Our principal offices in Allentown, Pennsylvania occupy two buildings owned by the Company, totaling approximately 37,000 square feet of office space in a 40,000 square foot building and all of a 16,879 square foot building. We also own and lease additional office space for ancillary operations of our agency subsidiaries and New York staff.
The following selected consolidated statement of operations data and balance sheet data as of and for the years ended December 31, 2006, 2005, 2004, 2003 and 2002 have been derived from our Consolidated GAAP Financial Statements.
In June 2007, we received notification that the Internal Revenue Service had accepted a claim for refund of excise taxes related to premiums that had been paid to Centre during the years 2002 to 2005. The estimated amount of the refund is $9,003 which included interest of $924. As a result the Company recorded $8,079 as Federal excise tax revenue for the year ended December 31, 2006 and recorded $924 of net investment income for the year ended December 31, 2006.
Based on retrospective tests on the development of claims incurred on or before December 31, 2006, we have increased our claim reserves approximately $34.6 million above the amounts produced by the reserving methodology we employed, which utilized the continuance curves completed in 2006. The retrospective tests were based on the development of all claims incurred on or before December 31, 2006, and the increase was based on the development of these claims through December 31, 2007. We believe that this increase was needed because the duration of
We accrued additional expenses related to accounting, actuarial, legal and consulting fees in 2006 and 2005. These fees were incurred due to work related to our increase in claim reserves in 2006 and in the fourth quarter of 2005, the settlement of litigation, cost associated with the development of the financial advisor distribution channel, our written submission to the SEC related to prospective unlocking, the delay in filing our 2005 and 2006 Form 10-K and the restatement of our 2005 financial statements.
We test for impairment of goodwill on an annual basis unless an event occurs or circumstances change that would more likely than not indicate that an impairment has occurred. During our impairment test in 2004, we determined that goodwill related to our agency subsidiaries was impaired. This impairment was a result of declining sales, which led to lower than planned net income at the reporting unit level.
In late 2005, we determined that the new administrative system that we were in the process of installing would not yield the benefits and efficiencies to operations that were originally intended. As a result of this determination we impaired its capitalized value through a charge to income of $2,337 in 2005 and 337 in 2006.
The 2001 Centre Agreement was commuted in May 2005. We recorded a termination fee of $18,300 in 2005 related to the early commutation of this agreement and $7,267 for warrants that were forfeited.
In 2002, we determined that the goodwill associated with our insurance subsidiaries was impaired and recognized an impairment charge of $5,151, net of related tax effect, which we recorded as a cumulative effect of change in accounting principle.
Diluted shares outstanding include shares issuable upon the conversion of our convertible debt and exercise of options outstanding in 2004. They are excluded for 2006, 2005, 2003 and 2002 since inclusion of such shares would be anti-dilutive.
We measure our GAAP combined ratio as the total of all expenses, including benefits to policyholders, related to policies in-force divided by premium revenue. This ratio provides an indication of the portion of premium revenue that is devoted to the coverage of policyholder related expenses. We depend on our investment returns to offset the amounts by which our combined ratio is greater than 100%. For 2006, 2005 and 2002, see note 4 above. Expenses considered in the expense ratio and combined ratio calculations are benefits to policyholders, commissions, net acquisition costs amortized, general and administrative expenses and expense and risk charges and excise tax.
Return on average equity, which is the ratio of net income or losses to average shareholders’ equity, measures the current period return provided to shareholders on invested equity. New or existing shareholders could be dissuaded from future investment in our common stock and may choose to sell their common stock if they are not satisfied with our return on equity.
As a result of our reinsurance agreement with Centre Solutions (Bermuda) Limited, effective December 31, 2001, we transferred substantially all of our investable assets to the reinsurer. We received back our investable assets upon commutation of the reinsurance agreement in May 2005.
In November 2005, the remaining balance of the convertible debt due 2008, $46,544, mandatorily converted to 6,649 shares of our common stock.
Our unaudited quarterly data have been derived from unaudited financial statements and include all adjustments, which we consider necessary for a fair presentation of the results of operations for such periods.
Net (loss) income before cumulative effect of change in accounting principle
In connection with the preparation and audit of the financial statements for the year ended December 31, 2006, we discovered certain financial statements errors. These errors are not material to either the year ended December 31, 2005 or prior years. However, an error related to our actuarial assumptions did have a material impact on each of the quarters of 2005, and therefore, we have restated the previously issued financial statements for the year ended December 31, 2005. There was no adjustment to years prior to 2005. As a result of the restatement, shareholders' equity decreased $526 at December 31, 2005 compared to the previously issued financial statements.
We offer a Return of Premium Benefit in some of our policies, which generally requires that a portion of the premium paid be returned to the policyholder if no claims have been incurred after a certain number of years or upon lapse of the policy or death of the policyholder. Due to an error in our process for identifying which policyholders should be paid, not all required payments were made when due. Further, we determined that, under the terms of the policies, interest on the unpaid balance was due to the policyholder as well. The total cumulative impact of the restatement for this error that affected shareholders equity as of December 31, 2005 was a decrease in shareholders’ equity and net income of $1,102. There was no adjustment to years prior to 2005.
In connection with the adoption of SAB 108 in 2005, we recorded a cumulative effect adjustment in 2005 for return of premium benefits that should have been paid to policyholders in prior years. The adjustment above corresponds to additional items not considered when the SAB 108 adjustment was made in 2005.
Changes in the estimate or different estimated amounts that could have been selected could have a material impact on our financial condition or results of operations.
We assess whether declines in market value for debt and equity securities held as investments are other than temporary. Securities are evaluated considering factors such as financial condition, near-term and long-term prospects of the issuer, as well as underlying factors such as specific events or circumstances that may influence the operations of the issuer, the financial condition and prospects for the issuer’s geographic region and industry, the duration and extent to which the market value has been less than cost and our ability and intent to hold these investments for a period of time sufficient for them to recover in value. Upon such determination, we will impair the security’s amortized cost and record an impairment charge to results of operations.
Morbidity based upon past Company experience and industry data. We also include an estimate for improving morbidity trends in the general population.
The use of the 1990-1995 Select and Ultimate, Sex Distinct, actuarial table for mortality.
For policies issued in 2002 through 2005, we use a 4.5% interest rate to discount future experience. For policies issued prior to 2002, we use a 5.7% interest rate to discount future experience.
We also include an estimate of premium rate increases for certain policies issued prior to 2002, based on the premium rate increases we estimated as of September 30, 2002. This is the last time we revised our assumptions and recorded an impairment to our DAC. We have achieved 100% of these premium rate increases as of September 30, 2005.
An estimate that claims expense will improve beyond the assumptions we utilized in our locked-in estimates due to the expected results from recently implemented and future planned improvements to our claims adjudication procedures.
