SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transaction period from ___________________ to ____________________
Commission File Number: 0-25505
NCRIC GROUP, INC.
______________________________________________________
(Exact Name of Registrant as Specified in its Charter)
DISTRICT OF COLUMBIA 52-2134774
_________________________________________________ ________________________
(State or Other Jurisdiction of Incorporation or (I.R.S. Employer
Organization) Identification Number)
1115 30TH STREET, N.W., WASHINGTON, D.C. 20007
________________________________________________ __________
(Address of Principal Executive Offices) (Zip Code)
(202) 969-1866
___________________________________________________
(Registrant's Telephone Number including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
_________________________________________
(Title of Class)
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(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 twelve months (or for such shorter period that the
Registrant was required to file reports) and (2) has been subject to such
requirements for the past 90 days.
YES X NO
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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
amendments to this Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
YES NO X
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As of February 28, 2003, there were issued and outstanding 3,708,399
shares of the Registrant's Common Stock. The aggregate value of the voting stock
held by non-affiliates of the Registrant, computed by reference to the last
trade price of the Common Stock as of February 28, 2003 was $17.9 million.
TABLE OF CONTENTS
PAGE
PART I
ITEM 1. Business........................................................2
ITEM 2. Properties.....................................................25
ITEM 3. Legal Proceedings..............................................25
ITEM 4. Submission of Matters to a Vote of Security Holders............25
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters..........................................25
ITEM 6. Selected Financial Data........................................27
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................28
ITEM 7A. Quantitative and Qualitative Disclosures About Market Price....49
Item 8. Financial Statements and Supplementing Data....................51
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.....................................86
PART III
ITEM 10. Directors and Executive Officers of the Registrant.............86
ITEM 11. Executive Compensation.........................................88
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters...................93
ITEM 13. Certain Relationships and Related Transactions.................93
ITEM 14. Controls and Procedures........................................93
PART IV
ITEM 15. Exhibits, Financial Statement Schedules and Reports on
Form 8-K:....................................................93
PART I
ITEM 1. BUSINESS
OVERVIEW
We are a healthcare financial services organization that provides
individual physicians and groups of physicians and other healthcare providers
with economical, high-quality medical professional liability insurance and the
practice management and financial services necessary for them to succeed in the
current healthcare environment. We own NCRIC, Inc., a medical professional
liability insurance company and NCRIC MSO, Inc., a physician practice management
and financial services company.
We offer medical professional liability insurance and practice
management services to physicians and other health care providers in Delaware,
the District of Columbia, Maryland, Virginia and West Virginia. We currently
provide our insurance products and practice management services to approximately
5,000 physicians throughout this market area as of December 31, 2002. This
compares to approximately 4,000 physicians in 2001 and 3,000 physicians in 2000.
This increase is primarily driven by growth in our insurance segment. The number
of our practice management clients has remained stable at approximately 1,000
over this same period. The following table shows our insurance segment policy
count and gross premiums written over the last ten years.
GROSS PREMIUMS
WRITTEN (IN
POLICY COUNT THOUSANDS)
____________ _________________
1992 1,229 $ 23,541
1993 1,215 22,801
1994 1,226 21,509
1995 1,223 19,506
1996 1,231 19,017
1997 1,250 17,869
1998 1,328 19,214
1999 1,532 21,353
2000 2,010 22,727
2001 2,953 34,459
2002 3,785 51,799
As reflected in the table above, we have experienced significant growth
since 1999, and not during the soft-market pricing environment of the
mid-to-late 1990s. We have maintained a disciplined approach towards
underwriting, product pricing and loss reserves, and we have remained focused on
selective expansion in our core markets as pricing conditions have improved.
According to data provided by A.M. Best, in 2001, we had 53.3% of the
District of Columbia medical professional liability market share. We believe
that we have one of the highest retention rates of policyholders in the industry
at more than 95%, for 2002, and our market presence has expanded significantly
as competing medical professional liability insurers have been forced to either
restrict their premium writings or exit the market completely due to financial
difficulties.
We have a strong management team with many years of industry
experience. R. Ray Pate, President and Chief Executive Officer, has 7 years
with us and 16 years of experience in the medical professional liability
insurance business. William E. Burgess, Senior Vice President, has been
with us for 22 years and has been responsible for our risk management and
claims processing functions. Stephen S. Fargis, Senior Vice President and
Chief Operating Officer, joined us in 1995 and has 19 years of experience
in the healthcare industry. Mr. Fargis has been responsible for
implementing our growth strategy in our existing and new geographic
markets. Rebecca B. Crunk, Senior Vice President and Chief Financial
Officer, has been with us since 1998 and is responsible for our financial
reporting functions. Ms. Crunk is a certified public accountant with 25
years' experience in insurance industry accounting.
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Given the long-tail nature of our professional liability insurance
business, we focus on our operating ratio, which combines the ratio of
underwriting income or loss to net premiums earned, referred to as the combined
ratio, offset by the benefit of investment income generated from our cash and
invested assets, also expressed as a percentage of premiums earned. Our average
statutory operating ratio for the five year period ended December 31, 2001 was
77.0%. This compares favorably to an average statutory operating ratio of 94.4%
for the property and casualty industry over the same period, according to data
published by A.M. Best. The long-tail nature also results in a higher level of
invested assets and investment income as compared to other property and casualty
lines of business. At December 31, 2001 our ratio of cash and invested assets,
which totaled $108.6 million, to statutory surplus was 3.3x as compared to 2.7x
for the property and casualty industry according to information reported by A.M.
Best. For the five years ended December 31, 2001, our net investment income
averaged 34.4% of net premiums earned compared to 14.0% for the property and
casualty industry over the same period according to information reported by A.M.
Best, in each case determined on a statutory basis.
For the year ended December 31, 2002, we generated $51.8 million of
gross premiums written, $30.1 million of net premiums earned and $42.3 million
of total revenues. At December 31, 2002, we had consolidated assets of $202.7
million, liabilities of $154.9 million, and stockholders' equity of $47.8
million. Our insurance subsidiaries are rated "A-" (Excellent) by A.M. Best.
FORWARD-LOOKING STATEMENTS
Certain statements contained herein are not based on historical facts
and are "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Such forward-looking statements may be identified by reference to a future
period or periods, or by the use of forward-looking terminology, such as "may,"
"will," "believe," "expect," "estimate," "anticipate," "continue," or similar
terms or variations on those terms, or the negative of those terms. These
forward-looking statements include: statements of our goals, intentions and
expectations; statements regarding our business plans, prospects, growth and
operating strategies; and estimates of our risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions
and uncertainties, including, among other things, the following important
factors that could affect the actual outcome of future events:
o general economic conditions, either nationally or in our market
area, that are worse than expected;
o price competition;
o inflation and changes in the interest rate environment and
performance of financial markets;
o adverse changes in the securities markets;
o changes in laws or government regulations affecting medical
professional liability insurance and practice management and
financial services;
o NCRIC, Inc.'s concentration in a single line of business;
o our ability to successfully integrate acquired entities;
o changes to our ratings assigned by A.M. Best;
o impact of managed healthcare;
o uncertainties inherent in the estimate of loss and loss
adjustment expense reserves and reinsurance;
o the cost and availability of reinsurance;
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o changes in accounting policies and practices, as may be adopted
by our regulatory agencies and the Financial Accounting Standards
Board; and
o changes in our organization, compensation and benefit plans.
We wish to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and wish to
advise readers that the factors listed above could affect our financial
performance and could cause actual results for future periods to differ
materially from any opinions or statements expressed with respect to future
periods in any current statements. We do not undertake and specifically decline
any obligation to publicly release the result of any revisions that may be made
to any forward-looking statements to reflect events or circumstances after the
date of such statements or to reflect the occurrence of anticipated or
unanticipated events.
BUSINESS STRATEGY
Our business strategy is designed to enhance our profitability and
strengthen our position as a leading provider of medical professional liability
insurance, alternative risk financing services, and financial and practice
management services in the Mid-Atlantic region. The major elements of our
business strategy are:
STRENGTHEN AND EXPAND OUR MEDICAL PROFESSIONAL LIABILITY INSURANCE BUSINESS BY:
ADHERING TO STRICT UNDERWRITING CRITERIA AND DISCIPLINED PRICING
PRACTICES. We consistently have followed strict underwriting procedures with
respect to the issuance of all of our insurance policies and do not manage our
business to achieve a certain level of premium growth or market share. In
addition, we solicit the input of physicians from a cross section of medical
specialties to assess accurately the underwriting risks in each of our market
territories. We seek to achieve our principal objective of attracting and
retaining high quality business by focusing on independent physicians who
practice individually or in small groups who we believe are more receptive to
our service-intensive approach and more likely to remain with us in times of
price based competition. We continually monitor market conditions to identify
potentially negative trends that may require corrective actions in our prices
and underwriting criteria.
AGGRESSIVELY MANAGING POLICYHOLDER CLAIMS. In addition to prudent risk
selection, we seek to control our underwriting results through effective claims
management. Our claims department focuses on the early evaluation and aggressive
management of medical professional liability claims. We investigate each claim
and vigorously litigate claims that we consider unwarranted or claims where
settlement resolution cannot be achieved. We have established an understanding
of the legal climates in our core market area and we retain locally based
attorneys who specialize in medical professional liability defense. We believe
this approach contributes to lower overall costs, and results in greater
customer loyalty.
MAINTAINING OUR FINANCIAL STRENGTH. We are rated "A-" (Excellent) by
A.M. Best. An "A-" rating is assigned to companies that have, on balance,
excellent balance sheet strength, operating performance and business profile.
These companies, in A.M. Best's opinion, have a strong ability to meet their
ongoing obligations to policyholders. We have sustained our financial strength
and stability during difficult market conditions through adhering to strict
underwriting, pricing and loss reserving practices. We are committed to abiding
to these practices. We recognize the importance of our A.M. Best rating to our
customers and agents and intend to manage our business to protect our financial
security.
EXPANDING OUR DISTRIBUTION CHANNELS AND PURSUING STRATEGIC
ACQUISITIONS. In addition to our leading position in the District of Columbia,
we are a significant insurer in Delaware, Maryland, Virginia, and West Virginia.
Historically, direct sales in the District of Columbia were the primary source
of written premiums. In recent years, growth in states outside of the District
of Columbia has largely come through our independent agents. In 2002, 17% of all
new business was written through direct distribution and 83% through independent
agents. We believe we can further increase new business through the continued
use of independent agents. We also believe that consolidation will continue in
the medical professional liability insurance industry. This may give rise to
opportunities for us to make strategic acquisitions to expand our business.
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MAINTAINING CLOSE RELATIONSHIPS WITH AREA MEDICAL COMMUNITIES. National
Capital Reciprocal Insurance Company was founded in 1980 with the strong support
of the Medical Society of the District of Columbia (MSDC) and the District of
Columbia's physicians. We maintain the exclusive endorsement of the MSDC, as
well as that of the Virginia-based Arlington County Medical Society. We also
maintain strong working relationships with the Medical Society of Virginia and
the Delaware Medical Society.
ENHANCING OUR PRODUCT OFFERINGS. We have developed other insurance
products in addition to our core medical professional liability insurance
offerings. These products include comprehensive premises liability coverage for
medical offices and PracticeGard Plus. PracticeGard Plus is designed to protect
physicians from costly civil fees and penalties related to the government's
regulations regarding billing coding and compliance.
UTILIZE OUR EXPERTISE IN MEDICAL PROFESSIONAL LIABILITY INSURANCE TO OFFER
ALTERNATIVE RISK TRANSFER PRODUCTS TO HEALTHCARE PROVIDERS.
As a result of significant premium rate increases, healthcare providers
are seeking alternatives methods to secure medical professional liability
coverage. We established ACC under District of Columbia Law in 2001 to form
independent protected captive cells to accommodate affinity groups seeking to
manage their own risk through an alternative risk transfer structure.
Alternative risk transfer is broadly defined as the use of alternative insurance
mechanisms as a substitute for traditional risk-transfer products offered by
insurers. ACC is well positioned to meet current professional liability
insurance market needs due to our ability to manage risk and provide access to
increasingly unavailable reinsurance markets. We believe this venture is
strategically placed to capitalize on the emerging opportunities as demand for
these specialized services increases. Our first protected-cell captive is
expected to commence operations upon final regulatory approval, which is
anticipated in 2003. We are competing with established national brokerage and
specialty companies to provide both the risk transfer vehicle and services to
support and manage captives. We also compete on a regulatory level with other
jurisdictions and varying regulatory requirements in such domiciles as Hawaii,
Bermuda, the Caribbean and Europe.
PROVIDE PRACTICE MANAGEMENT SERVICES TO ASSIST PHYSICIANS IN THE PRACTICE OF
MEDICINE.
We offer practice management and financial services to physicians in
the District of Columbia, North Carolina and Virginia. These services are
heavily concentrated in North Carolina and Virginia and are utilized by more
than 1,000 physicians. Most of our clients are small and solo practitioners. We
compete most often with single source providers of individual services who
target small business. In our accounting, tax and financial services we also
compete with local and regional certified public accounting firms. In our
retirement plan administration we compete with large brokerage firms; while with
respect to our payroll services we compete with national companies.
GROWTH OPPORTUNITIES
Financial pressure on medical professional liability companies and
market contraction in the industry has occurred as companies that expanded
nationally or outside of their traditional market areas have sought to reduce or
in some cases eliminate their medical professional liability insurance business
on a going forward basis in order to regain financial stability. For several
years in the 1990s, many of these carriers engaged in soft-market pricing
tactics that generally resulted in lower premiums rates. Reduced profitability,
reductions in surplus and capacity constraints have led many medical
professional liability carriers to withdraw from, or limit new business in, one
or more markets.
We have maintained strict underwriting criteria and a disciplined
approach with respect to pricing our product and establishing reserves. We have
remained focused on growth in our existing markets as pricing conditions have
improved. Further industry contraction and a hard insurance market characterized
by increasing premium rates, lesser competition and a shortage of capital may
create additional opportunities for growth within our market area. We are
raising additional capital through this offering to better position ourselves to
pursue further growth and market opportunities that arise.
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In our market areas, The St. Paul Companies, a national writer and the
country's largest medical professional liability insurance carrier in 2001,
exited the market leaving behind an approximately 9% industry-wide market share.
This had a significant impact on our Delaware and Virginia markets as The St.
Paul Companies had 2001 market shares of 22% and 15%, respectively. In addition,
Fireman's Fund, another leading carrier also withdrew from the market. Princeton
Insurance Company and MIIX Group, Inc. also have restricted writing premium
policies to their domiciled states leaving former policyholders seeking coverage
in our key markets of Delaware, Maryland and Virginia. Furthermore, financial
difficulties have led to the insolvency of Doctors' Insurance Reciprocal (a
subsidiary of The Reciprocal Group of America), leaving more than 1,000
physicians needing coverage in Virginia.
Further industry contraction and a continued hard insurance market may
create additional opportunities for expansion within our market area. The
additional capital raised in this offering will better position us to pursue
continued growth and market opportunities that arise.
COMPETITION
The competitive environment in the medical professional liability
industry has changed significantly over the past several years. We do not expect
competition from the national companies, such as The St. Paul Companies and CNA
Insurance Companies, which have historically been our largest competitors. The
largest writers of medical professional liability insurance have recently
decided to retrench or exit the marketplace. As a result, the market now is
composed of smaller companies that offer only medical professional liability
insurance.
We expect to face competition from those companies that are focused on
narrow geographic markets. In addition, our competitors may have existing
relationships with insurance brokers or other distribution channels, which we
may be unable to supplant.
The following is a brief summary of our primary competitors in the
jurisdictions in which we operate.
DISTRICT OF COLUMBIA. We are one of a few remaining carriers currently
writing insurance policies in Washington, D.C. According to A.M. Best 2001 data,
the most recent available, we have 53% of the District of Columbia medical
professional liability market share. The Doctors Company Insurance Group holds a
9% market share in the District of Columbia. Professionals Advocate, a member of
The Medical Mutual Group, holds an 8% market share in the District of Columbia.
DELAWARE. As a result of the withdrawal of The St. Paul Companies and
Fireman's Fund from the Delaware market and the downgrade of Princeton Insurance
Company, we are expanding our market share among Delaware physicians. Companies
licensed to do business in the state include MLMIC Group and SCPIE Holdings,
Inc. which hold market shares of 13% and 7%, respectively.
MARYLAND. We also have been writing insurance policies in Maryland
since 1980. The departure of Princeton Insurance Company and MIIX Group, Inc.
from Maryland and the insolvency of PHICO Insurance Company has created
opportunities for growth in the state. Our primary competitor in Maryland is
Medical Mutual of Maryland, a physician-governed carrier that has approximately
49% of the market share.
VIRGINIA. Our primary competitors in the Virginia marketplace include
State Volunteer Mutual Insurance Company, Medical Mutual of North Carolina, The
Doctors Company Insurance Group, MAG Mutual Insurance Company, Professionals
Advocate, and ProAssurance Corporation. We have experienced significant growth
in the Virginia market in the last two years. In 2002, The St. Paul Companies,
Princeton Insurance Company and MIIX Group, Inc. exited this market creating
additional growth opportunities. In addition, in January 2003 the largest
underwriter of medical professional liability insurance in Virginia, Doctors
Insurance Reciprocal, entered into receivership, which we believe will present
additional growth opportunities. It is estimated that as a result of these
developments, approximately 30% of the physicians in Virginia will be seeking
alternative coverage.
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WEST VIRGINIA. We currently do not expect to expand our business and we
intend to maintain a limited exposure in West Virginia. Although few carriers
are currently writing new business in West Virginia, ProAssurance Corporation
has emerged as one of the state's primary markets for physicians.
INSURANCE ACTIVITIES
GENERAL. We provide medical professional liability insurance for
independent physicians who practice individually or in small groups. We
generally sell an insurance product with $1 million of coverage for any one
incident with a $3 million limit for incidents reported within the policy year.
Our policies are written on a claims made basis and include coverage for the
entire defense cost of the claim. These policies provide coverage for claims
arising from incidents that both occur and are reported to us while the policy
is in force. A claims-made policy is in force from the starting date of the
initial policy period and continues in force from that date through each
subsequent renewal. Policyholders can purchase up to $10 million dollars of
excess coverage that provides coverage for losses up to $11 million with an
annual limit of $13 million.
UNDERWRITING. Our policyholder services department is responsible for
the evaluation of applicants for medical professional liability coverage, the
issuance of policies and the establishment and implementation of underwriting
standards. In addition, this department provides information to the D.C.
Underwriting Committee and Virginia, West Virginia and Delaware Physician
Advisory Boards. These boards are comprised of physicians who represent a cross
discipline of medical specialties and provide valued input on local standards of
care as they relate to understanding medical risk and underwriting in each area.
We believe this combination of medical and insurance industry professionals
provides a competitive advantage in underwriting services when compared to our
competitors.
We adhere to consistent and strict underwriting procedures with respect
to the issuance of all physician medical professional liability policies. Each
applicant or member of an applicant medical group is required to complete and
sign a detailed application that provides a personal and professional history,
the type and nature of the applicant's professional practice, information
relating to specific practice procedures, hospital and professional affiliations
and a complete history of any prior claims and incidents.
We also perform a continuous process of underwriting policyholders at
renewal. Information concerning physicians with large losses, a high frequency
of claims or changing or unusual practice characteristics is developed through
renewal applications, claims history and risk management reports.
CLAIMS. Our claims department is responsible for claims investigation,
establishment of appropriate case reserves for losses and LAE, defense planning
and coordination, monitoring of attorneys engaged by us to defend an insured
against a claim and negotiation of the settlement or other disposition of a
claim.
We emphasize early evaluation and aggressive management of claims. When
a claim is reported, our claims professionals complete a preliminary evaluation
and set the initial reserve. After a full evaluation of the claim has been
completed, which generally occurs within seven months, the initial reserve may
be adjusted.
As of December 31, 2002, we had approximately 517 open cases with an
average of 65 cases being handled by each claims representative. Our claims
department consists of nine claims professionals and the level of education
ranges from certified paralegal to juris doctor. The current professional claims
staff has an average of 12 years of experience handling medical professional
liability cases. We limit the number of claims handled by each representative to
fewer than 90 cases. We believe this number is lower than other companies in the
medical professional liability insurance industry.
Our focus is to maintain a local presence in the jurisdictions where we
write coverage. We have obtained an understanding of the local medical and legal
climates where we write policies through on-site visits, interviews with local
law firms, discussions with policyholders and ongoing communications with local
law firms. We retain locally-based attorneys who specialize in medical
professional liability defense and share our philosophy to represent our
policyholders. We also retain the services of medical experts who are leaders in
their specialties and who bring credibility and expertise to the litigation
process.
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Our D.C. claims committee is composed of 9 physicians from various
specialties and meets monthly to provide evaluation and guidance on claims. The
multi-specialty approach of these physicians adds a unique perspective to the
claims handling process as it provides an opportunity to obtain the opinions of
several different specialists meeting to share their knowledge in the area of
liability evaluation and general peer review.
Our objective of local physician claims guidance is carried out in
Delaware, Virginia and West Virginia through advisory boards which serve as our
preliminary risk screening mechanism. These boards meet to review medical
incidents, assess claims and practice characteristics of current and prospective
policyholders, and bring to our attention all matters of special interest to
healthcare providers in their state.
RISK MANAGEMENT. The goal of our risk management staff is to assist our
policyholders in identifying potential areas of exposure to loss and to develop
strategies to reduce or eliminate such risk. Our risk management committee, a
group of nine physicians comprising various specialties, lend their individual
expertise in the development of risk management services tailored to the needs
of the individual policyholders to aid in this endeavor.
Our risk management staff presents educational seminars throughout the
year in locations convenient to our policyholders. Programs designed to address
the needs and interests of physicians are held throughout the District of
Columbia, Delaware, Maryland, Virginia and West Virginia, and cover a wide
variety of topics. Our staff is also available to present customized programs,
on an as requested basis, to individual physician groups and/or office staff.
Physicians unable to attend a live seminar are given the opportunity to
access our risk management services in other ways. Currently, three home study
courses are available and accessible either on-line or in booklet format. Those
physicians wanting a more involved approach to dealing with their risk
management concerns may participate in an office assessment conducted by one of
our risk management staff members.
CME accreditation through the MSDC, allows us to award Category 1 CME
credit to those physicians who attend a live seminar, successfully complete a
home study course, or undergo an office assessment. Participation in one of
these activities also entitles policyholders to a 5% policy premium discount.
MARKETING. Within the District of Columbia, we market directly to
individual physicians and other prospective policyholders through our sponsored
relationship with the MSDC, referrals by existing policyholders, advertisements
in medical journals, and direct solicitation to licensed physicians. We attract
new physicians by targeting medical residents and physicians just entering
medical practice. In addition, we participate as a sponsor and participant in
various medical group and hospital administrators' programs, medical association
and specialty society conventions and similar events. We believe that our
comprehensive approach, market knowledge and insurance expertise all play key
roles in the successful direct marketing of our medical professional liability
insurance in this jurisdiction.
Our primary marketing channel in Delaware, Maryland, Virginia and West
Virginia is our independent agent network. In 2002, our agent network totaled 32
agencies. These agents produced 83% of new premiums and 50% of renewing premiums
in 2002. Healthcare providers frequently utilize agents when they purchase
medical professional liability insurance. Therefore, we believe that developing
our broker relationships in these states is important to grow our market share.
We select agents who have demonstrated experience and stability in the medical
professional liability insurance industry. Brokers and agents receive market
rate commissions and other incentives averaging 9% based on the business they
produce and maintain. We strive to foster relationships with those brokers and
agents who are committed to promoting our products and are successful in
producing business for us. In 2002, we created the President's Gold Circle to
recognize agencies that contribute growth in excess of $1 million in premium.
Account information is communicated to all policyholders and agents
through our Policyholder Services Department. This department strives to
maintain a close relationship with the medical groups and individual
practitioners insured by us as well as the agents who make up our agency
network. To best serve clients and agents, we deploy client service
representatives who can answer most inquiries and, in other instances, provide
immediate access to an appropriate individual who has the expertise to provide a
response. For hospital-based programs and
8
large and mid-size medical groups, we have an account manager assigned to each
group who leads a team comprised of underwriting, risk management and claims
management representatives, each of whom may be contacted directly by the
policyholder for prompt response. Over the years, we believe this approach has
resulted in our high customer retention and satisfaction rate.
RISK SHARING ARRANGEMENTS. We have entered into agreements for risk
sharing programs for groups of physicians practicing at some hospitals in the
Washington, D.C. metropolitan area. The type of risk sharing arrangement offered
involves the initial funding of a portion of a premium being held to pay losses.
In this type of arrangement, we receive full gross premium, less applicable
credits otherwise granted. After quota share losses are determined, if loss
development is favorable, any premium in excess of the losses is returned.
Risk sharing arrangements help lower our risk associated with medical
care provided by the hospital's attending physicians. The arrangements also
establish a cost-effective source of professional liability coverage for
physicians participating in the program.
We reduced the level of risk share discount offered in our risk sharing
programs in 2003, and established an administrative management program for
intensive risk management services specific to these programs. This new
administrative program is provided on a fee basis and generates additional
non-risk bearing revenue.
RATES. We establish rates and rating classifications for physician and
medical group policyholders in the District of Columbia based on the losses and
LAE experience we have developed over the past 21 years. For our other market
areas, we rely on losses and LAE experience data from the medical professional
liability industry. We have various rating classifications based on practice
location, medical specialty and other factors. We utilize premium discounts,
including discounts for part-time practice, physicians just entering medical
practice, claim-free physicians and risk management participation. Generally,
total discounts granted to a policyholder do not exceed 25% of the base premium.
In addition, surcharges generally do not exceed 25% of the base premium.
Effective rates equal our base rate, less any discounts, plus any surcharges to
the policyholder.
Our rates are established based on previous loss experience, loss
adjustments expenses, anticipated policyholder discounts or surcharges, and
fixed and variable operating expenses. In recognition of the increase in the
severity of losses, the weighted average rate increase for our base premiums
was 29% effective January 1, 2003, and 15.8% effective January 1,2002.
RESERVES FOR LOSSES AND LAE. The determination of losses and LAE
reserves involves projection of ultimate losses through an actuarial analysis of
our claims history and other medical professional liability insurers, subject to
adjustments deemed appropriate by us due to changing circumstances. Included in
our claims history are losses and LAE paid by us in prior periods, and case
reserves for losses and LAE developed by our claims department as claims are
reported and investigated. Actuaries rely primarily on historical loss
experience in determining reserve levels on the assumption that historical loss
experience provides a good indication of future loss experience despite the
uncertainties in loss trends and the delays in reporting and settling claims. As
additional information becomes available, the estimates reflected in earlier
loss reserves might be revised. Any increase or decrease in the amount of
reserves, including reserves for insured events of prior years, would have a
corresponding adverse or beneficial effect on our results of operations for the
period in which the adjustments are made.
Our estimates of the ultimate cost of settling the claims are based on
numerous factors including, but not limited to:
o information then known;
o predictions of future events;
o estimates of future trends in claims frequency and severity;
o predictions of future inflation rates;
9
o judicial theories of liability;
o judicial interpretations of insurance contracts; and
o legislative activity.
The inherent uncertainty of establishing reserves is greater for
medical professional liability insurance because lengthy periods may elapse
before notice of a claim or a determination of liability. Medical professional
liability insurance policies are long tail policies, which means that claims and
expenses may be paid over a period of 10 or more years. This is longer than most
property and casualty claims. As a result of these long payment periods, trends
in medical professional liability policies may be slow to emerge, and we may not
promptly modify our underwriting practices and change our premium rates to
reflect underlying loss trends. Finally, changes in the practice of medicine and
healthcare delivery, like the emergence of new, larger medical groups that do
not have an established claims history, and additional claims resulting from
restrictions on treatment by managed care organizations, may not be fully
reflected in our underwriting and reserving practices.
Our independent actuary reviews our reserves for losses and LAE
periodically and prepare semi-annual reports that include a recommended level of
reserves. We consider this recommendation as well as other factors, like loss
retention levels and anticipated or estimated changes in frequency and severity
of claims, in establishing the amount of its reserves for losses and LAE. We
continually refine reserve estimates as experience develops and claims are
settled. Medical professional liability insurance is a line of business for
which the initial losses and LAE estimates may change significantly as a result
of events occurring long after the reporting of the claim. For example, losses
and LAE estimates may prove to be inadequate because of sudden severe inflation
or adverse judicial or legislative decisions.
Activity in the liability for unpaid losses and LAE is summarized as
follows:
YEAR ENDED DECEMBER 31,
---------------------------------------
2002 2001 2000
----------- ----------- -----------
(IN THOUSANDS)
Balance, beginning of year.................... $ 84,560 $ 81,134 $ 84,282
Less reinsurance recoverable on unpaid
claims...................................... 29,624 27,312 25,815
----------- ----------- -----------
Net balance................................... 54,936 53,822 58,467
----------- ----------- -----------
Incurred related to:
Current year................................ 24,063 23,056 17,829
Prior years................................. 2,766 (4,198) (5,883)
----------- ----------- -----------
Total incurred........................... 26,829 18,858 11,946
----------- ----------- -----------
Paid related to:
Current year................................ 1,491 1,599 917
Prior years................................. 18,664 16,145 15,674
----------- ----------- -----------
Total paid............................... 20,155 17,744 16,591
----------- ----------- -----------
Net balance................................... 61,610 54,936 53,822
Plus reinsurance recoverable on unpaid
claims...................................... 42,412 29,624 27,312
----------- ----------- -----------
Balance, end of year.......................... $ 104,022 $ 84,560 $ 81,134
=========== =========== ===========
The amounts shown above and the reserve for unpaid losses and LAE on
the chart located on the next page are presented in conformity with GAAP.
The following table reflects the development of reserves for unpaid
losses and LAE for the years indicated, at the end of that year and each
subsequent year. The first line shows the reserves, as originally reported at
the end of the stated year. Each calendar year-end reserve includes the
estimated unpaid liabilities for that coverage year and for all prior coverage
years. The section under the caption "Cumulative Liability Paid Through End of
Year" shows the cumulative amounts paid through each subsequent year on those
claims for which reserves were carried as of
10
each specific year-end. The section under the caption "Re-estimated Liability"
shows the original recorded reserve as adjusted as of the end of each subsequent
year to reflect the cumulative amounts paid and any other facts and
circumstances discovered during each year. The line "Redundancy (deficiency)"
sets forth the difference between the latest re-estimated liability and the
liability as originally established.
