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 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.
(3) The operating ratio is the statutory combined ratio offset by the benefit of investment income expressed as a percentage of premiums earned.
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.
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
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.
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
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.
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.
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
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.
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.
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.
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.
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.
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.
The following table is a summary of our net premiums earned:
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.
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
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.
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.
Year Ended December 31, ------------------------ 2003 2002 ------- ------- (in thousands)
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
Virginia. In 2002, agent new business also included $403,000 for the Princeton hospital program which was discontinued in 2003.
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% ======= === ======= ===
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.
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.
Gross premiums earned before renewal credits increased $15.9 million, or 56%, to $44.1 million for the year ended December 31, 2002 from $28.2 million for the year ended December 31, 2001. The increase was
primarily due to $13.2 million of additional premiums earned under basic medical professional liability insurance and $2.0 million of additional gross premiums earned for excess limits coverage.
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.
Year Ended December 31, ----------------------- 2002 2001 ------- ------- (in thousands)
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.
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 losses were $131,000 for the year ended December 31, 2002 compared to $278,000 for the year ended December 31, 2001. During the fourth quarter of 2002, we repositioned our portfolio to replace weak credits with stronger rated bonds, realizing a net gain of $473,000. This partially offset the losses realized in prior quarters of 2002. In 2002, we determined that one fixed maturity security, issued by WorldCom, had experienced an other-than-temporary impairment, and recorded a pre-tax investment loss of $557,000, reducing the
carrying value to fair value during the second quarter when the determination was made. Additionally, in 2001, we determined that an equity security consisting of common stock experienced an other-than-temporary impairment. Accordingly, we recorded a pre-tax impairment loss of $300,000 in 2001 relating to that investment.
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.
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 == == ==
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.
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
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.
Three months ended December 31,2003 compared to three months ended December 31,
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 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.
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.
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.
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.
Reinsurance recoverable on losses ... $ 48,100 $ 43,231 ======== ========
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.
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.
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.
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 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.
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% === === ===
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.
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.
We had cash flows provided by operations for the years ended December 31, as follows:
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:
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.
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.
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.
The following table summarizes our contractual obligations as of December 31, 2003, in thousands:
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.
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
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.
To the Board of Directors of NCRIC Group, Inc. and Subsidiaries Washington, D.C.
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.
NCRIC GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (IN THOUSANDS) - --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
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)
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.
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.
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
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.
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.
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.
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.
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.
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
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 ------- ------- -------
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.
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
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 ======= ======= =======
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.
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.
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.
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.
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, 2003 516,919 $ 9.18 124,311 $ 3.75 ======== ====== ======== ======
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.
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):
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.
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 following are reconciliations of reportable segment revenues, net investment income, assets, liabilities, and profit to the Company's consolidated totals (in thousands):
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE I SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2003 (IN THOUSANDS) - --------------------------------------------------------------------------------
Equity in undistributed earnings of subsidiaries (4,016) (361) 942 ------- ------- ------
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,
See Investments in the Consolidated Financial Statements and in Note 3 of the Notes to the Consolidated Financial Statements.
See Note 5 of the Notes to the Consolidated Financial Statements
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 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, 2003, 2002, AND 2001 (IN THOUSANDS) - --------------------------------------------------------------------------------
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 - ------------------- ------ --------- --------- ------ ------
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE V VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 2003 AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------