time. During thesecond quarter 2002, the Company completed an impairment analysis of goodwill,in accordance with SFAS No. 142. The Company’s goodwill was recorded as aresult of its purchase of its agencies and its insurance subsidiaries. As partof its evaluation, the Company completed numerous steps in determining therecoverability of its goodwill. The first required step was the measurement oftotal enterprise fair value versus book value. Because the Company’s fairmarket value, as measured by its stock price, was below book value at January1, 2002, goodwill was next evaluated at a reporting unit level, which includedits insurance agencies and insurance subsidiaries.

 

Uponcompletion of this evaluation, the Company determined that the goodwillassociated with the agency purchases was fully recoverable. The deficiency ofcurrent market value to book value was attributed to the insurance subsidiaryvalues. As a result, the Company determined that the goodwill associated withits insurance subsidiaries was impaired and recognized an impairment loss of$5,151 from its transitional impairment test of goodwill, which it recorded asa cumulative effect of change in accounting principle. The impairment has beenrecorded effective January 1, 2002. Management has completed an assessment of other intangible assets and hasdetermined to continue to amortize these assets so as to closely match thefuture profit emergence from these assets. No goodwill was amortized for the three months ended March 31, 2003 orMarch 31, 2002.

 

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InNovember 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” (“FIN No. 45”), which addresses thedisclosures to be made by a guarantor in its interim and annual financialstatements about its obligations under guarantees. This interpretation alsoclarifies the requirements related to the recognition of a liability by aguarantor at the inception of a guarantee for the obligations the guarantor hasundertaken in issuing that guarantee. The provisions related to the disclosurerequirements to be made by a guarantor are effective for financial statementsof interim and annual reporting periods ending after December 15, 2002. The provisionsrelated to the recognition of a liability and initial measurement shall beapplied prospectively to guarantees issued or modified after December 31, 2002,irrespective of the guarantor’s fiscal year-end. The adoption of FIN No. 45 didnot have a material impact on the Company’s consolidated financial statements.

 

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 their primary beneficiaries if theentities do not effectively disperse risks among parties involved. FIN No. 46applies immediately to variable interest entities created after January 31,2003, and to variable interest entities in which an enterprise obtains aninterest after that date. It applies in the first fiscal year or interim periodbeginning after June 15, 2003, to variable interest entities in which anenterprise holds a variable interest that it acquired before February 1, 2003.FIN No. 46 applies to public enterprises as of the beginning of the applicableinterim or annual period.  FIN No. 46may be applied prospectively with a cumulative-effect adjustment as of the dateon which it is first applied or by restating previously issued financialstatements for one or more years with a cumulative-effect adjustment as of thebeginning of the first year restated. The implementation of FIN No. 46 is notexpected to have a material impact on the Company’s consolidated financialstatements.

 

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,was at an amount that required PTNA to file a Corrective Action Plan (the“Plan”) with the insurance commissioner. In addition, American Network Insurance Company (“ANIC”), which is owned100% by PTNA, is also subject to the provisions of the Plan.

 

On February 12, 2002, theDepartment approved the Plan which, among other things:

 

a)              required the Company to enter into areinsurance agreement with Centre Solutions (Bermuda) Limited (the “2001 CentreAgreement”) for substantially all of its existing business at December 31, 2001(See Note 3 – Reinsurance Agreements);

b)             limits new investments to those rated by theNational Association of Insurance Commissioners (“NAIC”) as 1 or 2;

c)              limits and requires Department approval foraffiliated transactions; and

 

8

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d)             requires a $125,000 increase in statutoryreserves over a three-year period, of which a $40,000 increase remains to bemade 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 Company does not file and obtainsuch premium rate increases, the aggregate limit of liability would be reducedby 50% of the premium amount that would 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 ANICwould have to retain any reserve liabilities in excess of the limit ofliability, which could have a materially adverse impact upon their statutorysurplus.

 

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’sinsurance subsidiaries determine their statutory policy reserves could have amaterial adverse impact on PTNA or ANIC, possibly resulting in regulatorycontrol or liquidation.

 

*New Policy Sales*

 

The Company is licensed and receives renewal premium revenue frompolicyholders in all states, but is currently restricted from issuing newpolicies in 14 states. In March 2003, the Company agreed on terms for therecommencement of sales in California, which is pending subject to certainconditions. California represented approximately 14% of the Company’s premiumrevenue for the period ended March 31, 2003. The Company is approved for salesin Florida and Pennsylvania (subject to Corrective Action Plans), whichaccounted for approximately 19% and 11%, respectively, of the Company’s premiumrevenue for the period ended March 31, 2003. No other state’s sales accountedfor more than 10% of the Company’s premium revenue for the period ended March31, 2003.

 

9

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3.                                       ReinsuranceAgreements:

 

*2001 Centre Agreement*

 

As a primary component of the Plan, effective December 31, 2001, theCompany entered the 2001 Centre Agreement to reinsure, on a quota share basis,substantially all of its respective long-term care insurance policies thenin-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 areintended to match the duration of the Company’s reserve liability.

 

The notional experience account represents a hybrid instrument,containing both a fixed debt host contract and an embedded derivative. Theeconomic characteristics and risks of the embedded derivative instrument arenot clearly and closely related to the economic characteristics and risks ofthe fixed debt host contract. The Company is accounting for the investmentcredit 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 $72,000.

 

10

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For the periods ended March 31, 2003 and 2002, respectively, thenotional experience account activity was as follows:

 
|                                           |   | **Three Months Ended March 31,** |    |
|------------------------------------------------|--------|----------------------------------|---------|
|                                           |   | **2003**                         |    | **2002** | ** ** |
|                                           |   |                             |    |   |   |
| Beginning balance                              |   | $                                | 708,982 |   | $ | — |   |
| Initial premium                                |   | —                           |    | 563,300 |   |
| Premiums, net  of claims and ceding allowance: |   | 13,755                           |    | 10,354 |   |
| Investment  credit:                            |   |                             |    |   |   |
| Investment  income                             |   | 9,882                            |    | 8,843 |   |
| Market  gain(loss)                             |   | 4,302                            |    | (25,953 | ) |
| Expense and  risk charges                      |   | (2,768                           | )       | (3,577 | ) |
| Broker/Custodian/Trustee  fees                 |   | (116                             | )       | — |   |
| Ending balance                                 |   | $                                | 734,037 |   | $ | 552,967 |   |

 

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 support the reacquired business incompliance with all statutory requirements. Upon commutation, the Company willreceive cash or other liquid assets equaling the value of the notionalexperience account from the reinsurer. The Company would also record thenecessary reserves for the business in PTNA’s and ANIC’s statutory financialstatements. Accordingly, the Company’s ability to commute the agreement is highlydependent upon the value of the notional experience account exceeding the levelof required statutory reserves to be established. As of March 31, 2003, thestatutory basis reserve liabilities of $906,826 exceeded the combination of thenotional experience account value and funds held due to the reinsurer of$790,037. Management expects the value of the notional experience account toexceed the reserve liabilities at December 31, 2007. In addition to theperformance 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 $72,000 and jeopardize theCompany’s ability to commute as planned. As the intended commutation dateapproaches, the sensitivity of the 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 thenotional experience 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 December31, 2007 at common stock equivalent prices ranging from $4.00 to $12.00 pershare. If exercised and converted the convertible preferred stock wouldrepresent approximately 15% of the then outstanding shares of our common stockon a fully diluted basis.

 

11

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If the agreement is not commuted on December 31, 2007, the reinsurermay exercise the fourth tranche of convertible preferred stock purchasewarrants at a common stock equivalent price of $2.00 per share, and theconvertible preferred stock would represent, if converted, an additional 20% ofthe 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 rate of 4.74%. The $15,855 value ofthe warrants was recorded as a deferred premium as of December 31, 2001. Of theoriginal $15,855 value, $660 of deferred premium was amortized during each ofthe periods ended March 31, 2003 and 2002. The unamortized value of the warrants at March 31, 2003 and December 31,2002 is $12,553 and $13,213, respectively. These amounts are included in other assets on the Consolidated BalanceSheets.

 

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 to thereinsurer, 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 available to enable it to commute theagreement 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.

 

12

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4.                                       Contingencies:

 

Litigation:

 

The Company’ssubsidiaries are parties to various lawsuits generally arising in the normalcourse of their business. The Company does not believe that the eventualoutcome of any of the suits to which it is party will have a material adverseeffect on its financial condition or results of operations. However, theoutcome of any single event could have a material impact upon the quarterly orannual financial results of the period in which it occurs.