The table reflects the effects of all changes in amounts of prior
periods. For example, if a loss determined in 1996 to be $100,000 was first
reserved in 1992 at $150,000, the $50,000 favorable loss development, being the
original estimate minus the actual loss, would be included in the cumulative
redundancy in each of the years 1992 through 1996 shown below. This table
presents development data by calendar year and does not relate the data to the
year in which the claim was reported or the incident actually occurred.
Conditions and trends that have affected the development of these reserves in
the past will not necessarily recur in the future.
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Reserve for Unpaid
Losses and LAE...... $ 86,727 $ 88,891 $ 77,647 $ 68,928 $ 68,101 $ 72,031 $ 84,595 $ 84,282 $ 81,134 $ 84,560
CUMULATIVE LIABILITY
PAID THROUGH END OF
YEAR:
One year later.... 18,103 19,786 21,667 16,084 14,916 9,667 13,865 20,813 20,828 21,995
Two years later... 35,861 39,293 34,829 27,634 22,237 21,810 32,778 38,078 34,253
Three years later. 51,163 47,348 43,237 32,409 29,135 36,310 42,381 44,696
Four years later.. 56,648 51,845 45,219 34,657 39,938 42,553 44,352
Five years later.. 59,473 52,984 45,682 41,578 44,297 43,581
Six years later... 60,335 53,208 51,450 43,753 44,724
Seven years later. 60,440 58,246 52,551 43,962
Eight years later. 63,395 59,086 52,737
Nine years later.. 64,113 59,108
Ten years later... 64,115
RE-ESTIMATED LIABILITY:
One year later.... $ 79,174 $ 70,640 $ 68,891 $ 62,028 $ 61,121 $ 71,419 $ 72,575 $ 77,373 $ 73,582 $ 86,534
Two years later... 65,174 63,248 66,439 53,429 62,097 64,980 66,733 71,489 73,654
Three years later. 62,521 65,422 60,858 55,883 58,169 61,336 60,752 68,439
Four years later.. 65,225 64,460 62,625 53,400 54,324 54,996 59,069
Five years later.. 67,681 66,275 61,077 50,744 50,977 53,952
Six years later... 69,765 64,877 58,220 47,946 50,666
Seven years later. 68,415 63,514 55,739 47,099
Eight years later. 67,740 61,262 55,156
Nine years later.. 65,671 60,160
Ten years later... 64,213
Redundancy (deficiency) $ 22,514 $ 28,731 $ 22,491 $ 21,829 $ 17,435 $ 18,079 $ 25,526 $ 15,843 $ 7,480 $ (1,974)
General office premises liability incurred losses have been less than
1% of medical professional liability incurred losses in the last five years. We
do not have reserves for pollution claims as our policies exclude liability for
pollution. We have never been presented with a pollution claim brought against
us or our insureds.
REINSURANCE. We follow customary industry practice by reinsuring a
portion of our risks and paying a reinsurance premium based upon the premiums
received on all policies subject to reinsurance. By reducing our potential
liability on individual risks, reinsurance protects us against large losses. We
have full underwriting authority for medical professional liability policies
including premises liability policies issued to physicians, surgeons, dentists
and professional corporations and partnerships. The 2003 reinsurance program
cedes to the reinsurers up to the maximum reinsurance policy limit those risks
insured by us in excess of our $1 million retention.
Although reinsurance does not discharge us from our primary liability
for the full amount of our insurance policies, it contractually obligates the
reinsurer to pay successful claims against us to the extent of risk ceded. Our
11
current reinsurance program is designed to provide coverage through separate
reinsurance treaties for two layers of risk.
LOSSES IN EXCESS OF $1,000,000 PER CLAIM UP TO $2,000,000. Effective
January 1, 2003 to January 1, 2006, the treaty, which reinsures us for losses in
excess of $1,000,000 per claim up to $2,000,000, is a fixed rate treaty. The
reinsurance premium is agreed upon as a fixed percentage of gross net earned
premium income. Gross net earned premium income is our gross premium earned net
of discounts for coverage limits up to $2,000,000.
Effective January 1, 2000 to January 1, 2003 our primary treaty
reinsures losses in excess of $500,000 per claim up to $1,000,000 and is a fixed
rate treaty. Our first excess cession treaty covers losses up to $1,000,000 in
excess of $1,000,000 per claim. For risks related to claims submitted January 1,
2000 to January 1, 2003, under this first excess cession treaty, we cede 100% of
our risks and premium.
For claims submitted for 1999 and prior years, we have a swing-rated
treaty which reinsures us for losses in excess of $500,000 per claim up to
$1,000,000, subject to an inner aggregate deductible of 5% of gross net earned
premium income. The ultimate reinsurance premium is subject to incurred losses
and ranges between a minimum premium of 4% of gross net earned premium income
and a maximum premium of 22.5% of gross net earned premium income. The inner
aggregate deductible means that we must pay losses within the reinsurance layer
until the inner aggregate deductible is satisfied. We paid a deposit premium
equal to 14% of gross net earned premium income that is ultimately increased or
decreased based on actual losses, subject to the minimum and maximum premium.
Following are the reinsurance premium terms for the swing-rated treaty for
calendar years 1999, 1998, 1997 and 1996.
PERCENTAGE OF GROSS NET EARNED
PREMIUM INCOME
----------------------------------------------
1999 1998 1997 1996
--------- -------- -------- --------
Deposit premium.............. 14.0% 14.0% 14.0% 14.0%
Maximum premium.............. 22.5 22.5 22.5 30.0
Minimum premium.............. 4.0 4.0 4.0 4.0
Inner aggregate deductible... 5.0 5.0 5.0 10.0
We have recorded, based on actuarial analysis, management's best
estimate of premium expense under the terms of the swing-rated treaty. In the
initial year of development for each coverage year, the premium was capped at
the maximum rate. We then adjust the liability and expense as losses develop in
subsequent years.
For claims related to 1999 and prior years, we cede 91% of its risks
and premium to the $1,000,000 excess layer treaty program and retain 9% of the
risks and premium. We receive a ceding commission from the reinsurers to cover
the costs associated with issuing this coverage.
LOSSES UP TO $9,000,000 IN EXCESS OF $2,000,000 PER CLAIM. An excess
cession layer treaty covers losses up to $9,000,000 in excess of $2,000,000
per claim. We cede 100% of our risks to the $2,000,000 excess layer treaty
program and retain none of the risks. The premium for the $2,000,000 excess
layer treaty is 100% of the premium collected from insureds for this coverage.
We receive a ceding commission from the reinsurers to cover the costs
associated with issuing this coverage.
Ceding commissions, which are 15% of gross ceded reinsurance premiums
in the excess layer and other treaties are deducted from other underwriting
expenses. Ceding commissions were $1.1 million, $644,000 and $357,000 in 2002,
2001 and 2000, respectively.
Additionally, our reinsurance program protects us from paying multiple
retentions for claims arising out of one event. In most situations we will
only pay one $1,000,000 retention regardless of the number of original
policies or claimants involved. We also have protection against losses in
excess of its existing reinsurance. We may provide higher policy limits
reinsured through facultative reinsurance programs. Facultative reinsurance
programs are reinsurance programs which are specifically designed for a
particular risk not covered by our existing reinsurance arrangements.
12
We determine the amount and scope of reinsurance coverage to purchase
each year based upon evaluation of the risks accepted, consultations with
reinsurance consultants and a review of market conditions, including the
availability and pricing of reinsurance. Our primary reinsurance treaty is
placed with non-affiliated reinsurers for a three-year term with annual
renegotiations. Our current three-year treaty expires January 1, 2006.
The reinsurance program is placed with a number of individual
reinsurance companies and Lloyds' syndicates to mitigate the concentrations of
reinsurance credit risk. Most of the reinsurers are European companies or
Lloyds' syndicates; there is a small percentage placed with a domestic
reinsurer. As of December 31, 2002, the amounts recoverable from reinsurers
attributable to Lloyds of London represents a total of 42 syndicates. We rely on
our wholly owned brokerage firm, National Capital Insurance Brokerage, Ltd.,
Willis Re, Inc. and a London-based intermediary to assist in the analysis of the
credit quality of reinsurers. We also require reinsurers that are not authorized
to do business in the District of Columbia to post a letter of credit to secure
reinsurance recoverable on paid losses.
The following table reflects reinsurance recoverable on paid and unpaid
losses at December 31, 2002 by reinsurer:
REINSURANCE A.M. BEST
REINSURER RECOVERABLE RATING
- ------------ -------------- ---------
(IN THOUSANDS)
Lloyd's of London syndicates................................. $ 25,846 A-
Hanover Rueckversicherungs - AG.............................. 4,091 A+
CNA Reinsurance LTD.......................................... 3,102 NR3
Unionamerica Insurance....................................... 1,948 C++
Transatlantic Reinsurance Company............................ 3,491 A++
AXA Reassurance.............................................. 2,622 A
Terra Nova Insurance Company LTD............................. 1,208 B++
Other reinsurers............................................. 923 A/A-
-------------
Total.................................................... $ 43,231
=============
The effect of reinsurance on premiums written and earned for the years
ended December 31, 2002, 2001 and 2000 is as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------- ------------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
----------- ----------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
Direct........... $ 51,799 $ 44,113 $ 34,459 $ 28,192 $ 22,727 $ 19,965
Ceded............ (18,003) (14,023) (10,542) (7,296) (5,874) (4,110)
----------- ----------- ----------- ----------- ----------- -----------
Net.............. $ 33,796 $ 30,090 $ 23,917 $ 20,896 $ 16,853 $ 15,855
=========== =========== =========== =========== =========== ===========
In late 1999, we introduced PracticeGard Plus, which provides errors
and omissions coverage on Medicare/Medicaid billing to health care providers.
This coverage provides up to $1 million in indemnity and expense protection and
only pays indemnity on civil fines and penalties. We reinsure 100% of this risk
and receive a ceding commission. We intend to evaluate our level of risk
acceptance based on how losses develop in the future. Since this coverage
protects a new risk based on recently passed national legislation, current loss
development is uncertain.
INVESTMENT PORTFOLIO. Investment income is an important component in
support of our operating results. We utilize external investment managers who
adhere to policies established and supervised by our investment
13
committee. Our current investment policy has placed primary emphasis on
investment grade, fixed income securities and seeks to maximize after-tax yields
while minimizing portfolio credit risk. Toward achieving this goal, our
investment guidelines, which set the parameters for our investment policy,
permit investments in tax-advantaged securities such as municipal bonds and
preferred stock. Our investment guidelines document is reviewed and updated as
needed but at least annually.
Deutsche Asset Management (DeAM), previously Zurich Scudder Insurance
Asset Management, was the external investment manager for our fixed income
securities including tax advantaged preferred stocks for the three years ended
December 31, 2002. Effective January 1, 2003, Standish Mellon Asset Management
became the external investment manager for our portfolio.
Each year we, along with our investment manager, have conducted
extensive financial analyses of the investment portfolio using stochastic models
to develop a risk appropriate investment portfolio given the business
environment and risks relevant to us. DeAM supplemented stochastic modeling with
the output from their independent investment research and strategy group to
develop a tailored investment approach for us. Analysis of our capital structure
and risk-bearing ability, valuation, peer comparisons, as well as proprietary
and third party modeling, determine the optimal level of tax advantaged
investments and provide strategy input.
DeAM used Dynamic Financial Analysis (DFA) a total company tool to test
our capital structure and business plan under numerous potential future economic
scenarios. The results of DFA, in the form of probability distributions on key
financial statistics, allow us to make risk informed decisions on the structure
of our investment portfolio as it relates to our business profile. DFA output
has been especially useful in setting portfolio policy regarding average
duration and optimizing potential equity exposure.
We have classified our investments as available for sale and report
them at fair value, with unrealized gains and losses excluded from net income
and reported, net of deferred taxes, as a component of stockholders' equity.
During periods of rising interest rates, as experienced during 1999, the fair
value of our investment portfolio will generally decline resulting in decreases
in our stockholders' equity. Conversely, during periods of falling interest
rates, as experienced during 2002, the fair value of our investment portfolio
will generally increase resulting in increases in our stockholders' equity.
14
The following table sets forth the fair value and the amortized cost of
our investment portfolio at the dates indicated.
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
------------ ----------- ---------- ------------
(IN THOUSANDS)
AT DECEMBER 31, 2002
U.S. Government and agencies...... $ 27,664 $ 292 $ (4) $ 27,952
Corporate......................... 32,680 1,567 (488) 33,759
Tax-exempt obligations............ 30,416 2,309 (21) 32,704
Asset and mortgage-backed securities 19,549 882 (150) 20,281
------------ ----------- ---------- ------------
110,309 5,050 (663) 114,696
Equity securities................. 5,561 150 (287) 5,424
------------ ----------- ---------- ------------
Total........................... $ 115,870 $ 5,200 $ (950) $ 120,120
============ =========== ========== ============
AT DECEMBER 31, 2001
U.S. Government and agencies...... $ 4,600 $ 161 $ -- $ 4,761
Corporate......................... 43,739 977 (1,311) 43,405
Tax-exempt obligations............ 19,304 634 (134) 19,804
Asset and mortgage-backed securities 28,073 695 (15) 28,753
------------ ----------- ---------- ------------
95,716 2,467 (1,460) 96,723
Equity securities................. 6,691 118 (407) 6,402
------------ ----------- ---------- ------------
Total........................... $ 102,407 $ 2,585 $ (1,867) $ 103,125
============ =========== ========== ============
AT DECEMBER 31, 2000
U.S. Government and agencies...... $ 13,037 $ 490 $ (14) $ 13,513
Corporate......................... 32,301 181 (1,763) 30,719
Tax-exempt obligations............ 15,379 631 -- 16,010
Asset and mortgage-backed securities 31,335 208 (303) 31,240
------------ ----------- ---------- ------------
92,052 1,510 (2,080) 91,482
Equity securities................. 7,121 45 (603) 6,563
------------ ----------- ---------- ------------
Total........................... $ 99,173 $ 1,555 $ (2,683) $ 98,045
============ =========== ========== ============
Our investment portfolio of fixed maturity securities consists
primarily of intermediate-term, investment-grade securities. Our investment
policy provides that all security purchases be limited to rated securities or
unrated securities approved by management on the recommendation of our
investment advisor. At December 31, 2002, we held 58 asset and mortgage-related
securities, most of which had a quality of Agency/AAA. Collectively, our
mortgage-related securities had an average yield to maturity of approximately
3.42%. Approximately 53.4% of the mortgage-related securities are pass-through
securities. We do not have any interest only or principal only pass-through
securities.
The following table contains the investment quality distribution of our
fixed maturity investments at December 31, 2002.
TYPE/RATINGS OF INVESTMENT PERCENTAGE
----------------------------------------- ----------
Treasury/Agency.......................... 34.4%
AAA...................................... 29.8
AA....................................... 9.8
A........................................ 19.7
BBB...................................... 6.1
B........................................ 0.2
-----
100.0%
=====
The ratings set forth in the table are based on ratings assigned by
Standard & Poor's Corporation and Moody's Investors Service, Inc.
The following table sets forth information concerning the maturities of
fixed maturity securities in our investment portfolio as of December 31, 2002,
by contractual maturity. Actual maturities will differ from contractual
maturities because borrowers may have the right to prepay obligations with or
without prepayment penalties.
15
AT DECEMBER 31, 2002
----------------------------------------
PERCENTAGE
AMORTIZED OF FAIR
COST FAIR VALUE VALUE
---------- ----------- -----------
(IN THOUSANDS)
Due in one year or less........... $ 742 $ 750 1%
Due after one year through five
years............................. 40,685 42,283 35
Due after five years through ten
years............................. 36,707 38,825 32
Due after ten years............... 12,626 12,557 10
---------- ---------- --------
90,760 94,415 78%
Equity securities................. 5,561 5,424 5
Asset and mortgage-backed securities 19,549 20,281 17
---------- ---------- --------
Total.......................... $ 115,870 $ 120,120 100%
========== ========== ========
Proceeds from bond maturities, sales and redemptions of available for
sale investments during the years 2002, 2001, and 2000 were $39.0 million, $22.0
million and $10.5 million, respectively. Gross gains of $1,437,000, $787,000 and
$16,000 and gross losses of $1,568,000, $1,065,000 and $21,000 were realized on
available for sale investment redemptions during 2002, 2001, and 2000,
respectively.
The average effective maturity and the average modified duration of the
securities in our fixed maturity portfolio as of December 31, 2002 and 2001, was
4.4 years and 4.7 years, respectively.
A.M. BEST COMPANY RATINGS
A.M. Best, which rates insurance companies based on factors of concern
to policyholders, rated NCRIC, Inc. and CML "A-" (Excellent). This is the fourth
highest rating of the 15 ratings that A.M. Best assigns. NCRIC, Inc. received
its initial rating of "B" in 1988, was upgraded to "B+" in 1989, to "B++" in
1996 and was upgraded to "A-" in 1997. A.M. Best reaffirmed the "A-" ratings of
NCRIC, Inc. and CML in 2002. A.M. Best reviews its ratings periodically.
A.M. Best's "A-" rating is assigned to those companies that in A.M.
Best's opinion have a strong ability to meet their obligations to policyholders
over a long period of time. In evaluating a company's financial and operating
performance, A.M. Best reviews:
o the company's profitability, leverage and liquidity;
o its book of business;
o the adequacy and soundness of its reinsurance;
o the quality and estimated market value of its assets;
o the adequacy of its reserves and surplus;
o its capital structure;
o the experience and competence of its management; and
o its market presence.
RISK FACTORS
OUR RESULTS MAY BE AFFECTED IF ACTUAL INSURED LOSSES DIFFER FROM OUR LOSS
RESERVES
Significant periods of time often elapse between the occurrence of an
insured loss, the reporting of the loss to us and our payment of that loss. To
recognize liabilities for unpaid losses, we establish reserves as balance sheet
liabilities representing estimates of amounts needed to pay reported losses and
the related loss adjustment expenses. The process of estimating loss reserves is
a difficult and complex exercise involving many variables and subjective
16
judgments. We regularly review our reserving techniques and our overall level of
reserves. As part of the reserving process, we review historical data and
consider the impact of various factors such as:
o Trends in claim frequency and severity;
o Changes in operations;
o Emerging economic and social trends;
o Inflation; and
o Changes in the regulatory and litigation environments.
This process assumes that past experience, adjusted for the effects of
current developments and anticipated trends, is an appropriate, but not
necessarily accurate, basis for predicting future events. There is no precise
method for evaluating the impact of any specific factor on the adequacy of
reserves, and actual results are likely to differ from original estimates. To
the extent loss reserves prove to be inadequate in the future, we would need to
increase our loss reserves and incur a charge to earnings in the period the
reserves are increased, which could have a material adverse impact on our
financial condition and results of operations. Although we intend to estimate
conservatively our future payments relating to losses incurred, there can be no
assurance that currently established reserves will prove adequate in light of
subsequent actual experience. Our ultimate liability will be known only after
all claims are closed, which is likely to be several years into the future.
The loss reserves of our insurance subsidiaries also may be affected by
court decisions that expand liability on our policies after they have been
priced and issued. In addition, a significant jury award, or series of awards,
against one or more of our insureds could require us to pay large sums of money
in excess of our reserved amounts. Our policy to litigate aggressively claims
against our insureds that we consider unwarranted or claims where settlement
resolution cannot be achieved may increase the risk that we may be required to
make such payments.
THE CHANGE IN OUR REINSURANCE PROGRAM EFFECTIVE JANUARY 1, 2003 EXPOSES US TO
LARGER LOSSES
We increased our retention of loss from $500,000 to $1,000,000 for each
and every loss. As a result, we expect a higher level of losses and are subject
to a higher level of loss volatility since it is more difficult to predict the
number and timing of losses in excess of $500,000.
We purchase limited reinsurance for protection against more than one
insured being involved in a single incident so that we are exposed to no more
than one retention of loss in a single medical incident. The limited protection
may not be adequate if there are several policyholders involved in a single
medical incident and a jury returns an extraordinarily high verdict against all
defendants.
OUR EARNINGS MAY NOT INCREASE AS A RESULT OF GROWTH IN NEW BUSINESS IN STATES IN
WHICH WE HAVE LIMITED OPERATING EXPERIENCE
In recent years we have expanded our business in Delaware, Virginia and
West Virginia. We utilize publicly available information on loss experience of
our competitors when we price our products in states when we can not rely on our
own experience. The use of competitor data does not provide the same level of
confidence as when we can use our own historical data from territories we have
been operating in for many years, i.e., the District of Columbia and Maryland.
The increase in uncertainty is a result of us not knowing the effectiveness of
our underwriting and claims adjudication process in the new territory.
OUR REVENUES AND INCOME MAY FLUCTUATE WITH INTEREST RATES AND INVESTMENT RESULTS
We generally rely on the positive performance of our investment
portfolio to offset insurance losses and to contribute to our profitability. As
our investment portfolio is primarily comprised of interest-earning assets,
prevailing economic conditions, particularly changes in market interest rates,
may significantly affect our operating
17
results. Changes in interest rates also can affect the value of our
interest-earning assets, which are principally comprised of fixed rate
investment securities. Generally, the value of fixed rate investment securities
fluctuates inversely with changes in interest rates. Interest rate fluctuation
could adversely affect our GAAP stockholders' equity, total comprehensive income
and/or cash flows. As of December 31, 2002, $119 million of our $120 million
investment portfolio was invested in fixed maturities. Unrealized pre-tax net
investment gains on investments in fixed maturities were $4.2 million and
$700,000 as of December 31, 2002, and 2001, respectively.
In accordance with our investment policies, the duration of our
investment portfolio is intended to be similar to our expectation for the
duration of our loss reserves. Changes in the actual duration of our loss
reserves from our expectations may affect our results. Our investment portfolio,
however, is subject to prepayment risk primarily due to our investments in
mortgage-backed and other asset-backed securities. An investment has prepayment
risk when there is a risk that the timing of cash flows that result from the
repayment of principal might occur earlier than anticipated because of declining
interest rates or later than anticipated because of rising interest rates. We
are subject to reinvestment risk to the extent that we are not able to reinvest
prepayments at rates comparable to the rates on the maturing investments.
REGULATORY CHANGES COULD HAVE A MATERIAL IMPACT ON OUR OPERATIONS
Our insurance businesses are subject to extensive regulation by state
insurance authorities in each state in which we operate. Regulation is intended
for the benefit of policyholders rather than stockholders. In addition to the
amount of dividends and other payments that can be made by our insurance
subsidiaries, these regulatory authorities have broad administrative and
supervisory power relating to:
o rates charged to insurance customers;
o licensing requirements;
o trade practices;
o capital and surplus requirements; and
o investment practices.
These regulations may impede or impose burdensome conditions on rate
increases or other actions that we may want to take to enhance our operating
results, and could affect our ability to pay dividends on our common stock. In
addition, we may incur significant costs in the course of complying with
regulatory requirements. Most states also regulate insurance holding companies
like us in a variety of matters such as acquisitions, changes of control, and
the terms of affiliated transactions. Future legislative or regulatory changes
may adversely affect our business operations.
THE UNPREDICTABILITY OF COURT DECISIONS COULD HAVE A MATERIAL IMPACT ON OUR
FINANCIAL RESULTS
The financial position of our insurance subsidiaries may also be
affected by court decisions that expand insurance coverage beyond the intention
of the insurer at the time it originally issued an insurance policy or by a
judiciary's decision to accelerate the resolution of claims through an expedited
court calendar, thereby reducing the amount of investment income we would have
earned on related reserves. In addition, a significant jury award, or series of
awards, against one or more of our insureds could require us to pay large sums
of money in excess of our reserve amount.
OUR REVENUES AND OPERATING PERFORMANCE MAY FLUCTUATE WITH INSURANCE BUSINESS
CYCLES
Growth in premiums written in the medical professional liability
industry have fluctuated significantly over the past 10 years as a result of,
among other factors, changing premium rates. The cyclical pattern of such
fluctuation has been generally consistent with similar patterns for the broader
property and casualty insurance industry, due in part to the participation in
the medical professional liability industry of insurers and reinsurers
18
which also participate in many other lines of property and casualty insurance
and reinsurance. Historically, the financial performance of the property and
casualty insurance industry has tended to fluctuate in cyclical patterns
characterized by periods of greater competition in pricing and underwriting
terms and conditions, a soft insurance market, followed by period of capital
shortage, lesser competition and increasing premium rates, a hard insurance
market.
For several years in the 1990s, the medical professional liability
industry faced a soft insurance market that generally resulted in lower premium
rates. The medical professional liability industry is currently in a hard
insurance market cycle. We cannot predict whether, or the extent to which, the
recent increase in premium rates will continue.
OUR GEOGRAPHIC CONCENTRATION TIES OUR PERFORMANCE TO THE ECONOMIC, REGULATORY
AND DEMOGRAPHIC CONDITIONS OF THE MID-ATLANTIC REGION
Our revenues and profitability are subject to prevailing economic,
regulatory, demographic and other conditions in the region in which we write
insurance. We write our medical professional liability insurance in the District
of Columbia, Delaware, Maryland, Virginia and West Virginia. Because our
business is concentrated in a limited number of states, we may be exposed to
adverse developments that may have a greater affect on us than the risks of
doing business in a broader market area.
OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE ARE NOT ABLE TO ATTRACT AND
RETAIN INDEPENDENT AGENTS
We depend in part on the services of independent agents in marketing
our insurance products. We face competition from other insurance companies for
the services and allegiance of our independent agents. While we believe that the
commissions and services we provide to our agents are competitive with other
insurers, changes in commissions, services or products offered by our
competitors could make it more difficult for us to attract and retain
independent agents to sell our insurance products.
IF WE ARE UNABLE TO MAINTAIN A FAVORABLE A.M. BEST COMPANY RATING, IT MAY BE
MORE DIFFICULT FOR US TO WRITE NEW BUSINESS OR RENEW OUR EXISTING BUSINESS
A.M. Best assesses and rates the financial strength and claims-paying
ability of insurers based upon its criteria. The financial strength ratings
assigned by A.M. Best to insurance companies represent independent opinions of
financial strength and ability to meet policyholder obligations, and are not
directed toward the protection of investors. A.M. Best ratings are not ratings
of securities or recommendations to buy, hold or sell any security and are not
applicable to the securities being offered by this prospectus.
Our insurance subsidiaries hold a financial strength rating of "A-"
(Excellent) by A.M. Best. An "A-" rating is A.M. Best's fourth highest rating
out of its 15 possible rating classifications. Financial strength ratings are
used by agents and customers as an important means of assessing the financial
strength and quality of insurers. If our financial position deteriorates, we may
not maintain our favorable rating. A downgrade or withdrawal of any such rating
could severely limit or prevent us from writing desirable business or renewing
our existing business.
IF MARKET CONDITIONS CAUSE REINSURANCE TO BE MORE COSTLY OR UNAVAILABLE, WE MAY
BE REQUIRED TO BEAR INCREASED RISKS OR REDUCE THE LEVEL OF OUR UNDERWRITING
COMMITMENTS
As part of our overall risk and capacity management strategy, we
purchase reinsurance for significant amounts of risk underwritten by our
insurance company subsidiaries. Market conditions beyond our control determine
the availability and cost of the reinsurance we purchase, which may affect the
level of our business and profitability. We may be unable to maintain our
current reinsurance coverage or to obtain other reinsurance coverage in adequate
amounts and at favorable rates. If we are unable to renew our expiring
reinsurance coverage or to obtain new reinsurance coverage, either our net
exposure risk would increase or, if we are unwilling to bear an increase in net
risk exposures, we would have to reduce the amount of risk we underwrite.
19
WE CANNOT GUARANTEE THAT OUR REINSURERS WILL PAY IN A TIMELY FASHION, IF AT ALL,
AND, AS A RESULT, WE COULD EXPERIENCE LOSSES
We transfer some of the risk we have assumed to reinsurance companies
in exchange for part of the premium we receive in connection with the risk.
Although reinsurance coverage makes the reinsurer liable to us to the extent the
risk is transferred, it does not relieve us of our liability to our
policyholders. If our reinsurers fail to pay us or fail to pay us on a timely
basis, our financial results would be adversely affected.
THE GUARANTY FUND ASSESSMENTS THAT WE ARE REQUIRED TO PAY TO STATE GUARANTY
ASSOCIATIONS MAY INCREASE AND OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITIONS
COULD BE ADVERSELY AFFECTED
Each jurisdiction in which we operate has separate insurance guaranty
fund laws requiring property and casualty insurance companies doing business
within their respective jurisdictions to be members of their guaranty
associations. These associations are organized to pay covered claims (as defined
and limited by the various guaranty association statutes) under insurance
policies issued by insolvent insurance companies. Most guaranty association laws
enable the associations to make assessments against member insurers to obtain
funds to pay covered claims after a member insurer becomes insolvent. These
associations levy assessments (up to prescribed limits) on all member insurers
in a particular state on the basis of the proportionate share of the premiums
written by member insurers in the covered lines of business in that state.
Maximum assessments permitted by law in any one year generally vary between 1%
and 2% of annual premiums written by a member in that state.
Property and casualty guaranty fund assessments incurred by us totaled
$355,000 and $243,000 for 2002 and 2001, respectively. Our policy is to accrue
the guaranty fund assessments when notified and in accordance with GAAP. We
cannot reasonably estimate liabilities for insolvency because of the lack of
adequate financial data on insolvent companies.
OUR BUSINESS COULD BE ADVERSELY AFFECTED BY THE LOSS OF ONE OR MORE EMPLOYEES
We are heavily dependent upon our senior management and the loss of
services of our senior executives could adversely affect our business. Our
success has been, and will continue to be, dependent on our ability to retain
the services or our existing key employees and to attract and retain additional
qualified personnel in the future. The loss of services of any of our senior
management or any other key employee, or the inability to identify, hire and
retain other highly qualified personnel in the future, could adversely affect
the quality and profitability of our business operations. While we have
employment agreements with our senior executives, we currently do not maintain
key employee insurance with respect to any of our employees.
WE ARE A HOLDING COMPANY AND ARE DEPENDENT ON DIVIDENDS AND OTHER PAYMENTS FROM
OUR OPERATING SUBSIDIARIES, WHICH ARE SUBJECT TO DIVIDEND RESTRICTIONS
We are a holding company whose principal source of funds is cash
dividends and other permitted payments from our operating subsidiaries,
principally NCRIC, Inc. If our subsidiaries are unable to make payments to us,
or are able to pay only limited amounts, we may be unable to pay dividends or
make payments on our indebtedness. The payment of dividends by these operating
subsidiaries is subject to restrictions set forth in the insurance laws and
regulations of the District of Columbia. See "Insurance Regulatory Matters -
Regulation of Dividends and Other Payments From Our Operating Subsidiaries."
