(4) The Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," on January 1, 1994. The cumulative effect of this adoption was an increase on January 1, 1994 in shareholders' equity of $3,529,000 to reflect the net unrealized gain (net of $1,512,000 in deferred income taxes) on investment securities classified as available for sale. As of December 31, 1994, shareholders' equity was decreased by $2,714,000 due to unrealized losses of $4,112,000 in the Company's investment portfolio. As of December 31, 1995, shareholders' equity was increased by $4,056,000 due to gains of $6,146,000 in the Company's investment portfolio. These increases were caused primarily by decreases in interest rates.
The following table sets forth the components of the Company's condensed statements of operations for the years ended December 31, 1993, 1994 and 1995, expressed as a percentage of total revenues.
Penn Treaty develops and markets insurance products designed for individuals primarily age 65 and over. The Company's principal products are individual fixed, defined benefit accident and health insurance policies covering long-term skilled, intermediate and custodial nursing home care, home health care, hospital care and policies that supplement Medicare benefits. 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. During recent years, the Company has expanded its insurance products to include home health care insurance policies, an important segment of the Company's business and of the accident and health insurance industry nationwide. As the home health care
Level of required reserves for policies in force. The amount of reserves relating to reported and unreported claims incurred is determined by periodically evaluating historical claims experience and statistical information with respect to the probable number and nature of such claims. Claim reserves reflect actual experience through the most recent time period and policy reserves reflect expectations of claims related to a block of business over its entire life. The Company compares actual experience with estimates and adjusts its reserves on the basis of such comparisons. Revisions to reserves are reflected in the Company's results of operations through benefits to policyholders expense.
Policy premium levels. The Company attempts to set premium levels to ensure profitability, subject to the constraints of competitive market conditions and state regulatory approvals.
The number of years a policy has been in effect. Claims costs tend to be higher on policies which have been in force for a longer period of time. As the policy ages, it is more likely that the insured will have need for services covered by the policy. On the other hand, the longer the policy is in effect, the more premium the Company will receive.
Other factors which affect the Company's results of operations are lapsation and persistency, both of which relate to the renewal of insurance policies, and first year compared to renewal premiums. Lapsation is the termination of a policy by nonrenewal and, pursuant to the Company's policy, is automatic if and when premiums become more than 31 days overdue; however, policies may be reinstated, if approved by the Company, within six months after the policy lapses. Conversely, persistency represents the percentage of premiums renewed, which the Company calculates by dividing the total annual premiums at the end of each year (less first year business for that year) by the total annual premiums in force for the prior year. For purposes of this calculation, a decrease in total annual premiums in force at the end of any year would be a result of non- renewal of policies, including those policies that have terminated by reason of death, lapse due to nonpayment of premiums, and/or conversion to other policies offered by the Company. First year premiums are premiums covering the first twelve months a policy is in force. Renewal premiums are premiums covering all subsequent periods.
The unaudited quarterly data for the Company for each quarter of 1994 and 1995 have been derived from unaudited financial statements and include all adjustments, consisting only of normal recurring accruals, which the Company considers necessary for a fair presentation of the results of operations for these periods. Such quarterly operating results are not necessarily indicative of the Company's future results of operations. The GAAP loss ratio for the fourth quarter of 1994 was 67.9% compared to 56.7% for the first nine months of 1994. The primary cause of this increase was an increase in policy reserves resulting from improved documentation of the Company's reserve system, which was undertaken following the engagement of the new actuarial consultant in the
Renewal life premiums earned by the Company in 1995 increased 210.7% to $1,494,153, compared to $480,842 in 1994. This increase was primarily the result of renewal of first year policies written in 1993 and 1994.
Net Investment Income. Net investment income earned by the Company in 1995 increased 36.3% to $8,102,809, compared to $5,946,034 in 1994. This increase was primarily the result of growth in the Company's investment assets due to continued premium growth during 1995 and proceeds of $22,065,000 from the Company's
General and Administrative Expenses. General and administrative expenses increased 18.6% to $12,170,913, compared to $10,262,410 in 1994. This increase was due to increases in marketing and underwriting costs associated with the introduction of a new product and increased sales. The ratio of general and administrative expenses to total revenues was 11.0% in 1995 compared to 11.6% in 1994, due to the Company's ability to control these expenses.
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.
Accident and Health Premiums. First year accident and health premiums earned by the Company in 1994, including long-term care and Medicare supplement, increased 4.4% to $26,967,973, compared to $25,836,521 in 1993.
First year long-term care premiums earned by the Company in 1994 increased 5.3% to $26,669,960, compared to $25,328,748 in 1993. This increase reflects growth in new business in California and other states. The Company believes that new business growth was moderated, in part, by consumer concerns regarding the proposed federal health care legislation. First year Medicare supplement premiums earned by the Company in 1994 decreased 41.3% to $298,013, compared to $507,773 in 1993. This decrease was due to the Company's gradual de-emphasis of its Medicare supplement products because of lower profit margins associated with this line of business.
