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 ten years, commencing April 15, 1998 and expiring April 30, 2008. Annual rental is $421,476 with 2% annual increases, except in the sixth year of the term when the rent increases by $2.00 per rentable square foot. 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, Fredericksburg and Richmond, Virginia; Greensboro, North Carolina; Wilmington, Delaware; and Charleston, West Virginia.
Premium income. Gross premiums written represent the amounts billed to policyholders. Gross premiums written are reduced by premiums ceded to reinsurers and renewal credits in determining net premiums written. Premiums ceded to reinsurers represent the cost to us of reducing our exposure to medical professional liability losses by transferring agreed upon insurance risks to reinsurers through a reinsurance contract or treaty. Renewal credits are reductions in premium billings to renewing policyholders. Net premiums written are adjusted by any amount which has been billed but not yet earned during the period in arriving at earned premiums. Extended reporting endorsements premium is earned in the same period it is written.
Reserves for losses and loss adjustment expenses. We write one line of business, medical professional liability. Losses and LAE reserves are estimates of future payments for reported claims and related expenses of adjudicating claims with respect to insured events that have occurred in the past. The change in these reserves from year to year is reflected as an increase or decrease to our losses and LAE expense incurred.
Our ultimate liability will be known after all claims are closed, which is likely to be several years into the future. For example, as of December 31, 2004, the oldest report date of an open claim is 1993. Incurred losses for each report year will develop with a change in estimate in each subsequent calendar year until all claims are closed for that report year. Loss development could potentially have a significant impact on our results of operations. Developments changing the ultimate aggregate liability as little as 1% could have a material impact on our reported operating results.
For 1999 and prior years, in accordance with one of our primary reinsurance contracts, the portion of the policyholder premium ceded to the reinsurers was swing-rated or experience-rated on a retrospective basis. This swing-rated cession program is subject to a minimum and maximum premium range to be paid to the reinsurers in the future, depending upon the extent of losses actually paid by the reinsurers. A deposit premium is paid by us during the initial policy year. An additional liability, "retrospective premiums accrued under reinsurance treaties," is recorded by us to represent an estimate of net additional payments to be made to the reinsurers under the program, based on the level of loss and LAE reserves recorded. Like loss and LAE reserves, adjustments to prior year ceded premiums payable to the reinsurers are reflected in the results of the periods in which the adjustments are made. The swing-rated reinsurance premiums are estimated in a manner consistent with the estimation of our loss reserves, and therefore contain uncertainties like those inherent in the loss reserve estimate.
Our practice for accounting for the liability for retrospective premiums accrued under reinsurance treaties is to record the current year swing-rated reinsurance premium at management's best estimate of the ultimate liability, which was generally the maximum rate payable under terms of the treaty. Due to the long tail nature of the medical professional liability insurance business, it takes several years for the losses for any given report year to fully develop. Since the ultimate liability for reinsurance premiums depends on the ultimate losses, among other things, it is several years after the initial reinsurance premium accrual before the amount becomes known. During the intervening periods, reevaluations are made and adjustments to the accrued retrospective premiums are made as considered appropriate by management. As of December 31, 2004, twenty open claims are from report years covered by the swing-rated reinsurance treaties.
Investment portfolio. Our investment portfolio is composed principally of fixed maturity securities classified as available-for-sale. All securities with gross unrealized losses at the balance sheet date are evaluated for evidence of other-than-temporary impairment on a quarterly basis. We write down to fair value any security with an impairment that is deemed to be other-than-temporary in the period the determination is made. The assessment of whether such impairment has occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Factors considered in the evaluation include but are not limited to: (1) interest rates; (2) market-related factors other than interest rates; and (3) financial conditions, business prospects and other fundamental factors specific to the securities issuer. Declines attributable to issuer fundamentals are reviewed in further detail. We have a security monitoring process which includes quarterly review by an investment committee comprised of members of our Board of Directors. Our CEO and CFO also participate in the committee meetings in which our professional investment advisors review with the committee and management the analysis prepared by our investment managers
of each security that has certain characteristics, reviewing: deterioration of the financial condition of the issuer; the magnitude and duration of unrealized losses; and the credit rating and industry of the issuer. The primary factors considered in evaluating whether a decline in value is other-than-temporary include: the length of time and the extent to which the fair value has been less than cost; the financial condition and near-term prospects of the issuer; whether the issuer is current on contractually obligated interest and principal payments; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery.
The evaluation for other-than-temporary impairments is a quantitative and qualitative process involving judgments which is subject to risks and uncertainties. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition and the effects of changes in interest rates.
Our goodwill asset, $7.3 million as of December 31, 2004, resulted from the 1999 acquisition of three businesses which now operate as divisions of our practice management services. We completed our goodwill impairment testing under SFAS 142 and concluded that the goodwill asset was not impaired as of the annual evaluation date, nor was it impaired as of December 31, 2004.