OUR PROFITABILITY COULD BE ADVERSELY AFFECTED BY MARKET DRIVEN CHANGES IN THE
HEALTHCARE INDUSTRY
Managed care has negatively impacted physicians' ability to efficiently
conduct a traditional medical practice. As a result, many physicians have joined
or affiliated with managed care organizations, healthcare delivery systems or
practice management organizations. The impact of managed care and tightened
Medicare/Medicaid reimbursement may impact a physician's decision to continue
purchasing consulting and practice management services, shifting a purchase
decision from quality and value to price only. Larger healthcare systems
generally retain more risk by accepting higher deductibles and self-insured
retentions or form their own captive insurance companies. This consolidation has
reduced the role of the individual physician and the small medical group, which
20
represents a significant portion of our policyholders, in the medical
professional liability insurance purchasing decision.
RISING INTEREST RATES WOULD INCREASE INTEREST COSTS ASSOCIATED WITH THE TRUST
PREFERRED SECURITIES ISSUED BY US
In December 2002 we issued $15,000,000 of trust preferred securities.
The trust preferred securities bear interest at a rate of 400 basis points over
the three-month London Interbank Offered Rate (LIBOR) and adjust quarterly
subject to a maximum interest rate of 12.5%. Our interest expense will increase
if the three-month LIBOR increases.
STATE INSURANCE REGULATORS MAY NOT BE WILLING TO APPROVE OUR CAPTIVE INSURANCE
OPERATIONS
While higher pricing and reduced availability of traditional insurance
sources have created favorable market conditions for this risk financing
vehicle, state insurance regulatory may not be willing to approve our captive
insurance operations or market conditions may change.
A DECLINE IN REVENUE AND PROFITABILITY IN NCRIC MSO COULD RESULT IN A SFAS 142
IMPAIRMENT CHARGE
NCRIC MSO's revenue is subject to clients facing declining
reimbursement for their services. Therefore, in an effort to pare their own
expenses to improve their net profitability, our clients may not order new
services, or may diminish and possibly cease using our existing services. This
could result in a reduction of revenue to us, thereby reducing net income and
resulting in an impairment charge relative to the goodwill ascribed to NCRIC
MSO.
INSURANCE COMPANY REGULATION
GENERAL. NCRIC, Inc. is subject to supervision and regulation by the
District of Columbia Department of Insurance and Securities Regulation and
insurance authorities in Maryland. CML is subject to supervision and regulation
by the District of Columbia Department of Insurance and Securities Regulation
and insurance authorities in Delaware, Maryland, Virginia and West Virginia.
This regulation is concerned primarily with the protection of policyholders'
interests rather than stockholders' interests. Accordingly, decisions of
insurance authorities made with a view to protecting the interests of
policyholders may reduce our profitability. The extent of regulation varies by
jurisdiction, but this regulation usually includes:
o regulating premium rates and policy forms;
o setting minimum capital and surplus requirements;
o regulating guaranty fund assessments;
o licensing of insurers and agents;
o approving accounting methods and methods of setting statutory
loss and expense reserves;
o underwriting limitations;
o the terms upon which a full demutualization transaction can
occur;
o restrictions on transactions with affiliates;
o setting requirements for and limiting the types and amounts of
investments;
o establishing requirements for the filing of annual statements and
other financial reports;
o conducting periodic statutory examinations of the affairs of
insurance companies;
o approving proposed changes of control; and
o limiting the amounts of dividends that may be paid without prior
regulatory approval.
21
Without the approval of the District of Columbia Commissioner of
Insurance and Securities, neither NCRIC, Inc. nor CML may diversify out of the
healthcare and insurance fields through an acquisition or otherwise.
NAIC CODIFICATION. The Codification of Statutory Accounting Principles
was developed by the NAIC as a comprehensive guide to statutory accounting
intended to provide analysts and other users with more comparable financial
statements. Much of statutory accounting is based on GAAP with modifications
that emphasize the concepts of conservatism and solvency inherent in statutory
accounting. The Codification was mandated by the NAIC to be effective as of
January 1, 2001. Statutory accounting changes resulting from this guidance do
not have an effect on the financial statements prepared in accordance with GAAP,
which have been included with this document and filed with the Securities and
Exchange Commission.
GUARANTY FUND LAWS. Each of the jurisdictions in which we do business
has guaranty fund laws under which insurers doing business in those
jurisdictions can be assessed on the basis of premiums written by the insurer in
that jurisdiction in order to fund policyholder liabilities of insolvent
insurance companies. Under these laws in general, an insurer is subject to
assessment, depending upon its market share of a given line of business, to
assist in the payment of policyholder claims against insolvent insurers. In the
District of Columbia, insurance companies are assessed in three categories: (i)
automobile; (ii) workers' compensation; and (iii) all other. An insurance
company licensed to do business in the District of Columbia is only liable to
pay an assessment if another insurance company within its category becomes
insolvent. We are in the "all other" category.
Significant assessments could have a material adverse effect on our
financial condition or results of operations. While we will not necessarily be
liable to pay assessments each year, the insolvency of another insurance company
within our category of insurance could result in the maximum assessment being
imposed on us over several years. We cannot predict the amount of future
assessments. During 2001 we received an assessment due to the insolvency of
Reliance Insurance Company. Recently PHICO Insurance Company went into
receivership; this resulted in guaranty fund assessments to us of $355,000 in
2002. In each of the jurisdictions in which we conduct business, the amount of
the assessment cannot exceed 2% of our direct premiums written per year in that
jurisdiction.
EXAMINATION OF INSURANCE COMPANIES. Every insurance company is subject
to a periodic financial examination under the authority of the insurance
commissioner of its jurisdiction of domicile. Any other jurisdiction interested
in participating in a periodic examination may do so. The last completed
periodic financial examination of NCRIC, Inc., based on December 31, 1999
financial statements, was completed and a final report was issued on February
20, 2001. The final report positively assessed our financial stability and
operating procedures. The last periodic financial examination report of CML,
based on December 31, 2001 financial statements, was issued on August 30, 2002.
The periodic financial examination positively assessed CML's financial stability
and operating procedures.
APPROVAL OF RATES AND POLICIES. The District of Columbia, Virginia and
Delaware require us to submit rates to regulators on a file and use basis. Under
a file and use system, an insurer is permitted to bring new rates and policies
into effect on filing them with the appropriate regulator, subject to the right
of the regulator to object within a fixed period of days. In each of the
District of Columbia, Delaware and Virginia, rating plans, policies and
endorsements must be submitted to the regulators 30 days prior to their
effectiveness. Maryland and West Virginia are prior approval jurisdictions. The
possibility exists that we may be unable to implement desired rates, policies,
endorsements, forms or manuals if these items are not approved by an insurance
commissioner.
MEDICAL PROFESSIONAL LIABILITY REPORTS. We principally write medical
professional liability insurance, as such, requirements are placed upon us to
report detailed information with regard to settlements or judgments against our
insureds. In addition, we are required to report to the D.C. Department of
Insurance and Securities Regulation or state regulatory agencies or the National
Practitioners Data Bank payments, claims closed without payments and actions
like terminations or premiums surcharges with respect to our insureds. Penalties
may attach if we fail to report to either the Department of Insurance and
Securities Regulation or an applicable state insurance regulator or the National
Practitioners Data Bank.
CHANGES IN GOVERNMENT REGULATION OF THE HEALTHCARE SYSTEM. Federal and
state governments recently have considered reforming the healthcare system.
While some of the proposals could be beneficial to our business the
22
adoption of others could adversely affect us. Public discussion of a broad range
of healthcare reform measures will likely continue in the future. These measures
that would affect our medical professional liability insurance business and our
practice management products and services include, but are not limited to:
o spending limits;
o price controls;
o limits on increases in insurance premiums;
o limits on the liability of doctors and hospitals for tort claims;
and
o changes in the healthcare insurance system.
INSURANCE HOLDING COMPANY REGULATION. The Commissioner of Insurance and
Securities of the District of Columbia has jurisdiction over NCRIC Group as an
insurance holding company. We are required to file information periodically with
the Department of Insurance and Securities Regulation, including information
relating to its capital structure, ownership, financial condition and general
business operations. In the District of Columbia, transactions by an insurance
company with affiliates involving loans, sales, purchases, exchanges, extensions
of credit, investments, guarantees or other contingent obligations, which within
any 12-month period aggregate at least 3% of the insurance company's admitted
assets or 25% of its surplus, whichever is greater, require prior approval.
Prior approval is also required for all management agreements, service contracts
and cost-sharing arrangements between an insurance company and its affiliates.
Some reinsurance agreements or modifications also require prior approval.
District of Columbia insurance laws also provide that the acquisition
or change of control of a domestic insurance company or of any person or entity
that controls an insurance company cannot be consummated without prior
regulatory approval. A change in control is generally defined as the acquisition
of 10% or more of the issued and outstanding shares of an insurance holding
company.
REGULATION OF DIVIDENDS FROM INSURANCE SUBSIDIARIES. The District of
Columbia insurance laws limit the ability of NCRIC, Inc. to pay dividends.
Without prior notice to and approval of the Commissioner of Insurance and
Securities, NCRIC, Inc. may not declare or pay an extraordinary dividend, which
is defined as any dividend or distribution of cash or other property whose fair
market value, together with other dividends or distributions made, within the
preceding 12 months exceeds the lesser of (1) 10% of NCRIC, Inc.'s statutory
surplus as of the preceding December 31, or (2) NCRIC, Inc.'s statutory net
income excluding realized capital gains, for the 12-month period ending the
preceding December 31, but does not include pro rata distributions of any class
of our own securities. In calculating net income under the test, NCRIC, Inc. may
carry forward net income, excluding realized capital gains, from the previous
two calendar years that has not been paid out as dividends. District of Columbia
law gives the Commissioner of Insurance and Securities broad discretion to
disapprove dividends even if the dividends are within the above-described
limits. The District of Columbia permits the payment of dividends only out of
unassigned statutory surplus. Using these criteria, as of December 31, 2002,
because of the statutory loss from operations in 2002, NCRIC, Inc. would be able
to pay approximately $1.2 million in dividends without regulatory approval.
CML's dividend restrictions are identical to NCRIC, Inc.'s. Based on its 2002
operating results, CML would be able to pay approximately $500,000 in dividends
without prior approval of the Commissioner of Insurance and Securities.
OUR COMPANIES
We were organized in December 1998 in connection with the
reorganization of National Capital Reciprocal Insurance Company into a mutual
holding company structure. NCRIC, A Mutual Holding Company owns all of the
outstanding shares of NCRIC Holdings, Inc., which prior to July 29, 1999, owned
all of the outstanding shares of NCRIC Group, Inc. Effective July 29, 1999, we
completed an initial public offering and issued 2,220,000 shares of the common
stock to NCRIC Holdings, Inc. and 1,480,000 shares of the common stock in a
subscription and community offering at a price of $7.00 per share.
23
NCRIC, INC. NCRIC, Inc., a wholly owned subsidiary of NCRIC Group,
Inc., is the former National Capital Reciprocal Insurance Company incorporated
in 1980 and is a licensed property and casualty insurance company domiciled in
the District of Columbia. NCRIC, Inc. provides professional liability insurance
to physicians in the District of Columbia. Policyholders of NCRIC, Inc. are also
members of NCRIC, A Mutual Holding Company.
COMMONWEALTH MEDICAL LIABILITY INSURANCE COMPANY. Commonwealth Medical
Liability Insurance Company, a wholly owned subsidiary of NCRIC, Inc.
incorporated in 1989, is a licensed property and casualty insurance company
domiciled in the District of Columbia. CML provides professional liability
insurance to physicians in Delaware, Maryland, Virginia and West Virginia and is
licensed to conduct business in Tennessee.
NATIONAL CAPITAL INSURANCE BROKERAGE, LTD. National Capital Insurance
Brokerage, Ltd., a wholly owned subsidiary of NCRIC, Inc. incorporated in 1984,
is a licensed insurance brokerage that provides reinsurance brokerage services
to NCRIC, Inc., CML and protected cells within American Captive Corporation.
AMERICAN CAPTIVE CORPORATION. ACC, a wholly owned subsidiary of NCRIC,
Inc. incorporated in 2001, is an organization that is authorized to form
independent protected cells to accommodate affinity groups seeking to manage
their own risk through an alternative risk transfer structure. In February 2002,
NCRIC announced formation of a joint venture with Risk Services, LLC, to form
National Capital Risk Services to offer a complete range of alternative risk
transfer services to healthcare clients throughout the nation.
NCRIC INSURANCE AGENCY, INC. NCRIC Insurance Agency, Inc., a wholly
owned subsidiary of NCRIC, Inc. incorporated in 1989, is a licensed insurance
agency that has strategic partnerships with experienced brokers to provide life,
health, disability, and long term care coverage to our clients. These products
are not underwritten by us.
NCRIC MSO, INC. NCRIC MSO, Inc., a wholly owned subsidiary of NCRIC
Group, Inc. incorporated in 1998, provides practice management services and
employee benefits services to physicians and dentists in the District of
Columbia, North Carolina and Virginia.
NCRIC PHYSICIANS ORGANIZATION, INC. NCRIC PO, Inc., a wholly owned
subsidiary of NCRIC MSO, Inc., was organized in 1994 to provide a network for
managed care contracting with third party payers. NCRIC PO no longer contracts
as a network and effective October 1, 2004 will reach the end of a settlement
agreement with a former health plan partner, American Medical Services. In this
settlement, AMS currently pays $6,000 per month to NCRIC PO.
NCRIC STATUTORY TRUST I. NCRIC Statutory Trust I was formed in 2002 as
a special purpose entity for the purpose of issuing trust preferred securities.
PERSONNEL
As of December 31, 2002, we employed 108 full-time persons. None of our
employees are represented by a collective bargaining unit and we consider our
relationship with our employees to be good.
WEBSITE DISCLOSURE OF CERTAIN REGULATORY FILINGS
We maintain a website at www.ncric.com and make available, free of
charge, through this website our annual reports on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and all amendments to those reports
as soon as reasonably practicable after such material is electronically filed
with or furnished to the Securities and Exchange Commission ("SEC"). These forms
can be accessed within the Investor Relations portion of the website by clicking
on "SEC Filing."
24
ITEM 2. PROPERTIES
Our principal business operations are conducted from our leased
executive offices, which consist of approximately 18,156 square feet located at
1115 30th Street, N.W., Washington, D.C. 20007. The term of the lease is for 10
years, commencing April 15, 1998 and expiring April 30, 2008. Annual rental is
$421,476 with 2% annual increases for the first five years of the term. In the
sixth year of the term, the rent increases by $2.00 per rentable square foot and
remains at that level for the balance of the term. We have the option to renew
the lease for one additional term of five years. We also maintain office space
in Lynchburg and Richmond, Virginia as well as in Greensboro, North Carolina.
The following table sets forth the facilities leased by us at December
31, 2002, along with the applicable lease expiration date:
LEASE
PROPERTY LOCATION EXPIRATION DATE
- ----------------------------------------------------------- -----------------
OFFICES:
1115 30th Street, N.W., Washington, D.C. 20007 April 30, 2008
424 Graves Mill Road, Lynchburg, Virginia 24502 October 31, 2007
4701 Cox Road, Richmond, Virginia 23060 April 30, 2004
600 Green Valley Road, Greensboro, North Carolina 27408 March 31, 2008
ITEM 3. LEGAL PROCEEDINGS
We are from time to time named as a defendant in various lawsuits
incidental to our insurance business. In many of these actions, plaintiffs
assert claims for exemplary and punitive damages. We vigorously defend
these actions, unless a reasonable settlement appears appropriate. We
believe that these legal proceedings in the aggregate are not to our
consolidated financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
We do not currently pay cash dividends on our common stock and we do
not intend to pay any cash dividends in the foreseeable future. As a holding
company with no direct operations, we rely on cash dividends and other permitted
payments from our insurance subsidiaries to pay any future dividends to our
stockholders. State insurance laws and restrictions under our credit agreement
limit the amounts that may be paid to us by our insurance subsidiaries See
"Business of NCRIC Group - Insurance company regulation."
Our common stock is traded on the Nasdaq SmallCap Market under the
symbol "NCRI." The following table sets forth the high and low closing
prices for shares of our common stock for the periods indicated. As of
December 31, 2002, there were 1,488,399 publicly held shares of our common
stock issued and outstanding held by approximately 333 shareholders of
record.
YEAR ENDED DECEMBER 31, 2002 HIGH LOW
- ---------------------------- ----------- ----------
Fourth quarter $11.000 $9.870
Third quarter 11.200 9.940
Second quarter 11.625 10.350
First quarter 12.980 10.430
25
YEAR ENDED DECEMBER 31, 2001 HIGH LOW
- ---------------------------- ----------- ----------
Fourth quarter $12.000 $9.750
Third quarter 12.120 9.900
Second quarter 14.000 8.000
First quarter 9.750 8.250
Set forth below is information as of December 31, 2002 as to any equity
compensation plans of the Company that provides for the award of equity
securities or the grant of options, warrants or rights to purchase equity
securities of the Company.
====================================================================================================================
NUMBER OF SECURITIES TO
BE ISSUED UPON EXERCISE NUMBER OF SECURITIES
EQUITY COMPENSATION PLANS OF OUTSTANDING OPTIONS WEIGHTED AVERAGE REMAINING AVAILABLE FOR
APPROVED BY SHAREHOLDERS AND RIGHTS EXERCISE PRICE ISSUANCE UNDER PLAN
- --------------------------------------------------------------------------------------------------------------------
Stock Option Plan............. 74,000 $7.00 0
- --------------------------------------------------------------------------------------------------------------------
Stock Award Plan.............. 24,667(1) Not Applicable 0
- --------------------------------------------------------------------------------------------------------------------
EQUITY COMPENSATION PLANS NOT None None None
APPROVED BY SHAREHOLDERS
- --------------------------------------------------------------------------------------------------------------------
Total.................... 98,667 $7.00 0
====================================================================================================================
_______________________________
(1) Represents shares that have been granted but have not yet vested.
26
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following tables set forth selected consolidated historical
financial and other data of NCRIC Group for the years and at the dates indicated
is derived in part from and should be read together with the audited
consolidated financial statements and notes thereto of NCRIC Group, as well as
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" which are included elsewhere in this Form 10-K.
AT OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Gross premiums written................. $ 51,799 $ 34,459 $ 22,727 $ 21,353 $ 19,214
========== ========== ========== ========== ==========
Net premiums written after renewal credits $ 33,804 $ 23,624 $ 15,610 $ 16,188 $ 21,014
========== ========== ========== ========== ==========
Net premiums earned.................... $ 30,098 $ 20,603 $ 14,611 $ 14,666 $ 18,459
Net investment income.................. 5,915 6,136 6,407 6,089 5,996
Net realized investment (losses) gains. (131) (278) (5) (71) 159
Practice management and related income. 5,800 6,156 5,317 4,576 78
Other income........................... 1,013 602 470 373 357
---------- ---------- ---------- ---------- ----------
Total revenues...................... 42,695 33,219 26,800 25,633 25,049
Losses and loss adjustment expenses.... 26,829 18,858 11,946 12,867 15,677
Underwriting expenses.................. 8,168 4,877 3,591 3,010 3,858
Practice management and related expenses 5,811 6,063 4,970 4,845 378
Other expenses......................... 1,467 1,245 1,237 1,439 1,510
---------- ---------- ---------- ---------- ----------
Total expenses...................... 42,275 31,043 21,744 22,161 21,423
Income before income taxes............. 420 2,176 5,056 3,472 3,626
Income tax provision (benefit)......... (322) 597 1,561 967 1,079
---------- ---------- ---------- ---------- ----------
Net income............................. $ 742 $ 1,579 $ 3,495 $ 2,505 $ 2,547
========== ========== ========== ========== ==========
BALANCE SHEET DATA:
Invested assets........................ $ 120,120 $ 103,125 $ 98,045 $ 95,092 $ 96,348
Total assets........................... 202,687 161,002 145,864 140,947 134,326
Reserves for losses and loss
adjustment expenses.................. 104,022 84,560 81,134 84,282 84,595
Total liabilities.................... 154,870(1) 116,548 104,415 105,152 103,315
Total stockholders' equity............. 47,817 44,454 41,449 35,795 31,011
SELECTED GAAP UNDERWRITING RATIOS(2):
Losses and loss adjustment expenses ratio 89.1% 91.5% 81.7% 87.7% 84.9%
Underwriting expense ratio............. 27.2% 23.7% 24.6% 20.5% 20.9%
Combined ratio after renewal credits... 116.3% 115.2% 106.3% 108.2% 105.8%
SELECTED STATUTORY DATA:
Losses and loss adjustment expenses ratio 89.2% 90.0% 75.3% 80.8% 82.5%
Underwriting expense ratio............. 22.6% 21.8% 19.7% 15.7% 15.1%
Combined ratio......................... 111.8% 111.8% 95.0% 96.5% 97.6%
Operating ratio(3)..................... 92.4% 84.3% 63.6% 66.7% 82.5%
Ratio of net premiums written
to policyholders' surplus............ 0.83 0.77 0.60 0.63 1.24
Policyholders' surplus................. $ 44,269 $ 32,759 $ 29,764 $ 29,212 $ 24,116
__________________________
(1) Includes $15.0 million of Trust Preferred Securities.
(2) In calculating GAAP underwriting ratios, renewal credits are considered a
reduction of premium income. In addition, earned premium is used to
calculate the GAAP loss and underwriting expense ratios. For statutory
purposes, renewal credits are not considered a reduction in premium income,
and written premiums are used to calculate the statutory underwriting
expense ratio. Due to these differences in treatment, GAAP combined ratios
can differ significantly from statutory combined ratios. See Note 11 to the
consolidated financial statements for a discussion of the differences
between statutory and GAAP reporting.
(3) The operating ratio is the statutory combined ratio offset by the benefit
of investment income expressed as a percentage of premiums earned.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The financial statements and data presented herein have been prepared
in accordance with generally accepted accounting principles (GAAP) unless
otherwise noted. GAAP differs from statutory accounting practices used by
regulatory authorities in their oversight responsibilities of insurance
companies. See Note 11 to the consolidated financial statements for a
reconciliation of our net income and equity between GAAP and statutory
accounting bases.
CRITICAL ACCOUNTING POLICIES
Following is a discussion of key financial concepts and of those
accounting policies which we believe to be the most critical. That is, these are
most important to the portrayal of our financial condition and results of
operations and they require management's most complex judgments, including the
need to make estimates about the effect of insurance losses and other matters
that are inherently uncertain.
PREMIUM INCOME. Gross premiums written represent the amounts billed to
policyholders. Gross premiums written are reduced by premiums ceded to
reinsurers and renewal credits in determining net premiums written. Premiums
ceded to reinsurers represent the cost to us of reducing our exposure to medical
professional liability losses by transferring agreed upon insurance risks to
reinsurers through a reinsurance contract or treaty. Renewal credits are
reductions in premium billings to renewing policyholders. Net premiums written
are adjusted by any amount which has been billed but not yet earned during the
period in arriving at earned premiums. For several large groups of
policyholders, we have insurance programs where the premiums are retrospectively
determined based on losses during the period. Under all of the current programs,
the full premium level is determined and billed at the inception of the policy
term. The premium level could potentially be reduced and a premium refund made
if the program loss experience is favorable. Premiums billed under retrospective
programs are recorded as premiums written, while premium refunds accrued under
retrospective programs are recorded as unearned premiums. Under retrospective
programs, premiums earned are premiums written reduced by premium refunds
accrued. Premium refunds are accrued to reflect the risk-sharing program results
on a basis consistent with the underlying loss experience. The program loss
experience is that which is included in the determination of our losses and loss
adjustment expenses (LAE). As described more fully below, one component of the
expense for losses and LAE is the estimate of future payments for claims and
related expenses of adjudicating claims.
Unearned premiums represent premiums billed but not yet fully earned at
the end of the reporting period. Premiums receivable represent annual billed and
unbilled premiums which have not yet been collected.
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES. We write one line of
business, medical professional liability. Losses and LAE reserves are estimates
of future payments for reported claims and related expenses of adjudicating
claims with respect to insured events that have occurred in the past. The change
in these reserves from year to year is reflected as an increase or decrease to
our losses and LAE.
Medical professional liability losses and LAE reserves are established
based on an estimate of these future payments as reflected in our past
experience with similar cases and historical trends involving claim payment
patterns. Other factors that modify past experience are also considered in
setting reserves, including court decisions; economic conditions; current trends
in losses; and inflation. Reserving for medical professional liability claims is
a complex and uncertain process, requiring the use of informed estimates and
judgments. Although we intend to estimate conservatively our future payments
relating to losses incurred, there can be no assurance that currently
established reserves will prove adequate in light of subsequent actual
experience.
The estimation process is an extensive effort. It begins in our claims
department with the initial report of a claim. For each claim reported, a case
reserve is established by the claims department based on analysis of the facts
of the particular case and the judgment of claims management. This estimation
process is not by formula but is driven by the investigation of facts combined
with the experience and insight of claims management applied to each individual
case. The timing of establishing case reserves follows established protocols
based on the underlying facts and circumstances on a case by case basis.
Specific factors considered include: the claimants assertion of loss; the amount
of documented damages asserted; an expert medical assessment; the jurisdiction
where the incident occurred; our experience with any similar cases in the past;
as well as any other factors pertinent to the specific case.
28
Each quarter, the aggregate of case reserves by report year is compiled
and subjected to extensive analysis. Semiannually, our independent actuary
performs an actuarial valuation of reserves based on the data comprising our
detailed claims experience since inception.
The actuarial valuation entails application of various statistically
based actuarial formulae, an analysis of trends, and a series of judgments to
produce an aggregate estimate of our liability at the balance sheet date.
Specific factors included in the estimation process include: the level of case
reserves by jurisdiction by report year; the change in case reserves between
each evaluation date; historical trends in the development of our initial case
reserves to final conclusion; expected losses and LAE levels based on past
experience relative to the level of premium earned; reinsurance treaty terms;
and any other pertinent factors that may arise.
In consultation with our independent actuary, we utilize several
methods in order to estimate losses and LAE reserves by projecting ultimate
losses. By utilizing and comparing the results of these methods, we are better
able to analyze loss data and establish an appropriate reserve. Our independent
actuary provides a point estimate for loss reserves rather than a range. The
actuarial valuation of reserves is a critical component of the financial
reporting process and provides the foundation for the determination of reserve
levels. In addition to reporting under GAAP, we file financial statements with
state regulatory authorities based on statutory accounting requirements. These
requirements include a certification of reserves by an appointed actuary. The
reserves in our statutory filings have been certified by an independent medical
professional liability insurance actuary.
Our ultimate liability will be known after all claims are closed, which
is likely to be several years into the future. For example, as of December 31,
2002, the oldest report date of an open claim is 1993. Incurred losses for each
report year will develop with a change in estimate in each subsequent calendar
year until all claims are closed for that report year. Loss development could
potentially have a significant impact on our results of operations. Developments
changing the ultimate liability as little as 1% could have a material impact on
our reported operating results.
The inherent uncertainty in establishing reserves is relatively greater
for companies writing long-tail medical professional liability business. Each
claim reported has the potential to be significant in amount. For the three-year
period ended December 31, 2002, the average indemnity payment per paid claim was
$360,000 with total indemnity payments of $12.9 million, $14.0 million and $14.8
million for the years ended December 31, 2002, 2001 and 2000, respectively. The
cost of individual indemnity payments over this three-year period ranged from
$1,000 to $3 million. Due to the extended nature of the claim resolution process
and the wide range of potential outcomes of professional liability claims,
established reserve estimates may be adversely impacted by: judicial expansion
of liability standards; unfavorable legislative actions; expansive
interpretations of contracts; inflation associated with medical claims; lack of
a legislated cap on non-economic damages; and the propensity of individuals to
file claims. These risk factors are amplified given the increase in new business
written in new markets because there is limited historical data available which
can be used to estimate current loss levels. We refine reserve estimates as
experience develops and additional claims are reported or existing claims are
closed; adjustments to losses reserved in prior periods are reflected in the
results of the periods in which the adjustments are made.
Losses and LAE reserve liabilities as stated on the balance sheet are
reported gross before recovery from reinsurers for the portion of the claims
covered under the reinsurance program. Losses and LAE expenses as stated on the
income statement are reported net of reinsurance recoveries.
REINSURANCE. We manage our exposure to individual claim losses, annual
aggregate losses, and LAE through our reinsurance program. Reinsurance is a
customary practice in the industry. It allows us to obtain indemnification
against a specified portion of losses associated with insurance policies we have
underwritten by entering into a reinsurance agreement with other insurance
enterprises or reinsurers. We pay or cede part of our policyholder premium to
reinsurers. The reinsurers in return agree to reimburse us for a specified
portion of any claims covered under the reinsurance contract. While reinsurance
arrangements are designed to limit losses from large exposures and to permit
recovery of a portion of direct losses, reinsurance does not relieve us of
liability to our insureds.
Under our current primary reinsurance contract, the premium ceded to
the reinsurers is based on a fixed rate applied to policy premium for that
coverage layer. During the year, estimated payments are made to the reinsurers,
and a final adjustment is made at the end of the year to reflect actual premium
earned in accordance with
29
the treaty. For the years through 2002, we retained risk exposure up to $500,000
for each and every claim. Beginning January 1, 2003, the retention level has
been increased to $1,000,000 for each and every claim.
For 1999 and prior years, in accordance with one of our primary
reinsurance contracts, the portion of the policyholder premium ceded to the
reinsurers was swing-rated or experience-rated on a retrospective basis. This
swing-rated cession program is subject to a minimum and maximum premium range to
be paid to the reinsurers in the future, depending upon the extent of losses
actually paid by the reinsurers. A deposit premium is paid by us during the
initial policy year. An additional liability, "retrospective premiums accrued
under reinsurance treaties" is recorded by us to represent an estimate of net
additional payments to be made to the reinsurers under the program, based on the
level of loss and LAE reserves recorded. Like loss and LAE reserves, adjustments
to prior year ceded premiums payable to the reinsurers are reflected in the
results of the periods in which the adjustments are made. The swing-rated
reinsurance premiums are estimated in a manner consistent with the estimation of
our loss reserves, and therefore contain uncertainties like those inherent in
the loss reserve estimate.
Our practice for accounting for the liability for retrospective
premiums accrued under reinsurance treaties was to record the current year
swing-rated reinsurance premium at management's best estimate of the ultimate
liability, which was generally the maximum rate payable under terms of the
treaty. Due to the long tail nature of the medical professional liability
insurance business, it takes several years for the losses for any given report
year to fully develop. Since the ultimate liability for reinsurance premiums
depends on the ultimate losses, among other things, it is several years after
the initial reinsurance premium accrual before the amount becomes known. During
the intervening periods, reevaluations are made and adjustments to the accrued
retrospective premiums are made as considered appropriate by management.
