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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2003
Commission File Number: 0-25505
[LOGO](SM) NCRIC Group, Inc.
District of Columbia 52-2134774
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
1115 30th Street, N.W., Washington, D.C. 20007
(Address of Principal Executive Offices)
202-969-1866
(Registrant's Telephone Number)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par
value $.01 per share
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|
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). NO |X|
As of March 5, 2004, there were issued and outstanding 6,898,865 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 March 5, 2004 was $57.0 million.
Documents Incorporated by Reference
The following documents, in whole or in part, are specifically incorporated by
reference in the indicated Part of this Annual Report on Form 10-K:
I. Portions of the NCRIC Group, Inc. Proxy Statement for the 2004 Annual Meeting
of Shareholders are incorporated by reference into certain items of Part III.
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 ........................... 53
Item 8. Financial Statements and Supplementing Data ........................................... 54
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .. 89
Item 9A. Controls and Procedures ............................................................... 89
PART III
Item 10. Directors and Executive Officers of the Registrant .................................... 89
Item 11. Executive Compensation ................................................................ 89
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters ........................................................... 89
Item 13. Certain Relationships and Related Transactions ........................................ 89
Item 14. Principal Accountant Fees and Services ................................................ 89
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K ....................... 89
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, other health care providers and medical practice
corporations 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, 2003. The following table shows our insurance segment policy count
and gross premiums written over the last eleven years.
Gross
Premiums
Written (in
Policy Count thousands)
------------ -----------
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
2003 4,229 71,365
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 Company, Inc., in 2002, we had
56.5% 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 approximately 91% for 2003 and 95% for January, 2004 eligible
renewals, 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. According to A.M. Best, in 2002, the most recent available, we had
the following market shares by jurisdiction:
NCRIC Market Share of
Market Departing
Share 2002 Carriers
---------- ---------------
District of Columbia 56.5% 9.5%
Delaware 7.7 57.5
Virginia 8.7 17.5
Maryland 3.3 22.4
West Virginia 7.5 31.9
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We have a strong management team with many years of industry experience.
R. Ray Pate, President and Chief Executive Officer, has 8 years with us and 19
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 20 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
26 years of experience in insurance industry accounting.
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, 2002 was
77.9%. This compares favorably to an average statutory operating ratio of 97.0%
for the property and casualty industry over the same period, according to data
published by A.M. Best. The long-tail nature of our business 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, 2002 our ratio of cash
and invested assets, which totaled $122.5 million, to statutory surplus was 2.8x
as compared to 2.9x for the property and casualty industry according to
information reported by A.M. Best, the most recent available industry data. For
the five years ended December 31, 2002, our net investment income averaged 29.4%
of net premiums earned compared to 13.2% 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, 2003, we generated $71.4 million of gross
premiums written, $47.3 million of net premiums earned and $61.3 million of
total revenues. At December 31, 2003, we had consolidated assets of $262.5
million, liabilities of $184.5 million, and stockholders' equity of $78.0
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;
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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;
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.
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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, and 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 2003, 6% of all new business was
written through direct distribution and 94% through independent agents. We
believe we can further increase 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.
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.
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 American Captive Corporation (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. 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 approximately
900 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 premium 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
5
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 raised additional capital through the 2003 stock offering to
better position ourselves to pursue further growth and market opportunities that
arise.
In our market areas, over the past 24 months we have experienced
contraction of competition. 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 2002 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
policies to their domiciled states leaving former policyholders seeking coverage
in our key markets of Delaware, Maryland and Virginia. Furthermore, financial
difficulties 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.
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 companies similar to us that offer a single line of insurance,
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 medical professional liability insurance policies in Washington, D.C.
According to A.M. Best 2002 data, the most recent available, we have 56.5% of
the District of Columbia medical professional liability market share. The
Doctors Company Insurance Group holds a 12.7% market share in the District of
Columbia. Professionals Advocate, a member of The Medical Mutual Group, holds an
8.5% market share in the District of Columbia.
Delaware. As a result of the withdrawal of Fireman's Fund, CNA Insurance
Companies and MLMIC Group from the Delaware market, which held 21.8%, 18.3% and
11.5%, respectively, of the Delaware market share, we are expanding our market
share among Delaware physicians. Companies licensed to do business in the state
include GE Global Insurance Group and SCPIE Holdings, Inc. which hold market
shares of 11.7% and 6.9%, respectively, based on 2002 data.
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 43% 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 three years. In 2002, The St. Paul Companies,
Princeton Insurance Company, CNA
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Insurance Companies 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.
West Virginia. We currently expect to reduce our business in West
Virginia. In 2004 we are non-renewing policies at their expiration and we are
not writing new business.
Insurance Activities
General. We provide medical professional liability insurance for
independent physicians, and their professional corporations, 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 an 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, 2003, we had approximately 616 open cases with an
average of 62 cases being handled by each claims representative. Our claims
department consists of 11 claims professionals and the level of education ranges
from certified paralegal to juris doctor. The current professional claims staff
has an average of 11 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
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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.
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 and 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 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 and 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 2003, our agent network totaled 33
agencies. These agents produced 94% of new premiums and 53% of renewing premiums
in 2003. 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 and
to foster enhanced communications with these top producers.
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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 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 continued to reduce 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 23 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
adjustment expenses, anticipated policyholder discounts or surcharges, and fixed
and variable operating expenses. In recognition of the increase in the severity
of losses and increases in other cost components, the weighted average rate
increase for our base premiums was 27% effective January 1, 2004, and 27%
effective January 1, 2003.
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;
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o predictions of future events;
o estimates of future trends in claims frequency and severity;
o predictions of future inflation rates;
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 between
notice of a claim and 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 prepares 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 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,
----------------------------------
2003 2002 2001
-------- -------- --------
(in thousands)
Balance, beginning of year ................. $104,022 $ 84,560 $ 81,134
Less reinsurance recoverable on unpaid
claims ................................... 42,412 29,624 27,312
-------- -------- --------
Net balance ................................ 61,610 54,936 53,822
-------- -------- --------
Incurred related to:
Current year ............................. 44,588 24,063 23,056
Prior years .............................. 5,885 2,766 (4,198)
-------- -------- --------
Total incurred ........................ 50,473 26,829 18,858
-------- -------- --------
Paid related to:
Current year ............................. 4,383 1,491 1,599
Prior years .............................. 26,382 18,664 16,145
-------- -------- --------
Total paid ............................ 30,765 20,155 17,744
-------- -------- --------
Net balance ................................ 81,318 61,610 54,936
Plus reinsurance recoverable on unpaid
claims ................................... 44,673 42,412 29,624
-------- -------- --------
Balance, end of year ....................... $125,991 $104,022 $ 84,560
======== ======== ========
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.
10
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 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
1993 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 1993 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.
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
------- ------- ------- ------- ------- ------- -------- -------- -------- --------
(in thousands)
Reserve for Unpaid
Losses and LAE .......... $88,891 $77,647 $68,928 $68,101 $72,031 $84,595 $ 84,282 $ 81,134 $ 84,560 $104,022
Cumulative Liability
Paid Through End of
Year:
One year later ........ 19,786 21,667 16,084 14,916 9,667 13,865 20,813 20,828 21,995 31,872
Two years later ....... 39,293 34,829 27,634 22,237 21,810 32,778 38,078 34,253 45,764
Three years later ..... 47,348 43,237 32,409 29,135 36,310 42,381 44,696 47,273
Four years later ...... 51,845 45,219 34,657 39,938 42,553 44,352 50,634
Five years later ...... 52,984 45,682 41,578 44,297 43,581 48,120
Six years later ....... 53,208 51,450 43,753 44,724 46,324
Seven years later ..... 58,246 52,551 43,962 46,385
Eight years later ..... 59,086 52,737 44,058
Nine years later ...... 59,108 52,824
Ten years later ....... 59,110
Re-estimated Liability:
One year later ........ 70,640 68,891 62,028 61,121 71,419 72,575 77,373 73,582 86,534 107,980
Two years later ....... 63,248 66,439 53,429 62,097 64,980 66,733 71,489 73,654 87,074
Three years later ..... 65,422 60,858 55,883 58,169 61,336 60,752 68,439 68,528
Four years later ...... 64,460 62,625 53,400 54,324 54,996 59,069 63,028
Five years later ...... 66,275 61,077 50,744 50,977 53,952 55,191
Six years later ....... 64,877 58,220 47,946 50,666 51,136
Seven years later ..... 63,514 55,739 47,099 47,994
Eight years later ..... 61,262 55,156 45,329
Nine years later ...... 60,160 53,927
Ten years later ....... 59,926
Redundancy (deficiency) .. $28,965 $23,720 $23,599 $20,107 $20,895 $29,404 $ 21,254 $ 12,606 $ (2,514) $ (3,958)
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 and 2004 reinsurance
program cedes to
11
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
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 our 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, are deducted from other underwriting expenses. Ceding
commissions were $833,000, $1.1 million and $644,000 in 2003, 2002 and 2001,
respectively.
12
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 retention regardless of the number of original policies or
claimants involved. We also have protection against losses in excess of our
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.
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, 2003, the amounts recoverable from reinsurers attributable to
Lloyds of London represents a total of 48 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, 2003 by reinsurer:
Reinsurance A.M. Best
Reinsurer Recoverable Rating
--------- -------------- ---------
(in thousands)
Lloyd's of London syndicates .................. $28,117 A+
Hanover Rueckversicherungs - AG ............... 5,494 NR3
CX Reinsurance LTD ............................ 2,393 B+
Unionamerica Insurance ........................ 1,331 A++
Transatlantic Reinsurance Company ............. 3,183 A-
AXA Reassurance ............................... 3,664 A-
Terra Nova Insurance Company LTD .............. 1,015 A/A-
Other reinsurers .............................. 2,903
-------
Total ..................................... $48,100
=======
The effect of reinsurance on premiums written and earned for the years
ended December 31, 2003, 2002 and 2001 is as follows:
Year Ended December 31,
------------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Written Earned Written Earned Written Earned
-------- -------- -------- -------- -------- --------
(in thousands)
Direct ... $ 71,365 $ 61,023 $ 51,799 $ 44,113 $ 34,459 $ 28,192
Ceded .... (12,088) (13,759) (18,003) (14,023) (10,542) (7,296)
-------- -------- -------- -------- -------- --------
Net ...... $ 59,277 $ 47,264 $ 33,796 $ 30,090 $ 23,917 $ 20,896
======== ======== ======== ======== ======== ========
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.
13
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 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
high-yield bonds, tax-advantaged securities such as municipal bonds and
preferred stock, and common stock. During 2003, an allocation to common stock
was implemented as a measure to provide a level of protection against a rising
interest rate environment. An allocation of the portfolio to high-yield
securities was funded in January, 2004. Our investment guidelines document is
reviewed and updated as needed, 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 year ended December
31, 2002. Effective January 1, 2003, Standish Mellon Asset Management became the
external investment manager for our fixed income portfolio. We utilize three
different managers, each with a different investment objective, for our equity
securities portfolio. The high-yield bond allocation is invested through a
mutual fund instrument in order to achieve adequate diversity of underlying
credits.
Each year we, along with our fixed maturity securities 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. Standish Mellon 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.
Standish Mellon 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 mid-year 2003, the fair
value of our fixed income 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, 2003
U.S. Government and agencies ........... $ 29,328 $ 75 $ (118) $ 29,285
Corporate .............................. 41,773 247 (720) 41,300
Tax-exempt obligations ................. 35,329 1,907 (78) 37,158
Asset and mortgage-backed securities ... 55,446 186 (631) 55,001
-------- ------- --------- --------
161,876 2,415 (1,547) 162,744
-------- ------- --------- --------
Equity securities ...................... 10,269 1,373 (29) 11,613
-------- ------- --------- --------
Total ................................ $172,145 $ 3,788 $ (1,576) $174,357
======== ======= ========= ========
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
======== ======= ========= ========
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, 2003, we held 134 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
4.47%. Approximately 81.3% 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, 2003.
Type/Ratings of Investment Percentage
-------------------------------------------- ----------
Treasury/Agency ............................ 42.3
AAA ........................................ 27.4
AA ......................................... 6.0
A .......................................... 14.1
BBB ........................................ 10.2
-----
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, 2003,
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, 2003
------------------------------------
Percentage
Amortized of Fair
Cost Fair Value value
--------- -------------- ----------
(in thousands)
Due in one year or less ............................... $ 1,912 $ 1,923 1%
Due after one year through five years ................. 39,363 39,886 23
Due after five years through ten years ................ 45,918 46,483 27
Due after ten years ................................... 19,237 19,451 11
-------- -------- ---
106,430 107,743 62%
Equity securities ..................................... 10,269 11,613 7
Asset and mortgage-backed securities .................. 55,446 55,001 31
-------- -------- ---
Total .............................................. $172,145 $174,357 100%
======== ======== ===
Proceeds from bond maturities, sales and redemptions of available for sale
investments during the years 2003, 2002, and 2001 were $138.6 million, $39.0
million and $22.0 million, respectively. Gross gains of $3,441,000, $1,437,000
and $787,000 and gross losses of $1,511,000, $1,568,000 and $1,065,000 were
realized on available for sale investment redemptions during 2003, 2002, and
2001, respectively.
The average duration of the securities in our fixed maturity portfolio as
of December 31, 2003 and 2002, was 4.8 years and 4.4 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 2003. 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 subsidiary 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, 2003, $162.7 million of our $174.4 million
investment portfolio was invested in fixed maturities. Unrealized pre-tax net
investment gains on investments in fixed maturities were $867,000 and $4.2
million as of December 31, 2003, and 2002, 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.