Recognition of actual premium rate increases achieved as well as an estimate related to premium rate increases that we began filing in November of 2006. Our assumption is that the premium rate increases will be implemented beginning in the second half of 2007 and most of them will be approved by 2010, although we also assume that some of the premium rate increases will be implemented in 2011. There is also an assumption related to an increased number of people lapsing due to the premium rate increases and therefore an assumption related to anti-selection as a result of the premium rate increases. Anti-selection is the lapsation of policies held by healthier policyholders, leading to a higher expected ratio of claims to premiums in future periods.
We base our premium rate increase assumptions on our past experience and our expectations of the amounts of actual rate increases that we will be able to achieve. If we are unsuccessful in obtaining the assumed level of premium rate increases, we could recognize an impairment in the future, which could have a material adverse effect on our financial condition and results of operations.
care being reimbursed, the interest rate utilized to discount the claim reserves, claims that have been incurred but not yet reported, claims that have been closed but are expected to reopen and assumptions about which claims that are currently in their eligibility review stage will eventually become claims that have payments associated with them. We establish our claim reserves in each period based upon our most currently available information and assumptions.
Both our experience and the industry’s experience with claims that last longer than three years is much more limited due to the relatively small number of claims that go past the third year. A majority of our policies were written in the late 1990’s through 2001 and therefore there are only a limited number of claims on which to base any conclusions. Therefore, we rely on a combination of our experience and studies performed by the Society of Actuaries or other sources for claims in the later durations. Due to the limited amount of data, there is a higher likelihood of variance related to this assumption and any variance could have a material affect on our financial condition and results of operations. In the fourth quarter of 2005, we changed our assumption related to claims that lasted longer than three years, resulting in a revised assumption that once a claim lasted longer than three years, it would last longer than we previously assumed. As a result of this change in assumptions, we increased claim reserves approximately $42,000 in the fourth quarter of 2005. As part of continuance assumptions, we also try to reflect anticipated changes in mortality of disabled lives and recovery rates of people on claim. Reviewing past experience is a partial guide, but changes in the future may not follow past patterns.
We make an assumption that there have been a number of claims that have been incurred but not yet reported. This assumption is based on historical studies related to the number of claims that are reported after the date of the
In order to commute the agreement and remain in compliance with requisite minimum regulatory standards, we will need to have a risk based capital ratio (“RBC”) of at least 200%. Our current modeling and actuarial projections suggest that our RBC ratio should be at or slightly above 200% and therefore we may be able to commute the 2001 Imagine Agreement on January 1, 2010. We also believe that we should have an additional margin for any adverse development in order to recapture the block of business. These projections include assumptions related to premiums (new sales, persistency and the timing of the collection of premium rate increases by 2011), investment income, expense levels, incurred claims (paid claims plus change in claim reserves) and changes in our future
policyholder benefits. Because our current projections show that we are unable to commute the 2001 Imagine Agreement until January 1, 2010, we have included additional expense and risk charges in our DAC recoverability analysis. Our DAC is still recoverable with these additional expense and risk charges. We are considering alternatives that may allow us to either commute the 2001 Imagine Agreement prior to January 1, 2010 or reduce the expense and risk charges that escalate as a result of not commuting on January 1, 2009. We believe that alternatives such as modifications to the current reinsurance agreement, new reinsurance agreements, additional capital issuances or a transaction that is completed as a result of our current review of strategic alternatives are available to allow us to commute the 2001 Imagine Agreement on January 1, 2009. We may not be able to commute the 2001 Imagine Agreement on January 1, 2010, as planned, which could have a material adverse affect on our financial condition and results of operations. In the event we determine that commutation of the Imagine Agreement is unlikely on or before January 1, 2010, but likely at some future date, we will include additional annual expense and risk charges in our unamortized DAC recoverability analysis. As a result, we could impair the value of our DAC asset and record the impairment in our financial statements at that time.
During our quarterly impairment test as of December 31, 2004, we determined that the goodwill was impaired. This impairment was a result of declining sales, particularly in the fourth quarter of 2004, which led to lower than planned net income at the reporting unit level. The decline in sales is attributable to a decline in sales across the long-term care industry during 2004 as a result of higher priced policies and the negative impact of premium rate increases that have been implemented on previously issued policies. The fair value of the reporting unit is determined utilizing the present value of cash flows, which includes assumptions for future growth in sales. During the impairment test, we lowered the assumptions related to future sales growth and as a result recognized an impairment of $13,376 in 2004. There was no impairment in 2006 or 2005.
subsidiaries. The renewal commission stream is based on the contracts that the agencies have with various insurance carriers and historical patterns of persistency.
Total first year premium revenue earned in 2006 decreased 4.5% to $11,549, compared to $12,095 in 2005. First year long-term care premiums earned in 2006 decreased 2.6% to $11,538, compared to $11,842 in 2005. We believe that this decrease was due to the uncertainty created by the late filing of our audited statutory financial statements, the uncertainty created by the late filing of our 2005 Form 10-K, the amount of time that we were prohibited from selling new business in the state of Florida during 2006 and the focus by a number of our independent agents on the new Medicare Part D and fee for service products.
Market gain on notional experience account. We recorded a gain on our notional experience account of $48,799 in 2005. Following the commutation of our 2001 Centre agreement in May 2005, we no longer record gains or losses attributable to a notional experience account.
Benefits to policyholders. Total benefits to policyholders in 2006 increased 5.2% to $298,385 compared to $283,667 in 2005. Our loss ratio, or policyholder benefits to premiums, was 101.2% in 2006, compared to 91.6% in 2005. In 2006 our long-term care claim reserves increased approximately $42,600 compared to an increase of approximately $39,800 in 2005. Based on retrospective tests on the development of claims incurred on or before December 31, 2006, we have increased our claim reserves approximately $34,600 above the amounts produced by the reserving methodology we employed which utilized the continuance curves completed in 2006. The retrospective tests were based on the development of all claims incurred on or before December 31, 2006, and the increase was based on the development of these claims through December 31, 2007. We believe that this increase was needed because the duration of claims is longer than we previously estimated. We believe that the claims reserves at December 31, 2006, represent our best estimate based on all information available through December 31, 2007. However, if these estimates are not accurate it could have a material adverse effect on our financial condition and results of operations.
The increased amount in 2005 was primarily a result of an adjustment to our assumption related to the length of time a claim will stay open after it has been open for more than three years along with a change in the discount rate used to set our claim reserves from 5.9% to 5.1%, based on the yield of our portfolio at December 31, 2005. The remaining variance in the loss ratio is due to lower premium revenue in 2006 compared to 2005.
As our block of policies in-force ages, we generally anticipate an increase in our loss ratio. Because we have collected premiums over the life of these policies, and invested the premiums in investment securities, a greater portion of our income comes from interest income each year, which is not reflected in the loss ratio. In addition, if we remain locked in to our assumption in our future policy benefit reserves, we anticipate loss ratios similar to those experienced in 2006 and 2005 until such time as enough premium rate increases are implemented.