Exposure to individual losses in excess of $1 million is known as
excess layer coverage. Excess layer premiums are recorded as current year
reinsurance ceded costs. Under the excess layer treaties, prior to 2000 we ceded
to our reinsurers over 90% of our exposure. Effective since January 1, 2000, we
cede 100% of our risks and premiums related to these coverage layers.
INVESTMENT PORTFOLIO. Our investment portfolio is composed principally
of fixed maturity securities classified as available-for-sale. All securities
with gross unrealized losses at the balance sheet date are evaluated for
evidence of other-than-temporary impairment, on a quarterly basis. We write down
to fair value any security with an impairment that is deemed to be
other-than-temporary in the period the determination is made. The assessment of
whether such impairment has occurred is based on management's case-by-case
evaluation of the underlying reasons for the decline in fair value. Management
considers a wide range of factors and uses its best judgment in evaluating the
cause of the decline in the estimated fair value of the security and in
assessing the prospects for near-term recovery. Factors considered in the
evaluation include but are not limited to: (1) interest rates; (2)
market-related factors other than interest rates; and (3) financial conditions,
business prospects and other fundamental factors specific to the securities
issuer. Declines attributable to issuer fundamentals are reviewed in further
detail. We have a security monitoring process which includes quarterly review by
an investment committee comprised of members of our Board of Directors and
representatives of policyholders. Our CEO and CFO also participate in the
committee meetings in which our professional investment advisors review with the
committee and management the analysis prepared by our investment manager of each
security that has certain characteristics including, but not limited to:
deterioration of the financial condition of the issuer; the magnitude and
duration of unrealized losses; and the credit rating and industry of the issuer.
The primary factors considered in evaluating whether a decline in value is
other-than-temporary include: the length of time and the extent to which the
fair value has been less than cost; the financial condition and near-term
prospects of the issuer; whether the issuer is current on contractually
obligated interest and principal payments; and our intent and ability to retain
the investment for a period of time sufficient to allow for any anticipated
recovery.
The evaluation for other-than-temporary impairments is a quantitative
and qualitative process involving judgments which is subject to risks and
uncertainties. The risks and uncertainties include changes in general economic
conditions, the issuer's financial condition and the effects of changes in
interest rates.
GOODWILL. In July 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" (SFAS 142). SFAS 142 changes the accounting for goodwill from
an amortization method to an impairment-only approach. Amortization of goodwill
ceased upon adoption of SFAS 142 on January 1, 2002.
30
Our goodwill asset, $7.3 million as of December 31, 2002, resulted from
the 1999 acquisition of three businesses which now operate as divisions of the
Practice Management Services Segment. We completed our initial goodwill
impairment testing under SFAS 142 and concluded that the goodwill asset was not
impaired as of the date of implementation of SFAS 142, nor was it impaired as of
December 31, 2002.
The basic steps involved in the goodwill impairment test are (1)
identification of the reporting unit to be tested; and (2) calculation of the
current fair value of the reporting unit and comparing it to the carrying value.
If the current fair value of the reporting unit exceeds the carrying value,
goodwill is not impaired. Because the acquired divisions are not publicly
traded, a discounted cash value calculation is used to determine the current
fair value of the unit.
Estimates as to future performance of the divisions along with current
market value indicators provide the basis for determination of the current fair
value of the unit. There is no guarantee of either the accuracy of the estimate
of future performance of the divisions or of the accuracy of current market
value indicators, since the real test of market value is what a potential
acquirer is willing to pay.
RECENT INDUSTRY PERFORMANCE
Our results of operations have historically been influenced by factors
affecting the medical professional liability industry in general. The operating
results of the U.S. medical professional liability industry have been subject to
significant variations over time due to competition, general economic
conditions, judicial trends and fluctuations in interest rates. We actively
monitor industry trends and consider them in relation to our circumstances when
setting rates or establishing reserves.
According to the January 2003 Best's Review, published by A.M. Best
Company, Inc. (A.M. Best), in 2002, physicians across the country were faced
with higher medical professional liability insurance premiums and fewer
companies offering the coverage. The escalation in premium rates in recent years
is a reflection of rising frequency and severity of claims at a time when
premium rates were depressed thereby exacerbating insurers' poor operating
performance. The medical professional liability insurance marketplace is
adjusting to the departure of The St. Paul Companies, the largest medical
professional liability insurer at that time, from the sector, while other
companies have scaled back their market share or left some states entirely. Of
the 12 states identified by A.M. Best as having a crisis in medical care
stemming from the lack of availability of medical professional liability
insurance, only one - West Virginia - falls into our market territory. Two of
our other market jurisdictions, Virginia and Delaware, have been significantly
impacted by the changes in market profile described by Best's Review. In the
January 2001 issue of Best's Review, A.M. Best predicted trends to include
sustained price increases and worsening claims severity. The realization of this
prediction throughout 2001 and 2002 ultimately resulted in the change in the
entire medical professional liability insurance market as a number of the
insurance providers experienced adverse financial results and subsequently
withdrew from the market.
Medical professional liability lawsuits have been identified as a key
factor in the rising cost of the U.S. tort system according to an article in the
February 17, 2003, issue of BestWeek, a publication of A.M. Best. The article
further states that since 1975, medical professional liability tort costs rose
an average of 11.6% a year, outpacing the average overall growth in tort costs
of 9.4% over the same period. The February, 2003 issue of Best's Review reports
that between 1999 and 2000, median professional liability jury awards increased
43%, causing a rise in medical professional liability insurance rates. Several
of the jurisdictions in which we operate have not adopted tort reform, most
notably the District of Columbia which had the highest cumulative mean medical
professional liability indemnity payment level for the ten year period ending
December 31, 2001, according to the latest data available from the National
Practitioner Data Bank.
CONSOLIDATED NET INCOME YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net income totaled $742,000 for the year ended December 31, 2002
compared to $1.6 million for the year ended December 31, 2001. Year-to-date 2002
results were negatively impacted by the increase in allowance for uncollectible
premium receivable and unfavorable development of losses on claims reported in
prior years. Net realized investment losses, after tax, for the year ended
December 31, 2002 totaled $86,000 compared to net realized investment losses of
$183,000 for the year ended December 31, 2001.
31
The operating results of our insurance segment for the year ended
December 31, 2002 were primarily driven by the following factors. We continued
to experience a significant increase in new business written in 2002. For the
year, new business written (excluding the 100% ceded HCA program) was $12.7
million, up $0.5 million or 4%, from $12.2 million for 2001. The rise in new
business written coupled with the increased premium rates resulted in a 46%
increase in net premiums earned. The strain on current period earnings as a
result of the large increase in new business written, combined with investment
yield declines, resulted in pressure on short-term profitability. While the cost
for claims reported in 2002 increased due to the rise in exposure, the
development of losses for claims originally reported in 2000 and 2001 reduced
pre-tax earnings for 2002.
Our practice management segment earnings in 2002 decreased compared to
2001 primarily as a result of a decrease in client revenue combined with an
increase in expenses. Client revenue decreases stem from a reduction in
non-recurring consulting assignments; as medical practice income comes under
increasing pressure due to reductions in the payer system, physicians have less
discretionary funds available for consultant engagements. Expense decreases are
due to the cessation of goodwill amortization due to the implementation of SFAS
142 beginning January 1, 2002, offset by expenses associated with the transition
of client service for two of the former owners as they moved towards the
expiration of their employment contracts at the end of 2002 and other
transitional costs associated with the continued integration of the purchased
companies.
THREE MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2001
Net income for the fourth quarter of 2002 was $801,000 compared to a
net loss of $312,000 in the fourth quarter of 2001. The 2002 fourth quarter
result includes realized investment gains, net of tax, of $312,000 compared to
realized investment losses, net of tax, of $312,000 in the fourth quarter of
2001. The pre-tax operating result for the insurance segment was income of
$677,000 in 2002 compared to $228,000 in 2001, respectively. For the practice
management services segment, the fourth quarter result for 2002 was pre-tax
income of $37,000 compared to a pre-tax loss of $159,000 for the fourth quarter
of 2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Net income totaled $1.6 million for the year ended December 31, 2001
compared to $3.5 million for the year ended December 31, 2000. Excluding net
realized investment losses, operating earnings for the year 2001 were $1.8
million compared to $3.5 million for the year 2000. Total revenue in 2001
increased 24% over the 2000 level. The higher revenue was offset by an increase
in loss and loss adjustment expenses, in underwriting expenses, and in practice
management expenses.
Our insurance segment experienced a substantial increase in new
business written in the year ended December 31, 2001, which resulted in a rise
in net premiums earned. The profitability of a medical professional liability
insurance policy is designed to emerge over a period of years rather than in the
year the policy is written; profits are designed to accrue through investment
income on the invested premiums and through successful resolution of claims.
Therefore, the large increase in new business written in the current period
causes a strain on current period earnings. In addition, earnings were impacted
by reduced net investment income because of lower market yields and by increased
incurred losses reflecting increased frequency and severity trends.
Our practice management segment produced a significant increase in
revenue primarily as a result of its focused efforts on new business
development. Higher revenue was offset by expenses related to the ongoing
servicing of new business, the allocation of additional resources to new
business development and additional expenses associated with the execution of
the contingent purchase payouts. Similar to the insurance segment, in the
start-up of new client relationships, we incur costs not covered by initial
client revenue; the design of the revenue stream is to recover the initial costs
through the on-going client relationship.
THREE MONTHS ENDED DECEMBER 31, 2001 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2000
Results for the fourth quarter of 2001 were a net loss of $312,000
compared to net income of $924,000 in the fourth quarter of 2000. The 2001
fourth quarter result includes net realized investment losses, net of tax, of
$312,000. The insurance segment experienced a significant increase in new
business written, with the associated impact on net earnings as described above,
producing pre-tax earnings of $228,000 before realized investment losses,
compared to 2000 fourth quarter pre-tax earnings of $1.6 million. Practice
management segment revenues
32
increased 25% in the fourth quarter of 2001 over 2000; the segment produced
quarterly pre-tax results of a loss of $159,000 compared to pre-tax earnings of
$41,000 in the fourth quarter of 2000.
NET PREMIUMS EARNED
The following table is a summary of our net premiums earned:
YEAR ENDED DECEMBER 31,
-------------------------------------------
2002 2001 2000
----------- ----------- -------------
(IN THOUSANDS)
Gross premiums written............................ $ 51,799 $ 34,459 $ 22,727
Change in unearned premiums....................... (7,686) (6,267) (2,762)
----------- ----------- -----------
Gross premiums earned before renewal credits...... 44,113 28,192 19,965
Reinsurance premiums ceded related to:
Current year................................... (14,429) (8,992) (5,982)
Prior years.................................... 406 1,696 1,872
----------- ----------- -----------
Total reinsurance premiums ceded............. (14,023) (7,296) (4,110)
----------- ----------- -----------
Net premiums earned before renewal credits........ 30,090 20,896 15,855
Renewal credits................................... 8 (293) (1,244)
----------- ----------- -----------
Net premiums earned............................... $ 30,098 $ 20,603 $ 14,611
=========== =========== ===========
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Gross premiums written increased by $17.3 million, or 50%, to $51.8
million for the year ended December 31, 2002 from $34.5 million for the year
ended December 31, 2001 due to net new business written combined with the
premium rate increases, which averaged 14%. The gross premiums written include
premiums for retrospectively rated programs of $2.2 million for the year ended
December 31, 2002 and $1.4 million for the year ended December 31, 2001. Written
premium in 2002 included $0.4 million for the billing of previously accrued
premium for one of the retrospectively rated risk sharing programs discussed in
the "Premium Collection Litigation" section below. Gross premiums written on
excess layer coverage increased $2.1 million to $6.6 million for the year ended
December 31, 2002 from $4.5 million for the year ended December 31, 2001.
The change in unearned premiums for the period increased by $1.4
million to $7.7 million for the year ended December 31, 2002 from $6.3 million
for the year ended December 31, 2001. This increase resulted from net new
business written throughout the year combined with premium rate increases.
Gross premiums earned before renewal credits increased $15.9 million,
or 56%, to $44.1 million for the year ended December 31, 2002 from $28.2 million
for the year ended December 31, 2001. The increase was primarily due to $13.2
million of additional premiums earned under basic medical professional liability
insurance and $2.0 million of additional gross premiums earned for excess limits
coverage.
Reinsurance premiums ceded increased by $6.7 million to $14.0 million
for the year ended December 31, 2002 from $7.3 million for the year ended
December 31, 2001. The increase was primarily the result of the increase in
gross premiums earned. Reinsurance premiums are affected by current year
premiums payable to the reinsurers, as well as the retrospective adjustments to
accruals for prior year premiums.
Current year reinsurance premiums ceded increased by $5.4 million, or
60%, to $14.4 million for the year ended December 31, 2002 from $9.0 million for
the year ended December 31, 2001. This increase was due to the increased gross
premium reinsured, including an increase of $2.0 for excess limit coverage which
was 100% ceded to unaffiliated reinsurers. The reinsurance premium rates in 2002
were unchanged from the 2001 level.
Reinsurance premiums related to prior years under the swing-rated
treaty were reduced by $0.4 million in 2002 and $1.7 million in 2001 due to
favorable loss development of reinsured losses compared to our prior estimates.
Generally, losses covered by the swing-rated treaty are in the range excess of
$500,000 to $1 million. Loss development results from the re-estimation and
settlement of individual losses. The 2002 change is primarily reflective of the
favorable loss development in the 1995, 1997 and 1998 coverage years. The 2001
change is primarily reflective of the favorable loss development in the 1992 and
1996 coverage years. As claims are brought
33
to conclusion, each year there are fewer outstanding claims in the years covered
by this reinsurance treaty. The potential for loss development impacting this
reinsurance coverage is reduced each year as the inventory of open claims is
reduced. While loss development on an aggregate basis has been favorable, there
is no guarantee that development for the remainder of the unresolved claims will
follow the same pattern. The liability "retrospective premiums accrued under
reinsurance treaties" decreased to $0.6 million at December 31, 2002 from $2.4
million at December 31, 2001.
Renewal credits for the year ended December 31, 2002, reflect our
decision to not provide a renewal premium credit for 2003 renewals.
Net premiums earned increased by $9.5 million, or 46%, to $30.1 million
for the year ended December 31, 2002 from $20.6 million for the year ended
December 31, 2001. The increase reflects the $15.9 million growth in gross
earned premiums and the lower renewal credits partially offset by the $6.7
million higher reinsurance premiums in 2002 compared to 2001.
In 2002 we initiated a program to provide insurance coverage to
physicians at four HCA hospitals in West Virginia. Under this arrangement, we
cede 100% of the insurance exposure to a captive insurance company affiliated
with the sponsoring hospitals. We receive a ceding commission for providing
complete policy underwriting, claims and administrative services for these
policies. While accounting standards require the premium written to be included
as a part of our direct written premium, we have no net written nor net earned
premium from this program.
American Captive Corporation (ACC), our subsidiary, developed its first
protected-cell captive, the Princeton Community Hospital Cell (West Virginia),
in 2002. In anticipation of the initiation of the Princeton Cell within ACC,
some insurance was underwritten by us during the first nine months of 2002 for
policies that will be 100% reinsured by the Princeton Cell when it becomes
active. The premium amounts for these policies are separately identified in the
following table to aid comparisons.
The mix of business produced directly by us versus by agents has
changed between years as shown on the following chart of new gross written
premium:
YEAR ENDED DECEMBER 31,
-------------------------------
2002 2001
------------- -------------
(IN THOUSANDS)
Direct.................... $ 2,309 $ 1,206
Agent..................... 9,988 10,964
HCA....................... 793 --
Princeton Cell............ 403 --
------------- -------------
$ 13,493 $ 12,170
============= =============
The distribution of premium written shows notable growth in our market
areas outside of the District of Columbia. We continue to maintain strict
underwriting standards as we expand our business.
34
The following chart illustrates the components of gross premium written
by state as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2002 2001
----------------------- -----------------------
(DOLLARS IN THOUSANDS)
AMOUNT % AMOUNT %
---------- ------ ---------- ------
District of Columbia................ $ 21,796 42% $ 17,486 51%
Virginia............................ 14,863 29 7,853 23
Maryland............................ 5,663 11 5,236 15
West Virginia....................... 6,292 13 2,886 8
West Virginia, HCA.................. 993 1 -- --
West Virginia, Princeton Cell....... 403 1 -- --
Delaware............................ 1,789 3 998 3
---------- ----- ---------- -----
Total.......................... $ 51,799 100% $ 34,459 100%
========== ===== ========== =====
PREMIUM COLLECTION LITIGATION. During 2000, it was determined that one
of our hospital-sponsored retrospective programs would not be renewed. This is
the only retrospective program in which the full policy premium was not billed
at the beginning of the policy period. Rather, and in accordance with the terms
of the contract, in 2000 we billed the hospital sponsor $1.3 million, and an
additional $700,000 was billed during 2002 based on the actual accumulated loss
experience of the terminated program. As a result of the amount billed in 2002,
written premium for the year 2002 increased by a net amount of $372,000 over the
same period in 2001 while net earned premium was unaffected by the billing.
Because the original 2000 bill was not paid when due, we initiated
legal proceedings to collect. We have filed a motion for summary judgment, which
has not yet been decided. The hospital sponsor stopped admitting patients in May
2002 and sold its principal assets during the third quarter of 2002.
Although we continue to pursue the claim, based on information received
during the third quarter of 2002 and consultation with legal counsel, it appears
that the hospital assets may not be sufficient to cover its liabilities,
including our claim. Accordingly, we increased our allowance for
uncollectibility by $1.2 million to cover 100% of the amount receivable. The
charge for the allowance is included in underwriting expense. Since the amount
due to us is significant, we will continue to pursue collection of the amount
due. Legal fees incurred through the year ended December 31, 2002 for this
action were approximately $180,000 higher than in 2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Gross premiums written increased by $11.8 million, or 52%, to $34.5
million for the year ended December 31, 2001 from $22.7 million for the year
ended December 31, 2000 due to net new business written combined with the
premium rate increases, which averaged 7.5%. The gross premiums written include
premiums for retrospectively rated programs of $1.4 million for the year ended
December 31, 2001 and $2.5 million for the year ended December 31, 2000. Written
premium in 2000 included $1.3 million for the billing of previously accrued
premium for one of the retrospectively rated risk sharing programs further
discussed below. Gross premiums written on excess layer coverage increased $1.8
million to $4.5 million for the year ended December 31, 2001 from $2.7 million
for the year ended December 31, 2000.
During 2000, it was determined that one of our retrospective programs
would not be renewed at the September 1, 2000 renewal date. Under this type of
risk sharing program, physicians are underwritten directly by us and pay lower
individual premiums than if not part of the risk-sharing program. At the end of
the policy year covered by the premium, a review of the actual loss experience
of the physician group is completed. Should the group's loss experience be
unfavorable, we will require additional premium payments from the sponsoring
hospital to offset the unfavorable losses.
Under terms of the contract based on the actual accumulated loss
experience of the terminated program, we billed the hospital sponsor $1.3
million in 2000 and an additional $800,000 in January 2002. Based on the
continuing development of loss experience, during the year ended December 31,
2001, $500,000 of gross premium earned has been accrued related to additional
amounts due to us from the hospital sponsor.
35
Because the September 2000 bill was not paid when due, we initiated
legal proceedings to collect. We will use all means legally available to collect
the amount due. Although we believe that we will prevail, since the premium
amount is disputed, an allowance for uncollectibility has been established and
is included in underwriting expenses. Pursuit of this litigation requires an
expense for legal fees, which is reported as an underwriting expense, and
reduces our net earnings.
The change in unearned premiums for the period increased by $3.5
million to $6.3 million for the year ended December 31, 2001 from $2.8 million
for the year ended December 31, 2000. This increase resulted from net new
business written throughout the year.
Gross premiums earned before renewal credits increased $8.2 million, or
41%, to $28.2 million for the year ended December 31, 2001 from $20.0 million
for the year ended December 31, 2000. The increase was primarily due to $6.8
million of additional premiums earned under basic medical professional liability
insurance and $1.6 million of additional gross premiums earned for excess limits
coverage.
Reinsurance premiums ceded increased by $3.2 million to $7.3 million
for the year ended December 31, 2001 from $4.1 million for the year ended
December 31, 2000. The increase was primarily the result of the increase in
gross premiums earned. Reinsurance premiums are affected by current year
premiums payable to the reinsurers, as well as the retrospective adjustments to
accruals for prior year premiums.
Current year reinsurance premiums ceded increased by $3.0 million, or
50%, to $9.0 million for the year ended December 31, 2001 from $6.0 million for
the year ended December 31, 2000. This increase is due to the increased gross
premium reinsured. The reinsurance premium rates in 2001 were unchanged from the
2000 level.
Reinsurance premiums related to prior years under the swing-rated
treaty were reduced by $1.7 million in 2001 and $1.9 million in 2000 due to
favorable loss development of reinsured losses compared to prior estimates by
us. Generally, losses covered by the swing-rated treaty are in the range excess
of $500,000 to $1 million. The 2001 change is primarily reflective of the
favorable loss development in the 1992 and 1996 coverage years. The 2000 change
is primarily reflective of the favorable loss development in the 1993 through
1996 years. The liability "retrospective premiums accrued under reinsurance
treaties" decreased to $2.4 million at December 31, 2001 from $5.5 million at
December 31, 2000.
Renewal credits decreased to $293,000 for the year ended December 31,
2001 from $1.2 million for the year ended December 31, 2000, reflecting our
decision to not provide a renewal premium credit for 2002 renewals. In general,
renewal credits apply to policies written in the District of Columbia. A growing
proportion of our business is written in other jurisdictions where renewal
credits are not issued.
Net premiums earned before renewal credits increased $5.0 million, or
31%, to $20.9 million for the year ended December 31, 2001 from $15.9 million
for the year ended December 31, 2000. Net premiums earned after renewal credits
increased by $6.0 million, or 41%, to $20.6 million for the year ended December
31, 2001 from $14.6 million for the year ended December 31, 2000. The increase
reflects the $8.2 million growth in gross earned premiums and the lower renewal
credits, partially offset by the $3.2 million higher reinsurance premiums in
2001 compared to 2000.
The mix of business produced directly by us versus by agents has
changed between years as shown on the following chart of new gross written
premium. The proportion of business produced by our independent agency force has
increased to 90% of total new business written in 2001 from 59% during in 2000.
YEAR ENDED DECEMBER 31,
---------------------------------
2001 2000
------------- ----------
(IN MILLIONS)
Direct.......................... $ 1.2 $ 1.8
Agent........................... 11.0 2.6
While insurance in force continues to follow the historic pattern of
insuring risks concentrated in the District of Columbia, there has been notable
growth in premium written in our other market areas. Of the increase
36
in written premium in 2001 over 2000, 26% comes from business written in
Maryland, 39% from Virginia, 24% from West Virginia, and 8% from Delaware.
In 2001, premium written to clients of the Practice Management Services
Segment totaled $854,000 compared to $540,000 in 2000.
THREE MONTHS ENDED DECEMBER 31, 2001 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2000
Gross premiums written increased to $5.6 million for the quarter ended
December 31, 2001 from $943,000 for the quarter ended December 31, 2000. In
addition to the premium rate increase effective for 2001 renewal dates, new
business written in the fourth quarter of 2001 significantly exceeded the prior
fourth quarter, as shown in the following chart:
THREE MONTHS ENDED DECEMBER 31,
---------------------------------
2001 2000
----------- ----------
(IN MILLIONS)
Direct.......................... $ 0.2 $ 0.5
Agent........................... 3.9 0.3
Gross premiums earned increased $3.3 million to $8.1 million for the
three months ended December 31, 2001 compared to $4.8 million for the 2000
fourth quarter. Reinsurance premiums ceded increased by $1.3 million to $2.2
million for the fourth quarter of 2001. Current year reinsurance ceded premiums
increased by $1.0 million to $2.5 million for the fourth quarter of 2001
compared to the fourth quarter of 2000 corresponding to the increase in gross
premiums earned. Reinsurance premiums related to prior years under the
swing-rated treaty decreased by $279,000 to $301,000 for the fourth quarter of
2001 compared to $580,000 for the fourth quarter of 2000. Favorable development
of losses under the swing-rated treaty results in the reduction of premiums due
related to prior report years. The 2001 fourth quarter development was less
favorable than the 2000 fourth quarter development.
Net premiums earned for the three months ended December 31, 2001
increased $2.3 million to $5.9 million from $3.6 million for the three months
ended December 31, 2000, reflecting the increase in gross earned premiums
partially offset by the lower favorable development of prior years under the
swing-rated reinsurance treaty.
NET INVESTMENT INCOME
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net investment income decreased by $221,000, or 4%, for the year ended
December 31, 2002 compared to the prior year reflecting a decrease in yields
partially offset by a higher base of average invested assets. Net investment
income for the year ended December 31, 2002 was $5.9 million compared to $6.1
million for the year ended December 31, 2001. Average invested assets, which
include cash equivalents, increased by $5.7 million, or 4%, to $111.4 million
for the year ended December 31, 2002. New investments were primarily directed to
corporate bonds, and tax-exempt securities with the strategy of maximizing
after-tax returns with investment grade securities. The average effective yield
was approximately 5.33% for the year ended December 31, 2002 and 5.80% for the
year ended December 31, 2001. The tax equivalent yield was approximately 5.94%
at December 31, 2002 and 6.30% at December 31, 2001. The change in investment
yields is reflective of the market change in interest rates in 2002 compared to
2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Net investment income decreased by $271,000, or 4%, for the year ended
December 31, 2001 compared to the prior year reflecting a decrease in yields
partially offset by a higher base of average invested assets. Net investment
income for the year ended December 31, 2001 was $6.1 million compared to $6.4
million for the year ended December 31, 2000. Average invested assets, which
include cash equivalents, increased by $4.1 million, or 4%, to $105.7 million at
December 31, 2001. New investments were primarily directed to corporate bonds
and tax-exempt securities with the strategy of maximizing after-tax returns with
investment grade securities. The average effective yield was approximately 5.80%
for the year ended December 31, 2001 and 6.31% for the year ended
37
December 31, 2000. The tax equivalent yield was approximately 6.30% at December
31, 2001 and 6.72% at December 31, 2000. The change in investment yields is
reflective of the market change in interest rates in 2001 compared to 2000.
NET REALIZED INVESTMENT LOSSES
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net realized investment losses were $131,000 for the year ended
December 31, 2002 compared to $278,000 for the year ended December 31, 2001.
During the fourth quarter of 2002, we repositioned our portfolio to replace weak
credits with stronger rated bonds, realizing a net gain of $473,000. This
partially offset the losses realized in prior quarters of 2002. In 2002, we
determined that one fixed maturity security, issued by WorldCom, had experienced
an other-than-temporary impairment, and recorded a pre-tax investment loss of
$557,000, reducing the carrying value to fair value during the second quarter
when the determination was made. Additionally, in 2001, we determined that an
equity security consisting of common stock experienced an other-than-temporary
impairment. Accordingly, we recorded a pre-tax impairment loss of $300,000 in
2001 relating to that investment.
For securities sold during 2002 at a loss, the following is a summary
of facts and circumstances related to the securities: Five securities, all
corporate fixed maturities, were sold for consideration totaling $2.5 million
resulting in realized pre-tax losses totaling $1.0 million. In 2002, prior to
the sale, these securities experienced a decline in fair value of $1.1 million
from December 31, 2001. Three additional securities, all corporate fixed
maturities, were sold for consideration totaling $1 million, resulting in
pre-tax realized losses of approximately $430,000. The fair value of these
securities had not changed significantly in 2002 compared to December 31, 2001.
All of these securities were sold upon the recommendation of the outside
investment manager, based upon the desire to maintain the overall credit quality
of the portfolio or in response to the underlying business fundamentals relating
to the securities. Finally, upon exercise of an issuer call option, one
preferred stock produced consideration of $1.1 million and a pre-tax realized
loss of $113,000.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Net realized investment losses were $278,000 for the year ended
December 31, 2001 compared to $5,000 for the year ended December 31, 2000.
Through September 30, 2001, the net realized investment gains were comprised of
gains on sales of equity securities and corporate and agency bonds. The net
realized losses in the fourth quarter of 2001 were comprised of:
Osprey bond $ (738,000)
E-Health Solutions Group (300,000)
Treasury securities 536,000
Miscellaneous gains 30,000
-------------
Total $ (472,000)
=============
The loss realized on the Osprey bond (an Enron partnership) represents
our entire exposure to Enron securities. In addition, we realized a loss from a
start-up equity investment in E-Health Solutions Group, a medical information
technology company that is developing software products to be used by healthcare
companies. While the investment in E-Health Solutions Group may produce value in
future periods, an evaluation conducted during the fourth quarter concluded that
under GAAP, we needed to write off the carrying value of the investment.
The realized investment losses in 2000 were from the sale of U.S.
government and agencies securities partially offset by realized gains from the
sale of asset and mortgage-backed securities.
PRACTICE MANAGEMENT AND RELATED INCOME
Revenue for practice management and related services is comprised of
fees for the following categories of services provided in 2002: practice
management (38%); accounting (31%); tax and personal financial planning (12%);
retirement plan accounting and administration (13%); and all other services
(6%).
38
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Practice management and related revenues decreased by $356,000, or 6%,
to $5.8 million for the year ended December 31, 2002, from $6.2 million for the
year ended December 31, 2001. This revenue consists of fees generated by NCRIC
MSO through its HealthCare Consulting and Employee Benefits Services divisions.
The decreased revenue was a result of a reduced level of non-recurring
consulting assignments in the HealthCare Consulting division compared to 2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Practice management and related revenues increased by $839,000, or 16%,
to $6.2 million for the year ended December 31, 2001, from $5.3 million for the
year ended December 31, 2000. This revenue consists of fees generated by NCRIC
MSO through HealthCare Consulting and Employee Benefits Services. The increased
revenue is a result of the focused efforts on new business development through
the addition of new clients in both recurring business and one-time consulting
assignments and the 2001 increase in consulting rates.
OTHER INCOME
Other income includes revenues from insurance brokerage, insurance
agency and physician services, as well as service charge income from installment
payments for our insurance premium billings.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Other income increased $411,000, or 68%, to $1,013,000 for the year
ended December 31, 2002 from $602,000 for the year ended December 31, 2001. The
increased revenue resulted primarily from increased brokerage reinsurance treaty
commission income generated by the increased current year reinsurance ceded
premiums and from services fees generated by premium installment payments. In
late 2001 we began offering an installment payment option to our insureds. As a
result, the revenue generated by service fees on installment payments grew
throughout 2002 compared to 2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Other income increased $132,000, or 28%, to $602,000 for the year ended
December 31, 2001 from $470,000 for the year ended December 31, 2000. The
increased revenue resulted primarily from increased brokerage reinsurance treaty
commission income generated by the increased current year reinsurance ceded
premiums.
LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED AND COMBINED RATIO RESULTS
The expense for incurred losses and LAE for each year is summarized as
follows. All loss expense amounts incurred are reported net of reinsurance
amounts recoverable.
YEAR ENDED DECEMBER 31,
------------------------------------
2002 2001 2000
---------- ---------- ----------
(IN THOUSANDS)
Incurred losses and LAE related to:
Current year losses................... $ 24,063 $ 23,056 $ 17,829
Prior years loss development.......... 2,766 (4,198) (5,883)
---------- ---------- ----------
Total incurred for the year ......... $ 26,829 $ 18,858 $ 11,946
========= ========= =========
39
Traditionally, property and casualty insurer results are judged using
ratios of losses and underwriting expenses compared to net premiums earned.
Following is a summary of these ratios for each period.
YEAR ENDED DECEMBER 31,
-----------------------------------
2002 2001 2000
----------- ----------- ---------
Losses and LAE ratio:
Current year losses.................... 79.9% 111.9% 122.0%
Prior years loss development........... 9.2 (20.4) (40.3)
---------- ---------- ---------
Total losses and LAE ratio ............. 89.1 91.5 81.7
Underwriting expense ratio.............. 27.2 23.7 24.6
---------- ---------- ---------
Combined ratio.......................... 116.3% 115.2% 106.3%
========== ========== =========
The combined ratio and its component loss and underwriting expense
ratios are profitability measures used throughout the insurance industry as a
relative measure of underwriting performance. Insurance premium rates are
designed to cover the costs of providing insurance coverage. These costs include
loss expenses arising from indemnity claims, costs required to adjudicate
claims, and costs to issue and service insurance policies. The calculations show
the cost of each expense component as a percentage of earned premium income. A
general guide for interpreting the combined ratio is a lower ratio indicates
greater profitability than does a higher ratio.
The resolution of many of the claims reported to us is determined
through a trial. Following is a summary of the trial results for each period.
YEAR ENDED DECEMBER 31,
-----------------------------------
2002 2001 2000
--------- ----------- ---------
Plaintiff verdicts................... 5 5 5
Defense verdicts..................... 13 13 7
Mistrials or hung juries............. 4 2 2
--------- ----------- ---------
Total trials......................... 22 20 14
========= =========== =========
Of the five plaintiff verdicts in 2002, three verdicts were awarded in
excess of our $500,000 retention. Of the five plaintiff verdicts in 2001, one
verdict was awarded in excess of our $500,000 retention. No verdicts exceeded
our $500,000 retention in 2000.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Total incurred losses and LAE expense of $26.8 million for year ended
December 31, 2002 represented an increase of $8.0 million, or 42%, compared to
$18.9 million incurred for the year ended December 31, 2001.
The total incurred losses are broken into two components - incurred
losses related to the current coverage year and development on prior coverage
year losses. Current year incurred losses increased by $1.0 million, or 4%, to
$24.1 million for the year ended December 31, 2002 from $23.1 million for the
year ended December 31, 2001, reflecting the rise in the level of liability
exposure as a result of expanding business, combined with a moderation of claims
frequency.
Prior year development results from the re-estimation and resolution of
individual losses not covered by reinsurance, which are generally losses under
$500,000. In 2002 we experienced unfavorable development of $2.8 million on
estimated losses for prior years' claims. The re-estimation of loss cost takes
into consideration a variety of factors including recent claims settlement
experience, new information on open claims, and changes in the judicial
environment. The primary factors driving our 2002 development, which is
comprised of favorable development in the 1999 report year offset by adverse
development in the 1998, 2000 and 2001 report years, include additional
information on claims originally reported in prior years and interpretation of
emerging settlement trends in our expansion market areas.
An increase in severity was first noted in 1996 and continued through
2002 for claims reported in the District of Columbia. The increase in severity
reflects the growing size of plaintiff verdicts and settlements. Our escalation
in this adverse claims trend is similar to the conditions faced by many medical
professional liability
40
insurance carriers across the nation. While an increase in severity would tend
to cause loss ratios to deteriorate, our reinsurance program for losses in
excess of $500,000 provides a layer of protection against the increase in
severity of losses.
In the market territories outside of the District of Columbia, or our
expansion market areas, our experience covers a time-period insufficient to make
a determination on severity trends. In these new market areas, we carefully
evaluate developing data to identify and recognize emerging trends as soon as
possible.
The total losses and LAE ratio was increased by 9 points for the year
ended December 31, 2002 and was decreased by 20 points for the year ended
December 31, 2001 as a result of prior years loss development. The 2002 change
is primarily reflective of favorable loss development for the 1996 and 1999 loss
years, more than offset by adverse development in the 1998, 2000 and 2001 loss
years; whereas, the 2001 change is primarily reflective of the favorable loss
development for the 1992, 1996, 1997 and 1998 loss years, partially offset by
adverse development in the 1995 loss year.
The underwriting expense ratio increased to 27.2% for the year ended
December 31, 2002 from 23.7% for the year ended December 31, 2001. This increase
is reflective of the reserve against the hospital-sponsored program receivable
of $1.2 million, as previously discussed. Underwriting expenses increased $3.3
million to $8.2 million for the year ended December 31, 2002 from $4.9 million
for the year ended December 31, 2001. Of the 67% increase in underwriting
expenses, 25% was attributed to the receivable allowance; this translates into
an addition of 4.1% to the underwriting expense ratio. See "Underwriting
Expenses."
The combined ratio increased to 116.3% for the year ended December 31,
2002 from 115.2% for the year ended December 31, 2001. The primary factor
driving the increased combined ratio was the increase in underwriting expenses
offset by a lower incurred loss ratio.
The statutory combined ratio was 111.8% for the year ended December 31,
2002, and the same for the year ended December 31, 2001. This includes a slight
decrease in the loss ratio offset by a slight increase in the expense ratio,
reflecting the same premium, loss and expense factors noted previously.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Total incurred losses and LAE expense of $18.9 million for year ended
December 31, 2001 represented an increase of $7.0 million, or 59%, compared to
$11.9 million incurred for the year ended December 31, 2000.
The total incurred losses are broken into two components; incurred
losses related to the current coverage year and development on prior coverage
year losses. Current year incurred losses increased by $5.3 million, or 30%, to
$23.1 million for the year ended December 31, 2001 from $17.8 million for the
year ended December 31, 2000 reflecting the rise in the level of liability
exposure as a result of expanding business, an increase in the frequency of
reported claims, and a rise in the cost of adjudicating and settling claims. An
increase in severity was first noted in 1996 and continued through 2001. The
increase in severity reflects the growing size of plaintiff verdicts and
settlements. Our escalation in this adverse claims trend is similar to the
conditions faced by many medical professional liability insurance carriers
across the nation. While an increase in severity would tend to cause loss ratios
to deteriorate, our reinsurance program for losses in excess of $500,000
provides protection against the increase in severity of losses.
We experienced favorable development on estimated losses for prior
year's claims for both years. Prior year development results from the
re-estimation and settlement of individual losses not covered by reinsurance,
which are generally losses under $500,000. The favorable loss development
related to prior years' claims was $4.2 million for the year ended December 31,
2001, and $5.9 million for the year ended December 31, 2000. The total losses
and LAE ratio was reduced by 20 points for the year ended December 31, 2001 and
40 points for the year ended December 31, 2000, as a result of this favorable
development. The 2001 change is primarily reflective of the favorable loss
development for the 1992, 1996, 1997 and 1998 loss years, partially offset by
adverse development in the 1995 loss year; whereas, the 2000 change is primarily
reflective of the favorable loss development for the 1994, 1996, 1998 and 1999
loss years, partially offset by adverse development in the 1995 loss year. The
reduced level of favorable development in 2001 compared to 2000 reflects claims
closed as well as the continuing upward pressure of severity of losses noted
above.
41
The underwriting expense ratio decreased to 23.7% for the year ended
December 31, 2001 from 24.6% for the year ended December 31, 2000. This decrease
is reflective of the 31% increase in net earned premiums partially offset by the
36% increase in underwriting expenses. Underwriting expenses increased $1.3
million to $4.9 million for the year ended December 31, 2001 from $3.6 million
for the year ended December 31, 2000. Of the 36% increase in underwriting
expenses, 19% was attributed to a guaranty fund assessment of $243,000; this
translates into an addition of 1.2% to the underwriting expense ratio. See
"Underwriting Expenses."
The combined ratio increased to 115.2% for the year ended December 31,
2001 from 106.3% for the year ended December 31, 2000. The primary factor
driving the increased combined ratio was the increase in incurred losses
stemming from the lower favorable prior year loss development.
The statutory combined ratio was 111.8% for the year ended December 31,
2001 compared to 95.0% for the year ended December 31, 2000. This increase
reflects the same premium and loss level factors noted previously.
THREE MONTHS ENDED DECEMBER 31, 2001 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2000
The fourth quarter expense for incurred losses and LAE net of
reinsurance is summarized as follows:
YEAR ENDED DECEMBER 31,
-----------------------
2001 2000
---------- ----------
(IN THOUSANDS)
Incurred losses and LAE related to:
Current year-losses.............................. $ 6,358 $ 4,541
Prior years-development.......................... (405) (1,520)
--------- ---------
Total incurred for the quarter.................... $ 5,953 $ 3,021
========= =========
Total incurred losses and LAE expense of $6.0 million for the fourth
quarter of 2001 increased by $3.0 million over the fourth quarter of 2000. The
increase in current year losses to $6.4 million for the fourth quarter of 2001
reflects the increase in the level of liability exposure as a result of our
expanding business and a rise in the cost of settling claims. The lower level of
favorable development of losses reported in prior years reflects the experience
on the claims closed during the quarter as well as the continuing upward
pressure of severity of losses as reported previously.
LOSSES AND LOSS ADJUSTMENT EXPENSES LIABILITY
The losses and LAE reserve liabilities for unpaid claims as of each
period are as follows:
AT DECEMBER 31,
-----------------------------
2002 2001
------------ ------------
(IN THOUSANDS)
Liability for:
Loss......................................... $ 70,314 $ 56,802
Loss adjustment expense...................... 33,708 27,758
------------ ------------
Total liability............................... $ 104,022 $ 84,560
============ ============
Reinsurance recoverable on losses............. $ 43,231 $ 30,077
============ ============
Number of cases pending....................... 517 430
Each case represents claims against one or more policyholders relating
to a single incident. Losses in the medical professional liability industry can
take up to eight to ten years, or occasionally more, to fully resolve. Amounts
are not due from the reinsurers until we pay a claim. We believe that all of our
reinsurance recoverables are collectible. "See Business - Reinsurance" for a
discussion on the reinsurance program.
42
UNDERWRITING EXPENSES
For 2002, salaries and benefits accounted for approximately 24% of
other underwriting expenses, bad debt expense 16%, with professional fees,
including legal, auditing and director's fees, accounting for approximately
another 14% of the underwriting expenditures. The amortization of premium taxes
and commissions related to the change in unearned premiums reflects the balance.
Guaranty fund assessments are based on industry loss experience in the
jurisdictions where we do business, which loss experience is not entirely
predictable.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Underwriting expenses increased $3.3 million, or 67%, to $8.2 million
for the year ended December 31, 2002 from $4.9 million for the year ended
December 31, 2001. The increase in expenses primarily stems from the increase in
new business, particularly agent produced business, through increases in
commissions, travel, and other underwriting costs. These expenses were partially
offset by an increase in ceding allowances as a result of the increase in
premiums earned. Underwriting expenses also increased due to legal fees incurred
for the collection litigation initiated by us and for the $1.2 million addition
to the allowance for uncollectible premiums, as more fully discussed in the
section "Net Premiums Earned." In addition, we received guaranty fund
assessments totaling $355,000 stemming from the insolvency of PHICO Insurance
Company. There is the possibility we could be assessed additional amounts in the
future. However, since the amount of any potential future assessment is not
reasonably estimable at this time, no additional expense accrual has been
recorded.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Underwriting expenses increased $1.3 million, or 36%, to $4.9 million
for the year ended December 31, 2001 from $3.6 million for the year ended
December 31, 2000. The increase in expenses primarily stems from the increase in
new business, particularly agent produced business, through increases in
commissions, travel, and other underwriting costs. These expenses were partially
offset by an increase in ceding allowances as a result of the increase in
premiums earned. Underwriting expenses also increased due to legal fees incurred
for the collection litigation initiated by us, as discussed in "Net Premiums
Earned," and for the allowance for potential uncollectible premiums. In
addition, we received a guaranty fund assessment from the D.C. Guaranty Fund of
$243,000 stemming from the insolvency of Reliance Insurance Company. There is
the possibility we could be assessed additional amounts in the future. However,
since the amount of any potential future assessment is not reasonably estimable
at this time, no additional expense accrual has been recorded. No similar
assessment was received in 2000.
PRACTICE MANAGEMENT AND RELATED EXPENSES
Practice management and related expenses consist primarily of expenses,
such as salaries, general office expenses and interest on debt, related to NCRIC
MSO operations of the businesses acquired January 4, 1999. The management
services organization was established in 1997 to provide physicians with a
variety of administrative support and other services but did not have
substantive operations until 1998.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Practice management and related expenses decreased $252,000 million, or
4%, to $5.8 million for the year ended December 31, 2002 compared to $6.1
million for the year ended December 31, 2001. Expense decreased due to the
cessation of goodwill amortization with the implementation of SFAS 142 effective
January 1, 2002 partially offset by additional expenses associated with the
transition of client service for two of the former owners as they moved towards
the expiration of their employment contracts at the end of 2002 and other
transitional costs associated with the continued integration of the purchased
companies.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Practice management and related expenses increased $1.1 million, or
22%, to $6.1 million for the year ended December 31, 2001 compared to $5.0
million for the year ended December 31, 2000. Expenses increased as a result of
the growth in new business and business development efforts during 2001. In
addition, goodwill amortization increased by $131,000, interest expense
increased $75,000, and compensation expense increased by $70,000 as a result of
the contingent purchase payments made in 2001 to the prior owners of HealthCare
Consulting, Inc., HCI Ventures, LLC, and Employee Benefits Services, Inc.
43
THREE MONTHS ENDED DECEMBER 31, 2001 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2000
Practice management and related expenses of $1.7 million in the fourth
quarter of 2001 increased over the $1.2 million incurred in the fourth quarter
of 2000 due to the same factors influencing the growth of expenses throughout
the year 2001, that is, expenses associated with the growth of new business and
with the contingent purchase payments made in 2001. Additional fourth quarter
expense included increases for bad debts and employee compensation.
OTHER EXPENSES
Other expenses include expenditures for holding company and subsidiary
operations which are not directly related to the issuance of medical
professional liability insurance or practice management and related operations,
including insurance brokerage, insurance agency, and captive development.
In April 2001, we announced the formation of ACC, a wholly owned
subsidiary and the first captive insurance company to be licensed in the
District of Columbia under the Captive Insurance Act of 2000. As a captive
insurance company, ACC was established to provide an alternative risk-financing
vehicle for affinity groups. The captive program is marketed to organizations
and groups wishing to finance and manage their own risk. During 2002, ACC
incurred $247,000 in expenses. While one sponsored-cell contract has been
signed, the captive cell has not yet begun operations due to delays in
regulatory approval in West Virginia.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Other expenses of $1.5 million for the year ended December 31, 2002
increased $222,000, or 18% compared to the year ended December 31, 2001. Expense
increases are for captive business development costs and holding company
operations.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Other expenses of $1.2 million for the year ended December 31, 2001 are
unchanged from the expense level for the year ended December 31, 2000. Other
expenses include amounts incurred to meet the various requirements associated
with having common stock traded in the public market; the expense of the stock
grants made in September, 2000 under the Stock Award Plan; and, in 2001,
$184,000 of start-up expenses for the new captive insurance company subsidiary.
INCOME TAXES
Our effective tax rate is lower than the federal statutory rate
principally due to nontaxable investment income.
YEAR ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
-------- -------- -------
Federal income tax at statutory rates........ 34% 34% 34%
Tax exempt income............................ (89) (12) (4)
Dividends received........................... (21) (4) (1)
Goodwill amortization........................ 0 5 1
Other, net................................... (1) 4 1
------ ------ ------
Income tax at effective rates................ (77)% 27% 31%
====== ====== ======
Our net deferred tax assets are created by temporary differences that
will result in tax benefits in future years due to the differing treatment of
items for tax and financial statement purposes. The primary difference is the
requirement to discount or reduce loss reserves for tax purposes because of
their long-term nature.
44
AT DECEMBER 31,
----------------------------------
2002 2001
----------------- -------------
Deferred income tax asset............. $ 3,789,000 $ 2,482,000
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
The tax benefit for the year ended December 31, 2002 was $322,000
compared to tax expense of $597,000 for the year ended December 31, 2001. The
Federal corporate income tax rate of 34% was adjusted to an effective tax rate
of (77%) for the year ended December 31, 2002 due to tax-exempt income and
nontaxable dividends.
The increase in the deferred income tax asset to a balance of $3.8
million as of December 31, 2002 resulted primarily from the growth of the
insurance business, particularly in unearned premiums and loss reserves where
the timing of recognition for financial statement and tax return reporting
differ, in addition to completion of the amortization of the deferred tax
liability that had arisen from a change in tax accounting method four years ago.
The increase in the deferred income tax asset was partially reduced by the
deferred tax liability on unrealized investment gains.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Tax expense for the year ended December 31, 2001 was $597,000 compared
to $1.6 million for the year ended December 31, 2000. The Federal corporate
income tax rate of 34% was reduced to an effective tax rate of 27% for the year
ended December 31, 2001 due to tax-exempt income and nontaxable dividends
received, partially offset by non-deductible goodwill amortization and other,
principally state income taxes. The effective rate of 31% for the year ended
December 31, 2000 was higher than the 2001 effective rate primarily due to a
lower level of tax-exempt income in 2000. The decrease in the provision for
income tax is reflective of the decreased income before tax combined with the
decrease in the effective tax rate.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
NCRIC GROUP, PARENT COMPANY
FINANCIAL CONDITION AND CAPITAL RESOURCES. We are a stock holding
company whose operations and assets primarily consist of its ownership of NCRIC,
Inc. and NCRIC MSO, Inc. We assist our subsidiaries in their efforts to compete
effectively and create long-term growth. As a part of this strategy, we may seek
to take advantage of acquisition opportunities and alternative financing.
In December 2002, we completed the private placement sale of $15
million of 30-year floating rate trust preferred securities. The securities are
callable at par five years from the date of issuance. The interest rate on the
securities is floating at the 3-month London Interbank Offered Rate (LIBOR) plus
400 basis points. The initial rate is 5.42%. We contributed $13.5 million of the
funds raised to the statutory surplus of our insurance subsidiaries.
LIQUIDITY. Liquidity is a measure of an entity's ability to secure
enough cash to meet its contractual obligations and operating needs. Our cash
flow from operations consists of dividends from our subsidiaries, if declared
and paid, and other permissible payments from our subsidiaries, offset by
holding company expenses, which consist of costs for corporate management and
interest on the trust preferred securities. The amount of the future cash flow
available to us may be influenced by a variety of factors, including NCRIC,
Inc.'s financial results and regulation by the District of Columbia Department
of Insurance and Securities Regulation.
The payment of dividends to us by NCRIC, Inc. is subject to limitations
imposed by the District of Columbia Holding Company System Act of 1993. Under
the DC Holding Company Act, NCRIC, Inc. must seek prior approval from the
Commissioner to pay any dividend which, combined with other dividends made
within the preceding 12 months, exceeds the lesser of (A) 10% of the surplus at
the end of the prior year or (B) the prior year's net income excluding realized
capital gains. Net income, excluding realized capital gains, for the 2 years
preceding the current year is carried forward for purposes of the calculation to
the extent not paid in dividends. The law also requires that an insurer's
statutory surplus following a dividend or other distribution be reasonable in
relation to the insurer's outstanding liabilities and adequate to meet its
financial needs. The District of Columbia permits the
45
payment of dividends only out of unassigned statutory surplus. Using these
criteria, as of December 31, 2002, NCRIC, Inc. had approximately $1.2 million of
unassigned statutory surplus available for dividends.
NCRIC GROUP AND SUBSIDIARIES, CONSOLIDATED
LIQUIDITY. The primary sources of our liquidity are insurance premiums,
net investment income, practice management and financial services fees,
recoveries from reinsurers and proceeds from the maturity or sale of invested
assets. Funds are used to pay losses and LAE, operating expenses, reinsurance
premiums, taxes, and to purchase investments.
We had cash flows provided by (used in) operations for the years ended
December 31, as follows:
2002.............$ 3.4 million
2001.............$ 8.3 million
2000.............$ (0.8) million
The $4.9 million of decreased cash flow provided by operations in 2002
compared to 2001 results primarily from an increase in net claims and claims
settlement cost payments and a change in the timing of the receipt of premiums.
Prior to 2002, a majority of insureds financed their annual premium through an
outside financing company, which then remitted the full annual premium to us at
the beginning of the policy year. For policies with 2002 effective dates, we
provide the option to policyholders to pay their premiums in installments
throughout the policy year. This has the impact of spreading the cash receipts
from premiums over the policy year. Because of the long-term nature of both the
payments of claims and the settlement of swing-rated reinsurance premiums due to
reinsurers, cash from operations for a medical professional liability insurer
like us can vary substantially from year to year.
Comprehensive income was a gain of $3.1 million for the year ended
December 31, 2002 compared to $2.8 million for the year ended December 31, 2001.
The increase in comprehensive income results from the $1.1 million increase in
net unrealized investment gains, combined with the $0.8 million lower net
income.
FINANCIAL CONDITION AND CAPITAL RESOURCES. We invest our positive cash
flow from operations primarily in investment grade, fixed maturity securities.
As of December 31, 2002, the carrying value of the securities portfolio was
$120.1 million, compared to a carrying value of $103.1 million at December 31,
2001. The portfolios were invested as follows:
AT DECEMBER 31,
-------------------------
2002 2001
---------- ---------
U.S. Government and agencies.................... 23% 4%
Asset and mortgage-backed securities............ 28 29
Tax exempt securities .......................... 27 19
Corporate bonds................................. 17 42
Equity securities............................... 5 6
------- -------
100% 100%
======= =======
Over 64% of the bond portfolio at December 31, 2002 was invested in
U.S. Government and agency securities or has a rating of AAA or AA. Over 99% of
the bond portfolio as of December 31, 2002 was held in investment grade (BBB or
better) securities as rated by Standard & Poor's. For regulatory purposes, as of
December 31, 2002, 94% of the portfolio is rated Class 1, which is the highest
quality rated group as classified by the NAIC. The accumulated other
comprehensive income totaled $2.8 million at December 31, 2002 compared to
$474,000 at December 31, 2001. This improvement in asset values resulted
primarily from the reduction in market interest rates.
At December 31, 2002, our portfolio included total gross unrealized
gains of $5.2 million, or 4.3% of the $120.1 million carrying value of the
portfolio, and total unrealized losses of $950,000, or less than 1% of the
carrying value of the portfolio. The total unrealized losses are comprised of
seventeen different securities, including eight Treasury Note issues, six
corporate debt fixed maturity securities (five of which are investment grade),
with lengths of time to maturity ranging from nine to twenty-eight years, two
preferred stock issues, and one equity issue.
46
All of the fixed maturity securities are meeting and are expected to continue to
meet all contractual obligations for interest payments.
At December 31, 2002, the aggregate fair value of the securities with
unrealized losses was $12.6 million, or 93% of the aggregate carrying value of
those securities of $13.6 million. The largest single security with an
unrealized loss at December 31, 2002 relates to a bond issued by Xerox Capital
Trust, which matures in 2027 and carries a coupon rate of 8%. The unrealized
pre-tax loss relating to this security is approximately $241,000 based on the
fair value of $280,000 at December 31, 2002. We will continue to actively
monitor the financial position and outlook for this investment and take any
action determined to be appropriate. Unrealized losses related to other
securities are not individually significant, nor is there any concentration of
unrealized losses with respect to the type of security or industry.
The following table displays characteristics of the securities with an
unrealized loss in value as of December 31, 2002. No concentrations of
industries exist in these securities.
Total securities Below investment grade and equity securities
------------------------------------- ---------------------------------------------
Length of time in Unrealized Unrealized
unrealized loss position Amortized Cost Fair Value Loss Amortized Cost Fair Value Loss
- ------------------------ -------------- ---------- ----------- -------------- ---------- -----------
(in thousands)
Less than 1 year...... $ 4,060 $ 3,957 $ 103 $ 135 $ 90 $ 46
Over 1 year........... 9,539 8,692 847 3,947 3,464 483
---------- ---------- ----------- ------------ ---------- -----------
Total................. $ 13,599 $ 12,649 $ 950 $ 4,082 $ 3,554 $ 529
========== ========== =========== ============ ========== ===========
The following table displays the maturity distribution of those fixed
maturity securities with an unrealized loss in value as of December 31, 2002:
Fixed maturity securities
-------------------------------------------
Unrealized
Amortized Cost Fair Value Loss
------------- ------------ -----------
(in thousands)
During one year or less.................. $ 153 $ 152 $ 1
Due after one year through five years.... 1,347 1,345 2
Due after five years through ten years... 1,000 967 33
Due after twenty years................... 7,538 6,911 627
------------ ------------ -----------
Total........................... $ 10,038 $ 9,375 $ 663
============ ============ ===========
We believe that all of our fixed maturity securities are readily
marketable. Investment duration is closely monitored to provide adequate cash
flow to meet operational and maturing liability needs. Asset and liability
modeling, including sensitivity analyses and cash flow testing, are performed on
a regular basis.
We are required to pay aggregate annual salaries in the amount of
$945,000 to four persons under employment agreements.
Under terms of the purchase agreement between the previous owners of
HealthCare Consulting, Inc., HCI Ventures, LLC, Employee Benefits Services, Inc.
and us, contingency payments totaling $3.1 million could be paid in cash if the
acquired companies achieved earnings targets in 2000, 2001, and 2002. During
2000, the earnings target was met and we paid the prior owners $1.55 million on
March 31, 2001. After analyzing the acquired companies' operations since the
acquisition, terms were negotiated and agreed upon for an early payment of the
second contingent payment originally scheduled to be paid in 2002. As a result,
on June 23, 2001, we paid $1.46 million, the present value of the remaining
payments to the prior owners. During June 2001, NCRIC MSO, Inc. borrowed
$1,971,000 from SunTrust Bank to finance these payments. The term of the loan is
3 years at a floating rate of LIBOR plus one and one-half percent. The interest
rate was 2.93% and 4.83% at December 31, 2002 and December 31, 2001,
respectively. Principal and interest payments are due on a monthly basis.
47
Our stockholders' equity totaled $47.8 million at December 31, 2002 and
$44.5 million at December 31, 2001. The $3.3 million increase for the year ended
December 31, 2002 was due primarily to $742,000 of net income plus $2.3 million
of net unrealized investment gains. The $3.0 million increase for the year ended
December 31, 2001 was primarily due to $1.6 million of net income plus $1.2
million of net unrealized investment gains.
EFFECTS OF INFLATION AND INTEREST RATE CHANGES
The primary effect of inflation on us is in estimating reserves for
unpaid losses and LAE for medical professional liability claims in which there
is a long period between reporting and settlement. The rate of inflation for
malpractice claim settlements can substantially exceed the general rate of
inflation. The actual effect of inflation on our results cannot be conclusively
known until claims are ultimately settled. Based on actual results to date, we
believe that loss and LAE reserve levels and our ratemaking process adequately
incorporate the effects of inflation.
Interest rate changes expose us to market risk on our investment
portfolio. This market risk is the potential for financial losses due to the
decrease in the value or price of an asset resulting from broad movements in
prices, such as interest rates. In general, the market value of our fixed
maturity portfolio increases or decreases in an inverse relationship with
fluctuation in interest rates. In addition, our net investment income increases
or decreases in a direct relationship with interest rate changes on monies
re-invested from maturing securities and investments of positive cash flow from
operating activities.
FEDERAL INCOME TAX MATTERS
For tax years prior to the stock offering, we filed a consolidated
United States Federal income tax return with our parent and subsidiaries. For
tax years after the stock offering, we do not file as part of a consolidated
United States Federal income tax return with NCRIC, A Mutual Holding Company or
NCRIC Holdings because NCRIC, A Mutual Holding Company and NCRIC Holdings own
directly and indirectly less than 80% of the outstanding shares of NCRIC Group.
Tax years 1999, 2000 and 2001 are open but not currently under audit. In 2000
the Internal Revenue Service approved a change in accounting method for us
relative to the timing of revenue recognition for tax purposes.
REGULATORY MATTERS
NAIC STATUTORY ACCOUNTING CODIFICATION. The National Association of
Insurance Commissioners (NAIC) is an association of the insurance regulators of
all 50 states and the District of Columbia. The NAIC has codified the statutory
accounting practices, which are the accounting rules and guidelines prescribed
by the state insurance regulators. The project was intended to re-examine
current statutory accounting practices and to ensure uniform accounting
treatment from a regulatory standpoint. Many of the changes to statutory
accounting are based on generally accepted accounting principles with
modifications that emphasize the concept of conservatism and solvency inherent
in statutory accounting. The accounting mandated by the codification applied
commencing January 1, 2001. Statutory accounting changes resulting from this
codification do not have an effect on the financial statements prepared in
accordance with GAAP, which have been included in this document and filed with
the Securities and Exchange Commission. The effect on our statutory surplus on
January 1, 2001 was an increase of $1.6 million. This increase is mainly due to
the effect of accounting changes related to the implementation of deferred taxes
and the removal of the excess of statutory reserves over statement reserves
penalty, offset by charges to surplus for overdue receivables.
NAIC IRIS RATIOS. The NAIC Insurance Regulatory Information System
(IRIS) is an early warning system that is primarily intended to be utilized by
state and District of Columbia insurance department regulators to assist in
their review and oversight of the financial condition and results of operations
of insurance companies operating in their respective jurisdictions. IRIS is a
ratio analysis system that is administered by the NAIC. The NAIC provides state
and District of Columbia insurance department regulators with ratio reports for
each insurer within their jurisdiction based on standardized annual financial
statements submitted by the insurers. IRIS identifies 12 ratios to be analyzed
for a property-casualty insurer, and specifies a range of values for each of
these ratios. The ratios address various aspects of each insurer's financial
condition and stability including profitability, liquidity, reserve adequacy and
overall analytical ratios. Departure from the usual range of a ratio may require
the submission of an explanation to the state or District of Columbia insurance
regulator. Departure from the usual range on four or more ratios may lead to
increased regulatory oversight.