Our insurance subsidiary holds 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 subsidiary. 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 for 2002. We received a refund of $25,000 and accrued an assessment of
$137,000 in 2003. 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 regulators 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
or 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.
The premium collection litigation may reduce earnings and stockholders equity
As disclosed elsewhere in this report, a jury returned an $18.2 million
judgment against NCRIC, Inc. in connection with the premium collection
litigation initiated by NCRIC, Inc. against Columbia Hospital for Woman, CHW.
NCRIC, Inc. intends to appeal this verdict, and has filed post-trial motions,
including motions to set aside and to reduce the verdict. The outcome of the
post-trial motions and potential appellate process is not predictable. An
outcome that requires NCRIC to pay a significant amount to CHW would reduce
stockholders' equity and would reduce the statutory measure of policyholders
surplus and therefore could potentially reduce our capacity to write insurance.
In addition, expenses incurred in appealing the verdict are expected to be
significant and will reduce earnings.
Insurance Company Regulation
General. NCRIC, Inc. is subject to supervision and regulation by the
District of Columbia Department of Insurance, Securities and Banking 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 restrictions on transactions with affiliates;
21
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.
Without the approval of the District of Columbia Commissioner of
Insurance, Securities and Banking, NCRIC, Inc. may not 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. The 2003 assessment covered PHICO, Legion and Reciprocal of America. 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. The District of Columbia has informed us of their
intention to perform a periodic financial examination in 2004 of NCRIC, Inc. as
of December 31, 2003.
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.
22
Medical professional liability reports. We principally write medical
professional liability insurance and, 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, Securities and Banking 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, Banking
and Securities 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 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,
Securities and Banking 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, Securities and Banking, including
information relating to our 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,
Securities and Banking, 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 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, 2003, because of the
statutory loss from operations in 2002 and 2003, NCRIC, Inc. has no amounts
available for dividends without regulatory approval.
23
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 owned all of the outstanding shares
of NCRIC Holdings, 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.
On June 24, 2003, a plan of conversion and reorganization was approved by
the members of NCRIC, A Mutual Holding Company and by the shareholders of NCRIC
Group, Inc. In the conversion and related stock offering, the Mutual Holding
Company offered for sale its 60% ownership interest in NCRIC Group. As a result
of the conversion and stock offering, the Mutual Holding Company ceased to
exist, and NCRIC Group became a fully public company.
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, Delaware, Maryland, Virginia and West
Virginia. Commonwealth Medical Liability Insurance Company, CML, was merged into
NCRIC, Inc. as of December 31, 2003. CML was originally incorporated in 1989.
CML provided professional liability insurance to physicians in Delaware,
Maryland, Virginia and West Virginia.
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. and to 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, 2003, we employed 98 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.
24
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."
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. In November, 2003 we leased additional
space across the street from our executive offices at 1055 Thomas Jefferson
Street, N.W. Washington, D.C. 20007. 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,
2003, along with the applicable lease expiration date:
Property Location Lease Expiration Date
-------------------------------------------------------- ---------------------
Offices:
1115 30th Street, N.W., Washington, D.C. 20007 April 30, 2008
1055 Thomas Jefferson Street, N.W. Washington, D.C. 2007 May 31, 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. Aside from the
matter discussed in Item 7 under Net Premiums Written, Year ended December 31,
2003 compared to Year ended December 31, 2002, Premium Collection Litigation and
reported in Note 14 to the Consolidated Financial Statements included in Item 8
of this Form 10-K, we believe that these legal proceedings in the aggregate are
not material 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."
25
Our common stock is traded on the Nasdaq National 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, 2003,
there were 6,898,865 publicly held shares of our common stock issued and
outstanding held by approximately 564 shareholders of record. Note: the stock
prices for dates prior to the June, 2003 conversion and stock offering have been
adjusted to reflect the conversion and issuance of additional shares.
Year Ended December 31, 2003 High Low
---------------------------- ------- -------
Fourth quarter $11.510 $ 9.110
Third quarter 11.560 10.150
Second quarter 10.600 8.203
First quarter 12.858 5.792
Year Ended December 31, 2002 High Low
---------------------------- ------- -------
Fourth quarter $ 5.893 $ 5.325
Third quarter 6.001 5.325
Second quarter 6.161 5.545
First quarter 6.954 5.588
Set forth below is information as of December 31, 2003 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 - 1999 ........ 124,311 $ 3.75 0
- --------------------------------------------------------------------------------------------------------------------
Stock Option Plan - 2003 ........ 392,608 $10.90 21,762
- --------------------------------------------------------------------------------------------------------------------
Stock Award Plan - 1999 ......... 28,730(1) Not Applicable 0
- --------------------------------------------------------------------------------------------------------------------
Stock Award Plan - 2003 ......... 125,970(1) Not Applicable 39,778
- --------------------------------------------------------------------------------------------------------------------
Equity compensation plans None None None
not approved by shareholders
- --------------------------------------------------------------------------------------------------------------------
Total ...................... 671,439 Not Applicable 32,810
====================================================================================================================
- ----------
(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 are
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,
-------------------------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(Dollars in thousands)
Statement Of Operations Data:
Gross premiums written .......................... $ 71,365 $ 51,799 $ 34,459 $ 22,727 $ 21,353
========= ========= ========= ========= =========
Net premiums written ............................ $ 59,277 $ 33,804 $ 23,624 $ 15,610 $ 16,188
========= ========= ========= ========= =========
Net premiums earned ............................. $ 47,264 $ 30,098 $ 20,603 $ 14,611 $ 14,666
Net investment income ........................... 6,008 5,915 6,136 6,407 6,089
Net realized investment gains (losses) .......... 1,930 (131) (278) (5) (71)
Practice management and related income .......... 4,906 5,800 6,156 5,317 4,576
Other income .................................... 1,155 1,013 602 470 373
--------- --------- --------- --------- ---------
Total revenues .............................. 61,263 42,695 33,219 26,800 25,633
Losses and loss adjustment expenses ............. 50,473 26,829 18,858 11,946 12,867
Underwriting expenses ........................... 10,003 8,168 4,877 3,591 3,010
Practice management and related expenses ........ 5,222 5,811 6,063 4,970 4,845
Interest expense on Trust Preferred Securities .. 826 62 0 0 0
Other expenses .................................. 1,651 1,405 1,245 1,237 1,439
--------- --------- --------- --------- ---------
Total expenses .............................. 68,175 42,275 31,043 21,744 22,161
--------- --------- --------- --------- ---------
Income (loss) before income taxes ............... (6,912) 420 2,176 5,056 3,472
Income tax provision (benefit) .................. (2,694) (322) 597 1,561 967
--------- --------- --------- --------- ---------
Net income (loss)................................ $ (4,218) $ 742 $ 1,579 $ 3,495 $ 2,505
========= ========= ========= ========= =========
Balance Sheet Data:
Invested assets ................................. $ 174,357 $ 120,120 $ 103,125 $ 98,045 $ 95,092
Total assets .................................... 262,546 202,687 161,002 145,864 140,947
Reserves for losses and loss adjustment expenses. 125,991 104,022 84,560 81,134 84,282
Total liabilities ............................... 184,567(1) 154,870(1) 116,548 104,415 105,152
Total stockholders' equity ...................... 77,979 47,817 44,454 41,449 35,795
Selected GAAP Underwriting Ratios(2):
Losses and loss adjustment expenses ratio ....... 106.8% 89.1% 91.5% 81.7% 87.7%
Underwriting expense ratio ...................... 21.2% 27.2% 23.7% 24.6% 20.5%
Combined ratio .................................. 128.0% 116.3% 115.2% 106.3% 108.2%
Selected Statutory Data:
Losses and loss adjustment expenses ratio ....... 106.8% 89.2% 90.0% 75.3% 80.8%
Underwriting expense ratio ...................... 22.6% 22.6% 21.8% 19.7% 15.7%
Combined ratio .................................. 129.4% 111.8% 111.8% 95.0% 96.5%
Operating ratio(3) .............................. 113.3% 92.4% 84.3% 63.6% 66.7%
Ratio of net premiums written to policyholders'
surplus ...................................... 0.84 0.83 0.77 0.60 0.63
Policyholders' surplus .......................... $ 70,372 $ 44,269 $ 32,759 $ 29,764 $ 29,212
- ----------
(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. Extended reporting endorsements premium
is earned in the same period it is written. 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 expense incurred.
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
28
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.
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 of estimates.
The statistical accuracy of the actuarial estimate indicates that the actual
ultimate value of reserved losses will be in the range of approximately plus or
minus 10% of the calculated point estimate. 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,
2003, 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 aggregate 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, 2003, the average indemnity payment per paid closed
claim was $306,000 with total indemnity payments of $22.2 million, $12.9 million
and $14.0 million for the years ended December 31, 2003, 2002 and 2001,
respectively. The cost of individual indemnity payments over this three-year
period ranged from $1,000 to $2.2 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 reported in
the statement of operations 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
29
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 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 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 is 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, reviewing 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
30
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.
Our goodwill asset, $7.3 million as of December 31, 2003, 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, 2003.
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.
The industry trends noted in the prior two years continued through 2003
and into 2004. The November/December 2003 issue of Contingencies, published by
the American Academy of Actuaries, reported that the industry is now entrenched
in the third medical malpractice crisis since the mid-1970s, noting that the
current crisis may be defined by St. Paul's decision to exit the market,
followed by PHICO, Reliance, Frontier, and MIIX. This articles concludes, among
other things, that the driver of the crisis is a sustained 25% jump in claims
payments over a two-year period, and that the data supports the premise that
caps on noneconomic damages are an effective means of reducing malpractice
costs.
According to the January 2003 Best's Review, published by 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
31
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, 2002, according to the latest data available from the National
Practitioner Data Bank.
OVERVIEW
While financial results for 2003 were disappointing, we achieved
significant accomplishments in 2003. We successfully deployed a significant
amount of capital in our growth territories of Delaware and Virginia, with
written premium increasing 38%. Cash flow from operations was $20.6 million in
2003, a record level for NCRIC. Our business model is intact and we anticipate
continued progress in 2004 and 2005 toward achieving our return on equity
target. The insurance premium rate structure for policies with 2004 effective
dates is designed to produce a combined ratio of 96.5% and a 10% return on
equity of deployed capital. We restructured our investment portfolio to
strengthen the overall credit quality of the fixed income portfolio and we
diversified the portfolio to add a common stock equity component. We merged the
two companies writing insurance into one to achieve efficiencies within
administrative operations.
A key aspect of the mission of our insurance business is to provide
financial protection for our policyholders at rates that produce a fair return
on capital invested by our shareholders. A fundamental of profitable insurance
business is appropriate pricing of our insurance policies. Two of the most
important elements of premium rates are assumptions about costs of losses which
will be sustained under the insurance contracts we issue and the investment
income that will be generated by funds between the time of premium collection
and claim payment. Both of these elements require us to make estimates of what
will happen in the future. We take a disciplined approach to develop the prices
for our insurance policies, however, there is no assurance that we will
accurately predict future developments of loss costs or investment returns.
As described in Recent Industry Performance above, the tort environment
continues to drive loss costs upward. We believe that our many years of
successful operation in the District of Columbia, which over the past ten years
has the highest mean indemnity payments of any jurisdiction, prepares us to
successfully meet the challenges presented by the pressures in the judicial
environment.
The adverse verdict in the hospital premium collection litigation is
unfortunate. We believe that the verdict was wrong. Since we believe the verdict
was unfounded, we have not accrued any potential loss from this litigation.
32
CONSOLIDATED NET INCOME Years ended December 31, 2003, 2002 and 2001
Year ended December 31, 2003 compared to year ended December 31, 2002
Net income was a loss of $4.2 million for the year ended December 31, 2003
compared to income of $742,000 for the year ended December 31, 2002. 2003
results were negatively impacted by adverse development of claims originally
reported in earlier years.
The operating results of our insurance segment for the year ended December
31, 2003 were primarily driven by growth in new business written and the
increase in the estimate of loss reserves for claims reported in prior years.
For the year, new business premium written was $10.5 million compared to $12.7
million for 2002. The new business written coupled with the increased premium
rates resulted in a 57% 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 2003 increased due to the
rise in exposures, the development of losses for claims originally reported in
2001 and 2002 reduced pre-tax earnings for 2003. The re-estimation of losses was
driven by two primary factors - increases in the estimate of direct losses,
primarily in Virginia for the 2001 and 2002 report years, and a change in
estimate of the level of reinsurance to be recovered for the losses reported in
the years 2000, 2001 and 2002.
Our practice management segment earnings in 2003 decreased compared to
2002 primarily as a result of a decrease in client revenue combined with a
decrease 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 reductions in operating expense consistent with the changes in revenue
levels. Since the size of our practice management business relative to our
entire business has decreased as the insurance segment has increased, this
business no longer meets the requirements for separate segment reporting.
Therefore, we intend to not report this business as a separate segment in future
periods.
Three months ended December 31, 2003 compared to three months ended December 31,
2002
Net income for the fourth quarter of 2003 was a loss of $5.6 million
compared to income of $801,000 in the fourth quarter of 2002. The 2003 fourth
quarter result was driven by adverse development of $6.0 million on prior year
losses in addition to an increased reserving level on 2003 losses. The loss
reserve development was estimated based on new information on specific losses
and related revision of estimates of loss trends, primarily in report years 2001
and 2002, combined with a re-estimation of reinsurance to be recovered on losses
in the 2000, 2001 and 2002 report years based on actual development as those
years mature. Related to the change in estimate of losses, the reinsurance
premium on prior year losses covered by the swing-rated reinsurance program was
a charge of $931,000 in the fourth quarter of 2003 compared to a credit of
$106,000 in the fourth quarter of 2002.
