The following table sets forth the facilities leased by us at December 31, 2004, along with the applicable lease expiration date:
The following tables set forth selected consolidated historical financial and other data of NCRIC Group for the years and at the dates indicated and 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.
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. When an accrued premium refund is paid, written premiums are reduced with no change to earned premium. 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.
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, 2004, the average indemnity payment per paid closed claim was $301,000 with total indemnity payments of $31.4 million, $22.2 million and $12.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. The cost of individual indemnity payments over this three-year period ranged from $1,500 to $2.4 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.
Reinsurance. We manage our exposure to individual claim losses, annual aggregate losses, and LAE through our reinsurance program. Reinsurance is a customary practice in the industry. It allows us to obtain indemnification against a specified portion of losses associated with insurance policies we have underwritten by entering into a reinsurance agreement with other insurance enterprises or reinsurers. We pay or cede part of our policyholder premium to reinsurers. The reinsurers in return agree to reimburse us for a specified portion of any claims covered under the reinsurance contract. While reinsurance arrangements are designed to limit losses from large exposures and to permit recovery of a portion of direct losses, reinsurance does not relieve us of liability to our insured policyholders. We monitor the creditworthiness of reinsurers on an ongoing basis. We also routinely evaluate for collectibility amounts recoverable from reinsurers. No allowance for uncollectible reinsurance recoverable has been determined to be necessary.
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 related to these coverage layers.
Financial results for 2004 were very disappointing. While over-shadowed by the financial results, we achieved significant accomplishments during the year. Results were driven by a few key factors: earned premium growth, increase in claims severity, and moderation of claims frequency. Earned premiums grew due primarily to the rate level increases. Approximately 89% of policies eligible for renewal did renew during 2004. As a result of non-renewals initiated by NCRIC, both from the annual underwriting process and from West Virginia, combined with attrition, the overall number of insurance policies in force went down by 287, or 6.8%, during the year. As we have reported previously, in the first quarter of 2004, we began non-renewing policies in the West Virginia market at the end of each policy term. After the approval of a rate increase effective September 1, we again began to renew business in West Virginia.
Claims severity increases impact both claims reported in the current calendar year and claims originally reported in prior years. In the first half of 2004, we incurred an increase in the severity of losses, principally from the 2001 report year claims in Virginia and the 2000 report year claims in the District of Columbia. The fourth quarter adverse development of claims reported in prior years stemmed from claims reported in 2001, 2002 and 2003 across all our market territories except West Virginia.
On February 28, 2005, the Company announced its Board had approved an agreement to merge NCRIC Group, Inc. into ProAssurance Corporation in a stock-for-stock transaction that values the Company at $10.10 per share, based on the closing price of ProAssurance common stock on Friday, February 25, 2005. Under the terms of the agreement each holder of common stock of the Company will have the right to receive 0.25 of a share of ProAssurance common stock for each share of NCRIC Group. This exchange ratio is subject to adjustment in the event that the market price of the ProAssurance stock prior to the closing of the transaction either exceeds $44.00 or is less than $36.00 such that the exchange ratio would then be adjusted such that the value per NCRIC Group share would neither exceed $11.00 nor be less than $9.00, respectively. The transaction is subject to required regulatory approvals and a vote of NCRIC Group stockholders and is expected to close early in the third quarter of 2005.
CONSOLIDATED NET INCOME Years ended December 31, 2004, 2003 and 2002
Net results were a loss of $7.1 million for the year ended December 31, 2004 compared to a loss of $4.2 million for the year ended December 31, 2003. 2004 results were negatively impacted by adverse development of claims originally reported in earlier years.
Net income for the fourth quarter of 2004 was a loss of $8.3 million driven by adverse development on losses originally reported in prior years. The section on Losses and Loss Adjustment Expenses provides a discussion of these loss costs.
Net income was a loss of $4.2 million for the year ended December 31, 2003 compared to income of $742,000 for the prior year. 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.
Gross premiums written increased by $15.8 million, or 22%, to $87.2 million for the year ended December 31, 2004 from $71.4 million for the year ended December 31, 2003, 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 $218,000 for the year ended
The change in unearned premiums for the period decreased by $4.1 million to $6.2 million for the year ended December 31, 2004 from $10.3 million for the year ended December 31, 2003. This decrease resulted from policy cancellations and the refund of previously accrued retrospective rating program premium, partially offset by premium rate increases and new business written.