Renewal commissions on accident and health business in 2006 decreased 7.2% to $30,383, compared to $32,732 in 2005, primarily due to the decrease in renewal accident and health premiums. The ratio of renewal accident and health commissions to renewal accident and health premiums was 10.7% in 2006 and 11.1% in 2005. We have implemented premium rate increases on a majority of policies written prior to December 31, 2002. We do not pay commissions on the additional premium collected as a result of a premium rate increase, which reduces the ratio of renewal commissions to renewal premium revenue. We anticipate that this ratio will continue to decline until all premium rate increases are fully implemented. Both the renewal commissions total and the ratio of renewal commissions to renewal premiums include the commissions paid to our subsidiaries.
The net amortization of deferred policy acquisition costs is affected by new business generation, imputed interest on prior reserves and policy persistency. The amortization of deferred costs is generally offset largely by the deferral of costs associated with new premium generation. However, the level of new premium sales during the 2006 and 2005 periods produced less expense deferral than needed to offset amortized costs.
Expense and risk charges on reinsurance. In 2006 and 2005, we incurred expense and risk charges of $13,325 and $11,708, respectively. Our Imagine Agreements provide the reinsurer an expense and risk charge equal to the sum of (1) 0.25% of total ceded statutory reserves at the end of a quarter and (2) 0.50% of the value of the combination of any letters of credit or funds deposited in trust by the reinsurer as of the beginning of the quarter. Our 2001 Centre Agreement provided the reinsurer with expense and risk charges. The annual charge consisted of a fixed cost and a variable component based upon reserve and capital levels needed to support the reinsured business.
Benefit for federal income taxes. In 2006 and 2005, we recorded a benefit for Federal income taxes of $17,723 and $8,917 respectively. The effective tax rate was 34.8% in 2006 compared to 39.9% in 2005.
Total renewal premium revenue earned in 2005 decreased 3.7% to $297,421, compared to $308,699 in 2004. Renewal long-term care premiums earned in 2005 decreased 3.8% to $284,840, compared to $295,959 in 2004. The decrease in renewal premium revenue is due to the lapsation of existing policies. We anticipate that we will continue to experience reduced levels of renewal premium revenue until such time as the combination of an increased level of new premiums and the implementation of premium rate increases on policies issued prior to 2002 is sufficient to offset the lapsation of existing policies. Our persistency was 88.8% and 88.7% for the 2005 and 2004 periods, respectively.
We evaluate our prior year assumptions by reviewing the development of reserves for the prior period. During 2005, reserve amounts relating to December 31, 2004 and prior had an unfavorable development of $30,696. These changes to prior year reserve amounts (particularly when calculated as a percentage of the prior year-end reserve balance) provide a relative measure of deviation in actual performance as compared to our initial assumptions. The adjustments to reserves for claims incurred in prior periods are primarily attributable to claims incurred from our long-term care insurance policies, which represent approximately 96% of our premium in-force. The unfavorable development in 2005 is attributable to the change in our assumption related to the mortality of policyholders that are on claim in excess of three years.
Net policy acquisition costs amortized. The net deferred policy acquisition costs amortized in 2005 decreased to $8,746, compared to $11,578 in 2004.
The net amortization of deferred policy acquisition costs is affected by new business generation, imputed interest on prior reserves and policy persistency. The amortization of deferred costs is generally offset largely by the deferral of costs associated with new premium generation. However, the level of new premium sales during the 2005 and 2004 periods produced less expense deferral than needed to offset amortized costs.
Litigation Accrual Expense. During 2005, we accrued $737 for the final resolution of the two lawsuits related to the sale of long-term care policies. In addition we accrued $700 related to the final resolution of two additional lawsuits in 2005. During 2004, we accrued $3,000 related to the anticipated resolution of two lawsuits related the sale of long-term care policies. In addition, we accrued $1,150 in 2004 related to the settlement of a separate lawsuit.
Commutation expense. The 2001 Centre Agreement was commuted effective May 24, 2005. We recorded a termination fee of $18,300 in 2005 related to the early commutation of this agreement.
Reinsurance warrants expense. As part of the 2001 Centre Agreement, the reinsurer was granted four tranches of warrants to purchase shares of non-voting convertible preferred stock. The warrants were forfeited as part of the early commutation of the agreement. The remaining value of $7,267 was recorded as an expense in 2005.
Benefit (Provision) for federal income taxes. In 2005, we recorded a benefit for Federal income taxes of $8,917 compared to a provision for Federal income taxes of $15,676 in 2004. The effective tax rate was 39.9% in 2005 compared to 43.3% in 2004.
In 2005, the effective tax rate utilized to record our benefit for Federal income taxes was higher than our statutory tax rate of 35% primarily due to the release of $1,197 of contingency reserves related to tax positions taken in the past for which the tax years are no longer open to audit. In 2004, the effective tax rate utilized to record our provision for Federal income taxes was higher than our statutory tax rate of 35% primarily due to the impairment charge recorded against the goodwill of UIG, which is not deductible for Federal income tax purposes.
We have also engaged Friedman, Billings, Ramsey & Co., Inc. to assist us in the review of strategic alternatives. These strategic alternatives, include, but are not limited to, capital structure review, strategic partnerships, business combination transactions or the sale of certain assets. An objective of this effort is to identify a stronger financial platform from which distribution partners and financial advisors can promote and increase the sale of our products, which would also help return us to profitable operations. There can be no assurance that this effort will result in any specific transaction or that any such transaction will be on terms favorable to us.
Our cash and cash equivalents increased $2,488 in 2004 primarily due to $26,000 in additional funds generated from the issuance of convertible subordinated debt. This was supplemented by $30,076 from operations and the sale of $34,177 of bonds. The major source of cash from operations was premium received. Cash decreased in 2004 primarily due to payments made to our reinsurer of $43,354 and the purchase of $51,469 in bonds.
The maturities of our principal contractual cash obligations at December 31, 2006, are as follows (amounts in thousands):
Insurance liabilities consist of future policy benefits and unpaid claims relating to the Company’s insurance products. Substantially all of the amounts contained in this table with respect to such liabilities consist of estimates by the Company’s management based on various actuarial and other assumptions relating to morbidity, mortality and persistency. In accordance with GAAP, a substantial portion of such liabilities are carried on a discounted basis on the consolidated balance sheet, however, the amounts contained in the table are presented on an undiscounted basis. The actual payments relating to these liabilities will differ, both in amount and timing, from indicated in the table.