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.
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.
33
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.
NET PREMIUMS EARNED
The following table is a summary of our net premiums earned:
Year ended December 31,
------------------------------------
2003 2002 2001
-------- -------- --------
(in thousands)
Gross premiums written ....................... $ 71,365 $ 51,799 $ 34,459
Change in unearned premiums .................. (10,342) (7,686) (6,267)
-------- -------- --------
Gross premiums earned ........................ 61,023 44,113 28,192
Reinsurance premiums ceded related to:
Current year .............................. (12,833) (14,429) (8,992)
Prior years ............................... (926) 406 1,696
-------- -------- --------
Total reinsurance premiums ceded ........ (13,759) (14,023) (7,296)
-------- -------- --------
Net premiums earned before renewal credits ... 47,264 30,090 20,896
Renewal credits .............................. -- 8 (293)
-------- -------- --------
Net premiums earned .......................... $ 47,264 $ 30,098 $ 20,603
======== ======== ========
Year ended December 31, 2003 compared to year ended December 31, 2002
Gross premiums written increased by $19.6 million, or 38%, to $71.4
million for the year ended December 31, 2003 from $51.8 million for the year
ended December 31, 2002, due to net new business written, which is new business
net of lost business, combined with the premium rate increases, which averaged
27%. The gross premiums written include premiums for retrospectively rated
programs of $1.1 million for the year ended December 31, 2003 and $2.2 million
for the year ended December 31, 2002. Gross premiums written also include $3.2
million in 2003 and $1.3 million in 2002 for extended reporting endorsements.
Gross premiums written on excess layer coverage increased $3.6 million to $10.2
million for the year ended December 31, 2003 from $6.6 million for the year
ended December 31, 2002.
The change in unearned premiums for the period increased by $2.6 million
to $10.3 million for the year ended December 31, 2003 from $7.7 million for the
year ended December 31, 2002. This increase resulted from net new business
written throughout the year combined with premium rate increases.
Gross premiums earned increased $16.9 million, or 38%, to $61.0 million
for the year ended December 31, 2003 from $44.1 million for the year ended
December 31, 2002. The increase was primarily due to $14.3 million
34
for premiums earned under basic medical professional liability insurance and
$2.5 million for excess limits coverage. Extended reporting endorsements premium
is earned in the same period as it is written.
Reinsurance premiums ceded decreased by $0.2 million to $13.8 million for
the year ended December 31, 2003 from $14.0 million for the year ended December
31, 2002. The decrease was the result lower reinsurance premium rates, partially
offset by higher gross earned premiums and additional premium ceded related to
prior years. 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 decreased by $1.6 million, or
11.4%, to $12.8 million for the year ended December 31, 2003 from $14.4 million
for the year ended December 31, 2002. This decrease was due to lower reinsurance
premium rates charged by reinsurers as a result of the increase in NCRIC's
retention level to $1 million from $500,000, partially offset by the increase in
gross earned premiums.
Reinsurance premiums related to prior years under the swing-rated treaty
were a charge of $0.9 million in 2003 and a benefit of $0.4 million in 2002 due
to 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 2003 change is due to an increase in the
estimate of losses covered by the swing-rated treaty in the 1997 and 1999 years.
The 2002 change is primarily reflective of the favorable loss development in the
1995, 1997 and 1998 coverage years. As claims are brought to conclusion, each
year there are fewer outstanding claims in the years covered by this reinsurance
treaty. While the potential for loss development impacting this reinsurance
coverage is reduced each year as the inventory of open claims is reduced, until
all claims covered by the treaty are closed the potential remains for changes
from current estimates. As of December 31, 2003, there are 36 open claims in the
years covered by swing-rated reinsurance compared to 48 open claims as of
December 31, 2002. The liability "retrospective premiums accrued under
reinsurance treaties" increased to $1.8 million at December 31, 2003 from $0.6
million at December 31, 2002.
Renewal credits for the years ended December 31, 2003 and 2002, reflect
our decision to not provide a renewal premium credit for 2003 or 2004 renewals.
Net premiums earned increased by $17.2 million, or 57.1%, to $47.3 million
for the year ended December 31, 2003 from $30.1 million for the year ended
December 31, 2002. The increase reflects the $16.9 million growth in gross
earned premiums supplemented by the lower reinsurance premiums ceded in 2003
compared to 2002.
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. This program was terminated effective with July 1,
2003 renewals.
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 premiums:
Year Ended December 31,
------------------------
2003 2002
------- -------
(in thousands)
Direct ............... $ 618 $ 2,309
Agent ................ 9,900 10,391
HCA .................. 0 793
------- -------
$10,518 $13,493
======= =======
Direct new business is primarily in the District of Columbia. The D.C.
market does not provide significant opportunity for new business production.
Agent-produced new business in 2003 came primarily from Delaware and
35
Virginia. In 2002, agent new business also included $403,000 for the Princeton
hospital program which was discontinued in 2003.
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.
The following chart illustrates the components of gross premiums written
by state as follows:
Year Ended December 31,
------------------------------------
2003 2002
--------------- ---------------
(dollars in thousands)
Amount % Amount %
------- --- ------- ---
District of Columbia ..... $23,216 33% $21,796 42%
Virginia ................. 22,640 32 14,863 29
Maryland ................. 8,819 12 5,663 11
West Virginia ............ 7,935 11 7,688 15
Delaware ................. 8,755 12 1,789 3
------- --- ------- ---
Total ............... $71,365 100% $51,799 100%
======= === ======= ===
Premium collection litigation. During 2000, it was determined that one of
NCRIC's hospital-sponsored retrospective programs would not be renewed. In
accordance with the terms of the contract, NCRIC billed the hospital sponsor,
Columbia Hospital for Women Medical Center, Inc., for premium due based on the
actual accumulated loss experience of the terminated program. Because the
original 2000 bill was not paid when due, we initiated legal proceedings to
collect. As of December 31, 2003 the amount due to NCRIC for this program was
$3.0 million. NCRIC has accrued no amount of net receivable due to the pending
litigation and questionable collectability.
On February 13, 2004, a District of Columbia Superior Court jury rejected
NCRIC's claim for premiums due and returned a verdict in favor of Columbia
Hospital for Women Medical Center, Inc. (CHW) in counterclaims to the premium
collection litigation initiated by NCRIC. The jury awarded $18.2 million in
damages to CHW.
NCRIC filed post-trial motions on March 5, 2004, to set aside the verdict
or reduce the amount of the award. Since we believe the verdict against NCRIC
was wrong and that we will ultimately prevail, no liability has been accrued in
the financial statements for any possible loss arising from this litigation.
Legal expenses incurred for this litigation in 2004 are estimated to be
approximately $750,000. The expenses associated with the $19.5 million appellate
bond and the collateral letter of credit are estimated to be approximately
$300,000.
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
36
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 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 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. As of December 31, 2003 it was determined that this cell would not
become operational.
37
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 premiums:
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.
The following chart illustrates the components of gross premiums 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 filed a motion for summary judgment, which was not
decided as of December 31, 2002. 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.
38
NET INVESTMENT INCOME
Year ended December 31, 2003 compared to year ended December 31, 2002
Net investment income increased by $93,000, or 2%, for the year ended
December 31, 2003 compared to the prior year reflecting a higher base of average
invested assets partially offset by a decrease in yields. Net investment income
for the year ended December 31, 2003 was $6.0 million compared to $5.9 million
for the year ended December 31, 2002. Average invested assets, which include
cash equivalents, increased by $42.3 million, or 38%, to $153.7 million for the
year ended December 31, 2003, due to the proceeds from the issuance of stock and
cash from operations. New investments were primarily directed to mortgage-backed
securities; in addition, the investment portfolio added an allocation to common
stocks as part of the strategy to protect the portfolio in a rising interest
rate environment. The average effective yield was approximately 3.9% for the
year ended December 31, 2003 and 5.3% for the year ended December 31, 2002. The
tax equivalent yield was approximately 4.4% at December 31, 2003 and 5.9% at
December 31, 2002. The change in investment yields is reflective of the market
change in interest rates in 2003 compared to 2002 as well as being reflective of
the new allocation to lower-yielding common stocks and the portfolio
restructuring executed in the first half of 2003. Securities sold as a part of
the restructuring generally had above market coupon rates and were therefore
sold at gains. New securities acquired brought current market rate yields into
the portfolio, thereby reducing the overall portfolio yield.
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 5.3% for the year ended December 31, 2002 and 5.8% for the
year ended December 31, 2001. The tax equivalent yield was approximately 5.9% at
December 31, 2002 and 6.3% at December 31, 2001. The change in investment yields
is reflective of the market change in interest rates in 2002 compared to 2001.
NET REALIZED INVESTMENT GAINS (LOSSES)
Year ended December 31, 2003 compared to year ended December 31, 2002
Net realized investment gains were $1.9 million for the year ended
December 31, 2003 compared to net realized investment losses of $131,000 for the
year ended December 31, 2002. The 2003 gains resulted from portfolio
restructuring implemented by our new fixed income investment portfolio manager
to replace weak credits with stronger rated bonds as well as from routine
portfolio management activity, partially offset by the recognition of an other
than temporary impairment loss of $135,000 on an investment in common stock. The
circumstance giving rise to the other-than-temporary impairment charge was a
sharp decline in the value of the stock in 2003, which we do not expect to be
temporary based on available financial information of the issuer. 2002 realized
losses included an other-than-temporary impairment charge of $557,000 for a
fixed maturity security issued by WorldCom.
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
39
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.
PRACTICE MANAGEMENT AND RELATED INCOME
Revenue for practice management and related services is comprised of fees
for the following categories of services provided: practice management;
accounting; tax and personal financial planning; retirement plan accounting and
administration; and other services.
Year ended December 31, 2003 compared to year ended December 31, 2002
Practice management and related revenues decreased by $0.9 million, or
15.5%, to $4.9 million for the year ended December 31, 2003, from $5.8 million
for the year ended December 31, 2002. This revenue consists of fees generated by
NCRIC MSO through its HealthCare Consulting and Employee Benefits Services
divisions. The decreased revenue was primarily a result of a reduced level of
non-recurring and recurring assignments in the HealthCare Consulting division
compared to 2002. Additionally, in the later part of 2003 there was some loss of
clients and revenue resulting from the departure from NCRIC of two consultants.
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.
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, 2003 compared to year ended December 31, 2002
Other income increased $142,000, or 14%, to $1,155,000 for the year ended
December 31, 2003 from $1.0 million for the year ended December 31, 2002. The
increased revenue resulted primarily from 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
40
installment payment option to our insureds. As a result, the revenue generated
by service fees on installment payments grew throughout 2002 compared to 2001.
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,
------------------------------
2003 2002 2001
------- ------- --------
(in thousands)
Incurred losses and LAE related to:
Current year losses ................ $44,588 $24,063 $ 23,056
Prior years loss development ....... 5,885 2,766 (4,198)
------- ------- --------
Total incurred for the year ....... $50,473 $26,829 $ 18,858
======= ======= ========
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,
----------------------------
2003 2002 2001
------ ------ ------
Losses and LAE ratio:
Current year losses ............. 94.3% 79.9% 111.9%
Prior years loss development .... 12.5 9.2 (20.4)
------ ------ ------
Total losses and LAE ratio ....... 106.8 89.1 91.5
Underwriting expense ratio ....... 21.2 27.2 23.7
------ ------ ------
Combined ratio ................... 128.0% 116.3% 115.2%
====== ====== ======
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.
41
The resolution of some 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,
-----------------------
2003 2002 2001
---- ---- ----
Plaintiff verdicts ................... 11 5 5
Defense verdicts ..................... 22 13 13
Mistrials or hung juries ............. 0 4 2
-- -- --
Total trials ......................... 33 22 20
== == ==
Of the 11 plaintiff verdicts in 2003, four verdicts were awarded in excess
of our $500,000 retention, and one verdict was in excess of our $1 million
retention limit. Under the clash protection provided by our reinsurance program,
our exposure to the retention limit was limited to three of the five verdicts.
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.
Year ended December 31, 2003 compared to year ended December 31, 2002
Total incurred losses and LAE expense of $50.5 million for year ended
December 31, 2003 represents an increase of $23.7 million compared to $26.8
million incurred for the year ended December 31, 2002.
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 $20.5 million to $44.6 million
for the year ended December 31, 2003 from $24.1 million for the year ended
December 31, 2002, reflecting an increase in severity of reported claims, the
rise in the level of liability exposure as a result of expanding business, and
the increase in retention under our reinsurance program to $1 million for each
and every loss from $500,000 for each and every loss in 2002.
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 2003 we experienced unfavorable development of $5.9 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 2003 development, which is
comprised of favorable development in the 1999 report year offset by adverse
development in the 2000, 2001 and 2002 report years, include additional
information on claims originally reported in prior years and interpretation of
emerging settlement trends in our expansion market areas. The primary market
territory driving the adverse loss development experience is Virginia claims
reported in 2001 and 2002. Additionally, one 2001 claim in West Virginia and
2002 Maryland claims contributed to the adverse development. In addition, the
estimate of reinsurance recoverable, primarily on 2000, 2001 and 2002 losses
across all our market territories, declined.