Gross premiums earned increased $20.0 million, or 33%, to $81.0 million for the year ended December 31, 2004 from $61.0 million for the year ended December 31, 2003. The increase consists of $16.2 million for premiums earned under basic medical professional liability insurance and $3.8 million for excess limits coverage. Extended reporting endorsements premium is earned in the same period as it is written.
Renewal credits for the years ended December 31, 2004 and 2003 reflect our decision to not provide a renewal premium credit for 2004 or 2005 renewals.
In 2002, we initiated a program to provide insurance coverage to physicians at four HCA hospitals in West Virginia. Under this arrangement, we ceded 100% of the insurance exposure to a captive insurance company affiliated with the sponsoring hospitals. We received 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.
Direct new business comes primarily from the District of Columbia. Agent-produced new business in 2004 came primarily from Delaware and Virginia. The following chart of new written premiums shows the composition of new business by distribution channel.
Year Ended December 31, ------------------------ 2004 2003 ------- ------- (in thousands)
The distribution of premium written continues to show notable growth in our market areas outside of the District of Columbia. For seven months in 2004 in West Virginia we stopped writing new business and non-renewed policies at their anniversary dates due to inadequate rate levels allowed by the West Virginia Department of Insurance. After receiving approval for a rate increase effective September 1, 2004, we began offering renewals on some West Virginia business.
The following chart reports the components of gross premium written by state as follows:
Year Ended December 31, -------------------------------------------- 2004 2003 ------------------- ------------------- (dollars in thousands) Amount % Amount % ------- ------- ------- -------
District of Columbia .... $25,650 30% $23,216 33% Virginia ................ 29,612 34 22,640 32 Maryland ................ 11,451 13 8,819 12 West Virginia ........... 7,174 8 7,935 11 Delaware ................ 13,342 15 8,755 12 ------- ------- ------- ------- Total .............. $87,229 100% $71,365 100% ======= ======= ======= =======
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, 2004 the amount due to NCRIC for this program was $2.9 million. NCRIC has accrued no amount of net receivable due to the pending litigation and questionable collectibility.
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. No decision has yet been rendered on the post-trial motions. In connection with the filing of post-trial motions, NCRIC secured a $19.5 million appellate bond and associated letter of credit. The amount of the bond represents the verdict
Expenses incurred in 2004 for the trial portion of the litigation were $525,000, reported as a component of underwriting expenses, and post-trial costs were $620,000, reported as a component of other expenses. NCRIC Group, Inc. has indemnified NCRIC, Inc. for post-trial costs expected to be incurred in 2004 and for any potential final judgment up to $5.5 million, on an after-tax basis.
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.
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 of 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.
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.
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.
Direct ....... $ 618 $ 2,309 Agent ........ 9,900 10,391 HCA .......... 0 793 ------- ------- $10,518 $13,493 ======= =======
The distribution of premium written shows notable growth in our market areas outside of the District of Columbia. The following chart illustrates the components of gross premium written by state.
Year Ended December 31, -------------------------------------------- 2003 2002 ------------------- ------------------- (dollars in thousands) Amount % Amount % ------- ------- ------- -------
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 collectibility.
NCRIC filed post-trial motions on March 5, 2004, to set aside the verdict or reduce the amount of the award. No liability has been accrued in the financial statements for any possible loss arising from this litigation.
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.
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 ConsiCare 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.
Other income decreased $335,000, or 29%, to $820,000 for the year ended December 31, 2004 from $1.2 million for the year ended December 31, 2003. The decreased revenue resulted from a decrease of $500,000 in service charge income due to the initiation of an installment billing program through a third party premium finance company, partially offset by an increase of $126,000 in brokerage commission income resulting from the increase in ceded premium and a small increase in insurance agency commissions.
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.
Total incurred losses and LAE expense of $70.3 million for year ended December 31, 2004 represents an increase of $19.8 million compared to $50.5 million incurred for the year ended December 31, 2003.
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 $8.6 million to $53.2 million for the year ended December 31, 2004 from $44.6 million for the year ended December 31, 2003, reflecting an increase in severity of reported claims and an increase in exposures for extended reporting endorsements.
As described in the opening section of this MD&A, the process for determining our estimates of loss cost begins with the establishment of case reserves within our claims department. 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. Case reserves are decreased either when a case is resolved at a lower level than previously estimated or when reinsurance recoverable becomes applicable. Actuarial reserves are established based on case reserves combined with historical loss development trends utilizing a complex mathematical analysis to determine the actuarially based estimate of losses.
