The Company owns a 2.42 acre parcel of land and a warehouse, both located across the street from its home office for future use.
(4) The Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," on January 1, 1994. The cumulative effect of this adoption was an increase on January 1, 1994 in shareholders' equity of $3,529,000 to reflect the net unrealized gain (net of $1,512,000 in deferred income taxes) on investment securities classified as available for sale. As of December 31, 1995, shareholders' equity was increased by $4,056,000 due to unrealized gains of $6,146,000 in the Company's investment portfolio. As of December 31, 1996, shareholders' equity was increased by $2,261,000 due to unrealized gains of $3,426,000 in the Company's investment portfolio. These increases were caused primarily by decreases in interest rates since the date of purchase of the debt securities in the Company's portfolio.
Investment income. The Company's investment portfolio consists primarily of high-grade fixed income securities. Income generated from this portfolio is largely dependent upon prevailing levels of interest rates. As of December 31, 1996, approximately 5.3% of the Company's investment portfolio was committed to high quality large capitalization common stocks. Due to the longevity of the Company's investment portfolio duration (approximately 4 years), investment interest income does not immediately reflect changes in market interest rates. However, the Company is susceptible to changes in market rates when cash flows from maturing investments are reinvested at prevailing market rates.
Other factors which affect the Company's results of operations are lapsation and persistency, both of which relate to the renewal of insurance policies, and first year compared to renewal premiums. Lapsation is the termination of a policy by nonrenewal and, pursuant to the Company's policy, is automatic if and when premiums become more than 31 days overdue; however, policies may be reinstated, if approved by the Company, within six months after the policy lapses. Persistency represents the percentage of premiums renewed, which the Company calculates by dividing the total annual premiums at the end of each year (less first year business for that year) by the total annual premiums in force for the prior year. For purposes of this calculation, a decrease in total annual premiums in force at the end of any year would be a result of non-renewal of policies, including those policies that have terminated by reason of death, lapse due to nonpayment of premiums, and/or conversion to other policies offered by the Company. First year premiums are premiums covering the first twelve months a policy is in force. Renewal premiums are premiums covering all subsequent periods.
The unaudited quarterly data for the Company for each quarter of 1995 and 1996 have been derived from unaudited financial statements and include all adjustments, consisting only of normal recurring accruals, which the Company considers necessary for a fair presentation of the results of operations for these periods. Such quarterly operating results are not necessarily indicative of the Company's future results of operations.
The following table presents unaudited quarterly data for the Company for each quarter of 1995 and 1996.
Accident and Health Premiums. First year accident and health premiums earned by the Company, excluding the contribution of ANIC, in the twelve month period ended December 31, 1996, increased 19.9% to $44,071,649, compared to $36,769,835 in 1995. First year long-term care premiums in 1996 increased 19.1% to $43,478,707, compared to $36,507,436 in 1995. This increase was primarily attributable to increased sales of home health care policies, which increased to $19,866,692 for 1996 from $14,560,437 for 1995. Premiums from sales of nursing home care policies increased from $21,946,999 in 1995 to $23,612,015 in 1996. Management believes that the increase in the sale of home health care policies reflects the continued growth in the home health care market. Management further believes that the lower increase in the sale of nursing home policies primarily resulted from nursing home policies increasingly being sold as riders to home care policies as opposed to separate stand-alone policies. First year Medicare supplement premiums earned by the Company in 1996 increased to $592,083 from $262,399 in 1995. The Company places reduced emphasis upon this product due to reduced profitability caused by regulation.
Life Premiums. First year life premiums earned by the Company decreased 14.3% to $1,457,044, in 1996, compared to $1,700,549 in 1995. The Company's life business has remained stable as the Company is focusing its marketing efforts on its Independent Living policy and its other long-term care products. Renewal life premiums in 1996 increased to $2,077,325, compared to $1,494,153 in 1995. This increase was primarily the result of renewals of first-year policies written in 1995.
Life benefits to policyholders in 1996 increased to $1,154,868, compared to $1,032,224 for 1995. The life loss ratio was 32.7% in 1996, compared to 32.3% in 1995. This increase relates to the maturing of the life products that the Company first introduced in 1993.