An increase in severity was first noted in 1996 and continued through 2003
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 insurance carriers across the nation. While an increase
in severity would tend to cause loss ratios to deteriorate, our reinsurance
program 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 complete 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 13 points for the year
ended December 31, 2003 and was increased by 9 points for the year ended
December 31, 2002 as a result of prior years loss development. The 2003 change
is primarily reflective of favorable loss development for the 1999 report years,
more than offset by adverse development in the 2000, 2001 and 2002 loss years;
whereas, the 2002 change is primarily reflective of favorable
42
loss development for the 1996 and 1999 loss years, more than offset by adverse
development in the 1998, 2000 and 2001 loss years.
The underwriting expense ratio decreased to 21.2% for the year ended
December 31, 2003 from 27.2% for the year ended December 31, 2002. In 2002
underwriting expenses included $1.2 million for a reserve against the
hospital-sponsored program receivable, as previously discussed. A similar charge
was unnecessary in 2003, contributing 4.1 points of improvement to the
underwriting expense ratio. Underwriting expenses increased $1.8 million to
$10.0 million for the year ended December 31, 2003 from $8.2 million for the
year ended December 31, 2002. The 22% increase in underwriting expenses was
primarily attributable to the growth in expenses, consisting primarily of
commissions, directly related to the expansion in business, consistent with the
growth in premium.
The combined ratio increased to 128.0% for the year ended December 31,
2003 from 116.3% for the year ended December 31, 2002. The primary factor
driving the increased combined ratio was the adverse development of losses
reported in prior years. While adverse development directly contributed 3.3
points of the increase, the experience on 2001 and 2002 adverse development was
factored into the estimate of 2003 incurred losses, resulting in an increase in
the current year component of the combined ratio.
The statutory combined ratio was 129.4% for the year ended December 31,
2003, and 111.8% for the year ended December 31, 2002. This increase stems from
the same factors noted previously.
Three months ended December 31,2003 compared to three months ended December 31,
2002
Three Months Ended December 31,
-------------------------------
2003 2002
--------- ---------
(in thousands)
Incurred losses and LAE related to:
Current year losses ................. $ 13,403 $ 6,759
Prior years loss development ........ 5,987 998
--------- ---------
Total incurred for the quarter.... $ 19,390 $ 7,757
========= =========
Current year losses ................. 108.2% 77.4%
Prior years loss development ........ 48.4% 11.4%
--------- ---------
Total losses and LAE ratio ............ 156.6% 88.8%
Underwriting expense ratio ............ 22.3% 21.8%
--------- ---------
Combined ratio ........................ 178.9% 110.7%
========= =========
Current year losses in the fourth quarter of 2003 totaled $13.4, million
increasing over the level of the fourth quarter of 2002 and over the level of
the prior quarters of 2003. While the number of new claims reported in the
fourth quarter was the lowest experienced in 2003, the higher level of current
year losses was established to take into consideration the prior year loss
development trends that emerged during the year-end actuarial valuation. The
loss ratio on current year losses at 108.3%, higher than previous quarters in
2003, reflects this recognition of higher severity. Additionally, the level of
current year losses in 2003 was higher than in 2002 due to the increase in
retention to $1 million in 2003 from $500,000 in 2002.
Development on losses reported in prior years totaled $6.0 million in the
fourth quarter of 2003. This adverse loss development emerged during the fourth
quarter from two primary sources:
o upward development on claims, primarily in Virginia and Maryland in
2001 and 2002; and
o lower estimate of reinsurance to be recovered on losses in the
2000, 2001 and 2002 report years across all territories.
Evaluations of individual claims are updated when additional information
on each case is determined, often as a part of the preparation for trial. Case
reserves on individual claims are raised when new information indicates a
greater loss exposure. Actuarial reserves are established based on case reserves
combined with historical loss development trends. The upward development in the
fourth quarter on case reserves of individual claims was not consistent with
43
trends experienced previously. Therefore, in addition to the recognition of the
upward development on individual claims, the actuarial estimates of losses were
increased.
NCRIC's retention of losses in the 2000, 2001 and 2002 report years is
$500,000 for each and every loss. The estimate of reinsurance amounts to be
recovered from reinsurers is based primarily on historical trends, combined with
information on individual claims. In the first three quarters of 2003 NCRIC
recognized in its losses a lesser estimate of reinsurance recoveries. The
revised estimate prepared as of year-end 2003 further reduced the amount of
estimated reinsurance recoveries on losses initially reported in prior years.
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 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."
44
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.
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,
---------------------
2003 2002
-------- --------
(in thousands)
Liability for:
Loss ............................... $ 87,778 $ 70,314
Loss adjustment expense ............ 38,213 33,708
-------- --------
Total liability ..................... $125,991 $104,022
======== ========
Reinsurance recoverable on losses ... $ 48,100 $ 43,231
======== ========
Number of cases pending ............. 616 517
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.
UNDERWRITING EXPENSES
For 2003, salaries and benefits accounted for approximately 25% of other
underwriting expenses, bad debt expense 5%, with professional fees, including
legal, auditing and director's fees, accounting for approximately 18% of the
underwriting expenditures. Premium taxes, guaranty assessments and commissions
comprise the balance. Guaranty fund assessments are based on industry loss
experience in the jurisdictions where we do business, and are not predictable.
Year ended December 31, 2003 compared to year ended December 31, 2002
Underwriting expenses increased $1.8 million, or 22%, to $10.0 million for
the year ended December 31, 2003 from $8.2 million for the year ended December
31, 2002. 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. In addition, expenses
increased for ceding allowances as a result of the change in the primary
reinsurance treaty effective for 2003, legal fees incurred for the collection
litigation initiated by us as more fully discussed in the section "Net Premiums
Earned," and $364,000 of expense resulting from a fraudulent act of a former
sales agent. Although we believe it is reasonably possible that we could incur
additional expense as a result of the fraudulent act, the amount or timing of
any expense is not reasonably estimable at this time.
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
45
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.
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, 2003 compared to year ended December 31, 2002
Practice management and related expenses decreased $589,000, or 10%, to
$5.2 million for the year ended December 31, 2003 compared to $5.8 million for
the year ended December 31, 2002. Expense decreased primarily due to reductions
in staffing commensurate with the reductions in revenue. A portion of this
decrease stemmed from the elimination of costs associated with the transition of
client service for two of the former owners as their employment contracts
expired.
Year ended December 31, 2002 compared to year ended December 31, 2001
Practice management and related expenses decreased $252,000, 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.
INTEREST EXPENSE
Interest expense was incurred for the debt service on the Trust Preferred
Securities issued in December, 2002. Interest expense for the year ended
December 31, 2003 totaled $826,000, a full year of interest, compared to
$62,000, a partial month of interest in the prior year. The interest rate in
2003 averaged 5.31% and the interest rate in 2002 was 5.42%.
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 2003, ACC
incurred $151,000 in expenses. As of December 31, 2003, ACC does not have any
active protected cells.
Year ended December 31, 2003 compared to year ended December 31, 2002
Other expenses of $1.7 million for the year ended December 31, 2003
compares to other expense of $1.4 million for the year ended December 31, 2002.
Expense increases are for holding company operations.
46
Year ended December 31, 2002 compared to year ended December 31, 2001
Other expenses of $1.4 million for the year ended December 31, 2002
increased $160,000, or 13% compared to the year ended December 31, 2001. Expense
increases are for captive business development costs and holding company
operations.
INCOME TAXES
Our effective tax rate is lower than the federal statutory rate
principally due to nontaxable investment income.
Year Ended December 31,
------------------------
2003 2002 2001
---- ---- ----
Federal income tax at statutory rates .. 34% 34% 34%
Tax exempt income ...................... 6 (89) (12)
Dividends received ..................... 0 (21) (4)
Goodwill amortization .................. 0 0 5
Other, net ............................. (1) (1) 4
--- --- ---
Income tax at effective rates .......... 39% (77)% 27%
=== === ===
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.
At December 31,
-------------------------
2003 2002
---------- ----------
Deferred income tax asset ............. $5,307,000 $3,789,000
Year ended December 31, 2003 compared to year ended December 31, 2002
The tax benefit for the year ended December 31, 2003 was $2.7 million
compared to $0.3 million for the year ended December 31, 2002. A federal tax
benefit was incurred in 2003 due primarily to the pre-tax loss. In addition, the
effective tax benefit rate improved by 6% due to tax exempt income.
The increase in the deferred income tax asset to a balance of $5.3 million
as of December 31, 2003 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.
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 benefit 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.
47
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 our 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.
Second Step Conversion and Public Offering. On June 24, 2003, a plan of
conversion and reorganization was approved by the members of NCRIC, A Mutual
Holding Company and by the shareholders of NCRIC Group, Inc. In the conversion
and related stock offering, the Mutual Holding Company offered for sale its 60%
ownership interest in NCRIC Group. As a result of the conversion and stock
offering, the Mutual Holding Company ceased to exist, and NCRIC Group became a
fully public company.
In the conversion and stock offering, 4,143,701 shares of the common stock
of NCRIC Group were sold to Eligible Members, Employee Benefit Plans, Directors,
Officers and Employees and to members of the general public in a Subscription
and Community Offering at $10.00 per share. The Subscription stock offering
period expired on June 16, 2003. All stock purchase orders received in the
offering were satisfied.
As part of the conversion, 2,778,144 shares were issued to the former
public stockholders of NCRIC Group. The exchange ratio was 1.8665 new shares for
each share of NCRIC Group held by public stockholders as of the close of
business on June 25, 2003. Accordingly, after the conversion, NCRIC Group had
6,921,845 shares outstanding.
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,
Securities and Banking.
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 two 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 payment of dividends only
out of unassigned statutory surplus. As of December 31, 2003, NCRIC, Inc. had
approximately $70 million of unassigned statutory surplus. Any dividend payment
by NCRIC, Inc. would require the approval of the Commissioner.
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.
48
We had cash flows provided by operations for the years ended December 31,
as follows:
2003............. $20.6 million
2002............. $ 3.4 million
2001............. $ 8.3 million
Comprehensive income was a loss of $5.6 million for the year ended
December 31, 2003 compared to income $3.1 million for the year ended December
31, 2002. The decrease in comprehensive income results from the $1.3 million
decrease in net unrealized investment gains, combined with the $4.2 million net
loss for the year ended December 31, 2003 compared to the net income of $0.7
million for the year ended December 31, 2002.
Financial condition and capital resources. We invest our positive cash
flow from operations primarily in investment grade, fixed maturity securities.
As of December 31, 2003, the carrying value of the securities portfolio was
$174.4 million, compared to a carrying value of $120.1 million at December 31,
2002. The portfolios were invested as follows:
At December 31,
---------------
2003 2002
---- ----
U.S. Government and agencies ........... 17% 23%
Asset and mortgage-backed securities ... 31 28
Tax exempt securities .................. 21 27
Corporate bonds ........................ 24 17
Equity securities ...................... 7 5
--- ---
100% 100%
=== ===
Over 76% of the bond portfolio at December 31, 2003 was invested in U.S.
Government and agency securities or had a rating of AAA or AA. The entire bond
portfolio as of December 31, 2003 was held in investment grade (BBB or better)
securities as rated by Standard & Poor's. For regulatory purposes, as of
December 31, 2003, 90% 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 $1.5 million at December 31, 2003 compared to $2.8
million at December 31, 2002. This reduction in asset values resulted primarily
from the portfolio restructuring undertaken in 2003. While the restructuring
improved the overall asset quality of the bond portfolio, in general, securities
with higher coupon interest rates were sold and securities with lower, market
level, coupon rates were purchased. The securities with higher coupon rates
generally carry higher unrealized gains than do securities with lower coupon
rates of interest.
At December 31, 2003, our portfolio included total gross unrealized gains
of $3.8 million, or 2% of the $174.4 million carrying value of the portfolio,
and total unrealized losses of $1.6 million, or less than 1% of the carrying
value of the portfolio. The total unrealized losses are comprised of 219
different securities, including nine Treasury Note issues, 200 corporate debt
and municipal bonds (all of which are investment grade), with lengths of time to
maturity ranging from two to 35 years, and ten equity issues. All of the fixed
maturity securities are meeting and are expected to continue to meet all
contractual obligations for interest payments.
At December 31, 2003, the aggregate fair value of the securities with
unrealized losses was $81.0 million, or 98% of the aggregate carrying value of
those securities of $82.6 million. The largest single security with an
unrealized loss at December 31, 2003 relates to a FNMA pool which matures in
2033 and carries a coupon rate of 5.5%. The unrealized pre-tax loss relating
to this security is approximately $75,000 based on the fair value of $5.8
million at December 31, 2003. 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.
49
The following table displays characteristics of the securities with an
unrealized loss in value as of December 31, 2003. No concentrations of
industries exist in these securities.
Total securities Equity securities
---------------------------------- ----------------------------------
Length of time in Amortized Fair Unrealized Amortized Fair Unrealized
unrealized loss position Cost Value Loss Cost Value Loss
- ------------------------ --------- ----- ---------- --------- ----- ----------
(in thousands)
Less than 1 year .......... $82,598 $81,022 $1,576 $845 $816 $29
Over 1 year ............... -- -- -- -- -- --
------- ------- ------ ---- ---- ---
Total ..................... $82,598 $81,022 $1,576 $845 $816 $29
======= ======= ====== ==== ==== ===
The following table displays the maturity distribution of those fixed
maturity securities with an unrealized loss in value as of December 31, 2003:
Fixed maturity securities
---------------------------------------
Amortized Unrealized
Cost Fair Value Loss
--------- ---------- ----------
(in thousands)
During one year or less .................... $ -- $ -- $ --
Due after one year through five years ...... 12,574 12,490 84
Due after five years through ten years ..... 22,884 22,310 574
Due after twenty years ..................... 33,475 32,937 538
Due after ten through twenty years ......... 12,820 12,469 351
------- ------- ------
$81,753 $80,206 $1,547
======= ======= ======
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 $992,250
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
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 2.67% and 2.93% at December 31,
2003 and December 31, 2002, respectively. Principal and interest payments are
due on a monthly basis. The unpaid balance as of December 31, 2003 was $289,000.
