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IN RE PENN TREATY AMERICAN CORP. SECURITIES LITIGATION

May 15, 2002

IN RE PENN TREATY AMERICAN CORP. SECURITIES LITIGATION


The opinion of the court was delivered by: Buckwalter, United States District Judge.

  MEMORANDUM

This is a securities class action lawsuit brought by shareholders of Penn Treaty American Corporation ("Penn Treaty" or the "Company") against the Company and two of its top executives. Plaintiffs allege that during the period July 23, 2000 through and including March 29, 2001 (the "Class Period"), Defendants made false and misleading statements and material omissions regarding the Company's financial health and viability in violation of the Securities and Exchange Act of 1934 ("Exchange Act"). Count I of the Complaint alleges Defendants are liable under section 10(b) of the Exchange Act, 15 U.S.C.A. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Count II, based on the same factual allegations, asserts the liability of the individual defendants under section 20(a) of the Exchange Act. Defendants move to dismiss Plaintiffs' Complaint pursuant to Fed.R.Civ.P. 12(b)(6). For the reasons stated below, Defendants' motion is denied.

I. Facts

Plaintiffs are shareholders of Penn Treaty, a registered insurance holding company. Through its various subsidiaries, Penn Treaty primarily engages in the underwriting, marketing and sale of individual and group accident and health insurance products, principally covering long-term nursing home and home health care. Penn Treaty's principal subsidiary is Penn Treaty Network America ("PTNA"), representing 94% of the Company's direct premiums.

By way of background, and pertinent to this litigation, each of Penn Treaty's subsidiaries is subject to the insurance laws and regulations of each state in which it is licensed to sell insurance. As long-term health insurers, Penn Treaty's insurance subsidiaries are required by state law to have statutory surplus, which is calculated using statutory accounting principles ("SAP"). Various state insurance departments have adopted risk-based capital ("RBC") requirements for insurance companies, which assist regulators in evaluating the adequacy of statutory capital and surplus in relation to investment and insurance risks. As described in the Company's 2000 Annual Report:

The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines minimum capital standards which an insurer must maintain. Regulatory compliance is determined by a ratio of the enterprise's regulatory Total Adjusted Capital, to its Authorized Control Level RBC, as defined by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which may require specific corrective action depending upon the insurer's state of domicile.

At the varying levels of RBC, the Company's subsidiaries are subject to the following:

(i) Regulatory Action Level — below which a company must file a Corrective Action Plan that details the insurer's plan to raise additional statutory capital over the next four years. The plan must be approved by the state Insurance Commissioner, who may perform an audit of the insurer's financial position.
(ii) Authorized Control Level — below which the Insurance Commissioner is authorized to take actions it considers necessary to protect the best interests of the policyholders and creditors of an insurer, which may include placing the insurance company under regulatory control, which in turn, may result in rehabilitation or, ultimately, liquidation.
(iii) Mandatory Control Level — below which the Insurance Commissioner is required to take the actions it considers necessary to protect the best interests of the policyholders and creditors of an insurer, which include placing the insurance company under regulatory control, which in turn, may result in rehabilitation or, if deemed appropriate, liquidation.

The focus of this litigation concerns revelations of the Company's deficient statutory capital and surplus levels, which caused the Company's stock price to drop from $17.46 per share on March 29, 2001 to $3.00 per share three days later on April 3, 2001. According to Plaintiffs' Complaint, this situation was caused by Penn Treaty's decision to undergo tremendous growth in sales without maintaining minimum capital levels to cover their existing claims plus expected business growth.

Plaintiffs allege that it was materially false and misleading for Penn Treaty to tout the Company's future growth prospects and assure investors that this growth was (1) not jeopardizing Penn Treaty's financial health; (2) that Penn Treaty was closely monitoring the Company's statutory capital and surplus levels; and (3) that Penn Treaty's capital and surplus were adequate for the increased level of business, because these statements were made at a time when the Company was facing regulatory intervention and insolvency as a result of its precarious financial condition.

Plaintiffs' Complaint identifies numerous statements made by Irving Levit ("Levit"), Penn Treaty's Chairman, Chief Executive Officer and President, and Cameron B. Waite ("Waite"), Penn Treaty's Chief Financial Officer, in various newspaper articles, press releases and SEC filings. The statements include:

1. A 1999 article appearing in the Allentown Morning Call Report in which Waite stated:

Our growth is indicative of our position as the premier provider in the long-term care insurance marketplace today. We support this growth financially through actuarial review, constant monitoring of operating efficiencies and proven access to the capital markets[.]

2. A May 1, 2000 Company press release in which Levit stated:

the Company continues "to monitor [its] actuarial results closely in order to preserve the profitability that [its] shareholders deserve."

A. Throughout 2000, Company supervisors instructed its employees to advise insurance agents, that they had "no information" regarding industry rumors that Penn Treaty was in trouble; that "everything is okay" with respect to the financial health of the Company; and it was "business as usual" at Penn Treaty.
B. A July 23, 2000 Allentown Morning Call Report article in which Levit stated:
The task of raising money for the future is safe in the hands of management . . . We're in a high-growth mode, and we're a public company, and therefore have access to public funds. We are not in trouble.
C. Also in the July 23, 2000 Allentown Morning Call Report article, Levit stated:
Congratulations, we're big enough to be controversial . . . I don't understand why we were targeted, but it's sort of a case where you say, talk good or ...

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