48
For 2002 and 2001, our subsidiary CML was outside the usual range on
three ratios. The ratio results were impacted by two primary factors: the rapid
increase in new premium written in CML and the increase in severity of losses,
particularly the adverse development in losses of one prior year. In the opinion
of management, because of the reasons for the ratio results for the current
year, the ratio results are not indicative of operational problems in this
subsidiary. For 2002 and 2001, another subsidiary, NCRIC, Inc., was outside the
usual range for two ratios as the result of the rapid increase in premiums and
the increase in severity of losses, particularly the adverse development of
prior year losses.
NAIC RISK-BASED CAPITAL. The NAIC has established a methodology for
assessing the adequacy of each insurer's capital position based on the level of
statutory surplus and an evaluation of the risks in the insurer's product mix
and investment portfolio profile. This risk-based capital (RBC) formula is
designed to allow state and District of Columbia insurance regulators to
identify potentially under-capitalized companies. For property-casualty
insurers, the formula takes into account risks related to the insurer's assets
including risks related to its investment portfolio, and the insurer's
liabilities, including risks related to the adverse development of coverages
underwritten. The RBC rules provide for different levels of regulatory attention
depending on the ratio of the insurer's total adjusted capital to the authorized
control level of RBC. The first level of regulatory action, a review by the
domiciliary insurance commissioner of a company prepared RBC plan, is instituted
at the point a company's total adjusted capital is at a level equal to or less
than two times greater than the authorized control level risk-based capital. For
all periods presented, the total adjusted capital levels for NCRIC, Inc. and CML
were significantly in excess of the authorized control level of RBC. As a
result, the RBC requirements are not expected to have an impact on our
operations. Following is a presentation of the total adjusted capital for NCRIC,
Inc. and CML compared to the authorized control level of RBC:
AUTHORIZED CONTROL LEVEL
RISK-BASED CAPITAL TOTAL ADJUSTED CAPITAL
------------------------- ------------------------
NCRIC, INC. CML NCRIC, INC. CML
------------ -------- ------------ -------
(in millions)
December 31, 2002......................... $ 6.7 $0.49 $ 44.3 $ 4.7
December 31, 2001......................... $ 4.7 $0.17 $ 32.8 $ 4.3
December 31, 2000......................... $ 3.7 $0.19 $ 29.8 $ 4.5
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET PRICE
Our investment portfolio is exposed to various market risks, including
interest rate and equity price risk. Market risk is the potential for financial
losses due to the decrease in the value or price of an asset resulting from
broad movements in prices. At December 31, 2002, fixed maturity securities
comprised 95% of total investments at fair value. U.S. government and tax-exempt
bonds represent 50% of the fixed maturity securities. Equity securities,
consisting primarily preferred stock, account for the remainder of the
investment portfolio. We have classified our investments as available for sale.
Because of the high percentage of fixed maturity securities, interest
rate risk represents the greatest exposure we have on our investment portfolio.
In general, the market value of our fixed maturity portfolio increases or
decreases in an inverse relationship with fluctuation in interest rates. During
periods of rising interest rates, the fair value of our investment portfolio
will generally decline resulting in decreases in our stockholders' equity.
Conversely, during periods of falling interest rates, the fair value of our
investment portfolio will generally increase resulting in increases in our
stockholders' equity. In addition, our net investment income increases or
decreases in a direct relationship with interest rate changes on monies
reinvested from maturing securities and investments of positive cash flow from
operating activities.
Generally, the longer the duration of the security, the more sensitive
the asset is to market interest rate fluctuations. To control the adverse
effects of the changes in interest rates, our investment portfolio of fixed
maturity securities consists primarily of intermediate-term, investment-grade
securities. Our fixed income portfolio at December 31, 2002 reflected an average
effective maturity of 4.4 years and an average modified duration of 4.7 years.
Our investment policy also provides that all security purchases be limited to
rated securities or unrated securities approved by management on the
recommendation of our investment advisor. Over 99% of our bond portfolio as of
December 31, 2002 was held in investment grade securities.
49
During the early part of 2002, there was a change in the allocation of
our portfolio which increased the proportion of tax-exempt securities in the
portfolio for the purpose of maximizing after-tax yields while minimizing
portfolio credit risk. In December 2002, the funds provided through issuance of
the Trust Preferred Securities were invested in U.S. Treasury securities,
decreasing the percentage of tax-exempt and corporate bonds to 58% of the total
fixed maturity securities compared to 65% at December 31, 2001.
One common measure of the interest sensitivity of fixed maturity
securities is effective duration. Effective duration utilizes maturities,
yields, and call terms to calculate an average age of expected cash flows. The
following table shows the estimated fair value of our fixed maturity portfolio
based on fluctuations in the market interest rates.
PROJECTED MARKET
YIELD CHANGE VALUE
(BP) MARKET YIELD (IN MILLIONS)
------------ ------------ ----------------
-300 0.86% $136.0
-200 1.86 130.7
-100 2.86 125.4
Current Yield** 3.86 120.1
100 4.86 114.8
200 5.86 109.5
300 6.86 104.2
**Current yield is as of December 31, 2002.
The actual impact of the market interest rate changes on the securities
may differ from those shown in the sensitivity analysis above.
50
ITEM 8.
INDEX TO FINANCIAL STATEMENTS
PAGE
NCRIC GROUP, INC. AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT 52
Consolidated Balance Sheets as of December 31, 2002 and 2001 53
Consolidated Statements of Operations for the Years Ended
December 31, 2002, 2001, and 2000 54
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2002, 2001, and 2000 55
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001, and 2000 56
Notes to Consolidated Financial Statements for the Years Ended
December 31, 2002, 2001, and 2000 57
Schedule I - Summary of Investments - Other Than Investments in
Related Parties 77
Schedule II - Condensed Financial Information of Registrant 78
Schedule III - Supplementary Insurance Information 82
Schedule IV - Reinsurance 83
Schedule V - Valuation and Qualifying Accounts 84
Schedule VI - Supplemental Information Concerning Property-Casualty
Insurance Companies 85
51
INDEPENDENT AUDITORS' REPORT
To The Board of Directors of
NCRIC Group, Inc. and Subsidiaries
Washington, D.C.
We have audited the accompanying consolidated balance sheets of NCRIC Group,
Inc. and Subsidiaries (the Company) as of December 31, 2002 and 2001, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ending December 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of NCRIC Group, Inc. and Subsidiaries
as of December 31, 2002 and 2001, and the results of their operations, and their
cash flows for each of the three years in the period ending December 31, 2002,
in conformity with accounting principles generally accepted in the United States
of America.
As discussed in Note 1 to the consolidated financial statements, in 2002 the
Company changed its method of accounting for goodwill to conform with Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets".
Our audits were conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. The additional schedules listed in the
table of contents are presented for the purpose of additional analysis and are
not a required part of the basic financial statements. The additional schedules
are the responsibility of the Company's management. Such information has been
subjected to the auditing procedures applied in our audits of the basic
financial statements and, in our opinion, is fairly stated in all material
respects when considered in relation to the basic financial statements taken as
a whole.
Deloitte & Touche LLP
February 15, 2003
McLean, Virginia
52
NCRIC GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2002 AND 2001 (IN THOUSANDS, EXCEPT FOR SHARE DATA)
- ---------------------------------------------------------------------------------------------------------
2002 2001
ASSETS
INVESTMENTS:
Securities available for sale, at fair value:
Bonds and U.S.Treasury Notes (Amortized cost $110,309
and $95,716) $ 114,696 $ 96,723
Equity securities (Cost $5,561 and $6,691) 5,424 6,402
--------- ---------
Total securities available for sale 120,120 103,125
OTHER ASSETS:
Cash and cash equivalents 10,550 7,565
Reinsurance recoverable 43,231 30,077
Goodwill, net 7,291 7,291
Premiums and accounts receivable, net 9,477 4,802
Deferred income taxes 3,789 2,482
Other assets 8,229 5,660
--------- ---------
TOTAL ASSETS $ 202,687 $ 161,002
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Losses and loss adjustment expenses:
Losses $ 70,314 $ 56,802
Loss adjustment expenses 33,708 27,758
--------- ---------
Total losses and loss adjustment expenses 104,022 84,560
Other liabilities:
Retrospective premiums accrued under
reinsurance treaties 607 2,408
Unearned premiums 24,211 17,237
Advance premium 2,971 4,138
Reinsurance premium payable 5,045 2,452
Bank debt 995 1,662
Trust preferred securities 15,000 -
Other liabilities 2,019 4,091
--------- ---------
TOTAL LIABILITIES 154,870 116,548
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 4, 6, and 9)
STOCKHOLDERS' EQUITY:
Common stock $0.01 par value - 10,000,000 shares authorized;
as of December 31, 2002, 3,708,399 shares issued and outstanding
(net of 34,456 treasury shares); as of December 31, 2001, 3,711,427
shares issued and outstanding (net of 31,428 treasury shares) 37 37
Additional paid in capital 9,630 9,552
Unallocated common stock held by the ESOP (682) (786)
Common stock held by the stock award plan (202) (339)
Accumulated other comprehensive income 2,806 474
Retained earnings 36,518 35,776
Treasury stock, at cost (290) (260)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 47,817 44,454
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 202,687 $ 161,002
========= =========
See notes to consolidated financial statements.
53
NCRIC GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- ------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
REVENUES:
Net premiums earned $ 30,098 $ 20,603 $ 14,611
Net investment income 5,915 6,136 6,407
Net realized investment losses (131) (278) (5)
Practice management and related income 5,800 6,156 5,317
Other income 1,013 602 470
-------- -------- --------
Total revenues 42,695 33,219 26,800
-------- -------- --------
EXPENSES:
Losses and loss adjustment expenses 26,829 18,858 11,946
Underwriting expenses 8,168 4,877 3,591
Practice management and related expenses 5,811 6,063 4,970
Other expenses 1,467 1,245 1,237
-------- -------- --------
Total expenses 42,275 31,043 21,744
-------- -------- --------
INCOME BEFORE INCOME TAXES 420 2,176 5,056
-------- -------- --------
INCOME TAX PROVISION (BENEFIT) (322) 597 1,561
-------- -------- --------
NET INCOME $ 742 $ 1,579 $ 3,495
======== ======== ========
OTHER COMPREHENSIVE INCOME, NET OF TAX:
Unrealized holding gains on securities $ 2,478 $ 1,567 $ 2,119
Reclassification adjustment for gains (losses) included in net income (146) (349) 3
-------- -------- --------
OTHER COMPREHENSIVE INCOME 2,332 1,218 2,122
-------- -------- --------
COMPREHENSIVE INCOME $ 3,074 $ 2,797 $ 5,617
======== ======== ========
Net income per common share:
Basic:
Average shares outstanding 3,557 3,529 3,526
-------- -------- --------
Earnings Per Share $ 0.21 $ 0.45 $ 0.99
======== ======== ========
Diluted:
Weighted average shares outstanding 3,557 3,529 3,526
Dilutive effect of stock options 75 86 33
-------- -------- --------
Weighted average shares outstanding -diluted 3,632 3,615 3,559
-------- -------- --------
Earnings Per Share $ 0.20 $ 0.44 $ 0.98
======== ======== ========
See notes to consolidated financial statements.
54
NCRIC GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(IN THOUSANDS)
- -------------------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Unallocated Stock Other Total
Common Paid In ESOP Award Treasury Comprehensive Retained Stockholders'
Stock Capital Shares Shares Stock Income(Loss) Earnings Equity
------- ---------- ----------- ------- -------- -------------- -------- -------------
BALANCE, JANUARY 1, 2000 $ 37 $ 9,433 $ (993) $ (518) $ - $(2,866) $30,702 $35,795
Net income - - - - - - 3,495 3,495
Other comprehensive income - - - - - 2,122 - 2,122
Acquistion of treasury stock - - - - (131) - - (131)
Shares released - 22 104 42 - - - 168
------ ------- ------- ------- ------- ------- ------- --------
BALANCE, DECEMBER 31, 2000 37 9,455 (889) (476) (131) (744) 34,197 41,449
Net income - - - - - - 1,579 1,579
Other comprehensive income - - - - - 1,218 - 1,218
Acquistion of treasury stock - - - - (129) - - (129)
Shares released - 97 103 137 - - - 337
------ ------- ------- ------- ------- ------- ------- --------
BALANCE, DECEMBER 31, 2001 37 9,552 (786) (339) (260) 474 35,776 44,454
Net income - - - - - - 742 742
Other comprehensive income - - - - - 2,332 - 2,332
Acquistion of treasury stock - - - - (30) - - (30)
Shares released - 78 104 137 - - - 319
------ ------- ------- ------- ------- ------- ------- --------
BALANCE, DECEMBER 31, 2002 $ 37 $ 9,630 $ (682) $ (202) $ (290) $ 2,806 $36,518 $47,817
====== ======= ======= ======= ======= ======= ======= ========
See notes to consolidated financial statements.
55
NCRIC GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 (IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 742 $ 1,579 $ 3,495
Adjustments to reconcile net income
to net cash flows from operating activities:
Net realized investment losses 131 278 5
Amortization and depreciation 661 748 656
Provision for uncollectable receivables 1,362 212 238
Deferred income taxes (2,508) (914) 287
Stock released for coverage of benefit plans 319 337 168
Changes in assets and liabilities:
Reinsurance recoverable (13,154) (2,528) (922)
Premiums and accounts receivable (6,037) (1,576) (1,298)
Other assets (2,132) 658 (1,176)
Losses and loss adjustment expenses 19,462 3,426 (3,148)
Retrospective premiums accrued under
reinsurance treaties (1,801) (3,070) (1,686)
Unearned premiums 6,974 5,765 2,574
Advance premium (1,167) 3,372 151
Reinsurance premium payable 2,593 1,649 70
Other liabilities (2,071) (1,682) (248)
-------- -------- --------
Net cash flows provided by (used in) operating
activities 3,374 8,254 (834)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (52,824) (24,736) (10,286)
Sales, maturities and redemptions of investments 39,027 21,956 10,543
Investment in purchased business, net of cash acquired - (3,014) -
Purchases of property and equipment (895) (400) (727)
-------- -------- --------
Net cash flows used in investing activities (14,692) (6,194) (470)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of trust preferred securities 15,000 - -
Payments to acquire treasury stock (30) (129) (131)
Proceeds from bank debt - 1,971 -
Repayment of bank debt (667) (309) -
-------- -------- --------
Net cash flows provided by (used in) financing
activities 14,303 1,533 (131)
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS 2,985 3,593 (1,435)
-------- -------- --------
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 7,565 3,972 5,407
-------- -------- --------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 10,550 $ 7,565 $ 3,972
======== ======== ========
SUPPLEMENTARY INFORMATION:
Cash paid for income taxes $ 2,200 $ 2,172 $ 1,375
======== ======== ========
Interest paid $ 61 $ 72 $ -
======== ======== ========
See notes to consolidated financial statements.
56
NCRIC GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
____________________________________________________
1. SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF REPORTING - On April 20, 1998, the Board of
Governors of National Capital Reciprocal Insurance Company adopted a
plan of reorganization which authorized the formation of NCRIC, A
Mutual Holding Company (Mutual Holding Company) and the conversion into
NCRIC, Inc. (NCRIC), a stock medical professional liability insurance
company. The reorganization became effective on December 31, 1998.
Through a series of stock transfers effected in connection with the
reorganization, Mutual Holding Company owns all of the outstanding
shares of NCRIC Holdings, Inc., which owns all of the outstanding
shares of NCRIC Group, Inc. (Company) which owns all of the outstanding
shares of NCRIC. District of Columbia law provides that the Mutual
Holding Company must at all times own, directly or indirectly, a
majority of the outstanding voting stock of NCRIC. In 1999 the Company
completed an initial public offering of 1,480,000 shares, which
represented approximately 40% of its outstanding shares. NCRIC Holdings
continues to own approximately 60% of the outstanding shares of the
Company.
On December 4, 2002, the Company formed NCRIC Statutory Trust I for the
purpose of issuing $15,000,000 in trust preferred securities in a
pooled transaction to unrelated investors. (See Note 5)
The Company provides comprehensive professional liability and office
premises liability insurance under nonassessable policies to physicians
having their principal practice in the District of Columbia, Maryland,
Virginia, West Virginia, or Delaware.
The Company also provides (i) practice management services, accounting
and tax services, and personal financial planning services to medical
and dental practices and (ii) retirement planning services and
administration to medical and dental practices and certain other
businesses throughout the Mid-Atlantic Region.
The Company has issued policies on both an occurrence and a claims-made
basis. However, subsequent to June 1, 1986, substantially all policies
have been issued on the claims-made basis. Occurrence-basis policies
provide coverage to the policyholder for losses incurred during the
policy year regardless of when the related claims are reported.
Claims-made basis policies provide coverage to the policyholder for
covered claims reported during the current policy year provided the
related losses were incurred while claims-made basis policies were in
effect.
Tail coverage is offered for doctors terminating their insurance
policies. This coverage
57
extends ad infinitum the period in which to report future claims
resulting from incidents occurring while a claims-made policy was in
effect. Beginning in 1988, prior acts insurance coverage was first
issued, subject to underwriting criteria for new insureds. Such
coverage extends the effective date of claims-made policies to
designated periods prior to initial coverage.
PRINCIPLES OF CONSOLIDATION - The accompanying financial statements
present the consolidated financial position and results of operations
of the Company and its subsidiaries. All significant intercompany
transactions have been eliminated in the consolidation.
The accompanying financial statements have been prepared in conformity
with generally accepted accounting principles (GAAP), which differ from
statutory accounting practices prescribed or permitted for insurance
companies by regulatory authorities.
CASH EQUIVALENTS - For purposes of reporting cash flows, the Company
considers short-term investments purchased with an initial maturity of
three months or less to be cash equivalents.
INVESTMENTS - The Company has classified its investments as available
for sale and has reported them at fair value, with unrealized gains and
losses excluded from earnings and reported, net of deferred taxes, as a
component of equity and other comprehensive income. Realized gains and
losses are determined using the specific identification method.
Investment securities are exposed to various risks such as interest
rate, market and credit risk. Fair values of securities fluctuate based
on the magnitude of changing market conditions; significant changed
market conditions could materially affect the portfolio value in the
near term. When a security has a decline in fair value which is other
than temporary, the Company reduces the carrying value of the security
to its current fair value.
The Company evaluates investments for other-than-temporary impairment
whenever events or changes in circumstances, such as business
environment, legal issues and other relevant data, indicate that the
carrying amount of an investment may not be recoverable. Any resulting
impairment loss is reported as a realized investment loss. During the
year ended December 31, 2002 the Company recorded an impairment loss
on securities in the second quarter. These securities were
subsequently sold during 2002. Additionally, in 2001 the Company
determined that an equity security consisting of common stock
experienced an other-than-temporary impairment. Accordingly, the
Company recorded a pre-tax impairment loss of $300,000 in 2001
relating to that investment. During the year ended December 31,2000,
the Company did not find it necessary to recognize an impairment loss.
GOODWILL - In July 2001, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" ("SFAS 142"). SFAS 142 changes the
accounting for goodwill from an amortization method to an
impairment-only approach. Amortization of goodwill ceased upon adoption
58
of SFAS 142 on January 1, 2002. For each of the years ended December
31, 2001 and 2000, goodwill amortization was $384,000.
NCRIC's goodwill asset resulted from the 1999 acquisition of three
businesses which now operate as divisions of the Practice Management
Services Segment. NCRIC completed its initial goodwill impairment
testing under SFAS 142 and concluded that the goodwill asset was not
impaired as of the date of implementation of SFAS 142, nor was it
impaired as of December 31, 2002. Goodwill is reported net of
accumulated amortization of $909,000 as of December 31, 2002 and 2001.
DEFERRED POLICY ACQUISITION COSTS - Commissions and premium taxes
associated with acquiring insurance that vary with and are directly
related to the production of new and renewal business are deferred and
amortized over the terms of the policies to which they relate. Deferred
policy acquisition costs totaled approximately $1.5 million and
$850,000 as of December 31, 2002 and 2001, respectively, and are
reported as a component of other assets. Since NCRIC's insurance
policies are generally written for a term of one year, the entire
year-end balance is amortized in the following year. NCRIC amortized
$2.9 million, $1.4 million and $645,000 in the years ended December 31,
2002, 2001 and 2000, respectively. Amortization is reported as a
component of underwriting expense.
PROPERTY AND EQUIPMENT - Fixed assets are recorded at cost and reported
as a component of other assets. Depreciation is recorded using the
straight-line method over estimated useful lives ranging from three to
five years for computer software and equipment and furniture and
fixtures and ten years for leasehold improvements. The balances of
fixed assets of $2.0 million and $1.6 million as of December 31, 2002
and 2001, respectively, are net of accumulated depreciation of $1.9
million and $1.8 million.
LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES - Liabilities for
losses and loss adjustment expenses are established on the basis of
reported losses and a provision for losses incurred but not reported
and related loss adjustment expenses. These amounts are based on the
estimates of management and are subject to risks and uncertainties. As
facts become known, adjustments to these estimates are reflected in
earnings.
REINSURANCE - The Company protects itself from excessive losses by
reinsuring certain levels of risk in various areas of exposure. Amounts
recoverable from reinsurance are estimated in a manner consistent with
the loss and loss adjustment expense reserve associated with the
reinsured loss.
INCOME TAXES - The Company uses the asset and liability method of
accounting for income taxes. Under this method, deferred income taxes
are recognized for tax consequences of temporary differences by
applying enacted statutory tax rates applicable to future years to
differences between the financial statement carrying amounts and the
tax bases of existing assets and liabilities. The Company files a
consolidated Federal income tax return.
59
IMPAIRMENT OF LONG-LIVED ASSETS - The Company reviews long-lived assets
for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. During the
years ended December 31, 2002 and 2001, the Company did not find it
necessary to record a provision for impairment of assets.
USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles 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. Significant accounts
subject to management estimates are reinsurance recoverable,
liabilities for losses and loss adjustment expenses, retrospective
premiums accrued under reinsurance treaties, retrospective premiums
accrued under risk-sharing programs, and impairment of goodwill.
CONCENTRATIONS OF CREDIT RISK - Financial instruments which potentially
expose the Company to concentrations of risk consist principally of
cash equivalent investments, investments in securities and reinsurance
recoverables. Concentrations of credit risk for investments are limited
due to the large number of such investments and their distributions
across many different industries and geographical areas. Concentrations
of credit risk for reinsurance recoverables are limited due to the
large number of reinsurers participating in the program.
GEOGRAPHIC CONCENTRATION - NCRIC's market territory for its medical
professional liability insurance is limited to the District of
Columbia, Delaware, Maryland, Virginia and West Virginia. Because our
business is concentrated in a limited number of states, we may be
exposed to adverse developments that may have a greater affect on us
than the risks of doing business in a broader market area. In
particular, the lack of tort reform in the District of Columbia and
some of our other market areas exposes NCRIC to the potential for
extremely high jury awards. NCRIC's reinsurance program is designed to
provide protection against such a loss.
LITIGATION - The Company is subject to claims arising in the normal
course of its business. Management does not believe that any such
claims or assessments will have a material effect on the Company's
financial position, results of operations, or cash flows.
REVENUE RECOGNITION - Premiums revenue is earned pro rata over the
terms of the policies. The portion of premiums that will be earned in
the future are deferred and reported as unearned premiums. In 2000 and
1999, the Company declared renewal credit dividends to its
policyholders, which are payable in the form of a premium credit on the
succeeding year's policy premiums. Policyholder renewal credit
dividends are accrued as reductions to premium income in the policy
year declared.
The Company writes policies under certain retrospectively rated
programs. Premium
60
revenue related to these contracts is earned based on the contractual
terms and estimated losses under those contracts. Earned premiums are
premiums written reduced by premium refunds accrued. Premium refunds
are accrued to reflect the risk-sharing program results on a basis
consistent with the underlying loss experience.
Practice management revenue is recognized as services are performed
under terms of management and other contracts. Revenue is generally
billed in the month following the performance of related services.
STOCK-BASED COMPENSATION - As of December 31, 2002 and 2001 the company
has one stock option plan, which is described more fully in Note 10.
NCRIC Group accounts for compensation cost using the intrinsic value
based method prescribed by APB Opinion No. 25, "Accounting for Stock
Issued to Employees". Accordingly, no compensation expense was
recognized since the stock options granted were at an exercise price
equal to the fair market value of the common stock on the date the
options were granted.
The Company's pro forma information using the Black-Scholes valuation
model follows:
2002 2001 2000
------ ------- -----
Net income as reported $ 742 $1,579 $3,495
Less: Total stock based employee compensation,
net of related tax effect 37 64 64
------ ------ ------
Pro forma net income (in thousands) $ 705 $1,515 $3,431
====== ====== ======
Earnings per share - Basic as reported $ 0.21 $ 0.45 $ 0.99
Basic pro forma $ 0.20 $ 0.43 $ 0.97
Diluted as reported $ 0.20 $ 0.44 $ 0.98
Diluted pro forma $ 0.19 $ 0.42 $ 0.96
RECLASSIFICATION - Certain prior year amounts have been reclassified to
conform with the current year presentation.
2. ACQUISITION
On January 4, 1999, NCRIC Group acquired all of the outstanding shares
of HealthCare Consulting, Inc., all of the outstanding interests of HCI
Ventures, LLC, and all the assets of Employee Benefits Services, Inc.
Under terms of the purchase agreement, an additional $3.1 million could
be paid in cash if the acquired companies achieve earnings targets in
2000, 2001 and 2002.
The acquisition has been accounted for using the purchase method.
Goodwill was being amortized over 20 years on a straight-line basis.
With the adoption of SFAS 142 on January 1, 2002, the amortization of
goodwill ceased.
61
The acquired companies achieved the earnings target for 2000, and NCRIC
paid the prior owners $1.55 million on March 31, 2001. After analyzing
the acquired companies' operations since the acquisition, terms were
negotiated and agreed upon for an early payment of the second
contingent payment originally scheduled to be paid in 2002. As a
result, on June 23, 2001, NCRIC paid $1.46 million, the present value
of the remaining payments, to the prior owners. These payments were
added to the balance of goodwill.
In June 2001, NCRIC MSO, Inc. borrowed $1,971,000 from SunTrust Bank to
finance payments made in accordance with the purchase of HealthCare
Consulting, Inc., HCI Ventures, LLC, and Employee Benefits Services,
Inc. In September, 2002, the Company pledged securities to
collateralize this loan lowering the interest rate from a floating rate
of LIBOR plus two and three-quarter percent to plus one and one-half
percent. The term of the loan is 3 years. At December 31, 2002, the
interest rate was 2.93%. Principal and interest payments are due on a
monthly basis.
3. INVESTMENTS
The following tables show the amortized cost and fair value of
investments (in thousands):
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
As of December 31, 2002
U.S. Government and agencies $ 27,664 $ 292 $ (4) $ 27,952
Corporate 32,680 1,567 (488) 33,759
Tax-exempt obligations 30,416 2,309 (21) 32,704
Asset and mortgage-backed
securities 19,549 882 (150) 20,281
--------- ------- ------- ---------
110,309 5,050 (663) 114,696
Equity securities 5,561 150 (287) 5,424
--------- ------- ------- ---------
Total $ 115,870 $ 5,200 $ (950) $ 120,120
========= ======= ======= =========
As of December 31, 2001
U.S. Government and agencies $ 4,600 $ 161 $ - $ 4,761
Corporate 43,739 977 (1,311) 43,405
Tax-exempt obligations 19,304 634 (134) 19,804
Asset and mortgage-backed
securities 28,073 695 (15) 28,753
--------- ------- ------- ---------
95,716 2,467 (1,460) 96,723
Equity securities 6,691 118 (407) 6,402
--------- ------- ------- ---------
Total $ 102,407 $ 2,585 $(1,867) $ 103,125
========= ======= ======= =========
62
The amortized cost and fair value of debt securities at December 31,
2002 and 2001 are shown by maturity. Actual maturities will differ from
contractual maturities because borrowers may have the right to prepay
obligations with or without prepayment penalties.
DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------------- ------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
(IN THOUSANDS)
Due in one year or less $ 742 $ 750 $ 757 $ 778
Due after one year through five years 40,685 42,283 14,645 15,152
Due after five years through ten years 36,707 38,825 22,778 23,486
Due after ten years 12,626 12,557 29,463 28,554
--------- --------- --------- ---------
90,760 94,415 67,643 67,970
Equity securities 5,561 5,424 6,691 6,402
Asset and mortgage-backed securities 19,549 20,281 28,073 28,753
--------- --------- --------- ---------
Total $ 115,870 $ 120,120 $ 102,407 $ 103,125
========= ========= ========= =========
Proceeds from bond maturities and redemptions of available for sale
investments during the years ended December 31, 2002, 2001, and 2000,
were $39.0 million, $22.0 million, and $10.5 million, respectively.
Gross gains of $1,437,000, $787,000, and $16,000, and gross losses of
$1,568,000, $1,065,000, and $21,000, were realized on bond redemptions
and available for sale investments during years ended December 31,
2002, 2001, and 2000, respectively.
For the years ended December 31, 2002, 2001, and 2000 net investment
income earned was as follows (in thousands):
2002 2001 2000
-------- -------- -------
U. S Government and agencies $ 255 $ 470 $ 811
Corporate 3,038 3,144 2,252
Tax-exempt obligations 1,290 895 727
Asset and mortgage-backed securities 1,178 1,266 2,167
Equity securities 431 433 360
Short term investments 103 241 381
-------- ------- -------
Total investment income earned 6,295 6,449 6,698
Investment expenses (380) (313) (291)
-------- ------- -------
Net investment income $ 5,915 $ 6,136 $ 6,407
======== ======= =======
63
4. LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Liabilities for unpaid losses and loss adjustment expenses represent an
estimate of the ultimate net cost of all losses that are unpaid at the
balance sheet date and are based on the loss and loss adjustment
expense factors inherent in the Company's experience and expectations.
Estimation factors used by the Company reflect current case-basis
estimates, supplemented by industry statistical data, and give effect
to estimates of trends in claim severity and frequency. These estimates
are continually reviewed, and adjustments, reflected in current
operations are made as deemed necessary.
Although the Company believes the liabilities for losses and loss
adjustment expenses are reasonable and adequate for the circumstances,
it is possible that the Company's actual incurred losses and loss
adjustment expenses will not conform to the assumptions inherent in the
determination of the liabilities. Accordingly, the ultimate settlement
of losses and the related loss adjustment expenses may vary from the
amounts included in the financial statements.