Renewal accident and health premiums earned by the Company in 1994, including long-term care and Medicare supplement, increased 19.8% to $52,236,980, compared to $43,614,746 in 1993.
consistent with the Company's de-emphasis in marketing this product discussed above.
Life Premiums. First year life premiums earned by the Company in 1994 increased to $2,149,039, compared to $360,601 in 1993. This increase was the result of sales for the first full year of the Company's new life insurance products introduced in August 1993. Sales were enhanced during 1994 as additional states granted regulatory approvals of these new products.
Life benefits to policyholders increased to $1,260,480 from $293,621 in 1993. The life loss ratio was 47.9% in 1994, compared to 55.4% in 1993. The increase in benefits was due to increased sales of the new life products discussed above. The life loss ratio decreased as a result of a change in the life insurance product mix, reflecting the introduction of new life products discussed above.
General and Administrative Expenses. General and administrative expenses increased 9.8% to $10,262,410, compared to $9,349,746 in 1993. This increase was due to increases in personnel and underwriting costs as a result of increases in new business and utilization of stricter underwriting standards. The ratio of general and administrative expenses to total revenues was 11.6 % in 1994 compared to 12.4% in 1993, due to the Company's ability to control these expenses.
First Year Commissions. First year commissions on accident and health business increased 7.7% to $17,694,410, compared to $16,433,432 in 1993. The ratio of first year accident and health commissions to first year accident and health premiums was 65.6% in 1994 compared to 63.6% in 1993. This increase 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 increased to $1,670,785, compared to $288,038 in 1993. The ratio of first year life commissions to first year life premiums was 77.8% in 1994 compared to 80.0% in 1993, reflecting a commission structure which varies with the premium payment terms of policies. The increase in commissions paid is consistent with the growth of life premiums.
In May 1993, the Financial Accounting Standards Board issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Refer to "Liquidity and Capital Resources" for discussion of adoption.
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.
Liquidity and Capital Resources. The Company's consolidated liquidity ------------------------------- requirements have historically been created and met from the operations of the Insurers. The Company's primary sources of cash are premiums and investment income. The primary uses of cash are policy acquisition costs (principally commissions), payments to policyholders, investment purchases and general and administrative expenses.
On December 28, 1994, the Company entered into an agreement with CoreStates Bank, N.A., whereby a loan was extended to the Company in an amount of $4,000,000. The proceeds of the loan were contributed to the surplus of PTLIC in the form of cash to strengthen its overall capital position. The Company repaid this loan as required by the loan agreement, with a portion of the proceeds of the Company's recent public offering of 2,300,000 shares of common stock. The public offering was consummated on July 6, 1995 and the Company realized net proceeds of $26,165,000, including the proceeds from the exercise of the underwriters' over-allotment option.
The capital position of the Insurers was improved by the contribution of $14,000,000 of the net proceeds of the recent public offering to the capital and surplus of the Insurers during
the third quarter of 1995. During 1994, the Company contributed $4,000,000 in cash to PTLIC. During 1993, the Company contributed $2,000,000 in bonds to the Insurers. The Company believes that the Insurers' capital and surplus presently meets or exceeds the requirements in all jurisdictions in which they each are licensed.
The long-term care insurance industry is a subject of pending legislation in Congress which, in its present form, provides for a number of modifications of existing law, including the tax deductibility of long-term care insurance premiums and the implementation of minimum consumer protection standards to be included in all long-term care insurance policies. See "Government Regulation." There can be no assurance that such legislation will be enacted or, if enacted, that the current proposals will be included.
power of senior citizens, the Company's results of operations, liquidity and capital resources could be adversely affected.
Financial Statements: Consolidated Balance Sheets at December 31, 1995 and 1994 3
Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993 4
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993 5
We have audited the accompanying consolidated balance sheets of Penn Treaty American Corporation and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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.
Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993
* Restated to reflect a 50% stock dividend, see Note 13.
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994* and 1993*
The accompanying consolidated financial statements of Penn Treaty American Corporation and its Subsidiaries (the Company) have been prepared in accordance with generally accepted accounting principles (GAAP) and include Penn Treaty Life Insurance Company (PTLIC), Senior Financial Consultants Company and Network America Life Insurance Company (Network America). All significant intercompany transactions and balances have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform with the current year presentation.
The costs primarily related to and varying with the acquisition of new business, principally commissions, underwriting and policy issue expenses, have been deferred. These deferred costs are amortized over the related premium-paying periods utilizing the same projected premium assumptions used in computing reserves for future policy benefits. Net policy acquisition costs deferred, on the consolidated statements of operations, are net of amortization of $6,859,194, $7,010,329, and $6,567,642 for the years ended December 31, 1995, 1994, and 1993, respectively.
The costs in excess of fair value of net assets acquired are being amortized to expense on a straight-line basis over a 40-year period.