 

The Companyand certain of its key executive officers are defendants in consolidatedactions that were instituted on April 17, 2001 in the United States DistrictCourt for the Eastern District of Pennsylvania by its shareholders, on theirown behalf and on behalf of a putative class of similarly situated shareholderswho purchased shares of the Company’s common stock from July 23, 2000 throughand including March 29, 2001. The consolidated amended class action complaintseeks damages in an unspecified amount for losses allegedly incurred as aresult of misstatements and omissions allegedly contained in the Company’speriodic reports filed with the SEC, certain press releases issued by theCompany, and in other statements made by the Company’s officials. The allegedmisstatements and omissions relate, among other matters, to the statutorycapital and surplus position of its largest subsidiary, PTNA. On July 1, 2002,the defendants filed an answer to the complaint, denying all liability.  Plaintiffs filed a motion for classcertification on August 15, 2002, which is currently pending. On February 26,2003, the parties reached an agreement in principle to settle the litigationfor $2,300, to be paid entirely by the Company’s directors and officersliability insurance carrier.  Thesettlement remains subject to documentation and court approval.

 

The Companyand its subsidiary, PTNA, are defendants in an action in the United StatesDistrict Court, Middle District of Florida, Ocala Division.  Plaintiffs filed this matter on January 10,2003 in the Fifth Judicial Circuit of the State of Florida in and for MarionCounty, Civil Division, on behalf of themselves and a class of similarly situatedFlorida long-term care policyholders. The Company removed this case from theFlorida State court to Federal Court. Plaintiffs claim wrongdoing in connectionwith the sale of long-term care insurance policies to the Plaintiffs and theClass. Plaintiffs allege claims for reformation, breach of fiduciary duty,breach of the implied duty of good faith and fair dealing, negligentmisrepresentation, fraudulent misrepresentation, and restitution. The Companyhas 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. Plaintiffs filed a motion to remand on March 7, 2003. Briefing iscontinuing on all of these motions. While the Company cannot predict theoutcome 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 Companyand two of its subsidiaries, PTNA and Senior Financial Consultants Company, aredefendants in an action instituted on June 5, 2002 in the United StatesDistrict Court for the Eastern District of Pennsylvania by National HealthcareServices, Inc. The complaint seeks compensatory damages in excess of $150 andpunitive damages in excess of $5,000 for an alleged breach of contract andmisappropriation. The claims arise out of a joint venture related to theAllRisk Healthcare program, which was marketed first by PTNA and then later bySenior Financial Consultants Company. The defendants have denied theallegations of the complaint and will continue to defend the matter vigorously.While the Company cannot predict the outcome of this case, the Company believesthat any resolution of this action will not have a material impact on itsfinancial condition or results of operations.

 

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Reinsurance:

 

PTNA is aparty to a reinsurance agreement to cede the risk of certain home health careclaims that extend beyond 36 months. Reinsurance recoverables related to thistreaty were $10,566 and $10,175 at March 31, 2003 and December 31, 2002,respectively. The reinsurer has notified PTNA that it believes that the Companyis in breach of its current agreement as a result of entering the 2001 CentreAgreement without the prior written approval of the reinsurer. PTNA hascontested this assertion of breach and is continuing discussions with thereinsurer to reach an equitable resolution.  The ultimate resolution of this dispute cannot be determined at thistime.

 

5.                                     Investments:

 

Management has categorized all of its investment securities asavailable for sale because they may be sold in response to changes in interestrates, prepayments and similar factors. Investments in this category arereported at their current market value, with net unrealized gains and losses,net of the applicable deferred income tax effect, being added to or deductedfrom the Company’s total shareholders’ equity on the balance sheet. As of March31, 2003, shareholders’ equity was increased by $1,100 due to unrealized gainsof $1,693 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 investmentportfolio. The amortized cost and estimated market value of the Company’savailable for sale investment portfolio as of March 31, 2003 and December 31,2002 are as follows:

 
|                                                                                   |   | **March  31, 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 |   | $                   | 26,226 |                        | $      | 27,343 |   | $ | 15,689 |   | $ | 16,861 |   |
|                                                                                   |   |                |   |                        |   |   |   |   |   |
| Mortgage  backed securities                                                            |   | 2,950               |   | 3,018                       |   | 1,603 |   | 1,681 |   |
|                                                                                   |   |                |   |                        |   |   |   |   |   |
| Debt  securities issued by foreign governments                                         |   | 204                 |   | 219                         |   | 205 |   | 216 |   |
|                                                                                   |   |                |   |                        |   |   |   |   |   |
| Corporate  securities                                                                  |   | 22,606              |   | 23,099                      |   | 9,278 |   | 9,696 |   |
|                                                                                   |   |                |   |                        |   |   |   |   |   |
| Policy  loans                                                                          |   | 267                 |   | 267                         |   | 238 |   | 238 |   |
|                                                                                   |   |                |   |                        |   |   |   |   |   |
| Total  investments                                                                     |   | $                   | 52,253 |                        | $      | 53,946 |   | $ | 27,013 |   | $ | 28,692 |   |
|                                                                                   |   |                |   |                        |   |   |   |   |   |
| Net  unrealized gain                                                                   |   | $                   | 1,693  |                        |   |   | $ | 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 hedges. The notional experience accountbalance at March 31, 2003 and December 31, 2002 was $734,037 and $708,982,respectively (See Note 2).

 

Pursuant to certain statutory licensing requirements, as of March 31,2003 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.

 

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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$11,869 and $11,174 at March 31, 2003 and December 31, 2002, respectively, forthe policies assumed under this agreement. At both March 31, 2003 and December31, 2002, the market value of the assets in trust exceeded the required amount.

 

6.                                       Reconciliationof Earnings Per Share:

 

A reconciliation of the numerator and denominator of the basic earningsper share computation to the numerator and denominator of the diluted earningsper share computation follows. Basic earnings per share excludes dilution andis computed by dividing income available to common shareholders by the weightedaverage number of common shares outstanding for the period. Diluted earningsper share reflect the potential dilution that could occur if securities orother contracts to issue common stock were exercised or converted into commonstock. Anti-dilutive effects are not included.

 

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|                                                                                                           |   | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                                                           |   | **2003**                         |       | **2002** | ** ** |
| Net  income (loss) before cumulative effect of change in accounting principle                                  |   | $                                | 3,056      |   | $ | (13,626 | ) |
| Weighted  average common shares outstanding                                                                    |   | 19,439                           |       | 18,853 |   |
| Basic  earnings per share from net income (loss) before cumulative effect of change  in accounting principle   |   | $                                | 0.16       |   | $ | (0.72 | ) |
|                                                                                                           |   |                             |       |   |   |
| Net  income (loss) before cumulative effect of change in accounting principle                                  |   | $                                | 3,056      |   | $ | (13,626 | ) |
| Cumulative  effect of change in accounting principle                                                           |   | —                           |       | (5,151 | ) |
| Net  income (loss)                                                                                             |   | $                                | 3,056      |   | $ | (18,777 | ) |
|                                                                                                           |   |                             |       |   |   |
| Basic  earnings per share from net income (loss)                                                               |   | $                                | 0.16       |   | $ | (1.00 | ) |
|                                                                                                           |   |                             |       |   |   |
| Adjustments  net of tax:                                                                                       |   |                             |       |   |   |
| Interest  expense on convertible debt                                                                          |   | $                                | 1,021      |   | $ | — |   |
| Amortization  of debt offering costs                                                                           |   | 56                               |       | — |   |
| Diluted  net income (loss) before cumulative effect of change in accounting principle                          |   | $                                | 4,133      |   | $ | (13,626 | ) |
| Diluted  net income (loss)                                                                                     |   | $                                | 4,133      |   | $ | (18,777 | ) |
|                                                                                                           |   |                             |       |   |   |
| Weighted  average common shares outstanding                                                                    |   | 19,439                           |       | 18,853 |   |
| Common  stock equivalents due to dilutive effect of stock options/warrants                                     |   | 4                                |       | — |   |
| Shares  converted from convertible debt                                                                        |   | 36,488                           |       | — |   |
| Total  outstanding shares for diluted earnings per share computation                                           |   | 55,931                           |       | 18,853 |   |
|                                                                                                           |   |                             |       |   |   |
| Diluted  earnings per share from net income (loss) before cumulative effect of change  in accounting principle |   | $                                | 0.07       |   | $ | (0.72 | ) |
| Diluted  earnings per share from net income (loss)                                                             |   | $                                | 0.07       |   | $ | (1.00 | ) |

 

Securities that could potentially dilute basic earnings per share inthe future that were not included in the computation of diluted earnings pershare, because to do so would have been anti-dilutive, were 30,765 and 14,588 atMarch 31, 2003 and December 31, 2002, respectively. These securities includeoptions, warrants (see Note 3) and convertible debt securities.

 

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 Company filed a registration statement registering theshares granted in the private placement for resale, which was declaredeffective on June 20, 2002. The proceeds of the private placement providedadditional liquidity to the parent company to meet its current year debt serviceobligations.

