SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended _____December 31, 2001_______________________________
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to __________
Commission file Number ___022316_____
____________PENN-AMERICA GROUP, INC.____________________________________________
(Exact Name of Registrant as Specified in Its Charter)
____________Pennsylvania_________________________________________23-2731409_____
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
____________420 S. York Road, Hatboro, PA____________ ______19040___________
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code ______(215) 443-3600_________
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on
Which Registered
_Common stock, par value, per share______________New York_______________________
Securities registered pursuant to Section 12(g) of the Act:
____None________________________________________________________________________
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _____.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
As of March 22, 2002, the aggregate market value of the outstanding Common Stock
held by non-affiliates of the Registrant was approximately $69,149,535. As of
March 22, 2002, there were 11,546,204 shares of the Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's definitive Proxy Statement with respect to the
Registrant's 2002 Annual Meeting of Shareholders, to be filed not later than 120
days after the close of the Registrant's fiscal year, are incorporated by
reference in Part III of this report.
PENN-AMERICA GROUP, INC.
ANNUAL REPORT ON FORM 10-K/A
DECEMBER 31, 2001
Page
PART I
ITEM 1. BUSINESS...........................................................3
ITEM 2. PROPERTIES........................................................19
ITEM 3. LEGAL PROCEEDINGS.................................................19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY-HOLDERS..................................................19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK
AND RELATED STOCKHOLDER MATTERS...................................20
ITEM 6. SELECTED FINANCIAL DATA...........................................21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.....................22
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK.......................................................35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE........................................................61
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT........................................................62
ITEM 11. EXECUTIVE COMPENSATION............................................62
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT.............................................62
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................62
ITEM 14. CONTROLS AND PROCEDURES...........................................63
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K...............................................64
Page 2
PART I
Explanatory Note
Penn-America Group, Inc. ("PAGI" or the "Company") has recently resolved various
accounting and disclosure comments from the Securities and Exchange Commission
("SEC"), in conjunction with the Company's registration statement filing
relating to the issuance of additional shares of common stock. One of the
comments addressed the timing of recording other-than-temporary ("OTT") declines
in the market value of certain equity securities. In order to resolve the
comments, the Company agreed to amend its accounting policy and record OTT
write-downs on these securities for the periods ending December 31, 2001, 2000
and 1999. This restatement affects net income for each of these periods but has
no affect on stockholders' equity since the unrealized loss on these securities
was already recorded in Accumulated Other Income (Loss) in the Consolidated
Balance Sheets and Statements of Stockholders' Equity. The Company has restated
its financial statements for the affected periods and has filed such
restatements on this amended Form 10-K for the year ended December 31, 2001. For
further information, see Note 1 of the Notes to Consolidated Financial
Statements.
In addition, the SEC staff requested that PAGI add certain disclosures or not
report certain items. Business, Selected Financial Data, the Consolidated
Financial Statements and Managements' Discussion and Analysis of Financial
Condition and Results of Operations, included herein, have been amended as
appropriate to respond to these requests.
The filing of this amended Form 10-K shall not be deemed an admission that the
original filing, when made, included any untrue statement of a material fact or
omitted to state a material fact necessary to make a statement not misleading.
ITEM 1. BUSINESS
General
Penn-America Group, Inc. ("PAGI") is a specialty property and casualty insurance
holding company which, through its subsidiary, Penn-America Insurance Company
("Penn-America") and its subsidiary, Penn-Star Insurance Company ("Penn-Star")
(collectively the "Company"), markets and underwrites commercial property,
general liability and multi-peril insurance for small businesses located
primarily in small towns and suburban and rural areas. Penn-America writes
business in all fifty states and the District of Columbia. The Company writes
business on both an admitted and non-admitted (excess and surplus lines) basis
in thirty-six states, on only an admitted basis in two states and on only a
non-admitted basis in twelve states and the District of Columbia. The Company
chooses in each state whether to write business on an admitted or non-admitted
basis based upon the Company's analysis of competition in each state. Writing
business on an admitted basis is highly regulated. The regulations, which vary
by state, generally govern licensing, underwriting rules, rates and policy
forms, and require insurance companies to pay premium taxes and guaranty fund
assessments. Writing business on a non-admitted basis is significantly less
regulated and provides much more freedom in setting rules, rates and policy
forms and removes insurance companies from premium taxes and guaranty fund
assessment liabilities. Coverage written on a non-admitted basis is less
comprehensive than coverage issued on an admitted basis. If the Company chooses
non-admitted status, the Company could be at a competitive disadvantage to
carriers writing on an admitted basis if those competitors choose to offer
coverages which are more comprehensive and attractive to an insured. Further,
surplus lines agents are prohibited from writing nonadmitted business in states
in which they are not resident. Thus, if the Company does not have resident
surplus lines agents in every state (currently, we do not in 7 states), the
Company is precluded from writing business on a non-admitted basis in those
states.
Page 3
Penn-America Insurance Company was formed in 1975 by Irvin Saltzman, Chairman of
the Board of Directors, who began working in the insurance industry in 1947 when
he founded a general agency. The Company completed an initial public offering
("IPO") on October 28, 1993, at a price of $4.00 per share, which was then
followed by a secondary offering in July of 1997 where 4,537,500 shares were
sold by the Company for net proceeds of approximately $9.67 per share.
Currently, the Saltzman family, substantially through their ownership of Penn
Independent Corporation ("Penn-Independent"), owns approximately 40% of the
Company's Common Stock. Jon S. Saltzman, Irvin Saltzman's son, is a Director,
President and Chief Executive Officer of the Company and has been employed by
the Company since 1986. Prior to 1986, Jon Saltzman was employed by Penn
Independent from 1976 to 1986.
Marketing and Distribution
Penn-America's commercial insureds consist primarily of small, "Main Street"
businesses including restaurants, mercantiles and non-residential service
contractors. In addition, the Company has developed customized products and
coverages for other small commercial insureds such as daycare facilities,
fitness centers and special events. The Company believes it has benefited from a
general migration of small businesses out of urban centers and into suburban and
rural areas. Industry consolidation, corporate downsizing and the increased use
of communications technology and personal computers, among other factors, have
contributed to the high growth in the number of small businesses in these areas.
The Company selects only insurance lines of business and industry segments for
which it reasonably can estimate future loss costs and the resulting price
levels needed to produce a satisfactory return to the Company. Therefore, the
Company avoids high-hazard risks and high-hazard lines of business such as
medical malpractice and environmental liability.
Penn-America markets its products through fifty-seven (57) general agents, who
in turn produce business through more than 25,000 retail insurance brokers
located throughout the United States. The Company focuses on serving the
insurance needs of small businesses in small towns and rural areas that are
serviced by retail insurance brokers with limited access to larger, standard
lines insurers. The Company believes that larger, standard lines insurers, which
often limit their underwriting to larger policies and to certain risk classes,
generally underserve these markets. Penn-America believes that its distribution
network enables it to effectively access these numerous small markets at a
relatively low fixed-cost through the marketing, underwriting and administrative
support of its general agents. This access also is enabled by the local market
knowledge and expertise of these general agents and their retail insurance
brokers.
Penn-America's distribution strategy is to maintain strong relationships with a
select group of high-quality general agents. The Company carefully selects a
limited number of general agents based on their experience and reputation and
strives to preserve each agent's franchise value within its marketing territory.
The Company seeks to grow with these general agents and develop strong,
long-standing relationships by providing a high level of service and support.
The success of the Company's strategy is demonstrated by its strong and
consistent growth. From 1992 to 2001, commercial gross written premiums grew at
an 18% compound annual rate from $22.6 million to $98.4 million while the number
of general agents rose from 38 to 57.
Core Commercial Business
The Company underwrites its core commercial business (excluding the Company's
exited commercial automobile business - see Exited Lines, below) on a Binding
Authority, Submit and Specialty Lines basis, which are defined as follows:
o Binding authority business represents risks that may be quoted and
bound by the Company's general agents prior to the Company's
underwriting review.
Page 4
o Submit business represents risks that must be submitted by the
Company's general agents to the Company prior to quoting or binding the
account.
o Specialty lines business represents risks that meet specific,
pre-determined industry-segment and territorial parameters and may be
quoted or bound by the Company's general agents prior to the Company's
underwriting review.
Binding Authority business accounted for approximately 88% of the Company's core
commercial gross written premiums in 2001. Of this amount, approximately 85% is
bound by general agents in accordance with the Company's underwriting manual.
New and renewal Binding Authority business issued by the general agents is
reviewed on a continuous basis to ensure that the Company's underwriting
guidelines are followed. The Company provides its general agents with a
comprehensive, regularly updated underwriting manual, which also is available
online through a private intranet site called PennLink. This manual clearly
outlines the Company's risk eligibility, pricing, underwriting guidelines and
policy issuance instructions. Penn-America closely monitors the underwriting
quality of its business through online system edits and in-force account
reviews. The Company also periodically audits each agent's office to determine
if the Company's underwriting guidelines are followed in all aspects of risk
selection, underwriting compliance, policy issuance and pricing. In addition to
standard commissions, the Company provides strong incentives to its general
agents to produce profitable business through a contingent profit commission
structure that is tied directly to underwriting profitability. Payments of these
contingent profit commissions have been through the issuance of shares of PAGI
common stock and cash. Since 1996, the Company has awarded agents approximately
276,000 shares of PAGI common stock through its contingent profit commission
structure.
The Company began writing business on a Submit basis in 1999 in response to
general agents who had risks similar to the Company's risk profile but were
outside of their underwriting authority. This provides a market to the Company's
general agents for approximately fifty classes of business. One hundred percent
of the business is quoted and bound by Penn-America underwriters; general agents
have no binding authority. This business accounted for approximately 5% of core
commercial gross written premiums in 2001.
Specialty Lines business, which accounted for 7% of the Company's core
commercial gross written premiums in 2001, represents specialized underwriting
and marketing programs for individual general agents based upon specific
territorial needs and opportunities. An individual general agent typically is
given exclusive marketing authority for a special program subject to territorial
limitations. The Company believes it can achieve superior underwriting results
and expense savings on these programs. The Company continuously is developing
specialized programs for certain industry segments to meet the needs of insureds
in these segments. For example, Penn-America has developed programs for cargo
and Alaskan dwellings. Collectively, these programs are a significant benefit to
Penn-America's marketing efforts.
Exited Lines
The Company offered commercial automobile coverage from 1998 through the first
quarter of 2001. In late 2000, the Company announced that it was exiting this
line of business due to unsatisfactory underwriting results. No new policies
have been written since the first quarter of 2001 and all policies are being
non-renewed. Gross written premiums for commercial automobile business decreased
to $1.1 million in 2001 from $11.5 million in 2000 and $7.0 million in 1999.
The Company exited the non-standard personal automobile business in 1999 and, as
a result, gross written premiums declined to $2,000 in 2001 from $2.8 million in
2000 and $11.5 million in 1999.
Page 5
Financial Information About Business Segments
The Company has two reportable segments: personal lines and commercial lines.
The Company exited the non-standard personal automobile business in 1999 and
announced that it would run-off its remaining portfolio of such business. The
Company will continue to report on this segment separately until the amounts
relating to the non-standard personal automobile business become immaterial to
the financial statements presented. These segments were managed separately
because they have different customers, pricing and expense structures. The
Company does not allocate assets between segments because assets are reviewed in
total by management for decision-making purposes.
The accounting policies of the segments are the same as those more fully
described in the summary of significant accounting policies in Note 1 to the
consolidated financial statements, included herein . The Company evaluates
segment profit based on profit or loss from operating activities. Segment profit
or loss from operations is pre-tax and does not include unallocated expenses but
does include investment income attributable to insurance transactions. Segment
profit or loss therefore excludes income taxes, unallocated expenses and
investment income attributable to equity. The aforementioned segment information
is presented in Note 8 to the consolidated financial statements included herein.
The following table sets forth the geographic distribution of the Company's
gross written premiums for the periods indicated:
Years ended December 31,
-----------------------------------------------------------------------------------------------------
2001 2000 1999
------------------------------- ------------------------------- -------------------------------
(Dollars in Thousands) Amount Percent Amount Percent Amount Percent
Pacific $ 15,613 15.9% $ 19,961 18.2% $21,404 22.3%
Midwest 17,338 17.6 21,768 19.8 17,516 18.2
South 17,021 17.3 16,539 15.1 13,812 14.4
Southwest 12,306 12.5 15,532 14.1 13,971 14.6
Mid-Atlantic 17,633 17.9 17,253 15.7 12,496 13.0
Mountain/Northwest 8,088 8.2 10,457 9.5 10,849 11.3
New England 10,413 10.6 8,281 7.6 5,935 6.2
-------------- ------------ --------------- ------------ --------------- ------------
$ 98,412 100.0% $109,791 100.0% $95,983 100.0%
============== ============ =============== ============ =============== ============
Page 6
Lines of Business
The following table sets forth an analysis of gross written premiums by specific
product lines during the periods indicated:
Years ended December 31,
------------------------------------------------------------------------------------------------
2001 2000 1999
----------------------------- ------------------------------- ----------------------------
(Dollars in thousands) Amount Percent Amount Percent Amount Percent
Core commercial lines
Special property $10,118 10.3% $5,930 5.4% $ 5,374 5.6%
CMP - property 36,381 37.0 32,677 29.8 25,418 26.5
CMP - liability 27,348 27.8 27,660 25.2 21,649 22.6
Other & product liability 23,483 23.8 29,268 26.6 24,966 26.0
----------- ------------ --------------- -------------- --------------- ------------
Total core commercial 98.9 80.7
97,330 95,535 87.0 77,407
Exited lines
Commercial auto liability 874 0.9 8,779 8.0 5,477 5.7
Commercial auto physical damage 206 0.2 2,690 2.5 1,569 1.6
Personal lines 2 - 2,787 2.5 11,530 12.0
----------- ------------ --------------- -------------- --------------- ------------
Total exited lines 1,082 1.1 14,256 13.0 18,576 19.3
----------- ------------ --------------- -------------- --------------- ------------
Total gross written premiums $ 98,412 100.0% $109,791 100.0% $95,983 100.0%
=========== ============ =============== ============== =============== ============
o The Company's Commercial General Liability insurance is written on an
occurrence policy form, which generally provides coverage for bodily injury
or property damage that arises during the policy period, even though a
claim is made after the policy expires, as opposed to a claims-made policy
form, which generally provides coverage for claims made against an insured
during the policy period, irrespective of when the bodily injury or
property damage occurred. The Company's insurance coverage provides limits
generally ranging from $25,000 to $3 million per occurrence, with the
majority of such policies having limits between $500,000 and $1 million.
The Company's general liability policies provide for defense and related
expenses in addition to per occurrence and aggregate policy limits.
o The Company's Commercial Property lines provide limits usually no higher
than $2 million per risk, with almost all of the policies being written at
limits of $1 million per risk or less.
o The Company writes Commercial Multi-Peril policies that provide the same
commercial property and general liability coverages bundled together as a
"package" for its insureds. The limits on these policies are the same as if
written on a monoline basis.
o The Company also offers Commercial Umbrella policies to enhance its
commercial multi-peril and commercial general liability writings.
Commercial umbrella insurance is written for limits up to $5 million per
occurrence. For commercial umbrella coverage, Penn-America usually writes
the primary $1 million liability limit.
o Commercial Automobile policies were written with liability limits up to $1
million per occurrence.
o Non-Standard Personal Automobile policies were written with liability
limits up to $100,000 per person and $300,000 per occurrence.
Page 7
Pricing
In the commercial property and casualty market, the rates and terms of coverage
provided by property and casualty insurance carriers are frequently based on
benchmarks and forms promulgated by the Insurance Services Office ("ISO"). ISO
makes available to its members advisory rating, statistical and actuarial
services, policy language and other related services. ISO currently provides
such services to more than 1,500 property and casualty insurance companies in
the U.S. One of the services that ISO provides is an actuarial-based estimate of
the expected loss cost for risks in each of approximately 1,000 risk
classifications. These benchmark loss costs reflect an analysis of the loss and
allocated loss adjustment expenses on claims reported to ISO. ISO statistics,
however, include only claims and policy information reported to ISO, and
therefore do not reflect all of the loss experience for each class. Also, the
historical results for a particular class may not be sufficient to provide
actuarially meaningful results.
The Company primarily uses ISO statistics as a benchmark for risk selection and
pricing. Other carriers may or may not rely as heavily on this information, and
several of the larger standard carriers have developed their own actuarial
databases. As a general rule, most standard lines insurers set rates lower than
ISO benchmarks. However, the Company, because of its strategy of providing
insurance to underserved markets, typically charges 100% or more of prescribed
ISO benchmarks. Generally, the Company establishes a pricing strategy on a
countrywide basis that is designed to support its loss costs and operating
expenses plus a targeted return on equity. This pricing strategy is regionalized
to incorporate variables such as historical loss experience, the types and lines
of business written and state regulatory considerations. The Company provides
its general agents with pricing flexibility on a per-policy basis, with the
objective that in the aggregate, the weighted average premium of all new and
renewal commercial policies written by a general agent are at approximately
110-150% of ISO benchmarks.
Claims Management and Administration
Commercial Claims:
The Company's approach to commercial claims management is designed to
investigate reported incidents at the earliest juncture, to select, manage and
supervise all legal and adjustment aspects thereof and to provide a high level
of service and support to general agents, retail insurance brokers and insureds
throughout the claims process. The Company's commercial general agents have no
authority to settle commercial claims or otherwise exercise control over the
claims process. All commercial lines claims are supervised and processed
centrally by the Company's claims management staff. Senior claims management
reviews all claims greater than $25,000.
Discontinued Personal Automobile Claims:
All claims for the personal automobile business are handled by the Company's
internal claims unit. Prior to February 1, 2000, if an automobile claim was in
the States of California or Washington, they were handled by outside third-party
claims management companies.
Insurance Loss Reserves
The Company is directly liable for losses and loss adjustment expenses under the
terms of the insurance policies that it writes. In many cases, several years may
lapse between the occurrence of an insured loss, the reporting of the loss to
the Company and the Company's payment of that loss. The Company reflects its
liability for the ultimate payment of all incurred losses and loss adjustment
expenses by establishing loss and loss adjustment expense reserves as balance
sheet liabilities for both reported and unreported claims.
Page 8
When a claim involving a probable loss is reported, the Company establishes a
case reserve for the estimated amount of the Company's ultimate loss. The
estimate of the amount of the ultimate loss is based upon such factors as the
type of loss, jurisdiction of the occurrence, knowledge of the circumstances
surrounding the claim, severity of injury or damage, potential for ultimate
exposure and policy provisions relating to the claim. Loss adjustment expenses
are determined via a formula method that estimates loss adjustment expenses as a
percentage of expected indemnity losses based on historical patterns adjusted to
current experience.
In addition to case reserves, management establishes reserves on an aggregate
basis to provide for incurred but not reported losses and loss adjustment
expenses ("IBNR"). The establishment of reserves for IBNR requires an estimate
of the ultimate liability based primarily on past experience. The Company
applies a variety of traditional actuarial techniques to determine its estimate
of ultimate liability. The techniques recognize, among other factors, the
Company's and the industry's experience, historical trends in reserving patterns
and loss payments, the impact of claim inflation, the pending level of unpaid
claims, the cost of claim settlements, the line of business mix and the economic
environment in which property and casualty insurance companies operate.
Estimates continually are reviewed and, based on new developments and new
information, adjustments of the probable ultimate liability are included in
operating results for the periods in which the adjustments are made. In general,
reserves are established initially based upon the actuarial and underwriting
data utilized to set pricing levels and are reviewed as additional information,
including claims experience, becomes available. The establishment of loss and
loss adjustment expense reserves makes no provision for the broadening of
coverage by legislative action or judicial interpretation or for the
extraordinary future emergence of new types of losses not sufficiently
represented in the Company's historical experience, or which cannot yet be
quantified. The Company regularly analyzes its reserves and reviews its pricing
and reserving methodologies so that future adjustments to prior year reserves
can be minimized. However, given the complexity of this process, reserves will
require continual updates and the ultimate liability may be higher or lower than
previously indicated. The Company does not discount its loss reserves.
Activity in the liability for unpaid losses and loss adjustment expenses is
summarized as follows:
Year ended December 31,
----------------------------------------------
2001 2000 1999
------------- ------------ -------------
(in thousands)
Balance, beginning of year $115,314 $93,719 $88,937
Less reinsurance recoverable 24,093 18,086 16,502
------------- ------------ -------------
Net balance, beginning of year 91,221 75,633 72,435
Incurred related to:
Current year 60,885 66,214 54,768
Prior years 36 9,164 8,419
------------- ------------ -------------
Total incurred 60,921 75,378 63,187
Paid related to:
Current year 19,913 26,273 23,540
Prior years 38,183 33,517 36,449
------------- ------------ -------------
Total paid 58,096 59,790 59,989
Net balance, end of year 94,046 91,221 75,633
Plus reinsurance recoverable 25,552 24,093 18,086
------------- ------------ -------------
Balance, end of year $119,598 $115,314 $93,719
============= ============ =============
In 2001, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $36,000. This increase related
entirely to the commercial automobile line of business. During 2001, the Company
increased its estimate for the commercial multi-peril liability line of business
by $1.8 million due to the development of outstanding claim reserves on claims
occurring primarily in 1998 and 1999.
Page 9
This increase was almost entirely offset by a reduction in the Company's
estimate for the non-standard personal automobile line of business due to
favorable settlements on closed claims.
In 2000, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $9,164,000. The increase is
primarily attributable to changes in the Company's estimates for losses and loss
adjustment expense reserves of $1,400,000 for commercial automobile, $3,900,000
for commercial multi-peril liability and $3,400,000 for other liability lines of
business.
The Company began writing commercial automobile coverage for vehicles and light
trucks in 1998. The initial estimates for 1998 and 1999 were based on a
relatively low level of claims reported to the Company. In 2000, the Company
received a significant number of claims relating to accidents incurred in 1998
and 1999. In the fourth quarter of 2000, the Company exited the commercial
automobile line of business due to unsatisfactory underwriting results.
The change in estimates in 2000 for the commercial multi-peril liability line of
business resulted principally from increased exposure to liquor liability losses
for policies primarily written in 1998 and 1999. In 2000, the Company revised
its underwriting approach significantly to reduce its exposure to liquor
liability.