As a holding company, the Parent Company’s ability to meet its ongoing cash requirements (including debt service payments or other expenses and dividends on its common shares, if and when declared) will depend upon its ability to obtain cash dividends or loans from its operating subsidiaries. The payments of cash dividends from its insurance subsidiaries are subject to regulatory restrictions, and as of December 31, 2006 and December 31, 2007, are limited. As a result, there can be no assurance that our insurance subsidiaries will be able to pay us dividends. Our insurance agency subsidiaries, however, are able to pay dividends and advance cash if needed. We currently have enough cash at our agency subsidiaries to meet the Parent Company's ongoing cash requirements.
The majority of our insurance subsidiaries’ cash flow results from our existing long-term care policies, which have been ceded to the reinsurer under reinsurance agreements. Our subsidiaries’ ability to meet additional liquidity needs and cover fixed expenses in the future is highly dependent upon our ability to issue new policies and to control expense growth. Our future growth and new policy issuance is dependent upon our ability to continue to expand our historical markets, retain and expand our network of agents and effectively market our products and our ability to fund our marketing and expansion while maintaining minimum statutory levels of capital and surplus required to support such growth.
States also restrict the dividends our insurance subsidiaries are permitted to pay. Dividend payments will depend on profits arising from the business of our insurance company subsidiaries, computed according to statutory formulae. Under the insurance laws of Pennsylvania and New York, where our insurance subsidiaries are domiciled, insurance companies can pay ordinary dividends only out of earned surplus. In addition, under Pennsylvania law, our Pennsylvania insurance subsidiaries (including our primary insurance subsidiary) must give the Department at least 30 days’ advance notice of any proposed “extraordinary dividend” and cannot pay such a dividend if the Department disapproves the payment during that 30-day period. For purposes of that provision, an extraordinary dividend is a dividend that, together with all other dividends paid during the preceding twelve months, exceeds the greater of 10% of the insurance company’s surplus as shown on the company’s last annual statement filed with Department or its statutory net income as shown on that annual statement. Statutory earnings are generally lower than earnings reported in accordance with generally accepted accounting principles due to the immediate or accelerated recognition of all costs associated with premium growth and benefit reserves. Additionally, our Corrective Action Plan requires the Commonwealth of Pennsylvania Department of Insurance to approve all dividend requests made by PTNA, regardless of normal statutory requirements for allowable dividends. We believe that the Department is unlikely to consider any dividend request in the foreseeable future as a result of PTNA’s current statutory surplus position. Although not stipulated in the Plan, this requirement is likely to continue until such time as PTNA meets normal statutory allowances, including reported net income and positive cumulative earned surplus.
Under New York law, our New York insurance subsidiary (American Independent Network Insurance Company of New York) must give the New York Insurance Department 30 days’ advance notice of any proposed dividend and cannot pay any dividend if the regulator disapproves the payment during that 30-day period. In addition, our New York insurance company must obtain the prior approval of the New York Insurance Department before paying any dividend that, together with all other dividends paid during the preceding twelve months, exceeds the lesser of 10% of the insurance company’s surplus as of the preceding December 31 or its adjusted net investment income for the year ended the preceding December 31.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 123(R) (“SFAS 123(R)”) “Share-Based Payment”. SFAS 123(R) replaces SFAS 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) requires that the cost of share-based payment transactions (including those with employees and non-employees) be recognized in the financial statements. SFAS 123(R) applies to all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share options, or other equity instruments or by incurring liabilities (1) in amounts based (even in part) on the price of the entity’s shares or other equity instruments, or (2) that require (or may require) settlement by the issuance of an entity’s shares or other equity instruments. We have adopted the provisions of SFAS 123(R) on January 1, 2006, and we have recorded an expense of $359 during the year ended December 31, 2006. See Note 13 - "Stock options Plans".
In June of 2006, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) reached a consensus on EITF Issue No, 06-5 “Accounting for Purchases of Life Insurance - Determining the Amount that Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4” (“EITF 06-5”). EITF 06-5 relates to accounting for corporate-owned life insurance (“COLI”). The Company owns a COLI policy, which is utilized to fund the future payment of employee benefit expenses. The EITF reached a consensus that a policyholder should consider any additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract. The EITF also reached a consensus that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2006. The Company has adopted EITF 06-5 on January 1, 2007 and it had no effect on the determination or reporting of the Company's financial results.
In September, 2005, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) No. 05-1”Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts”, effective for internal replacements occurring on fiscal years beginning after December 15, 2006. The SOP provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of certain insurance and investment contracts. An internal replacement is a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. Contract modifications meeting the conditions of the SOP result in a replacement contract that is substantially unchanged from the replaced contract band should be accounted for as a continuation of the replaced contract. An internal replacement that is determined to result in a replacement contract that is substantially changed from the replaced contract should be accounted for as an extinguishment of the replaced contract. Unamortized deferred acquisition costs, unearned revenue liabilities, and deferred sales inducement assets from the replaced contract in an internal replacement transaction that results in a substantially changed contract should not be deferred in connection with the replacement contract. The Company is currently evaluating the effect the adoption of SOP 05-1 will have on its financial statements.
133") and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"), and addresses issues raised in SFAS 133 Implementation Issue No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." The primary objectives of SFAS 155 are: (i) with respect to SFAS 133, to address the accounting for beneficial interests in securitized financial assets and (ii) with respect to SFAS 140, to eliminate a restriction on the passive derivative instruments that a qualifying special purpose entity may hold. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company has adopted SFAS 155 on January 1, 2007 and it had no effect on the determination or reporting of the Company's financial results.
In September 2006, the FASB issued SFAS No. 158, "Employer’s Accounting for Defined Benefit Pension and Other Post Retirement Plan - an amendment of FASB Statements No. 87, 88, 106 and 132(R)” ("SFAS 158"). SFAS 158 requires an entity to recognize in its balance sheet an asset for a defined benefit post-retirement plan’s over funded status or a liability for a plan’s under funded status and additional disclosures. The Company has previously recorded its post-retirement defined benefit obligations through earnings and currently maintains a “pay-as-you-go” funding of defined benefits. On December 31, 2006, the Company adopted the recognition and funding provisions of SFAS 158, which did not have a significant impact on the determination or reporting of our financial results. See Note 12 - "Employee Benefits".
quantifying financial statement misstatements. Specifically, the SEC staff believes that registrants must quantify the impact on current period financial statements of correcting all misstatements, including both those occurring in the current period and the effect of reversing those that have accumulated from prior periods. This SAB should be applied beginning with the first fiscal year ending after November 15, 2006, with early adoption encouraged. The Company has elected to adopt SAB No. 108 early, and it is therefore effective for the Company’s financial statements for the year ended December 31, 2005.
