The Company's principal offices in Allentown, Pennsylvania, occupy approximately 25,500 square feet of office space in a 40,000 square foot building, owned by the Company. The Company also leases additional office space in Florida and California, and owns office space in Vermont.
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. The warehouse is currently used for storage and houses the Company's printing equipment.
The Company develops and markets insurance products primarily designed for individuals age 65 and over. The Company's principal products are individual fixed, defined benefit accident and health insurance policies which consist of nursing home care, home health care, Medicare supplement and long-term disability insurance. The Company's underwriting practices rely upon the base of experience which it has developed over twenty years of providing nursing home care insurance, as well as upon available industry and actuarial information. As the home health care market has developed, the Company has encouraged the purchase of both nursing home care and home health care coverage, and has introduced new life insurance products as well, thus providing policyholders with enhanced protection while broadening the Company's policy base. In late 1996, the Company introduced its Personal Freedom Plan and Assisted Living Plan. Both plans are designed to provide comprehensive nursing home and home health care coverage. Long-term nursing home care and home health care policies accounted for approximately 91% of the Company's total annualized premiums in force as of December 31, 1997 and approximately 82% of its consolidated revenues for 1997.
The Company's results of operations are affected significantly by the following factors:
The number of years a policy has been in effect. Claims costs tend to be higher on policies which have been in force for a longer period of time. As the policy ages, it is more likely that the insured will have need for services covered by the policy. However, the longer the policy is in effect, the more premium the Company will receive.
Investment income. The Company's investment portfolio consists primarily of high-grade fixed income securities. Income generated from this portfolio is largely dependent upon prevailing levels of interest rates. 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. As of December 31,
The following table presents unaudited quarterly data for the Company for each quarter of 1996 and 1997.
Renewal accident and health premiums earned by the Company in 1997 increased 28.5% to $103,184,695, compared to $80,311,319 in 1996. Renewal long-term care premiums in 1997 increased 29.5% to $100,673,867, compared to $77,734,271 in 1996. This increase reflects higher persistency and growth of in-force premiums. Renewal Medicare supplement premiums earned by the Company in 1997 decreased 2.6% to $2,510,828, compared to $2,577,048 in 1996. This trend is consistent with the Company's decision not to actively pursue Medicare supplement business.
Life Premiums. First year life premiums earned by the Company decreased 27.5% to $1,055,873, in 1997, compared to $1,457,044 in 1996. The Company's life business has remained stable as the Company is focusing its marketing efforts on its long-term care products. Renewal life premiums in 1997 increased to $2,482,542, compared to $2,077,325 in 1996. This increase was primarily the result of renewals of first-year policies written in 1996.
Net Investment Income. Net investment income earned by the Company for 1997 increased 54.9% to $17,008,955 from $10,982,131 for 1996. This increase was primarily the result of growth in the Company's investment assets due to continued premium growth, and additional funds of approximately $72,000,000 obtained from the issuance of convertible debt late in 1996. The Company recognized $1,416,659, of capital gains in 1997 due primarily to its desire to bolster investment earnings, which are reduced by the Company's investments in equity securities. Fixed income levels are lower from dividends received rather than interest from bonds. During March 1998, the Company sold its entire equity securities portfolio, or approximately $21,000,000 of invested assets. From this sale, the Company recognized an approximate $6,5000,000 capital gain, which is reportable in the first quarter of 1998.
Commissions. Commissions to agents increased 27.6% to $55,240,438 in 1997 compared to $43,305,148 in 1996. Included are ANIC commissions on long-term disability policies, which generated $1,251,476 of expenses in 1997.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs in 1997 increased 48.6% to $28,294,358 compared to $19,042,509 in 1996, primarily due to an increase in policyholder persistency used in the establishment of deferred acquisition cost reserve factors. The result of higher persistency incorporated into reserve factors is lengthier amortization of expenses and reduced net expenses in earlier periods. This deferral is net of amortization, which decreases or increases as the Company's actual persistency is higher or lower than the persistency assumed for reserving purposes. The deferral of policy acquisition costs has remained consistent with the growth of premiums, and the growth in amortization of policy acquisition costs has been modified by improved persistency.