The change in estimates in 2000 for the other liability line resulted
principally from construction defect claims, which were new types of claims that
were not anticipated when the Company wrote these policies between 1991 and
1996. These claims predominantly related to residential contractors and
sub-contractors in California. In 2000, the Company completed its withdrawal
from the residential contractors and sub-contractors industry segment.
In 1999, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $8,419,000. The increase is
primarily attributable to changes in estimates for losses and loss adjustment
expense reserves for non-standard personal automobile line of business. In 1999,
the Company received a significant number of claims relating to accidents
incurred prior to 1999, resulting in an increase in loss estimates. In 1999, the
Company exited the non-standard personal automobile lines.
Incurred losses and loss adjustment expenses include estimates, recorded as loss
and loss adjustment expense reserves on the balance sheet, for the ultimate
payment on both reported and unreported claims. The Company changes its
estimates for loss and loss adjustment expenses reserves as new events occur, as
more loss experience is acquired or as additional information is received.
Estimates for loss and loss adjustment expense reserves result from a continuous
review process and the change in these estimates, as required by Financial
Accounting Standards Board No. 60, Accounting and Reporting by Insurance
Enterprises, paragraph 18, is recorded in the period that the change in these
estimates is made.
The Company believes that its loss and loss adjustment expense reserves are
fairly stated as of December 31, 2001 due to the exiting of non-standard
personal and commercial automobile lines of business and the reduction in
exposure to construction defect and liquor liability losses. In addition, the
Company implemented improvements in the loss reserving process, including the
development of monthly and quarterly loss and loss adjustment expense reserve
analyses and the creation of a reserve committee that meets quarterly.
The following table presents the Company's accident year loss and loss
adjustment expense ratios (the sum of losses and loss adjustment expenses
divided by premiums earned) for the ten most recent accident years (the year in
which the loss occurred), as recorded as of December 31, 1999, 2000 and 2001
after giving effect to the increase in loss and loss adjustment expenses
relating to changes in estimates of insured events of prior years. These
"accident year" loss ratios differ from the loss ratios included in the
Company's financial statements set forth elsewhere in this report in that the
Page 10
latter loss ratios are based upon the year in which losses are recognized for
accounting purposes, regardless of when the loss actually occurred or was
reported. See the notes to the consolidated financial statements included
herein.
As of December 31,
------------------------------------------------
Accident Year 1999 2000 2001
------------ -------------- ------------
1992 69.6 72.1 72.5
1993 70.9 70.2 71.3
1994 69.1 72.0 71.8
1995 63.9 65.4 65.1
1996 68.1 68.3 69.4
1997 62.4 62.0 62.1
1998 63.6 65.8 65.0
1999 63.8 68.2 70.0
2000 72.4 70.2
2001 68.5
The following table represents the development of unpaid loss and loss
adjustment expense reserves during the ten years ended December 31, 2001. The
top of the table reflects the ten-year development of the Company's reserves,
net of reinsurance. The bottom of the table reconciles 1992 through 2001 ending
reserves to the gross reserves in the Company's consolidated financial
statements. Prior to 1992, the Company developed its reserves on a net of
reinsurance basis and restatement for those prior years is not presented. The
top line of the table shows the estimated reserve for unpaid loss and loss
adjustment expenses at the balance sheet date for each of the indicated years.
These figures represent the estimated amount of unpaid loss and loss adjustment
expenses for claims arising in all prior years that were unpaid at the balance
sheet date, including losses that had been incurred but not yet reported. The
table also shows the re-estimated amount of the previously recorded reserve
based on experience as of the end of each succeeding year. The estimate changes
as more information becomes available about the frequency and severity of
claims. The cumulative redundancy or deficiency represents the aggregate change
in the reserve estimates over all prior years.
Page 11
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
---------------------------------------------------------------------------------------------------------------
Reserves for unpaid
losses and loss
adjustment $25,681 $26,110 $26,830 $35,307 $46,512 $55,656 $68,863 $72,435 $75,633 $91,221 $94,046
Expenses,
as stated
(In thousands)
a. Net cumulative
paid as of
1 year later $6,605 $7,381 $6,852 $12,383 $17,208 $23,660 $30,236 $36,449 $34,626 38,183
2 years later 10,988 11,127 13,127 20,617 29,612 38,819 51,141 55,718 57,415
3 years later 13,325 15,546 18,656 27,266 38,091 50,982 63,470 70,370
4 years later 16,417 19,253 22,254 32,119 44,016 57,613 72,651
5 years later 19,283 21,503 24,303 34,883 48,236 62,724
6 years later 20,872 22,796 25,642 37,687 51,485
7 years later 21,881 23,714 27,121 39,863
8 years later 22,452 24,959 28,449
9 years later 23,303 25,979
10 years later 24,006
b. Reserves
re-estimated as
of end of year
1 year later $23,228 $24,478 $23,897 $33,601 $45,708 $55,997 $68,946 $80,855 $84,797 $91,257
2 years later 22,383 21,945 23,489 34,281 47,225 57,913 76,217 86,351 86,863
3 years later 20,471 22,032 24,558 36,453 47,378 63,575 79,881 86,899
4 years later 20,819 22,767 26,335 36,359 50,704 67,310 81,226
5 years later 21,726 23,935 26,380 38,768 54,245 68,567
6 years later 22,550 24,143 27,532 41,425 54,740
7 years later 22,761 24,776 29,050 42,095
8 years later 23,117 26,485 29,804
9 years later 24,280 26,948
10 years later 24,644
Net cumulative
redundancy
(deficiency) $1,037 ($839) ($2,974) ($6,788) ($8,228) ($12,911) ($12,363) ($14,463) ($11,230) ($36)
Gross liability
for unpaid
losses and
loss adjustment
expenses,
as stated $31,703 $33,314 $44,796 $60,139 $70,728 $84,566 $88,937 $93,719 $115,314 $119,598
Reinsurance recoverable 5,593 6,484 9,489 13,627 15,072 15,703 16,502 18,086 24,093 25,552
Net liability for unpaid
losses and loss adjustment
expenses, as stated 26,110 26,830 35,307 46,512 55,656 68,863 72,435 75,633 91,221 94,046
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated
- 1 year later 30,609 32,796 48,173 63,884 71,644 85,640 98,395 101,597 115,350
Reinsurance
recoverable
re-estimated 6,131 8,899 14,572 18,176 15,647 16,694 17,540 16,800 24,093
Net liability
re-estimated -
1 year later 24,478 23,897 33,601 45,708 55,997 68,946 80,855 84,797 91,257
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated -
2 years later 30,390 36,243 53,009 66,405 74,312 92,832 104,664 104,137
Reinsurance
recoverable
re-estimated 8,445 12,754 18,728 19,180 16,399 16,615 18,313 17,274
Net liability
re-estimated -
2 years later 21,945 23,669 34,281 47,225 57,913 76,217 86,351 86,863
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated -
3 years later 33,992 41,600 56,042 66,891 80,574 97,786 105,248
Reinsurance
recoverable
re-estimated 11,960 17,042 19,589 19,513 16,999 17,905 18,349
Net liability
re-estimated
- 3 years later 22,032 24,558 36,453 47,378 63,575 79,881 86,899
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated
- 4 years later 38,165 43,824 56,167 68,927 84,831 98,244
Reinsurance
recoverable
re-estimated 15,398 17,489 19,808 18,223 17,521 17,018
Net liability
re-estimated
- 4 years later 22,767 26,335 36,359 50,704 67,310 81,226
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated -
5 years later 39,956 44,466 58,272 73,042 85,221
Reinsurance
recoverable
re-estimated 16,021 18,086 19,504 18,797 16,654
Net liability
re-estimated
- 5 years later 23,935 26,380 38,768 54,245 68,567
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated
- 6 years later 40,670 45,595 61,814 72,978
Reinsurance
recoverable
re-estimated 16,527 18,063 20,389 18,238
Net liability
re-estimated
- 6 years later 24,143 27,532 41,425 54,740
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated
- 7 years later 41,679 47,955 61,766
Reinsurance
recoverable
re-estimated 16,903 18,905 19,671
Net liability
re-estimated
- 7 years later 24,776 29,050 42,095
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated
- 8 years later 43,958 48,032
Reinsurance
recoverable
re-estimated 17,473 18,228
Net liability
re-estimated
- 8 years later 26,485 29,804
-------- --------- ---------- --------- ---------- ---------- ---------- ---------- ---------- --------
Gross liability
re-estimated
- 9 years later 44,248
Reinsurance
recoverable
re-estimated 17,300
Net liability
re-estimated
- 9 years later 26,948
Gross cumulative
deficiency ($12,545) ($14,718) ($16,970) ($12,838) ($14,493) ($13,678) ($16,311) ($10,418) ($36)
Page 12
The table below illustrates the sensitivity to a hypothetical change in the
Company's net loss and loss adjustment expense reserves as of December 31, 2001.
The selected scenarios are not predictions of future events, but rather
illustrative of the effect that such events may have on stockholders' equity.
Hypothetical
Percentage
Balance of Net Change in Net Increase
Loss and Loss Loss and Loss (Decrease) in
Hypothetical Change in Net Loss and Loss Adjustment Adjustment Adjustment Stockholders'
Expense Reserve Expense Reserves Expense Reserve Equity
------------------- ----------------- ---------------
3% increase $96,867 $2,821 (2.3)%
2% increase 95,927 1,881 (1.5)
1% increase 94,986 940 (0.8)
No change 94,046 --- ---
1% decrease 93,106 (940) 0.8
2% decrease 92,165 (1,881) 1.5
3% decrease 91,225 (2,821) 2.3
The following table sets forth ratios for the Company and the industry prepared
in accordance with statutory accounting practices ("SAP") prescribed or
permitted by state insurance authorities. The statutory combined ratio, which
reflects underwriting results but not investment income, is a traditional
measure of the underwriting performance of a property and casualty insurer. This
ratio is the sum of (i) the ratio of incurred losses and loss adjustment
expenses to net earned premium ("loss ratio"); and (ii) the ratio of expenses
incurred for commissions, premium taxes, administrative and other underwriting
expenses to net written premium ("expense ratio").
Years ended December 31,
---------------------------------------
2001 2000 1999
------------ ----------- ------------
The Company:
SAP Basis (3)
Loss and loss adjustment expense ratio 68.5 82.4 73.8
Expense ratio 33.6 33.2 34.9
------------ ----------- ------------
Combined ratio 102.1 115.6 108.7
============ =========== ============
Years ended December 31,
---------------------------------------
2001 (1) 2000 (2) 1999 (2)
------------ ----------- ------------
Property and casualty insurance industry :
SAP Basis (3)
Loss and loss adjustment expense ratio 88.0 81.5 78.8
Expense ratio 25.9 27.5 27.8
Dividend ratio .5 1.4 1.3
------------ ----------- ------------
Combined ratio 114.4 110.4 107.9
============ =========== ============
(1) Source: Industry Estimate for 2001, BestWeek, December 17, 2001 edition.
(2) Source: Best's Aggregates & Averages, Property/Casualty United States 2001
Edition
(3) While the SAP loss ratio is the same ratio as the loss ratio prepared in
accordance with generally accepted accounting principles ("GAAP"), the expense
ratio differs in two aspects. First, the numerator on a SAP basis represents
acquisition and other underwriting expenses relating to net written premiums
recorded during the calendar year, while, on a GAAP basis, the numerator
represents amortization of deferred policy acquisition costs and other
underwriting expenses. Second, the denominator on a SAP basis is net written
premiums, versus net earned premium on a GAAP basis.
Page 13
Reinsurance
The Company purchases reinsurance through contracts called "treaties" to reduce
its exposure to liability on individual risks and to protect against
catastrophic losses. Reinsurance involves an insurance company transferring or
"ceding" a portion of its exposure on a risk to another insurer (the
"reinsurer"). The reinsurer assumes the exposure in return for a portion of the
premium. The ceding of liability to a reinsurer does not legally discharge the
primary insurer from its liability for the full amount of the policies on which
it obtains reinsurance. The primary insurer will be required to pay the entire
loss if the reinsurer fails to meet its obligations under the reinsurance
agreement.
In formulating its reinsurance programs, the Company is selective in its choice
of reinsurers and considers numerous factors, the most important of which are
the financial stability of the reinsurer, its history of responding to claims
and its overall reputation. In an effort to minimize its exposure to the
insolvency of its reinsurers, the Company evaluates the acceptability and
reviews the financial condition of each reinsurer annually. The Company's policy
is to use only reinsurers that have an A.M. Best rating of "A- (Excellent)" or
better and that have at least $500 million in policyholders' surplus. A.M. Best
assigns ratings to each insurance company transacting business in the United
States. "A-" is the fourth highest of sixteen rating categories, and is
considered "excellent" by A.M. Best Co. These ratings are based upon factors of
concern to policyholders and are not directed toward the protection of
investors.
Since September 2001, the Company's multiple-line excess of loss treaty
reinsurance is with American Re, part of the Munich Re Group. American Re is
rated "A++" (Superior) by A.M. Best. For the three years prior to September 1,
2001, General Reinsurance Corporation, rated "A++" (Superior) by A.M. Best, was
the Company's reinsurer on their multiple-line excess of loss treaty. The
following is a summary of the Company's multiple-line excess of loss reinsurance
treaty:
Line of Business Company Policy Limit Reinsurance Coverage / Company Retention
--------------------------------- ---------------------------------- ------------------------------------------------------------
Property $2.0 million per risk $1.7 million per risk in excess of $300,000 per risk
Commercial Automobile $1.0 million per occurrence $750,000 per occurrence in excess of $250,000 per
occurrence
General Liability $3.0 million per occurrence $2.5 million per occurrence in excess of $500,000 per
occurrence
The combined Company retention for any one loss resulting from a common
occurrence involving both the property and general liability coverage on a
single risk is $500,000. The Company also maintains casualty contingent excess
coverage with American Re, which covers exposures such as punitive damages and
other extra-contractual obligations, losses in excess of policy limits (such as
bad faith and errors and omissions) and liability actions brought by two or more
of the Company's insureds against each other resulting from the same occurrence.
The Company offers umbrella liability policies up to $5.0 million per
occurrence. These policies are reinsured with American Re for 90% of policy
limits up to $1.0 million per occurrence and 100% of policy limits to $4.0
million in excess of $1.0 million per occurrence.
The Company maintains a catastrophic loss reinsurance program, the terms of
which provide for 100% retention of the first $1.0 million per occurrence,
Page 14
reinsurance of 90.0% of $1.0 million per occurrence in excess of $1.0 million
per occurrence and reinsurance of 100% of $23.0 million per occurrence in excess
of $2.0 million per occurrence.
As of January 1, 2002, the Company's catastrophic loss reinsurance program
includes: American Agricultural Insurance Company, Converium (North America),
Converium (UK), Everest Reinsurance Company, Hannover Ruckversicherungs, PXRE
Reinsurance Company, Shelter Reinsurance Company, Sirius International Insurance
Corporation and XL Re Ltd. All of these reinsurers are rated A- (Excellent) or
higher by A.M. Best and have policyholders' surplus greater than $500 million.
The Company may write individual policies with limits of liability greater than
the aforementioned Company policy limits. These limits of liability are 100%
reinsured on a facultative reinsurance basis.
Information regarding the amount of premiums written and ceded under reinsurance
treaties is included in Note 5 to the Consolidated Financial Statements included
herein.
Investments
The Company's investment policy seeks to maximize investment income consistent
with the overriding objective of maintaining liquidity and minimizing risk.
Approximately 93% of the Company's fixed-income securities as of December 31,
2001 were rated "A" or better by Standard & Poor's. Standard & Poor's rates
publicly traded securities in twenty categories ranging from AAA to CC.
Securities with ratings from AAA to BBB- (the top ten categories) are commonly
referred to as having an investment grade rating. As of December 31, 2001, the
Company's fixed-income investments had an effective average duration of
approximately 3.5 years. Publicly traded equity securities, the majority of
which consisted of preferred stocks, represented 16% of the Company's investment
portfolio as of December 31, 2001.
As of December 31, 2001, the Company's investment portfolio contained $48.8
million of mortgage-backed and asset-backed and collateral mortgage obligations.
All of these securities were rated "AA-" or better by Standard & Poor's or
Moody's and 75% were "AAA" or better by Standard & Poor's or Moody's, are
publicly traded, and have market values obtained from an external pricing
service. Changes in estimated cash flows due to changes in prepayment
assumptions from the original purchase assumptions are revised based on current
interest rates and the economic environment. Although the Company is permitted
to invest in other derivative financial instruments, real estate mortgages and
real estate, the Company does not invest in these financial instruments and does
not have any such investments in its investment portfolio.
The Company's investment portfolio is under the direction of its Investment
Committee, which is comprised of selected members of the Company's Board of
Directors and officers of the Company. The Investment Committee establishes and
monitors the Company's investment policies, which are intended to maximize
after-tax income while maintaining a high level of quality and liquidity in its
portfolio for insurance operations. All investment transactions are approved by
the Investment Committee.
The Investment Committee has retained General Re-New England Asset Management,
Inc, a wholly owned subsidiary of General Re Corporation, to manage its
investment portfolio in accordance with the investment strategy adopted by the
Investment Committee.
Page 15
The following table shows the classifications of the Company's investments at
December 31, 2001:
Amount
reflected
Fair on balance Percent of
value sheet total
----------------- ----------------- ---------------
(In thousands)
Fixed maturities:
Available for sale:
U.S. Treasury securities and obligations
of U.S. government agencies $ 4,195 $ 4,195 2.4%
Corporate securities 52,021 52,021 29.6
Mortgage-backed securities 27,316 27,316 15.6
Other structured securities 21,462 21,462 12.2
Municipal securities 21,004 21,004 12.0
Public utilities 9,255 9,255 5.3
-------- -------- -------
Total available for sale
135,253 135,253 77.1
-------- -------- -------
Held to maturity
U.S. Treasury securities and
obligations
of U.S. government agencies 14,025 13,812 7.9
Corporate securities 290 276 0.1
Public utilities 1,002 996 0.6
-------- -------- -------
Total held to maturity
15,317 15,084 8.6
-------- -------- -------
Total fixed-maturity securities 150,570 150,337 85.7
-------- -------- -------
Equity securities:
Common stock 7,977 7,977 4.5
Preferred stock 17,172 17,172 9.8
-------- -------- -------
Total equity securities 25,149 25,149 14.3
-------- -------- -------
Total investments $175,719 $175,486 100.0%
======== ======== =======
The composition of the Company's portfolio of fixed-income investments were
rated by Standard & Poor's or Moody's at December 31, 2001, as follows:
"AAA" 50%
"AA" 18%
"A" 25%
"BBB" 6%
Below "BBB" 1%
------
100%
======
The market risk of the Company's investment portfolio is descibed in
Quantitative and Qualitative Disclosures About Market Risk included herein.
Note 4 to the consolidated financial statements included herein sets forth the
net investment income results of the Company for 2001, 2000 and 1999.
Page 16
Competition
The property and casualty insurance industry is highly competitive and includes
several thousand insurers, ranging from large companies offering a wide variety
of products worldwide to smaller, specialized companies in a single state or
region and offering in some cases only a single product. The Company competes
with a significant number of these insurers in attracting quality general agents
and in selling insurance products. Many of the Company's existing or potential
competitors are larger excess and surplus lines and specialty admitted insurers
which have considerably greater financial and other resources, have greater
experience in the insurance industry and offer a broader line of insurance
products than the Company. The Company believes that in order to be successful
in its market, it must be aware of pricing cycles, must be able to minimize the
impact of such cycles through tight expense control and superior customer
service. Another competitive factor is the rating assigned by independent rating
organizations such as A.M. Best Company. Penn-America and Penn-Star currently
have a pooled rating from A.M. Best of "A-"(Excellent). "A-" is the fourth
highest of sixteen rating categories, and if considered "excellent" by A.M. Best
Co. These ratings are based upon factors of concern to policyholders and are not
directed toward the protection of investors.
The Company believes that its distribution strategy, which is based on building
and maintaining strong relationships with a small number of high quality general
agents that are enabled with the latest technological innovation, provides a
competitive advantage in the markets it targets. The "Marketing and
Distribution" section included herein more fully describes the elements of the
strategies which the Company believes provide this competitive advantage.
Regulation
General. The Company is subject to regulation under the insurance statutes and
regulations, including insurance holding company statutes, of the various states
in which it does business. These statutes are generally designed to protect the
interests of insurance policyholders, as opposed to the interests of
stockholders, and they relate to such matters as the standards of solvency which
must be met and maintained; the licensing of insurers and their agents; the
nature and limitations of investments; deposits of securities for the benefit of
policyholders; approval of policy forms and premium rates; periodic examination
of the affairs of insurance companies; annual and other reports required to be
filed on the financial condition of insurers or for other purposes;
establishment and maintenance of reserves for unearned premiums and losses; and
requirements regarding numerous other matters. All insurance companies must file
annual statements with certain state regulatory agencies and are subject to
regular and special financial examinations by those agencies. The last
regulatory financial examination of Penn-America was completed by the
Pennsylvania Insurance Department in 1999, covering the five-year period ended
December 31, 1998, and for Penn-Star, covering a two year period ended December
31, 1998, since its initial licensing in 1997.
Insurance Holding Company Laws. Pennsylvania, the Companies' state of domicile,
has laws governing insurers and insurance holding companies. The Pennsylvania
statutes generally require insurers and insurance holding companies to register
and file reports concerning their capital structure, ownership, financial
condition and general business operations. Under the statutes, a person must
generally obtain the Pennsylvania Insurance Department's approval to acquire,
directly or indirectly, 10% or more of the outstanding voting securities of the
company or any of its insurance company subsidiaries. The insurance department's
determination of whether to approve any such acquisition is based on a variety
of factors, including an evaluation of the acquirer's financial condition, the
competence of its management and whether competition would be reduced. All
transactions within a holding company's group affecting an insurer must be fair
and reasonable and the insurer's policyholders' surplus following any such
transaction must be both reasonable in relation to its outstanding liabilities
Page 17
and adequate for its needs. Notice to applicable regulators is required prior to
the consummation of certain transactions affecting insurance subsidiaries of the
holding company group.
Dividend Restrictions. PAGI is a holding company, the principal asset of which
is the common stock of Penn-America. The principal source of cash to meet the
Company's short-term liquidity needs, including the payment of dividends to
PAGI's stockholders and PAGI's operating expenses is dividends from
Penn-America. The Company has no long-term debt obligations or planned capital
expenditures that could impact its long-term liquidity needs. Penn-America's
principal sources of funds are underwriting operations, investment income and
proceeds from sales and redemptions of investments. Funds are used by
Penn-America and Penn-Star principally to pay claims and operating expenses, to
purchase investments and to make dividend payments to PAGI. The Company's future
liquidity is dependent on the ability of Penn-America to pay dividends to PAGI.