In 2004 the estimate of losses on claims reported in prior years on a case reserve basis was a net reduction in estimate. In contrast, the actuarially calculated losses on prior years' claims produced a net increase in estimate.
We rely on the guidance of our consulting actuary to establish reserves and each year-end we book the point estimate provided by the actuarial reserve calculation. However, over the past two years we have subsequently experienced various factors that have required an increase in the initial actuarial reserve estimates. The factors leading to the reserve adjustment include: the emergence over the past two years of our own experience in our new market territories; increasing severity trends that have been experienced by insurance carriers on a nationwide basis; claims development within the net retained layer resulting in less recovery from reinsurance; and environmental factors, such as the rise in Virginia's total loss cap on awards.
Since we have experienced a significant level of adverse development of losses two years in a row, we engaged a second consulting actuarial firm to independently calculate the reserve estimate as of December 31, 2004. The results of this study confirmed the estimate of losses at the level being reported as of December 31, 2004.
The lower loss ratio on current year losses at 80.0% in 2004 compared to 94.3% in 2003 reflects both the increase in premium rates and lower frequency of reported losses in 2004. The total loss ratio was increased by 26 points for the year ended December 31, 2004 and was increased by 13 points for the year ended December 31, 2003 as a result of the re-estimation of losses reported in prior years.
Approximately 66% of the net adverse development emerged from the 2003 report year. In the past during the first year of development following the initial report year, we have observed a general loss development pattern; in the fourth quarter of 2004, the case basis reserves across all jurisdictions appeared to be developing differently from that pattern, thus indicating an overall higher loss level. This higher level of indicated losses was recognized as adverse development in the fourth quarter.
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.
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 loss development for the 1996 and 1999 loss years, more than offset by adverse development in the 1998, 2000 and 2001 loss years.
Current year losses in the fourth quarter of 2003 totaled $13.4 million, increasing 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 108.2%, higher than previous quarters in 2003, reflects this recognition of higher severity.
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 a lower estimate of reinsurance to be recovered on losses in the 2000, 2001 and 2002 report years across all territories.
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.
At December 31, --------------------- 2004 2003 -------- -------- (in thousands) Liability for: Loss .............................. $107,746 $ 87,778 Loss adjustment expense ........... 45,496 38,213 -------- -------- Total liability ..................... $153,242 $125,991 ======== ========
For 2004, salaries and benefits accounted for approximately 24% of other underwriting expenses, commissions and brokerage expenses 28%, with professional fees, including legal, auditing and director's fees, accounting for approximately 16% of the underwriting expenditures. Premium taxes and guaranty fund assessments comprise the majority of the remaining balance. Guaranty fund assessments are based on industry loss experience in the jurisdictions where we do business, and are not predictable.
Practice management and related expenses decreased $0.2 million, or 4%, to $5.0 million for the year ended December 31, 2004 compared to $5.2 million for the year ended December 31, 2003. Expense decreased primarily due to reductions in staffing commensurate with the reductions in revenue. The expense decrease was net of increased expenses for branding, resulting in the name change to ConsiCare, and for strategic business development.
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.
Interest expense increased $31,000, or 3.75%, to $857,000 for the year ended December 31, 2004 compared to $826,000 for the year ended December 31, 2003. The interest rate in 2004 averaged 5.54% while the interest rate in 2003 averaged 5.31%.
Year Ended December 31, ----------------------- 2004 2003 2002 ---- ---- ----
Federal income tax at statutory rates . 34% 34% 34% Tax exempt income ..................... 4 6 (89) Dividends received .................... 1 0 (21) Other, net ............................ 1 (1) (1) ---- ---- ---- Income tax benefit at effective rates . 40% 39% (77)% ==== ==== ====
The tax benefit for the year ended December 31, 2004 was $4.8 million compared to $2.7 million for the year ended December 31, 2003. A federal tax benefit was incurred in 2004 due primarily to the pre-tax loss. In addition, the effective tax benefit rate was improved by 4% due to tax exempt income.
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 was 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.
Financial condition and capital resources. We are a stock holding company whose operations and assets primarily consist of our ownership of NCRIC, Inc. and ConsiCare, Inc. We assist our subsidiaries in their efforts to compete effectively and create long-term growth.
Trust Preferred Securities. 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. We contributed $13.5 million of the funds raised to the statutory surplus of our insurance subsidiary NCRIC, Inc.
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, 2004, NCRIC, Inc. had approximately $63 million of unassigned statutory surplus. Any dividend payment by NCRIC, Inc. would require the approval of the Commissioner.