General and Administrative Expenses. General and administrative expenses in 1997 increased 31.7% to $20,613,908, compared to $15,647,715 in 1996. ANIC expenses accounted for $2,317,068 in 1997, which includes the amortization of goodwill and the present value of future profits. In addition, the Company recognized approximately $400,000 in non-recurring settlement charges in 1997 due to the consolidation of certain ANIC operations at the Company headquarters. The settlement charges stemmed from severance costs, contract terminations and movement of operations. General and administrative expenses, excluding goodwill and convertible debt cost amortization, as a percentage of revenues were 11.9% in 1997, compared to 12.5% in 1996, which is due in part to the inclusion of approximately $450,000 of care management expenses in general and administrative expense in 1996 (.39% of premiums). Economies of scale achieved in 1997 were offset by ANIC consolidation charges and additional actuarial, compliance and legal fees associated with the duplicate filings of tax qualified plans in many states.
In addition, ANIC, which the Company acquired on August 30, 1996, generated accident and health premiums, comprised primarily of long-term disability coverage, of $2,274,442 during 1996.
Net Investment Income. Net investment income earned by the Company for 1996 increased 35.5% to $10,982,131 from $8,102,809 for 1995. This increase was primarily the result of growth in the Company's investment assets due to continued premium growth, additional funds of approximately $22,000,000 from the Company's public offering in July 1995, and additional funds of approximately $72,000,000 obtained from the issuance of convertible debt late in 1996.
claims expense. Had this expense been classified as Benefits to Policyholders, the total 1996 loss ratio would have increased by .35% of premiums to 64.9% compared to 63.4% in 1995.
Life benefits to policyholders in 1996 increased to $2,133,087, compared to $1,704,207 for 1995. The life loss ratio was 60.4% in 1996, compared to 53.3% in 1995. This increase relates to the maturing of the life products that the Company first introduced in 1993.
Restatement for earlier years is required for comparative purposes. The Company anticipates no material effect on its financial condition or results of operations due to the adoption of Statement 130.
The FASB also issued Statement 131, "Disclosures about Segments of an Enterprise and Related Information." This Statement, which supersedes Statement 14, Financial Reporting for Segments of a Business Enterprise, changes the way public companies report information about segments. The Statement, which is based on the management approach to segment reporting, includes requirements to report selected segment information quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues. The Statement is effective for periods beginning after December 15, 1997. Restatement for earlier years is required for comparative purposes unless impracticable. Statement 131 need not be applied to interim periods in the initial year; however, in subsequent years, interim period information must be presented on a comparative basis. The Company believes that the adoption of Statement 131 will not have a material impact on its financial condition or results of operations.
Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments" (SOP 97-3) was issued by the American Institute of Certified Public Accountants in December 1997 and provides guidance for determining when an insurance or other enterprise should recognize a liability for guaranty-fund assessments and guidance for measuring the liability. The statement is effective for 1999 financial statements with early adoption permitted. The Company does not expect adoption of this statement to have a material effect on its financial position or results of operations.
Many computer systems are reliant upon a two-digit field in determining the year for software applications involving dates. This use of a two-digit field presents difficulty for computers and application programs in differentiating between the year 1900 and 2000. The Company is in process of replacing its computer application systems with new systems which are year 2000 compliant. The Company is also changing its current systems to a four digit date field to avoid any potential year 2000 problems prior to its conversion to new systems. The Company does not expect that year 2000 compliance will have a material impact on its financial condition or results of operations. Non-compliance could have an adverse effect on the operations of the Company.