 

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In April 2002,the Company completed a private placement of 60 shares of common stock ascompensation to its financial advisor. Thirty of these shares were included inthe resale registration statement. The Company recorded $325 as an expense in2002 related to this item. In October 2002, the Company completed a privateplacement of an additional 20 shares of common stock to its financial advisorin conjunction with the exchange of its 2003 convertible subordinated notes(See Note 8). The Company recorded $68 as an expense related to this item.  In January 2003, the Company completed aprivate placement of an additional 20 shares of common stock to its financialadvisor in conjunction with the issuance of new 2008 convertible subordinatednotes (See Note 8). The Company recorded $34 as an expense related to thisitem.

 

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 to October 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 before October2005, and in doing so, may elect to receive a discounted amount of interestthat they would have otherwise received until that date.  The Company may elect to pay this interestin cash or in newly issued shares of common stock priced at a 10% discount tothe then fair market value of traded shares.

 

In conjunctionwith the issuance of the new 2008 Notes, the Company modified the terms of$63,343 in existing 2008 Notes outstanding at December 31, 2002 to be similarto those of the New 2008 Notes.

 

In March 2003, the Company issued an additional $2,450 of 2008 Notes inexchange for a like amount of its 6.25% convertible subordinated notes due 2003(“the 2003 Notes”).  At March 31, 2003,$8,957 of the 2003 Notes remained outstanding and the 2003 Notes will mature,if not called, in December 2003.

 

Principal repayment of the Company’s long-term debt outstanding atMarch 31, 2003, including the Company’s current mortgage outstanding is asfollows:

 
|   |   | **Debt** |    |
|--------|--------|----------|---------|
| 2003   |   | $        | 10,428  |   |
| 2004   |   | —   |    |
| 2005   |   | —   |    |
| 2006   |   | —   |    |
| 2007   |   | —   |    |
| 2008   |   | 98,214   |    |
| Total  |   | $        | 108,642 |   |

 

                As notedabove, holders of the 2008 Notes are entitled to convert their notes intoshares of the Company's common stock before October 2005, and in doing so, mayelect to receive a discounted amount of interest that they would have otherwiserecieved until that date. The Company may elect to pay this interest in cash orin newly issued shares of common stock priced at a 10% discount to the thenfair market value of traded shares. The Company has determined that thisfeature is an embedded derivative as defined in Statement of FinancialAccounting Standards No. 133 "Accounting for Derivative Instruments andHedging Activities." This embedded derivative is not clearly and closelyrelated to the host contract, the 2008 Notes, because it could at least doublethe investor's initial rate of return on the host contract and could also resultin a rate of return that is at least twice what otherwise would be the marketreturn for a contract that has the same terms as the host contract and thatinvolves a debtor with a similar credit quality.

 

                As a resultof this determination, the Company concluded that the embedded derivativeshould be separately valued and bifurcated from the host contract, the 2008Notes, upon the date that the option was granted. At each balance sheet date,the embedded derivative must be recorded at fair value, with any change in fairvalue recognized in current operations. Additionally, due to the bifurcation ofthe embedded derivative, the Company's long-term debt is recorded at adiscounted amount on the consolidated balance sheet. This discount is beingamortized through October 2008 using the effective interest method.

 

                The Companydetermined that the fair value of the embedded derivative upon the date thatthe option was granted was $2,038.  Thisamount was separately classified as preferred interest on early conversion inthe Consolidated Balance Sheets.  As ofMarch 31, 2003, the Company adjusted the embedded derivative to its then fairvalue of $2,099 by recognizing a loss of $61 in current operations. The Companyalso recorded $33 of additional interest expense during the quarter ended March31, 2003, due to the amortization of the discount on the long-term debt.

 

                Indetermining the fair value of the embedded derivative, the Company makescertain assumptions, including the future volatility and liquidity of the Company'scommon stock. If actual experience deviates from current assumptions, theCompany may be subject to significant volatility in future periods.

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9.                                       SubsequentEvent

 

On April 29, 2003, theCompany announced that its Board of Directors had approved certain changes inthe management of the Company to implement the succession plan initiated in2002.  In connection with the successionplan, effective May 23, 2003, the Company’s Founder, Chairman and ChiefExecutive Officer will step down as Chairman of the Board of Directors andChief Executive Officer, but, subject to his election by shareholders, willcontinue as a member of the Board of Directors.  In addition, the Company and its Founder, Chairman and ChiefExecutive Officer have entered into a consulting agreement.  The significant terms of the consultingagreement are as follows:

 

a)              The Company’s Founder, Chairman and ChiefExecutive Officer will assume the new position of Founding Chairman.

b)             The Company will pay the Founding Chairman orhis 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)              The Founding Chairman 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 andprovide him with other standard Company benefits.

 

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**Item 2.**Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

*(amounts inthousands, except per share data)*

 

*Overview*

 

Our principal products are individual, defined benefit accident andhealth insurance policies that consist of nursing home care, home health careand Medicare supplement. We experienced significant reductions in new premiumsales during 2001 and 2002 due to the cessation of new business generation inall states and as a result of market concerns regarding our Pennsylvaniainsurance subsidiaries’ statutory surplus. Under our Corrective Action Plan(the “Plan”) which was approved by the Pennsylvania Insurance Department (the“Department”) in February 2002, we recommenced sales in certain states, butintend to limit new business growth to levels that will allow us to maintainsufficient 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 March 31, 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 other 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, industryexperience and 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.Establishing reserves is based upon current assumptions and we cannot assureyou that actual experience will not differ materially from the assumptions usedin the establishment of our reserves. Any variance from these assumptions couldaffect our profitability in future periods.

 

*Deferred policy acquisition costs*. Inconnection with the sale of our insurance policies, we defer and amortize aportion of the policy acquisition costs over the related premium paying periodsof the life of the policy.

 

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These costs include all expenses that are directly related to, and varywith, the acquisition of the policy, including commissions, underwriting andother policy issue expenses. The amortization of deferred policy acquisitioncosts (“DAC”) is determined using the same projected actuarial assumptions usedin computing policy reserves. DAC can be affected by unanticipated terminationsof policies because, upon such terminations, we are required to expense fullythe DAC associated 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 rate increases.In the event planned premium rate increases are not achieved, we couldrecognize an impairment of our DAC in the future.  Whenever we determine that our DAC is not fully recoverable, weimpair the carrying value of our DAC through an expense to our ConsolidatedStatements 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.

 

*Investment income and notional experience account*.Our investment portfolio, excluding our notional experience account, consistsprimarily of investment grade fixed income securities. Income generated fromthis portfolio is largely dependent upon prevailing levels of interest rates.Due to the duration of our investments (approximately 3.3 years), investmentincome does not immediately reflect changes in market interest rates.

 

In connection with our 2001 reinsurance agreement with Centre Solutions(Bermuda) Limited (the “2001 Centre Agreement”) (see “*Liquidity and Capital Resources*”),we transferred substantially all of our investment portfolio to the reinsureras the initial premium payment. The initial and future premium for the reinsuredpolicies, less claims payments, ceding commissions and risk charges is creditedto a notional experience account, the balance of which also receives aninvestment credit. The notional experience account balance represents an amountto be paid to us in the event of commutation of the agreement. We believe thatthe notional experience account represents a hybrid instrument, containing botha fixed debt host contract and an embedded derivative. The economiccharacteristics and risks of the embedded derivative instrument are not clearlyand closely related to the economic characteristics and risks of the fixed debthost contract. The Company is accounting for the investment credit received onthe notional experience account as follows:

 

a)              The fixed debt host yields a fixed returnbased upon the yield to maturity of the underlying benchmark indices. Thereturn on the fixed debt host is reported as investment income in theStatements of Income 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.

 

As a result, our results of operations are subject to significantvolatility. Recorded market value gains or losses, although recognized incurrent earnings, are expected to be offset in future periods from the receiptof the most recent market rates for all subsequent periods. The benchmarkindices are comprised of U.S. Treasury strips, agencies and investment gradecorporate bonds, with weightings of approximately 25%, 15% and 60%,respectively, and have a duration of approximately 11 years.

 

*Lapsation and persistency*. Factors that affectour financial condition and results of operations include lapsation andpersistency, both of which relate to the renewal of insurance policies.

 

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Lapsation is the termination of a policy by non-renewal. Lapsation isautomatic if and when premiums become more than 31 days overdue, although, insome cases, a lapsed policy may be reinstated within six months. Persistencyrepresents the percentage of premiums renewed, which we calculate by dividingthe total number of policies in-force at the end of each year (less newpolicies added during the year) by the total number of policies in-force at theend of the prior year.  Prior toDecember 31, 2002 we calculated persistency by dividing the total annualpremiums at the end of each year (less first year premiums for that year) bythe total annual premiums in-force for the prior year. For purposes of thesecalculations, a decrease in total policies in-force or the annual premiumsin-force at the end of any year would be the result of non-renewal of policies,including policies that have terminated by reason of death, lapsed due tononpayment of premiums and/or been converted to other policies we offered. Thecalculation was changed at December 31, 2002 due to the impact of rateincreases on the annual premiums in-force at the end of December 31, 2002.  We believe that using the number of policiesin-force will provide a more accurate measure of persistency and will continueto utilize that method of calculation in the future.