Commissions. Commissions to agents increased 19.1% to $43,305,148 in 1996 compared to $36,351,140 in 1995. Included are ANIC commissions on long-term disability policies, which generated $445,084 of expenses in 1996.
Net Investment Income. Net investment income earned by the Company in 1995 increased 36.3% to $8,102,809, compared to $5,946,034 in 1994. This increase was primarily the result of growth in the Company's investment assets due to continued premium growth during 1995 and proceeds of approximately $22,000,000 from the Company's public offering in July 1995. See "-Liquidity and Capital Resources" below for a discussion of the public offering. The average yield on the Company's investments was 6.5% in 1995 and in 1994.
Life benefits to policyholders increased to $1,704,207 from $1,260,480 in 1994. The life loss ratio was 53.3% in 1995, compared to 47.9% in 1994. These increases in benefits and the Company's life loss ratio are a result of the sale of the Company's new life insurance products which were introduced in late 1993.
Renewal Commissions. Renewal commissions on accident and health business increased 27.1% to $9,964,110, compared to $7,840,877 in 1994, consistent with the increase in renewal premium discussed above. The ratio of renewal accident and health commissions to renewal accident and health premiums was 16.0% in 1995, compared to 15.0% in 1994. This ratio fluctuates in relation to the age of the policies in force and the rates of commissions paid to agents.
Provision for Federal Income Taxes. The provision for federal income taxes recorded by the Company in 1995 increased 40.9% to $3,609,000, compared to $2,562,000 in 1994. The effective tax rate increased to 29.0% in 1995 from 27.5% in 1994. The Company's effective tax rate was below the normal federal corporate rate as a result of credits from the small life insurance company deduction as well as the Company's investments in tax-exempt bonds.
In 1993, the Company adopted Statement of Financial Accounting Standards No. 113, "Accounting and Reporting of Short-Duration and Long-Duration Contracts" ("SFAS 113"). SFAS 113 established the conditions a reinsurance contract must meet in order to be accounted for as such. In addition, it eliminated the industry practice of reporting financial statement items, net of the effects of reinsurance. SFAS 113 did not impact the Company's results of operations, other than the financial statement presentation.
Increases in the cost of medical care tend to increase the need for insurance. Many policyholders who once had adequate insurance coverage increased their insurance coverage to provide the same relative financial benefit and protection. The increases in medical costs lead to accident and health policies requiring higher benefits and an increased need for the products. Consequently, the Company offers riders to its insurance policies which provide for increases in policyholder benefits each year in the amount of 5% compounded annually on the anniversary date of the policy for 20 years or to age 85, whichever occurs first, or for the lifetime of the policyholder, as is mandated in certain states.
The Company invests in securities and other investments authorized by applicable state laws and regulations and follows an investment policy designed to maximize yield to the extent consistent with liquidity requirements and preservation of assets. On December 31, 1995, the average maturity of the Company's bond portfolio was 6.4 years, and its market value exceeded cost by 4.1% or approximately $5,643,000. On December 31, 1994, the average maturity of the Company's portfolio was 6.9 years and its market value was below cost by 4.4% or approximately $4,165,000. The Company's equity portfolio exceeded cost by $503,083 or 23.9% in 1995 and $52,780 or 6.0% in 1994. At December 31, 1996, the average maturity of the Company's bond portfolio was 5.8 years, and its market value represented approximately 100.9% of its cost, with a current unrealized gain of $1,821,387. Its equity portfolio exceeded cost by $1,604,604 at December 31, 1996.
In December 1994, a loan was extended to the Company by a bank in the amount of $4,000,000. The proceeds of the loan were contributed to the surplus of PTLIC in the form of cash to strengthen its overall capital position. The Company repaid this loan as required by the loan agreement, with a portion of the proceeds of the Company's public offering of 2,300,000 shares of Common Stock. The public offering was consummated on July 6, 1995, and the Company realized net proceeds of approximately $22,000,000, including the proceeds from the exercise of the underwriters' over-allotment option.