SAB No. 108 permits companies to initially apply its provision either by (1) restating prior financial statements or (2) recording the cumulative effect of initially applying the methodology for quantifying errors described in SAB No. 108 as adjustments to the carrying values of assets and liabilities as of January 1, 2005. The Company elected to record the effects of applying SAB No. 108 using the cumulative effect transition method. Accordingly, as of January 1, 2005, the Company recorded a cumulative effect of accounting principle in the amount of $1,507. The following table summarizes the effects of applying the guidance in SAB No. 108:
We have audited the accompanying consolidated balance sheets of Penn Treaty American Corporation and subsidiaries (the “Company”) as of December 31, 2006 and 2005 and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2006. 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.
As discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for share-based compensation in 2006, as a result of adopting Statement of Financial Accounting Standards No. 123(R), Share-Based Payment.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Penn Treaty American Corporation’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 31, 2008 expressed an adverse opinion thereon.
(1) Cash and investments of $960,993 and $960,056, are restricted as to use as of December 31, 2006 and 2005, respectively (See Note 5).
(1) 2004 adjusted to reflect impact of reverse stock split (See Note 2).
(1) Adjusted to reflect impact of reverse stock split (See Note 2).
(1) Includes $12,015, $12,294 and $2,308 of cash and cash equivalents restricted as to use as of December 31, 2006, 2005 and 2004, respectively.
The Company is licensed in all states and receives renewal premiums from policyholders, but is currently restricted from issuing new policies in six states. Although the Company is approved for sales in Florida, it is currently restricted from issuing new business. See Note 11- “Statutory Information”. Sales in Florida, California and Pennsylvania (subject to Corrective Action Plans or Letter Agreements), accounted for approximately 15%, 14% and 11%, respectively, of the Company’s direct premium revenue for the year ended December 31, 2006. No other state’s sales accounted for more than 10% of the Company’s direct premium revenue for the year ended December 31, 2006.
A one-for-four reverse stock split for current holders of the Company’s common stock became effective July 11, 2005. The consolidated financial statements and notes related to the year ended December 31, 2004 have been restated to reflect the impact of the reverse stock split.
In connection with the preparation and audit of the financial statements for the year ended December 31, 2006 management discovered errors related to prior period financial statements. These prior year errors are not material to either the year ended December 31, 2005 or prior years. However, an error related to our actuarial assumptions did have a material impact on each of the quarters of 2005, and therefore, the Company has restated its previously issued financial statements for the year ended December 31, 2005. There was no adjustment to years prior to 2005. The total cumulative impact of the restatement for all errors that affected shareholders equity as of December 31, 2005 was a decrease of $526.
Calculation of the Company’s benefit reserves requires the application of various actuarial assumptions to the population of policies in-force. Due to an error in the application of a certain assumption used to calculate benefit reserves, policy reserves and deferred acquisition costs were calculated incorrectly. The incorrect assumption was the future modifier factor, which is an assumption that reduces the total in-forcer population in future periods for policyholders that are assumed to already be on claim. The effect for each of the quarters in 2005 was considered to be material, which is the primary reason that the Company has determined to restate the 2005 financial
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities and the reported amounts of revenues and expenses. Management believes that the estimates used are reasonable, although
Debt securities are regularly evaluated to determine if market values below amortized cost are as a result of credit quality, performance or general market decline. If market value declines are determined to be other than temporary, the amortized cost is adjusted to the market value of the security, with the loss recognized in the current period. Any future increases to the market value of a security that has been written down due to an other than temporary impairment is recorded as an unrealized gain in other comprehensive income.
Cash equivalents are highly liquid investments with an original maturity of 90 days or less.
Cash and cash equivalents - The carrying value approximates fair value.
Property and equipment are stated at cost, less accumulated depreciation and amortization. Expenditures for improvements, which materially increase the estimated useful life of the asset, are capitalized. Expenditures for repairs and maintenance are charged to operations as incurred. Depreciation is provided principally on a straight-line basis over the related asset’s estimated life. Upon sale or retirement, the cost of the asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss, if any, is included in operations.
The Company accounts for its internally developed software in accordance with Statement of Position 98-1 “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” All costs incurred during the preliminary project stage are expensed as they are incurred. Costs incurred to develop the internal-use software during the application development stage are capitalized with the exception of certain data conversion costs, which are expensed as incurred. Training costs and maintenance costs are expensed as incurred.
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, related to persistency, used in computing reserves for future policy benefits.
The Company regularly assesses the recoverability of DAC through actuarial analysis. To determine recoverability, the present value of future premiums less future costs and claims are added to current reserve balances. If this amount is greater than current DAC, the unamortized amount is deemed recoverable. The Company utilizes its most recent assumptions in the recoverability calculation including an assumption for premium rate increases. If premium rate increases are not approved, the Company will expense, as impaired, the attributed portion of the DAC in the current period. If the Company concludes that DAC is impaired, the Company will record an impairment loss and a reduction in the DAC. In the event of an impairment, the Company will also utilize its most recent assumptions for policy reserves and DAC to reflect current experience (referred to as “unlocking”) going forward. The primary assumptions include persistency, morbidity (claims expectations), investment yields, expenses and premium rate increases. Recoverability of DAC is highly dependent upon the Company’s ability to obtain future premium rate increases. While the Company has been successful in obtaining premium rate increases on existing policies in the past, the ability to obtain these increases is subject to regulatory
Recognition of actual premium rate increases achieved as well as an estimate related to premium rate increases that the Company began filing in November of 2006. The assumption is that these premium rate increases will be implemented beginning in the second half of 2007 and most of them will be approved 2010, although the Company also assumes that some of the premium rate increases will be implemented in 2011. There is also an assumption related to an increased number of people lapsing due to the premium rate increases and therefore an assumption related to anti-selection as a result of the premium rate increases. Anti-selection is the lapsation of policies held by healthier policyholders, leading to a higher expected ratio of claims to premiums in future periods.
Consideration of the terms and expected recapture timing of the Imagine Agreement.
The goodwill on the Company’s Consolidated Balance Sheets at December 31, 2006 and 2005 relates to the purchase of the Company’s insurance agencies, UIG and NISHD. The Company tests for impairment of goodwill
Prepaid assets are expensed over the period to which the related services are provided.
UIG and NISHD record receivables for amounts due from other insurance companies related to the sale of the other companies’ insurance products.
adjustments are reflected in operations in the period in which they become known. Future developments may result in losses and loss expenses greater or less than the liability for claim reserves.
Accounts payable and other liabilities consist primarily of amounts payable to agents, reinsurers and vendors, capitalized lease obligations, accrued post retirement benefits, as well as deferred income items.
Premiums on long duration accident and health insurance, the majority of which is guaranteed renewable, and life insurance are recognized when due. Estimates of premiums due but not yet collected are accrued.
Basic earnings per share (“EPS”) excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Anti-dilutive effects are not included. As such, the Company has not included securities of 631, 159 and 4,286 for 2006, 2005 and 2004, respectively, which could potentially dilute basic earnings per share in the future. 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.