The National Association of Insurance Commissioners has adopted a system to test
the adequacy of statutory capital, known as "risk-based capital", which applies
to Penn-America Insurance Company and Penn-Star Insurance Company, Penn-America
Insurance Company's wholly-owned subsidiary. This system establishes the minimum
amount of risk-based capital necessary for a company to support its overall
business operations. It identifies property and casualty insurers that may be
inadequately capitalized by looking at certain inherent risks of each insurer's
assets and liabilities and its mix of net written premiums. Insurers falling
below a calculated threshold may be subject to varying degrees of regulatory
action, including supervision or control. Penn-America is also subject to
regulations under which payment of dividends from statutory surplus may require
prior approval from the Pennsylvania Insurance Department. Penn-America may pay
dividends to PAGI without advance regulatory approval only from unassigned
surplus and only to the extent that all dividends in the past twelve months do
not exceed the greater of 10% of total statutory surplus or statutory net income
for the prior year. Using these criteria, the available ordinary dividend for
2002 is $6,473,325. Ordinary dividends paid by Penn-America to PAGI in 2001 were
$1.6 million. No ordinary dividends were paid to PAGI in 2000. Rather,
Penn-America paid a $6.4 million return of capital to PAGI in 2000, after
receiving approval from the Pennsylvania Insurance Department, which PAGI used
to repurchase stock and pay dividends and PAGI operating expenses.
Penn-America's ability to pay future dividends to us without advance regulatory
approval is dependent upon maintaining a positive level of unassigned and
policyholders' surplus, which in turn, is dependent upon Penn-America Insurance
Company and Penn-Star Insurance Company generating net income in excess of
dividends to the Company. As of December 31, 2001, Penn-America Insurance
Company's unassigned surplus was $64,733,251 million and Penn-Star Insurance
Company's policyholders' surplus was $33,389,965 million.
Insurance Guaranty Funds. Under insolvency or guarantee laws in states in which
Penn-America is licensed as an admitted insurer (and in New Jersey),
organizations have been established (often referred to as guaranty funds) with
the authority to assess admitted insurers up to prescribed limits for the claims
of policyholders insured by insolvent, admitted insurance companies. Surplus
lines insurance companies are generally not subject to such assessments except
in New Jersey and their policyholders are not eligible to file claims against
the guaranty funds.
Additional Legislation or Regulations. New regulations and legislation are
proposed from time to time to limit damage awards, to bring the industry under
regulation by the federal government, to control premiums, policy terminations
and other policy terms, and to impose new taxes and assessments. Difficulties
with insurance availability and affordability have increased legislative
activity at both the federal and state levels. Some state legislatures and
regulatory agencies have enacted measures, particularly in personal lines, to
Page 18
limit midterm cancellations by insurers and require advance notice of renewal
intentions. In addition, Congress is investigating possible avenues for federal
regulation of the insurance industry.
Employees
The Company has approximately 100 employees. The Company is not a party to any
collective bargaining agreements and believes that its employee relations are
good.
Item 2. Properties
The Company leases approximately 23,000 square feet in an office building
located in Hatboro, Pennsylvania. The office building also houses Penn
Independent and certain of its subsidiaries. The Company leases the space from
Mr. Irvin Saltzman, Chairman of the Board of Directors of the Company, pursuant
to a lease agreement renewed June 30, 2000 that expires on June 30, 2005, and
provides for an annual rental payment of $357,247. This amount is considered by
the Company to be at fair market value.
ITEM 3. Legal Proceedings
The Company's insurance subsidiaries are subject to routine legal proceedings in
connection with their property and casualty business. Penn-America has been
named as a defendant in litigation commenced in the Superior Court of
California, County of Los Angeles, on November 6, 2000 and in an identical suit
on December 18, 2000 in the County of Orange relating to the Company's exited
non-standard personal automobile business. Management believes that its position
is defensible as to such litigation, but, the Company is pursuing settlement
discussions at this time. Irrespective of Management's current activity,
Management does not believe at this time that any settlement or judgment will
have a material effect on the Company's financial statements. The Company is
involved in no other pending or threatened legal or administrative proceedings
which management believes might have a material adverse effect on the Company's
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during 2001 to a vote of holders of PAGI's common stock.
Page 19
PART II
ITEM 5. Market for the Registrant's Common Stock and Related
Stockholder Matters
Market and Common Stock Information
The Company's common stock trades on the New York Stock Exchange under the
symbol "PNG". As of February 1, 2002 there were 190 registered holders of record
and approximately 1,000 beneficial holders of record of the company's common
stock. The high and low sale prices of the common stock were as follows:
Market Price (1)
--------------------------------
High Low
-------------- --------------
Year Ended December 31, 2001
First Quarter $ 6.97 $4.79
Second Quarter 7.00 6.67
Third Quarter 6.80 6.40
Fourth Quarter 7.03 6.00
Year Ended December 31, 2000
First Quarter $ 6.00 $4.42
Second Quarter 6.50 4.75
Third Quarter 5.25 4.59
Fourth Quarter 6.29 4.59
(1) Market prices are adjusted to reflect a three-for-two split of the Company's
common stock effected on May 9, 2002.
Page 20
ITEM 6. SELECTED FINANCIAL DATA
Selected Financial Data
As described in Part I, the Company has restated its previously issued financial
statements for the years ended December 31, 2001, 2000, and 1999. See Note 1 to
consolidated financial statements for further information regarding the
restatement.
Year ended December 31,
--------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------- -------------- ------------- -------------- -------------
(Restated) (Restated) (Restated)
(dollars in thousand, except per share data)
Operating Data:
Premiums earned $ 88,934 $ 91,449 $ 85,677 $ 89,493 $ 91,649
Net investment income 11,339 10,454 9,537 10,763 9,218
Net realized investment gain (loss) 18 1,314 (1,178) (2,808) (110)
Total revenues 99,095 99,095 95,104 100,274 102,853
Net income (loss) 4,940 (4,831) 1,410 8,881 9,645
Comprehensive income (loss) 7,254 (343) (5,000) 9,946 10,301
Diluted net income (loss) per share (1) 0.43 (0.42) 0.11 0.60 0.78
Cash dividends per share (1) $ 0.14 $ 0.14 $ 0.1383 $ 0.1333 $ 0.1067
Cash flow provided (used) by
operations (2) 8,423 14,991 8,602 10,644 24,988
Insurance Performance Data
Gross written premiums (3) $ 98,412 $ 109,791 $ 95,983 $ 95,097 $ 104,694
Net written premiums (4) 87,123 97,250 87,036 87,829 96,561
GAAP basis:
Loss ratio (5) 68.5 82.4 73.8 62.3 63.0
Expense ratio (6) 34.6 34.0 34.5 33.9 33.2
--------- --------- --------- --------- ---------
Combined ratio (7) 103.1 116.4 108.3 96.2 96.2
Balance Sheet Data (at the end of the
period):
Cash and investments $ 188,615 $ 178,675 $ 166,227 $ 182,866 $ 177,819
Total assets 248,115 239,486 217,782 230,504 225,157
Total stockholders' equity 80,391 74,051 80,618 100,630 97,307
Total stockholders' equity per share (1) 7.00 6.52 6.67 7.14 6.56
__________
(1) Adjusted to reflect a three-for-two split of the Company's common stock effected on May 9, 2002.
(2) Cash flow provided (used) by operations differs from net income (loss), due to the fact that net income (loss) includes
accruals for non-cash items as required by GAAP and net realized investment gain (loss).
(3) The amount received or to be received for insurance policies written by us during a specific period of time without reduction
for acquisitions costs, reinsurance costs or other deductions.
(4) The total of gross written premiums less the portion of such premiums ceded to (reinsured by) other insurers during a specific
period of time.
(5) The ratio of losses and loss adjustment expenses to premiums earned.
(6) The ratio of amortization of deferred policy acquisition costs and other underwriting expenses to premiums earned.
(7) The addition of the loss ratio and expense ratio.
Page 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition
and Results of Operations
Penn-America Group, Inc. ("PAGI" or the "Company") has recently resolved various
accounting and disclosure comments from the Securities and Exchange Commission
("SEC"), in conjunction with the Company's registration statement filing
relating to the issuance of additional shares of common stock. One of the
comments addressed the timing of recording other than temporary ("OTT") declines
in the market value of certain equity securities. In order to resolve the
comments, the Company agreed to amend its accounting policy and record OTT
write-downs on these securities for the periods ending December 31, 2001, 2000
and 1999. This restatement affects net income for each of these periods but has
no affect on stockholders' equity since the unrealized loss on these securities
was already recorded in Accumulated Other Income (Loss) in the Consolidated
Balance Sheets and Statements of Stockholders' Equity. The Company has restated
its financial statements for the affected periods and has filed such
restatements on this amended Form 10-K for the year ended December 31, 2001. For
further information, see Note 1 of the Notes to Consolidated Financial
Statements.
The affect of the restatement on total revenues, net income (loss), and basic
and diluted net income (loss) per share are as follows:
For the years ended
-------------------------------------------------------------------------------------------------------
December 31, 2001 December 31, 2000 December 31, 1999
-------------------------------- ------------------------------- -------------------------------
As Reported As Restated As Reported As Restated As Reported As Restated
-------------- -------------- ------------- -------------- -------------- --------------
Total revenues $99,718 $99,095 $100,572 $99,095 $96,055 $95,104
Net income (loss) 5,351 4,940 (3,856) (4,831) 2,038 1,410
Net income (loss) per share
Basic 0.47 0.43 (0.33) (0.42) 0.16 0.11
Diluted 0.47 0.43 (0.33) (0.42) 0.16 0.11
The OTT write-downs are non-cash items, and have no affect on stockholders'
equity as the declines in market value on preferred and common stocks were
previously recorded in stockholders' equity as net unrealized losses in
accumulated other income (loss).
In addition, the SEC requested the Company add certain disclosures or not
disclose certain information. This Management's Discussion and Analysis of
Financial Condition and Results of Operations has been amended to respond to
those requests.
The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements of the Company and Notes to the Consolidated
Financial Statements.
General
Penn-America Group, Inc. ("PAGI") is a specialty property and casualty insurance
holding company which, through its subsidiary, Penn-America Insurance Company
and its subsidiary Penn-Star Insurance Company (collectively "Penn-America" or
the "Company") markets and underwrites commercial property, general liability
and multi-peril insurance for small businesses located primarily in small towns
and suburban and rural areas. Penn-America can write business in all fifty
states and the District of Columbia. The Company writes business on both an
Page 22
admitted and non-admitted (excess and surplus lines) basis in thirty-six states,
on only an admitted basis in two states and on only a non-admitted basis in
twelve states and the District of Columbia. The Company chooses in each state
whether to write business on an admitted or non-admitted basis based upon the
Company's analysis of competition in each state. Writing business on an admitted
basis is highly regulated. The regulations, which vary by state, generally
govern licensing, underwriting rules, rates and policy forms, and require
insurance companies to pay premium taxes and guaranty fund assessments. Writing
business on a non-admitted basis is significantly less regulated and provides
much more freedom in setting rules, rates and policy forms and removes insurance
companies from premium taxes and guaranty fund assessment liabilities. Coverage
written on a non-admitted basis is less comprehensive than coverage issued on an
admitted basis. If the Company chooses non-admitted status, the Company could be
at a competitive disadvantage to carriers writing on an admitted basis if those
competitors choose to offer coverages which are more comprehensive and
attractive to an insured. Further, surplus lines agents are prohibited from
writing non-admitted business in states in which they are not resident. Thus, if
the Company does not have resident surplus lines agents in every state
(currently, we do not in 7 states), the Company is precluded from writing
business on a non-admitted basis in those states.
Penn-America's commercial insureds consist primarily of small, "Main Street"
businesses including restaurants, mercantiles and non-residential service
contractors. In addition, the Company has developed customized products and
coverages for other small commercial insureds such as day-care facilities,
fitness centers and special events. The Company believes it has benefited from a
general migration of small businesses out of urban centers and into suburban and
rural areas. Industry consolidation, corporate downsizing and the increased use
of communications technology and personal computers, among other factors, have
contributed to the high growth in the number of small businesses in these areas.
The Company selects only insurance lines of business and industry segments for
which it can reasonably evaluate the probability of future loss exposure.
Therefore, the Company avoids high-hazard risks and high-hazard lines of
business such as medical malpractice and environmental liability.
Penn-America markets its products through fifty-seven high-quality general
agents, who in turn produce business through more than 25,000 retail insurance
brokers located throughout the United States. The Company focuses on serving the
insurance needs of small businesses in small towns and rural areas that are
serviced by retail insurance brokers with limited access to larger, standard
lines insurers. The Company believes that larger, standard lines insurers, which
often limit their underwriting to larger policies and to certain risk classes,
generally underserve these markets. Penn-America believes that its distribution
network enables it to effectively access these numerous small markets at a
relatively low fixed-cost through the marketing, underwriting and administrative
support of its general agents. This access also is enabled by the local market
knowledge and expertise of its general agents and their retail insurance
brokers.
Penn-America's distribution strategy is to maintain strong relationships with a
select group of high-quality general agents. The Company carefully selects a
limited number of general agents based on their experience and reputation and
strives to preserve each agent's franchise value within its marketing territory.
The Company seeks to grow with these general agents and to develop strong,
long-standing relationships by providing a high level of service and support.
The success of the Company's strategy is demonstrated by its strong and
consistent growth. From 1992 to 2001, commercial gross written premiums grew at
an 18% compound annual rate from $22.6 million to $98.4 million while the number
of general agents rose from 38 to 57.
Page 23
Commercial Gross Written Premium
Per General Agent
(Same Store Sales)
Compound
Annual
(Dollars in millions) 1992 2001 Growth %
--------------------------------------------------------------------------------
Commercial gross
written premiums $ 22.6 $98.4 18%
Number of general
agents 38 57 5%
Commercial gross
written premiums
per general agent $ 0.6 $ 1.7 13%
--------------------------------------------------------------------------------
Core Commercial Business
The Company underwrites its core commercial business (excluding the Company's
exited commercial automobile business - see Exited Lines, below) through three
underwriting units: the Binding Authority Unit, the Submit Unit and the
Specialty Lines Unit, which are defined as follows:
o Binding authority business represents risks that may be quoted and bound by
the Company's general agents prior to the Company's underwriting review.
o Submit business represents risks that must be submitted by the Company's
general agents to the Company prior to quoting or binding the account.
o Specialty lines business represents risks that meet specific,
pre-determined industry-segment and territorial parameters and may be
quoted or bound by the Company's general agents prior to the Company's
underwriting review.
The Binding Authority Unit accounted for approximately 88% of the Company's core
commercial gross written premiums in 2001. Of this amount, approximately 85% is
bound by general agents in accordance with the Company's underwriting manual.
The Binding Authority Unit reviews, on a continuous basis, the new and renewal
policies issued by the general agents to ensure that the Company's underwriting
guidelines are followed. The Company provides its general agents with a
comprehensive, regularly updated underwriting manual, which also is available
online through a private intranet site called PennLINK. This manual clearly
outlines the Company's risk eligibility, pricing, underwriting guidelines and
policy issuance instructions. Penn-America closely monitors the underwriting
quality of its business through on-line system edits and in-force account
reviews. The Company also periodically audits each agent's office to determine
if the Company's underwriting guidelines are followed in all aspects of risk
selection, underwriting compliance, policy issuance and pricing. In addition to
standard commissions, the Company provides strong incentives to its general
agents to produce profitable business through a contingent profit commission
structure that is tied directly to underwriting profitability. Payments of these
contingent profit commissions have been through the issuance of shares of PAGI
common stock and cash. Since 1996, the Company has awarded agents approximately
276,000 shares of PAGI common stock through its contingent profit commission
structure.
Page 24
The Submit Unit was formed in 1999 in response to general agents who had risks
similar to the Company's risk profile but were outside of their underwriting
authority. The unit provides a market to the Company's general agents for
approximately fifty classes of business. One hundred percent of the business is
quoted and bound by Penn-America underwriters; general agents have no binding
authority. This unit accounted for approximately 5% of core commercial gross
written premiums in 2001.
The Specialty Lines Unit, which accounted for 7% of the Company's core
commercial gross written premiums in 2001, creates specialized underwriting and
marketing programs for individual general agents based upon specific territorial
needs and opportunities. The individual general agent typically is given
exclusive marketing authority for the program subject to territorial
limitations. The Company believes it can achieve superior underwriting results
and expense savings on these programs. The Company continuously is developing
specialized programs for certain industry segments to meet the needs of these
insureds. For example, Penn-America has developed programs for cargo and Alaska
dwellings. Collectively, these programs are a significant benefit to the
Penn-America's marketing efforts.
Exited Lines
The Company offered commercial automobile coverage from 1998 through the first
quarter of 2001. In late 2000, the Company announced that it was exiting this
line of business due to unsatisfactory underwriting results. No new policies
have been written since the first quarter of 2001 and all policies are being
non-renewed. Gross written premiums for commercial automobile business decreased
to $1.1 million in 2001 from $11.5 million in 2000 and $7.0 million in 1999.
The Company exited non-standard personal automobile business in 1999 and, as a
result, gross written premiums declined to $2,000 in 2001 from $2.8 million in
2000 and $11.5 million in 1999.
Competition
The property and casualty insurance industry is highly competitive. Penn-America
competes with domestic and international insurers, some of which have greater
financial, marketing and management resources and experience than the Company.
The Company also may compete with new market entrants in the future. Competition
is based on many factors including the perceived market strength of the insurer,
pricing and other terms and conditions, services provided, the speed of claims
payment, the reputation and experience of the insurer and ratings assigned by
independent rating organizations such as A.M. Best Company. Penn-America
Insurance Company and Penn-Star Insurance Company currently have a pooled rating
from A.M. Best of "A-" (Excellent). "A-" is the fourth highest of sixteen rating
categories, and is considered "excellent" by A.M. Best Co. These ratings are
based upon factors of concern to policyholders and are not directed toward the
protection of investors.
Reinsurance
The Company purchases reinsurance in order to lower its retention for individual
risks, enable it to underwrite policies with higher limits of liability and to
protect against catastrophic losses. Reinsurance does not discharge the Company
from its primary liability for the full amount of insured claims. The Company
carefully examines the financial condition of its reinsurers and places its
coverage only with financially sound companies.
Page 25
The Company has a multiple-line excess-of-loss reinsurance treaty currently in
place that provides the following reinsurance coverage:
Line of Business Company Policy Limit Reinsurance Coverage / Company Retention
Property $2.0 million per risk $1.7 million per risk in excess of $300,000 per risk
Commercial Automobile $1.0 million per occurrence $750,000 per occurrence in excess of $250,000 per
occurrence
General Liability $3.0 million per occurrence $2.5 million per occurrence in excess of $500,000 per
occurrence
Umbrella liability coverages are provided up to $5.0 million per occurrence and
are reinsured for 90% of policy limits up to $1.0 million per occurrence and
100% of policy limits to $4.0 million in excess of $1.0 million per occurrence.
The Company may write individual policies with limits of liability greater than
the aforementioned Company policy limits. These limits of liability are 100%
reinsured on a facultative reinsurance basis.
The Company maintains a catastrophic loss reinsurance program the terms of which
provide for 100% retention of the first $1.0 million per occurrence, reinsurance
of 90.0% of $1.0 million per occurrence in excess of $1.0 million per occurrence
and reinsurance of 100% of $23.0 million per occurrence in excess of $2.0
million per occurrence.
Results of Operations
Year ended December 31, 2001 compared with year ended December 31, 2000
Gross written premiums decreased 10.4% to $98.4 million for the year ended
December 31, 2001 from $109.8 million for the year ended December 31, 2000. The
decrease was due to the decline of $13.2 million in gross written premiums for
the exited commercial and non-standard personal automobile lines. Core
commercial gross written premiums increased 1.9% in 2001 to $97.3 million from
$95.5 million in the prior year. This increase was attributable mainly to rate
increases implemented during the year as well as growth in new business, which
were offset partially by a decline in the renewal ratio due to the Company's
decision to exit the residential contractors industry segment.
Ceded written premiums, the portion of gross premiums reinsured by other
unaffiliated insurers, decreased to $11.3 million for the year ended December
31, 2001 compared to $12.5 million for the year ended December 31, 2000. The
decline is ceded written premiums is primarily due to the decline in gross
written premiums.
Net written premiums, which are gross written premiums less ceded written
premiums, decreased 10.4% to $87.1 million for the year ended December 31, 2001
from $97.3 million for the year ended December 31, 2000. This decline is
consistent with the drop in gross written premiums. Premiums earned decreased
2.8% to $88.9 million for the year ended December 31, 2001 from $91.5 million
for the year ended December 31, 2000.
Net investment income increased 8.5% to $11.3 million for the year ended
December 31, 2001 from $10.5 million for the year ended December 31, 2000. The
increase resulted principally from an increase in the investment yield of the
fixed-income investment portfolio and the growth in invested assets, partially
offset by a decline in interest rates on overnight cash balances.
Net realized investment loss for the year ended December 31, 2001 was $1.2
million for the year ended December 31, 2001 as compared with $2.8 million for
the year ended December 31, 2000. Net realized investment loss for the years
Page 26
ended December 31, 2001 and 2000 included other-than-temporary impairment
write-downs on certain of the Company's preferred and common stock investments
of $1.2 million and $1.7 million, respectively.
For the year ended December 31, 2001, the other-than-temporary impairment
write-down was primarily due to declines in the market value of two common stock
exchange-traded funds, S & P 500 Depositary Receipts and Biotech Holders Trust,
totaling $1.0 million. For the year ended December 31, 2000, the
other-than-temporary impairment write-downs were due to declines in the market
value of twelve preferred stock securities totaling $1.3 million and one common
stock, AMEX Technology Fund, totaling $0.4 million.
Losses and loss adjustment expenses decreased 19.2% to $60.9 million in 2001 as
compared with $75.4 million in 2000. The 2000 operating results included
strengthening of prior year loss reserves of $9.2 million. This prior year
reserve increase related principally to the commercial automobile liability,
commercial multi-peril liability and other liability lines of business.
The September 11, 2001 tragedies in New York, Washington D.C. and Pennsylvania
resulted in no property or casualty losses to the Company.