50
The following table summarizes our contractual obligations as of December
31, 2003, in thousands:
Over
Over three More
One one year years to than
year or to three five five
Total less years years years
------- ------- ---- -------- -------
Long-term debt $15,289 $ 289 $ -- $ -- $15,000
Operating leases 3,765 859 1,754 1,152 --
------- ------ ---- ------- -------
$19,054 $1,148 $1,754 $ 1,152 $15,000
======= ====== ===== ======= =======
Operating leases consist of office rental commitments. The table excludes
purchase obligations which consist of routine acquisitions of office supplies
which represent minimal commitments generally spanning one month or less. As an
insurance company, we have liabilities for losses and related loss adjustment
expenses in the normal course of business. While these liabilities arise due to
contractual obligations under the insurance policies we issue, the liabilities
are estimates of amounts to be paid at undetermined future dates and are not
included in this table.
Our stockholders' equity totaled $78.0 million at December 31, 2003 and
$47.8 million at December 31, 2002. The $30.2 million increase for the year
ended December 31, 2003 was due primarily to $35.8 million of net proceeds from
the issuance of common stock, partially reduced by the net loss of $4.2 million
and the reduction of $1.3 million in 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
NCRIC Group and its subsidiaries file a consolidated income tax return
with the Internal Revenue Service. Tax years 2000, 2001 and 2002 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
51
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.
For 2002 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. For 2002 and 2001, NCRIC,
Inc. was outside the usual range for two ratios as the result of the rapid
increase in premiums. For 2003 NCRIC, Inc. was outside the usual range for five
ratios as the result of the rapid increase in premiums, the adverse development
of prior year losses, the decrease in yield on the investment portfolio, and the
capital contribution from NCRIC Group.
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. Since CML was
merged into NCRIC, Inc. effective December 31, 2003, results for 2003 of NCRIC,
Inc. include the impact of the merged business of CML.
Authorized
control level
risk-based capital Total adjusted capital
------------------ ----------------------
NCRIC, NCRIC,
Inc. CML Inc. CML
------ ----- ------ -----
(in millions)
December 31, 2003 .... $10.5 -- $70.4 --
December 31, 2002 .... $ 6.7 $0.49 $44.3 $ 4.7
December 31, 2001 .... $ 4.7 $0.17 $32.8 $ 4.3
52
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, 2003, fixed maturity securities
comprised 93% of total investments at fair value. U.S. government and agencies
and tax-exempt bonds represent 38% of the fixed maturity securities. Equity
securities, consisting of common stocks, 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, 2003 reflected an average effective
maturity of 7.27 years and an average modified duration of 4.8 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. All of our bond portfolio as of December 31, 2003 was
held in investment grade securities.
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 0.91% $186.1
-200 1.91 178.3
-100 2.91 170.5
Current Yield** 3.91 162.7
100 4.91 154.9
200 5.91 147.1
300 6.91 139.3
** Current yield is as of December 31, 2003.
The actual impact of the market interest rate changes on the securities
may differ from those shown in the sensitivity analysis above.
53
Item 8. Financial Statements and Supplementing Data
INDEX TO FINANCIAL STATEMENTS
Page
NCRIC GROUP, INC. AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT 55
Consolidated Balance Sheets as of December 31, 2003 and 2002 56
Consolidated Statements of Operations for the Years Ended
December 31, 2003, 2002, and 2001 57
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2003, 2002, and 2001 58
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2003, 2002, and 2001 59
Notes to Consolidated Financial Statements for the Years Ended
December 31, 2003, 2002, and 2001 60
Schedule I - Summary of Investments - Other Than Investments in Related Parties 80
Schedule II - Condensed Financial Information of Registrant 81
Schedule III - Supplementary Insurance Information 85
Schedule IV - Reinsurance 86
Schedule V - Valuation and Qualifying Accounts 87
Schedule VI - Supplemental Information Concerning Property-Casualty Insurance
Companies 88
54
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, 2003 and 2002, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ending December 31, 2003. 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, 2003 and 2002, and the results of their operations, and their
cash flows for each of the three years in the period ending December 31, 2003,
in conformity with accounting principles generally accepted in the United States
of America.
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
March 5, 2004
McLean, Virginia
55
NCRIC GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2003 AND 2002 (IN THOUSANDS, EXCEPT FOR SHARE DATA)
- --------------------------------------------------------------------------------
2003 2002
ASSETS
INVESTMENTS:
Securities available for sale, at fair value:
Bonds and U.S.Treasury Notes (Amortized cost $161,876 and $110,309) $ 162,744 $ 114,696
Equity securities (Cost $10,269 and $5,561) 11,613 5,424
--------- ---------
Total securities available for sale 174,357 120,120
OTHER ASSETS:
Cash and cash equivalents 9,978 10,550
Reinsurance recoverable 48,100 43,231
Goodwill, net 7,296 7,291
Premiums and accounts receivable, net 9,333 9,477
Deferred income taxes 5,307 3,789
Other assets 8,175 8,229
--------- ---------
TOTAL ASSETS $ 262,546 $ 202,687
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Losses and loss adjustment expenses:
Losses $ 87,778 $ 70,314
Loss adjustment expenses 38,213 33,708
--------- ---------
Total losses and loss adjustment expenses 125,991 104,022
Other liabilities:
Retrospective premiums accrued under reinsurance treaties 1,809 607
Unearned premiums 34,553 24,211
Advance premium 3,110 2,971
Reinsurance premium payable 1,538 5,045
Bank debt 289 995
Trust preferred securities 15,000 15,000
Other liabilities 2,277 2,019
--------- ---------
TOTAL LIABILITIES 184,567 154,870
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 4, 6, and 9)
STOCKHOLDERS' EQUITY:
Common stock $0.01 par value - 12,000,000 shares authorized; 6,898,865
shares issued and outstanding (net of 33,339 treasury shares) at
December 31, 2003; 3,708,399 shares issued and outstanding (net of
34,456 treasury shares) at December 31, 2002 70 37
Preferred stock $0.01 par value - 1,000,000 shares authorized, 0 shares issued -- --
Additional paid in capital 48,962 9,630
Unallocated common stock held by the ESOP (2,616) (682)
Common stock held by the stock award plan (1,594) (202)
Accumulated other comprehensive income 1,461 2,806
Retained earnings 32,046 36,518
Treasury stock, at cost (350) (290)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 77,979 47,817
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 262,546 $ 202,687
========= =========
See notes to consolidated financial statements.
56
NCRIC GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
2003 2002 2001
REVENUES:
Net premiums earned $ 47,264 $ 30,098 $ 20,603
Net investment income 6,008 5,915 6,136
Net realized investment gains (losses) 1,930 (131) (278)
Practice management and related income 4,906 5,800 6,156
Other income 1,155 1,013 602
-------- -------- --------
Total revenues 61,263 42,695 33,219
-------- -------- --------
EXPENSES:
Losses and loss adjustment expenses 50,473 26,829 18,858
Underwriting expenses 10,003 8,168 4,877
Practice management and related expenses 5,222 5,811 6,063
Interest expense on Trust Preferred Securities 826 62 --
Other expenses 1,651 1,405 1,245
-------- -------- --------
Total expenses 68,175 42,275 31,043
-------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES (6,912) 420 2,176
-------- -------- --------
INCOME TAX PROVISION (BENEFIT) (2,694) (322) 597
-------- -------- --------
NET INCOME (LOSS) $ (4,218) $ 742 $ 1,579
======== ======== ========
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Unrealized holding gains (losses) on securities $ (724) $ 2,478 $ 1,567
Reclassification adjustment for losses included in net income (621) (146) (349)
-------- -------- --------
OTHER COMPREHENSIVE INCOME (LOSS) (1,345) 2,332 1,218
-------- -------- --------
COMPREHENSIVE INCOME (LOSS) $ (5,563) $ 3,074 $ 2,797
======== ======== ========
Net income per common share:
Basic:
Average shares outstanding 6,486 6,639 6,587
-------- -------- --------
Earnings (Loss) Per Share $ (0.65) $ 0.11 $ 0.24
======== ======== ========
Diluted:
Average shares outstanding 6,486 6,639 6,587
Dilutive effect of stock options -- 140 160
-------- -------- --------
Average shares outstanding -diluted 6,486 6,779 6,747
-------- -------- --------
Earnings (Loss) Per Share $ (0.65) $ 0.11 $ 0.23
======== ======== ========
See notes to consolidated financial statements.
57
NCRIC GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(IN THOUSANDS)
- --------------------------------------------------------------------------------
Accumulated
Additional Unallocated Stock Other Total
Common Paid In ESOP Award Treasury Comprehensive Retained Stockholders'
Stock Capital Shares Shares Stock Income Earnings Equity
-------- ---------- ----------- -------- -------- ------------- -------- -------------
BALANCE, JANUARY 1, 2001 $ 37 $ 9,455 $ (889) $ (476) $ (131) $ (744) $ 34,197 $ 41,449
Net income -- -- -- -- -- -- 1,579 1,579
Other comprehensive income -- -- -- -- -- 1,218 -- 1,218
Acquisition 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
Acquisition 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
Net loss -- -- -- -- -- -- (4,218) (4,218)
Other comprehensive loss -- -- -- -- -- (1,345) -- (1,345)
Public stock offering 32 39,190 (2,072) (1,657) 290 -- -- 35,783
Conversion of mutual holding
company -- -- -- -- -- -- (254) (254)
Acquisition of treasury stock -- -- -- -- (350) -- -- (350)
Shares released 1 142 138 265 -- -- -- 546
-------- -------- -------- -------- -------- -------- -------- --------
BALANCE, DECEMBER 31, 2003 $ 70 $ 48,962 $ (2,616) $ (1,594) $ (350) $ 1,461 $ 32,046 $ 77,979
======== ======== ======== ======== ======== ======== ======== ========
See notes to consolidated financial statements.
58
NCRIC GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (IN THOUSANDS)
- --------------------------------------------------------------------------------
2003 2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (4,218) $ 742 $ 1,579
Adjustments to reconcile net income
to net cash flows from operating activities:
Net realized investment (gains) losses (1,930) 131 278
Amortization and depreciation 1,503 661 748
Provision for uncollectable receivables 486 1,362 212
Deferred income taxes (825) (2,508) (914)
Stock released for coverage of benefit plans 546 319 337
Changes in assets and liabilities:
Reinsurance recoverable (4,869) (13,154) (2,528)
Premiums and accounts receivable (342) (6,037) (1,576)
Other assets (151) (2,132) 658
Losses and loss adjustment expenses 21,969 19,462 3,426
Retrospective premiums accrued under
reinsurance treaties 1,202 (1,801) (3,070)
Unearned premiums 10,342 6,974 5,765
Advance premium 139 (1,167) 3,372
Reinsurance premium payable (3,507) 2,593 1,649
Other liabilities 257 (2,071) (1,682)
--------- --------- ---------
Net cash flows provided by operating activities 20,602 3,374 8,254
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (193,911) (52,824) (24,736)
Sales, maturities and redemptions of investments 138,607 39,027 21,956
Investment in purchased business -- -- (3,014)
Purchases of property and equipment (597) (895) (400)
--------- --------- ---------
Net cash flows used in investing activities (55,901) (14,692) (6,194)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from public stock offering 35,783 -- --
Proceeds from the issuance of trust preferred securities -- 15,000 --
Purchase of Treasury Stock (350) (30) (129)
Proceeds from bank debt -- -- 1,971
Repayment of bank debt (706) (667) (309)
--------- --------- ---------
Net cash flows provided by financing activities 34,727 14,303 1,533
--------- --------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS (572) 2,985 3,593
--------- --------- ---------
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 10,550 7,565 3,972
--------- --------- ---------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 9,978 $ 10,550 $ 7,565
========= ========= =========
SUPPLEMENTARY INFORMATION:
Cash paid for income taxes $ 1,200 $ 2,200 $ 2,172
========= ========= =========
Interest paid $ 858 $ 61 $ 72
========= ========= =========
See notes to consolidated financial statements.
59
NCRIC GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
1. SIGNIFICANT ACCOUNTING POLICIES
Organization and Basis of Reporting - NCRIC, Group, Inc. (the Company) is
a healthcare financial services organization that provides individual
physicians and groups of physicians and other healthcare providers with
professional liability insurance and practice management services through
its subsidiary companies.
On June 24, 2003, a plan of conversion and reorganization was approved by
the members of NCRIC, A Mutual Holding Company and by the shareholders of
NCRIC Group, Inc. In the conversion and related stock offering, NCRIC, A
Mutual Holding Company offered for sale its 60% ownership interest in
NCRIC Group, Inc. As a result of the conversion and stock offering, NCRIC,
A Mutual Holding Company ceased to exist, and NCRIC Group, Inc. became a
fully public company.