(1) Amounts not included in 2006 and 2005 because they are anti-dilutive.
Effective January 1, 2006, the Company adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standard ("SFAS") No. 123(R) Share-Based Payment which requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair-value of those awards, in the financial statements.
Prior to the adoption of SFAS 123(R), the Company measured compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by APB No. 25. The Company applied the disclosure provisions of SFAS 123 as amended by SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure as if the fair-value based method had been applied in measuring compensation expense. Under APB No. 25, when the exercise price of the Company's employee stock options was equal to the market price of the underlying stock on the date of the grant, no compensation expense was recognized. The table below reflects
the compensation cost and net loss/income and basic and diluted net loss/income per share as if the fair value recognition provision of SFAS 123(R) had been applied for the years ended December 31, 2005 and 2004 using the BSM option pricing method for stock options (in thousands except per share amounts):
In June 2006, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) reached a consensus on EITF Issue No, 06-5 “Accounting for Purchases of Life Insurance - Determining the Amount that Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4” (“EITF 06-5”). EITF 06-5 relates to accounting for corporate-owned life insurance (“COLI”). The Company owns a COLI policy, which is utilized to fund the future payment of employee benefit expenses. The EITF reached a consensus that a policyholder should consider any additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract. The EITF also reached a consensus that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2006. The Company has adopted EITF 06-5 on January 1, 2007 and it had no effect on the determination or reporting of the Company’s financial results.
with Modifications or Exchanges of Insurance Contracts”, effective for internal replacements occurring on fiscal years beginning after December 15, 2006. The SOP provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of certain insurance and investment contracts. An internal replacement is a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. Contract modifications meeting the conditions of the SOP result in a replacement contract that is substantially unchanged from the replaced contract band should be accounted for as a continuation of the replaced contract. An internal replacement that is determined to result in a replacement contract that is substantially changed from the replaced contract should be accounted for as an extinguishment of the replaced contract. Unamortized deferred acquisition costs, unearned revenue liabilities, and deferred sales inducement assets from the replaced contract in an internal replacement transaction that results in a substantially changed contract should not be deferred in connection with the replacement contract. The Company is currently evaluating the effect the adoption of SOP 05-1 will have on its financial statements.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments" ("SFAS 155"), which amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"), and addresses issues raised in SFAS 133 Implementation Issue No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." The primary objectives of SFAS 155 are: (i) with respect to SFAS 133, to address the accounting for beneficial interests in securitized financial assets and (ii) with respect to SFAS 140, to eliminate a restriction on the passive derivative instruments that a qualifying special purpose entity may hold. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company has adopted SFAS 155 on January 1, 2007 and it had no effect on the determination of the Company’s financial results.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157") which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement is applicable in conjunction with other accounting pronouncements that require or permit fair value measurements, where the FASB previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within these fiscal years. The Company is currently evaluating the effect the adoption of SFAS 157 will have on its financial statements.
In September 2006, the staff of the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” The interpretations in this SAB express the staff’s views regarding the process of quantifying financial statement misstatements. Specifically, the SEC staff believes that registrants must quantify the impact on current period financial statements of correcting all misstatements, including both those occurring in the current period and the effect of reversing those that have accumulated from prior periods. This SAB should be applied beginning with the first fiscal year ending after November 15, 2006, with early adoption encouraged. The Company has adopted SAB No. 108 effective for the Company's financial statements for the year ended December 31, 2005.
SAB No. 108 permits companies to initially apply its provision either by (1) restating prior financial statements or (2) recording the cumulative effect of initially applying the methodology for quantifying errors described in SAB No. 108 as adjustments to the carrying values of assets and liabilities as of January 1, 2005. The Company elected to record the effects of applying SAB No. 108 using the cumulative effect transition method. Accordingly, as of January 1, 2005, the Company recorded a cumulative effect of change in accounting principle in the amount of $1,507. The following table summarizes the effects of applying the guidance in SAB No. 108:
The amortized cost and market values of debt securities at December 31, 2006 and 2005 are shown below.
Effective June 30, 2005, the Company entered into a reinsurance agreement with an unaffiliated reinsurer for policies issued prior to January 1, 2002 on a funds withheld basis. As a condition precedent to withholding the funds due to the reinsurer, the Company has agreed to hold assets in trust for the benefit of the reinsurer. The amount required to be held in trust at December 31, 2006 and 2005 was $918,093 and $920,525, respectively.
Pursuant to certain statutory licensing requirements, as of December 31, 2006 and 2005, the Company had on deposit bonds with an estimated market value aggregating $12,118 and $12,121, respectively, in Insurance Department special deposit accounts. The Company is not permitted to remove the bonds from these accounts without approval of the regulatory authority.
The Company maintains assets in a certificate of deposit for the benefit of the lessor under its sale leaseback agreement entered into in 2005. As of December 31, 2006 and 2005 the amount of the certificate of deposit was $3,500.
During 2005 the notional experience account activity was as follows (See Note 4 for a description of the notional experience account):
In June 2007, the Company received notification that the Internal Revenue Service had accepted a claim for refund that the Company had filed related to return premiums associated with the commutation of the reinsurance transaction with Centre Solutions (Bermuda) Ltd. (“Centre”). The excise taxes related to premiums that had been paid to Centre as part of a reinsurance agreement the Company had with Centre during the years 2002 to 2005. The estimated amount of the refund is $9,003 which includes interest of $924. As a result the Company recorded $8,079 as Federal excise tax revenue for the year ended December 31, 2006 and recorded $924 of net investment income for the year ended December 31, 2006.
The significant assumptions utilized in setting the accident and health policy reserves are:
Morbidity based upon past Company experience and industry data. There is also an estimate for improving morbidity trends in the general population.
An estimate of premium rate increases for certain policies issued prior to 2002, based on the premium rate increases that were estimated as of September 30, 2002. This is the last time the assumptions utilized in our policy reserves were locked-in following a DAC impairment. The Company has achieved 100% of these premium rate increases as of September 30, 2005.
At December 31, 2006, the Company utilized discount rates ranging between 4.0% and 4.5% for claim reserves, depending upon the year the claims were incurred. Because the Company’s claim payments are made over a period of time, the Company utilized a discount rate of 5.1% at December 31, 2005 for claim reserves in order to determine the present value of future expected payments. This discount rate approximates the current yield to maturity of the Company’s assets supporting this future liability.
There are also assumptions related to claims that are closed but are expected to reopen. These are typically claims where the Company has requested information that has not been received and therefore closes the claim and receives the requested information subsequent to closing the claim. The assumption related to these claims is also based on the Company’s historical experience.