Activity in the liabilities for losses and loss adjustment expenses is
summarized as follows (in thousands):
YEAR ENDED DECEMBER 31,
---------------------------------------
2002 2001 2000
--------- ---------- ----------
BALANCE, Beginning of year $ 84,560 $ 81,134 $ 84,282
Less reinsurance recoverable on
unpaid claims 29,624 27,312 25,815
--------- ---------- ----------
NET BALANCE 54,936 53,822 58,467
--------- ---------- ----------
Incurred related to:
Current year 24,063 23,056 17,829
Prior years 2,766 (4,198) (5,883)
--------- ---------- ----------
Total incurred 26,829 18,858 11,946
--------- ---------- ----------
Paid related to:
Current year 1,491 1,599 917
Prior years 18,664 16,145 15,674
--------- ---------- ----------
Total paid 20,155 17,744 16,591
--------- ---------- ----------
NET BALANCE 61,610 54,936 53,822
Plus reinsurance recoverable on
unpaid claims 42,412 29,624 27,312
--------- ---------- ----------
BALANCE, End of year $ 104,022 $ 84,560 $ 81,134
========= ========== ==========
The net change in incurred losses related to prior years represents
development of net
64
losses incurred in prior years. This development results from the
re-estimation and settlement of individual losses not covered by
reinsurance, which are generally losses under $500,000. The 2002 change
is primarily reflective of adverse loss development for the 2001 and
2000 loss years, partially offset by favorable development in the 1999
and 1996 loss years; whereas, the 2000 change is primarily reflective
of the favorable loss development for the 1994, 1996, 1998 and 1999
loss years, partially offset by adverse development in the 1995 loss
year. The 1999 change is primarily reflective of the favorable loss
development for the 1992 through 1996 loss years. The change in
development over the three-year period ended December 31, 2002,
reflects the increase in severity, which reflects the growing size of
plaintiff verdicts and settlements.
5. TRUST PREFERRED SECURITIES
On December 4, 2002, the Company issued trust preferred securities
(TPS) in the amount of $15,000,000 in a pooled transaction to unrelated
investors. The Company estimates that the fair value of the TPS issued
approximates the proceeds of cash received at the time of issuance. The
Company contributed $13,500,000 of the funds raised to the statutory
surplus of its insurance subsidiaries.
The TPS have a maturity of thirty years, and bear interest at an annual
rate equal to three-month LIBOR plus 4.00%, payable quarterly beginning
March 4, 2003. Interest is adjusted on a quarterly basis provided that
prior to December 4, 2007, this interest rate shall not exceed 12.50%.
The Company may defer payment of interest on the TPS for up to twenty
consecutive quarters. The TPS are callable by the Company at par
beginning December 4, 2007.
The initial interest rate is 5.42% and $62,000 in interest was accrued
for the year ended December 31, 2002. Issuance costs of $451,000 were
incurred related to the TPS and included in other assets. Issuance
costs will be amortized over thirty years as a component of other
expense.
The Company formed NCRIC Statutory Trust I for the purpose of issuing
the TPS. The gross proceeds from issuance were used to purchase Junior
Subordinated Deferrable Interest Debentures, the Debentures, from the
Company. The Debentures are the sole assets of the NCRIC Statutory
Trust I. The Debentures have a maturity of thirty years, and bear
interest at an annual rate equal to three-month LIBOR plus 4.00%,
payable quarterly beginning March 4, 2003. Interest is adjusted on a
quarterly basis provided that prior to December 4, 2007, the interest
rate shall not exceed 12.50%. The Debentures are callable by the
Company at par beginning December 4, 2007. The Debentures are unsecured
obligations of the Company and are junior in the right of payment to
all future senior indebtedness of the Company. The Debentures and
related investment in NCRIC Statutory Trust I have been eliminated in
consolidation.
65
6. REINSURANCE AGREEMENTS
The Company has reinsurance agreements that allow the Company to write
policies with higher coverage limits than it is individually capable or
desirous of retaining by reinsuring the amount in excess of its
retention. The Company has both excess of loss treaties and quota share
treaties.
The Company would sustain the loss in the event the reinsurers are
unable to meet their obligations under these contracts. There were
unused letters of credit executed by reinsurers in favor of the Company
of $128,000 at December 31, 2002 and 2001. Such letters of credit are
issued as security against ceded losses recoverable in the future.
The effect of reinsurance on premiums written and earned for the years
ended are as follows (in thousands):
DECEMBER 31
--------------------------- --- --------------------------- -- ----------------------------
2002 2001 2000
--------------------------- --------------------------- ----------------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
Direct $ 51,799 $ 44,113 $ 34,459 $ 28,192 $ 22,727 $ 19,965
Ceded
Current year (18,409) (14,429) (12,238) (8,992) (7,746) (5,982)
Prior Year 406 406 1,696 1,696 1,872 1,872
-------- -------- -------- -------- -------- --------
Total Ceded (18,003) (14,023) (10,542) (7,296) (5,874) (4,110)
-------- -------- -------- -------- -------- --------
Net before renewal
credits $ 33,796 $ 30,090 $ 23,917 $ 20,896 $ 16,853 $ 15,855
======== ======== ======== ======== ======== ========
7. INCOME TAXES
Deferred income tax is created by temporary differences that will
result in net taxable amounts in future years due to the differing
treatment of certain items for tax and financial statement purposes.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities
consist of the following (in thousands):
66
AS OF DECEMBER 31,
----------------------------------------
2002 2001
---------------- ----------------
Deferred tax assets:
Unearned premiums $ 1,670 $ 903
Discounted loss reserves 3,034 2,709
Depreciation and amortization 117 71
Capital loss carry-forwards 150 107
Allowance for doubtful accounts 608 165
Other 163 156
--------- ---------
5,742 4,111
Deferred tax liabilities
Change in tax accounting method - (1,084)
Fair valuation of investments (1,446) (244)
Deferred policy acquisition costs (503) (289)
Other (4) (12)
--------- ---------
(1,953) (1,629)
--------- ---------
Net Deferred tax assets $ 3,789 $ 2,482
========= =========
The capital losses can be carried forward for five years. Management
expects to utilize the current capital loss carry-forwards within that
period.
The income tax provision (benefit) consists of the following:
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------
2002 2001 2000
----------- ---------- ----------
Federal:
Current $ 2,214 $ 1,734 $ 1,220
Deferred (2,501) (1,206) 298
--------- --------- ----------
(287) 528 1,518
State:
Current (28) 83 53
Deferred (7) (14) (10)
--------- --------- ----------
(35) 69 43
--------- --------- ----------
Total provision (benefit) $ (322) $ 597 $ 1,561
========= ========= ==========
Federal income tax expense differs from that calculated using the
established corporate rate primarily due to nontaxable investment
income, as follows (in thousands):
67
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------
2002 2001 2000
------------------------- ------------------------- -------------------------
AMOUNT % OF AMOUNT % OF AMOUNT % OF
PRETAX PRETAX PRETAX
INCOME INCOME INCOME
Federal income tax
at statutory rates $ 142 34% $ 740 34% $ 1,719 34%
Tax-exempt income (374) (89) (259) (12) (209) (4)
Dividends received (87) (21) (88) (4) (73) (1)
Goodwill - - 115 5 74 1
Other (3) (1) 89 4 50 1
------- ------- ------- ------ ------- -----
Income tax
at effective rates $ (322) (77)% $ 597 27% $ 1,561 31%
======= ======= ======= ====== ======= =====
8. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share data):
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------
2002 2001 2000
--------- ---------- --------
Net income $ 742 $ 1,579 $ 3,495
========= ========== ========
Weighted average common shares outstanding - basic 3,557 3,529 3,526
Dilutive effect of stock options 75 86 33
--------- ---------- --------
Weighted average common shares outstanding - diluted 3,632 3,615 3,559
--------- ---------- --------
Net income per common share:
Basic $ 0.21 $ 0.45 $ 0.99
========= ========== ========
Diluted $ 0.20 $ 0.44 $ 0.98
========= ========== ========
Earnings per share is calculated by dividing the net income by the
weighted average shares outstanding for the period.
9. COMMITMENTS
NCRIC entered into an operating lease for office space located in
Washington, D.C., effective on April 15, 1998. The lease terms are for
10 years with a monthly base rent of $35,000 and a 2.0% annual
escalator. The Company also maintains office space in Lynchburg,
Richmond, and Fredericksburg, Virginia as well as in Greensboro, North
Carolina.
68
As of December 31, 2002, the future minimum annual commitments under
noncancellable leases are as follows:
2003 $ 628,000
2004 624,000
2005 638,000
2006 652,000
2007 643,000
Thereafter 177,000
-----------
Total $ 3,362,000
===========
Rent expense during the years ended December 31, 2002, 2001, and 2000
was $634,000, $662,000, and $678,000, respectively.
NCRIC has established 3 letters of credit to secure specified amounts
of appellate bonds for cases, which are in the District of Columbia
appellate process. As of December 31, 2002, these letters of credit
totaled $3.2 million.
The Company and its subsidiaries have entered into four employment
agreements with certain key employees. These agreements include
covenants not to compete and provide for aggregate annual compensation
of $945,000.
In June 2001, NCRIC MSO, Inc. borrowed $1,971,000 from SunTrust Bank to
finance payments made in accordance with the purchase of HealthCare
Consulting, Inc., HCI Ventures, LLC, and Employee Benefits Services,
Inc. In September, 2002, the Company pledged securities held in our
investment portfolio with a fair value of $1.5 million at December 31,
2002, to collateralize this loan lowering the interest rate from a
floating rate of LIBOR plus two and three-quarter percent to plus one
and one-half percent. The term of the loan is 3 years. At December 31,
2002, the interest rate was 2.93%. At December 31, 2001, the interest
rate was 4.83%. Principal and interest payments are due on a monthly
basis.
10. BENEFIT PLANS
DEFINED CONTRIBUTION PLANS - NCRIC sponsors a defined contribution
401(k) profit-sharing plan. Employees who are 21 years or older and
have completed 30 days of service are eligible for participation in the
plan. Employees may elect to contribute up to 15% of total
compensation, and all contributions are 100% vested. Effective January
1, 2002 both NCRIC MSO plans were merged into NCRIC's plan. NCRIC is
not required to make matching contributions to the plan, but may make
discretionary contributions. Total contributions to the plan by NCRIC
for the years ended December 31, 2002, 2001, and 2000, were $328,000,
$145,000, and $177,000, respectively.
69
NCRIC MSO sponsored two plans for its employees. The first plan was a
defined contribution money purchase plan in which employees who are 21
years or older and have two years of service are eligible to
participate. Under the plan, NCRIC MSO contributed 3% of each
participant's total annual compensation. All contributions are 100%
vested. The contributions from NCRIC MSO for the years ended December
31, 2001, and 2000 were $67,000, and $57,000.
The second plan was a defined contribution 401(k) profit-sharing plan.
Employees who were 21 years or older and had one year of service were
eligible for participation in the plan. Employees could elect to
contribute up to 15% of total compensation. All contributions were 100%
vested. NCRIC MSO was not required to make matching contributions to
the plan, but could make discretionary contributions. Total
contributions to the plan by NCRIC MSO for year ended December 31, 2000
were $76,000. No contribution was made for the year ended December 31,
2001.
STOCK OPTION PLAN - NCRIC Group has a stock option plan for directors
and officers of Mutual Holding Company and its subsidiaries. Options
for common stock in an aggregate amount of 74,000 shares were granted
at July 29, 1999. The options have terms of ten years and an exercise
price of $7 per share, the fair market value of the common stock at the
date of grant. The options became exercisable at a rate of 33-1/3% at
the end of each 12 months of service with NCRIC Group or its
subsidiaries after the date of grant. As of December 31, 2002, all
options are exercisable.
NCRIC Group accounts for compensation cost using the intrinsic value
based method prescribed by APB Opinion No. 25, "Accounting for Stock
Issued to Employees". Accordingly, no compensation expense was
recognized since the stock options granted were at an exercise price
equal to the fair market value of the common stock on the date the
options were granted. Statement of Financial Accounting Standards No.
123, ACCOUNTING FOR STOCK-BASED COMPENSATION, requires disclosure of
the pro forma net income and earnings per share as if the Company had
accounted for its stock options under the fair value method defined in
that Statement.
The exercise price per share for the 74,000 options outstanding at
December 31, 2002 is $7.00. The weighted average remaining contractual
life of those options is 6.6 years, 7.6 years, and 8.6 years at
December 31, 2002, 2001, 2000, respectively. There was no change in the
number of options outstanding or the exercise price since December 31,
1999.
For pro forma disclosure purposes, the fair value of stock options was
estimated at the date of grant using a Black-Scholes option pricing
model using the following assumptions: risk free rate of return of
3.50%; no dividends granted during the life of the option; volatility
factors of the expected market price of the Company's common stock
ranging from .489 to .843; and an expected life of the option of 10
years.
70
EMPLOYEE STOCK OWNERSHIP PLAN - NCRIC Group has an ESOP for employees
who have attained age 21 and completed one year of service. As part of
the stock offering, the ESOP borrowed $1.0 million from NCRIC Group to
purchase 148,000 shares, which are held in a trust account for
allocation among participants as the loan is repaid. For shares
allocated to the accounts of the ESOP participants as the result of
payments made to reduce the ESOP loan, the compensation charge is based
upon the average fair value of the shares over the service period.
Scheduled loan repayments on December 31, 2002, 2001, and 2000 have
been made. During the years ended December 31, 2002, 2001, and 2000
contributions were made to the plan of $162,800, $162,800 and $120,000,
respectively. During 2002, 2001 and 2000, 14,800 shares were allocated
to the plan.
STOCK AWARD PLAN - NCRIC Group has a stock award plan under which
directors, officers and employees of Mutual Holding Company and its
subsidiaries would be awarded common stock. As a part of the stock
offering, the stock award plan borrowed $518,000 from NCRIC Group to
purchase 74,000 shares, which are held in a trust account for
allocation among participants. Scheduled loan repayments on December
31, 2002, 2001, and 2000 have been made. On September 10, 2000, NCRIC
Group granted 74,000 shares of common stock to directors and officers
under its stock award plan. The compensation expense is measured at the
fair value of the stock on the grant date, $7.875 per share, over the
vesting period. For the years ended December 31, 2002, 2001 and 2000,
the expense was $153,800, $153,800 and $47,200, respectively.
11. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS
The effects on these GAAP financial statements of the differences
between the statutory basis of accounting prescribed or permitted by
the District of Columbia Department of Insurance and Securities
Regulation (DISR) and GAAP are summarized below (in thousands):
DECEMBER 31,
----------------------------------------
2002 2001 2000
--------- -------- ---------
POLICYHOLDERS' SURPLUS -
STATUTORY BASIS $ 44,269 $ 32,759 $ 29,764
Fair valuation of investments 2,806 474 (744)
Deferred taxes 3,012 2,726 1,535
Group stock issuance 7,642 7,353 7,145
Capital contribution (13,500) - -
Nonadmitted assets and other 3,588 1,142 3,749
--------- -------- ---------
STOCKHOLDERS' EQUITY - GAAP BASIS $ 47,817 $ 44,454 $ 41,449
========= ======== =========
NET INCOME - STATUTORY BASIS $ (1,510) $ 593 $ 4,409
Deferred taxes 2,508 1,220 (287)
GAAP consolidation and other (256) (234) (627)
--------- -------- ---------
NET INCOME - GAAP BASIS $ 742 $ 1,579 $ 3,495
========= ======== =========
As of December 31, 2002, 2001, and 2000, statutory capital and surplus
for NCRIC was sufficient to satisfy regulatory requirements. Each
insurance company is restricted under
71
the applicable Insurance Code as to the amount of dividends it may pay
without regulatory consent.
In March 1998, the National Association of Insurance Commissioners
adopted the Codification of Statutory Accounting Principles
(Codification). The Codification, which is intended to standardize
regulatory accounting and reporting for the insurance industry, was
effective January 1, 2001. The effect on NCRIC's statutory surplus on
January 1, 2001 was an increase of $1.6 million. This increase is
primarily due to the effect of the recognition of deferred taxes and
the removal of the excess of statutory reserves over statement reserves
penalty, partially offset by charges to surplus for overdue premium
receivables.
The District of Columbia has adopted the National Association of
Insurance Commissioners' statutory accounting practices as the basis of
its prescribed statutory accounting practices. In addition the
Commissioner of the DISR has the right to permit other specific
practices that may deviate from prescribed practices.
During 1999, NCRIC received permission from DISR to include as admitted
assets its investments in asset-backed securities, which are not
specifically authorized as permitted investments under D.C. regulations
as the total investment exceeds five percent of total admitted assets.
12. REPORTABLE SEGMENT INFORMATION
The Company has two reportable segments: Insurance and Practice
Management Services. The insurance segment provides medical
professional liability and other insurance. The practice management
services segment provides medical practice management services to
private practicing physicians. The accounting policies of the segments
are the same as those described in the summary of significant
accounting policies. The Company evaluates performance based on profit
and loss from operations before income taxes.
The Company's reportable segments are strategic business units that
offer different products and services and therefore are managed
separately. Selected financial data is presented below for each
business segment for the year ended December 31 (in thousands):
2002 2001 2000
---- ---- ----
INSURANCE
Revenues from external customers $ 31,023 $ 21,118 $ 14,990
Net investment income 5,877 6,087 6,317
Depreciation and amortization 524 193 208
Segment profit before taxes 1,323 2,834 5,394
Segment assets 190,522 152,130 137,618
Segment liabilities 138,297 114,424 102,542
Expenditures for segment assets 637 153 677
72
PRACTICE MANAGEMENT SERVICES
Revenues from external customers $ 5,886 $ 6,239 $ 5,396
Net investment income 27 55 84
Depreciation and amortization 137 555 448
Segment profit before taxes 83 205 456
Segment assets 8,290 9,188 8,114
Segment liabilities 2,800 3,762 2,541
Expenditures for segment assets 82 247 50
TOTAL
Revenues from external customers $ 36,909 $ 27,357 $ 20,386
Net investment income 5,904 6,142 6,401
Depreciation and amortization 661 748 656
Segment profit before taxes 1,406 3,039 5,850
Segment assets 198,812 161,318 145,732
Segment liabilities 141,097 118,186 105,083
Expenditures for segment assets 719 400 727
The following are reconciliations of reportable segment revenues, net
investment income, assets, liabilities, and profit to the Company's
consolidated totals (in thousands):
2002 2001 2000
---- ---- ----
REVENUES:
Total revenues for reportable segments $ 36,909 $ 27,357 $ 20,386
Other Income 8 12 23
Elimination of intersegment revenues (6) (8) (11)
-------- --------- -------
Consolidated total $ 36,911 $ 27,361 $ 20,398
======== ========= =======
Net Investment Income:
Total investment income for reportable segments $ 5,904 $ 6,142 $ 6,401
Elimination of intersegment income (4) (6) -
Other Unallocated amounts 15 - 6
------- --------- -------
Consolidated total $ 5,915 $ 6,136 $ 6,407
======= ========= =======
Assets:
Total assets for reportable segments $ 198,812 $ 161,318 $145,732
Elimination of intersegment receivables (1,324) (1,675) (740)
Elimination of affiliate receivables 120 1,139 487
Other unallocated amounts 5,079 220 385
-------- -------- -------
Consolidated total $ 202,687 $ 161,002 $145,864
======== ======== =======
73
Liabilities:
Total liabilities for reportable segments $ 141,097 $118,186 $105,083
Elimination of intersegment payables (1,324) (1,675) (740)
Other liabilities 15,097 37 72
--------- --------- --------
Consolidated total $ 154,870 $116,548 $104,415
========= ========= ========
Profit before taxes:
Total profit for reportable segments $ 1,406 $ 3,039 $ 5,850
Other unallocated amounts (986) (863) (794)
--------- -------- -------
Consolidated total $ 420 $ 2,176 $ 5,056
========= ======== =======
13. TRANSACTIONS WITH AFFILIATES
NCRIC MSO rented an office building for one of its divisions from a
partnership whose partners are HealthCare Consulting senior executives.
The lease terminated October 31, 2002. For this property, NCRIC MSO
paid approximately $57,000 in rent for the year ended December 31, 2002
and $62,000 for the years ended December 31, 2001 and 2000.
During 2002, 2001, and 2000, members of the Company's Board of
Directors paid NCRIC MSO approximately $163,000, $183,000 and $157,000,
respectively, for practice management related services.
14. SUBSEQUENT EVENTS
January 28, 2003, the Mutual Holding Company and the Company announced
that their respective boards of directors approved a plan of conversion
and reorganization for NCRIC MHC which will complete the transition of
the Company to full public stock ownership.
As part of the conversion, the Mutual Holding Company will terminate
its existence, and the ownership interest of the Mutual Holding Company
in the Company will be offered for sale to members and others on a
priority basis in a subscription offering. The Mutual Holding Company
currently owns approximately 60% of the outstanding shares of the
Company.
To complete the conversion, approval is needed from the members of
Mutual Holding Company, the Commissioner of the District of Columbia
Department of Insurance and Securities Regulation, and shareholders of
the Company. It is expected that members of the Mutual Holding Company
and shareholders of the Company will be asked to approve the proposed
conversion and reorganization plan in June 2003.
The Mutual Holding Company members will receive priority subscription
rights to purchase shares issued in the conversion offering. Any
shares of the Company that are not purchased by members, the Company's
employee stock ownership plan, and officers, directors, and employees
will be offered for sale to the public in a community offering.
74
As part of the conversion, shareholders of the Company will have their
existing shares exchanged for new shares of NCRIC Group, Inc., a
Delaware corporation, based on an exchange ratio that assures that they
receive the same proportionate ownership interest in the new
corporation as their existing ownership interest in the Company
immediately prior to the conversion and reorganization.
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations
for 2002, 2001 and 2000:
Year Ended December 31, 2002
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
Premiums earned and other revenues $8,339 $8,702 $9,478 $ 10,392
Net investment income 1,550 1,524 1,444 1,397
Realized investment gains (losses) (36) (574) 6 473
Net income (loss) 534 198 (791) 801
Basic earnings per share of common
stock $ 0.15 $ 0.06 $(0.22) $ 0.22
Diluted earnings per share of
common stock $ 0.15 $ 0.05 $(0.22) $ 0.22
Year Ended December 31, 2001
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
Premiums earned and other revenues $6,494 $6,397 $6,909 $ 7,561
Net investment income 1,558 1,538 1,521 1,519
Realized investment gains (losses) 95 2 97 (472)
Net income (loss) 930 315 646 (312)
Basic earnings per share of common
stock $ 0.26 $ 0.09 $ 0.18 ($ 0.09)
Diluted earnings per share of
common stock $ 0.26 $ 0.09 0.18 ($ 0.09)
75
Year Ended December 31, 2000
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
Premiums earned and other revenues $5,106 $5,094 $5,224 $4,974
Net investment income 1,594 1,588 1,632 1,593
Realized investment gains (losses) - - - (5)
Net income (loss) 878 851 842 924
Basic earnings per share of common
stock $ 0.25 $ 0.24 $ 0.24 $ 0.26
Diluted earnings per share of
common stock $ 0.25 $ 0.24 $ 0.24 $ 0.26
76
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE I
SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2002 (IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------
AMOUNT AT
WHICH SHOWN IN
TYPE OF INVESTMENT COST (1) VALUE BALANCE SHEET
Fixed Maturities:
United States Government and government
agencies and authorities $ 27,664 $ 27,952 $ 27,952
States, municipalities, and political subdivisions 30,416 32,704 32,704
All other corporate bonds 32,680 33,759 33,759
Asset and mortgage-backed securities 19,549 20,281 20,281
Redeemable preferred stocks 4,561 4,330 4,330
--------- --------- --------
Total fixed maturities 114,870 119,026 119,026
Equity securities:
Industrial, miscellaneous, and all other - - -
Nonredeemable preferred stocks 1,000 1,094 1,094
--------- --------- ---------
Total equity securities 1,000 1,094 1,094
Total investments $ 115,870 $ 120,120 $ 120,120
========= ========= =========
(1) Original cost of equity securities, and, as to fixed maturities, original
costs reduced by repayments and adjusted for amortization of premiums or accrual
of discounts.
77
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET
AS OF DECEMBER 31, 2002 AND 2001 (IN THOUSANDS)
- ---------------------------------------------------------------------------------------------------------
2002 2001
ASSETS
INVESTMENTS:
Investments in subsidiaries* $ 58,179 $ 42,248
Bonds 3,392 -
-------- --------
Total investments 61,571 42,248
OTHER ASSETS:
Cash and cash equivalents 99 25
Receivables 60 133
Property and equipment, net 973 904
Due from subsidiaries* 120 1,162
Other assets 555 18
-------- --------
TOTAL ASSETS $ 63,378 $ 44,490
======== ========
-
LIABILITIES AND STOCKHOLDERS' EQUITY
Junior Subordinated Deferrable Interest Debentures $ 15,464 $ -
Other liabilities 97 36
-------- --------
TOTAL LIABILITIES 15,561 36
-------- --------
STOCKHOLDERS' EQUITY:
Common stock 37 37
Other stockholders' equity, including unrealized gains
or losses on securities of subsidiaries 47,780 44,417
-------- --------
TOTAL STOCKHOLDERS' EQUITY 47,817 44,454
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 63,378 $ 44,490
======== ========
* Eliminated in consolidation. See notes to condensed financial statements.
78
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY)
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS)
- ---------------------------------------------------------------------------------------------------------
2002 2001 2000
REVENUES:
Net investment income $ 16 $ - $ 7
Dividends from subsidiaries* 1,750 1,500 1,500
Other income 7 12 22
------- -------- --------
Total revenues 1,773 1,512 1,529
------- -------- --------
EXPENSES:
Other operating expenses 670 875 824
------- -------- --------
Total expenses 670 875 824
------- -------- --------
INCOME BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF SUBSIDIARIES 1,103 637 705
Equity in undistributed earnings of subsidiaries (361) 942 2,790
------- -------- --------
NET INCOME $ 742 $ 1,579 $ 3,495
======= ======== ========
* Eliminated in consolidation. See notes to condensed financial statements.
79
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY)
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001 (IN THOUSANDS)
- ---------------------------------------------------------------------------------------------------------
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 742 $ 1,579
Adjustments to reconcile net income
to net cash flows from operating activities:
Equity in undistributed earnings of subsidiaries 361 (942)
Amortization and depreciation 106 51
Stock released for coverage of benefit plans 319 337
Other changes in assets and liabilities: 639 (604)
--------- ---------
Net cash flows from operating activities 2,167 421
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (3,392) -
Investment in purchased business (13,960) (300)
Purchases of property and equipment (175) (73)
--------- ---------
Net cash flows from investing activities (17,527) (373)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from Junior Subordinated Deferrable Interest
Debentures 15,464 -
Payments to acquire treasury stock (30) (129)
--------- ---------
Net cash flows from financing activities 15,434 (129)
NET CHANGE IN CASH AND CASH EQUIVALENTS 74 (81)
--------- ---------
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 25 106
--------- ---------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 99 $ 25
========= =========
SUPPLEMENTARY INFORMATION:
Interest paid $ - $ -
========= =========
See notes to condensed financial statements.
80
NOTES TO CONDENSED FINANCIAL STATEMENTS
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
The accompanying condensed financial statements should be read in conjunction
with the consolidated financial statements and notes of NCRIC Group, Inc. and
Subsidiaries.
I. REORGANIZATION
On December 31, 1998, National Capital Reciprocal Insurance Company consummated
its plan of reorganization from a reciprocal insurer to a stock insurance
company and became a wholly owned subsidiary of NCRIC Group, Inc. (Group) and
converted into NCRIC, Inc. Group has no historical operations and was organized
in December, 1998, as part of the plan to reorganize its corporate structure.
II. BASIS OF PRESENTATION
In Group's financial statements, investment in subsidiaries is stated at cost
plus equity in undistributed earnings of subsidiaries since date of
reorganization plus unrealized gains and losses of subisidiaries' investments.
III. ACQUISITION
On January 4, 1999, Group acquired all of the outstanding shares of HealthCare
Consulting, Inc., all of the outstanding interests of HCI Ventures, LLC, and all
the assets of Employee Benefit Services. See Note 2 of the Notes to the
Consolidated Financial Statements.
IV. INVESTMENTS
See Investments in the Consolidated Financial Statements and in Note 3 of the
Notes to the Consolidated Financial Statements.
V. JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES
See Note 5 of the Notes to the Consolidated Financial Statements
VI. COMPREHENSIVE INCOME
See Comprehensive Income in the Consolidated Financial Statements.
VII. INCOME TAXES
Group and its eligible subsidiaries file a consolidated U.S Federal Income tax
return. Income tax liabilities or benefits are recorded by each subsidiary based
upon separate return calculations.
For further information on income taxes, see Income Taxes in Note 7 of the Notes
to the Consolidated Financial Statements.
VIII. ACCOUNTING CHANGES
For information concerning new accounting standards adopted in 2002 and 2001,
see Note 1 of the Notes to the Consolidated Financial Statements.