 

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 of 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 affect futureearnings. Reduced lapsation and higher persistency generally result in higherrenewal premiums and lower amortization of DAC, but may lead to increasedclaims in future periods. Higher lapsation can result in reduced premiumcollection, a greater percentage of higher-risk policyholders, and acceleratedexpensing of DAC. However, higher lapsation may also lead to decreased claimsin future periods.

 

###### *Results ofOperations*

 

**Three Months EndedMarch 31, 2003 and 2002**

 

*Premiums*. Total premium revenue earned in the threemonth period ended March 31, 2003 (the “2003 quarter”), including long-termcare, disability, life and Medicare supplement, decreased 0.8% to $83,578,compared to $84,236 in the same period in 2002 (the “2002 quarter”).

 

Totalfirst year premium revenue in the 2003 quarter decreased 32.2% to $1,542,compared to $2,275 in the 2002 quarter. First year long-term care premiumrevenue in the 2003 quarter decreased 34.6% to $1,332, compared to $2,037 inthe 2002 quarter. We experienced significant reductions in new premium revenuedue to the cessation of new business generation in all states in 2001 and dueto continued market concerns regarding our insurance subsidiaries’ statutorysurplus. See *“Liquidity and Capital Resources.”*

 

EffectiveSeptember 10, 2001, we determined to discontinue the sale nationally of all newlong-term care insurance policies until the Plan was completed and approved bythe Department. This decision resulted from our concern about further depletionof statutory surplus from new policy sales prior to the completion and approvalof the Plan and from increasing concern with respect to the status of the Planexpressed by many states in which we are licensed to conduct business.

 

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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, including Florida, Virginia, Illinois,Arizona and Texas (See *“Liquidity and Capital Resources*”).  These 36 states represented approximately71% in aggregate of our total premium revenue in the 2003 quarter.  We have recently agreed upon terms for therecommencement of sales in California, which is pending subject to certainconditions.  California represented 14%of our premium revenue in the 2003 quarter. We are actively working with theremaining states to recommence new policy sales in all jurisdictions.

 

Totalrenewal premium revenue in the 2003 quarter increased 0.1% to $82,036 comparedto $81,961 in the 2002 quarter. Renewal long-term care premium revenue in the2003 quarter decreased 0.5% to $78,907, compared to $79,276 in the 2002quarter. We may continue to experience reduced renewal premium revenue in thefuture, primarily driven by the reduced level of new premium revenue discussedabove and the lapsation of existing policies.

 

*Net investment income.* Net investment income earned for the 2003quarter increased 8.5% to $10,347, from $9,535 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 hedges, which are designed toclosely match the duration of our liabilities.

 

Our averageyield on invested assets at cost, including cash and cash equivalents, was5.22% and 6.42% in the 2003 and 2002 quarters, respectively. The investmentincome component of our notional experience account investment credit generated$9,882 and $8,843 in the 2003 and 2002 quarters, respectively.  The yield on our notional experience accountwas 5.68% and 6.36% in the 2003 and 2002 quarters, respectively. The decreasein our average yield is due to a decline in market interest rates which has thegreatest impact on our notional experience account.  The notional experience account yields a fixed return based uponthe yield to maturity of the underlying benchmark indices, which are comprisedof U.S. Treasury strips, agencies and investment grade corporate bonds, withweightings of approximately 25%, 15% and 60%, respectively, and have a durationof approximately 11 years.

 

In addition, we heldadditional assets in cash and short term securities during the 2003 quarter dueto our recently completed issuance of new convertible bonds, the proceeds ofwhich were invested in short term, lower yielding instruments.

 

*Net realized capital gains*. During the 2003 quarter, we recognizedcapital gains of $79 compared to $14,523 in the 2002 quarter. The capital gainsin the 2003 quarter were recorded as a result of our normal investmentmanagement operations. The capital gains recognized in the 2002 quarterresulted from the transfer of substantially all of our invested assets to ourreinsurer.

 

*Market gain (loss) on notionalexperience account*.We recorded a market gain on our notional experience account balance of $4,302in the 2003 quarter and a market loss of $25,953 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.

 

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Periodicchanges in the market values of the benchmark indices and derivative hedges arerecorded in our financial statements as a realized gain or loss in the periodin which they occur. The notional experience account is susceptible to marketinterest rate changes.  As a result, ourfuture financial statements are subject to significant volatility.  During the 2003 quarter market ratesdecreased, leading to a market gain on the notional experience account ascompared to the 2002 quarter during which market interest rates increased.

 

*Other income*. We recorded $2,263 in other income duringthe 2003 quarter, down from $2,770 in the 2002 quarter. The decrease isattributable primarily to a decrease of approximately $300 in the incomegenerated from our ownership of corporate owned life insurance policies.  In addition, net commission payments earnedby our agency subsidiaries were $106 less in the 2003 quarter than in the 2002quarter, 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 2003quarter decreased 20.0% to $64,167, compared to $80,187 in the 2002 quarter.Our loss ratio, or policyholder benefits to premium revenue, was 76.8% in the2003 quarter, compared to 95.2% in the 2002 quarter.

 

Asdiscussed in “*Overview*” above, we establish claim reserves based uponcurrent and historical experience of our policyholder benefits, including anexpectation of claims incidence and duration, as well as the establishment of areserve for claims that have been incurred but are not yet reported. Wecontinuously monitor our experience to determine the best estimate of reservesto be held for future payments of these claims. As a result, we periodicallyrefine our process to incorporate the most recent known information inestablishing these reserves.

 

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 further believe that additional premium rate increases will berequired on many policies in-force as result of our new claim assumptionsestablished in the third quarter of 2002. We are currently assessing the impact of the new claims assumptions withregard to our pricing for new product sales. We have been generally successful in the past in obtaining stateinsurance department approvals for increases. If we are unsuccessful inobtaining future rate increases when deemed necessary, or if we do not pursuerate increases when actual claims experience exceeds our expectations, we wouldsuffer a financial loss.

 

Historically, more new claims are reported during thefirst quarter than in later quarters. This seasonality generates higher incurred claim ratios in the firstquarter than in subsequent quarters. Management employs these seasonal assumptions throughout the year in theestablishment of its claim reserves so that it can more consistently monitorloss ratio variances from its expectations based upon other significant factorssuch as claims duration and incidence. Management estimates that seasonality resulted in approximately $4,500and $5,000 in higher incurred claims in the 2003 and 2002 quarters,respectively, and as a result established lower claim reserves during bothquarters to reflect this seasonal variation.

 

Ourpolicy reserves, which are held for policyholders not currently on claim, arehighly dependent upon several factors, including policyholder persistency andthe mix of policies with varying benefit amounts or types.  We project the growth of our policy reservesbased upon the current and projected mix of policies in-force.

 

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Variancesfrom our expectations result from future changes in this mix that differ fromour assumptions.

 

Ourloss ratio during the 2003 quarter did not differ materially from ourexpectations.  During the 2002 quarter, we increased our policy reserves byapproximately $16,500 above the levels that we would have normallyanticipated.  This increase in reservesresulted from the following:

 

1)  We establishreserves utilizing expectations for future events, including anticipatedlapses.  We generally assume that thosepolicies that are expected to lapse are representative of the total in-forcepolicy base and that the composition of in-force policies will remain the samein future periods.  During the 2002quarter, we experienced shifts in the general composition of our policyholderbase that caused us to hold an additional $11,000 in policy reserves at March31, 2002, compared to our expectations. This shift resulted in a higher than expected number of policies withfeatures that require additional reserves to be held for future benefits,including more policies with inflation protection, skilled facility care andreduced elimination periods.  Thischange in the composition of our policies occurred as a result of higher lapsesof policies without these features rather than as a result of new sales.

 

2)  Policypersistency, or the retention of renewing policies, increased by 0.3% duringthe 2002 quarter, which generated additional policy reserves of approximately$5,500.  This increase was onlypartially offset by higher premium revenue and lower amortization of DAC.

 

*Commissions*. Commissions to agents decreased 16.6% to$10,704 in the 2003 quarter, compared to $12,830 in the 2002 quarter.

 

Firstyear commissions on accident and health business in the 2003 quarter decreased46.4% to $780, compared to $1,456 in the 2002 quarter, due to the decrease infirst year accident and health premium revenue. The ratio of first yearaccident and health commissions to first year accident and health premiumrevenue was 50.6% in the 2003 quarter and 64.0% in the 2002 quarter. We believethat the decrease in the first year commission ratio is primarily attributableto the increased sale of our Secured Risk, Medicare Supplement and franchisegroup policies as a percentage of total sales. All of these policies pay alower commission as a percentage of premium revenue to agents than ourindividual long-term care policies.  ** **We believe that we are likely toexperience an increase in the sale of these policies as a percentage of newsales when we recommence sales in many states as a result of our lowerfinancial ratings with A.M. Best and Standard and Poor’s rating services andcontinued consumer and agent concerns regarding our financial strength.