Amortization of deferred acquisition costs (ADAC) decreased 9.9% to $22.7
million for the year ended December 31, 2001 from $25.2 million for the year
ended December 31, 2000. The decrease is due to lower commission rates to
general agents that were implemented in the third quarter of 2000 and lower
premium taxes as a result of the Company writing a larger portion of its
business on a non-admitted basis. Also contributing to the decrease were lower
commissions related to the exited lines of business. Non-standard personal
automobile commission rates were higher than commercial rates.
Other underwriting and corporate expenses increased 29.2% to $8.6 million for
the year ended December 31, 2001 from $6.6 million for the year ended December
31, 2000. This increase was due to the recording of additional expenses related
to guarantee fund assessments and an increase in the allowance for doubtful
accounts. Costs related to audits of assureds' records and salary expenses also
were higher in 2001 than in the prior year.
The GAAP combined ratio, which is the sum of the loss and expense ratios,
decreased to 103.1 for the year ended December 31, 2001 compared with 116.4 for
the year ended December 31, 2000. The loss ratio, which is calculated by
dividing losses and loss adjustment expenses by premiums earned, decreased to
68.5 for the year ended December 31, 2001 from 82.4 for the year ended December
31, 2000. As noted above, 2000 operating results included the strengthening of
prior year loss reserves by $9.2 million. This strengthening added approximately
10.0 points to the 2000 loss and combined ratios. The GAAP expense ratio, which
is calculated by dividing the sum of ADAC and other underwriting expenses by
premiums earned, for the year ended December 31, 2001, increased slightly to
34.6 from 34.0 for the year ended December 31, 2000. The GAAP combined ratio is
a standard measure of underwriting profitability used throughout the property
and casualty insurance industry. A ratio below 100.0 generally indicates
profitable underwriting results.
As a result of the factors described above, net income for the year ended
December 31, 2001 was $4.9 million or $0.43 per share (basic and diluted) as
compared with a net loss of $4.8 million or $0.42 per share (basic and diluted)
for the year ended December 31, 2000.
Page 27
Year ended December 31, 2000, compared with year ended December 31, 1999
Gross written premiums increased 14.4% to $109.8 million for the year ended
December 31, 2000 from $96.0 million for the year ended December 31, 1999. This
increase resulted from a 26.7% increase in commercial lines gross written
premiums to $107.0 million, partially offset by a 75.8% decline in gross written
premiums for the non-standard personal automobile lines of business to $2.8
million. The Company exited the non-standard personal automobile lines of
business in 1999.
Net written premiums increased 11.7% to $97.3 million for the year ended
December 31, 2000 from $87.0 million for the year ended December 31, 1999.
During the same period, net premiums earned increased 6.7% to $91.5 million from
$85.7 million. The increase in net premiums earned corresponds to the increase
in gross and net written premiums.
Net investment income increased 9.6% to $10.5 million for the year ended
December 31, 2000 from $9.5 million for the year ended December 31, 1999. The
increase resulted principally from an increase in yields on fixed-income
investments and an increase in cash flows from operations due principally to the
growth in written premiums and a reduction in paid losses.
Net realized investment loss for the year ended December 31, 2000 was $2.8
million as compared with $0.1 million for the year ended December 31, 1999.
Realized investment losses were generated in 2000 due to our decision to sell
selected securities and reinvest the proceeds into higher-yielding securities,
along with other-than-temporary impairment write-downs due to declines in the
market value of eleven preferred stock securities totaling $1.3 million and one
common stock, AMEX Technology Fund, totaling $0.4 million.
Losses and loss adjustment expenses increased 19.3% to $75.4 million in 2000 as
compared with $63.2 million in 1999. The 2000 operating results included
strengthening of prior year loss reserves of $9.2 million relating principally
to our commercial automobile liability, commercial multi-peril liability and
other liability lines of business. Operating results in 1999 included adverse
loss development of $8.4 million in our discontinued non-standard personal
automobile, other liability and property lines of business. Property results in
1999 also were affected by losses related to Hurricanes Floyd and Irene and
other windstorm damage.
Amortization of deferred acquisition costs (ADAC) increased 1.7% to $25.2
million for the year ended December 31, 2000 from $24.8 million for the year
ended December 31, 1999. The increase was attributable primarily to the growth
in premiums earned.
Other underwriting and corporate expenses increased 10.0% to $6.6 million for
the year ended December 31, 2000 from $6.0 million for the year ended December
31, 1999. This increase was mainly attributable to increases in salary and
benefit expenses.
The GAAP combined ratio increased to 116.4 for the year ended December 31, 2000
compared with 108.3 for the year ended December 31, 1999. The loss ratio
increased to 82.4 for the year ended December 31, 2000 from 73.8 for the year
ended December 31, 1999. The GAAP expense ratio decreased to 34.0 for the year
ended December 31, 2000 from 34.5 for the year ended December 31, 1999.
Page 28
As a result of the factors described above, net loss for the year ended December
31, 2000 was $4.8 million or $0.42 per share (basic and diluted) as compared
with net income of $1.4 million or $0.11 per share (basic and diluted) for the
year ended December 31, 1999.
Critical Accounting Estimates and Policies
The Company is directly liable for losses and loss adjustment expenses under the
terms of the insurance policies it writes. In many cases, several years may
lapse between the occurrence of an insured loss, the reporting of the loss and
the payment of that loss. The Company reflects its liability for the ultimate
payment of all incurred losses and loss adjustment expenses by establishing loss
and loss adjustment expense reserves as balance sheet liabilities for both
reported and unreported claims.
When a claim involving a probable loss is reported, the Company establishes a
case reserve for the estimated amount of its ultimate loss. The estimate of the
amount of the ultimate loss is based upon factors such as:
o the type of loss,
o the jurisdiction of the occurrence,
o the Company's knowledge of the circumstances surrounding the claim,
o the severity of injury or damage,
o the potential for ultimate exposure, and
o policy provisions relating to the claim.
The Company determines loss adjustment expenses via a formula method that
estimates loss adjustment expenses as a percentage of expected indemnity losses
based on historical patterns adjusted to current experience.
In addition to case reserves, the Company establishes reserves on an aggregate
basis to provide for incurred but not reported losses and loss adjustment
expenses, commonly referred to as "IBNR". To establish reserves for IBNR, the
Company must estimate the ultimate liability based primarily on past experience.
The Company applies a variety of traditional actuarial techniques to estimate
its ultimate liability. The techniques recognize, among other factors:
o the Company's and the industry's experience,
o historical trends in reserving patterns and loss payments,
o the impact of claim inflation,
o the pending level of unpaid claims,
o the cost of claim settlements, o the line of business mix, and
o the economic environment in which property and casualty insurance
companies operate.
The Company continually reviews these estimates and, based on new developments
and information, the Company includes adjustments of the probable ultimate
liability in the operating results for the periods in which the adjustments are
made. In general, initial reserves are based upon the actuarial and underwriting
data utilized to set pricing levels and are reviewed as additional information,
including claims experience, becomes available. The establishment of loss and
loss adjustment expense reserves makes no provision for the broadening of
coverage by legislative action or judicial interpretation or for the
extraordinary future emergence of new types of losses not sufficiently
represented in our historical experience, or which cannot yet be quantified. The
Company regularly analyzes its reserves and reviews pricing and reserving
Page 29
methodologies so that future adjustments to prior year reserves can be
minimized. However, given the complexity of this process, reserves will require
continual updates and the ultimate liability may be higher or lower than
previously indicated. The Company does not discount its loss reserves.
The table below illustrates the sensitivity to a hypothetical change in the
estimated net loss and loss adjustment expense reserves as of December 31, 2001.
The selected scenarios are not predictions of future events, but rather
illustrative of the effect that such events may have ultimate stockholders'
equity.
(Dollars in thousands) Balance of Change in Hypothetical
Hypothetical change in net loss and loss adjustment expense reserve Net Loss and Net Loss Percentage
Loss and Loss Increase
Adjustment Adjustment (Decrease)
Expense Expense in
Reserves Reserve Stockholders'
Equity
----------------------------------------------------------------------- -------------- ------------ --------------
3% adjustment - increase $96,867 $2,821 (2.3)%
2% adjustment - increase 95,927 1,881 (1.5)
1% adjustment - increase 94,986 940 (0.8)
No change 94,046 - -
1% adjustment - decrease 93,106 (940) 0.8
2% adjustment - decrease 92,165 (1,881) 1.5
3% adjustment - decrease 91,225 (2,821) 2.3
Activity in the liability for unpaid losses and loss adjustment expenses
is summarized as follows:
Year ended December 31,
----------------------------------------------
2001 2000 1999
----------------------------------------------
(in thousands)
Balance, beginning of year $115,314 $93,719 $88,937
Less reinsurance recoverable 24,093 18,086 16,502
---------- ------------- ------------
Net balance, beginning of year 91,221 75,633 72,435
Incurred related to:
Current years 60,885 66,214 54,768
Prior years 36 9,164 8,419
---------- ------------- ------------
Total incurred 60,921 75,378 63,187
Paid related to:
Current year 19,913 26,273 23,540
Prior year 38,183 33,517 36,449
---------- ------------- ------------
Total paid 58,096 59,790 59,989
Net balance, end of year 94,046 91,221 75,633
Plus reinsurance recoverable 25,552 24,093 18,086
---------- ------------- ------------
Balance, end of year $119,598 $115,314 $93,719
========== ============= ============
In 2001, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $36,000. This increase related
entirely to the commercial automobile line of business. During 2001, the Company
increased its estimate for the commercial multi-peril liability line of business
by $1.8 million due to the development of outstanding claim reserves on claims
occurring primarily in 1998 and 1999. This increase was almost entirely offset
by a reduction in the Company's estimate for the non-standard personal
automobile line of business due to favorable settlements on closed claims.
In 2000, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $9,164,000. The increase is
primarily attributable to changes in the Company's estimates for losses and loss
Page 30
adjustment expense reserves of $1,400,000 for commercial automobile, $3,900,000
for commercial multi-peril liability and $3,400,000 for other liability lines of
business.
The Company began writing commercial automobile coverage for vehicles and light
trucks in 1998. The initial estimates for 1998 and 1999 were based on a
relatively low level of claims reported to us. In 2000, the Company received a
significant number of claims relating to accidents incurred in 1998 and 1999. In
the fourth quarter of 2000, the Company exited the commercial automobile line of
business due to unsatisfactory underwriting results.
The change in estimates in 2000 for the commercial multi-peril liability line of
business resulted principally from increased exposure to liquor liability losses
for policies primarily written in 1998 and 1999. In 2000, the Company revised
its underwriting approach significantly to reduce its exposure to liquor
liability.
The change in estimates in 2000 for the other liability line resulted
principally from construction defect claims, which were new types of claims that
were not anticipated when the Company wrote these policies between 1991 and
1996. These claims predominantly related to residential contractors and
sub-contractors in California. In 2000, the Company completed its withdrawal
from the residential contractors and sub-contractors industry segment.
In 1999, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $8,419,000. The increase is
primarily attributable to changes in estimates for losses and loss adjustment
expense reserves for non-standard personal automobile line of business. In 1999,
the Company received a significant number of claims relating to accidents
incurred prior to 1999, resulting in an increase in loss estimates. In 1999, the
Company exited the non-standard personal automobile lines.
Incurred losses and loss adjustment expenses include estimates, recorded as loss
and loss adjustment expense reserves on the balance sheet, for the ultimate
payment on both reported and unreported claims. The Company changes its
estimates for loss and loss adjustment expenses reserves as new events occur, as
more loss experience is acquired or as additional information is received.
Estimates for loss and loss adjustment expense reserves result from a continuous
review process and the change in these estimates, as required by Financial
Accounting Standards Board No. 60, Accounting and Reporting by Insurance
Enterprises, paragraph 18, is recorded in the period that the change in these
estimates is made.
The Company believes that its loss and loss adjustment expense reserves are
fairly stated as of December 31, 2001 due to the exiting of non-standard
personal and commercial automobile lines of business and the reduction in
exposure to construction defect and liquor liability losses. In addition, the
Company implemented improvements in the loss reserving process, including the
development of monthly and quarterly loss and loss adjustment expense reserve
analyses and the creation of a reserve committee that meets quarterly.
The following table presents accident year loss and loss adjustment expense
ratios (the sum of losses and loss adjustment expenses divided by premiums
earned) for the ten most recent accident years (the year in which the loss
occurred), as recorded as of December 31, 1999, 2000 and 2001 after giving
effect to the increase in loss and loss adjustment expenses relating to changes
in estimates of insured events of prior years. These "accident year" loss ratios
differ from the loss ratios included in the Company's financial statements in
Page 31
that the latter loss ratios are based upon the year in which we recognize the
loss for accounting purposes, regardless of when the loss actually occurred or
was reported to the Company. See notes to consolidated financial statements in
this report.
As of December 31,
Accident Year 1999 2000 2001
----------- ---------- -----------
1992 69.6 72.1 72.5
1993 70.9 70.2 71.3
1994 69.1 72.0 71.8
1995 63.9 65.4 65.1
1996 68.1 68.3 69.4
1997 62.4 62.0 62.1
1998 63.6 65.8 65.0
1999 63.8 68.2 70.0
2000 72.4 70.2
2001 68.5
Liquidity and Capital Resources
PAGI is a holding company, the principal asset of which is the common stock of
Penn-America Insurance Company. The principal source of cash to meet short-term
liquidity needs, including the payment of PAGI dividends to stockholders and
corporate expenses, is dividends from Penn-America Insurance Company. PAGI has
no long-term debt obligations or planned capital expenditures that could impact
PAGI's long-term liquidity needs. Penn-America Insurance Company's principal
sources of funds are underwriting operations, investment income and proceeds
from sales and redemptions of investments. Funds are used by Penn-America
Insurance Company and Penn-Star Insurance Company principally to pay claims and
operating expenses, to purchase investments and to make dividend payments to
PAGI. PAGI's future liquidity is dependent on the ability of Penn-America
Insurance Company to pay dividends to PAGI.
The Company's insurance subsidiaries are restricted by statute as to the amount
of dividends that they may pay without the prior approval of regulatory
authorities. Penn-America Insurance Company may pay dividends to PAGI without
advance regulatory approval only from unassigned surplus and only to the extent
that all dividends in the past twelve months do not exceed the greater of 10% of
total statutory policyholders' surplus, or statutory net income for the prior
year. Using these criteria, the available ordinary dividend payable by
Penn-America Insurance Company to PAGI for 2002 is $6,473,325. No ordinary
dividends have been paid to PAGI in 2002. Ordinary dividends paid by
Penn-America Insurance Company to PAGI in 2001 were $1.6 million. No ordinary
dividends were paid to PAGI in 2000. Rather, after receiving approval from the
Pennsylvania Insurance Department, Penn-America Insurance Company paid a $6.4
million return of capital to PAGI in 2000, which PAGI used to repurchase common
stock and to pay common stock dividends and PAGI operating expenses.
Penn-America Insurance Company's ability to pay future dividends to PAGI without
advance regulatory approval is dependent upon maintaining a positive level of
unassigned and policyholders' surplus, which in turn, is dependent upon
Penn-America Insurance Company and Penn-Star Insurance Company generating net
income in excess of dividends to PAGI.
Penn-America Insurance Company and Penn-Star Insurance Company are required by
law to maintain a certain minimum level of policyholders' surplus on a statutory
basis. Policyholders' surplus is calculated by subtracting total liabilities
from total assets. The National Association of Insurance Commissioners adopted
risk based capital standards designed to identify property and casualty insurers
that may be inadequately capitalized based on inherent risks of each insurer's
assets and liabilities and its mix of net written premiums. Insurers falling
below a calculated threshold may be subject to varying degrees of regulatory
action. As of December 31, 2001, the policyholders' surplus of Penn-America
Insurance Company and Penn-Star Insurance Company was in excess of the
prescribed risk-based capital requirements. Penn-America Insurance Company's
Page 32
policyholders' surplus at December 31, 2001 was $64,733,251 and its regulatory
action level was $17,124,648. Penn-Star Insurance Company's policyholders'
surplus at December 31, 2001 was $33,389,965 and its regulatory action level was
$5,675,459.
Net cash provided by operating activities decreased to $8.4 million for the year
ended December 31, 2001 from $15.0 million for the year ended December 31, 2000.
The decrease in net cash provided by operations resulted principally from the
decrease in net written premiums during 2001, partially offset by a decrease in
paid losses. Net cash used by investing activities was $5.5 million for the year
ended December 31, 2001, compared with $9.1 million for the year ended December
31, 2000.
Net cash used by financing activities was $1.2 million for the year ended
December 31, 2001 as compared with $6.5 million for the same period in 2000. In
2000, $4.7 million was used by us to repurchase 858,638 shares of our common
stock through a stock buy-back program, which was discontinued in the third
quarter of 2000.
Investment Portfolio
The Company seeks to maintain sufficient liquidity from operations, investing
and financing activities to meet its anticipated insurance obligations and
operating and capital expenditure needs. The Company's investment strategy
emphasizes quality, liquidity and diversification, as well as total return. With
respect to liquidity, the Company considers liability durations, specifically
related to loss reserves, when determining desired investment maturities. In
addition, maturities have been staggered to produce cash flows for loss payments
and reinvestment opportunities. At December 31, 2001, the Company held a total
of $188.6 million in cash and investments. Of this amount, cash represented
$13.1 million, equity securities represented $25.1 million, and fixed-income
securities represented $150.4 million.
The Company's cash and investments portfolio mix as December 31, 2001, was as
follows:
Fixed income:
U.S. Treasury securities and obligations of U.S. government agencies 10%
Corporate securities 33%
Mortgage-backed securities 8%
Other structured securities 18%
Municipal securities 11%
------
Total fixed income 80%
Cash and short-term 7%
Preferred stock 9%
Common stock 4%
------
100%
======
The Company's fixed-income portfolio of $150.4 million was 80% of the total cash
and investments as of December 31, 2001. Approximately 93% of these securities
were rated "A" or better by Standard & Poor's. Standard & Poor's rates publicly
traded securities in twenty categories ranging from AAA to CC. Securities with
ratings from AAA to BBB- (the top ten categories) are commonly referred to as
having an investment grade rating. Equity securities, the majority of which
consist of preferred stocks and common stocks (comprised exclusively of
exchange-traded funds), were $25.1 million or 13% of total cash and investments
as of December 31, 2001.
Page 33
As of December 31, 2001, the Company's investment portfolio contained corporate
fixed-income and preferred stock securities with a market value of $79.7
million. A summary of these securities by industry segment is as follows:
Financial institutions 48%
Communications 11%
Utilities 11%
Industrial 8%
Consumer, cyclical 6%
Basic materials 6%
Energy 4%
Technology 3%
Consumer, non-cyclical 3%
------
100%
======
As of December 31, 2001, the Company's investment portfolio contained $48.8
million of mortgage-backed, asset-backed and collateralized mortgage
obligations. All of these securities were rated "AA-" or better and 75% were
rated "AAA" by Standard & Poor's. These securities are publicly traded, and had
market values obtained from an independent pricing service. Changes in estimated
cash flows due to changes in prepayment assumptions from the original purchase
assumptions are revised based on current interest rates and the economic
environment. The Company had no derivative financial instruments, real estate or
mortgages in the investment portfolio as of December 31, 2001. The quality of
the fixed-income portfolio as of December 31, 2001, was as follows:
"AAA" 50%
"AA" 18%
"A" 25%
"BBB" 6%
Below "BBB" 1%
------
100%
======
The Company regularly evaluates its investment portfolio to identify
other-than-temporary impairments of individual securities. We consider many
factors in determining if any other-than-temporary impairment exists, including
the length of time and extent to which the market value of the security has been
less than cost, the financial condition and near-term prospects of the issuer of
the security and our ability and willingness to hold the security until the
market value is expected to recover. The following table contains an analysis of
the Company's securities with gross unrealized losses, categorized by the period
that the securities were in a continuous unrealized loss position as of December
31, 2001:
Investment Securities with Gross Unrealized Losses, Categorized by
Period of Continuous Unrealized Loss Position
Over
Six
Number Gross Six Months Over
of Fair Book Unrealized Months to One One
(in thousands) Securities Value Value Losses or Less Year Year
---------- --------- ---------- ------------ --------- ----------- ---------
Fixed income securities 13 $16,502 $16,802 $300 $46 $183 $ 71
Preferred stock 1 1,005 1,053 48 48
Common stock 3 1,888 2,018 130 9 80 41
------------ --------- ----------- ---------
$478 $55 $263 $160
============ ========= =========== =========
Page 34
As of December 31, 2001, the Company's fixed-income investment portfolio had
thirteen securities with $300,000 of gross unrealized losses. No single issuer
had an unrealized loss position greater than $109,000. The over one year gross
unrealized losses for fixed income securities of $71,000 represents 3 issuers
rated A-, A- and BBB+ by Standard & Poor's, and the unrealized loss position was
2.3% of the securities' original cost. The over six months to one year gross
unrealized losses for fixed income securities of $183,000 primarily represents
two public utility securities with maturity dates in 2004, were upgraded to B-
and BB by Standard & Poor's in February 2002 and the unrealized loss position
was 6% of the securities' original cost.
As of December 31, 2001, the Company's preferred stock portfolio had one
security with a gross unrealized loss of $48,000. This security is an investment
grade security (Standard and Poor's rating "AA-") and the unrealized loss was
4.5% of its original cost.
As of December 31, 2001, the Company's common stock portfolio had three
securities, all of which were exchange-traded funds, with $130,000 of gross
unrealized losses. No single issuer had an unrealized loss position of greater
than $80,000 or 11% of its book value.
Three-for-Two Stock Split
On April 11, 2002, the Company announced a three-for-two stock split to be
effected in the form of a 50% stock dividend payable to stockholders of record
as of April 25, 2002. The distribution date was May 9, 2002.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk is the potential economic loss principally arising from adverse
changes in the market value of financial instruments. The major components of
market risk affecting us are interest rate risk and equity price risk.
Interest Rate Risk
The Company had fixed-income and preferred stock investments with a market value
of $167.7 million at December 31, 2001 that are subject to interest rate risk.
The Company manages its exposure to interest rate risk through a disciplined
asset/liability matching and capital management process. In the management of
this risk, the characteristics of duration, credit and variability of cash flows
are critical elements. These risks constantly are assessed and balanced within
the context of the Company's liability and capital position.
