SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
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OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-22316
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Penn-America Group, Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2731409
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
420 South York Road, Hatboro, Pennsylvania 19040
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(Address of principal executive offices, including zip code)
(215) 443-3600
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(Registrant's telephone number, including area code)
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 other 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No __
At May 8, 2003, 14,617,265 shares of the registrant's common stock, $0.01 par
value, were outstanding.
Page 1
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Index
Page Number
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 2003 (unaudited) and
December 31, 2002 3
Consolidated Unaudited Statements of Operations - For the three
months ended March 31, 2003 and 2002 4
Consolidated Unaudited Statement of Stockholders' Equity -
For the three months ended March 31, 2003 5
Consolidated Unaudited Statements of Cash Flows -
For the three months ended March 31, 2003 and 2002 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk 19
Item 4. Controls and Procedures 20
Part II - Other Information 21
Page 2
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
March 31, December 31,
2003 2002
---------------- -----------------
(Unaudited)
ASSETS
Investments:
Fixed maturities:
Available for sale, at fair value (amortized cost, $253,886 and $237,450) $ 262,561 $ 246,583
Held to maturity, at amortized cost (fair value, $1,317 and $2,017) 1,277 1,963
Equity securities, at fair value (cost, $10,966 and $17,859) 11,933 18,625
---------------- -----------------
Total investments 275,771 267,171
Cash and cash equivalents 7,137 9,796
Accrued investment income 2,971 3,196
Premiums receivable 14,065 12,564
Reinsurance recoverable 27,612 27,843
Prepaid reinsurance premiums 9,196 8,965
Deferred policy acquisition costs 12,866 13,159
Capital lease, affiliate 1,557 1,579
Deferred income taxes 2,217 2,105
Income tax recoverable -- 60
Other assets 724 801
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Total assets $ 354,116 $ 347,239
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LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss adjustment expenses $ 143,185 $ 137,747
Unearned premiums 65,229 65,365
Accounts payable and accrued expenses 6,495 7,700
Capitalized lease obligation, affiliate 1,389 1,428
Company obligated mandatorily redeemable preferred securities of
subsidiary trust holding solely junior subordinated debentures 15,000 15,000
Income tax payable 1,502 --
Other liabilities 1,574 3,404
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Total liabilities 234,374 230,644
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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 and outstanding, 14,610,577 and 14,572,098 shares 147 146
Additional paid-in capital 71,275 70,875
Accumulated other comprehensive income 6,199 6,401
Retained earnings 42,930 39,995
Officers' stock loans (629) (629)
Unearned compensation from restricted stock awards (180) (193)
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Total stockholders' equity 119,742 116,595
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Total liabilities and stockholders' equity $ 354,116 $ 347,239
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Page 3
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)
For the three months ended March 31, 2003 and 2002
(In thousands, except share data)
Three months ended March 31,
----------------------------------------
2003 2002
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Revenues
Premiums earned $ 34,365 $ 22,983
Net investment income 3,213 2,833
Net realized investment gain (loss) 714 (252)
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Total revenues 38,292 25,564
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Losses and expenses
Losses and loss adjustment expenses 22,012 15,286
Amortization of deferred policy acquisition costs 8,617 6,011
Other underwriting expenses 2,046 1,657
Corporate expenses 185 111
Interest expense 304 35
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Total losses and expenses 33,164 23,100
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Income before income tax 5,128 2,464
Income tax expense 1,554 678
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Net income $ 3,574 $ 1,786
=================== ==================
Net income per share
Basic $ 0.24 $ 0.15
Diluted $ 0.24 $ 0.15
Weighted average shares outstanding
Basic 14,591,096 11,536,694
Diluted 14,798,913 11,710,482
Cash dividend per share $ 0.04375 $ 0.03833
Page 4
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(Unaudited)
For the three months ended March 31, 2003
(In thousands, except share data)
Unearned
Accumulated Compensation
Additional Other Officers' From Total
Common Paid-In Comprehensive Retained Stock Restricted Stockholders'
Stock Capital Income Earnings Loans Stock Awards Equity