81
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION
DECEMBER 31, 2002, 2001, AND 2000 (IN THOUSANDS)
- ---------------------------------------------------------------------------------------------------------------------------------
AMORTIZATION
DEFERRED FUTURE POLICY OTHER POLICY BENEFITS, OF DEFERRED
POLICY BENEFITS, LOSSES, CLAIMS AND NET LOSSES AND POLICY OTHER
ACQUISITION CLAIMS, AND UNEARNED BENEFITS PREMIUM INVESTMENT LOSS ACQUISITION OPERATING PREMIUMS
SEGMENT COSTS LOSS EXPENSES PREMIUMS PAYABLE REVENUE INCOME EXPENSES COSTS EXPENSES WRITTEN
- ------- ----- ------------- -------- ------- ------- ------ -------- ----- -------- -------
Insurance:
2002 $ 1,480 $ 104,022 $ 24,211 $ - $ 30,098 $ 5,915 $ 26,829 $ 2,890 $ 5,728 $ 51,799
2001 $ 851 $ 84,560 $ 17,237 $ - $ 20,603 $ 6,136 $ 18,858 $ 1,337 $ 3,890 $ 34,459
2000 $ 252 $ 81,134 $ 11,472 $ - $ 14,611 $ 6,407 $ 11,946 $ 645 $ 3,310 $ 22,727
82
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE IV
REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(IN THOUSANDS)
- --------------------------------------------------------------------------------
CEDED ASSUMED PERCENTAGE
PROPERTY AND GROSS TO OTHER FROM OTHER NET OF ASSUMED
LIABILITY INSURANCE AMOUNT COMPANIES COMPANIES AMOUNT TO NET
- ------------------- ------ --------- --------- ------ ------
2002 $ 44,113 $ (14,023) $ - $ 30,090 0%
2001 $ 28,192 $ (7,296) $ - $ 20,896 0%
2000 $ 19,965 $ (4,110) $ - $ 15,855 0%
83
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE V
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 2002 AND 2001 (IN THOUSANDS)
- -------------------------------------------------------------------------------------------------
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
DESCRIPTION OF YEAR EXPENSES DEDUCTIONS OF YEAR
----------- ------- -------- ---------- -------
2002
Allowance for Doubtful
Accounts $ 562 $ 1,367 $ (5) $ 1,924
2001
Allowance for Doubtful
Accounts $ 350 $ 415 $ (203) $ 562
84
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE VI
SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE COMPANIES
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(IN THOUSANDS)
- ----------------------------------------------------------------------------------------------------------------------------------
AMORTIZATION
DEFERRED RESERVE FOR LOSS AND LOSS OF DEFERRED PAID LOSS
POLICY UNPAID CLAIMS NET NET ADJUSTMENT EXPENSES POLICY AND LOSS
ACQUISITION AND CLAIM UNEARNED PREMIUMS INVESTMENT RELATED TO : (1) ACQUISITION ADJUSTMENT PREMIUMS
COSTS ADJUSTMENT EXPENSES PREMIUMS EARNED INCOME CURRENT YEAR PRIOR YEAR COSTS EXPENSES (1) WRITTEN
----- ------------------- -------- ------ ------ ------------- ---------- ----- ------------ -------
2002 $ 1,480 $ 104,022 $ 24,211 $ 30,098 $ 5,915 $ 24,063 $ 2,766 $ 2,890 $ 20,155 $ 51,799
2001 $ 851 $ 84,560 $ 17,237 $ 20,603 $ 6,136 $ 23,056 $ (4,198) $ 1,337 $ 17,744 $ 34,459
2000 $ 252 $ 81,134 $ 11,472 $ 14,611 $ 6,407 $ 17,829 $ (5,883) $ 645 $ 16,591 $ 22,727
(1) Loss and loss adjustment expenses shown net of reinsurance
85
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The table below lists certain information regarding our Board of
Directors, including the terms of office of the members of the Board of
Directors.
Shares of
Positions Common Stock
Held in the Director Term to Beneficially Percent
Name Age(1) Company Since(2) Expire Owned (3) of Class
----- ------ ------- -------- ------ --------- --------
DIRECTORS
Nelson P. Trujillo 65 Chairman of the Board 1980 2004 46,330 1.3%
R. Ray Pate, Jr. 43 President, Chief 1996 2003 60,365 1.6%
Executive Officer and
Vice Chairman of the Board
Vincent C. Burke, III 51 Director 1998 2005 4,370 *
Pamela W. Coleman 46 Director 1989 2005 10,821 *
Martin W. Dukes, Jr. 57 Director 1997 2004 2,620 *
Leonard M. Glassman 56 Director 1993 2003 22,770 *
Luther W. Gray, Jr. 62 Director 1984 2004 7,641 *
Prudence P. Kline 51 Director 1995 2005 3,720 *
Edward G. Koch 60 Director 1996 2004 3,020 *
J. Paul McNamara 53 Director 1998 2005 20,095 *
Leonard M. Parver 58 Director 1998 2004 14,912 *
Raymond Scalettar 73 Director 1980 2003 7,642 *
David M. Seitzman 73 Director 1980 2003 7,645 *
Robert L. Simmons 70 Director 1984 2003 9,220 *
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
Stephen S. Fargis 43 Senior Vice President and n/a n/a 34,640 *
Chief Operating Officer
Rebecca B. Crunk 51 Senior Vice President and n/a n/a 31,943 *
Chief Financial Officer
William E. Burgess 47 Senior Vice President and n/a n/a 18,235 *
Secretary
All Directors and Executive
Officers as a Group (17 persons) 305,989 8.2%
_______________________
* Less than 1%.
(1) As of March 1, 2003.
(2) With respect to years prior to 1998, as a governor of National Capital
Reciprocal Insurance Company, or a director of its attorney-in-fact, or its
subsidiary, Commonwealth Medical Liability Insurance Company.
(3) Includes shares of common stock held directly and by spouses or minor
children and in trust and other indirect ownership, as well as shares owned
under NCRIC, Inc.'s 401(k) Plan, ESOP, and Stock Award Plan and vested
stock options.
DIRECTORS
The principal occupation during the past five years of each director
and executive officer of NCRIC Group is set forth below. All directors have held
their present positions for five years unless otherwise stated.
NELSON P. TRUJILLO, M.D. is Chairman of the Board of Directors of NCRIC
Group and its subsidiaries. He was a governor and Chairman of the Board of
National Capital Reciprocal Insurance Company from 1980 until its mutual holding
company reorganization on December 31, 1998. Dr. Trujillo is currently President
of Metropolitan Gastroenterology Group where he is a physician.
86
R. RAY PATE, JR. is President and Chief Executive Officer of NCRIC
Group and NCRIC, Inc. and Chief Executive Officer of NCRIC MSO. He was the
Treasurer of National Capital Reciprocal Insurance Company and President, Chief
Executive Officer and Director of National Capital Underwriters, Inc.,
attorney-in-fact for National Capital Reciprocal Insurance Company, from 1996
until the mutual holding company reorganization in 1998. Since June 2000 he has
served as Vice Chairman of the Board of Directors.
VINCENT C. BURKE, III has been a director of NCRIC Group and
subsidiaries since the reorganization in 1998. He is a partner with the firm of
Furey, Doolan & Abell, LLP. From April 1992 to May 1998, he was counsel to the
law firm of Reed Smith Shaw & McClay. Mr. Burke's practice is in the areas of
corporate, business, real estate and closely-held businesses. He practices in
the District of Columbia and Maryland.
PAMELA W. COLEMAN, M.D. was a governor of National Capital Reciprocal
Insurance Company from 1989 until the mutual holding company reorganization in
1998, and has been a Director of NCRIC Group and subsidiaries since the
reorganization. Dr. Coleman is a urologist in private practice.
MARTIN W. DUKES, JR., M.D. was a Director of National Capital
Underwriters from 1997 until the mutual holding company reorganization in 1998,
a Director of NCRIC, Inc. since the reorganization, and a Director of NCRIC
Group and subsidiaries since May 2001. Dr. Dukes is a physician in private
practice in the District of Columbia.
LUTHER W. GRAY, JR., M.D. was a governor of National Capital Reciprocal
Insurance Company from 1984 until the mutual holding company reorganization in
1998 and has been a Director of NCRIC Group and subsidiaries since the mutual
holding company reorganization. He is currently the Chairman of the Underwriting
Committee for NCRIC, Inc. Dr. Gray is a physician and general surgeon with
Luther W. Gray, Jr., M.D., PC and is Chair of the Department of Surgery at
Sibley Memorial Hospital.
LEONARD M. GLASSMAN, M.D. was a Director of National Capital
Underwriters, Inc. from 1993 until the mutual holding company reorganization in
1998 and has been a director of NCRIC Group and subsidiaries since the
reorganization. He is currently the Chairman of the Investment Committee of
NCRIC, Inc. and served as Chairman of the Board of NCRIC, Inc. from 1998 until
2000. Dr. Glassman is a physician with Washington Radiology Associates, P.C. He
is a past member of the Finance Committee of the Medical Society of the District
of Columbia and was Chief of Radiology of Columbia Hospital for Women Medical
Center from 1984 to 1999.
PRUDENCE P. KLINE, M.D. was a Director of National Capital
Underwriters, Inc. from 1995 until the mutual holding company reorganization in
1998 and has been a director of NCRIC Group and subsidiaries since the
reorganization. Dr. Kline has been a physician in private practice in the
District of Columbia since 1986.
EDWARD G. KOCH, M.D. has served as a Director of Commonwealth Medical
Liability Insurance Company since 1996 and a director of NCRIC Group and
subsidiaries since the reorganization in 1998. Dr. Koch is a gynecological
physician in private practice in Arlington, Virginia and the District of
Columbia. Since 1997 he has been President of the Arlington County Medical
Society Foundation. Sponsored by the Medical Society of Virginia, he is an
alternate delegate to the AMA from Virginia.
J. PAUL MCNAMARA has been a director of NCRIC Group and subsidiaries
since the reorganization in 1998. He is President and Chief Operating Officer of
SequoiaBank
LEONARD M. PARVER, M.D. has been a Director of NCRIC Group and
subsidiaries since the reorganization in 1998. He was Chairman of the Board of
Directors of NCRIC MSO, Inc. from 1998 until 2000. He has practiced medicine in
the District of Columbia for the past 22 years.
RAYMOND SCALETTAR, M.D., D.SC., was Vice Chairman of the Board of
Directors of National Capital Underwriters, Inc. from 1980 until the mutual
holding company reorganization in 1998 and has been a director of NCRIC Group
and subsidiaries since the reorganization. He is a founder of the Washington
Internal Medicine Group, a health policy consultant, a past trustee and Chair of
the Board of Trustees of the AMA, and a past Commissioner and Senior Consultant
to the Joint Commission on Accreditation of HealthCare Organizations. As
President of the Medical Society of the District of Columbia in 1977, he
commissioned the study that led to the formation of NCRIC in 1980.
87
DAVID M. SEITZMAN, M.D. was a member of the Board of Directors of
National Capital Underwriters, Inc. from 1980 until the mutual holding company
reorganization in 1998 and has been a Director of NCRIC Group and subsidiaries
since the reorganization. Dr. Seitzman is now retired from the practice of
medicine. He served on the boards of Blue Cross and Blue Shield of the National
Capital Area and the Medical Society of the District of Columbia and served as
President and co-founder of the Center for Ambulatory Surgery, Inc. Since 1993,
Dr. Seitzman was a trustee of portfolios of The 59 Wall Street Fund, Inc., which
is advised by Brown Brothers Harriman & Co., one of NCRIC, Inc.'s investment
advisors until January 1, 2000.
ROBERT L. SIMMONS, M.D. was a member of the Board of Directors of
National Capital Underwriters, Inc. from 1984 until the mutual holding company
reorganization in 1998, a Director of NCRIC, Inc. since the reorganization, and
a Director of NCRIC Group and subsidiaries since May 2001. Dr. Simmons is Vice
President of Medical Affairs at Providence Hospital in the District of Columbia
and is a thoracic and cardiovascular surgeon.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
STEPHEN S. FARGIS was Senior Vice President - Business Development of
National Capital Underwriters, Inc. from 1995 until the mutual holding company
reorganization in 1998. Since the reorganization he has also been Senior Vice
President and Chief Operating Officer of NCRIC, Inc. and in 2001 was named
President of NCRIC MSO, Inc.
REBECCA B. CRUNK was the Chief Financial Officer of National Capital
Underwriters, Inc. from April 1998 until the mutual holding company
reorganization in 1998. Since the reorganization she has also been Senior Vice
President, Chief Financial Officer and Treasurer of NCRIC, Inc. Ms. Crunk is a
certified public accountant and is a member of the American Institute of
Certified Public Accountants. From 1995 to 1998, she was Vice President,
Treasurer and Controller of ReliaStar United Services Life Insurance Company.
WILLIAM E. BURGESS was Senior Vice President - Claims and Risk
Management of National Capital Underwriters, Inc. from August 1997 until the
mutual holding company reorganization in 1998. From 1993 to August 1997, he was
a Vice President of National Capital Underwriters, Inc. Since the reorganization
he has also been Senior Vice President and Secretary of NCRIC, Inc.
OWNERSHIP REPORTS BY OFFICERS AND DIRECTORS
The Common Stock of NCRIC Group is registered pursuant to Section 12(g)
of the Securities Exchange Act of 1934. The officers and directors of the
Company and beneficial owners of greater than 10% of the Company's common stock
("10% beneficial owners") are required to file reports on Forms 3, 4 and 5 with
the SEC disclosing changes in beneficial ownership of the Common Stock. SEC
rules require disclosure in the Company's Proxy Statement and Annual Report on
Form 10-K of the failure of an officer, director or 10% beneficial owner of the
Company's Common Stock to file a Form 3, 4 or 5 on a timely basis. All of the
Company's directors and officers filed these reports on a timely basis.
ITEM 11. EXECUTIVE COMPENSATION
DIRECTOR COMPENSATION
FEES. Each non-employee director of NCRIC Group (other than the
Chairman) receives annual cash compensation of $45,000. The Chairman of the
Board receives annual cash compensation of $80,000. Directors who are also
officers or employees of NCRIC Group do not receive any cash compensation
for serving as directors. Directors who serve on the nominating or the
compensation committee receive a fee of $400 for each committee meeting
attended ($500 for the Chairman of the committee). Directors who serve on
the nominating committee receive a fee of $300 for each committee meeting
attended ($350 for the Chairman of the committee). All directors are
reimbursed for out-of-pocket expenses in connection with attendance at any
meeting of the Board of Directors or any committee.
STOCK BENEFIT PLANS. Directors of NCRIC Group are eligible to
participate in and have received awards of stock options and restricted stock.
88
EXECUTIVE COMPENSATION
The following table sets forth information for the years ended December
31, 2002, 2001 and 2000 as to compensation paid to the President and Chief
Executive Officer and the other executive officers (collectively referred to as
"Named Executive Officers") who earned over $100,000 in salary and bonuses
during 2002.
========================================================================================================================
SUMMARY COMPENSATION TABLE
- ------------------------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION(1) LONG-TERM COMPENSATION
AWARDS
- --------------------------------------------------------------------------------------------------------
NAME AND PRINCIPAL POSITION FISCAL SALARY BONUS OTHER RESTRICTED OPTIONS/ ALL OTHER
ANNUAL STOCK SARS
YEAR(1) COMPENSATION AWARD(2) (#) COMPENSATION
- ------------------------------------------------------------------------------------------------------------------------
R. Ray Pate, Jr., 2002 $290,000 $ -0- - - - $26,208
President and Chief 2001 290,000 -0- - - - 22,346
Executive Officer 2000 240,000 60,000 - $104,895 - 22,528
- ------------------------------------------------------------------------------------------------------------------------
Stephen S. Fargis, 2002 $170,000 $ -0- - - - $24,339
Senior Vice President & 2001 170,000 -0- - - - 22,130
Chief Operating Officer 2000 151,667 30,308 - $ 69,930 - 22,312
- ------------------------------------------------------------------------------------------------------------------------
Rebecca B. Crunk, 2002 $170,000 $ -0- - - - $26,500
Senior Vice President & 2001 170,000 -0- - - - 22,453
Chief Financial Officer 2000 135,000 27,000 - $ 69,930 - 22,414
- ------------------------------------------------------------------------------------------------------------------------
William E. Burgess, 2002 $128,398 $ -0- - - - $18,739
Senior Vice President and 2001 120,000 -0- - - - 20,690
Secretary 2000 120,000 24,000 - $ 58,275 - 20,249
========================================================================================================================
_____________________
(1) For the fiscal years ended December 31.
(2) Equals the market value of the stock award on the date of the grant, which
was $7.875 per share. The total number and dollar value of unvested shares
of stock awarded to Mr. Pate, Mr. Fargis, Ms. Crunk and Mr. Burgess as of
December 31, 2002, based on the market value of the common stock on
December 31, 2002 ($11.00 per share), was 7,992, 5,328, 5,328 and 4,400
shares, and $87,912, $58,608, $58,608 and $48,400, respectively.
EMPLOYMENT AGREEMENTS. R. Ray Pate, Jr. serves as the President and
Chief Executive Officer of NCRIC Group under an employment agreement between
NCRIC Group and Mr. Pate dated January 1, 2001. Under the terms of his
employment agreement, Mr. Pate is entitled to basic compensation of $350,000 for
2003 and is reimbursed for all reasonable and proper business expenses incurred
by him in the performance of his duties. The terms of the employment agreement
also provide that Mr. Pate is entitled to participate in any retirement and/or
pension plans or health and medical insurance plans offered to NCRIC Group's
senior executives; receive use of an automobile; and be covered by both term
life insurance and disability insurance.
The term of the employment agreement is five years commencing January
1, 2001. NCRIC Group may terminate the employment agreement for cause or without
cause, at any time. Any dispute as to whether NCRIC Group had cause will be
determined by arbitration. If NCRIC Group terminates Mr. Pate's employment
agreement without cause, Mr. Pate is entitled to receive, as severance pay, an
amount equal to three years' base compensation at the level in effect on the
date of the termination. Mr. Pate may voluntarily terminate his employment
provided that he gives 60 days prior notice of his voluntary termination or pays
liquidated damages equal to the amount of his base compensation for two months.
NCRIC Group entered into an employment agreement commencing December 1,
2000 with Stephen S. Fargis on substantially similar terms to Mr. Pate's except
that Mr. Fargis' employment agreement terminates November 30, 2003, and provides
for base compensation of $200,000 for 2003.
NCRIC Group entered into an employment agreement commencing January 1,
2001 with Rebecca B. Crunk on substantially similar terms to Mr. Pate's, except
Ms. Crunk's agreement terminates December 31, 2003, and provides for base
compensation of $220,000 for 2003.
89
NCRIC Group entered into an employment agreement commencing January 1,
2002 with William E. Burgess on substantially similar terms to Mr. Pate's,
except Mr. Burgess' employment agreement terminates December 31, 2004, and
provides for base compensation of $175,000 for 2003.
STOCK OPTION PLAN. The Company has established a stock option plan for
its directors, officers and key employees. No options were granted to or
exercised by the named executive officers during 2002.
Set forth below is information relative to options outstanding at
December 31, 2002.
======================================================================================================
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES
======================================================================================================
NAME SHARES ACQUIRED VALUE NUMBER OF VALUE OF
SECURITIES
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT FISCAL OPTIONS AT FISCAL
UPON EXERCISE REALIZED YEAR-END YEAR-END(1)
-------------------- ---------------------
EXERCISABLE/ EXERCISABLE/
UNEXERCISABLE UNEXERCISABLE
- -------------------------- ----------------- -------------- -------------------- ---------------------
R. Ray Pate, Jr. 0 $ - 13,320/0 $53,280/0
- -------------------------- ----------------- -------------- -------------------- ---------------------
Stephen S. Fargis 0 $ - 9,250/0 $37,000/0
- -------------------------- ----------------- -------------- -------------------- ---------------------
William E. Burgess 0 $ - 7,400/0 $29,600/0
- -------------------------- ----------------- -------------- -------------------- ---------------------
Rebecca B. Crunk 0 $ - 7,400/0 $29,600/0
========================== ================= ============== ==================== =====================
______________________
(1) Equals the difference between the aggregate exercise price of the options
and the aggregate fair market value of the shares of common stock that
would be received upon exercise, assuming such exercise occurred on
December 31, 2002, at which date the closing price of the common stock as
quoted on the Nasdaq SmallCap Market was at $11.00.
DEFERRED COMPENSATION PLAN. Effective January 1, 2003, we established a
compensation deferral plan for officers and board members. The compensation
deferral plan is an unfunded plan and is matched by us in an amount equal to 5%
of total annual compensation. Contributions credited for an officer's deferral
account and the earnings attributable to these contributions shall be one
hundred percent vested or nonforfeitable when the officer has five years of
service in his or her position. Under the compensation deferral plan, officers
may defer up to 15% of total compensation and board members may defer up to 100%
of fees. Contributions are credited with a 6% guaranteed rate of return.
Pursuant to the terms of the plan, a participant's account balance will
be paid in cash by (a) lump sum, or (b) annual installments over a 5, 10 or 15
year period. The deferred compensation liability is recorded at the full
accumulation value of the accumulated contributions and interest and is included
in accrued expenses.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee has adopted a compensation strategy that
seeks to provide competitive compensation that is strongly aligned with our
business objectives and financial and stock performance. The compensation
program has three key elements: base salary, annual incentives and long-term
incentives. The Compensation Committee periodically reviews salary levels and
other aspects of executive compensation to ensure that our overall executive
compensation program remains competitive and that executive pay reflects both
the individual's performance and our company's performance.
We have an annual incentive plan based on a combination of our
Company's and the individual executive's performance in relation to established
objectives. Plan pay-outs vary based on our performance in relation to the
targeted objectives. Individual payments are then increased or decreased based
on the performance of the individual executive during the year. The target level
of incentive pay opportunities is 20% - 25% of base pay, with actual payments in
a range of zero to 150% of the target percentage based on performance levels. No
incentive pay-outs were made to the four executives in 2002 due to our 2002
financial results.
90
The Committee believes that long-term incentives are an effective way
of aligning executive compensation with the creation of value for the
shareholders through stock appreciation. The Stock Option Plan and the Stock
Award Plan were established in connection with the Initial Public Offering. The
stock options were allocated in 1999 and the restricted stock awards were
allocated in 2000.
In January 2001, we entered into a five-year employment agreement with
Mr. Pate. This employment agreement, with an annual base salary of $290,000 for
the Chief Executive Officer, was effective for the year 2002.
This report has been provided by the Compensation Committee
Vincent C. Burke, III, Esq., Chair
Prudence P. Kline, M.D.
David M. Seitzman, M.D.
Nelson P. Trujillo, M.D.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDERS PARTICIPATION
No member of our Compensation Committee has ever been an officer or
employee of NCRIC Group or of any of our subsidiaries. None of our executive
officers has served on the board of directors or on the compensation committee
of any other entity, for which any officers of that entity served either on our
Board or our Compensation Committee.
91
STOCK PERFORMANCE
The following graph compares the cumulative total return for our common
stock, the S&P 500 index, and a peer group of medical professional liability
insurance companies, for the period July 29, 1999, the first day of public
trading of our common stock on the Nasdaq SmallCap Market, through December 31,
2002. The graph assumes an investment on July 29, 1999 of $100 in each of NCRIC
Group's common stock, the stocks comprising the S&P 500 index, and the common
stocks of the peer group companies. The graph further assumes that all paid
dividends were reinvested. The peer group and the S&P 500 index are weighted by
market capitalization. The calculations for the information below were prepared
by SNL Securities, LC of Charlottesville, Virginia.
CUMULATIVE TOTAL RETURN
NCRIC GROUP, INC.
[TOTAL RETURN PERFORMANCE GRAPH GOES HERE]
92
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Persons and groups who beneficially own in excess of 5% of our common
stock are required to file certain reports with us and with the Securities and
Exchange Commission (SEC), regarding such ownership pursuant to the Securities
Exchange Act of 1934. The following table sets forth information regarding each
person known to be the beneficial owner of more than 5% of the issued and
outstanding shares of Common Stock of NCRIC Group on the Record Date. For
information regarding stock ownership by our directors and officers refer to the
information provided in Item 10 of this report.
AMOUNT OF SHARES
NAME AND ADDRESS OWNED AND NATURE PERCENT OF SHARES OF
OF BENEFICIAL OWNER OF BENEFICIAL OWNERSHIP COMMON STOCK OUTSTANDING
- ------------------------------- ----------------------- ------------------------
NCRIC, A Mutual Holding Company 2,220,000(1) 59.9%
1115 30th Street, N.W.
Washington, D.C. 20007
_______________
(1) Represents shares of common stock that are held by NCRIC Holdings, Inc.,
a wholly owned subsidiary of NCRIC, A Mutual Holding Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-14(c) and 15d-14(c) under the Exchange Act)
as of a date (the Evaluation Date) within 90 days prior to the filing date of
this report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the Evaluation Date, our disclosure
controls and procedures are effective to ensure that information required to be
disclosed in the reports that NCRIC Group, Inc. files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SEC's rules and forms. There have been no significant
changes in NCRIC Group, Inc.'s internal controls or in other factors that could
significantly affect these controls subsequent to the Evaluation Date.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K:
(a)(1) FINANCIAL STATEMENTS. The following consolidated financial statements
of NCRIC Group, Inc. and subsidiaries are included herein in accordance with
Item 8 of Part II of this report.
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Operations for the Years Ended December 31, 2002,
2001 and 2000
Consolidated Statements of Stockholders' Equity for the Years Ended December
31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002,
2001 and 2000
Notes to Consolidated Financial Statements for the Years Ended December 31,
2002, 2001 and 2000
(a)(2) FINANCIAL STATEMENT SCHEDULES. The following consolidated financial
statement schedules of NCRIC Group, Inc. and subsidiaries are included herein in
accordance with Item 8 of Part II of this report.
I. Summary of Investments - Other Than Investments in Related Parties
II. Condensed Financial Information of Registrant
III. Supplementary Insurance Information
93
IV. Reinsurance
V. Valuation and Qualifying Accounts
VI. Supplemental Information Concerning Property-Casualty Insurance
Companies
(a)(3) EXHIBITS. The following exhibits are filed as part of this report.
3.1 Articles of Incorporation of NCRIC Group, Inc.*
3.2 Bylaws of NCRIC Group, Inc.*
10.1 Stock Option Plan*
10.2 Stock Award Plan*
10.3 Employment Agreement between NCRIC Group, Inc., NCRIC Inc., and R. Ray
Pate, Jr.**
10.4 Employment Agreement between NCRIC Group, Inc, NCRIC, Inc. and Rebecca
B. Crunk**
10.5 Employment Agreement between NCRIC Group, Inc. and Stephen S. Fargis***
10.6 Employment Agreement with William E. Burgess****
10.7 Lease*
10.8 Amendment to Lease*
10.9 Termination Agreement and Release between NCRIC Group, Inc., NCRIC
MSO, Inc., HCI Ventures, LLC, and L.E. Shepherd Jr.,
William A. Hunter, Jr. and Barry S. Pillow**
10.10 Administrative Services Agreement*
10.11 Tax Sharing Agreement*
21 Subsidiaries
23.2 Consent of Deloitte & Touche LLP
99.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Incorporated herein by reference into this document from the Exhibits to
Form SB-2 Registration Statement, initially filed on December 23, 1998
and subsequently amended on April 15, 1999, March 12, 1999 and May 7,
1999, Registration No. 333-69537.
** Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 0-25505), originally filed with the Commission on March 27,
2002.
*** Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 0-25505), originally filed with the Commission on March 23,
2001.
**** Incorporated by reference into this document from the Exhibits to Form
S-1 Registration Statement, originally filed with the Commission on
March 25, 2003, Registration No. 333-104023.
(b) REPORTS ON FORM 8-K:
On December 4, 2002, NCRIC Group, Inc. filed a report on Form 8-K
relating to the issuance of $15 million of trust preferred securities.
(c) The exhibits listed under (a)(3) above are filed herewith.
(d) Not applicable.
94
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, R. Ray Pate, Jr., President and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of NCRIC 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 officers 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 officers 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 officers 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.
March 31, 2003 /s/ R. Ray Pate, Jr.
__________________ _____________________________________
Date R. Ray Pate, Jr.
President and Chief Executive Officer
95
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Rebecca B. Crunk, Senior Vice President and Chief Financial Officer, certify
that:
1. I have reviewed this annual report on Form 10-K of NCRIC 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 officers 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 officers 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 officers 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.
March 31, 2003 /s/ Rebecca B. Crunk
_______________ _________________________________________________
Date Rebecca B. Crunk
Senior Vice President and Chief Financial Officer
96
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.
NCRIC GROUP, INC.
Date: March 31, 2003 By: /s/ R. Ray Pate, Jr.
_____________________________________
R. Ray Pate, Jr.
Vice Chairman, President and Chief
Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURES TITLE DATE
/s/ Nelson P. Trujillo Chairman of the Board of March 31, 2003
_____________________________ Directors
Nelson P. Trujillo, M.D.
/s/ R. Pate, Jr. Vice Chairman of the Board of March 31, 2003
_____________________________ Directors, President and Chief
R. Ray Pate, Jr. Executive Officer (Principal
Executive Officer)
/s/ Rebecca B. Crunk Senior Vice President and Chief March 31, 2003
_____________________________ Financial Officer (Principal
Rebecca B. Crunk Financial and Accounting Officer)
/s/ Vincent C. Burke, III Director March 31, 2003
_____________________________
Vincent C. Burke, III
/s/ Pamela W. Coleman Director March 31, 2003
_____________________________
Pamela W. Coleman, M.D.
/s/ Martin W. Dukes, Jr. Director March 31, 2003
_____________________________
Martin W. Dukes, Jr., M.D.
/s/ Leonard M. Glassman Director March 31, 2003
_____________________________
Leonard M. Glassman, M.D.
/s/ Luther W. Gray, Jr. Director March 31, 2003
_____________________________
Luther W. Gray, Jr., M.D.
/s/ Prudence Pl Kline Director March 31, 2003
_____________________________
Prudence P. Kline, M.D.
97
/s/ Edward G. Koch Director March 31, 2003
_____________________________
Edward G. Koch, M.D.
/s/ J. Paul McNamara Director March 31, 2003
_____________________________
J. Paul McNamara
/s/ Leonard M. Parver Director March 31, 2003
_____________________________
Leonard M. Parver, M.D.
/s/ Raymond Scalettar Director March 31, 2003
_____________________________
Raymond Scalettar, M.D.
/s/ David M. Seitzman Director March 31, 2003
_____________________________
David M. Seitzman, M.D.
/s/ Robert L. Simmons Director March 31, 2003
_____________________________
Robert L. Simmons, M.D.
98
EXHIBIT INDEX
3.1 Articles of Incorporation of NCRIC Group, Inc.*
3.2 Bylaws of NCRIC Group, Inc.*
10.1 Stock Option Plan*
10.2 Stock Award Plan*
10.3 Employment Agreement between NCRIC Group, Inc., NCRIC Inc., and R. Ray
Pate, Jr.**
10.4 Employment Agreement between NCRIC Group, Inc, NCRIC, Inc. and Rebecca
B. Crunk**
10.5 Employment Agreement between NCRIC Group, Inc. and Stephen S. Fargis***
10.6 Employment Agreement with William E. Burgess****
10.7 Lease*
10.8 Amendment to Lease*
10.9 Termination Agreement and Release between NCRIC Group, Inc., NCRIC
MSO, Inc., HCI Ventures, LLC, and L.E. Shepherd Jr.,
William A. Hunter, Jr. and Barry S. Pillow**
10.10 Administrative Services Agreement*
10.11 Tax Sharing Agreement*
21 Subsidiaries
23.2 Consent of Deloitte & Touche LLP
99.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Incorporated herein by reference into this document from the Exhibits to
Form SB-2 Registration Statement, initially filed on December 23, 1998
and subsequently amended on April 15, 1999, March 12, 1999 and May 7,
1999, Registration No. 333-69537.
** Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 0-25505), originally filed with the Commission on March 27,
2002.
*** Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 0-25505), originally filed with the Commission on March 23,
2001.
**** Incorporated by reference into this document from the Exhibits to Form
S-1 Registration Statement, originally filed with the Commission on
March 25, 2003, Registration No. 333-104023.