The table below summarizes the Company's interest rate risk. The table
illustrates the sensitivity of the market value of fixed-income and preferred
stock investments to selected hypothetical changes in interest rates as of
December 31, 2001. The selected scenarios are not predictions of future events,
but rather illustrative of the effect that such events may have on the market
value of the fixed-income and preferred stock portfolio and stockholders'
equity.
Page 35
Estimated Market
(dollars in thousands) Value of Fixed Hypothetical Percentage
Income and Estimated Increase (Decrease) in
------------------------------------
Preferred Stock Change in Stockholders'
Hypothetical Change in Interest Rates Investments Market Value Market Value Equity
------------------ --------------- ----------------- ---------------
200 basis point increase. $153,680 $(14,062) (8.4)% (11.4)%
100 basis point increase 160,460 (7,282) (4.3) (5.9)
No change 167,742 --- --- ---
100 basis point decrease 175,463 7,721 4.6 6.3
200 basis point decrease 183,532 15,790 9.4 12.8
Equity Price Risk
Equity price risk is the Company's underlying exposure to an economic loss from
the decline of common stock prices. The Company's common equity portfolio was
$8.0 million at December 31, 2001.
The Company attempts to mitigate equity price risk to its common stock portfolio
by investing exclusively in exchange-traded funds, or ETFs. ETFs are securities
that represent an interest in a trust that owns and holds a basket of common
stocks that replicate a major market index (such as the S&P 500 or the Dow Jones
Industrial Average) or a portion of a major market index (such as the Value
Component of the S&P). Since these securities represent an interest in the
equity capital markets as a whole, or a sub-sector thereof, they are a
diversified, index-based exposure to common stocks. As such, the value of these
ETFs will be determined by the performance of the equity capital markets in
general or of a particular sub-sector and reduces equity price risk to a single
issuer of stock.
The table below summarizes the Company's common equity price risk. The table
illustrates the sensitivity of the market value of common stock investments to
selected hypothetical changes in market prices as of December 31, 2001. The
selected scenarios are not predictions of future events, but rather illustrative
of the effect that such events may have on the fair value of the common stock
investment portfolio and stockholders' equity.
Estimated Hypothetical
(dollars in thousands) Market Percentage
Value of Estimated Increase
Common Change in (Decrease) in
Equity Market Stockholders'
Hypothetical Change in Market Price Investments Value Equity
--------------------- --------------- -----------------
20% price increase $9,572 $1,595 1.3%
10% price increase 8,775 798 0.7
No change 7,977 --- ---
10% price decrease 7,179 (798) (0.7)
20% price decrease 6,382 (1,595) (1.3)
Impact of Inflation
Inflation can have a significant impact on property and casualty insurers
because premium rates are established before the amounts of losses and loss
adjustment expenses are known. The Company attempts to anticipate increases from
inflation in establishing rates, subject to limitations imposed for competitive
pricing. The Company also considers inflation when estimating liabilities for
losses and loss adjustment expenses, particularly for claims having a long
period between occurrence and settlement. The liabilities for losses and loss
adjustment expenses are management's best estimates of the ultimate net cost of
underlying claims and expenses and are not discounted for the time value of
Page 36
money. In times of high inflation, the normally higher yields on investments may
be offset partially by higher claims and expenses.
Cautionary Statements
Certain information included in management's discussion and analysis of
financial condition and results of operations and elsewhere in this report are
not historical facts but are forward-looking statements including, but not
limited to, such matters as anticipated financial performance, business
prospects, technological developments, new and existing products, expectations
for market segment growth and similar matters. In connection with the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995, the
Company provides the following cautionary remarks regarding important factors
which, among others, could cause the Company's actual results and experience to
differ materially from the anticipated results or other expectations expressed
in the Company's forward-looking statements. The risks and uncertainties that
may affect the operations, performance, development, results of the Company's
business and the other matters referred to above include, but are not limited
to: (1) changes in the business environment in which the Company operates,
including inflation and interest rates; (2) changes in taxes, governmental laws
and regulations; (3) competitive product and pricing activity; and (4)
difficulties of managing growth profitably. For additional disclosure regarding
potential risk factors, please refer to the Company's 2001 10-K and other
documents filed with the Securities and Exchange Commission.
Page 37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Auditors
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Penn America Group, Inc.
We have audited the accompanying consolidated balance sheets of
Penn-America Group, Inc. (the Company) as of December 31, 2001 and 2000, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2001. Our
audit also included the financial statement schedules listed in Item 14(a) as of
December 31, 2001 and for the year then ended. These financial statements and
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedules based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As discussed in Note 1 to the consolidated financial statements, the
Company has restated its 2001, 2000, and 1999 financial statements regarding the
timing of recording other than temporary declines in the market value of certain
equity securities.
In our opinion the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Penn-America Group, Inc. as restated at December 31, 2001 and 2000, and the
consolidated results of its operations and its cash flows as restated for each
of the three years in the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
Philadelphia, Pennsylvania
January 18, 2002
except for share and per share
information in Notes 2, 11, 14
and 15, the section entitled
"restatement of financial information"
in Note 1, the 7th and 13th paragraphs
in Note 1, all information marked
"restated" in the notes to consolidated
financial statements, the first paragraph
in Note 3, the next-to-last paragraphs in Note 4
and Note 8,and the last paragraph in Note 6,
as to which the date is November 1, 2002
Page 38
Penn-America Group, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31,
--------------------------------------
(In thousands, except for per share data) 2001 2000
---------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
AAssets
Investments:
Fixed maturities:
Available for sale, at fair value (amortized cost 2001, $130,976; 2000, $123,873) $135,253 $125,477
Held to maturity, at amortized cost (fair value 2001, $15,317; 2000, $17,441) 15,084 17,282
Equity securities, at fair value (cost 2001, $24,720; 2000, $24,895) 25,149 24,491
--------------------------------------
Total investments 175,486 167,250
Cash 13,129 11,425
Accrued investment income 2,199 2,181
Premiums receivable (net of allowances of $972 in 2001and $422 in 2000) 12,285 9,695
Reinsurance recoverable 25,804 24,447
Prepaid reinsurance premiums 4,241 4,635
Deferred policy acquisition costs 9,083 10,317
Capital lease, affiliate 1,666 1,753
Deferred income taxes 3,790 4,272
Income tax recoverable 66 2,982
Other assets 366 529
--------------------------------------
Total assets $248,115 $239,486
--------------------------------------
Liabilities and Stockholders' Equity
Liabilities:
Unpaid losses and loss adjustment expenses $119,598 $115,314
Unearned premiums 41,034 43,239
Accounts payable and accrued expenses 3,800 2,353
Capitalized lease obligation, affiliate 1,570 1,701
Other liabilities 1,722 2,828
--------------------------------------
Total liabilities 167,724 165,435
--------------------------------------
Stockholders' equity:
Preferred stock, $.01 par value; authorized 2,000,000 shares;
None issued -- --
Common stock, $.01 par value; authorized 20,000,000 shares;
issued 2001 and 2000, 15,228,351 and 15,114,038 shares, respectively;
outstanding 2001 and 2000, 11,478,351 and 11,364,038 shares, respectively 152 151
Additional paid-in capital 70,735 70,114
Accumulated other comprehensive income 3,106 792
Retained earnings 31,320 27,980
Treasury stock, 3,750,000 shares, at cost (24,161) (24,161)
Officers' stock loans (629) (546)
Unearned compensation from restricted stock awards (132) (279)
--------------------------------------
Total stockholders' equity 80,391 74,051
--------------------------------------
Total liabilities and stockholders' equity $248,115 $239,486
======================================
See accompanying notes to Consolidated Financial Statements
Page 39
Penn-America Group, Inc. and Subsidiaries
Consolidated Statements of Operations
Year ended December 31,
------------------------------------------------------
(In thousands, except per share data) 2001 2000 1999
--------------------------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Revenues
Premiums earned $ 88,934 $ 91,449 $ 85,677
Net investment income 11,339 10,454 9,537
Net realized investment loss (1,178) (2,808) (110)
Total revenues 99,095 99,095 95,104
Losses and expenses
Losses and loss adjustment expenses 60,921 75,378 63,187
Amortization of deferred policy acquisition costs 22,715 25,219 24,802
Other underwriting expenses 8,030 5,850 4,733
Corporate expenses 548 791 1,306
Interest expense 160 161 145
Total losses and expenses 92,374 107,399 94,173
Income (loss) before income tax 6,721 (8,304) 931
Income tax expense (benefit) 1,781 (3,473) (479)
Net income (loss) $ 4,940 $ (4,831) $ 1,410
Net income (loss) per share
Basic $ 0.43 $ (0.42) $ 0.11
Diluted $ 0.43 $ (0.42) $ 0.11
Weighted average shares outstanding
Basic 11,420,213 11,518,968 12,887,651
Diluted 11,501,703 11,518,968 12,986,603
Cash dividend per share $ 0.14 $ 0.14 $ 0.1383
See accompanying notes to Consolidated Financial Statements
Page 40
Penn-America Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Accumulated
Additional Other
Common Paid-In Comprehensive Retained Treasury
(In thousands, except per share amounts) Stock Capital Income (Loss) Earnings Stock
---------------------------------------------------------------------------------------------------------------------------------
(Restated) (Restated)
Balance at December 31, 1998 $ 149 $ 68,985 $ 2,714 $ 34,779 $ (5,643)
Net income -- -- -- 1,410 --
Other comprehensive loss:
Unrealized loss on investments, net of
tax and reclassification adjustment -- -- (6,410) -- --
Comprehensive loss
Issuance of common stock 1 556 -- -- --
Unearned compensation from restricted
stock awards issued -- -- -- -- --
Amortization of compensation expense from
restricted stock awards issued -- -- -- -- --
Cash dividends paid ($0.1383 per share) -- -- -- (1,767) --
Purchase of treasury stock, at cost -- -- -- -- (13,831)
-------- -------- -------- -------- --------
Balance at December 31, 1999 $ 150 $ 69,541 $ (3,696) $ 34,422 $(19,474)
-------- -------- -------- -------- --------
Net loss -- -- -- (4,831) --
Other comprehensive income:
Unrealized gains on investments, net of
tax and reclassification adjustment -- -- 4,488 -- --
Comprehensive loss
Issuance of common stock 1 573 -- -- --
Officers' stock loans -- -- -- -- --
Unearned compensation from restricted
stock awards issued -- -- -- -- --
Amortization of compensation expense from
restricted stock awards issued -- -- -- -- --
Cash dividends paid ($0.14 per share) -- -- -- (1,611) --
Purchase of treasury stock, at cost -- -- -- -- (4,687)
-------- -------- -------- -------- --------
Balance at December 31,2000 $ 151 $ 70,114 $ 792 $ 27,980 $(24,161)
-------- -------- -------- -------- --------
Net income -- -- -- 4,940 --
Other comprehensive income:
Unrealized gains on investments, net of
tax and reclassification adjustment -- -- 2,314 -- --
Comprehensive income
Issuance of common stock 1 621 -- -- --
Officers' stock loans -- -- -- -- --
Forfeiture of restricted stock awards -- -- -- -- --
Amortization of compensation expense from
restricted stock awards issued -- -- -- -- --
Cash dividends paid ($0.14 per share) -- -- -- (1,600) --
-------- -------- -------- -------- --------
Balance at December 31, 2001 $ 152 $ 70,735 $ 3,106 $ 31,320 $(24,161)
======== ======== ======== ======== ========
Unearned
Compensation
Officers' From Total
Stock Restricted Stockholders'
(In thousands, except per share amounts) Loans Stock Awards Equity
----------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 $ 0 $ (354) $ 100,630
Net income -- -- 1,410
Other comprehensive loss:
Unrealized loss on investments, net of
tax and reclassification adjustment -- -- (6,410)
Comprehensive loss (5,000)
Issuance of common stock -- -- 557
Unearned compensation from restricted
stock awards issued -- (91) (91)
Amortization of compensation expense from
restricted stock awards issued -- 120 120
Cash dividends paid ($0.1383 per share) -- -- (1,767)
Purchase of treasury stock, at cost -- -- (13,831)
--------- --------- ---------
Balance at December 31, 1999 $ 0 $ (325) $ 80,618
--------- --------- ---------
Net loss -- -- (4,831)
Other comprehensive income:
Unrealized gains on investments, net of
tax and reclassification adjustment -- -- 4,488
Comprehensive loss (343)
Issuance of common stock -- -- 574
Officers' stock loans (546) -- (546)
Unearned compensation from restricted
stock awards issued -- (74) (74)
Amortization of compensation expense from
restricted stock awards issued -- 120 120
Cash dividends paid ($0.14 per share) -- -- (1,611)
Purchase of treasury stock, at cost -- -- (4,687)
--------- --------- ---------
Balance at December 31,2000 $ (546) $ (279) $ 74,051
--------- --------- ---------
Net income -- -- 4,940
Other comprehensive income:
Unrealized gains on investments, net of
tax and reclassification adjustment -- -- 2,314
Comprehensive income 7,254
Issuance of common stock -- -- 622
Officers' stock loans (83) -- (83)
Forfeiture of restricted stock awards -- 32 32
Amortization of compensation expense from
restricted stock awards issued -- 115 115
Cash dividends paid ($0.14 per share) -- -- (1,600)
--------- --------- ---------
Balance at December 31, 2001 $ (629) $ (132) $ 80,391
========= ========= =========
See accompanying notes to Consolidated Financial Statements
Page 41
Penn-America Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Year ended December 31,
(In thousands) 2001 2000 1999
-----------------------------------------------------
(Restated) (Restated) (Restated)
Cash flows from operating activities:
Net income (loss) $ 4,940 $ (4,831) $ 1,410
Adjustments to reconcile net income (loss) to net cash provided by
Operating activities:
Bond amortization (accretion) and depreciation expense, net (5) 393 493
Net realized investment loss 1,178 2,808 110
Deferred income tax benefit (711) (1,096) (586)
Net (increase) decrease in premiums receivable, prepaid
reinsurance premiums and unearned premiums (4,401) 5,087 2,727
Net increase in unpaid losses and loss adjustment expenses
and reinsurance recoverable 2,927 15,432 5,264
Accrued investment income (18) (216) (94)
Deferred policy acquisition costs 1,234 (1,011) (578)
Income tax recoverable 2,915 (1,330) (768)
Other assets 23 (134) (64)
Accounts payable and accrued expenses 1,447 598 576
Other liabilities (1,106) (709) 112
----------------------------------------------
Net cash provided by operating activities 8,423 14,991 8,602
----------------------------------------------
Cash flows from investing activities:
Purchases of equity securities (4,162) (10,405) (8,320)
Purchases of fixed maturities available for sale (28,672) (87,573) (38,521)
Purchases of fixed maturities held to maturity -- (9,974) (2,785)
Proceeds from sales of equity securities 3,146 11,202 4,462
Proceeds from sales of fixed maturities available for sale 21,911 78,154 --
Proceeds from maturities of fixed maturities available for sale -- -- 25,995
Proceeds from maturities and calls of fixed maturities held to maturity 2,250 9,000 13,256
Change in short-term investments -- 449 548
----------------------------------------------
Net cash used by investing activities (5,527) (9,147) (5,365)
----------------------------------------------
Cash flows from financing activities:
Issuance of common stock 622 500 465
Purchase of treasury stock -- (4,687) (13,831)
Officers' stock loans (83) (546) --
Principal payments on capital lease obligations, affiliate (131) (120) (136)
Dividends paid (1,600) (1,611) (1,767)
----------------------------------------------
Net cash used by financing activities (1,192) (6,464) (15,269)
----------------------------------------------
Increase (decrease) in cash 1,704 (620) (12,032)
Cash, beginning of period 11,425 12,045 24,077
----------------------------------------------
Cash, end of period $ 13,129 $ 11,425 $ 12,045
==============================================
Supplemental disclosure of cash flow information:
Interest paid, affiliate $ 160 $ 161 $ 145
Taxes (recovered) paid (492) (950) 875
See accompanying notes to Consolidated Financial Statements
Page 42
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 Summary of Significant Accounting Policies
Basis of Presentation and Description of Business
Penn-America Group, Inc. ("PAGI") is an insurance holding company. Penn
Independent Corporation ("Penn Independent") owned approximately 40% of the
outstanding common stock of PAGI at December 31, 2001. The accompanying
financial statements include the accounts of PAGI and its wholly owned
subsidiary, Penn-America Insurance Company ("Penn-America") and its wholly owned
subsidiary Penn-Star Insurance Company ("Penn-Star"), (collectively the
"Company"). All significant inter-company accounts and transactions have been
eliminated in consolidation. These financial statements are prepared in
conformity with accounting principles generally accepted in the United States,
which differ in some respects from those required by insurance regulatory
authorities.
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The Company underwrites commercial property and general liability insurance and
multi-peril insurance for small businesses located primarily in small towns and
suburban and rural areas. The Company can write business in all fifty states and
the District of Columbia. The Company writes business on both an admitted and
non-admitted basis in thirty-six states, on only an admitted basis in two states
and on only a non-admitted basis in twelve states and the District of Columbia.
Restatement of Financial Information
In conjunction with the Company's registration statement filing relating to the
issuance of additional shares of common stock, the Company has resolved various
accounting and disclosure comments from the Securities and Exchange Commission
("SEC"). One of the comments addressed the timing of recording other than
temporary ("OTT") declines in the market value of certain equity securities. In
order to resolve the comment, the Company agreed to amend its accounting policy
and record OTT write-downs on these securities for the periods ending December
31, 2001, 2000, and 1999. This restatement affects net income for each of these
periods but has no affect on stockholders' equity since the unrealized loss on
these securities was already recorded in Accumulated Other Income (Loss) in the
Consolidated Balance Sheets and Statements of Stockholders' Equity. By means of
this filing, the Company is restating its previously issued financial statements
for the years ended December 31, 2001, 2000, and 1999.
Below is a table showing a comparison of previously reported and restated total
revenues, net income and net income per share (basic and diluted) for the
periods affected.
For the years ended,
-------------------------------------------------------------------------------------------------------
December 31, 2001 December 31, 2000 December 31, 1999
-------------------------------- ------------------------------- -------------------------------
As Reported As Restated As Reported As Restated As Reported As Restated
-------------- -------------- ------------- -------------- -------------- --------------
Total revenues $99,718 $99,095 $100,572 $99,095 $96,055 $95,104
Net income (loss) 5,351 4,940 (3,856) (4,831) 2,038 1,410
Net income (loss) per share
Basic 0.47 0.43 (0.33) (0.42) 0.16 0.11
Diluted 0.47 0.43 (0.33) (0.42) 0.16 0.11
Page 43
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
In addition, the SEC requested that the Company add certain disclosures. The
consolidated financial statements have been amended as appropriate to respond to
these requests.
Revenue Recognition
Premiums written are recognized as earned ratably over the terms of the
respective policies and include estimates for premiums earned but not yet billed
of $1,185,000 and $0 as of December 31, 2001, and 2000, respectively. Unearned
premiums represent the portion of premiums written applicable to the unexpired
terms of policies in force and are calculated on a semi-monthly pro-rata basis.
Valuation of Premiums Receivable
The Company evaluates the collectibility of premiums receivable based on a
combination of factors. In circumstances in which the Company is aware of a
specific customer's inability to meet its financial obligations to the Company,
a specific reserve for bad debts against amounts due is recorded to reduce the
net receivable to the amount reasonably believed to be collectible. No such
instances occurred in 2001. For all remaining balances, reserves are recognized
for bad debts based on the length of time the receivables are past due based on
historical statistics.
Investments
At the time of purchase of fixed-maturity investments, management makes a
determination as to the investment classification ("Available for Sale" or "Held
to Maturity"). Factors taken into consideration by management in determining the
appropriate investment category are: maturity, yield, cash flow requirements and
anticipated changes in interest rates. Fixed maturities classified as "Available
for Sale" are carried at fair value with unrealized investment gains or losses,
net of deferred income taxes, included as a separate component of accumulated
other comprehensive income in stockholders' equity. "Held to Maturity"
investments are carried at amortized cost.
Investments in fixed-maturity securities are adjusted for amortization of
premium and accretion of discounts to maturity date using the interest method.
Interest income is recognized on the accrual basis.
The amortized cost of mortgage-backed and asset-backed securities is calculated
using the interest method including consideration of anticipated prepayments at
the date of purchase. Significant changes in estimated cash flows from the
original assumptions are accounted for using the composite method.
Equity securities are carried at fair value with the change in unrealized
investment gains or losses, net of deferred income taxes, included as a separate
component of accumulated other comprehensive income in stockholders' equity.
Realized gains or losses represent the difference between the book value of
securities sold and the proceeds realized upon sale. The Company uses the
specific identification method to determine the cost of securities sold. The
cost of securities is adjusted where appropriate to include a provision for a
decline in value that is considered to be other- than-temporary. The Company
considers four factors in determining if an other-than-temporary decline exists:
length of time and extent that a security has been in an unrealized loss
position; the existence of an event that would impair the issuer's future
earnings potential; the near term prospects for recovery of the market value of
a security; and the intent and ability of the Company to hold the security until
the market value recovers. Realized gains or losses, including any provision for
other-than-temporary declines in value, are included in the statement of
operations.
Page 44
Penn-America Group, Inc. and Subsidiaries Notes to Consolidated
Financial Statements - (Continued)
Policy Acquisition Costs
Policy acquisition costs such as commissions, salaries, premium taxes and
certain other underwriting expenses, which vary with and are directly related to
the production of business, are deferred and amortized over the effective
periods of the related insurance policies. The method followed in computing
deferred policy acquisition costs limits the amount of such deferred costs to
their estimated realizable values, which gives effect to the premium to be
earned, related investment income, losses and loss adjustment expenses and
certain other costs expected to be incurred as the premium is earned.
Losses and Loss Adjustment Expenses
The liability for losses and loss adjustment expenses represents estimates of
amounts needed to pay reported and unreported claims and related expenses. These
estimates are based on certain actuarial and other assumptions related to the
ultimate cost to pay such claims. All estimates are reviewed periodically and as
experience develops and new information becomes known, the reserves are adjusted
as necessary. Such adjustments are reflected in the results of operations in the
period in which they are determined.
Fair Values of Financial Instruments
The Company uses the following methods or assumptions in determining fair
values:
Investment Securities: Fair values are based on quoted market prices or on
quoted market prices of comparable instruments or values obtained from
independent pricing services.
Premium and Reinsurance Receivables and Payables: The carrying amounts reported
in the balance sheet for these instruments approximate their fair values.
Capitalized Lease Obligation: Fair value is based upon the present value of the
underlying cash flows discounted at the Company's incremental borrowing rate at
year-end. The carrying amounts reported in the balance sheet approximate fair
value.