 

Renewalcommissions on accident and health business in the 2003 quarter decreased 14.5%to $10,469, compared to $12,248 in the 2002 quarter. The ratio of renewalaccident and health commissions to renewal accident and health premiums was12.9% in the 2003 quarter and 15.1% in the 2002 quarter. We have implementedpremium rate increases on a majority of policies written prior to December 31,2001.  We do not pay commissions on theadditional premium collected as a result of a rate increase, which reduces theratio of renewal commissions to renewal premium revenue.

 

*Net policy acquisition costsamortized (deferred)*.The net policy acquisition costs amortized in the 2003 quarter increased to$3,054, compared to a deferral of $3,326 in the 2002 quarter.

 

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 underwriting. Deferred costs are amortized over the life of the policybased on actuarial assumptions, including persistency of policies in-force. Inthe event a policy lapses prematurely due to death or termination of coverage,the remaining unamortized portion of the deferred amount is immediatelyrecognized as expense in the current period.

 

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Thenet amortization of deferred policy acquisition costs is affected by newbusiness generation, imputed interest on prior reserves and policy persistency.The amortization of deferred costs is generally offset largely by the deferralof costs associated with new premium generation. However, lower new premiumrevenue throughout 2002 and continuing through the 2003 quarter producedsignificantly less expense deferral to offset amortized costs.

 

*General and administrativeexpenses*. General andadministrative expenses in the 2003 quarter increased 18.9% to $12,740,compared to $10,712 in the 2002 quarter. The ratio of total general andadministrative expenses to premium revenues was 15.2% in the 2003 quarter,compared to 12.7% in the 2002 quarter.

 

Duringthe 2003 quarter, we incurred additional expenses of approximately $540 relatedto the recommencement of new sales in certain key states as compared to the2002 quarter.  Salaries and employeebenefits increased approximately $575 in the 2003 quarter compared to the 2002quarter.  This increase is due to salaryincreases, increased health insurance premiums and the addition of employees inthe actuarial and accounting functions.  Legal expenses increased approximately $430 in the 2003 quarter comparedto the 2002 quarter.  The increase inlegal expenses was primarily due to costs associated with premium rate increaselitigation and expenses related to our special shareholders’ meeting held onMarch 28, 2003.  The expenses related toour information system replacement project, which started after the 2002quarter, were approximately $200.

 

Webelieve that if we remain unable to write new business in certain states wherewe have ceased new production, or if we are unable to use our existing staffand infrastructure capacity to generate additional premium revenue, we willneed to decrease production expenses, which could result in decisions to reduceour staff or other operating functions.

 

*Expense and risk charges onreinsurance and excise tax expense*. Our reinsurance agreement provides the reinsurer with annual expenseand risk charges, which are credited against our notional experience account inthe event of future commutation of the 2001 Centre Agreement. The annualexpense consists of a fixed cost and a variable component based upon reserveand capital levels needed to support the reinsured business. In the 2003quarter, we incurred an expense of $2,768 for this charge. In the 2002 quarter,we incurred an expense of $3,577.  Inaddition, we are subject to an excise tax for premium payments made to aforeign reinsurer. We recorded $789 and $581 for excise tax expenses in the2003 and 2002 quarters, respectively.

 

*Federal income tax provision(benefit)*. Due to therecognition of income in the 2003 quarter, our provision for Federal incometaxes was $1,574, compared to a tax benefit of $7,020 for the 2002 quarter. Theeffective tax rate of 34.0% in the 2003 and 2002 quarters is below the normalFederal corporate income tax rate as a result of anticipated credits from ourinvestments in corporate owned life insurance.

 

*Cumulative effect of change in accounting principle*. We recognized an impairment loss of $5,151in the 2002 quarter as a result of our transitional impairment test ofgoodwill. See “New Accounting Principles.”

 

*Comprehensive income (loss)*. During the 2003 quarter, our investmentportfolio generated pre-tax unrealized gains of $93, compared to unrealizedlosses of $634 in the 2002 quarter. After accounting for deferred taxes fromthese gains, shareholders’ equity increased by $3,066 from comprehensive incomeduring the 2003 quarter, compared to losses of $28,780 in the 2002 quarter.

 

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***Liquidity and Capital Resources***

 

Ourconsolidated liquidity requirements have historically been met from theoperations of our insurance subsidiaries, from the operations of our agencysubsidiaries and from funds raised in the capital markets. Our primary sourcesof cash are premium revenue, investment income and maturities of investments.We have 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 quarter, our cash flows were attributable to cash provided byoperations, cash used in investing and cash provided by financing. Our cashincreased $6,364 in the 2003 quarter primarily due to $32,421 in additionalfunds generated from the issuance of convertible subordinated debt. This wassupplemented by $15,191 from operations. The major source of cash fromoperations was premium revenue and investment income received. Our major usesof cash during the 2003 quarter were payments made to our reinsurer of $14,324and the purchase of $29,123 in bonds.

 

In the 2002 quarter, our cash flows were attributable to cash providedby operations, cash used in investing and cash provided by financing.  Our cash decreased $87,689 in the 2002quarter primarily due to payments of $573,654 made to our reinsurer and thepurchase of $12,908 in bonds and equity securities.  Cash was provided primarily from the maturity and sale of$478,795 in bonds and equity securities. These sources of funds were supplemented by $23,922 fromoperations.  The major provider of cashfrom operations was premium revenue and investment income 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 March 31, 2003, shareholders’ equity was increased by $1,100 dueto unrealized gains of $1,693 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 sold both debt and equity securities over the past two years tofund our liquidity and subsidiary capital needs. These activities haveincluded:

 

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 institutional investors, at $4.65 pershare. The offering price was a 10 percent discount to the 30-day average priceof our common stock prior to the issuance of the new shares.

 

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 would beconvertible into shares of our common stock at a conversion price of$5.31.  Prior to the termination of theexchange offer, we reduced the conversion price to $4.50.  The conversion price was ultimately reducedto $1.75 in February 2003.  In addition,beginning in October 2005, the 2008 Notes are mandatorily convertible if, atany time, the 15-day average closing price of our common stock exceeds 110% ofthe conversion price.

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We exchanged approximately $63,343 of the 2003 Notes for 2008 Notesprior to December 31, 2002. During the first quarter of 2003, we exchanged anadditional $2,450 of 2003 Notes for 2008 Notes. We expect to retire anyoutstanding amount of the 2003 Notes on or before their contractual maturity inDecember 2003.

 

3)  In December 2002, wecommenced the sale of additional 2008 Notes. During the 2003 quarter, we completed the sale of 2008 Notes andreceived proceeds of $32,421. We used $16,000 of the proceeds to satisfy thepremium to surplus requirements of our voluntary consent order with the FloridaInsurance Department. We intend to use the remaining proceeds to supplementparent liquidity, to retire our remaining 2003 Notes of $8,957 and for generalworking capital purposes.

 

In April 2002, October 2002 and January 2003, we completed privateplacements of 60, 20 and 20 shares of common stock respectively, ascompensation to our financial advisor related to the sale of the debt andequity securities.

 

At March 31, 2003, our total principal repayment and lease obligationsthrough 2008 were as follows:

 
|   |   | **Debt** |    | **Lease  Obligations** | ** ** | **Total** | ** ** |
|--------|--------|----------|---------|------------------------|------------|-----------|------------|
| 2003   |   | $        | 10,428  |                   | $          | 258       |       | $ | 10,686 |   |
| 2004   |   | —   |    | 252                    |       | 252       |       |
| 2005   |   | —   |    | 18                     |       | 18        |       |
| 2006   |   | —   |    | 18                     |       | 18        |       |
| 2007   |   | —   |    | 18                     |       | 18        |       |
| 2008   |   | 98,214   |    | 18                     |       | 98,232    |       |
| Total  |   | $        | 108,642 |                   | $          | 582       |       | $ | 109,224 |   |

 

Debtobligations in 2003 include a $1,471 mortgage obligation of our subsidiary.Other amounts due after 2008 are immaterial.

 

Inaddition to the terms noted above, holders of the 2008 Notes are entitled toconvert their notes into shares of our common stock before October 2005, and indoing so, may elect to receive a discounted amount of interest that they wouldhave otherwise received until that date. We may elect to pay this interest incash or in newly issued shares of common stock priced at a 10% discount to thethen fair market value of traded shares. We have determined that this featureis an embedded derivative as defined in Statement of Financial AccountingStandards No. 133 "Accounting for Derivative Instruments and HedgingActivities." This embedded derivative is not clearly and closely relatedto the host contract, the 2008 Notes, because it could at least double theinvestor's initial rate of return on the host contract and could also result ina rate of return that is at least twice what otherwise would be the marketreturn for a contract that has the same terms as the host contract and thatinvolves a debtor with a similar credit quality.