-------- ------------ -------------- ----------- ---------- ------------- ---------------
Balance at December 31, 2002 $ 146 $ 70,875 $ 6,401 $ 39,995 $ (629) $ (193) $ 116,595
Net income -- -- -- 3,574 -- -- 3,574
Other comprehensive loss:
Unrealized loss on investments, net
of tax and reclassification adjustment -- -- (170) -- -- -- (170)
Unrealized loss on cash-flow hedging
instrument, net of tax -- -- (32) -- -- -- (32)
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Comprehensive income
3,372
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Issuance of common stock 1 378 -- -- -- -- 379
Compensation expense on stock
options -- 22 -- -- -- -- 22
Amortization of compensation expense
from restricted stock awards issued -- -- -- -- -- 13 13
Cash dividends paid ($0.04375 per share) -- -- -- (639) -- -- (639)
-------- ------------ -------------- ----------- ---------- ------------- ---------------
Balance at March 31, 2003 $ 147 $ 71,275 $ 6,199 $ 42,930 $ (629) $ (180) $ 119,742
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Page 5
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
For the three months ended March 31, 2003 and 2002
(In thousands)
Three months ended March 31,
----------------------------------------
2003 2002
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Cash flows from operating activities:
Net income $ 3,574 $ 1,786
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization (accretion) and depreciation expense 365 (43)
Net realized investment loss (gain) (714) 252
Deferred income tax benefit (8) (154)
Net change in premiums receivable, prepaid reinsurance
premiums and unearned premiums (1,868) 5,327
Net change in unpaid losses and loss adjustment expenses
and reinsurance recoverable 5,669 4,544
Decrease (increase) in:
Accrued investment income 225 89
Deferred policy acquisition costs 293 (702)
Income tax recoverable/payable 1,562 831
Other assets 4 (36)
Decrease in:
Accounts payable and accrued expenses (1,183) (266)
Other liabilities (1,879) (3)
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Net cash provided by operating activities 6,040 11,625
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Cash flows from investing activities:
Purchases of fixed maturities available for sale (62,496) (17,476)
Proceeds from sales of equity securities 6,447 1,000
Proceeds from sales and maturities of fixed maturities available for sale 46,963 3,146
Proceeds from maturities and calls of fixed maturities held to maturity 686 5,315
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Net cash used by investing activities (8,400) (8,015)
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Cash flows from financing activities:
Issuance of common stock 379 100
Principal payments on capital lease obligations, affiliate (39) (36)
Dividends paid (639) (442)
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Net cash used by financing activities (299) (378)
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Increase (decrease) in cash (2,659) 3,232
Cash, beginning of period 9,796 13,129
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Cash, end of period $ 7,137 $ 16,361
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Page 6
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Note 1 - Organization and Basis of Presentation
Penn-America Group, Inc. ("PAGI") is an insurance holding company.
Approximately 32% of the outstanding common stock of PAGI was owned by Penn
Independent Corporation ("Penn Independent") at March 31, 2003. The accompanying
financial statements include the accounts of PAGI and its wholly-owned
subsidiaries, Penn-America Insurance Company ("Penn-America") and its
wholly-owned subsidiary, Penn-Star Insurance Company ("Penn-Star"); and
Penn-America Statutory Trust I (the "Trust") (collectively the "Company").
The Company markets and underwrites general liability, commercial
property, and multi-peril insurance for small businesses located primarily in
small towns and suburban and rural areas. The Company is licensed to write
business in all 50 states and the District of Columbia. The Company writes
business on both an admitted and non-admitted basis in 37 states, on only an
admitted basis in one state and on only a non-admitted basis in 12 states and
the District of Columbia.
The accompanying condensed unaudited consolidated financial statements
and notes have been prepared in accordance with accounting principles generally
accepted in the United States ("GAAP") for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and notes required by
GAAP for complete financial statements. In the opinion of management, all
adjustments (consisting of normal and recurring adjustments) considered
necessary for a fair presentation of results for the interim periods have been
included. All significant intercompany accounts and transactions have been
eliminated in consolidation. It is suggested that these condensed unaudited
consolidated financial statements and notes be read in conjunction with the
financial statements and notes in the Company's 2002 Annual Report which was
incorporated by reference into the Company's Form 10-K for the year ended
December 31, 2002. The Company's results of operations for interim periods are
not necessarily indicative of the results to be expected for the entire year.