In December, 1996, the Company contributed $20,000,000, $20,000,000, and $5,000,000 to the surplus of PTLIC, Network America, and ANIC, respectively, from the proceeds of the convertible subordinated debt.
The Company's continued growth is dependent upon its ability to (i) continue marketing efforts to expand its historical markets, (ii) continue to expand its network of agents and effectively market its products in states where its insurance subsidiaries are currently licensed and (iii) fund such marketing and expansion while at the same time maintaining minimum statutory levels of capital and surplus required to support such growth. Management believes that the funds necessary to accomplish the foregoing, including funds required to maintain adequate levels of statutory surplus in the Company's insurance subsidiaries can be met for the foreseeable future by funds generated from this offering, the Company's public offering in 1995 and from operations.
Certain statements made by the Company may be considered to be forward looking. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance actual results will not differ significantly from its expectations.
REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS as of December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994
We have audited the accompanying consolidated balance sheets of Penn Treaty American Corporation and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
The accompanying consolidated financial statements of Penn Treaty American Corporation and its Subsidiaries (the Company) have been prepared in accordance with generally accepted accounting principles (GAAP) and include Penn Treaty Life Insurance Company (PTLIC),Network America Life Insurance Company (Network America), American Network Insurance Company (ANIC) and Senior Financial Consultants Company. All significant intercompany transactions and balances have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform with the current year presentation.
The costs primarily related to and varying with the acquisition of new business, principally commissions, underwriting and policy issue expenses, have been deferred. These deferred costs are amortized over the related premium-paying periods utilizing the same projected premium assumptions used in computing reserves for future policy benefits. Net policy acquisition costs deferred, on the consolidated statements of operations, are net of amortization of $13,678,181, $11,720,966, and $13,012,937 for the years ended December 31, 1996, 1995, and 1994, respectively.
The costs in excess of fair value of net assets acquired (goodwill) for acquisitions made under purchase accounting methods are being amortized to expense on a straight-line basis over a 10 to 40-year range.
The present value of all anticipated future profits of ANIC's acquired business is being amortized over the life of insurance business acquired. During 1996, approximately $138,000 was amortized to expense.
The establishment of appropriate reserves is an inherently uncertain process, and there can be no assurance that the ultimate liability will not materially exceed the Company's claim and policy reserves and have a material adverse effect on the Company's results of operations and financial condition. Due to the inherent uncertainty of estimating reserves, it has been necessary, and may over time continue to be necessary, to revise estimated future liabilities as reflected in the Company's policy reserves and policy and contract claims.
loss ratios and may be required to adjust further its reserve levels with respect to this product.
Primary earnings per share amounts have been computed by dividing the applicable amounts by the weighted average common shares outstanding. Due to the issuance of the convertible debt, the Company calculated fully diluted earnings per share in 1996. Prior to 1996, the impact of the outstanding options was non-dilutive. Fully diluted earnings per share amounts have been computed by dividing the applicable net income amounts, as adjusted assuming all convertible debt had converted to common shares, by the weighted average common shares outstanding, as adjusted assuming all convertible debt had converted to common shares, and including the impact of all outstanding options as accounted for using the treasury stock methodology.
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 establishes standards for computing and presenting earnings per share, and simplifies the standards for computing earnings per share previously found in Accounting Principles Board Opinion No. 15, "Earnings per Share." Primary and fully diluted earnings per share will be replaced with basic and diluted earnings per share, and these amounts are required to be shown on the face of the income statement. In addition, a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation is required.
Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. This Statement is effective for financial statements issued for periods ending after December 15, 1997, and requires restatement of all prior-period earnings per share data presented. Management has not determined the impact that SFAS 128 may have on the financial statements.
On January 29, 1996, the Company acquired the rights to all renewal commissions on a block of in-force policies and sub-agent contracts from a marketing general agent. This agreement includes insurance policies of PTLIC and other unaffiliated insurance companies. The cost of the acquisition was $650,000. The Company recognized $251,108 of net commission income in 1996 from this acquisition.
The amortized cost and estimated market value of investments in debt securities as of December 31, 1996 and 1995 are as follows:
The Company's bond investment portfolio is comprised primarily of investment grade securities at December 31, 1996. Securities are classified as "investment grade" by utilizing ratings furnished by independent bond rating agencies.