Reinsurance
In the ordinary course of business, the Company reinsures certain risks,
generally on an excess-of-loss basis, with other insurance companies which
principally are rated "A" or higher by A.M. Best. Such reinsurance arrangements
serve to limit the Company's maximum loss. Amounts recoverable from reinsurers
are estimated in a manner consistent with the claim liabilities arising from the
reinsured policies and incurred but not reported losses.
Capitalized Lease
The capitalized lease is carried at cost less accumulated amortization.
Amortization is calculated using the interest method over 20 years, which
represents the term of the mortgage on the office space that the Company rents
from a related party.
Income Tax
Deferred income taxes are accounted for under the liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Page 45
Penn-America Group, Inc. and Subsidiaries Notes to Consolidated
Financial Statements - (Continued)
Comprehensive Income (Loss)
Comprehensive income (loss) encompasses all changes in stockholders' equity
(except those arising from transactions with stockholders) and includes net
income and net unrealized investment gains and losses on fixed-income
investments classified as "available-for-sale" and equity securities, net of
deferred income tax.
Reclassification
Certain prior-year amounts have been reclassified to conform to 2001
classifications.
Note 2 Income Per Share
Basic net income (loss) per share is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for each period. Diluted net income (loss) per share includes the potential
dilution that could occur if the contracts to issue common stock were exercised
and converted into common stock.
The following is a reconciliation of the basic and diluted net income (loss) per
share computations:
Year ended December 31,
-----------------------------------------------------
(In thousands, except per share data) 2001 2000 1999
---------------------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Basic per share computation:
Net income (loss) $ 4,940 $ (4,831) $ 1,410
Weighted average common shares outstanding 11,420,213 11,518,968 12,887,651
-----------------------------------------------------
Basic net income (loss) per share $ 0.43 $ (0.42) $ 0.11
-----------------------------------------------------
Diluted per share computation:
Net income (loss) $ 4,940 $ (4,831) $ 1,410
Weighted average common shares outstanding 11,420,213 11,518,968 12,887,651
Additional shares outstanding after the
assumed
exercise of options by applying the
treasury stock method 81,490 * 98,952
-----------------------------------------------------
Total shares 11,501,703 11,518,968 12,986,603
-----------------------------------------------------
Diluted net income (loss) per share $ 0.43 $ (0.42) $ 0.11
-----------------------------------------------------
* As of December 31, 2000, the Company issued options to purchase 538,875 shares
of common stock to employees and directors at prices ranging from $3.61 to
$12.67. These options were not considered in the 2000 computation, as the impact
was anti-dilutive.
Page 46
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note 3 Transactions with Affiliates
Penn-America was formed by Irvin Saltzman, chairman of PAGI's board of directors
and a director of Penn Independent. Jon S. Saltzman, Irvin Saltzman's son, is
President and Chief Executive Officer of PAGI and a director of Penn
Independent. The Saltzman family, substantially through their ownership of Penn
Independent, owns approximately 40% of the outstanding common stock of PAGI at
December 31, 2001.
Penn-America leases its home office facility from Irvin Saltzman and the lease
is accounted for as a capital lease. The amount of property capitalized of
$2,227,000 is presented net of accumulated amortization of $561,000 and $474,000
as of December 31, 2001 and 2000, respectively. Capitalized lease obligations of
$1,570,000 and $1,701,000 were recorded at December 31, 2001 and 2000,
respectively, representing the lease obligation arising from this lease, which
carries an 8.5% interest rate. Penn Independent and its subsidiaries also lease
a portion of the building in which the Company's home office facility is
located. Management believes that the lease terms are at market rates.
At December 31, 2001, the future minimum lease payments for the capitalized
lease obligation are $281,000 per year in 2002 through 2006 and the total
minimum lease payments are $2,262,000, of which $692,000 is the amount
representing interest.
Penn Independent provides the Company with human resource management and other
services. The Company paid $212,000, $200,000 and $200,000 in 2001, 2000 and
1999, respectively, for such services. Such amounts are based on allocations of
estimated costs. All costs incurred by Penn Independent on behalf of the Company
have been allocated to the Company and are reflected in the financial
statements. Management believes that the methods used to allocate such costs are
reasonable and that the Company's expenses on a stand-alone basis would not be
materially different.
Gross written premiums with insurance agency affiliates of Penn Independent were
$3,888,000, $3,282,000 and $1,732,000 in 2001, 2000 and 1999, respectively.
Commissions paid to such affiliates were $857,000, $740,000 and $441,000 in
2001, 2000 and 1999 respectively. Premiums receivable includes receivable from
affiliates of $454,000 and $535,000 as of December 31, 2001 and 2000,
respectively.
Page 47
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note 4 Investments
The Company invests primarily in investment-grade fixed maturities,
substantially all of which are rated "A" or higher by Standard & Poor's. The
cost, gross unrealized gains and losses and fair values of investments are as
follows:
December 31, 2001
---------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
-------------------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Fixed maturities:
Available for sale:
U.S. Treasury securities and
obligations of U.S. government agencies 4,013 $ 182 $ -- $ 4,195
Corporate securities 49,981 2,091 51 52,021
Mortgage-backed securities 26,483 863 30 27,316
Other structured securities 20,758 725 21 21,462
Municipal securities 20,569 457 22 21,004
Public utilities 9,172 259 176 9,255
---------------------------------------------------------------
Total available for sale 130,976 4,577 300 135,253
---------------------------------------------------------------
Held to maturity:
U.S. Treasury securities and obligations
of U.S. government agencies 13,812 213 -- 14,025
Corporate securities 276 14 -- 290
Public utilities 996 6 -- 1,002
---------------------------------------------------------------
Total held to maturity 15,084 233 -- 15,317
---------------------------------------------------------------
Total fixed-maturity securities 146,060 4,810 300 150,570
Equity securities 24,720 607 178 25,149
---------------------------------------------------------------
Total investments $170,780 $ 5,417 $ 478 $175,719
===============================================================
Page 48
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
December 31, 2000
--------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
-------------------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Fixed maturities:
Available for sale:
U.S. Treasury securities and obligations
of U.S. government agencies $ 4,015 $ 107 $ -- $ 4,122
Corporate securities 52,084 668 387 52,365
Mortgage-backed securities 23,321 629 6 23,944
Other structured securities 21,381 497 6 21,872
Municipal securities 15,882 537 -- 16,419
Public utilities 7,190 44 479 6,755
--------------------------------------------------------------
Total available for sale 123,873 2,482 878 125,477
--------------------------------------------------------------
Held to maturity:
U.S. Treasury securities and obligations
of U.S. government agencies 13,760 162 14 13,908
Corporate securities 2,378 -- 4 2,374
Municipal securities 150 -- -- 150
Public utilities 994 15 -- 1,009
--------------------------------------------------------------
Total held to maturity 17,282 177 18 17,441
--------------------------------------------------------------
Total fixed-maturity securities 141,155 2,659 896 142,918
Equity securities 24,895 454 858 24,491
--------------------------------------------------------------
Total investments $166,050 $ 3,113 $ 1,754 $167,409
--------------------------------------------------------------
Fixed maturities at December 31, 2001, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or to prepay obligations with or without call or
prepayment penalties.
Available for Sale Held to Maturity
----------------------------------- ---------------------------------
Amortized Amortized
(In thousands) Cost Fair Value Cost Fair Value
-------------------------------------------------------------------------- ---------------------------------
Due in one year or less $ 3,055 $ 3,132 $ 12,118 $ 12,261
Due after one year through
five years 45,659 47,565 2,966 3,056
Due after five years through
ten years 27,198 27,585 - -
Due after ten years 7,823 8,193 - -
Mortgage-backed and other
structured securities 47,241 48,778 - -
----------------------------------- ---------------------------------
Total $ 130,976 $ 135,253 $ 15,084 $ 15,317
----------------------------------- ---------------------------------
Page 49
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
A summary of net investment income is as follows:
Year ended December 31,
-----------------------------------------------
(In thousands) 2001 2000 1999
---------------------------------------------------------------------------------------------
Interest on fixed maturities $ 9,835 $ 8,508 $ 7,629
Dividends on equity securities 1,421 1,422 1,492
Interest on short-term investments and cash 377 815 787
Other 37 26 4
-----------------------------------------------
Total investment income 11,670 10,771 9,912
Less investment expense (331) (317) (375)
-----------------------------------------------
Net investment income $ 11,339 $ 10,454 $ 9,537
-----------------------------------------------
All investments in fixed-maturity securities were income-producing during 2001,
2000 and 1999. Realized pre-tax gains (losses) on the sale of investments are as
follows:
Year ended December 31,
-------------------------------------------------
(In thousands) 2001 2000 1999
-----------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Fixed maturities:
Gross realized gains $ 218 $ 24 $ 66
Gross realized losses (203) (1,461) (23)
-------------------------------------------------
Net realized investment gain (loss) 15 (1,437) 43
Equity securities:
Gross realized gains 240 1,128 1,266
Gross realized losses (1,433) (2,499) (1,419)
-------------------------------------------------
Net realized investment loss (1,193) (1,371) (153)
-------------------------------------------------
Total net realized investment loss $(1,178) $(2,808) $ (110)
-------------------------------------------------
Income tax benefit on net realized losses was $400,000, $955,000 and $38,000 in
2001, 2000, and 1999, respectively. Gross realized losses on equity securities
for the year ended December 31, 2001, 2000 and 1999, included an
other-than-temporary impairment write-down of $1,226,000, $1,770,000, and
$951,000, respectively.
The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 2001 and 2000 amounted to $10,998,000 and
$10,992,000, respectively.
Note 5 Reinsurance
In the normal course of business, the Company seeks to reduce the losses that
may arise from catastrophes or other events that cause unfavorable underwriting
results by reinsuring certain levels of risks in various areas of exposure with
other insurance enterprises or reinsurers. Reinsurance contracts do not relieve
the Company of its obligations to policyholders. Failure of reinsurers to honor
their obligations could result in losses to the Company. Allowances have been
established for amounts deemed uncollectible. The Company evaluates the
financial condition of its reinsurers and monitors concentrations of credit risk
arising from similar geographic regions, activities or economic characteristics
of the reinsurers to minimize its exposure to significant losses
Page 50
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
from reinsurer insolvencies. At December 31, 2001, reinsurance recoverable and
prepaid reinsurance premiums associated with two major reinsurers, General
Reinsurance Corporation and American Reinsurance Corporation, were $24.3 million
and $5.0 million, respectively.
Written premiums and premiums earned consisted of the following:
Year ended December 31,
------------------------------------------------
(In thousands) 2001 2000 1999
-----------------------------------------------------------------------------------------------------
Written premiums:
Gross $ 98,412 $ 109,791 $ 95,983
Ceded 11,289 12,541 8,947
------------------------------------------------
Net of reinsurance $ 87,123 $ 97,250 $ 87,036
------------------------------------------------
Premiums earned:
Gross $ 100,617 $ 102,883 $ 93,904
Ceded 11,683 11,434 8,227
------------------------------------------------
Net of reinsurance $ 88,934 $ 91,449 $ 85,677
------------------------------------------------
Loss and loss adjustment expenses are net of recoveries recognized under
reinsurance contracts as follows: $7,446,000, $9,438,000 and $7,182,000 in 2001,
2000 and 1999, respectively.
Note 6 Unpaid Losses and Loss Adjustment Expenses
Activity in the liability for unpaid losses and loss adjustment expenses is
summarized as follows:
Year ended December 31,
------------------------------------------------
(In thousands) 2001 2000 1999
-------------------------------------------------------------------------------------------------------
Balance, beginning of year $ 115,314 $ 93,719 $ 88,937
Less reinsurance recoverable 24,093 18,086 16,502
------------------------------------------------
Net balance, beginning of year
91,221 75,633 72,435
Incurred related to:
Current year 60,885 66,214 54,768
Prior years 36 9,164 8,419
------------------------------------------------
Total incurred
60,921 75,378 63,187
Paid related to:
Current year 19,913 26,273 23,540
Prior years 38,183 33,517 36,449
------------------------------------------------
Total paid
58,096 59,790 59,989
Net balance, end of year 94,046 91,221 75,633
Plus reinsurance recoverable 25,552 24,093 18,086
------------------------------------------------
Balance, end of year $ 119,598 $ 115,314 $ 93,719
------------------------------------------------
Page 51
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
In 2001, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $36,000. This increase related
entirely to the commercial automobile line of business. During 2001, the Company
increased its estimate for the commercial multi-peril liability line of business
by $1.8 million due to the development of outstanding claim reserves on claims
occurring primarily in 1998 and 1999. This increase was almost entirely offset
by a reduction in the Company's estimate for the non-standard personal
automobile line of business due to favorable settlements on closed claims.
In 2000, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $9,164,000. The increase is
primarily attributable to changes in the Company's estimates for losses and loss
adjustment expense reserves of $1.4 million for commercial automobile, $3.9
million for commercial multi-peril liability and $3.4 million for other
liability lines of business. The Company began writing commercial automobile
coverage for vehicles and light trucks in 1998. The Company's initial estimates
for 1998 and 1999 were based on a relatively low level of claims reported. In
2000, the Company received a significant number of claims relating to accidents
incurred in 1998 and 1999. In the fourth quarter of 2000, the Company exited the
commercial automobile line of business due to unsatisfactory underwriting
results. The Company's change in estimates in 2000 for the commercial
multi-peril liability line of business resulted principally from its increased
exposure to liquor liability losses for policies primarily written in 1998 and
1999. In 2000, the Company revised its underwriting approach significantly to
reduce its exposure to liquor liability claims. The Company's change in
estimates in 2000 for the other liability line resulted principally from
construction defect claims, which were new claims that were not anticipated by
the Company when the Company wrote these policies between 1991 and 1996. These
claims predominantly related to residential contractors and sub-contractors in
California. In 2000, the Company completed its withdrawal from the residential
contractors and sub-contractors industry segment.
In 1999, the Company increased incurred losses and loss adjustment expenses
attributable to insured events of prior years by $8,419,000. The increase is
primarily attributable to changes in estimates for losses and loss adjustment
expense reserves for our non-standard personal automobile line of business. For
1999, the Company received a significant number of claims relating to accidents
incurred prior to 1999, resulting in an increase in the Company's loss
estimates. For 1999, the Company exited the nonstandard personal automobile
lines. Incurred losses and loss adjustment expenses include estimates, recorded
as loss and loss adjustment expense reserves on the balance sheet, for the
ultimate payment on both reported and unreported claims. The Company changes its
estimates for loss and loss adjustment expenses reserves as new events occur, as
more loss experience is acquired, or as additional information is received. The
Company's estimates for loss and loss adjustment expense reserves result from a
continuous review process and the change in these estimates, as required by
Financial Accounting Standards Board No. 60, Accounting and Reporting by
Insurance Enterprises, paragraph 18, is recorded in the period that the change
in these estimates is made.
Page 52
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note 7 Income Tax
The components of income tax expense (benefit) are as follows:
Year ended December 31,
-----------------------------------------------
(In thousands) 2001 2000 1999
---------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Current $ 2,492 $(2,377) $ 107
Deferred (711) (1,096) (586)
-----------------------------------------------
Total tax expense (benefit) $ 1,781 $(3,473) $ (479)
-----------------------------------------------
The actual income tax rate differed from the statutory income tax rate
applicable to income before income taxes as follows:
Year ended December 31,
-------------------------------------------------
(In thousands) 2001 2000 1999
-------------------------------------------------------------------------------------------------------
(Restated) (Restated)
(Restated)
Statutory income tax rate 34.0% (34.0)% 34.0%
Tax-exempt interest and dividends received
deduction (7.7) (10.2) (44.5)
Other 0.2 2.4 (40.9)
-------------------------------------------------
26.5% (41.8)% (51.4)%
-------------------------------------------------
The tax effects of temporary differences that result in a net deferred tax asset
as of December 31, are summarized as follows:
(In thousands) 2001 2000
------------------------------------------------------------------------------------------------
(Restated) (Restated)
Assets
Effect of discounting unpaid losses
and loss adjustment expenses $4,490 $4,070
Excess of tax over financial
reporting of earned premium 2,502 2,625
Realized investment losses due to other-than temporary write-downs 1,241 826
Other 609 763
--------------------------------
Total deferred assets 8,842 8,284
--------------------------------
Liabilities
Deferred policy acquisition costs $3,088 $3,508
Net unrealized investment gain 1,600 408
Other 364 96
--------------------------------
Total deferred liabilities 5,052 4,012
--------------------------------
Net deferred tax asset $3,790 $4,272
--------------------------------
The Company is required to establish a valuation allowance for any portion of
the deferred tax asset that management believes will not be realized. In the
opinion of management, it is probable that the Company will realize the benefit
of the deferred tax asset and, therefore, no such valuation allowance has been
established.
Page 53
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note 8 Segment Information
The Company had two reportable segments: personal lines and commercial lines.
These segments were managed separately because they have different customers,
pricing and expense structures. The Company exited the non-standard personal
automobile business in 1999 and announced that it would run-off its remaining
portfolio of such business. The Company will continue to report on this segment
separately until the amounts relating to the non-standard personal automobile
business become immaterial to the financial statements presented. The Company
does not allocate assets between segments because assets are reviewed in total
by management for decision-making purposes.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates segment profit
based on profit or loss from operating activities. Segment profit or loss from
operations is pre-tax and does not include unallocated expenses but does include
investment income attributable to insurance transactions. Segment profit or loss
therefore excludes income taxes, unallocated expenses and investment income
attributable to equity.
The following is a summary of the Company's segment revenues, expenses and
profit:
Year ended December 31, 2001
----------------------------------------------
(In thousands) Commercial Personal Total
----------------------------------------------
(Restated) (Restated) (Restated)
Premiums earned $ 88,912 $ 22 $ 88,934
Net investment income and net realized investment loss from
insurance operations 6,667 -- 6,667
----------------------------------------------
Total segment revenues
95,579 22 95,601
----------------------------------------------
Segment losses and loss adjustment expenses 62,414 (1,493) 60,921
Segment expenses 26,087 8 26,095
----------------------------------------------
Total segment expenses
88,501 (1,485) 87,016
----------------------------------------------
Segment profit $ 7,078 $ 1,507 $ 8,585
----------------------------------------------
Plus unallocated items:
Net investment income from equity 3,494
Unallocated expenses (5,358)
Income tax expense (1,781)
-----------
Net income $ 4,940
-----------
Page 54
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Year ended December 31, 2000
----------------------------------------------
(In thousands) Commercial Personal Total
----------------------------------------------
(Restated) (Restated) (Restated)
Premiums earned $ 87,556 $ 3,893 $ 91,449
Net investment income and net realized investment loss from
insurance operations 3,801 353 4,154
----------------------------------------------
Total segment revenues
91,357 4,246 95,603
----------------------------------------------
Segment losses and loss adjustment expenses 72,893 2,485 75,378
Segment expenses 25,614 1,362 26,976
----------------------------------------------
Total segment expenses
98,507 3,847 102,354
----------------------------------------------
Segment profit (loss) ($ 7,150) $ 399 $ (6,751)
----------------------------------------------
Plus unallocated items:
Net investment income from equity 3,492
Unallocated expenses (5,045)
Income tax benefit 3,473
--------------
Net loss $ (4,831)
--------------
Year ended December 31, 1999
----------------------------------------------
(In thousands) Commercial Personal Total
----------------------------------------------
(Restated) (Restated) (Restated)
Premiums earned $ 71,731 $ 13,946 $ 85,677
Net investment income and net realized investment gain from
insurance operations 3,917 662 4,579
----------------------------------------------
Total segment revenues
75,648 14,608 90,256
----------------------------------------------
Segment losses and loss adjustment expenses 49,744 13,443 63,187
Segment expenses 21,905 4,533 26,438
----------------------------------------------
Total segment expenses
71,649 17,976 89,625
----------------------------------------------
Segment profit (loss) $ 3,999 $ (3,368) $ 631
-------------------------------------------------
Plus unallocated items:
Net investment income from equity 4,848
Unallocated Expenses (4,548)
Income tax benefit 479
--------------
Net income $ 1,410
--------------
Total segment revenues of $95,601,000, $95,603,000 and $90,256,000, plus
unallocated net investment income from equity of $3,494,000, $3,492,000 and
$4,848,000, equals total Company revenues of $99,095,000, $99,095,000 and
$95,104,000 for the years ended December 31, 2001, 2000, and 1999, respectively.
Page 55
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
In 2001, the Company had one general agency that accounted for approximately 11%
of gross premiums earned. In 2000 and 1999, no general agent accounted for more
than 10% of gross premiums earned.
Note 9 Dividends from Subsidiaries and Statutory Information
Penn-America and Penn-Star are highly regulated by the state in which they are
incorporated and the states in which they do business. Such regulations, among
other things, limit the amount of dividends, impose restrictions on the amount
and types of investments and regulate rates insurers may charge for various
products.
A source of cash for the payment of common stock dividends to PAGI's
stockholders is dividends from Penn-America. Penn-America is required by law to
maintain a certain minimum surplus on a statutory basis and is subject to
risk-based capital requirements and regulations under which payment of a
dividend from statutory surplus may require prior approval of the Pennsylvania
regulatory authorities. In 2001, the Company paid dividends of $1.6 million to
PAGI. No ordinary dividends were paid in 2000. In 2000, the Penn-America paid a
$6.4 million return of capital to PAGI, after receiving approval from the
Pennsylvania Insurance Department. The maximum dividend that may be paid by
Penn-America to PAGI without prior approval of regulatory authorities in 2002 is
$6,473,325.
The National Association of Insurance Commissioners ("NAIC") has developed
Property and Casualty Risk-Based Capital ("RBC") standards that relate an
insurer's reported statutory surplus to the risks inherent to overall
operations. The RBC formula uses the statutory annual statement to calculate the
minimum indicated capital level to support asset risk and underwriting risk. The
NAIC model law calls for various levels of regulatory action based on the
magnitude of an indicated RBC capital deficiency, if any. The Company regularly
monitors capital requirements along with the NAIC's RBC developments. The
Company has determined that its capital levels are in excess of the minimum
capital requirements for all RBC action levels and that its capital levels are
sufficient to support the level of risk inherent in its operations.