Note 2 - Reinsurance
Premiums earned are presented net of amounts ceded to reinsurers of
$6,200,000 and $3,100,000 for the three months ended March 31, 2003 and 2002,
respectively. Losses and loss adjustment expenses are presented net of amounts
ceded to reinsurers of $3,869,000 and $1,700,000 for the three months ended
March 31, 2003 and 2002, respectively.
Note 3 - Comprehensive Income
For the three months ended March 31, 2003, comprehensive income was
$3,372,000, which consisted of net income of $3,574,000 and other comprehensive
loss of $202,000 related to net unrealized losses on investments and a cash flow
hedging instrument. For the three months ended March 31, 2002, comprehensive
income was $769,000, which consisted of net income of $1,786,000 and other
comprehensive loss of $1,017,000 related to net unrealized losses on
investments.
Page 7
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 4 - Net Income Per Share
Basic net income per share is computed by dividing net income available
to common stockholders by the weighted average number of common shares
outstanding for each period. Diluted net income per share includes the potential
dilution that could occur if outstanding contracts to issue common stock were
exercised and converted to common stock. The following is a reconciliation of
the basic and diluted net income per share computations:
(in thousands, except per share data) Three months ended March 31,
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2003 2002
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Basic per share computation:
Net income $ 3,574 $ 1,786
Weighted average common shares outstanding 14,591,096 11,536,694
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Basic net income per share $ 0.24 $ 0.15
================ =================
Diluted per share computation:
Net income $ 3,574 $ 1,786
Weighted average common shares outstanding 14,591,096 11,536,694
Additional shares outstanding after the assumed
assumed exercise of stock options
by applying the treasury stock method 207,817 173,788
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Total shares 14,798,913 11,710,482
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Diluted net income per share $ 0.24 $ 0.15
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Note 5 - Segment Information
The Company has only one reportable segment. In 1999, the Company
exited the non-standard personal automobile line of business and announced that
it would run-off its remaining portfolio of such business. For the three months
ended March 31, 2003 and 2002, amounts relating to the non-personal automobile
business were not material to the financial statements presented, and therefore,
are not presented separately.
Page 8
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 6 - Stock Options
On January 1, 2003, the Company adopted the fair value recognition
provisions of SFAS No. 148, Accounting for Stock-Based Compensation - Transition
and Disclosure ("SFAS 148"), and SFAS No. 123, Accounting for Stock-Based
Compensation ("SFAS 123") by implementing the modified prospective transition
method permitted under SFAS 148. This method requires the Company to record
compensation expense in 2003, and annually thereafter, as if the fair value
recognition method had been used since January 1, 1995. For the three months
ended March 31, 2003, $22,000 of compensation expense was recorded.
Prior to January 1, 2003, the Company applied the recognition
principles of APB No. 25, Accounting for Stock Issued to Employees, and,
accordingly, no compensation expense was recognized. If the Company had applied
the fair value recognition provisions of SFAS 123 for the three months ended
March 31, 2002, $62,000 of compensation expense would have been recorded. The
following table illustrates the effect on net income and net income per share
for the three months ended March 31, 2002 as if the Company had applied the fair
value recognition provisions of SFAS 123.
Three
Months Ended
(in thousands, except per share data) March 31, 2002
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Net income:
As reported $ 1,786
Pro forma 1,745
Basic and diluted income per share:
As reported $ 0.15
Pro forma 0.15
Note 7 - Company Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trust Holding Solely Junior Subordinated Debentures
The Company has executed a letter of intent to issue $15 million of
floating rate trust preferred securities by a business trust subsidiary to be
established by the Company. These securities will have a thirty-year maturity,
with a provision that allows the Company to call these securities at par after
five years from the date of issuance. Cash distributions will be paid quarterly
in arrears at a rate of 410 basis points over three-month London Interbank
Offered Rates. Distributions on these securities can be deferred for up to five
years, but the Company may not declare or pay cash dividends on its common
stock. The Company will guarantee all obligations of the business trust
subsidiary with respect to distributions and payments of these securities.
Page 9
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(continued)
Note 7 - Company Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trust Holding SolelyJunior Subordinated Debentures
(continued)
Proceeds from the sale of these securities by the business trust
subsidiary will be used to acquire $15 million of Floating Rate Junior
Subordinated Deferrable Interest Rate Debentures issued by the Company. These
debentures will have the same terms with respect to maturity, payments, and
distributions as the floating rate trust preferred securities issued by the
business trust subsidiary. The intended use of the proceeds from these
debentures is to support growth in the Company's insurance operations and for
general corporate purposes. The transactions are expected to close on May 15,
2003.