The Company's cash flows are attributable to cash provided by operations, cash used in investing, and cash provided by financing. The Company's cash decreased by approximately $40,000,000 in 1997 primarily due to the purchase of approximately $134,000,000 in bonds, which more than offset cash from operations and approximately $44,000,000 in proceeds from the sale of bonds. The major provider of cash from operations was additions to reserves of approximately $59,000,000 in 1997.
Cash increased in 1995 by approximately $2,000,000, primarily due to approximately $26,000,000 provided by the Company's common stock offering. These funds and cash from operations of approximately $24,000,000 were used to purchase approximately $54,000,000 in bonds.
In July 1995, the Company consummated a public offering of 2,300,000 shares of common stock, from which it realized net proceeds of approximately $22,000,000, including the proceeds from the exercise of the underwriters' over-allotment option.
The Company's debt currently consists primarily of a mortgage note in the approximate amount of $2,000,000 and $74,750,000 in convertible subordinated debt. The convertible debt, issued in November 1996, is convertible at $28.44 per share until November 2003. The debt carries a fixed interest coupon of 6.25%, payable semi-annually. The mortgage note is currently amortized over 12 years, and has a balloon payment due on the remaining outstanding balance in September 1998. Although the note carries a variable interest rate, the Company has entered into an amortizing swap agreement with the same bank, with a notional amount equal to the outstanding debt, which has the effect of converting the note to a fixed rate of interest.
subsidiary insurers. In the event the Parent is unable to meet its financial obligations, becomes insolvent, or discontinues operations, the Insurers' financial condition and results of operations could be materially affected.
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 its most recent stock offering, the Company's issuance of convertible subordinated debt and from operations.
SOME OF THE INFORMATION PRESENTED IN THIS FILING CONSTITUTE FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SEUCRITIES LITIGATION REFORM ACT OF 1995. ALTHOUGH THE COMPANY BELEIVES THAT ITS EXPECTATIONS ARE BASED ON REASONABLE ASSUMPTIONS WITHIN THE BOUNDS OF ITS KNOWLEDGE OF ITS BUSINESS AND OPERATIONS, THERE CAN BE NO ASSURANCE THAT ACTUAL RESULTS OF THE COMPANY'S OPERATIONS WILL NOT DIFFER MATERIALLY FROM ITS EXPECTATIONS. FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER FROM EXPECTATIONS INCLUDE, AMONG OTHERS, THE ADEQUACY OF THE COMPANY'S LOSS RESERVES, THE COMPANY'S ABILITY TO QUALIFY NEW INSURANCE PRODUCTS, THE COMPANY'S ABILITY TO COMPLY WITH GOVERNMENT REGULATIONS, THE ABILITY OF SENIOR CITIZENS TO PURCHASE THE COMPANY'S PRODUCTS IN LIGHT OF THE INCREASING COSTS OF HEALTH CARE AND THE COMPANY'S ABILITY TO EXPAND ITS NETWORK OF PRODUCTIVE INDEPENDENT AGENTS.
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995
In 1997, the Company incorporated a new subsidiary, American Independent Network Insurance Company of New York (AINIC), which it intends to license as an insurer in 1998.
On December 31, 1997, PTLIC entered an assumption reinsurance treaty with Network America (formerly Network America Life Insurance Company), whereby Network America effectively purchased all of the premium in-force, assets and liabilities of PTLIC. Network America simultaneously changed its name to Penn Treaty Network America Insurance Company (PTNA). The Company has also filed with the Internal Revenue Service requesting a favorable ruling regarding the tax-free nature of the dividending of PTLIC common stock ownership of PTNA to the Company. Upon acceptance of a favorable ruling, PTNA will become a direct subsidiary of the Company, and will no longer be a direct subsidiary of PTLIC.