On April 20, 1998, the Board of Governors of National Capital Reciprocal
Insurance Company adopted a plan of reorganization that 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 domiciled in the District of Columbia. The
reorganization became effective on December 31, 1998. In 1999, the Company
completed an initial public offering of 1,480,000 shares, which
represented approximately 40% of its outstanding shares. Prior to the plan
of conversion discussed above, the Mutual Holding Company owned
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)
Through its property-casualty insurance company subsidiaries, NCRIC, Inc.
and Commonwealth Medical Liability Insurance Company (CML), 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. Effective December 31, 2003, the Insurance
Commissioner of the District of Columbia approved the statutory merger of
NCRIC, Inc. and CML. As a result, the assets, liabilities and policyholder
obligations of CML were transferred, at book value, to NCRIC, Inc. and CML
ceased to exist as a separate entity.
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.
60
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 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 accounting principles generally accepted in the United States of
America (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 that 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,
2003, the Company determined that an equity security experienced an
other-than-temporary impairment. Accordingly, the Company recorded a
pre-tax impairment loss of $135,000 during 2003. During the year ended
December 31, 2002 the Company recorded an impairment loss on securities in
the second quarter. These securities were subsequently
61
sold during 2002. Additionally, in 2001, the Company determined that an
equity security experienced an other-than-temporary impairment.
Accordingly, the Company recorded a pre-tax impairment loss of $300,000 in
2001 relating to that investment.
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. For the year ended December 31, 2001, 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 Group, Inc. 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, 2003. Goodwill is reported net of accumulated
amortization of $909,000 as of December 31, 2003 and 2002.
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 $2.4 million and $1.5
million as of December 31, 2003 and 2002, 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. Amortization of acquisition costs 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
$2.1 million and $2.0 million as of December 31, 2003 and 2002,
respectively, are net of accumulated depreciation of $2.5 million and $1.9
million.
Liabilities for Losses and Loss Adjustment Expenses - Liabilities for
losses and loss adjustment expenses are established on the basis of
reported losses and loss adjustment expenses and a provision for losses
incurred but not reported. These amounts are based on management's
estimates and are subject to risks and uncertainties. As facts become
known, adjustments to these estimates are reflected in earnings.
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 liability for
loss and loss adjustment expenses associated with the reinsured loss.
Income Taxes - The Company uses the asset and liability method of
accounting for income
62
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 basis of existing assets and
liabilities. The Company files a consolidated Federal income tax return.
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, 2003 and 2002, 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 GAAP 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 that 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.
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, except for the premium
collection litigation discussed in Note 14.
Revenue Recognition - Premium 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.
The Company writes policies under certain retrospectively rated programs.
Premium 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.
63
Stock-based Compensation - As of December 31, 2003 and 2002 the Company
has a stock option plan, which is described more fully in Note 10. NCRIC
Group, Inc. 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:
2003 2002 2001
--------- --------- ---------
Net income as reported ($4,218) $742 $1,579
Less: Total stock based employee compensation,
net of related tax effect (67) (37) (64)
------- ----- ------
Pro forma net income (in thousands) ($4,285) $705 $1,515
======= ===== ======
Earnings per share - Basic as reported $(0.65) $0.11 $0.24
Basic pro forma $(0.66) $0.11 $0.23
Diluted as reported $(0.65) $0.11 $0.23
Diluted pro forma $(0.66) $0.10 $0.23
2. SECOND STEP CONVERSION AND PUBLIC OFFERING
On June 24, 2003, a plan of conversion and reorganization was approved by
the members of NCRIC, A Mutual Holding Company and by the shareholders of
NCRIC Group, Inc. In the conversion and related stock offering, the Mutual
Holding Company offered for sale its 60% ownership interest in NCRIC
Group. As a result of the conversion and stock offering, the Mutual
Holding Company ceased to exist, and NCRIC Group, Inc. became a fully
public company.
In the conversion and stock offering, 4,143,701 shares of the common stock
of NCRIC Group, Inc. were sold to Eligible Members, Employee Benefit
Plans, Directors, Officers and Employees and to members of the general
public in a Subscription and Community Offering priced at $10.00 per
share. The Subscription stock offering period expired on June 16, 2003.
All stock purchase orders received in the offering were satisfied.
As part of the conversion, 2,778,144 shares were issued to the former
public stockholders of NCRIC Group, Inc. The exchange ratio was 1.8665 new
shares for each share of NCRIC Group, Inc. held by public stockholders as
of the close of business on June 25, 2003. Accordingly, after the
conversion, the Company had 6,921,845 shares outstanding immediately
following the offering. For the earnings per share calculations, the share
amounts for periods prior to the conversion and stock offering have been
revised to reflect the share exchange ratio applied in the conversion.
Prior year share data within the consolidated balance sheet has not been
revised for the exchange ratio applied in the conversion. The issuance of
the shares of common stock in the subscription and community offering and
in the exchange offering to existing stockholders was registered on Form
S-1 filed with the SEC (No. 333-104023), which registration statement was
declared effective on May 14, 2003.
64
The net proceeds of the offering have been deployed as follows:
o 75% has been added to the capital of NCRIC, Inc.;
o 9% has been used to provide loans to the employee stock ownership
plan and stock award plan to fund the purchase of shares of common
stock in the offering; and
o the remaining amount has been retained for general corporate
purposes.
The reconciliation of gross to net proceeds is as follows (in thousands):
Gross offering proceeds $ 41,437
Less: Offering expenses (1,924)
--------
Net proceeds 39,513
ESOP loan (2,072)
Stock Award Plan loan (1,657)
--------
Net proceeds as adjusted $ 35,784
========
The composition of shares after the second step conversion and public
offering is as follows (in thousands):
Issued in the conversion and stock offering 4,144
Issued to existing public shareholders of NCRIC Group 2,778
------
Total shares issued June 25, 2003 6,922
ESOP loan shares (270)
Stock Award Plan loan shares (179)
------
Net shares outstanding as of June 25, 2003 6,473
======
65
3. INVESTMENTS
The following tables show the amortized cost and fair value of investments
(in thousands):
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
As of December 31, 2003
U.S. Government and agencies $ 29,328 $ 75 $ (118) $ 29,285
Corporate 41,773 247 (720) 41,300
Tax-exempt obligations 35,329 1,907 (78) 37,158
Asset and mortgage-backed
Securities 55,446 186 (631) 55,001
-------- ------- --------- --------
161,876 2,415 (1,547) 162,744
Equity securities 10,269 1,373 (29) 11,613
-------- ------- --------- --------
Total $172,145 $ 3,788 $ (1,576) $174,357
======== ======= ========= ========
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair 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
======== ======= ========= ========
The amortized cost and fair value of debt securities at December 31, 2003
and 2002 are shown by maturity (in thousands). Actual maturities will
differ from contractual maturities because borrowers may have the right to
prepay obligations with or without prepayment penalties.
66
December 31, 2003 December 31, 2002
------------------------ ------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- -------- --------- --------
Due in one year or less $ 1,912 $ 1,923 $ 742 $ 750
Due after one year through five years 39,363 39,886 40,685 42,283
Due after five years through ten years 45,918 46,483 36,707 38,825
Due after ten years 19,237 19,451 12,626 12,557
-------- -------- -------- --------
106,430 107,743 90,760 94,415
Equity securities 10,269 11,613 5,561 5,424
Asset and mortgage-backed securities 55,446 55,001 19,549 20,281
-------- -------- -------- --------
Total $172,145 $174,357 $115,870 $120,120
======== ======== ======== ========
Proceeds from bond maturities and redemptions of available for sale
investments during the years ended December 31, 2003, 2002, and 2001, were
$138.6 million, $39.0 million, and $22.0 million, respectively. Gross
gains of $3,441,000, $1,437,000, and $787,000, and gross losses of
$1,511,000, $1,568,000, and $1,065,000, were realized on security sales,
redemptions and impairments during years ended December 31, 2003, 2002,
and 2001, respectively.
Net investment income consists of the following (in thousands):
For the Year Ended December 31,
2003 2002 2001
------- ------- -------
U. S Government and agencies $ 654 $ 255 $ 470
Corporate 1,794 3,038 3,144
Tax-exempt obligations 1,462 1,290 895
Asset and mortgage-backed securities 2,313 1,178 1,266
Equity securities 124 431 433
Short term investments 91 103 241
------- ------- -------
Total investment income earned 6,438 6,295 6,449
Investment expenses (430) (380) (313)
------- ------- -------
Net investment income $ 6,008 $ 5,915 $ 6,136
======= ======= =======
4. LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Liabilities for unpaid losses and loss adjustment expenses (LAE) 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.
67
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,
--------------------------------------
2003 2002 2001
--------- --------- --------
BALANCE, Beginning of the year $ 104,022 $ 84,560 $ 81,134
Less reinsurance recoverable on
unpaid claims (42,412) (29,624) (27,312)
--------- --------- --------
NET BALANCE 61,610 54,936 53,822
Incurred related to:
Current year 44,588 24,063 23,056
Prior years 5,885 2,766 (4,198)
--------- --------- --------
Total incurred 50,473 26,829 18,858
--------- --------- --------
Paid related to:
Current year 4,383 1,491 1,599
Prior years 26,382 18,664 16,145
--------- --------- --------
Total paid 30,765 20,155 17,744
--------- --------- --------
NET BALANCE 81,318 61,610 54,936
Plus reinsurance recoverable on
unpaid claims 44,673 42,412 29,624
--------- --------- --------
BALANCE, End of year $ 125,991 $ 104,022 $ 84,560
========= ========= ========
Incurred losses related to prior years represents development of net
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 2003 change
stems from adverse development on losses, primarily those reported
initially in 2002 and 2001 in Virginia, as well as from a change in
estimate of the amount of reinsurance recoverable. 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 2001 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 change
in development over the three-year period ended December 31, 2003,
reflects a continuing increase in severity caused by the growing size of
plaintiff verdicts and settlements.
68
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 4.0%, 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 12.5%. The
Company may defer payment of interest on the TPS for up to 20
consecutive quarters. The TPS are callable by the Company at par beginning
December 4, 2007.
The average interest rate was 5.31% and 5.42% and interest of $826,000 and
$62,000 was incurred for the years ended December 31, 2003 and 2002,
respectively. Issuance costs of $451,000 were incurred related to the TPS
and included in other assets. Issuance costs are being amortized over 30
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 30 years, and bear interest at an
annual rate equal to three-month LIBOR plus 4.0%, 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 12.5%. 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.
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 is liable in the event the reinsurers are unable to meet their
obligations under these contracts. NCRIC, Inc. holds letters of credit
executed by reinsurers in the amount of $1.3 million at December 31, 2003
and 2002. 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):
69
December 31
------------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Written Earned Written Earned Written Earned
Direct $ 71,365 $ 61,023 $ 51,799 $ 44,113 $ 34,459 $ 28,192
Ceded
Current year (11,162) (12,833) (18,409) (14,429) (12,238) (8,992)
Prior year (926) (926) 406 406 1,696 1,696
-------- -------- -------- -------- -------- --------
Total ceded (12,088) (13,759) (18,003) (14,023) (10,542) (7,296)
-------- -------- -------- -------- -------- --------
Net premiums before
renewal credits $ 59,277 $ 47,264 $ 33,796 $ 30,090 $ 23,917 $ 20,896
======== ======== ======== ======== ======== ========
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):
As of December 31,
2003 2002
------ ------
Deferred tax assets:
Unearned Premiums $ 2,367 $ 1,670
Discounted loss reserves 3,805 3,034
Depreciation and amortization -- 117
Capital loss carry-forwards -- 150
Net operating loss 127 --
Allowance for doubtful accounts 640 608
Other 210 163
------- -------
7,149 5,742
Valuation allowance (127) --
------- -------
7,022 5,742
Deferred tax liabilities
Unrealized gain on investments (753) (1,446)
Deferred policy acquisition costs (802) (503)
Depreciation and amortization (64) --
Other (96) (4)
------- -------
(1,715) (1,953)
------- -------
Net deferred tax assets $ 5,307 $ 3,789
======= =======
70
The income tax (benefit) provision consists of the following (in
thousands):
For the Year Ended December 31,
---------------------------------
2003 2002 2001
------- ------- -------
Federal:
Current $(1,919) $ 2,214 $ 1,734
Deferred (831) (2,501) (1,206)
------- ------- -------
(2,750) (287) 528
State:
Current 50 (28) 83
Deferred 6 (7) (14)
------- ------- -------
56 (35) 69
------- ------- -------
Total (benefit) provision $(2,694) $ (322) $ 597
======= ======= =======
Federal income tax expense differs from that calculated using the
established corporate rate primarily due to nontaxable investment income,
as follows (in thousands):
For the Year ended December 31,
------------------------------------------------------------
2003 2002 2001
------------------ ---------------- ----------------
% of % of % of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
Federal income tax
at statutory rates $(2,350) 34% $ 142 34% $ 740 34%
Tax-exempt income (425) 6 (374) (89) (259) (12)
Dividends received (25) -- (87) (21) (88) (4)
Goodwill -- -- -- -- 115 5
Other 106 (1) (3) (1) 89 4
------- --- ----- --- ----- ---
Income tax at
effective rates $(2,694) 39% $(322) (77)% $ 597 27%
======= === ===== === ===== ===
At December 31, 2003, the Company had regular federal net operating loss
carryforwards of approximately $374,000 which will begin to expire in
2019. Since the losses are subject to certain limitations under the
Internal Revenue Code, a valuation allowance of $127,000 was established
to offset the deferred tax asset associated with these net operating loss
carryforwards.