Page 10
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations
Results of Operations
Three Months Ended March 31, 2003 and 2002
Premiums earned increased 49.5% to $34.4 million for the three months
ended March 31, 2003, compared with $23.0 million for the same period in 2002,
due to the growth in net written premiums over the last 12 months.
Gross written premiums, which represent the amount received or to be
received for insurance policies written without reduction for acquisition costs,
reinsurance costs or other deductions, increased 34.5% for the three months
ended March 31, 2003 to $40.4 million, compared with $30.0 million for the three
months ended March 31, 2002. The increase was attributable to rate increases,
growth in new business and higher average exposures per policy.
Ceded written premiums, the portion of gross written premiums reinsured
by unaffiliated insurers, increased to $6.4 million for the three months ended
March 31, 2003, compared with $3.6 million for the three months ended March 31,
2002. The increase in ceded written premiums was due primarily to growth in
gross written premiums and an approximately 32.0% percent increase in
reinsurance rates on the Company's multiple-line excess of loss treaty.
Net written premiums, which are gross written premiums less ceded
written premiums, increased 28.9% for the three months ended March 31, 2003 to
$34.0 million, compared with $26.4 million for the three months ended March 31,
2002. The increase in net written premiums was consistent with the increase in
gross written premiums, but was offset partially by higher reinsurance costs.
Net investment income increased to $3.2 million for the three months
ended March 31, 2003, compared with $2.8 million for the three months ended
March 31, 2002, primarily due to the growth in average invested assets,
partially offset by a decrease in average yield on fixed-maturity investments.
Net realized investment gain was $714,000 for the three months ended
March 31, 2003, compared to a net realized investment loss of $252,000 for the
three months ended March 31, 2002. The net realized investment gain for 2003 is
attributable to the sale of certain of the Company's fixed-maturity securities
and all of the Company's common stock investments.
Losses and loss adjustment expenses increased 44.0% to $22.0 million
for the three months ended March 31, 2003, compared with $15.3 million for the
three months ended March 31, 2002. The loss ratio for the three months ended
March 31, 2003 was 64.1, compared with 66.5 for the three months ended March 31,
2002. The loss ratio is calculated by dividing losses and loss adjustment
expenses by premiums earned. The improvement in the loss ratio is primarily
attributable to rate increases implemented in 2002 and 2003.
Amortization of deferred policy acquisition costs ("ADAC") increased
43.4% to $8.6 million for the three months ended March 31, 2003 from $6.0
million for the three months ended March 31, 2002 primarily due to the growth in
premiums earned.
Page 11
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
Other underwriting expenses increased 23.5% to $2.0 million for the
three months ended March 31, 2003 from $1.7 million for the three months ended
March 31, 2002 primarily due to increases in salary and benefit expenses
associated with the hiring of additional underwriting and marketing personnel.
The overall GAAP combined ratio, which is the sum of the loss and
expense ratios, improved to 95.1 for the three months ended March 31, 2003 from
99.9 for the three months ended March 31, 2002. The loss ratio improved to 64.1
for the three months ended March 31, 2003 from 66.5 for the three months ended
March 31, 2002. The expense ratio, which is calculated by dividing the sum of
ADAC and other underwriting expenses by premiums earned, improved to 31.0 for
the three months ended March 31, 2003 from 33.4 for the three months ended March
31, 2002. 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 underwriting profitability.
Interest expense increased to $304,000 for the three months ended March
31, 2003 from $35,000 for the three months ended March 31, 2002 primarily due to
interest expense on $15.0 million of Company Obligated Mandatorily Redeemable
Preferred Securities of Subsidiary Trust Holding Solely Junior Subordinated
Debentures ("Trust Preferred Securities") issued in December 2002.
The factors described above resulted in net income for the three months
ended March 31, 2003 of $3.6 million or $0.24 per share (basic and diluted),
compared with $1.8 million or $0.15 per share (basic and diluted) for the three
months ended March 31, 2002.
