The following selected consolidated statement of operations data and balance sheet data of the Company as of and for the years ended December 31, 1992, 1993, 1994, 1995 and 1996, have been derived from the Consolidated GAAP Financial Statements of the Company, which have been audited by Coopers and Lybrand L.L.P., independent accountants.
(1) Restated to reflect adoption of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," as of January 1, 1990. The effect of adoption is as follows:
---- Net income (reduction) $ (116,000) Net income per share (reduction) $ (.02)
The following table sets forth the components of the Company's condensed statements of operations for the years ended December 31, 1994, 1995 and 1996, expressed as a percentage of total revenues.
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 1994, the Company introduced its Independent Living policy 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. Long-term nursing home care and home health care policies accounted for approximately 90% of the Company's total annualized premiums in force as of December 31, 1996 and approximately 86% of its consolidated revenues for 1996.
Deferred acquisition costs. In connection with the sale of its insurance policies, the Company defers and amortizes a portion of the policy acquisition costs over the related premium paying periods of the life of the policy. These costs include all expenses directly related to the acquisition of the policy, including commissions, underwriting and other policy issue expenses. The amortization of deferred acquisition costs is determined using the same projected actuarial assumptions used in computing policy reserves. Deferred acquisition costs can be affected by unanticipated termination of policies because, upon such unanticipated termination, the Company is required to expense fully the deferred acquisition costs associated with the terminated policy.
Renewal accident and health premiums earned by the Company in 1996 increased 28.7% to $80,311,319, compared to $62,402,068 in 1995. Renewal long-term care premiums in 1996 increased 30.4% to $77,734,271, compared to $59,624,488 in 1995. This increase reflects higher persistency and growth of in-force premiums. Renewal Medicare supplement premiums earned by the Company in 1996 decreased 7.2% to $2,577,048, compared to $2,777,580 in 1995. This trend is consistent with the Company's decision not to actively pursue Medicare supplement business.
In order to enhance the marketability of certain products, the Company has recently emphasized offering new policy holders a monthly premium payment plan. The Company believes that the lower monthly payment is more attractive than the historical larger annual premium payment and that offering the monthly payment option enables it to sell more policies. However, because the Company records premiums when due, and a higher percentage of new policy holders opted for the monthly payment option in 1996 compared with 1995, management believes that it has experienced a delay in premium recognition of approximately $5,000,000 throughout 1996.
Benefits to Policyholders. Benefits to policyholders in 1996 increased 29.5% to $83,993,132, including ANIC expenses of $1,078,073, compared to $64,879,275 in 1995. Accident and health benefits to policyholders in 1996 increased 29.6% to $81,860,045 compared to $63,175,068 in 1995. The Company's accident and health loss ratio was 64.9% in 1996, compared to 63.7% in 1995. This increase in loss ratio was due, in part, to the increase in premium and policies of the Company's Independent Living policy which is reserved for at a higher rate, and also to improved persistency. In addition, management believes that claims were reported more quickly throughout 1996 due to the Company's offer to waive a policy elimination period if the insured agreed to utilize a Case Manager. See "Business-Claims." Management believes that this acceleration of reported claims was completely recognized by the end of 1996. During 1996, expenses for case management services of approximately $450,000 were classified as general and administrative expenses. The Company utilizes case management services in order to reduce overall 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.
Renewal commissions on accident and health business in 1996 increased 23.6% to $12,312,521, compared to $9,964,110 in 1995, remaining consistent with the increase in renewal premiums discussed above. The ratio of renewal accident and health commissions to renewal accident and health premiums was 15.4% in 1996 and 16.0% in 1995. This ratio fluctuates in relation to the age of the policies in force and the rates of commissions paid to the producing agents.
General and Administrative Expenses. General and administrative expenses in 1996 increased 28.6% to $15,647,715, compared to $12,170,913 in 1995. ANIC expenses accounted for $928,385 in 1996, which includes the amortization of goodwill and the present value of future profits. Without the ANIC increase in expenses, general and administrative costs would have increased 20.9%. This amount also includes an additional $450,000 of case management charges, which will be reported as policyholder benefits in subsequent years. General and administrative expenses as a percentage of revenues were 11.1% in 1996, compared to 11.0% in 1995, which is due to the additional costs of ANIC and case management.