The following tables reconcile statutory surplus and net income (loss) of the
Company as determined in accordance with accounting procedures prescribed by the
insurance regulatory authorities to stockholders' equity and net income (loss)
of the Company calculated in accordance with accounting principles generally
accepted in the United States as reported herein:
Year ended December 31,
----------------------------------------------
(In thousands) 2001 2000 1999
------------------------------------------------------------------------------------------------
Statutory surplus as regards to policyholders $ 64,733 $ 55,530 $ 69,515
Deferred policy acquisition costs 9,083 10,317 9,306
Deferred income taxes (574) 4,272 5,483
Net unrealized investment gain (loss) 4,151 1,974 (5,027)
Non-admitted assets 2,171 1,175 896
Provision for uncollectible accounts (1,022) (522) (522)
Holding company assets 1,594 1,156 938
Other, net 255 149 29
---------------------------------------------------
GAAP stockholders' equity $ 80,391 $ 74,051 $ 80,618
---------------------------------------------------
Page 56
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Year ended December 31,
---------------------------------------------------
(In thousands) 2001 2000 1999
-------------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Statutory net income (loss) $ 6,827 $(5,020) $ 1,869
Deferred policy acquisition costs (1,268) 1,010 578
Deferred income tax 499 594 281
Allowance for uncollectible accounts (500) -- 100
Holding company expenses, net of tax (345) (500) (825)
GAAP restatement - other than temporary impairment (1) (411) (975) (628)
Other, net 138 60 35
---------------------------------------------------
GAAP net income (loss) $ 4,940 $(4,831) $ 1,410
---------------------------------------------------
(1) See Note 1 to the Consolidated Financial Statements.
The NAIC revised the Statutory Accounting Practices and Procedures Manual in a
process referred to as Codification. The objective of Codification is to
standardize the accounting practices prescribed by each State's Insurance
Department. The revised manual was effective January 1, 2001. Pennsylvania, the
domiciliary state for Penn-America and Penn-Star, has adopted the provisions for
the revised manual. The revised manual has changed, to some extent, prescribed
statutory accounting practices and has resulted in changes to the accounting
practices that Penn-America and Penn-Star use to prepare their statutory-basis
financial statements. These changes resulted in an increase in the
statutory-basis capital and surplus of the Company of $3.3 million at January 1,
2001.
Note 10 Incentive Savings and Retirement Plan
Penn-America participates in a profit-sharing and a 401(k) plan with Penn
Independent that covers qualified employees. Penn-America's contributions under
the 401(k) plan were $117,000, $72,000 and $105,000 for 2001, 2000, and 1999,
respectively. There were no profit-sharing distributions in 2001, 2000, and
1999.
Note 11 Stock Incentive Plans
Stock options: In August 1993, the Company adopted a Stock Incentive Plan (the
"Plan"), which was later amended and restated in April of 1994 and amended in
April 2000. The purpose of the Plan is to enable officers, employees, directors,
consultants, advisors and service providers of the Company and its affiliates
(as defined in the Plan) to participate in the Company's future and to enable
the Company to attract and retain these persons by offering them proprietary
interests in the Company. The Plan authorized the issuance of up to 1,237,500
shares of common stock pursuant to the exercise of stock options or the award of
restricted stock. Options are exercisable according to the various terms under
which they were granted varying from one year to ten years after the date of
grant. All options are subject in general to earlier termination if the optionee
leaves the employ of the Company.
....
The fair value of options is estimated on the grant date using the Black-Scholes
option pricing model. The model assumes the following for 2001, 2000, and 1999,
respectively: expected annual dividend rates of 2.0%, 2.8% and 1.9%; risk-free
interest rates of 2.0% for 2001 and 6.0% for 2000 and 1999; weighted-average
expected life of the options of 4.8 years for 2001 and 2.5 years for 2000 and
1999; and expected stock price volatility of 22% for 2001 and 30% for 2000 and
1999.
Page 57
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The Company has elected to account for these stock options in accordance with
the provisions of Accounting Principles Board Opinion ("APB") #25, "Accounting
for Stock Issued to Employees" and accordingly, no compensation expense has been
recorded for such grants. Statement of Financial Accounting Standards ("SFAS")
#123 "Accounting for Stock-Based Compensation," effective in 1996, would require
that compensation expense be recorded for these option grants. Accounting for
such options using APB 25 and SFAS 123 are both acceptable alternatives under
GAAP. Had the Company elected to adopt SFAS 123, the effect on the Company's net
income and per share results would have been:
Year ended December 31,
----------------------------------------------
(in thousands) 2001 2000 1999
------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Net income (loss):
As reported $ 4,940 $ (4,831) $ 1,410
Pro forma 4,914 (4,973) 1,385
Diluted net income (loss) per share:
As reported $ 0.43 $ (0.42) $ 0.11
Pro forma 0.43 (0.43) 0.11
A summary of the status of and changes in the Company's stock option plan is
presented below:
Year ended December 31,
-----------------------------------------
2001 2000 1999
------------------------------------------------------------------------------------------------------------------
(in thousands, except per share data)
Outstanding at beginning of year
(average price of $4.75, $4.73 and $4.65) 539 461 447
Granted (average price of $5.17, $4.96 and $7.09 per share) 54 111 14
Exercised (average price of $4.12 and $2.95 per share) (81) (24) -
Forfeited (average price of $4.95 and $10.92 per share) (20) (9) -
-----------------------------------------
Outstanding at end of year (average price of $4.87, $4.75 and $4.73) 492 539 461
=========================================
Options exercisable at end of year 418 442 447
-----------------------------------------
Weighted average fair value of options
granted during the year $ 0.81 $1.94 $2.19
Page 58
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The following table summarizes information about stock options outstanding at
December 31, 2001:
Options Outstanding Options Exercisable
-------------------------------------------------- ------------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
12/31/01 Contractual Exercise 12/31/01 Exercise
Exercise Prices (in 000's) Life (Years) Price (in 000's) Price
------------------------------------------------------------------------------- ------------------------------
$3.60 - $3.80 12 0.4 $ 3.63 12 $ 3.63
$3.81 - $5.07 347 2.8 $ 4.17 323 $ 4.11
$5.07 - $6.33 54 2.9 $ 5.56 36 $ 5.76
$6.34 - $7.60 45 3.4 $ 6.79 13 $ 7.09
$7.61 - $10.13 21 1.4 $ 9.17 21 $ 9.17
$10.14 - $12.67 13 2.4 $ 12.67 13 $ 12.67
On January 2, 2002, the Company granted 262,335 stock options to employees at an
exercise price equal to the market price on the date of the grant. These stock
option grants vest over a five-year period beginning January 2, 2003.
Restricted Stock: The Company has awarded shares of restricted stock to certain
employees. Such shares are held by the Company and released to each grantee at
the rate of 20% per year provided that the grantee is still employed by the
Company or its affiliates. The Company charged $115,000 in 2001 and $120,000 in
2000 and 1999 to compensation expense relating to these awards. During 2001,
2000 and 1999, 15,750, 9,750 and 9,750 shares, respectively, of the restricted
stock were released to the applicable employees as allowed by the provisions of
the grant.
Agents' Contingent Commission Plan: The Company's Agents' Contingent Commission
Plan allows its agents to receive up to 100% of their contingent profit
commission awards in PAGI common stock. Agents' common stock awards for the
2000, 1999 and 1998 years, which were issued in May of 2001, 2000 and 1999,
amounted to 35,189, 89,384, and 63,053 shares, respectively.
Note 12 Commitments and Contingencies
The Company's insurance subsidiaries are subject to routine legal proceedings in
connection with their property and casualty business. Penn-America has been
named as a defendant in litigation commenced in the Superior Court of
California, County of Los Angeles, on November 6, 2000 and in an identical suit
on December 18, 2000 in the County of Orange relating to our exited non-standard
personal automobile business. It is not possible at this time to evaluate the
probability of a favorable or unfavorable outcome, nor is it possible to
estimate the amount of loss, if any. Management believes that its position is
defensible as to such litigation and is of the opinion that the amount of loss,
if any, will not have a material affect on the Company's financial statements.
The Company is involved in no other pending or threatened legal or
administrative proceedings which management believes might have a material
adverse effect on the Company's financial condition or results of operations.
Page 59
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The Company leases various computer equipment for use by its insurance
subsidiaries. These leases have terms primarily expiring in less than a
three-year period. Rental expenses for these operating leases were $391,000
$349,000 and $392,000 for the years ended December 31, 2001, 2000 and 1999,
respectively.
At December 31, 2001, the future minimum rental payments required under
operating leases that have initial or remaining non-cancellable lease terms in
excess of one year were $341,000, $150,000 and $11,000 for 2002, 2003 and 2004,
respectively.
Note 13 Other Comprehensive Income
Accumulated other comprehensive income (loss) of the Company consists solely of
net unrealized gains and losses. The following table illustrates the components
of accumulated other comprehensive income:
Year ended December 31, 2001
-------------------------------------------
(In thousands) Pre-tax Tax Expense Net of Tax
Amount Amount
----------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Unrealized gains on investments:
Unrealized holding gains arising during period $ 2,328 $ (792) $ 1,536
Reclassification adjustments for losses
realized in net income 1,178 (400) 778
------------------------------------------
Other comprehensive income $ 3,506 $(1,192) $ 2,314
------------------------------------------
Year ended December 31, 2000
-------------------------------------------
(In thousands) Pre-tax Tax Expense Net of Tax
Amount Amount
----------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Unrealized gains on investments:
Unrealized holding gains arising during period $ 3,992 $(1,357) $ 2,635
Reclassification adjustments for losses
realized in net income 2,808 (955) 1,853
------------------------------------------
Other comprehensive income $ 6,800 $(2,312) $ 4,488
------------------------------------------
Year ended December 31, 1999
------------------------------------------
(In thousands) Pre-tax Tax Expense Net of Tax
Amount Amount
----------------------------------------------------------------------------------------------------
(Restated) (Restated) (Restated)
Unrealized losses on investments:
Unrealized holding losses arising during period $(9,822) $ 3,340 $(6,482)
Reclassification adjustments for losses
realized in net income 110 (38) 72
------------------------------------------
Other comprehensive loss $(9,712) $ 3,302 $(6,410)
------------------------------------------
Page 60
Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note 14 Unaudited Quarterly Financial Information
2001
-------------------------------------------------------------------------------------------------
(In thousands except
per share data) First Second Third Fourth Total
-------------------------------------------------------------------------------------------------------------------------------
(Restated)
Revenues $ 25,994 $ 24,687 $ 23,837 $ 24,577 $ 99,095
Net income 967 994 1,551 1,428 4,940
Net income per share:
Basic 0.09 0.09 0.14 0.12 0.43
Diluted 0.08 0.09 0.13 0.12 0.43
2000
-------------------------------------------------------------------------------------------------
(In thousands except
per share data) First Second Third Fourth Total
-------------------------------------------------------------------------------------------------------------------------------
(Restated)
Revenues $ 23,933 $ 24,923 $ 24,971 $ 25,268 $ 99,095
Net income (loss) 1,583 (662) (5,078) (674) (4,831)
Net income per share:
Basic 0.13 (0.06) (0.45) (0.06) (0.42)
Diluted 0.13 (0.06) (0.45) (0.06) (0.42)
Note 15--Subsequent Event
On April 11, 2002, the Company announced a three-for-two stock split to be
effected in the form of a 50% Stock dividend payable to shareholders of record
as of April 25, 2002. The distribution date was May 9, 2002. The number of
shares of common stock issued and outstanding and shares of treasury stock in
the stockholders' equity section of the consolidated balance sheet have been
adjusted to reflect the effect of the stock split. The balances for common stock
and additional paid-in capital have been adjusted to reflect the effect of the
stock split. The basic and diluted net income per share and basic and diluted
weighted average shares outstanding on the consolidated statement of operations
have been adjusted to reflect the effect of the stock split. The cash dividend
paid per share and the balances of common stock and additional paid-in capital
on the consolidated statement of stockholders' equity have been adjusted to
reflect the effect of the stock split. The per share information in notes 2, 11
and 14 have been adjusted to reflect the effect of the stock split.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
Page 61
PART III
ITEM 10. Directors and Executive Officers of the registrant
The Director's information will be in the Company's definitive Proxy Statement
with respect to the Company's 2002 Annual Meeting of Shareholders, to be filed
with the Securities and Exchange Commission within 120 days following the end of
the Company's fiscal year, and is hereby incorporated by reference thereto.
Executive Officers of the Registrant as of March 15, 2002 are as follows:
Irvin Saltzman 79 Chairman of the Board of Directors of PAGI
and Penn-America
Jon S. Saltzman 44 President and Chief Executive Officer of
PAGI and Penn-America
Joseph F. Morris 47 Senior Vice President, Chief Financial
Officer and Treasurer of PAGI and
Penn-America
Garland P. Pezzuolo 37 Vice President, Secretary and General
Counsel of PAGI and Penn-America
ITEM 11. EXECUTIVE COMPENSATION
This information will be contained in the Company's definitive Proxy Statement
with respect to the Company's 2002 Annual Meeting of Shareholders, to be filed
with the Securities and Exchange Commission within 120 days following the end of
the Company's fiscal year, and is hereby incorporated by reference thereto.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
This information will be contained in the Company's definitive Proxy Statement
with respect to the Company's 2002 Annual Meeting of Shareholders, to be filed
with the Securities and Exchange Commission within 120 days following the end of
the Company's fiscal year, and is hereby incorporated by reference thereto.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information will be contained in the Company's definitive Proxy Statement
with respect to the Company's 2002 Annual Meeting of Shareholders, to be filed
with the Securities and Exchange Commission within 120 days following the end of
the Company's fiscal year, and is hereby incorporated by reference thereto.
ITEM 14. CONTROLS AND PROCEDURES
As of December 31, 2001, an evaluation was performed under the supervision and
with the participation of the Company's management, including the President and
CEO and Senior Vice President, CFO and Treasurer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on that evaluation, the Company's management, including the President and CEO
and Senior Vice President, CFO and Treasurer, concluded that the Company's
disclosure controls and procedures were effective as of December 31, 2001. There
have been no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to December
31, 2001.
Page 62
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K
a.) The following consolidated financial statements, financial statement
schedules and exhibits are filed as part of this report:
1. Consolidated Financial Statements (Restated)
Page
--------------
Consolidated Balance Sheets at December 31, 2001 and 2000 39
Consolidated Statements of Operations for the years ended December 31, 2001, 2000, and 1999
40
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2001, 2000
and 1999. 41
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000, and 1999
42
Notes to Consolidated Financial Statements 43-61
Independent Auditors' Report for the years 2001, 2000 and 1999 38
The following consolidated financial statement schedules for the years
2001, 2000, and 1999 are submitted herewith:
2. Financial Statement Schedules.
Page
---------
Schedule I. Summary of Investments - Other Than Investments in Related Parties 71
Schedule II. Condensed Financial Information of Parent Company 72-74
Schedule III. Supplementary Insurance Information 75
Schedule IV. Reinsurance 76
Schedule VI. Supplemental Insurance Information Concerning Property and Casualty 77
Operations
Independent Auditors' Consent and Report on Schedules (filed as Exhibit 23)
All other schedules are omitted because they are not applicable or the required
information is included in the financial statements or notes thereto.
3. Exhibit Index: 64-70
Page 63
Exhibit Index
Exhibit No. Description
3.1 Articles of Incorporation of the Registrant,
incorporated by reference to Exhibit 3.1 to the
Registrant's Registration Statement on Form S-1 (No.
33-66892) filed with the Securities and Exchange
Commission on August 2, 1993.
3.2 Bylaws of the Registrant, incorporated by reference to
Exhibit 3.2 to the Registrant's Registration Statement
on Form S-1 (No. 33-66892) filed with the Securities and
Exchange Commission on August 2, 1993.
10.3 1993 Casualty Excess of Loss Reinsurance Agreement with
National Reinsurance Corporation, incorporated by
reference to Exhibit 10.3 to the Registrant's
Registration Statement on Form S-1 (No. 33-66892) and
filed with the Securities and Exchange Commission on
August 2, 1993.
10.3(i) Endorsements Nos. 4 through 6 (Termination Endorsement)
to 1993 Casualty Excess of Loss Reinsurance Agreement
with National Reinsurance Corporation, filed with the
Securities and Exchange Commission with Registrant's
Report on Form S-2 Amendment No. 1 (No. 333-91362) on
September 6, 2002.
10.7 Agreement dated August 20, 1993, between Penn
Independent Corporation ("Penn Independent") and the
Registrant regarding the reimbursement of certain
employment costs, incorporated by reference to Exhibit
10.7 to Amendment No. 1 to the Registrant's Registration
Statement on Form S-1 (No. 33-66892) and filed with the
Securities and Exchange Commission on August 26, 1993.
10.7(i) Amendment effective January 1, 1995 to August 20, 1993
Agreement between Penn Independent and Registrant
regarding the sharing of certain operating costs, filed
with Registrant's Report on Form 10-K for the period
ended December 31, 1995, which has been filed with the
Securities and Exchange Commission.
10.7(ii) Amendments dated January 1, 1996, and March 1, 1996, to
August 20, 1993 Agreement between Penn Independent and
Registrant regarding the sharing of certain operating
costs, filed with Registrant's Report on Form 10-K for
the period ended December 31, 1996, which has been filed
with the Securities and Exchange Commission.
10.7(iii) Amendment dated March 1, 1997, to August 20, 1993
Agreement between Penn Independent and Registrant
regarding the sharing of certain operating costs, filed
with Registrant's Report on Form 10-K for the period
ended December 31, 1997, which has been filed with the
Securities and Exchange Commission.
10.7(iv) Amendment dated January 1, 1999, to August 20, 1993
Agreement between Penn Independent and Registrant
regarding the sharing of certain operating costs, filed
with the Registrant's Report on Form 10-K for the period
ended December 31, 1998, which has been filed with the
Securities and Exchange Commission.
Page 64
Exhibit No. Description
10.7(v) Amendment dated January 1, 2000, to August 20, 1993
Agreement between Penn Independent and Registrant
regarding the sharing of certain operating costs, filed
with Registrant's Report on Form 10-K for the period
ended December 31, 1999, which has been filed with the
Securities and Exchange Commission.
10.7(vi) Amendment dated July 1, 2000, to August 20, 1993
Agreement between Penn Independent and Registrant
regarding the sharing of certain operating costs, filed
with Registrant's Report on Form 10-K for the period
ended December 31, 2000, which has been filed with the
Securities and Exchange Commission.
10.7(vii) Amendment dated January 1, 2001, to August 20, 1993
Agreement between Penn Independent and Registrant
regarding the sharing of certain operating costs, filed
with Registrant's Report on Form 10-K for the period
ended December 31, 2001, which has been filed with the
Securities and Exchange Commission.
10.9 Restated Investment Advisory Agreement effective July 1,
1990, between Penn America and Carl Domino Associates,
L.P., incorporated by reference to Exhibit 10.9 to the
Registrant's Registration Statement on Form S-1 (No.
33-66892) and filed with the Securities and Exchange
Commission on August 2, 1993.
10.9(i) Amended Investment Advisory Agreement effective
September 1, 1997, between and among Penn-America, its
subsidiary, Penn-Star and Carl Domino Associates, L.P.,
filed with the Registrant's Report on Form 10-K for the
period ending December 31, 1997, which was filed with
the Securities and Exchange Commission.
10.9(ii) Agreement dated April 15, 1997, between and among
General Re New England Asset Management, Inc.,
Penn-America, and its subsidiary, Penn-Star filed with
the Registrant's Report on Form 10-K for the period
ending December 31, 1997, which was filed with the
Securities and Exchange Commission.
10.9(iii) Investment Advisory Agreement effective February 19,
1999, between Penn-America Insurance Company and Madison
Monroe, Inc., filed with Registrant's Report on Form
10-K for the period ended December 31, 1999, which has
been filed with the Securities and Exchange Commission.
10.9(iv) Notice of Termination effective July 1, 2000, of
Investment Advisory Agreement dated September 1, 1997,
between and among Penn-America Insurance Company, its
subsidiary, Penn-Star Insurance Company and Carl Domino
Associates, L.P., filed with Registrant's Report on Form
10-K for the period ended December 31, 2000, which has
been filed with the Securities and Exchange Commission.
10.9(v) Amendment dated November 7, 2000, to Agreement dated
April 15, 1997, between and among General Re New England
Asset Management, Inc., Penn-America Insurance Company,
and its subsidiary, Penn-Star, filed with Registrant's
Report on Form 10-K for the period ended December 31,
2000, which has been filed with the Securities and
Exchange Commission.
Page 65
Exhibit No. Description
10.9(vi) Amendment dated August 2, 2000, to Investment Management
Agreement dated February 25, 1999, between Penn-America
Insurance Company and Madison Monroe, Inc., filed with
Registrant's Report on Form 10-K for the period ended
December 31, 2000, which has been filed with the
Securities and Exchange Commission.
10.9(vii) Notice of Termination dated November 2, 2000, of
Investment Management Agreement dated February 25, 1999,
between Penn-America Insurance Company and Madison
Monroe, Inc., filed with Registrant's Report on Form
10-K for the period ended December 31, 2000, which has
been filed with the Securities and Exchange Commission.
10.10 1993 Stock Incentive Plan, incorporated by reference to
Exhibit 10.10 to Amendment No. 4 to the Registrant's
Registration Statement on Form S-1 (No. 33-66892) and
filed with the Securities and Exchange Commission on
September 29, 1993.
10.10(i) Penn-America Group, Inc. 1993 Stock Incentive Plan, as
amended and restated April 4, 1994, incorporated by
reference to Exhibit 4.1 to the Registrant's
Registration Statement on Form S-8 (No. 33-82728) and
filed with the Securities and Exchange Commission on
August 11, 1994.
10.10(ii) Employee Bonus Plan dated January 1, 2000, filed with
Registrant's Report on Form 10-K for the period ended
December 31, 1999, which has been filed with the
Securities and Exchange Commission.
10.10(iii) Amendment dated April 1, 2000, to Penn-America Group,
Inc. 1993 Stock Incentive Plan, as amended and restated
April 4, 1994, filed with Registrant's Report on Form
10-K for the period ended December 31, 2001, which has
been filed with the Securities and Exchange Commission.
10.11 Lease effective July 1, 2000, between Penn-America
Insurance Company and Irvin Saltzman, filed with
Registrant's Report on Form 10-K for the period ended
December 31, 2000, which has been filed with the
Securities and Exchange Commission.
10.14 1995 Multiple Line Excess of Loss (Casualty and
Property) Reinsurance Agreement with National
Reinsurance Corporation, effective as of January 1,
1995, filed with Registrant's Report on Form S-2
Amendment No. 1 (No. 333-91362) with the Securities and
Exchange Commission on September 6, 2002.