Catastrophe Losses
The Company received several claims related to a series of severe
storms in the Midwestern states occurring between May 2 and May 11, 2003. The
Company is investigating these claims and is currently unable to reasonably
estimate the amount of its liabilities related to these storms. The Company
limits its exposure to catastrophic events by maintaining a catastrophic loss
reinsurance program which provides coverage of $29 million per occurrence in
excess of $1 million per occurrence. The Company's catastrophic loss reinsurance
program limits an occurence to all individual losses during any period of 72
consectutive hours arising from the same event. Since these storms occurred over
a period of 10 days, the Company has not yet determined if this event will be
deemed to be one or more occurrences under the Company's catastrophic loss
reinsurance program.
Critical Accounting Estimates and Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires the Company to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.
The Company has identified that the establishment of reserves for
unpaid losses and loss adjustment expenses and the valuation of investments are
critical accounting estimates because they involve a high degree of judgment.
Although variability is inherent in these estimates, the Company believes the
amounts provided are appropriate based upon facts available at this time. See
the Investment Portfolio section beginning on page 16 for information related to
the valuation of investments.
Page 12
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
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 its best estimate of 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:
|X| the type of loss,
|X| the jurisdiction of the occurrence,
|X| the Company's knowledge of the circumstances surrounding the claim,
|X| the severity of injury or damage,
|X| the potential for ultimate exposure, and
|X| policy provisions relating to the claim.
The Company determines 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:
|X| the Company's and the industry's experience,
|X| historical trends in reserving patterns and loss payments,
|X| the impact of claim inflation,
|X| the pending level of unpaid claims,
|X| the cost of claim settlements,
|X| the line of business mix, and
|X| 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 the extraordinary future emergence of new types of losses not
sufficiently represented in the Company's historical experience, or that cannot
yet be quantified. The Company regularly analyzes its reserves and reviews
pricing and reserving methodologies so that future
Page 13
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
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 Company received an unexpected increase in the number of new claims
reported relating to four policies issued to a single insured between January 1,
1980 and April 1, 1983. The insured is a manufacturer of safety equipment
including industrial masks and the new claims reported allege existing and
potential bodily injury due to medical condition called silicosis. This is the
only insured with which the Company has open claims relating to this type of
injury. The original policies covered products and completed operations only and
were issued with a $500,000 indemnity policy aggregate limit of liability and a
$5,000 insured deductible per claim. At this time, it is not possible to
evaluate the probability of a favorable or unfavorable outcome on these claims.
The Company believes that the amount of losses or loss adjustment expenses will
not have a material effect on the Company's financial position or results of
operations.
During the first three months of 2003, the Company increased incurred
losses and loss adjustment expenses attributable to insured events of prior
years by $320,000, primarily due to an increase in estimates for loss and loss
adjustment expense reserves for the exited commercial automobile lines of
business. The increase in these estimates is primarily attributable to an
increase in the expected loss adjustment expenses relating to open claims at
March 31, 2003.
In addition, the Company reduced its estimates for loss and loss
adjustment expense reserves for the commercial property lines of business for
the 2002 accident year by $900,000. This reduction was fully offset by an
increase in the Company's estimate for the commercial liability lines of
business due to the development of outstanding claim reserves on claims
occurring in various accident years.
Liquidity and Capital Resources
PAGI is a holding company, the principal asset of which is the common
stock of Penn-America Insurance Company. At March 31, 2003, PAGI's capital
structure consisted of common stockholders' equity of $119.7 million and Company
Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust
Holding Solely Junior Subordinated Debentures of $15.0 million.
The Company has executed a letter of intent to issue $15 million of
floating rate trust preferred securities by a business trust subsidiary to be
established by the Company. These securities will have a thirty-year maturity,
with a provision that allows the Company to call these securities at par after
five years from the date of issuance. Cash distributions will be paid quarterly
in arrears at a rate of 410 basis points over three-month London Interbank
Offered Rates. Distributions on these securities can be deferred for up to five
years, but the Company may not declare or pay cash dividends on its common
stock. The Company will guarantee all obligations of the business trust
subsidiary with respect to distributions and payments of these securities.
Page 14
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
Proceeds from the sale of these securities by the business trust
subsidiary will be used to acquire $15 million of Floating Rate Junior
Subordinated Deferrable Interest Rate Debentures issued by the Company. These
debentures will have the same terms with respect to maturity, payments, and
distributions as the floating rate trust preferred securities issued by the
business trust subsidiary. The intended use of the proceeds from these
debentures is to support growth in the Company's insurance operations and for
general corporate purposes. The transactions are expected to close on May 15,
2003.