The Company evaluates its prior year assumptions by reviewing the development of reserves for the prior period (i.e. incurred from prior years). This amount includes imputed interest from prior year-end reserve balances plus adjustments to reflect actual versus estimated claims experience. These adjustments (particularly when calculated as a percentage of the prior year-end reserve balance) provide a relative measure of deviation in actual performance as compared to its initial assumptions. The adjustments to reserves for claims incurred in prior periods are primarily attributable to claims incurred from our long-term care insurance policies, which represent approximately 97% of our premium in-force.
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 temporary differences and the approximate tax effect are as follows for the years ended December 31:
The Company has net operating loss carryforwards of $19,143, or $6,700 on a tax effected basis, which have been generated by taxable losses at the parent company, and if unused will expire between 2018 and 2025. The Company has net operating loss carryforwards of $18,983, or $6,644 on a tax effected basis, which have been generated by taxable losses at the Company’s life insurance subsidiaries, and if unused, will expire in 2016.
At December 31, 2006, the accumulated earnings of the Company for Federal income tax purposes included $1,451 of "Policyholders' Surplus", a special memorandum tax account. This memorandum account balance has not been currently taxed, but income taxes computed at then current rates will become payable if surplus is distributed. Provisions of the Deficit Reduction Act of 1984 do not permit further additions to the "Policyholders' Surplus" account.
The differences in statutory net income (loss) compared to GAAP net income (loss) are primarily due to the immediate expensing of acquisition costs, as well as differing reserving methodologies and treatment of reinsurance and deferred income taxes.
The Company’s Pennsylvania insurance subsidiaries are required to hold statutory surplus that is, at a minimum, above a calculated authorized control level at which the Pennsylvania Insurance Department (the “Department”) may place them under regulatory control, leading to rehabilitation or liquidation. At December 31, 2000, the Company’s primary insurance subsidiary, PTNA, which represented 90% of the Company’s direct premium revenue, 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, ANIC, which is owned 100% by PTNA, is also subject to the provisions of the Plan.
required the Company to enter into a reinsurance treaty with Centre Solutions (Bermuda) Limited through which PTNA and ANIC reinsured 100% of their individual long term care insurance business in effect on December 31, 2001. This treaty was commuted effective
The estimation of policy reserves for statutory accounting purposes differs from that utilized in GAAP. For statutory accounting purposes, the assumptions utilized and the methodology applied may be at the discretion of the Department in its interpretation of its regulations. The Department has provided the Company with guidelines for establishing its statutory policy reserves. Because PTNA and ANIC have limited statutory capital and the 2001 Imagine Agreement has a limit of liability, any changes in the Department’s interpretation or view of how the Company’s insurance subsidiaries determine their statutory policy reserves could have a material adverse impact on PTNA or ANIC, possibly resulting in regulatory control or liquidation.
Maintain compliance with Florida laws governing investments in subsidiaries and related corporations; and
In August 2006, PTNA agreed to temporarily suspend new sales of Florida insurance policies pending the filing of its 2005 statutory audit report and the review by the Florida OIR. Florida represented approximately 6% of new business applications prior to the temporary suspension. In November of 2006 PTNA entered into a revised voluntary consent agreement with the Florida OIR to recommence sales. The major provisions of the voluntary consent agreement, with which PTNA must comply in order to continue writing new policies in Florida include, but are not limited to the following:
PTNA will limit total Florida premium to current levels of approximately $48 million as of June 30, 2006, allowing for new business growth equal to lapses of existing policies. This base amount may increase as a result of any future premium rate increases on existing policies.
consent agreement in the future if its financial strength or its ratings with either A.M. Best Company or Standard and Poor’s improves.
In June of 2007 the Florida OIR suspended PTNA’s certificate of authority to conduct business in Florida for a period of at least twelve months. The action stems from PTNA’s not filing its 2006 audited statutory financial results on or before June 1, 2007, as is required by Florida statute. PTNA filed its 2006 audited statutory financial report on June 30, 2007. PTNA filed an appeal with the Florida OIR , as prescribed by statute, for consideration before an administrative law judge which was denied. PTNA has continued to actively work with the Florida OIR to reach a resolution. Florida sales represented 5.9% of PTNA’s new business applications for the first five months of 2007 and accounted for approximately 17.0% of PTNA’s direct premiums for the year ended December 31, 2006.
The Company uses December 31 as the measurement date for the pension and benefit plans, which are unfunded. The following table provides the components of the benefit obligation:
In January 2006, the Company adopted SFAS No. 123(R), Share-Based Payment using the modified-prospective application transition method. Under this method, compensation expense for the year ended December 31, 2006 includes compensation cost for all non-vested share-based awards at their grant-date fair value amortized over the respective vesting periods on the straight-line method. The Company determines the fair value of stock-based compensation using the BSM option pricing model. Prior to 2006, awards were accounted for and recorded at their intrinsic value. As a result, prior to the adoption of SFAS No. 123(R), no related compensation expense was recognized for the stock option awards, and the expense related to stock-based employee compensation included in the determination of net income for the years 2005 and 2004 is less than that which would have been included if the fair value method had been applied to all awards. Under the modified prospective application transition method, the results for the years ended December 31, 2005 and 2004 have not been restated.
As of December 31, 2006, the Company had three stock-based compensation plans. The Company’s 1998 Employee Non-Qualified Incentive Stock Option Plan provided for the granting of options to purchase up to 150 shares of common stock. During 2001, the Company granted 142 replacement options to its employees for all existing options granted under its 1998 Plan. As a result, these options are now subject to the variable
In addition, the Company has a Participating Agent Stock Option Plan that provides for the granting of options to purchase up to 75 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 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. SFAS No. 123(R) requires that the fair value of options granted to non-employees (agents) be recognized as compensation expense over the estimated life of the option. Options were granted to agents in 1997, 1996 and 1995. No agent options have been granted since 1997. The Company did not have any compensation expense related to this Plan in 2006, 2005 or 2004.
As of December 31, 2006 the Company had $283 of total unrecognized compensation cost related to nonvested options. That cost is expected to be recognized over a period of 1 year. The total fair value of stock options vested during the years ended December 31, 2006, 2005 and 2004 were $1,034, $575 and $342, respectively.
The total net rental expenses under all leases amounted to approximately $986, $1,071 and $1,173 for the years ended December 31, 2006, 2005 and 2004 respectively.
monetary relief sought by plaintiffs against the Company often bears little relevance to the merits or disposition value of the legal action.