Net Income. Net income of $12,160,347 (including a contribution of $299,354 from ANIC) for 1996 was $3,331,464 or 37.7% above 1995 income of $8,828,883. Net income includes income tax provisions of $4,847,000 and $3,609,000, for 1996 and 1995 period, respectively. Income before federal income taxes increased in 1996 by $4,569,464 or 36.7% to $17,007,347. This increase was primarily attributable to the continuing growth of premiums earned. The Company made a 1996 provision for federal income taxes of 4,847,000 or 28.5%, as compared to an effective 1995 tax provision rate of 29.0%.
Life Premiums. First year life premiums earned by the Company in 1995 decreased 20.9% to $1,700,549, compared to $2,149,039 in 1994. This change was attributable to record sales of the Company's life insurance products during 1994, particularly in the first quarter of 1994 resulting from the Company's focused marketing efforts in late 1993 and early 1994 related to the introduction of these new products. Since the first quarter of 1994, first year life premiums have been negatively impacted by the Company's utilization of stricter underwriting standards.
Net Policy Acquisition Costs Deferred. The net deferred policy acquisition costs in 1995 increased 100.2% to $15,303,161 compared to $7,642,875 in 1994, consistent with the growth of the Company's business. 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 Company believes that amortization decreased in 1995 relative to 1994 as a result of higher persistency.
First Year Commissions. First year commissions on accident and health business increased 40.7% to $24,897,878, compared to $17,694,410 in 1994. The ratio of first year accident and health commissions to first year accident and health premiums was 67.7% in 1995 compared to 65.6% in 1994. The increase in the ratio is a result of a decrease in the average age of the insured covered by new business, which results in a higher agent commission.
First year commissions on life business decreased to $1,325,521, compared to $1,670,785 in 1994, corresponding to a decrease in first year life premiums. The ratio of first year life commissions to first year life premiums was 78.0% in 1995 compared to 77.8% in 1994, reflecting a commission structure which varies with the premium payment terms of policies.
In the first quarter of 1993, the Company retroactively adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under the asset and liability method provided for by SFAS 109, deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities by applying enacted statutory tax rates.
On January 1, 1996, Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123") became effective. SFAS 123 provides an alternative method of accounting for stock-based compensation arrangements, based on the fair value of the stock-based compensation determined by an option pricing model utilizing various assumptions regarding the underlying attributes of the options and the Company's common stock. The accounting under SFAS 123 differs from the existing method of accounting for stock-based compensation which is provided in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB 25"). The Financial Accounting Standards Board encourages entities to adopt the fair value based method, but does not require the adoption of this method. For those entities that continue to apply APB 25, pro forma disclosure of the effects, if adopted, of SFAS 123 on net income and earnings per share is required in the 1996 financial statements. The Company has adopted the disclosure-only provisions of SFAS 123 and applies APB 25 in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. See Note 9 of the consolidated financial statements for full disclosure under SFAS 123.
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 establishes standards for computing and presenting earnings per share, and simplifies the standards for computing earnings per share previously found in Accounting Principles Board Opinion No. 15, "Earnings per Share." Primary and fully diluted earnings per share will be replaced with basic and diluted earnings per share, and these amounts are required to be shown on the face of the income statement. In addition, a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation will be required.
Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. This Statement is effective for financial statements issued for periods ending after December 15, 1997, and requires restatement of all prior-period earnings per share data presented. Management has not determined the impact that SFAS 128 may have on the Financial Statements.
The adequacy of premium rates in relation to the level of health claims is constantly monitored by the Company and, where appropriate, premium rates on such policies are increased as policy benefits increase. Failure to make such increases commensurate with health care cost increases may result in a loss from health insurance operations.
The Company's consolidated liquidity requirements have historically been created and met from the operations of its insurance subsidiaries. The Company's primary sources of cash are premiums and investment income. The Company has provided, and may continue to provide, cash through public offerings of its common stock, capital markets activities or debt instruments. The primary uses of cash are policy acquisition costs (principally commissions), payments to policyholders, investment purchases and general and administrative expenses.