PAGI's principal source of cash to meet short-term and long-term
liquidity needs, including the payment of dividends to stockholders, corporate
expenses and interest on its debentures, is dividends from Penn-America
Insurance Company. PAGI has no planned capital expenditures that could have an
impact on 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 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 2003 is $11,026,200. For the three
months ended March 31, 2003, ordinary dividends paid by Penn-America Insurance
Company to PAGI were $500,000. 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 paid to PAGI. As of March
31, 2003, Penn-America Insurance Company's policyholders' surplus was $114.4
million, and included unassigned surplus of $28.9 million.
Penn-America and Penn-Star 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, 2002, 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 policyholders'
surplus at December 31, 2002 was $110,262,000 and its regulatory action level
was $22,532,000. Penn-Star Insurance Company's policyholders' surplus at
December 31, 2002 was $37,356,000 and its regulatory action level was
$8,276,000.
Page 15
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
The Company has generated positive cash flows from operations to meet
its short-term liquidity requirements. Net cash provided by operating activities
was $6.0 million for the three months ended March 31, 2003 and $11.6 million for
the three months ended March 31, 2002.
Net cash used by investing activities was $8.4 million for the three
months ended March 31, 2003 and $8.0 million for the three months ended March
31, 2002.
Net cash used by financing activities was $299,000 for the three months
ended March 31, 2003 and $378,000 for the three months ended March 31, 2002.
Investment Portfolio
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. The Company outsources the management of its investment portfolio
to Gen Re New England Asset Management, Inc. ("NEAMS"). In accordance with the
asset management agreement between the Company and NEAMS, all investment
transactions are approved by the Investment Committee of the Company within 60
days of their initiation by NEAMS. At March 31, 2003, the Company held a total
of $282.9 million in cash and investments. Of this amount, cash and cash
equivalents represented $7.1 million, equity securities, consisting solely of
preferred stock, represented $11.9 million, and fixed-maturity securities
represented $263.9 million.
The Company's cash and investments portfolio mix as of March 31, 2003
was as follows:
Fixed-income:
U.S. Treasury securities and obligations of U.S. government agencies 6%
Corporate securities 35%
Mortgage-backed securities 6%
Other structured securities 26%
Municipal securities 20%
--------
Total fixed income 93%
Cash 3%
Preferred stock 4%
--------
100%
========
Page 16
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
The Company's fixed-maturity portfolio of $263.9 million was 93% of the
total cash and investments as of March 31, 2003. Approximately 93% of these
securities were rated "A" or better by Standard & Poor's. Standard & Poor's
rates publicly traded securities in 20 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, which
consist solely of preferred stocks, were $11.9 million or 4% of total cash and
investments as of March 31, 2003.
The quality of the fixed maturity portfolio as of March 31, 2003 was as
follows:
"AAA" 52%
"AA" 15%
"A" 26%
"BBB" 6%
Below "BBB" 1%
---------
100%
=========
As of March 31, 2003, our investment portfolio contained corporate
fixed-maturity and preferred stock securities with a market value of $111.0
million. A summary of these securities by industry segment is as follows:
Financial institutions 36%
Consumer, non-cyclical 21%
Utilities 19%
Communications 10%
Industrial 4%
Energy 3%
Basic materials 3%
Consumer, cyclical 2%
Technology 2%
---------
100%
=========
As of March 31, 2003, the investment portfolio contained $90.5 million
of mortgage-backed, asset-backed and collateralized mortgage obligations. All of
these securities were rated "A" or better and 85% were rated "AAA" by Standard &
Poor's. These securities are publicly traded, and have 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 real estate or mortgages in the investment portfolio as of March
31, 2003.
Page 17
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations (continued)
The Company regularly evaluates its investment portfolio to identify
other-than-temporary impairments of individual securities. The Company considers
many factors in determining if an 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 the Company's 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 March 31, 2003:
Number Gross Six More
of Fair Book Unrealized Months Than
(in thousands) Securities Value Value Losses or Less Six Months
--------------------------------------------------------------------------------------------------------------------------------
Fixed maturity securities 21 $26,208 $26,378 $170 $ 170 --
As of March 31, 2003, the Company's fixed-maturity investment portfolio
had 21 securities with 170,000 of gross unrealized losses. No single issuer had
an unrealized loss position of greater than $30,000. There were no equity
securities, which consist solely of preferred stocks, in an unrealized loss
position as of March 31, 2003.