 

Asa result of this determination, we concluded that the embedded derivativeshould be separately valued and bifurcated from the host contract, the 2008Notes, upon the date that the option was granted. At each balance sheet date,the embedded derivative must be recorded at fair value, with any change in fairvalue recognized in current operations. Additionally, due to the bifurcation ofthe embedded derivative, our long-term debt is recorded at a discounted amounton the consolidated balance sheet. This discount is being amortized throughOctober 2008 using the effective interest method.

 

Wedetermined that the fair value of the embedded derivative upon the datethat the option was granted was $ 2,038. This amount was separately classifiedas long-term debt embedded derivative in the Consolidated Balance Sheet. As ofMarch 31, 2003, we adjusted the embedded derivative to its then fair value of$2,099 by recognizing a loss of $61 in current operations. We also recorded $33of additional interest expense during the quarter ended March 31, 2003, due tothe amortization of the discount on our long-term debt.

 

In determining the fair value of the embedded derivative, we makecertain assumptions, including the future volatility and liquidity of ourcommon stock. If actual experience deviates from current assumptions, we may besubject to significant volatility in future periods.

 

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 (see “Subsidiary Operations”) and we may need to rely upon the dividendcapabilities of our agency subsidiaries to meet current liquidity needs. Ourcurrent cash on hand and these sources of funds are expected to be sufficientto meet our liquidity needs through September 2004, but may be insufficient tomeet our interest payments on and after October 2004. We will need to raiseadditional capital to satisfy any parent company liquidity needs, includingdebt service payments, beyond October 2004.

 

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Ouranticipated cash needs for 2003 are as follows:

 
| Retirement of 2003 Notes                                   |   | $      | 9,000  |   |
|------------------------------------------------------------|--------|--------|--------|--------|
| Debt interest payments                                     |   | 5,700  |   |
| Other parent expenses, net of reimbursement                |   | 900    |   |
|                                                       |   | $      | 15,600 |   |
|                                                       |   |   |   |
| Our anticipated sources to meet our 2003  obligations are: |   |   |   |
| Proceeds from debt offering                                |   | $      | 16,300 |   |
| Agency subsidiary dividends                                |   | 2,200  |   |
|                                                       |   | $      | 18,500 |   |

 

*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 thatpotentially are inadequately capitalized. In addition, the formula definesminimum capital standards that an insurer must maintain. Regulatory complianceis determined by a ratio of the enterprise’s regulatory Total Adjusted Capitalto its Authorized Control Level RBC, as defined by the NAIC. Companies belowspecific trigger points or ratios are classified within certain levels, each ofwhich may require specific corrective action depending upon the insurer’s stateof domicile.

 

Ourinsurance subsidiaries, Penn Treaty Network America Insurance Company (“PTNA”),American Network Insurance Company (“ANIC”), and American Independent NetworkInsurance Company of New York (“American Independent”) (representingapproximately 94%, 5% and 1% of our in-force premium, respectively) arerequired to hold statutory surplus that is above a certain required level. AtDecember 31, 2000, PTNA had Total Adjusted Capital at the Regulatory Actionlevel, which required it to file a Plan with the Department. Inaddition, ANIC, which is owned 100% by PTNA, is also subject to the provisionsof the Plan.

 

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 theirlong-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 thepremium rate increases that the reinsurance agreement may require are notobtained. We are required to perform annual comparisons of our actual toexpected claims experience. If we have reason to believe, whether from thisanalysis or other available information, that at least a 5% premium rateincrease is necessary, we are obligated to file and obtain such premium rateincreases in order to comply with the requirements of the agreement. If we donot file and obtain such premium rate increases, our aggregate limit ofliability would be reduced by 50% of the premium amount that would haveotherwise been received.

 

Aspart of this agreement, annual risk charges in excess of $10,000 are creditedagainst our notional experience account by the reinsurer. The annual amountincreases if we do not commute on December 31, 2007. However, this agreementdoes not qualify for reinsurance treatment in accordance with GAAP because itdoes not result in the reasonable possibility that the reinsurer may realize asignificant loss.

 

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Thisis due to a number of factors related to the agreement, including experiencerefund provisions, the expense and risk charges credited to the notionalexperience account by the reinsurer and the aggregate limit of liability.However, this agreement meets the requirements to qualify for reinsurancetreatment under statutory accounting rules.

 

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 experience accountbalance receives an investment credit based upon the total return from a seriesof benchmark indices and derivative hedges that are intended to match theduration 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 to commutethe agreement, our statutory capital following commutation must be sufficientto support the reacquired business in compliance with all statutoryrequirements. Upon commutation, PTNA and ANIC would receive cash or otherliquid assets equaling the market value of our notional experience account fromthe reinsurer. We would also record the necessary reserves for the business inPTNA’s and ANIC’s statutory financial statements. Our ability to commute theagreement is highly dependent upon the market value of the notional experienceaccount exceeding the level of required reserves to be established. As of March31, 2003, the statutory basis reserve liabilities of $906,826 exceeded thecombination of the notional experience account value and funds held due to thereinsurer of $790,037. We expect the value of the notional experience accountto exceed the reserve liabilities at December 31, 2007.  In addition to the performance of thereinsured policies from now until 2007, the notional experience account valueis susceptible to market interest rate changes. A market interest rate increaseof 100 basis points could reduce the market value of the current notionalexperience account by approximately $72,000 and jeopardize our ability tocommute as planned. As we approach the intended commutation date, thesensitivity of our notional experience account to market interest rate movementwill decline as the duration of the benchmark indices becomes shorter, howeverthe amount of assets susceptible to such interest sensitivity will continue togrow as additional net cash flows are added to the notional experience accountbalance prior to commutation. We intend to give notice to the reinsurer of ourintention to commute on December 31, 2007 at such time as we are highlyconfident of our ability to support the reacquired policies. The reinsurer hasagreed to fix the market value of the notional experience account at that time,and to then invest the assets in a manner that we request in order to minimizeshort 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, the fourth tranche would representan additional 20% of the then outstanding common stock on a fully dilutedbasis.

 

Asa result of our intention to commute, we assessed only the expense and riskcharges 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 and risk charge credits against our notionalexperience account in our DAC recoverability analysis. As a result, we couldimpair the value of our DAC asset and record the impairment in our financialstatements. However, we currently believe that we will have sufficientstatutory capital and surplus to commute the reinsurance agreement on December31, 2007 or that sufficient alternatives, such as proceeds from additionalcapital issuance or new reinsurance opportunities, will be available to enableus 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 of 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 the 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.

 

Theagreement 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 an aggregate limit ofliability that reduces the likelihood of the reinsurer realizing a significantloss on the agreement. However, this agreement meets the requirements toqualify for reinsurance treatment under statutory accounting rules.

 

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. The Company’s separate agreementwith the reinsurer to reinsure existing policies issued prior to December 31,2001 will be unaffected by any determination made by the reinsurer regardingnewly issued policies.

 

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

 

a)               limits new investments to those rated by theNAIC as 1 or 2;

b)              limits and requires Department approval foraffiliated transactions; and

c)               requires a $125,000 increase in statutoryreserves over a three-year period, of which a $40,000 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 quarter. 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 California, which represented approximately14% of our premium revenue during the 2003 quarter.

 

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Recommencementof sales is pending subject to the completion of certain conditions.

 

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 to issuenew policies and to control expense growth. Our future growth and new policyissuance is dependent upon our ability to continue to expand our historicalmarkets, retain and expand our network of agents and effectively market ourproducts and fund our marketing and expansion while maintaining minimumstatutory levels of capital and surplus required to support such growth.

 

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 in accordancewith GAAP due to the immediate or accelerated recognition of all costsassociated with premium growth and benefit reserves. For purposes of New Yorklaw, approval must be obtained for any dividend that, together with all otherdividends paid during the preceding twelve months, exceeds the lesser of 10% ofthe insurance company’s surplus as of the preceding December 31 or its adjustednet investment income for the year ended the preceding December 31.  Additionally, the Plan requires theDepartment to approve all dividends made by PTNA, regardless of normalstatutory requirements for allowable dividends. We believe that the Departmentis unlikely to approve any dividend in the foreseeable future as a result ofPTNA’s current statutory surplus position. Although not stipulated in the Plan,this requirement is likely to continue until such time as PTNA meets normalstatutory allowances, including reported net income and positive cumulativeearned surplus. We do not expect that this will occur in the foreseeablefuture.

 

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.  Wedo not anticipate that American Independent will make a dividend payment to theparent company in 2003.

 

Oursubsidiaries’ debt currently consists primarily of a mortgage note in theamount of $1,471 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%.

 

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***NewAccounting Principles***

 

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 an“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 certain provisions relating to forward purchases and sales ofwhen-issued securities or other securities that do not yet exist should beapplied to both existing contracts and new contracts entered into after June30, 2003.  The adoption of SFAS No. 149is not expected to have a material impact on our financial statements.

 

Statement of FinancialAccounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No.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 theevaluation, we determined that the goodwill associated with our 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.  We have completed an assessmentof other intangible assets and have determined to continue to amortize theseassets so as to closely match the future profit emergence from theseassets.  No goodwill was amortized forthe three months ended March 31, 2003 or March 31, 2002.