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,
-------------------------------
2003 2002 2001
------- ------ ------
Net income (loss) $(4,218) $ 742 $1,579
======= ====== ======
Weighted average common shares outstanding -
basic 6,486 6,639 6,587
Dilutive effect of stock options -- 140 160
------- ------ ------
Weighted average common shares outstanding -
diluted 6,486 6,779 6,747
------- ------ ------
Net income (loss) per common share:
Basic $ (0.65) $ 0.11 $ 0.24
======= ====== ======
Diluted $ (0.65) $ 0.11 $ 0.23
======= ====== ======
71
Earnings per share is calculated by dividing the net income by the
weighted average shares outstanding for the period. Incremental shares are
not included in 2003 because they would be anti-dilutive. The share
amounts for periods prior to the conversion and stock offering have been
revised to reflect the share exchange ratio applied in the conversion.
Prior year share data within the consolidated balance sheet has not been
revised for the exchange ratio applied in the conversion.
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 ten
years with a monthly base rent of $35,000 and a 2.0% annual escalator.
During 2003, the company entered in to an operating lease for additional
office space in Washington, D.C. The lease term is for 54 months with a
monthly base rent of $14,000 and a 2.5% annual escalator. The Company also
maintains office space in Lynchburg and Richmond, Virginia as well as in
Greensboro, North Carolina.
As of December 31, 2003, the future minimum annual commitments under
noncancellable leases are as follows:
2004 $ 859,000
2005 867,000
2006 887,000
2007 883,000
2008 and thereafter 269,000
----------
$3,765,000
==========
Rent expense during the years ended December 31, 2003, 2002, and 2001 was
$721,000, $634,000, and $662,000, respectively.
NCRIC has established four letters of credit to secure specified amounts
of appellate bonds for cases, which are in the Commonwealth of Virginia or
District of Columbia appellate process. As of December 31, 2003, these
letters of credit totaled $4.8 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 $992,250.
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
72
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, 2003, 2002 and 2001, the interest rate was 2.67%, 2.93%
and 4.83%, respectively. 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 Group, Inc.'s plan. NCRIC is not required to
make matching contributions to the plan, but may make discretionary
contributions. Total contributions to the plan by the Company for the
years ended December 31, 2003, 2002, and 2001, were $374,000, $328,000,
and $145,000, respectively.
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 contribution
by NCRIC MSO for the year ended December 31, 2001, was $67,000.
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. No contribution was made
for the year ended December 31, 2001.
Stock Option Plan - NCRIC Group, Inc. has a stock option plan for
directors and officers of the Company and its subsidiaries whereby awards
granted vest evenly over a three to five year period from the date of
grant. The options have terms of ten years and an exercise price equal to
the fair market value of the common stock at the date of grant.
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. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, 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.
As a part of the stock offering completed during 2003, the number and
exercise price of existing stock options granted to officers and directors
of the Company and its subsidiaries were converted at the exchange ratio
of 1.8665.
73
A summary of the status of the stock option plan as of December 31, 2003
and changes during the year is presented below:
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Exercisable Price
-------- -------- ----------- --------
January 1, 2001 74,000 $ 7.00 24,667 $ 7.00
December 31, 2001 74,000 $ 7.00 49,334 $ 7.00
December 31, 2002 74,000 $ 7.00 74,000 $ 7.00
Stock conversion 64,123 $ 3.75 64,123 $ 3.75
Granted 392,608 $10.90 -- --
Exercised (10,359) $ 3.75 (10,359) $ 3.75
Forfeited (3,453) $ 3.75 (3,453) $ 3.75
-------- ------ -------- ------
December 31, 2003 516,919 $ 9.18 124,311 $ 3.75
======== ====== ======== ======
The following table summarizes information for options outstanding and
exercisable at December 31, 2003:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Prices Number Contractual Exercise Number Exercise
per Share Outstanding Life Price Exercisable Price
$ 3.75 - $8.49 124,311 5.60 $ 3.75 124,311 $ 3.75
$8.50 - $11.00 392,608 9.83 $10.90 -- --
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 for grants made during 2003 and 1999,
respectively: risk free rate of return of 4.41% and 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 .386 to .829 and
.489 to .843; and an expected life of the option of 9.15 and 10 years. The
weighted average fair value of the options granted during 2003 as of the
grant date was $6.20.
74
Employee Stock Ownership Plan - NCRIC Group, Inc. has an Employee Stock
Ownership Plan (ESOP) for employees who have attained age 21 and completed
one year of service. As part of the 1999 stock offering, the ESOP borrowed
$1.0 million from NCRIC Group, Inc. to purchase 148,000 shares, 276,247
shares on a converted basis, 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, 2003, 2002, and 2001 have been made. During the
years ended December 31, 2003, 2002, and 2001 contributions were made to
the plan of $207,200, $162,800 and $120,000, respectively.
Stock Award Plans - The Company has established two Stock Award Plans
under which certain employees and directors may be awarded restricted
common stock vesting over a three to five year period. The trusts
established under each of the plans have borrowed funds from the Company
to support the purchase of NCRIC Group, Inc. common stock. All of the
scheduled loan repayments have been made. In September 2000, the board of
directors granted 74,000 shares to certain directors and officers under
the original Plan. During August 2003, the Board granted 159,120 shares
under the 2003 Stock Award Plan. The Company amortizes compensation
expense equal to the fair value of the stock on the date of award evenly
over the vesting period. During the years ended December 31, 2003, 2002
and 2001, compensation expense related to the Stock Award Plans was
$299,400, $153,800 and $153,800, respectively.
Executive Deferred Compensation Plan - In 2003 NCRIC established a
deferred compensation plan which is a non-qualified, unfunded plan under
which the Directors and Officers of NCRIC Group may defer a portion of
their compensation. The Company will provide a match for deferrals of 5%
of compensation for officers. Deferred amounts are credited with interest
at the rate of 6% per year. The matching expense under this plan totaled
$49,000 for the year ended December 31, 2003.
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,
----------------------------------
2003 2002 2001
-------- -------- --------
POLICYHOLDERS' SURPLUS -
STATUTORY BASIS $ 70,372 $ 44,269 $ 32,759
Fair valuation of investments 904 2,806 474
Deferred taxes (1,771) 3,012 2,726
Group stock issuance 7,838 7,642 7,353
Capital contribution -- (13,500) --
Non-admitted assets and other 636 3,588 1,142
-------- -------- --------
STOCKHOLDERS' EQUITY - GAAP BASIS $ 77,979 $ 47,817 $ 44,454
======== ======== ========
NET INCOME (LOSS) - STATUTORY BASIS $ (4,900) $ (1,510) $ 593
Deferred taxes 810 2,508 1,220
GAAP consolidation and other (128) (256) (234)
-------- -------- --------
NET INCOME (LOSS) - GAAP BASIS $ (4,218) $ 742 $ 1,579
======== ======== ========
75
As of December 31, 2003, 2002, and 2001, statutory capital and surplus for
NCRIC was sufficient to satisfy regulatory requirements. Each insurance
company is restricted under the applicable Insurance Code as to the amount
of dividends it may pay without regulatory consent.
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):
2003 2002 2001
--------- --------- ---------
Insurance
Revenues from external customers $ 48,343 $ 31,023 $ 21,118
Net investment income 5,749 5,877 6,087
Net realized investment gains (losses) 1,901 (131) (278)
Depreciation and amortization 1,378 524 193
Segment (loss) profit before taxes (4,844) 1,323 2,834
Segment assets 245,137 190,522 152,130
Segment liabilities 168,465 138,297 114,424
Expenditures for segment assets 410 637 153
Practice Management Services
Revenues from external customers $ 4,986 $ 5,886 $ 6,239
Net investment income 15 27 55
Net realized investment gains 20 -- --
Depreciation and amortization 125 137 555
Segment (loss) profit before taxes (210) 83 205
Segment assets 8,765 8,290 9,188
Segment liabilities 2,981 2,800 3,762
Expenditures for segment assets 98 82 247
Total
Revenues from external customers $ 53,329 $ 36,909 $ 27,357
Net investment income 5,764 5,904 6,142
Net realized investment gains (losses) 1,921 (131) (278)
Depreciation and amortization 1,503 661 748
Segment (loss) profit before taxes (5,054) 1,406 3,039
Segment assets 253,902 198,812 161,318
Segment liabilities 171,446 141,097 118,186
Expenditures for segment assets 508 719 400
76
The following are reconciliations of reportable segment revenues, net
investment income, assets, liabilities, and profit to the Company's
consolidated totals (in thousands):
2003 2002 2001
--------- --------- ---------
Revenues:
Total revenues from external customers for
reportable segments $ 53,329 $ 36,909 $ 27,357
Other income 221 8 12
Elimination of intersegment revenues (11) (6) (8)
--------- --------- ---------
Consolidated total $ 53,539 $ 36,911 $ 27,361
========= ========= =========
Net investment income:
Total investment income for reportable segments $ 5,764 $ 5,904 $ 6,142
Elimination of intersegment income (1,027) (4) (6)
Other unallocated amounts 1,272 15 --
--------- --------- ---------
Consolidated total $ 6,008 $ 5,915 $ 6,136
========= ========= =========
Net realized investment gains (losses):
Total investment income for reportable segments $ 1,921 $ (131) $ (278)
Other unallocated amounts 9 -- --
--------- --------- ---------
Consolidated total $ 1,930 $ (131) $ (278)
Assets:
Total assets for reportable segments $ 253,902 $ 198,812 $ 161,318
Elimination of intersegment receivables (2,162) (1,324) (1,675)
Elimination of affiliate receivables 1,397 120 1,139
Other unallocated amounts 9,409 5,079 220
--------- --------- ---------
Consolidated total 262,546 $ 202,687 $ 161,002
========= ========= =========
Liabilities:
Total liabilities for reportable segments $ 171,446 $ 141,097 $ 118,186
Elimination of intersegment payables (2,162) (1,324) (1,675)
Other liabilities 15,283 15,097 37
--------- --------- ---------
Consolidated total $ 184,567 $ 154,870 $ 116,548
========= ========= =========
Profit (loss) before taxes:
Total profit (loss)for reportable segments $ (5,054) $ 1,406 $ 3,039
Other unallocated amounts (1,858) (986) (863)
--------- --------- ---------
Consolidated total $ (6,912) $ 420 $ 2,176
========= ========= =========
77
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 year ended December 31, 2001.
During 2003, 2002, and 2001, members of the Company's Board of Directors
paid NCRIC MSO approximately $176,000, $163,000 and $183,000,
respectively, for practice management related services.
14. SUBSEQUENT EVENT
On February 13, 2004, a District of Columbia Superior Court jury
returned a verdict in favor of Columbia Hospital for Women Medical
Center, Inc. (CHW) in the premium collection litigation between NCRIC,
Inc. and CHW. The verdict came in a civil action stemming from NCRIC,
Inc.'s efforts to collect payment for nearly $3 million in premiums
that the Company alleges it is owed by CHW under a contract with the
hospital that expired in 2000. The jury rejected the claim by NCRIC,
Inc. and returned a verdict in favor of CHW counterclaims. The jury
awarded $18.2 million in damages to CHW.
The verdict was entered as a judgment on February 20, 2004. On March 5,
2004, NCRIC filed post-trial motions for judgment as a matter of law
and, in the alternative, for a new trial. As a result of these
post-trial motions, the judgment is not final, and jurisdiction with
respect to the verdict remains with the trial judge. In connection with
the filing of post-trial motions, NCRIC secured a $19.5 million
appellate bond and associated letter of credit. No amounts have been
drawn upon the letter of credit as of March 5, 2004. After the
post-trial motions have been ruled upon by the judge, any judgment will
be entered as final, but subject to appeal. No liability has been
accrued in these financial statements for any possible loss arising
from this litigation because the judgment is not yet final and remains
with the trial judge and, NCRIC believes that it has meritorious
defenses and that it is not probable that the preliminary judgment will
prevail, nor is any potential final outcome reasonably estimable at
this time. Legal expenses to be incurred for this litigation in 2004
are estimated to be approximately $750,000. The expenses associated
with the $19.5 million appellate bond and associated letter of credit
are estimated to be approximately $300,000. Such expenses are not
accrued in the 2003 financial statements.
78
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations
for 2003, 2002 and 2001 For the earnings per share calculations, the share
amounts for periods prior to the conversion and stock offering have been
revised to reflect the share exchange ratio applied in the conversion):
Year Ended December 31, 2003
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------
Premiums earned and other revenues $ 13,177 $ 12,599 $ 13,954 $ 13,595
Net investment income 1,322 1,389 1,657 1,640
Realized investment gains 199 1,155 498 78
Net income (loss) 514 542 370 (5,644)
Basic earnings per share of common
stock $ 0.08 $ 0.08 $ 0.06 $ (0.89)
Diluted earnings per share of common
stock $ 0.08 $ 0.08 $ 0.06 $ (0.89)
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 $ 0.08 $ 0.03 $ (0.12) $ 0.12
Diluted earnings per share of common
stock $ 0.08 $ 0.03 $ (0.12) $ 0.12
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 $ 0.14 $ 0.05 $ 0.10 $ (0.05)
Diluted earnings per share of common
stock $ 0.14 $ 0.05 $ 0.10 $ (0.05)
79
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE I
SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2003 (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 $ 29,328 $ 29,285 $ 29,285
States, municipalities, and political subdivisions 35,329 37,158 37,158
All other corporate bonds 41,773 41,300 41,300
Asset and mortgage-backed securities 55,446 55,001 55,001
Redeemable preferred stocks -- -- --
-------- -------- --------
Total fixed maturities 161,876 162,744 162,744
Equity securities:
Industrial, miscellaneous, and all other 10,269 11,613 11,613
Nonredeemable preferred stocks -- -- --
-------- -------- --------
Total equity securities 10,269 11,613 11,613
Total investments $172,145 $174,356 $174,356
======== ======== ========
(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.