Forward-Looking 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 and 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, results of the company's business, and
the other matters referred to above include, but are not limited to: (1) risks
inherent in establishing loss and loss adjustment expense reserves; (2)
uncertainties relating to the financial ratings of the company's insurance
subsidiaries; (3) uncertainties relating to government and regulatory policies;
(4) uncertainties arising from the cyclical nature of the company's business;
(5) changes in the company's relationships with, and the capacity of, its
general agents; and (6) the risk that the company's reinsurers may not be able
to fulfill their obligations to the company. For additional disclosure regarding
potential risk factors, refer to documents filed by the company with the
Securities and Exchange Commission, including the company's 2002 10-K.
Page 18
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Quantitative and Qualitative Disclosures About Market Risk
The Company's primary market risk is the potential economic loss
principally arising from adverse changes in the market value of its investment
portfolio. The major component of market risk affecting the Company's investment
portfolio is interest rate risk. The Company eliminated its underlying exposure
to equity price risk, as all of its common stock was sold in the first quarter
of 2003.
The Company had fixed-maturity and preferred stock investments with a
market value of $275.8 million at March 31, 2003 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 liability and capital position of the Company.
The Company's market risk associated with exposure to interest rate
risk at March 31, 2003 has not materially changed from that identified at
December 31, 2002.
Page 19
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
Controls and Procedures
As of March 31, 2003, 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 March 31, 2003. There
have been no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to March
31, 2003.
Page 20
PENN-AMERICA GROUP, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote by Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
An Exhibit Index has been filed as part of this report on
page E-1
(b) Reports on Form 8-K
On January 17, 2003, the Company filed a current report on
Form 8-K announcing that Martin Sheffield had tendered his
resignation as a Director of the Company for business
reasons and that Richard L. Duszak, CPA shall take his
place.
On January 22, 2003, the Company filed a current report on
Form 8-K announcing that the Company released its earnings
for the fourth quarter and year end of 2002.
On February 6, 2003, the Company filed a current report on
Form 8-K announcing the availability of materials presented
by Jon Saltzman, President and CEO, and Joseph Morris, Sr.
Vice President, CFO and Treasurer at the Tenth Annual
Emerald Groundhog Day Investment Forum.
On March 3, 2003, the Company filed a current report on Form
8-K announcing the availability of its Annual Statements for
its insurance subsidiaries, Penn-America Insurance Company
and Penn-Star Insurance Company, on the Company's web-site,
in hard copy from the Company, or from the Pennsylvania
Department of Insurance.
Page 21
SIGNATURE
Pursuant to the requirements 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: May 14, 2003 By: /s/ Jon S. Saltzman
---------------------- -------------------
Jon S. Saltzman
President and
Chief Executive Officer
By: /s/ Joseph F. Morris
--------------------
Joseph F. Morris
Senior Vice President,
Chief Financial Officer
and Treasurer
Page 22
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AS ADOPTED PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Jon S. Saltzman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Penn-America
Group, Inc.
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly
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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 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
quarterly 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: May 14, 2003 /s/ Jon S. Saltzman
-------------------
Jon S. Saltzman
President and Chief Executive Officer
Page 23
CERTIFICATION OF CHIEF FINANCIAL OFFICER AS ADOPTED PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Joseph F. Morris, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Penn-America
Group, Inc.
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly
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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 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
quarterly 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: May 14, 2003 /s/ Joseph F. Morris
--------------------
Joseph F. Morris
Senior Vice President, Chief Financial Officer
and Treasurer
Page 24
Exhibit No. Description
10.1 Property and Casualty Excess of Loss Agreement between
Penn-America Insurance Company, Penn-Star Insurance Company and
American Reinsurance Company, effective January 1, 2003.
99.1 Certification of Chief Executive Officer of Penn-America Group,
Inc., dated May 14, 2003 in accordance with 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of Sarbanes-Oxley Act of
2002.
99.2 Certification of Chief Executive Officer of Penn-America Group,
Inc., dated May 14, 2003 in accordance with 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of Sarbanes-Oxley Act of
2002.
E-1