S&P Announces: Penn Treaty Network America Insurance Co. and Penn Treaty American Corp. Ratings Affirmed; Outlook Positive

Business Wire, July 8, 2004

NEW YORK -- On July 8, 2004, Standard & Poor's Ratings Services affirmed its 'B-' counterparty credit and financial strength ratings on long-term care insurer Penn Treaty Network America Insurance Co. (PTNA).

At the same time, Standard & Poor's affirmed its 'CCC-' counterparty credit rating on PTNA's parent, Penn Treaty American Corp. (PTAC).

The outlook remains positive.

The positive outlook is based on PTNA's improvements in its underwriting and claims adjudication practices in 2003. This improvement is demonstrated by GAAP loss ratios of 75.4% for the fourth quarter of 2003 and 71.9% for the first quarter of 2004 compared with 79.6% and 76.8%, respectively, in 2002 and 2003 and should help the company achieve consistent operating profits as it works to align its sales and expense levels.

Outlook

Standard & Poor's expects PTAC's pretax consolidated GAAP operating earnings (which excludes the effect of market gains and losses, but includes interest expense) to be $12 million-$15 million in 2004, on new long-term annualized sales of $25 million-$30 million. Capitalization of the operating insurance companies is expected to remain adequate at year-end 2004. Should the company begin to consistently produce operating profits through proper alignment of its sales and expense levels, Standard & Poor's would likely raise the ratings.

Major Rating Factors

--Below-average business profile. PTNA continues to have the characteristics of a start-up company. Through a reinsurance agreement with Centre Solutions (Bermuda) Ltd. (Centre), a subsidiary of the Zurich Insurance Group, which was finalized in February 2002, PTNA and its subsidiary--American Network Insurance Co. (ANIC)--have reinsured substantially all long-term care insurance business underwritten on or before Dec. 31, 2001. In 2002 and early 2003, senior management's attention was primarily focused on raising additional capital at PTAC. The additional capital was used to refinance its convertible subordinated debt maturing at the end of 2003, comply with Florida statutory capital requirements, support sales growth, and provide the parent company with liquidity. Since the company's successful raising of capital, management has focused on writing new business and obtaining the necessary rate increases on its business underwritten on or before Dec. 31, 2001.

--Limited but improving new business volume. Annualized sales of new policies sold in 2003 were $13.7 million, which was significantly below expectations of $25 million-$30 million, but a significant improvement compared with annualized sales of $5.3 million in 2002 as PTNA continues to face considerable challenges as it attempts to reestablish its position in the long-term care insurance market after having suspended new sales of long-term care insurance. The company has faced regulatory delays in resuming sales, most notably in California (which historically constituted about 15% of premium revenue), where the company received approval in February 2004 to recommence sales of its long-term care insurance products subject to certain conditions and approval of its filed product forms and rates. In addition, the company has experienced delays in obtaining rate increases on its older blocks of business. These filed rate increases are indicative of potential reserve and earnings volatility, given the difficulties in forecasting policyholder behavior coupled with the industry's limited claim experience data.

--Adequate capitalization. Although PTNA's capital adequacy ratio (CAR) is more than 375% at year-end 2003, because of the Centre reinsurance agreement and the small volume of business issued since Jan. 1, 2002, the absolute level of capital (including the asset valuation reserve) is small at $26.4 million at year-end 2003, and includes the addition of about $16 million in 2002 from PTAC due to the parent company's capital-raising activities. As PTNA underwrites new long-term care insurance business in 2004 and thereafter, the CAR is expected to decline. PTNA's management is aware of this situation and entered into a 50% quota share reinsurance agreement with Centre for those long-term care insurance policies issued on or after Jan. 1, 2002. For reasons unrelated to PTNA, policies issued on or after Aug. 1, 2004, will not be reinsured by Centre. The company is in active discussions with several potential alternative reinsurers as part of its controlled growth strategy.

--Below-average earnings performance. PTAC, of which PTNA is the largest insurance subsidiary, has shown below-average earnings performance, as demonstrated by a pretax GAAP operating loss (which excludes the effect of market gains and losses, but includes interest expense) of $7.2 million in 2003. A major contributor to the operating loss was a $12.1 million increase (26%) in general and administrative expenses compared with 2002 levels, which included a $5.0 million increase in sales and marketing related expenses and $2.7 million in expenses related to the initial recognition of future retirement benefits payable to the company's former chairman and severance related for certain employees whose positions were eliminated. In 2003 the company overhauled and improved its underwriting and claims adjudication practices, as demonstrated by GAAP loss ratios of 75.4% for the fourth quarter of 2003 and 71.9% for the first quarter of 2004 compared with 79.6% and 76.8%, respectively, in 2002 and 2003. In the first quarter of 2004 the company experienced a GAAP operating loss of $341,000 compared with a gain of $249,000 in the 2003 period mainly because of an increase in the expense ratio (excluding interest expense) to 38.2% of premium compared with 36.0% in the 2003 period.