80
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET
AS OF DECEMBER 31, 2003 AND 2002 (IN THOUSANDS)
- --------------------------------------------------------------------------------
2003 2002
ASSETS
INVESTMENTS:
Investments in subsidiaries* $82,920 $58,179
Bonds 7,403 3,392
------- -------
Total investments 90,323 61,571
OTHER ASSETS:
Cash and cash equivalents 296 99
Receivables 76 60
Property and equipment, net 895 973
Due from subsidiaries* 1,397 120
Other assets 741 555
------- -------
TOTAL ASSETS $93,728 $63,378
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Junior Subordinated Deferrable Interest Debentures $15,464 $15,464
Other liabilities 285 97
------- -------
TOTAL LIABILITIES 15,749 15,561
------- -------
STOCKHOLDERS' EQUITY:
Common stock 70 37
Other stockholders' equity, including unrealized gains
or losses on securities of subsidiaries 77,909 47,780
------- -------
TOTAL STOCKHOLDERS' EQUITY 77,979 47,817
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $93,728 $63,378
======= =======
* Eliminated in consolidation.
See notes to condensed financial statements.
81
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY)
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (IN THOUSANDS)
- --------------------------------------------------------------------------------
2003 2002 2001
REVENUES:
Net investment income $ 272 $ 16 $ --
Dividends from subsidiaries* 1,000 1,750 1,500
Other income 15 7 12
------- ------- ------
Total revenues 1,287 1,773 1,512
------- ------- ------
EXPENSES:
Interest expense 826 62 --
Other operating expenses 663 608 875
------- ------- ------
Total expenses 1,489 670 875
------- ------- ------
INCOME BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF SUBSIDIARIES (202) 1,103 637
Equity in undistributed earnings of subsidiaries (4,016) (361) 942
------- ------- ------
NET INCOME $(4,218) $ 742 $1,579
======= ======= ======
* Eliminated in consolidation.
See notes to condensed financial statements.
82
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, 2003 AND 2002 (IN THOUSANDS)
- --------------------------------------------------------------------------------
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ (4,218) $ 742
Adjustments to reconcile net income
to net cash flows from operating activities:
Equity in undistributed earnings of subsidiaries 4,016 361
Net realized investment gains (8) --
Amortization and depreciation 199 106
Stock released for coverage of benefit plans 546 319
Other changes in assets and liabilities: (1,276) 639
-------- --------
Net cash flows provided by (used in) operating activities (741) 2,167
-------- --------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchases of investments (9,059) (3,392)
Sales, maturities and redemptions of securities 4,982 --
Conversion of holding company (254) --
Investment in subsidiaries (30,075) (13,960)
Purchases of property and equipment (89) (175)
-------- --------
Net cash flows used in investing activities (34,495) (17,527)
-------- --------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Net proceeds from Junior Subordinated Deferrable Interest Debentures -- 15,464
Net proceeds from public stock offering 35,783 --
Payments to acquire treasury stock (350) (30)
-------- --------
Net cash flows provided by financing activities 35,433 15,434
NET CHANGE IN CASH AND CASH EQUIVALENTS 197 74
-------- --------
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 99 25
-------- --------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 296 $ 99
======== ========
SUPPLEMENTARY INFORMATION:
Interest paid $ 830 $ --
======== ========
See notes to condensed financial statements.
83
NOTES TO CONDENSED FINANCIAL STATEMENTS
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY)
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
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 June 24, 2003, a plan of conversion and reorganization was approved by the
members of NCRIC, A Mutual Holding Company and by the shareholders of NCRIC
Group, Inc.(Group). In the conversion and related stock offering, NCRIC, A
Mutual Holding Company offered for sale its 60% ownership interest in NCRIC
Group, Inc. As a result of the conversion and stock offering, NCRIC, A Mutual
Holding Company ceased to exist, and NCRIC Group, Inc. became a fully public
company. See Note 2 of the Notes to the Consolidated Financial Statements.
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 Group, and converted into NCRIC,
Inc. Group was organized in December, 1998,
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. INVESTMENTS
See Investments in the Consolidated Financial Statements and in Note 3 of the
Notes to the Consolidated Financial Statements.
IV. JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES
See Note 5 of the Notes to the Consolidated Financial Statements
V. COMPREHENSIVE INCOME
See Comprehensive Income in the Consolidated Financial Statements.
VI. 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.
VII. ACCOUNTING CHANGES
For information concerning new accounting standards adopted in 2003 and 2002,
see Note 1 of the Notes to the Consolidated Financial Statements.
84
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION
DECEMBER 31, 2003, 2002, AND 2001 (IN THOUSANDS)
- --------------------------------------------------------------------------------
DEFERRED FUTURE POLICY OTHER POLICY
POLICY BENEFITS, LOSSES, CLAIMS AND
ACQUISITION CLAIMS, AND UNEARNED BENEFITS PREMIUM
SEGMENT COSTS LOSS EXPENSES PREMIUMS PAYABLE REVENUE
- ------- ----- ------------- -------- ------- -------
Insurance:
2003 $2,358 $125,991 $34,553 $ -- $47,264
2002 $1,480 $104,022 $24,211 $ -- $30,098
2001 $ 851 $ 84,560 $17,237 $ -- $20,603
AMORTIZATION
BENEFITS, OF DEFERRED
NET LOSSES AND POLICY OTHER
INVESTMENT LOSS ACQUISITION OPERATING PREMIUMS
SEGMENT INCOME EXPENSES COSTS EXPENSES WRITTEN
- ------- ------ -------- ----- -------- -------
Insurance:
2003 $6,008 $50,473 $4,360 $6,003 $71,365
2002 $5,915 $26,829 $2,890 $5,728 $51,799
2001 $6,136 $18,858 $1,337 $3,890 $34,459
85
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE IV
REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(IN THOUSANDS)
- --------------------------------------------------------------------------------
CEDED ASSUMED PERCENTAGE
PROPERTY AND GROSS TO OTHER FROM OTHER NET OF ASSUMED
LIABILITY INSURANCE AMOUNT COMPANIES COMPANIES AMOUNT TO NET
- ------------------- ------ --------- --------- ------ ------
2003 $61,023 $(13,759) $ -- $47,264 0%
2002 $44,113 $(14,023) $ -- $30,090 0%
2001 $28,192 $ (7,296) $ -- $20,896 0%
86
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE V
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 2003 AND 2002 (IN THOUSANDS)
- --------------------------------------------------------------------------------
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
DESCRIPTION OF YEAR EXPENSES DEDUCTIONS OF YEAR
----------- ------- -------- ---------- -------
2003
Allowance for Doubtful
Accounts $1,924 $ 486 $(528) $1,882
2002
Allowance for Doubtful
Accounts $ 562 $1,367 $ (5) $1,924
87
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE VI
SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE COMPANIES
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(IN THOUSANDS)
- --------------------------------------------------------------------------------
DEFERRED RESERVE FOR
POLICY UNPAID CLAIMS NET NET
ACQUISITION AND CLAIM UNEARNED PREMIUMS INVESTMENT
COSTS ADJUSTMENT EXPENSES PREMIUMS EARNED INCOME
----- ------------------- -------- ------ ------
2003 $2,358 $125,991 $34,553 $47,264 $6,008
2002 $1,480 $104,022 $24,211 $30,098 $5,915
2001 $ 851 $ 84,560 $17,237 $20,603 $6,136
AMORTIZATION
LOSS AND LOSS OF DEFERRED PAID LOSS
ADJUSTMENT EXPENSES POLICY AND LOSS
RELATED TO: (1) ACQUISITION ADJUSTMENT PREMIUMS
CURRENT YEAR PRIOR YEAR COSTS EXPENSES (1) WRITTEN
------------ ---------- ----- ------------ -------
2003 $44,588 $ 5,885 $4,360 $30,765 $71,365
2002 $24,063 $ 2,766 $2,890 $20,155 $51,799
2001 $23,056 $(4,198) $1,337 $17,744 $34,459
(1) Loss and loss adjustment expenses shown net of reinsurance
88
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Item 9A. 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 III
Item 10. Directors and Executive Officers of the Registrant
Information included in NCRIC Group, Inc.'s Proxy Statement for its 2004
Annual Meeting of Shareholders is incorporated herein by reference.
Item 11. Executive Compensation
Information included in NCRIC Group, Inc.'s Proxy Statement for its 2004
Annual Meeting of Shareholders is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information included in NCRIC Group, Inc.'s Proxy Statement for its 2004
Annual Meeting of Shareholders is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
None.
Item 14. Principal Accountant Fees and Services
Information included in NCRIC Group, Inc.'s Proxy Statement for its 2004
Annual Meeting of Shareholders is incorporated herein by reference.
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, 2003 and 2002
Consolidated Statements of Operations for the Years Ended December 31, 2003,
2002 and 2001
Consolidated Statements of Stockholders' Equity for the Years Ended December 31,
2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003,
2002 and 2001
Notes to Consolidated Financial Statements for the Years Ended December 31,
2003, 2002 and 2001
89
(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
IV. Reinsurance
V. Valuation and Qualifying Accounts
VI. Supplemental Information Concerning Property-Casualty Insurance
Companies
(b) Reports on Form 8-K.
On November 11, 2003 the Registrant filed a Current Report on Form 8-K,
pursuant to Item 12, to report the issuance of a press release announcing
earnings for the quarter ended September 30, 2003. The press release was
included as an exhibit to the Current Report.
(c) Exhibits.
The following exhibits are filed as part of this report or are
incorporated by reference to other filings.
3.1 Certificate of Incorporation of NCRIC Group, Inc. (1)
3.2 Bylaws of NCRIC Group, Inc.(2)
10.1 Stock Option Plan (3)
10.2 Stock Award Plan (3)
10.3 NCRIC Group, Inc. 2003 Stock Option Plan (4)
10.4 NCRIC Group, Inc. 2003 Stock Award Plan (4)
10.5 Employment Agreement between NCRIC Group, Inc., NCRIC Inc., and R.
Ray Pate, Jr. (5)
10.6 Employment Agreement between NCRIC Group, Inc, NCRIC, Inc. and
Rebecca B. Crunk (5)
10.7 Employment Agreement between NCRIC Group, Inc. and Stephen S. Fargis
(6)
10.8 Employment Agreement with William E. Burgess (2)
10.9 Lease (3)
10.10 Amendment to Lease (3)
10.11 Administrative Services Agreement
10.12 Tax Sharing Agreement
21 Subsidiaries
23.2 Consent of Deloitte & Touche LLP
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- ----------
(1) Incorporated by reference to the Pre-Effective Amendment No. 1 to
the Registration Statement on Form S-1 filed with the Commission on
May 12, 2003.
(2) Incorporated by reference to the Registration Statement on Form S-1
filed with the Commission on March 25, 2003.
(3) Incorporated by reference to the Registrant's Registration Statement
on Form SB-2 (File No. 333- 69537) filed with the Commission on
December 23, 1998 and subsequently amended on April 15, 1999, March
12, 1999 and May 7, 1999.
(4) Incorporated by reference to the Registrant's Proxy Statement for
the 2003 Annual Meeting of Shareholders filed with the Commission on
May 19, 2003.
(5) 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.
(6) 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.
(d) Not applicable.
90
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 25, 2004 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 25, 2004
- -------------------------------- Directors
Nelson P. Trujillo, M.D.
/s/ R. Ray Pate, Jr. Vice Chairman of the Board of March 25, 2004
- -------------------------------- Directors, President and Chief
R. Ray Pate, Jr. Executive Officer (Principal
Executive Officer)
/s/ Rebecca B. Crunk Senior Vice President and Chief March 25, 2004
- -------------------------------- Financial Officer (Principal
Rebecca B. Crunk Financial and Accounting
Officer)
/s/ Vincent C. Burke Director March 25, 2004
- --------------------------------
Vincent C. Burke, III
/s/ Pamela W. Coleman Director March 25, 2004
- --------------------------------
Pamela W. Coleman, M.D.
/s/ Martin W. Dukes, Jr. Director March 25, 2004
- --------------------------------
Martin W. Dukes, Jr. , M.D.
/s/ Leonard M. Glassman Director March 25, 2004
- --------------------------------
Leonard M. Glassman, M.D.
/s/ Luther W. Gray, Jr. Director March 25, 2004
- --------------------------------
Luther W. Gray, Jr., M.D.
/s/ Prudence P. Kline Director March 25, 2004
- --------------------------------
Prudence P. Kline, M.D.
91
/s/ Edward G. Koch Director March 25, 2004
- --------------------------------
Edward G. Koch, M.D.
/s/Stuart A. McFarland Director March 25, 2004
- --------------------------------
Stuart A. McFarland
/s/ J. Paul McNamara Director March 25, 2004
- --------------------------------
J. Paul McNamara
/s/ Leonard M. Parver Director March 25, 2004
- --------------------------------
Leonard M. Parver, M.D.
/s/ Frank Ross Director March 25, 2004
- --------------------------------
Frank Ross
/s/ David M. Seitzman Director March 25, 2004
- --------------------------------
David M. Seitzman, M.D.
92