The Company sells accident and health, life and disability insurance through its wholly-owned subsidiaries. The Company's principal lines of business are long-term care products and home health care products. The Company distributes its products principally through managing general agents and independent agents. The Company operates its home office in Allentown, Pennsylvania and has satellite offices in California, Florida and Vermont, whose principal functions are to market and underwrite new business. State regulatory authorities have powers relating to granting and revoking licenses to transact business, the licensing of agents, the regulation of premium rates and trade practices, the form and content of insurance policies, the content of advertising material, financial statements and the nature of permitted practices. The Company is licensed to operate in 49 states. Sales in Florida, Pennsylvania, and California accounted for approximately 26%, 15% and 14%, respectively, of the Company's premiums for the year ended December 31, 1997. No other state sales accounted for more than 10% of the Company's premiums for the year ended December 31, 1997.
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 $11,977,144, $13,678,181, and $11,720,966 for the years ended December 31, 1997, 1996, and 1995, respectively.
Policy and contract claims include amounts representing: (1) an estimate, based upon prior experience, for accident and health claims reported, and incurred but unreported losses; (2) the actual in force amounts for reported life claims and an estimate of incurred but unreported claims. The methods for making such estimates and establishing the resulting liabilities are continually reviewed and updated and any adjustments resulting therefrom are reflected in earnings currently.
In late 1994, the Company began marketing its Independent Living policy, a home health care insurance product which provides coverage over the full term of the policy for services furnished by a homemaker or companion who is not a qualified or licensed care provider. In late 1996, the Company began marketing its Personal Freedom policy, a comprehensive nursing home and home health care product, and its Assisted Living policy, a revised nursing home with attached home health care rider policy. Because of the Company's relatively limited claims experience with these products, the Company may incur higher than expected loss ratios and may be required to adjust further its reserve levels with respect to these products.
In February 1997, the Financial Accounting Standards Board ("FASB") 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." SFAS 128 prescribes that for all financial statements with effective dates after December 31, 1997, 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. Prior year per share amounts must also be restated if applicable. Basic earnings per share for 1995 and 1996 are unaffected by this change, however, diluted earnings per share are reported for 1995, which was not previously reported. Also, diluted earnings per share for 1996 is increased $.02 from previously reported fully diluted earnings per share due to the use of the average market price of Company shares in utilizing the treasury stock methodology to account for the dilutive nature of outstanding stock options.
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 follows. 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.
SFAS 128, however, prescribes that if the components of diluted earnings per share are anti-dilutive, then diluted earnings per share will not differ from basic earnings per share. In 1997, the Company reported basic and diluted earnings per share of $1.01 and $.98, respectively. Since the exclusion of the impact of interest expense from the Company's convertible debt would be anti-dilutive, the future anticipated conversion of the debt into additional shares is not included in the calculation of diluted earnings per share. The Company anticipates that approximately 2,600,000 additional shares will be issued in the future for the conversion of debt. However, the Company also expects that approximately $3,550,000 of annual after-tax interest expense due to this convertible debt would be excluded from the diluted earnings per share calculation.
The FASB recently issued Statement 130, "Reporting Comprehensive Income," which requires that changes in comprehensive income be shown in a financial statement that is displayed with the same prominence as other financial statements. While not mandating a specific financial statement format, Statement 130 requires that an amount representing total comprehensive income be reported for fiscal years beginning after December 15, 1997. Restatement for earlier years is required for comparative purposes. The Company anticipates no material effect on its financial condition or results of operations due to the adoption of Statement 130.
cash consideration of $2,200,380. Using the market value of the Company's common stock at the date of closing, the value of the shares of Company common stock issued on the merger was $10,870,817. For 1997 and the four-month period ended December 31, 1996, ANIC generated premiums of $6,821,784 and $2,274,442, respectively, and net income of $2,828,413 and $299,354, respectively. The acquisition was accounted for as a purchase.
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 $280,290 and $251,108 of commission income in 1997 and 1996, respectively, from this acquisition.