Total reserves, including policy and contract claims, reported to statutory authorities were approximately $3,510,000 and $3,077,000 less than those recorded for GAAP as of December 31, 1996 and 1995, respectively.
Long-term debt, at December 31, 1996 and 1995 are as follows:
1997.............. $ 367,002 1998.............. 1,997,590 1999.............. -- 2000.............. -- 2001.............. -- Thereafter........ 74,750,000 ---------- $77,114,592 ----------- ----------- 6. Federal Income Taxes:
Deferred income tax assets and liabilities have been recorded for temporary differences, between the reported amounts of assets and liabilities in the accompanying financial statements and those in the Company's income tax return. The sources of these differences and the approximate tax effect are as follows for the years ended December 31:
Deferred policy acquisition costs....... $20,677,263 $15,896,021 Policy reserves......................... (4,690,679) (2,627,583) Present value of future profits acquired.............................. 1,344,700 --
Under Pennsylvania and Vermont insurance law, dividends may be paid from PTLIC, Network America or ANIC only from statutory profits of earned surplus and require Insurance Department approval if the dividend is in excess of the greater of 10% of surplus or net statutory income of the prior year.
On August 1, 1996, the Company adopted a 401(k) retirement plan, covering substantially all employees with one year of service. Under the plan, participating employees may contribute up to 15% of their annual salary on a pre-tax basis. The Company, under the plan, equally matches employee contributions up to the first three percent of the employee's salary. The Company and employee portion of the plan is vested immediately. The Company expense in 1996 was $36,000. The Company may elect to make a discretionary contribution to the plan, which will be contributed proportionately to each eligible employee. The Company did not make a discretionary contribution in 1996.
ANIC maintained a defined benefit pension plan for all ANIC employees in 1996. This plan was subsequently terminated in 1997, with all eligible employees joining the Company's 401(k) plan. There was no 1996 contribution expense for this plan.
Compensation cost is estimated using the Black-Scholes model with the following assumptions for both 1995 and 1996: an expected life ranging from 5.3 to 8.3 years, volatility of 27.9% and a risk free rate ranging from 6.21% to 6.35%. The weighted average fair value of those options granted in 1995 and 1996 was $4.98 and $8.21, respectively. No compensation expense is calculated for those options granted prior to 1995.
Effective May, 1995, the Company adopted a Participating Agent Stock Option Plan which provides for the granting of options to purchase up to 300,000 shares of common stock. The exercise price of all options granted under the plan may not be less than the fair market value of the shares on the date of grant. The maximum allowable term of each option is ten years, and the options become exercisable in four equal, annual installments commencing one year from the option grant date.
OUTSTANDING REMAINING EXERCISABLE AT DECEMBER CONTRACTUAL AT DECEMBER RANGE OF EXERCISE PRICES 31, 1996 LIFE (YRS) 31, 1996 - ------------------------- ----------- ----------------- -----------
The total net rental expenses under all leases amounted to approximately $174,000, $142,000 and $148,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
During May 1987, the Company assigned its rights and interests in a land lease to a third party for $175,000. The agreement indemnifies the Company against any further liability with respect to future lease payments. The Company remains contingently liable to the lessor under the original deed of lease for rental payments of $16,080 per year, the amount being adjustable based upon changes in the consumer price index since 1987, through the year 2063.
IMC also received commission overrides on business written for PTLIC by certain agents, principally general agents who were IMC agents prior to January 1979 and any of their sub-agents hired prior and subsequent to January 1979. For the years ended December 31, 1996, 1995 and 1994, IMC commission overrides totaled approximately $539,000, $517,000, and $520,000, respectively.
Investments--The fair value of fixed maturities and equity securities are based on quoted market prices. It is not practicable to determine the fair value of policy loans since such loans are not separately transferable and are often repaid by reductions to benefits and surrenders.
Schedule III-Condensed Financial Information of Registrant Statements of Operations for the years ended December 31, 1996, 1995 and 1994
Schedule III-Condensed Financial Information of Registrant Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994