Renewal commissions paid to our agents, not to exceed 10.5% of premiums collected; plus
The Imagine Agreement contains an aggregate limit of liability, which limits the ultimate liability for paid claims of the reinsurer. The aggregate limit of liability is equal to:
In order to commute the agreement and remain in compliance with requisite minimum regulatory standards, the Company will need to have a risk based capital ratio (“RBC”) of at least 200%. The Company’s current modeling and actuarial projections suggest that its RBC ratio should be at or slightly above 200% and therefore it may be able to commute the 2001 Imagine Agreement on January 1, 2010, the Company also believes that it should have an additional margin for any adverse development in order to recapture the block of business. These projections include assumptions related to premiums (new sales, persistency and the timing of the collection of premium rate increases by 2011), investment income, expense levels, incurred claims (paid claims plus change in claim reserves) and changes in future policyholder benefits. Because the current projections show that the Company is unable to commute the 2001 Imagine Agreement until January 1, 2010, it has included additional expense and risk charges in its DAC recoverability analysis. DAC is still recoverable with these additional expense and risk charges. The Company is considering alternatives that may allow it to either commute the 2001 Imagine Agreement prior to January 1, 2010 or reduce the expense and risk charges that escalate as a result of not commuting on January 1, 2009. The Company believes that alternatives such as modifications to the current reinsurance agreement, new reinsurance agreements, additional capital issuances or a transaction that is completed as a result of its current review of strategic alternatives are available to allow it to commute the 2001 Imagine Agreement on January 1, 2009. The Company may not be able to commute the 2001 Imagine Agreement on January 1, 2010, as planned, which could have a material adverse affect on its financial condition and results of operations. In the event the Company determines that commutation of the Imagine Agreement is unlikely on or before January 1, 2010, but likely at some future date, it will include additional annual expense and risk charges in its unamortized DAC recoverability analysis. As a result, it could impair the value of its DAC asset and record the impairment in its financial statements at that time.
Pursuant to the Plan with the Insurance Department, which requires the pre-approval of new or modified reinsurance agreements, the Company has requested and received approval to modify the 2001 Imagine Agreement. The approved modification would waive an increase in the expense and risk charges that would be payable to the Reinsurer if the ceded policies are not recaptured and the entire Agreement is not commuted on or before January 1, 2009 and allow, Penn Treaty, in its sole discretion to recapture approximately 1/3 of the reinsured business in each of the years 2009, 2010 and 2011, with no escalation in the expense and risk charges. The modification would give the Company additional latitude in deciding the economics of commuting the treaty via other capital alternatives. At the time of the filing of this document, the modified Agreement has not been signed by the reinsurer or the Company.
The Company’s agreement requires it to file premium rate increases within 30 days of its determination of need for these increases. Failure to file such rate increases within the prescribed time is defined in the agreement as a Material Breach Event, which, if uncorrected would ultimately lead to a reduction in the reinsurer’s liability to reimburse claims made in the future under the agreement. Although the Company filed its premium rate increases more than 30 days after its determination of need in 2006, thereby creating a Material Breach Event, the Reinsurer considers the Company’s ultimate filings to be sufficient to cover its obligations under the agreement and has not reduced the aggregate limit of liability.
The Company also has a reinsurance agreement with General Re Life Corporation with respect to certain home health and nursing home claims. The claims ceded are either in excess of 60 months, $250,000 or $350,000 depending on the policy type. There have been no new policies reinsured under this agreement since 2001. The reinsurance recoverable related to this agreement was $169, $201 and $70 at December 31, 2006, 2005 and 2004, respectively.
In addition the Company also had a coinsurance agreement with General Re Life Corporation on a previously acquired block of long-term care business, whereby 66% was ceded to a third party. The reinsurance recoverable balance was $5,871 and $5,887 at December 31, 2005 and 2004, respectively.
In December 2006 the Company entered into a release and settlement agreement with General Re Life Corporation relating to two reinsurance agreements. Under the terms of this agreement General Re Life Corporation resumed its obligations under the excess of loss reinsurance treaties. As a result of this settlement, the Company released a contingency reserve of approximately $1,000. For the coinsurance agreement General Re Life Corporation agreed to pay the Company $5,200 to recapture the business, effective October 1, 2006, which is included in the reinsurance recoverable balance at December 31, 2006. As a result of the recapture, the Company has recorded the policy and claim reserves related to this business and recorded a loss of approximately $800.
In January 2006, PTNA entered into a Agreement of Reinsurance and Assumption for the sale of its remaining life insurance policies to an unaffiliated insurer on a 100% quota share assumption bases. Upon approval from state insurance departments in which the policies were issued, or policyholder approval as prescribed by state regulation, PTNA will transfer its rights and liabilities for all of the life insurance policies issued by PTNA. PTNA sold the life insurance portfolio for an amount equal to the statutory reserves to the insurer in the amount of $10,316 less commissions, receivables and policy loans.
In 2006, 2005 and 2004, the Company completed private placements of 10, 16 and 25 shares, respectively, as compensation to its financial advisor. In 2006 and 2005 the Company completed private placements of 7 and 11 shares as compensation to one of its independent agents. There was no compensation to agents in the form of shares in 2004. In 2005 the Company issued 12 shares as a result of the exercise of options. There were no exercises of options in 2006 or 2004.
During 2005 and 2006, the Company entered into sale leaseback agreements with a financial institution under which it sold and leased back software with a book value of $4,558. The leases are for a period of two years and provide for repurchasing the leased property at the end of the lease for its residual value. Additional cash collateral amounting to $3,500 was provided by the Company. Since the leases do not meet the criteria for lease accounting, they have been accounted for as a financing with no gain or loss recognized on the sale of the assets.
In October 2007, the office of the Attorney General of the state of New York issued subpoenas to all long-term care insurance carriers issuing policies in New York. The Company has been providing information in response on a continuing basis.
The Company is not aware of any material financial impact upon its financial condition or results of operations that will inure from these inquiries.
a later date, the Company shall not be obligated to make the remaining cash payments and shall instead grant that number of options for which the vesting dates have not passed. The option grant was approved by the Company's shareholders on December 28, 2007.
In December 2006, the Company entered into a purchase agreement to acquire Southern Security Life Insurance Company ("Southern Security"), a Florida-domiciled shell insurance company. The purchase price for Southern Security consisted of $400 plus the capital and surplus of Southern Security as of December 31, 2006, which was $3,861, plus all investment income and interest on the capital and surplus accruing between December 31, 2006 and the date of final distributions from escrow. The purchase agreement required the approval of the Pennsylvania Insurance Department, which was obtained, and the Florida Office of Insurance Regulation by December 21, 2007. Because the Florida Office of Insurance Regulation did not complete its review by that date, the seller exercised its right to terminate the purchase agreement and the escrowed purchase price is pending distribution. The Company is making no further attempt to consummate the transaction.
The following lists the condensed financial information for the parent company as of December 31, 2006 and 2005 and for the years ended December 31, 2006, 2005 and 2004.
Bonds available for sale at market (amortized cost of $1,255 and $4,345, respectively)
(1) The Company previously classified cash contributions to subsidiaries as a financing activity. The Company revised this
classification to instead appropriately disclose contributions to subsidiaries as an investing in 2006, with confirming changes in