On January 1, 1994, the Company adopted SFAS 115. The cumulative effect of adoption of SFAS 115 was an increase in shareholders' equity of $3,528,512, net of taxes, for unrealized gains of $5,040,731 in the investment securities available for sale portfolio. During the year ended December 31, 1994, the Company experienced a decrease in unrealized gains of $9,205,393. As of December 31, 1994, shareholders' equity was decreased by $2,713,842 due to unrealized losses of $4,111,882 in the investment portfolio. As of December 31, 1995, shareholders' equity was increased by $4,055,788 due to unrealized gains of $6,145,649 in the investment portfolio. As of December 31, 1996, shareholders' equity was increased by $2,261,154 due to unrealized gains of $3,425,991 in the investment portfolio.
During 1993, the Company contributed $2,000,000 in bonds to PTLIC and Network America. During 1994, the Company contributed $4,000,000 in cash to PTLIC. The capital position of PTLIC and Network America was further improved by the contribution of $14,000,000 of the net proceeds of the public offering in 1995 to the capital and surplus of PTLIC and Network America during the third quarter of 1995. In November 1996, the Company contributed an additional $5,000,000 of the net proceeds of the public offering in July 1995 to Network America. The Company believes that its insurance subsidiaries' capital and surplus presently meet or exceed the requirements in all jurisdictions in which they are licensed.
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.
The remaining approximately $27,000,000 in proceeds from the debt offering were retained at the parent in order to meet the interest service requirements of the debt. If the debt is not converted to common shares of the Company prior to December 2, 2003, the Company will be required to pay an aggregate of $32,703,125 in interest. The Company believes that it has retained sufficient funds to make these payments. The $74,750,000 balance of the debt is expected to convert to shares of common stock of the Company by design of the debt offering. However, in the event of maturity of the debt without conversion, the Company would be required to refinance the debt in order to meet its repayment obligations.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Penn Treaty American Corporation and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
PENN TREATY AMERICAN CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets as of December 31, 1996 and 1995
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 seven states accounted for approximately 73% of the Company's premiums for the year ended December 31, 1996.
The cumulative effect of adopting SFAS No. 115 as of January 1, 1994 was an increase in the balance of shareholders' equity of approximately $3,528,500 to reflect the net unrealized gain (net of approximately $1,512,000 in deferred income taxes) on investment securities classified as available for sale. As of December 31, 1995, shareholders' equity was increased by approximately $4,056,000 due to net unrealized gains of approximately $6,146,000 in the investment portfolio. As of December 31, 1996 shareholders' equity was increased by approximately $2,261,000 due to net unrealized gains of approximately $3,426,000.
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. During 1996, the Company capitalized approximately $1,500,000 in computer software expenses.
Other assets consist primarily of due and unpaid insurance premiums and unamortized debt offering costs.
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. Because of the Company's relatively limited claims experience with this product, the Company may incur higher than expected
The Company discounts all policy and contract claims which involve fixed periodic payments extending beyond one year. This is consistent with the method allowed for statutory reporting and the long duration of claims, as well as industry practice for long-term care policies. Benefits are payable over periods ranging from six months to five years and lifetime. These liabilites are discounted using an assumed rate of 7% for 1996, 1995 and 1994 claims, 6% for 1993 and 1992 claims and 8% for claims in 1991 and prior.
In connection with this purchase, the Company recognized goodwill in the amount of $4,294,947, which is being amortized, straight-line, over a 25 year period. The operating results of ANIC have been included in the consolidated statement of income from the date of acquisition. Consolidated pro forma net income and earnings per share would not have been materially different from the reported amounts for fiscal 1996 and 1995.
The amortized cost and estimated market value of debt securities at December 31, 1996 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.
Gross proceeds and realized gains and losses on the sales of equity securities were as follows:
Pursuant to certain statutory licensing requirements, as of December 31, 1996, the Company had on deposit bonds aggregating $8,029,732 in insurance department safekeeping accounts. The Company is not permitted to remove the bonds from these accounts without approval of the regulatory authority.
Policy reserves have been computed principally by the net level premium method based upon estimated future investment yield, mortality, morbidity, withdrawals and other benefits. The composition of the policy reserves at December 31, 1996 and 1995 and the assumptions pertinent thereto are presented below:
Policy and contract claims include approximately $45,300,000 and $38,150,000 at December 31, 1996 and 1995, respectively, that are discounted at varying interest rates. The amount of discount was $3,618,000 and $2,044,000 at December 31, 1996 and 1995, respectively.
The amounts related to prior years' incurral of claims reflects the accretion of interest due to the discounting of pending claim reserves as well as adjustments to reflect actual versus estimated claims experience.