10.14(i) Endorsement No. 1 to Multiple Line Excess of Loss
Reinsurance Agreement with National Reinsurance
Corporation, effective as of January 1, 1995, filed with
Registrant's Report on Form S-2 Amendment No. 1 (No.
333-91362) with the Securities and Exchange Commission
on September 6, 2002.
10.14(ii) Endorsement No. 2 to Multiple Line Excess of Loss
Reinsurance Agreement with National Reinsurance
Corporation, effective as of January 1, 1995, filed with
Registrant's Report on Form S-2 Amendment No. 1 (No.
333-91362) with the Securities and Exchange Commission
on September 6, 2002.
Page 66
Exhibit No. Description
10.14(iii) 1996 Property & Liability Reinsurance Agreement with
General Re Corporation effective May 1, 1996, filed with
Registrant's Report on Form S-2 Amendment No. 1 (No.
333-91362) with the Securities and Exchange Commission
on September 6, 2002.
10.14(iv) Property Catastrophe Excess of Loss Reinsurance Program
between subscribing reinsurers and Penn-America and
Penn-Star Insurance Companies effective January 1, 2000,
to January 1, 2002, filed with Registrant's Report on
Form 10-K for the period ended December 31, 2001, which
has been filed with the Securities and Exchange
Commission.
10.16 Penn-America Group, Inc. 1995 Key Employee Incentive
Compensation Plan, incorporated as Part I to
Registrant's Registration Statement on Form S-8 (No.
333-00050) and filed with the Securities and Exchange
Commission on January 4, 1996.
10.16(i) Penn-America Insurance Company 2001 Key Employee
Incentive Compensation Plan, effective January 1, 2001,
filed with Registrant's Report on Form 10-K for the
period ended December 31, 2000, which has been filed
with the Securities and Exchange Commission.
10.17 Penn-America Insurance Company's Agency Award and Profit
Sharing Plan, incorporated as Exhibit 4 to Registrant's
Registration Statement on Form S-3 (No. 333-00046) and
filed with the Securities and Exchange Commission on
January 4, 1996.
10.17(i) Penn-America Insurance Company's Agency Award and Profit
Sharing Plan, attached as Exhibit 4 to Registrant's
Registration Statement on Form S-3 (No. 333-49055) and
filed with the Securities and Exchange Commission on
March 31, 1998.
10.17(ii) Amended General Agency Profit Sharing Addendum to Agency
Award & Profit Sharing Plan, filed with Registrant's
Report on Form 10-K for the period ended December 31,
1999, which has been filed with the Securities and
Exchange Commission.
10.17(iii) General Agent Contingent Profit Commission Addendum
between agents and Penn-America and Penn-Star Insurance
Companies effective January 1, 2001, filed with
Registrant's Report on Form 10-K for the period ended
December 31, 2001, which has been filed with the
Securities and Exchange Commission.
10.18 Stipulation of Termination of Property and Liability
Reinsurance Agreement with National Reinsurance
Corporation effective May 1, 1996, filed with
Registrant's Report on Form S-2 Amendment No. 1 (No.
333-91362) with the Securities and Exchange Commission
on September 6, 2002.
10.19 Multiple Line Excess of Loss Agreement of Reinsurance
including Endorsement No. 1 between General Reinsurance
Corporation and Penn-America and Penn-Star Insurance
Companies effective January 1, 2000, filed with
Registrant's Report on Form 10-K for the period ended
December 31, 2001, which has been filed with the
Securities and Exchange Commission.
Page 67
Exhibit No. Description
10.19(i) Endorsement No. 2 to the Multiple Line Excess of Loss
Agreement of Reinsurance including Endorsement No. 1
(Exhibit 10.19) between General Reinsurance Corporation
and Penn-America and Penn-Star Insurance Companies,
effective September 1, 2001, filed with Registrant's
Report on Form 10-K for the period ended December 31,
2001, which has been filed with the Securities and
Exchange Commission.
10.20 Property and Casualty Excess of Loss Reinsurance
Agreement between American Re-Insurance Company and
Penn-America and Penn-Star Insurance Companies effective
September 1, 2001, filed with Registrant's Report on
Form 10-K for the period ended December 31, 2001, which
has been filed with the Securities and Exchange
Commission.
11 Statement re: computation of per share earnings,
incorporated by reference from Note 2 to the
Consolidated Financial Statements, filed with
Registrant's Report on Form 10-K/A for the period ended
December 31, 2001, which has been filed with the
Securities and Exchange Commission.
21 As of December 31, 2001, the Registrant's only
subsidiary is Penn-America Insurance Company, a
Pennsylvania Corporation.
28.2 Credit Agreement among Registrant, Certain Lenders and
First Union National Bank dated September 28, 1998,
filed with the Securities and Exchange Commission, filed
with the Registrant's Report on Form 10-K for the period
ended December 31, 1998, which has been filed with the
Securities and Exchange Commission.
28.3 First Amendment to Credit Agreement, dated May 12, 1999,
among registrant, certain lenders and First Union
National Bank, dated September 28, 1998, filed with
Registrant's Report on Form 10-K for the period ended
December 31, 1999, which has been filed with the
Securities and Exchange Commission.
28.4 Second Amendment to Credit Agreement, dated August 26,
1999, among registrant, certain lenders and First Union
National Bank, dated September 28, 1998, filed with
Registrant's Report on Form 10-K for the period ended
December 31, 1999, which has been filed with the
Securities and Exchange Commission.
28.5 Third Amendment to Credit Agreement, dated March 15,
2000, among registrant, certain lenders and First Union
National Bank, dated September 28, 1998, filed with
Registrant's Report on Form 10-K for the period ended
December 31, 1999, which has been filed with the
Securities and Exchange Commission.
28.6 Notice of Termination of Credit Agreement, dated July
31, 2000, among Registrant, Certain Lenders, and First
Union National Bank, parties to the Credit Agreement
dated September 28, 1998, filed with the Registrant's
Report on Form 10-K for the period ended December 31,
2000, which has been filed with the Securities and
Exchange Commission.
Page 68
Exhibit No. Description
30.0 Reinsurance Pooling Agreement between Penn-America
Insurance Company and Penn- Star Insurance Company dated
July 1, 1998, filed with the Securities and Exchange
Commission.
31.0 Amended and Restated Promissory Note and Security
Agreement effective January 2, 2001, between Jon S.
Saltzman and Penn-America Insurance Company which amends
and restates in its entirety, including any amendments
thereto, the Promissory Note and Security Agreement
dated January 17, 2000, filed with Registrant's Report
on Form 10-K for the period ended December 31, 2001,
which has been filed with the Securities and Exchange
Commission.
31.0(i) Amended and Restated Promissory Note and Security
Agreement effective January 2, 2001, between Jon S.
Saltzman and Penn-America Insurance Company which amends
and restates in its entirety, including any amendments
thereto, the Promissory Note and Security Agreement
dated March 10, 2000, filed with Registrant's Report on
Form 10-K for the period ended December 31, 2001, which
has been filed with the Securities and Exchange
Commission.
31.0(ii) Amended and Restated Promissory Note and Security
Agreement effective January 2, 2001, between Jon S.
Saltzman and Penn-America Insurance Company which amends
and restates in its entirety, including any amendments
thereto, the Promissory Note and Security Agreement
dated September 19, 2000, filed with Registrant's Report
on Form 10-K for the period ended December 31, 2001,
which has been filed with the Securities and Exchange
Commission.
31.0(iii) Amended and Restated Promissory Note and Security
Agreement effective January 2, 2001, between J. Ransley
Lennon and Penn-America Insurance Company which amends
and restates in its entirety, including any amendments
thereto, the Promissory Note and Security Agreement
dated February 16, 2000, filed with Registrant's Report
on Form 10-K for the period ended December 31, 2001,
which has been filed with the Securities and Exchange
Commission.
31.0(iv) Amended and Restated Promissory Note and Security
Agreement effective January 2, 2001, between Garland P.
Pezzuolo and Penn-America Insurance Company which amends
and restates in its entirety, including any amendments
thereto, the Promissory Note and Security Agreement
dated February 11, 2000, filed with Registrant's Report
on Form 10-K for the period ended December 31, 2001,
which has been filed with the Securities and Exchange
Commission.
31.0(v) Promissory Note and Security Agreement effective March
9, 2001, between Joseph F. Morris and Penn-America
Insurance Company, filed with Registrant's Report on
Form 10-K for the period ended December 31, 2001, which
has been filed with the Securities and Exchange
Commission.
Page 69
Exhibit No. Description
31.0(vi) Promissory Note and Security Agreement effective March
28, 2001, between Joseph F. Morris and Penn-America
Insurance Company, filed with Registrant's Report on
Form 10-K for the period ended December 31, 2001, which
has been filed with the Securities and Exchange
Commission.
31.0(vii) Promissory Note and Security Agreement effective March
9, 2001, between Garland P. Pezzuolo and Penn-America
Insurance Company, filed with Registrant's Report on
Form 10-K for the period ended December 31, 2001, which
has been filed with the Securities and Exchange
Commission.
31.0(viii) Promissory Note and Security Agreement effective
February 16, 2001, between Thomas P. Bowie and
Penn-America Insurance Company, filed with Registrant's
Report on Form 10-K for the period ended December 31,
2001, which has been filed with the Securities and
Exchange Commission.
31.0(ix) Promissory Note and Security Agreement effective
February 23, 2001, between Thomas P. Bowie and
Penn-America Insurance Company, filed with Registrant's
Report on Form 10-K for the period ended December 31,
2001, which has been filed with the Securities and
Exchange Commission.
31.0(x) Promissory Note and Security Agreement effective
February 27, 2001, between Thomas P. Bowie and
Penn-America Insurance Company, filed with Registrant's
Report on Form 10-K for the period ended December 31,
2001, which has been filed with the Securities and
Exchange Commission.
31.0(xi) Promissory Note and Security Agreement effective March
21, 2001, between Thomas P. Bowie and Penn-America
Insurance Company, filed with Registrant's Report on
Form 10-K for the period ended December 31, 2001, which
has been filed with the Securities and Exchange
Commission.
(b)
(1) Form 8-K dated November 14, 2001 re: Quarterly
Statements of Penn-America Insurance Company and
Penn-Star Insurance Company, which was filed with the
Securities and Exchange Commission.
(2) Form 8-K dated December 4, 2001, re: delivering a
presentation including a slide show to interested
parties outlining the Company's business strategies and
an overview of the Company's historical and financial
results, which was filed with the Securities and
Exchange Commission.
Page 70
PENN-AMERICA GROUP, INC.
Schedule I - Summary of Investments - Other than Investments in Related Parties
(in thousands)
December 31, 2001
--------------------------------------------------------------------
Amortized Fair Amount shown
Cost Value on Balance Sheet
--------------------------------------------------------------------
(Restated)
Fixed maturities
Available for sale
U.S. Treasury securities and obligations
of U.S. government agencies $ 4,013 $ 4,195 $ 4,195
Corporate securities 49,981 52,021 52,021
Mortgage-backed securities 26,483 27,316 27,316
Other structured securities 20,758 21,462 21,462
Municipal securities 20,569 21,004 21,004
Public utilities 9,172 9,255 9,255
------------------------------------------------------------
Total available for sale 130,976 135,253 135,253
------------------------------------------------------------
Held to maturity
U.S. Treasury securities and obligations
of U.S. government agencies 13,812 14,025 13,812
Corporate securities 276 290 276
Public utilities 996 1,002 996
------------------------------------------------------------
Total held to maturity 15,084 15,317 15,084
------------------------------------------------------------
Total fixed-maturity securities 146,060 150,570 150,337
Equity securities:
Common stock 7,814 7,977 7,977
Preferred stock 16,906 17,172 17,172
------------------------------------------------------------
Total equity securities 24,720 25,149 25,149
------------------------------------------------------------
Total investments $170,780 $175,719 $175,486
============================================================
Page 71
PENN-AMERICA GROUP, INC.
Schedule II--Condensed Financial Information of Parent Company
Condensed Balance Sheets
(in thousands except share data)
December 31,
----------------------------------
2001 2000
--------------- ----------------
(Restated) (Restated)
ASSETS
Cash $ 1,261 $ 972
Investment in subsidiary, equity method 79,425 73,441
Other assets 359 357
--------------- ----------------
Total assets $ 81,045 $ 74,770
=============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses $ 25 $ 173
--------------- ----------------
Total liabilities 25 173
--------------- ----------------
Stockholders' equity:
Preferred stock, $ .01 par value; authorized 2,000,000 shares;
none issued
Common stock, $.01 par value; authorized 20,000,000 in 2001 and 2000;
issued 2001, 15,228,351 and 2000, 15,114,038 shares; outstanding
2001, 11,478,351 and 2000, 11,364,038 (1) 152 151
Additional paid-in capital (1) 70,735 70,114
Accumulated other comprehensive loss, net 3,106 792
Treasury stock 3,750,000 shares at cost (1) (24,161) (24,161)
Retained earnings 31,320 27,980
Unearned compensation from restricted stock awards (132) (279)
--------------- ---------------
Total stockholders' equity 81,020 74,597
--------------- ----------------
Total liabilities and stockholders' equity $ 81,045 $ 74,770
=============== ================
(1) Adjusted to reflect the three-for-two split of the Company's common stock
effected on May 9, 2002.
Page 72
PENN-AMERICA GROUP, INC.
Schedule II--Condensed Financial Information of Parent Company
Condensed Statements of Operations
(in thousands except per share data)
Years ended December 31,
--------------------------------------------------
2001 2000 1999
------------- ------------- --------------
(Restated) (Restated) (Restated)
Revenue:
Dividend income $1,600 $ - $ 2,200
Other income 26 27 56
Operating expenses (548) (791) (1,306)
------------- ------------- --------------
Income before income tax and undistributed net income (loss)
of subsidiary 1,078 (764) 950
Income tax benefit 177 260 425
------------- ------------- --------------
Income before equity in undistributed
net income of subsidiary 1,255 (504) 1,375
Equity in undistributed net income (loss)
of subsidiary 3,685 (4,327) 35
------------- ------------- --------------
Net income (loss) $4,940 ($4,831) $ 1,410
============= ============= ==============
Net income (loss) per share
Basic $0.43 ($0.42) $ 0.11
============= ============= ==============
Diluted $0.43 ($0.42) $ 0.11
============= ============= ==============
NOTE: Certain prior year amounts have been reclassified to conform to the 2001 presentation.
(1) Adjusted to reflect a three-for-two stock split of the Company's common
stock effected on May 9, 2002.
Page 73
PENN-AMERICA GROUP, INC.
Schedule II - Condensed Financial Information of Parent Company
Condensed Statements of Cash Flows
(in thousands)
Years ended
December 31,
-----------------------------------------------
2001 2000 1999
(Restated) (Restated) (Restated)
Cash flows from operating activities:
Net income (loss) $ 4,940 $ (4,831) $ 1,410
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Return of capital from subsidiary -- 6,400 12,300
Equity in undistributed net (income) loss of subsidiary (3,685) 4,327 (35)
Amortization/depreciation 86 246 256
Increase (decrease) in :
Accounts payable and accrued expenses (148) 108 65
Other, net 74 16 328
-------------- ------------ ---------------
Net cash provided by operating activities 1,267 6,266 14,324
-------------- ------------ ---------------
Cash flows from investing activities:
Change in short-term investments - 449 548
-------------- ------------ ---------------
Net cash provided by investing activities - 449 548
-------------- ------------ ---------------
Cash flows from financing activities:
Issuance of common stock (net of expenses) 622 500 465
Purchase of treasury stock - (4,687) (13,831)
Dividends paid to common stockholders (1,600) (1,611) (1,767)
-------------- ------------ ---------------
Net cash used by financing activities (978) (5,798) (15,133)
-------------- ------------ ---------------
Increase (decrease) in cash 289 917 (261)
Cash, beginning of period 972 55 316
-------------- ------------ ---------------
Cash, end of period $ 1,261 $ 972 $ 55
============== ============ ===============
NOTE: Certain prior year amounts have been reclassified to conform to the 2001 presentation.
Page 74
PENN-AMERICA GROUP, INC.
Schedule III - Supplementary Insurance Information
Years Ended December 31, 2001, 2000 and 1999
(in thousands)
Liability
for Unpaid
Deferred Losses and Losses
Policy Loss Net and Loss
Acquisition Adjustment Unearned Earned Investment Adjustment
Costs Expenses Premiums Premiums Income Expenses
2001
Commercial $ 9,067 $ 117,555 $ 40,989 $ 88,912 $ 7,665 $ 62,414
Personal 16 2,043 45 22 - (1,493)
Unallocated - - - - 3,674 -
--------------- -------------- ------------- ------------- ------------- ----------------
Total $ 9,083 $ 119,598 $ 41,034 $ 88,934 $ 11,339 $ 60,921
--------------- -------------- ------------- ------------- ------------- ----------------
2000
Commercial $ 10,310 $ 109,377 $ 43,218 $ 87,556 $ 5,904 $ 72,893
Personal 7 5,937 21 3,893 549 2,485
Unallocated - - - - 4,001 -
--------------- -------------- ------------- ------------- ------------- ----------------
Total $ 10,317 $ 115,314 $ 43,239 $ 91,449 $ 10,454 $ 75,378
--------------- -------------- ------------- ------------- ------------- ----------------
1999
Commercial $ 8,914 $ 82,192 $ 35,188 $ 71,731 $ 4,347 $ 49,744
Personal 392 11,527 1,144 13,946 735 13,443
Unallocated - - - - 4,455 -
--------------- -------------- ------------- ------------- ------------- ----------------
Total $ 9,306 $ 93,719 $ 36,332 $ 85,677 $ 9,537 $ 63,187
--------------- -------------- ------------- ------------- ------------- ----------------
Amortization
of
Deferred
Policy Other Net
Acquisition Underwriting Premiums
Costs Expenses Written
2001
Commercial $ 22,707 $ 3,380 $ 87,121
Personal 8 - 2
Unallocated - 5,358 -
--------------- --------------- -------------
Total $ 22,715 $ 8,738 $ 87,123
--------------- --------------- -------------
2000
Commercial $ 23,857 $ 1,757 $ 94,481
Personal 1,362 1,362 2,769
Unallocated - 5,045 -
--------------- --------------- -------------
Total $ 25,219 $ 6,802 $ 97,250
--------------- --------------- -------------
1999
Commercial $ 20,269 $ 1,596 $ 75,574
Personal 4,533 - 11,462
Unallocated - 4,443 -
--------------- --------------- -------------
Total $ 24,802 $ 6,039 $ 87,036
--------------- --------------- -------------
Page 75
PENN-AMERICA GROUP, INC.
Schedule IV - Reinsurance
Years Ended December 31, 2001, 2000 and 1999
(in thousands)
Ceded to Assumed Net Premium Percentage
Property and Liability Other from Other Written of Assumed
Insurance Premiums Direct Companies Companies to Net
-------------- -------------- ------------ ------------- --------------
2001 $98,328 $11,289 $84 $87,123 0.1%
============== ============== ============ ============= ==============
2000 $108,622 $12,540 $ 1,169 $ 97,250 1.2%
============== ============== ============ ============= ==============
1999 $ 94,967 $ 8,947 $ 1,016 $ 87,036 1.2%
============== ============== ============ ============= ==============
Page 76
PENN-AMERICA GROUP, INC.
Schedule VI- Supplemental Insurance Information Concerning
Property and Casualty Operations
Years Ended December 31, 2001, 2000 and 1999
(in thousands)
Liability Loss and Loss
for Unpaid Discount Adjustment Expenses
Losses and If Any, (Benefits) Incurred Paid Losses
Loss Deducted Related to and Loss
------------------------------
Adjustment From Current Prior Adjustment
Expenses Reserves Year Year Expenses
--------------- -------------- ------------ -------------- -------------------
Years Ended
December 31, 2001 $119,598 - $60,885 36 $58,096
December 31, 2000 115,314 - 66,214 9,164 59,790
December 31, 1999 93,719 - 54,768 8,419 59,989
Page 77
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Penn-America Group, Inc.
Date: November 12, 2002 By: /s/ Jon S. Saltzman
Jon S. Saltzman,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant in the
capacities and on the dates indicated.
/s/ Irvin Saltzman Chairman of the Board of Directors November 12, 2002
Irvin Saltzman and Director
/s/ Jon S. Saltzman President, Chief Executive Officer and November 12, 2002
Jon S. Saltzman Director (Principal Executive Officer)
/s/ Robert A. Lear Director November 12, 2002
Robert A. Lear
/s/ Joseph F. Morris Senior Vice President, Chief Financial Officer November 12, 2002
Joseph F. Morris and Treasurer
/s/ Garland P. Pezzuolo Vice President, Secretary and General Counsel November 12, 2002
Garland P. Pezzuolo
/s/ Paul Simon Director November 12, 2002
Paul Simon
/s/ Charles Ellman Director November 12, 2002
Charles Ellman
/s/ M. Moshe Porat Director November 12, 2002
M. Moshe Porat
/s/ Jami Saltzman-Levy Director November 12, 2002
Jami Saltzman-Levy
/s/ Martin Sheffield Director November 12, 2002
Martin Sheffield
/s/ E. Anthony Saltzman Director November 12, 2002
E. Anthony Saltzman
Page 78
CERTIFICATIONS
I, Jon S. Saltzman, certify that:
1. I have reviewed this annual report on Form 10-K/A of Penn-America
Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Jon S. Saltzman
Jon S. Saltzman
President & CEO
Page 79
CERTIFICATIONS
I, Joseph F. Morris, certify that:
1. I have reviewed this annual report on Form 10-K/A of Penn-America
Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
d) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
e) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Joseph F. Morris
Joseph F. Morris
Senior Vice President, CFO
and Treasurer
Page 80
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Penn-America Group, Inc. (the "Company")
on Form 10-K/A for the period ending December 31, 2001, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Jon S.
Saltzman , Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of section 13(a)
and 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
/s/ Jon S. Saltzman
Jon S. Saltzman
President and Chief Executive Officer
November 12, 2002
Page 81
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Penn-America Group, Inc. (the "Company")
on Form 10-K/A for the period ending December 31, 2001, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Joseph
F. Morris, Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of section 13(a)
and 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
/s/ Joseph F. Morris
Joseph F. Morris
Senior Vice President, Chief Financial Officer
and Treasurer
November 12, 2002
Page 82