The amortized cost and estimated market value of investments in debt securities as of December 31, 1997 and 1996 are as follows:
The amortized cost and estimated market value of debt securities at December 31, 1997 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Policy and contract claims include approximately $65,143,000 and $45,300,000 at December 31, 1997 and 1996, respectively, that are discounted at varying interest rates. The amount of discount was $4,101,000 and $3,618,000 at December 31, 1997 and 1996, respectively.
Total reserves, including policy and contract claims, reported to statutory authorities were approximately $7,652,000 and $3,510,000 less than those recorded for GAAP as of December 31, 1997 and 1996, respectively.
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. Management believes the existing net deductible temporary differences are realizable on a more likely than not basis. The sources of these differences and the approximate tax effect are as follows for the years ended December 31:
The Company's insurance subsidiaries (PTLIC, PTNA, and ANIC) are required by insurance laws and regulations to maintain minimum capital and surplus. At December 31, 1997 and 1996, the subsidiaries' capital and surplus exceeded the minimum required capital and surplus in all states in which they are licensed to conduct business.
The National Association of Insurance Commissioners (NAIC) has established risk-based capital standards that life and health insurers and reinsurers must meet. In concept, risk-based capital standards are designed to measure the acceptable amount of capital an insurer should have based on the inherent and specific risks of each insurer. Insurers failing to meet their benchmark capital level may be subject to scrutiny by the insurer's domiciled insurance department and, ultimately, rehabilitation or liquidation. Based on the NAIC's currently adopted standards, the Company has capital and surplus in excess of the required levels. The differences in statutory net income compared to GAAP are primarily due to the immediate expensing of acquisition costs, reserving methodologies, and deferred income taxes. Due to these differences, under statutory accounting there is a net loss and decrease in surplus, called surplus strain, in years of high growth. The surplus needed to sustain growth must be raised externally or from profits from existing business. In 1995, the Company received permission to include $3,287,501 of this surplus strain, related to a new required valuation method, as a charge to surplus.
The Company has an Incentive Stock Option Plan which provides for the granting of options to purchase up to 1,200,000 shares of common stock. The exercise price of all options granted under
PTLIC and PTNA are parties to reinsurance agreements to cede 100% of benefits exceeding 36 months on certain home health care policies. Total reserve credits taken related to this agreement as of December 31, 1997 and 1996 were approximately $2,912,000 and $859,000, respectively. Effective January 1, 1998, no new business is reinsured under this facility.
Effective January, 1994, PTLIC and PTNA entered reinsurance agreements to cede 100% of certain life, accident and health and Medicare supplement insurance to a third party insurer. Total reserve credits taken related to this agreement as of December 31, 1997 and 1996 were approximately $569,000 and $530,000, respectively.
PTNA is party to a coinsurance agreement on a previously acquired block of long-term care business whereby 66% is ceded to a third party. At December 31, 1997 and 1996, reserve credits taken related to this treaty were approximately $1,947,000 and $1,615,000, respectively.
The Company has assumed and ceded reinsurance on certain life and accident and health contracts under various agreements. The tables below highlight the amounts shown in the accompanying consolidated statements of operations which are net of reinsurance activity:
Irv Levit Insurance Management Corporation ("IMC"), an insurance agency which is owned by the President of the Company, produced approximately $50,000, $55,000, and $62,000 of new and renewal premiums for PTLIC, for the years ended December 31, 1997, 1996 and 1995, respectively, for which it received commissions of approximately $13,000, $12,000 and $14,000, respectively.
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and investments. The Company places its cash and cash equivalents and investments with high quality financial institutions, and attempts to limit the amount of credit exposure to any one institution. However, at December 31, 1997, and at other times during the year, amounts in any one institution exceeded the Federal Deposit Insurance Corporation limits.
Our report on the consolidated financial statements of Penn Treaty American Corporation and Subsidiaries is included on page of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page S-1 of this Form 10-K.
Schedule II - Condensed Financial Information of Registrant Balance Sheets as of December 31, 1997 and 1996