1996 1995 ---- ---- Convertible, subordinated debt issued in November 1996, with semi-annual coupon of 6.25% annual percentage rate. Debt is callable after December 2, 1999 at declining redemption values and matures in 2003. Prior to maturity, the debt is convertible to shares of the Company's common stock at $28.44. $74,750,000 $ 0
Installment note for purchase of block of renewal commissions in January 1996, payable over two years with interest accrued at 7% 325,000 0
Capital lease 88,416 146,048 ----------- ---------- $77,114,592 $2,206,117 ----------- ---------- ----------- ----------
At December 31, 1996, the accumulated earnings of the Company for Federal income tax purposes included $1,055,873 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 (the "Act") do not permit further additions to the "Policyholders' Surplus"
account. "Shareholders' Surplus" represents an accumulation of taxable income (net of tax thereon) plus the dividends received deduction, tax-exempt interest, and certain other special deductions as provided by the Act. At December 31, 1996, the combined balance in the "Shareholders' Surplus" account amounted to approximately $21,470,000. There is no present intention to make distributions in excess of "Shareholders' Surplus."
The Company's insurance subsidiaries (PTLIC, Network America, and ANIC) are required by insurance laws and regulations to maintain minimum capital and surplus. At December 31, 1996 and 1995, 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 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.
Until August 1, 1996, the Company maintained a defined contribution pension plan covering substantially all employees. The Company contributed 3% of each eligible employee's annual covered payroll to the plan. All contributions were subject to limitations imposed by the Internal Revenue Code on retirement plans and Section 401(k) plans. Upon the termination of the plan on August 1, 1996, each participant became fully vested. A prorata portion of the 1996 scheduled contribution was put into the plan upon termination. Pension expense was $30,000, $55,000, and $70,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
At December 31, 1996, the Company has two stock-based compensation plans which are described below. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, ("SFAS No. 123"), and applies APB Opinion No. 25 "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. Had compensation cost for the Company's two stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of FASB Statement 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below. The effects of applying the SFAS No. 123 proforma disclosure are not indicative of future amounts.
The Company has an Incentive Stock Option Plan which provides for the granting of options to purchase up to 600,000 shares of common stock. The exercise price of all options granted under the plan may not be less than the fair market value of the shares on the date of grant (110% of fair market value in the case of any person who holds more than 10% of the combined voting power of all classes of outstanding stock). The maximum allowable term of each option is ten
years (five years in the case of holders of more than 10% of the combined voting power of all classes of outstanding stock), and the options become exercisable in four equal, annual installments commencing one year from the option grant date.
The Company is a defendant in various lawsuits arising in the ordinary course of business. In the opinion of management, the resolution of these lawsuits will not have a significant effect on the financial condition or results of operations of the Company.
Effective October, 1994, PTLIC and Network America entered into 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, 1996 and 1995 were approximately $859,000 and $391,000, respectively.
Effective January, 1994, PTLIC and Network America 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, 1996 and 1995 were approximately $530,000 and $662,000, respectively.
ANIC reinsures approximately $500,00 of its risk with three reinsuring companies, all of which are authorized to do business in the State of Vermont.
Irv Levit Insurance Management Corporation ("IMC"), an insurance agency which is owned by the President of the Company, produced approximately $55,000, $62,000, and $65,000 of new and renewal premiums for PTLIC, for the years ended December 31, 1996, 1995 and 1994, respectively, for which it received commissions of approximately $12,000, $14,000 and $15,000, respectively.
A managing general agent accounted for approximately 21%, 18% and 20% of total premiums in 1996, 1995 and 1994, 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, 1996, and at other times during the year, amounts in any one institution exceeded the Federal Deposit Insurance Corporation limits.
On April 19, 1995, the Board of Directors of the Company declared a 50% stock dividend payable to shareholders of record on May 3, 1995. The dividend was distributed on May 15, 1995. Certain amounts comprising shareholders' equity in these financial statements, weighted average shares outstanding and earnings per share have been restated to reflect this dividend.
Long-term debt--The statement value approximates the fair value of mortgage debt and capitalized leases, since the instruments carry interest rates which approximate market value. The convertible, subordinated debt, as a publicly traded instrument, has a readily accessible fair market value, and, as such is reported at that value.