 

In November2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others” (“FIN No. 45”), which addresses the disclosures to bemade by a guarantor in its interim and annual financial statements about itsobligations under guarantees. This interpretation also clarifies therequirements related to the recognition of a liability by a guarantor at theinception of a guarantee for the obligations the guarantor has undertaken inissuing that guarantee. The provisions related to the disclosure requirementsto be made by a guarantor are effective for financial statements of interim andannual reporting periods ending after December 15, 2002. The provisions relatedto the recognition of a liability and initial measurement shall be appliedprospectively to guarantees issued or modified after December 31, 2002,irrespective of the guarantor’s fiscal year-end. The adoption of FIN No. 45 didnot have a material impact on our consolidated financial statements.

 

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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 voluntarychange to 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, SFAS No. 148 amends the disclosure requirements ofSFAS 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.

 

In January2003, the FASB issued FASB Interpretation No. 46, “Consolidation of VariableInterest Entities, an Interpretation of Accounting Research Bulletin No. 51”(“FIN No. 46”). FIN No. 46 requires existing unconsolidated variable interestentities to be consolidated by their primary beneficiaries if the entities donot effectively disperse risks among parties involved. FIN No. 46 appliesimmediately to variable interest entities created after January 31, 2003, andto variable interest entities in which an enterprise obtains an interest afterthat date. It applies in the first fiscal year or interim period beginningafter June 15, 2003, to variable interest entities in which an enterprise holdsa variable interest that it acquired before February 1, 2003. FIN No. 46applies to public enterprises as of the beginning of the applicable interim orannual period.  FIN No. 46 may beapplied prospectively with a cumulative-effect adjustment as of the date onwhich it is first applied or by restating previously issued financialstatements for one or more years with a cumulative-effect adjustment as of thebeginning of the first year restated. The implementation of FIN No. 46 is notexpected to have a material impact on our 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 our expectationsare based upon reasonable assumptions within the bounds of our knowledge of ourbusiness and operations, there can be no assurance that actual results of ouroperations will not differ materially from our expectations. Factors whichcould cause actual results to differ from expectations include, among others,our ability to comply with the Plan, the Florida Consent Order, the orders ordirectives of other states in which we do business or any special provisionsimposed by states in connection with the resumption of writing new business,our ability to commute the 2001 Centre Agreement and to recapture our reinsuredpolicies and accumulated notional experience account balance, whether our Planwill be accepted and approved by all states, our ability to meet our futurerisk-based capital goals, the adverse financial impact of suspending newbusiness sales, our ability to raise adequate capital to meet regulatoryrequirements and to support anticipated growth, our ability to refinance,convert or repay our 2008 convertible notes, the cost associated withrecommencing new business sales, liquidity needs and debt obligations, ourability to obtain premium rate increases, our ability to obtain improvedratings from independent rating agencies, the adequacy of our loss reserves andthe recoverability of our DAC asset, our ability to sell insurance products incertain states, our ability to resume generating new business in all states,our ability to comply with government regulations and the requirements whichmay be imposed by state regulators as a result of our capital and surpluslevels, the ability of senior citizens to purchase our products in light of theincreasing costs of health care, our ability to defend ourself against adverselitigation, and our ability to recapture, expand and retain our network ofproductive independent agents, especially in light of the suspension of newbusiness.

 

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For additional information, please refer toour other reports filed with the Securities and Exchange Commission, which maybe viewed at www.sec.gov.

 

**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.

 

Wecurrently have an interest rate swap on our mortgage, which is used as a hedgeto convert the mortgage to a fixed interest rate. We believe that, since thenotional amount of the swap is amortized at the same rate as the underlyingmortgage and both financial instruments are with the same bank, no credit riskis carried with 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 balance, which representssubstantially all of our investable assets at March 31, 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 84.2% 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 March 31, 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 March 31, 2003, there wouldhave been a decrease of approximately $69,000 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 March 31, 2003 would have resultedin a decrease of approximately $130,000 in the net fair value. If interestrates had decreased by 100 and 200 basis points, there would have been a netincrease of approximately $77,000 and $163,000, respectively, in the net fairvalue of our total investments and debt.

 

EffectiveDecember 31, 2001, we entered a reinsurance agreement to reinsure, on a quotashare basis, substantially all of our long-term care insurance policiesin-force. The transaction resulted in the transfer of approximately $563,000 indebt and equity securities to the reinsurer. The agreement provides us with theopportunity to commute and recapture on or after December 31, 2007. To thatend, the reinsurer will maintain a notional experience account for our benefitonly in the event of commutation and recapture of our reinsured policies, whichreflects the initial premium paid, future premiums collected net of claims,expenses and accumulated investment earnings.

 

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Thenotional experience account balance will receive an investment credit basedupon the total return of a series of benchmark indices and hedges that aredesigned to closely match the duration of reserve liabilities. As a result, wewill likely experience significant volatility in our future financialstatements.

 

Our ability to commute the agreement is highly dependent upon themarket value of the notional experience account exceeding the level of requiredreserves to be established. In addition to the performance of the reinsuredpolicies from now until 2007, the notional experience account value issusceptible to market interest rate changes. A market interest rate increase of100 basis points could reduce the market value of the current notionalexperience account by approximately $72,000 and jeopardize our ability tocommute as planned. As we approach the intended commutation date, thesensitivity of our notional experience account to market interest rate movementwill decline as the duration of the benchmark indices becomes shorter, howeverthe amount of assets susceptible to such interest sensitivity will continue togrow as additional net cash flows are added to the notional experience accountbalance prior to commutation. We intend to give notice to the reinsurer of ourintention to commute on December 31, 2007 at such time as we are highlyconfident of our ability to support the reacquired policies. The reinsurer hasagreed to fix the market value of the notional experience account at that time,and to then invest the assets in a manner that we request in order to minimizeshort term volatility.

 

We hold certain mortgage and asset backed securities as part of ourinvestment portfolio. The fair value of these instruments may react in a convexor non-linear fashion when subjected to interest rate increases ordecreases.  The anticipated cash flowsof these instruments may differ from expectations in changing interest rateenvironments, resulting in duration drift or a varying nature of predictedtime-weighted present values of cash flows. The result of unpredicted cashflows from these investments could cause the above hypothetical estimates tochange. However, we believe that the minimal amount we have invested in theseinstruments and their broadly defined payment parameters sufficiently outweighthe cost of computer models necessary to accurately predict the possible impacton our investment income of hypothetical effects of changes in market rates orprices on the fair values of financial instruments as of March 31, 2003.

 

**Item 4. **Controls andProcedures

 

The Company carried out an evaluation of the effectiveness of theCompany’s disclosure controls and procedures within 90 days prior to the filingdate of this report. This evaluation was carried out under the supervision andwith the participation of the Company’s management, including the Company’sChairman and Chief Executive Officer, the Company’s President and ChiefOperating Officer and the Company’s Executive Vice President and ChiefFinancial Officer. Based upon that evaluation, the Company’s Chairman and ChiefExecutive Officer, the Company’s President and Chief Operating Officer and theCompany’s Executive Vice President and Chief Financial Officer concluded thatthe Company’s disclosure controls and procedures are effective. There have notbeen any significant changes in the Company’s internal controls, or in otherfactors which could significantly affect internal controls subsequent to thedate the Company carried out its evaluation, or any corrective actions withregard to significant deficiencies and material weaknesses.

 

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**PART II****   OTHER INFORMATION**

 

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

 

Our subsidiaries are parties to various lawsuits generally arising inthe normal course of their business. We do not believe that the eventualoutcome of any of the suits to which we are party will have a material adverseeffect on our financial condition or results of operations. However, theoutcome of any single event could have a material impact upon the quarterly orannual financial results of the period in which it occurs.

 

Our Company 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 its subsidiary, Penn Treaty Network America InsuranceCompany, are defendants in an action in the United States District Court,Middle District of Florida, Ocala Division. Plaintiffs filed this matter on January 10, 2003 in the Fifth JudicialCircuit of the State of Florida in and for Marion County, Civil Division, onbehalf of themselves and a class of similarly situated Florida long-term carepolicyholders. We removed this case from the Florida state court to FederalCourt on February 6, 2003. Plaintiffs claim wrongdoing in connection with thesale of long-term care insurance policies to the Plaintiffs and the Class.  Plaintiffs allege claims for reformation,breach of fiduciary duty, breach of the implied duty of good faith and fairdealing, negligent misrepresentation, fraudulent misrepresentation andrestitution. We filed motions to dismiss for failure to state a claim, lack ofpersonal jurisdiction against the Company, and to strike certain allegations ofthe complaint as irrelevant and improper. Plaintiffs filed a motion to remandon March 7, 2003. Briefing is continuing on all of these motions. We believethat the complaint is without merit and intend to continue to defend the mattervigorously.