Approximately 72% of the bond portfolio at December 31, 2004 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, 2004 was held in investment grade (BBB or better) securities as rated by Standard & Poor's. For regulatory purposes, as of December 31, 2004, 88% of the portfolio is rated Class 1 which is the highest quality rated group as classified by the NAIC. The accumulated other comprehensive income totaled $2.1 million at December 31, 2004 compared to $1.5 million at December 31, 2003. This increase in asset values resulted primarily from the improvement in fair values of investments in the equity component of the portfolio.
At December 31, 2004, our portfolio included total gross unrealized gains of $4.7 million, or 2.3% of the $202.3 million carrying value of the portfolio, and total unrealized losses of $1.5 million, or less than 1% of the carrying value of the portfolio. The total unrealized losses are comprised of six equity securities and 191 fixed maturity securities, including 12 Treasury Note issues, 179 corporate debt and municipal bonds (all of which are investment grade), with lengths of time to maturity ranging from one to 44 years. All of the fixed maturity securities are meeting and are expected to continue to meet all contractual obligations for interest payments.
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 was three years at a floating rate of LIBOR plus one and one-half percent. The balance of the loan was paid in May of 2004. The interest rate at the time of the payoff was 2.68%, and 2.67% as of December 31, 2003. Principal and interest payments were paid on a monthly basis until payoff.
Our stockholders' equity totaled $72.0 million at December 31, 2004 and $78.0 million at December 31, 2003. The $6.0 million decrease for the year ended December 31, 2004 was due primarily to the net loss of $7.1 million, offset by the increase of $648,000 in net unrealized investment gains.
On July 7, 2004, the Board of Directors accelerated the vesting of the 384,322 outstanding stock options granted in 2003. The options were originally scheduled to vest during the period from August, 2004 to August, 2008. On the accelerated vesting date, the per share market value of NCRIC stock of $10.00 was less than the strike price of the options, which ranges from $10.86 to $11.00 per share.
The acceleration eliminates future compensation expense we would otherwise recognize in our future income statements with respect to these options after FASB Statement No. 123R, Share-Based Payment, becomes effective in 2005. The pro forma note disclosure to the 2004 financial statements includes the maximum amount of expense which would have been reported in future years.
To the Board of Directors and Stockholders of NCRIC Group, Inc. and Subsidiaries Washington, DC
We have audited the accompanying consolidated balance sheets of NCRIC Group, Inc. and subsidiaries (the "Company") as of December 31, 2004 and 2003, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the table of contents. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
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, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 15 to the consolidated financial statements, the Company announced that its Board of Directors had approved an agreement to merge NCRIC Group, Inc. into ProAssurance Corporation in a stock-for-stock transaction. The transaction is subject to required regulatory approvals and a vote of NCRIC Group, Inc. stockholders.
NCRIC GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2004 AND 2003 (IN THOUSANDS, EXCEPT FOR SHARE DATA) - --------------------------------------------------------------------------------
NCRIC GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 - ----------------------------------------------------
Through its property-casualty insurance company subsidiary, NCRIC, Inc., 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 Commonwealth Medical Liability Insurance Company, 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 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.
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.
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.
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, 2004 and 2003, the Company did not find it necessary to record a provision for impairment of assets.
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
because borrowers may have the right to prepay obligations with or without prepayment penalties.
Total investment income earned 7,767 6,438 6,295 Investment expenses (511) (430) (380) ------- ------- ------- Net investment income $ 7,256 $ 6,008 $ 5,915 ======= ======= =======
At December 31, 2004, the aggregate fair value of the securities with unrealized losses was $112.8 million, or 99% of the amortized cost of those securities of $114.3 million. The largest single security with an unrealized loss at December 31, 2004 relates to a FNMA pool which matures in 2018 and carries a coupon rate of 5.0%. The unrealized pre-tax loss relating to this security is approximately $115,000 based on the fair value of $4.5 million at December 31, 2004. Unrealized losses related to other securities are not individually significant, nor is there any concentration of unrealized losses with respect to the type of security or industry.
The following table displays characteristics of the securities with an unrealized loss in value as of December 31, 2004. No concentrations of industries exist in these securities.
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.
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 generally are losses under $500,000 for losses reported prior to 2003 and under $1 million for losses reported in 2003 and 2004. The 2004 change in incurred losses related to prior years stems primarily from the reestimation of losses incurred initially in 2003 but also from the losses reported initially in 2002 and 2001. 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. The change in development over the three-year period ended December 31, 2004, reflects a continuing increase in severity caused by the growing size of plaintiff verdicts and settlements.