Premiums on accident and health insurance, the majority of which is guaranteed renewable, and life insurance are recognized when due. Premiums on credit life and credit accident and health insurance are reported as earned in proportion to the amount at risk over the contract term. Estimates of premiums due but not yet collected are accrued.
Policy and contract claims include amounts representing: (1) the actual in force amounts for reported life claims and an estimate of incurred but unreported claims; (2) an estimate, based upon prior experience, for accident and health claims reported, and incurred but unreported losses. The methods for making such estimates and establishing the resulting liabilities are continually reviewed and updated and any adjustments resulting therefrom are reflected in earnings currently.
The establishment of appropriate reserves is an inherently uncertain process, and there can be no assurance that the ultimate liability will not materially exceed the Company's claim and policy reserves and have a material adverse effect on the Company's results of operations and financial condition. Due to the inherent uncertainty of estimating reserves, it has been necessary, and may over time continue to be necessary, to revise estimated future liabilities as reflected in the Company's policy reserves and policy and contract claims .
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 loss ratios and may be required to adjust further its reserve levels with respect to this product.
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.
Gross proceeds and realized gains and losses on the sales of debt securities, excluding calls, were as follows:
Gross unrealized gains (losses) pertaining to equity securities were as follows:
The Company's bond investment portfolio is entirely comprised of investment grade securities at December 31, 1995. Securities are classified as "investment grade" by utilizing ratings furnished by independent bond rating agencies.
Policy and contract claims include approximately $38,150,000 and $31,096,000 at December 31, 1995 and 1994, respectively, that are discounted at varying interest rates. The amount of discount was $2,044,000 and $1,633,000 at December 31, 1995 and 1994, respectively.
Mortgage and other debt at December 31, 1995 and 1994 are as follows:
At December 31, 1995, 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, 1995, the combined balance in the "Shareholders' Surplus" account amounted to approximately $19,145,000. There is no present intention to make distributions in excess of "Shareholders' Surplus."
Under Pennsylvania insurance law, dividends may be paid from PTLIC or Network America only from statutory profits of earned surplus and require Insurance Department approval if the dividend is in excess of the greater of 10% of surplus or net statutory income of the prior year.
The Company's contributions become 20% vested after two years of service and are vested ratably over seven years, at which point all contributions are fully vested. Pension expense was $55,000, $70,000, and $60,000 for the years ended December 31, 1995, 1994 and 1993, respectively.
Since the inception of the plan, 43,775 options have been exercised and 20,886 options have been canceled.
In October 1995, Statement of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation," was issued. SFAS No. 123, which is effective January 1, 1996, provides an alternative method of accounting for stock-based compensation arrangements, based on 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 stock. The accounting under SFAS No. 123 differs from the existing method of accounting for stock-based compensation which is provided in Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for Stock Issued to Employees." 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 No. 123 on net income and earnings per share would be required in the 1996 financial statements. The Company will continue to apply APB No. 25 and, therefore, there will be no impact on the financial position and results of operation.
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, 1995 and 1994 were approximately $662,000 and $520,000, respectively.
Network America is party to a Reinsurance Agreement to cede 100% of certain whole life and deferred annuity policies to be issued by Network America to a third party insurer. These policies are intended for the funeral arrangement or "pre-need" market. Total reserve credits taken related to this agreement as of December 31, 1995 and 1994 were approximately $3,735,000 and $3,131,000, respectively. The third party reinsurer maintains securities at least equal to the statutory reserve credit in escrow with a bank.
Irv Levit Insurance Management Corporation ("IMC"), an insurance agency which is owned by the President of the Company, produced approximately $62,000, $65,000, and $72,000 of new and renewal premiums for PTLIC, for the years ended December 31, 1995, 1994 and 1993, respectively, for which it received commissions of approximately $14,000, $15,000 and $17,000, respectively.
A managing general agent accounted for approximately 18%, 20% and 21% of total premiums in 1995, 1994 and 1993, 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, 1995, and at other times during the year, amounts in any one institution exceeded the Federal Deposit Insurance Corporation limits.
On March 12, 1996, the Company entered into an Agreement and Plan of Merger with Health Insurance of Vermont, Inc. (HIVT). Per the terms of this agreement, each share of HIVT common stock shall be converted into shares of Penn Treaty American Corporation common stock (based on the average closing bid price for an agreed-upon period prior to the merger date) plus $4.00 of per share cash consideration. Total consideration paid in stock and cash will be approximately $11,002,000. This merger is subject to the approval of HIVT shareholder and regulatory authorities.
For the year ended December 31, 1995, HIVT had premium income and net income of $6,284,099 and $190,494, respectively. As of December 31, 1995, HIVT had shareholders' equity of $8,719,980.
The Company believes that this transaction will give them immediate access to do business in New Jersey, West Virginia, Kansas, Maine, and Massachusetts. The Company would then be licensed in the entire United States with the exception of New York. The merger will also expand the Company's agency force by the 2,500 life and health agents currently licensed with HIVT.