 

Our Company and two of our subsidiaries, Penn Treaty Network AmericaInsurance Company and Senior Financial Consultants Company, are defendants inan action instituted on June 5, 2002 in the United States District Court forthe Eastern District of Pennsylvania by National Healthcare Services, Inc. Thecomplaint seeks compensatory damages in excess of $150 and punitive damages inexcess of $5,000 for an alleged breach of contract and misappropriation.  The claims arise out of a joint venturerelated to the AllRisk Healthcare program, which was marketed first by PennTreaty Network 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.

 

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**Item 2. **Changes inSecurities

 

The terms of the 6.25%Convertible Subordinated Notes due 2008 (the “Exchange Notes”) that we issuedin exchange for our 6.25% Convertible Subordinated Notes due 2003 (the “2003Notes”) in the fourth quarter of 2002 and the first quarter of 2003 weremodified in the first quarter of 2003.

 

The redemption provisions ofthe Exchange Notes were modified as follows:

 

•                                          The date prior to which the Exchange Notesare not redeemable was changed from October 15, 2004 to October 15, 2005.

 

•                                          Holders were given the right to force ourredemption of the Exchange Notes if our Articles of Incorporation were notamended to increase the number of authorized shares on or before May 27, 2003,which right terminated upon the amendment of our Articles of Incorporation onMarch 28, 2003.

 

The conversion provisions ofthe Exchange Notes were modified as follows:

 

•                                          The terms of payment of interest uponconversion of the Exchange Notes prior to October 15, 2005 were specified to be(i) the amount equal to the interest that would have been otherwise earnedbetween the date of conversion and October 15, 2005, discounted to presentvalue utilizing a rate of 6.25% with simple interest over a 360 day year and(ii) payable at our option in cash or in shares of common stock based on 90% ofthe average closing prices of the common stock for the five trading daysimmediately preceding the conversion date.

 

•                                          The Exchange Notes were made mandatorilyconvertible on the first date on or after the fifteenth trading day followingOctober 15, 2005 on which (i) the average of the closing price of the commonstock on 15 consecutive trading dates is equal to or greater than 110% of the conversionprice and (ii) we have authorized the number of shares of common stock issuableupon conversion of the Exchange Notes.

 

•                                          The conversion price of the Exchange Noteswas reduced from $4.50 per share to $1.75 per share.

 

The Exchange Notes and theother 6.25% Convertible Subordinated Notes due 2008 (the “2008 Notes”), whichwere issued in the first quarter of 2003, are senior to our 6.25% ConvertibleSubordinated Notes due 2003.

 

In the first quarter of2003, we issued $2,450,000 in aggregate principal amount of Exchange Notes toexisting security holders in exchange for an equal aggregate principal amountof 2003 Notes.  The Exchange Notes wereissued without payment of any commission and therefore were exempt fromregistration pursuant to Section 3(a)(9) of the Securities Act of 1933.  The Exchange Notes are convertible intocommon stock at a price of $1.75 per share.

 

**Item 3. **Defaults UponSenior Securities

 

Not Applicable

 

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**Item 4. **Submission of Mattersto a Vote of Security Holders

 

A Special Meeting of Shareholders was held on March 28, 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 for each matter.

 

1.                                       Toapprove an amendment to Penn Treaty’s Restated Articles of Incorporation, asamended, to increase the aggregate number of authorized shares of common stock,par value $.10 per share from 40 million shares to 150 million shares.

 

| **For**    |   | **Against** |   | **Abstentions** |   | **Broker  Non-Votes** |   |
|------------|--------|-------------|--------|-----------------|--------|-----------------------|--------|
| 13,590,746 |   | 1,149,142   |   | 56,561          |   | 4,472,048             |   |

 

2.                                       Toratify and approve the issuance of $63,343,000 principal amount of 61⁄4%Convertible Subordinated Notes due 2008 and underlying shares of Common Stock.

 
| **For**    |   | **Against** |   | **Abstentions** |   | **Broker  Non-Votes** |   |
|------------|--------|-------------|--------|-----------------|--------|-----------------------|--------|
| 13,627,814 |   | 1,084,656   |   | 83,979          |   | 4,472,048             |   |

 

3.                                       Toratify and approve the issuance of up to $45,000,000 principal amount of 61⁄4%Convertible Subordinated Notes due 2008 and underlying shares of Common Stock.

 
| **For**    |   | **Against** |   | **Abstentions** |   | **Broker  Non-Votes** |   |
|------------|--------|-------------|--------|-----------------|--------|-----------------------|--------|
| 13,536,335 |   | 1,192,905   |   | 67,209          |   | 4,472,048             |   |

 

4.                                       Totransact other business that properly comes before the Special Meeting and anyand all adjournments and postponements.

 
| **For**    |   | **Against** |   | **Abstentions** |   | **Broker  Non-Votes** |   |
|------------|--------|-------------|--------|-----------------|--------|-----------------------|--------|
| 13,341,973 |   | 812,211     |   | 642,265         |   | 4,472,048             |   |

 

**Item 5. **Other Information

 

Not Applicable

 

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**Item 6. **Exhibits andReports on Form 8-K

 

(a)                                  Exhibits

 
| Exhibit Number |   | Description                                                                                                                                                     |
|----------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.1            |   | First  Supplemental Indenture, dated as of March 5, 2003, between Penn Treaty  American Corporation and Wells Fargo Bank Minnesota, N.A.                        |
|           |   |                                                                                                                                                            |
| 4.2            |   | Indenture,  dated as of February 12, 2003, between Penn Treaty American Corporation  and Wells Fargo Bank Minnesota, N.A.                                  |
|           |   |                                                                                                                                                            |
| 10.1           |   | Consulting  Agreement, dated as of April 28, 2003, between Penn Treaty American  Corporation and Irving Levit.                                                  |
|           |   |                                                                                                                                                            |
| 99.1           |   | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act.               |
|           |   |                                                                                                                                                            |
| 99.2           |   | Certification  of President and Chief Operating Officer pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. |
|           |   |                                                                                                                                                            |
| 99.3           |   | 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 Form 8-K.

 
| **Items** |   | **Financial  Statements** |   | **Date**           |
|-----------|--------|---------------------------|--------|--------------------|
|      |   |                      |   |               |
| 5  and 7  |   | No                        |   | January  21, 2003  |
|      |   |                      |   |               |
| 5         |   | No                        |   | January  28, 2003  |
|      |   |                      |   |               |
| 5         |   | No                        |   | February  12, 2003 |

 

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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:  | May 19, 2003 |                                                  | /s/  Irving Levit |
|   |         | Irving Levit                                          |
|   |         | Chairman of the Board and  Chief Executive Officer    |
|   |         |                                                  |
| Date:  | May 19, 2003 |                                                  | /s/  Cameron B. Waite |
|   |         | Cameron B. Waite                                      |
|   |         | Executive Vice President and  Chief Financial Officer |

 

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I, Irving Levit, certify that:

 

1.               I have reviewed this quarterly report onForm 10-Q of Penn Treaty American Corporation;

2.               Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

3.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

4.               The registrant’s other certifyingofficers and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

a).designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

5.               The registrant’s other certifyingofficers and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

6.               The registrant’s other certifyingofficers and I have indicated in this quarterly report whether or not therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  | May 19, 2003 |                                                     |  /s/ Irving Levit |   |
|--------|--------------|----------------------------------------------------------|------------------------|--------|
|   |         | Irving Levit                                             |
|   |         | Chairman of the Board and  Chief  Executive Officer |

 

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I, William W. Hunt, certify that:

 

1.               I have reviewed this quarterly report onForm 10-Q of Penn Treaty American Corporation;

2.               Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

3.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

4.               The registrant’s other certifyingofficers and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

5.               The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

6.               The registrant’s other certifyingofficers and I have indicated in this quarterly report whether or not therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  | May 19, 2003 |                                   |  /s/ William W. Hunt |   |
|--------|--------------|----------------------------------------|---------------------------|--------|
|   |         | William W. Hunt                        |
|   |         | President and  Chief Operating Officer |

 

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I, Cameron B. Waite, certify that:

 

1.               I have reviewed this quarterly report onForm 10-Q of Penn Treaty American Corporation;

2.               Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

3.               Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

4.               The registrant’s other certifyingofficers and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidated subsidiaries,is made known to us by others within those entities, particularly during theperiod in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controlsand procedures as of a date within 90 days prior to the filing date of thisquarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluationas of the Evaluation Date;

5.               The registrant’s other certifyingofficers and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant’s ability to record,process, summarize and report financial data and have identified for theregistrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management orother employees who have a significant role in the registrant’s internalcontrols; and

6.               The registrant’s other certifyingofficers and I have indicated in this quarterly report whether or not therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  | May 19, 2003 |                                                  |  /s/ Cameron B. Waite |   |
|--------|--------------|-------------------------------------------------------|----------------------------|--------|
|   |         | Cameron B. Waite                                      |
|   |         | Executive Vice President and  Chief Financial Officer |

 

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