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.
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, --------------------- 2004 2003 -------- -------- Deferred tax assets: Unearned premiums $ 2,921 $ 2,367 Discounted loss reserves 4,721 3,805 Net operating loss carryforwards 2,054 127 Alternative minimum tax credits 639 -- Allowance for doubtful accounts 70 640 Other 433 210 -------- -------- 10,838 7,149 Valuation allowance (127) (127) -------- -------- 10,711 7,022
Federal income tax benefit differs from that calculated using the established corporate rate primarily due to nontaxable investment income, as follows (in thousands):
At December 31, 2004, the Company had regular federal net operating loss carryforwards of approximately $6.0 million which will begin to expire in 2018. Since a portion of these 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.
Weighted average common shares outstanding - diluted 6,357 6,486 6,779 ------- ------- -------
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 employee contributions are 100% vested. Effective January 1, 2002, the NCRIC and MSO plans were merged into NCRIC Group, Inc.'s plan. The Company 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, 2004, 2003, and 2002, were $411,500, $374,000, and $328,000, respectively.
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.
A summary of the status of the stock option plans as of December 31, 2004 and changes during each of the three years then ended are presented below. 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.
December 31, 2004 427,838 $ 9.10 427,838 $ 9.10 ======== ======== ======== ========
The following table summarizes information for options outstanding and exercisable at December 31, 2004:
Weighted Number Average Weighted Outstanding Remaining Average Range of Prices and Contractual Exercise per Share Exercisable Life Price $3.75 - $8.49 107,737 4.60 $ 3.75 $8.50 - $11.00 320,101 8.83 $ 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. There were no options granted in 2004.
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, 2004, 2003 and 2002, compensation expense related to the Stock Award Plans was $424,900, $299,400 and $153,800, respectively.
December 31, --------------------------------- 2004 2003 2002 -------- -------- -------- POLICYHOLDERS' SURPLUS - STATUTORY BASIS $ 62,994 $ 70,372 $ 44,269 Fair valuation of investments 536 904 2,806 Deferred taxes (1,932) (1,771) 3,012 Group stock issuance 8,346 7,838 7,642 Capital contribution -- -- (13,500) Non-admitted assets and other 2,071 636 3,588 -------- -------- --------
NET LOSS - STATUTORY BASIS $ (8,984) $ (4,900) $ (1,510) Deferred taxes 2,850 810 2,508 GAAP consolidation and other (986) (128) (256) -------- -------- --------
NCRIC Group has one reportable segment: Insurance. The insurance segment provides medical professional liability and other insurance. The reportable segment is a strategic business unit that offers products and services and is therefore managed separately. NCRIC Group evaluates performance based on profit or loss before income taxes. In previous years, NCRIC Group reported a second segment, Practice Management Services. As noted in the Form 10-K for the year ended December 31, 2003, effective beginning in 2004, NCRIC Group no longer reports this business as a separate segment. The Insurance segment revenue has grown significantly over the past several years while the practice management revenue has not experienced the same growth. As a result, the practice management revenue constitutes less than 10% of consolidated revenues and, therefore, no longer meets the GAAP criteria for segment reporting. The data below has been reclassified to reflect this change in reportable segments. Selected financial data is presented below for each business segment for the year ended December 31 (in thousands):
During 2004, 2003, and 2002, members of the Company's Board of Directors paid NCRIC MSO approximately $199,000, $176,000 and $163,000, respectively, for practice management related services.
The following is a summary of unaudited quarterly results of operations for 2004, 2003 and 2002. 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:
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEET AS OF DECEMBER 31, 2004 AND 2003 (IN THOUSANDS) - --------------------------------------------------------------------------------
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------
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, 2004, 2003 AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------
The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes of NCRIC Group, Inc. and Subsidiaries.
On December 31, 1998, National Capital Reciprocal Insurance Company consummated its plan of reorganization from a reciprocal insurer to a stock insurance company and became a wholly owned subsidiary of NCRIC Group, Inc. (Group) and converted into NCRIC, Inc. Group was organized in December 1998, as part of the plan to reorganize the corporate structure.
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 information concerning new accounting standards adopted in 2004, 2003 and 2002, see Note 1 of the Notes to the Consolidated Financial Statements.
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION DECEMBER 31, 2004, 2003, AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE IV REINSURANCE FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE V VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 2004 AND 2003 (IN THOUSANDS) - --------------------------------------------------------------------------------