New accounting guidance. In July 2004, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus with respect to guidance to be used in determining whether an investment within the scope of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, is other than temporarily impaired. The guidance was to be applied in other-than-temporary impairment evaluations made in reporting periods beginning after June 15, 2004. In September 2004, the FASB issued, and the Company adopted, FSP EITF Issue 03-1-1, which deferred the effective date of the impairment measurement and recognition provisions contained in EITF 03-1 until final guidance is adopted. The disclosure requirements of EITF 03-1 were previously adopted by the Company as of December 31, 2003 for investments accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. For all other investments within the scope of EITF 03-01, the disclosures are effective and have been adopted by the Company as of December 31, 2004. As this accounting guidance develops, we will continue to review it to assess any potential impact to our fixed income portfolio and our asset management policy.
Claims frequency, as measured by the number of claims reported per 100 exposures, was lower by 23% in 2004 compared to 2003, was lower by 18% compared to 2002 and was lower by 34% compared to 2001. While the severity of claims continues to rise, lower frequency also has a direct impact on financial results.
The operating results of our insurance segment for the year ended December 31, 2004 were primarily driven by growth in earned premiums and the increase in the estimate of loss reserves for claims reported in prior years. Primarily due to increased premium rates, net premiums earned increased by 41%. While the cost for claims reported in 2004 increased due to severity, the development of losses for claims originally reported in 2001, 2002 and 2003 reduced earnings for 2004. The re-estimation of losses was driven by two primary factors -- increases in the estimate of direct losses, primarily for the 2001, 2002 and 2003 report years, and a change in estimate of the level of reinsurance to be recovered for the losses reported in the years 2001 and 2002.
The 2003 fourth quarter loss of $5.6 million 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.
Reinsurance premiums ceded increased by $0.7 million, or 5.6% to $14.5 million for the year ended December 31, 2004 from $13.8 million for the year ended December 31, 2003. Current year reinsurance premiums ceded increased by $1.7 million, or 13%, to $14.5 million for the year ended December 31, 2004 from $12.8 million for the year ended December 31, 2003 as the result of higher gross earned premiums. Reinsurance premiums are affected by current year premiums payable to the reinsurers, as well as the retrospective adjustments to accruals for prior year premiums.
Reinsurance premiums related to prior years under the swing-rated treaty were a benefit of $1,000 in 2004 and a charge of $0.9 million in 2003 due to loss development of reinsured losses compared to our prior estimates. Generally, losses covered by the swing-rated treaty are in the range excess of $500,000 to $1 million. Loss development results from the re-estimation and settlement of individual losses. As claims are brought to conclusion, each year there are fewer outstanding claims in the years covered by this reinsurance treaty. While the potential for loss development impacting this reinsurance coverage is reduced each year as the inventory of open claims is reduced, until all claims covered by the treaty are closed the potential remains for changes from current estimates. As of December 31, 2004, there are 20 open claims in the years covered by swing-rated reinsurance compared to 36 open claims as of December 31, 2003. The liability "retrospective premiums accrued under reinsurance treaties" decreased to $351,000 at December 31, 2004 from $1.8 million at December 31, 2003.
Net premiums earned increased by $19.2 million, or 40.6%, to $66.5 million for the year ended December 31, 2004 from $47.3 million for the year ended December 31, 2003. The increase reflects the $20.0 million growth in gross earned premiums offset by the higher reinsurance premiums ceded in 2004 compared to 2003.
Direct ............. $ 775 $ 618 Agent .............. 2,295 9,900 ------- -------
The overall level of new business produced in 2004 is lower than in 2003, as planned. In 2003 our business in Delaware expanded to place us in the top market share position, therefore, the opportunity for growth in Delaware in 2004 was limited. The other territory identified for growth is Virginia. We continue to write new business in Virginia, however, our product is priced at the high end of the market, which has the result of constraining growth. We believe our price level is required by the loss characteristics of the Virginia market. We continue to maintain that pricing integrity is critical to long-term viability.
On February 13, 2004, a District of Columbia Superior Court jury returned a verdict in favor of Columbia Hospital for Women Medical Center, Inc. (CHW) in the premium collection litigation between NCRIC, Inc. and CHW. The verdict came in a civil action stemming from NCRIC, Inc.'s efforts to collect payment for nearly $3 million in premiums that NCRIC alleges it is owed by CHW under a contract with CHW that expired in 2000. The jury ruled against the claim by NCRIC, Inc. and returned a verdict of $18.2 million in favor of CHW counterclaims.
plus a projection of post-trial interest. No amounts have been drawn upon the letter of credit as of March 18, 2005. After the post-trial motions have been ruled upon by the judge, any judgment will be entered as final, but subject to appeal. No liability has been accrued in these financial statements for any possible loss arising from this litigation because the judgment remains with the trial judge, and NCRIC believes that it has meritorious defenses and that it is not probable that the preliminary judgment will prevail, nor is any potential final outcome reasonably estimable at this time. Legal expenses incurred for this litigation in 2004 were $734,000. The expenses associated with the $19.5 million appellate bond and associated letter of credit were $261,000.
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 for premiums earned under basic medical professional liability insurance and $2.5 million for excess limits coverage. Extended reporting endorsements premium is earned in the same period as it is written.
Reinsurance premiums related to prior years under the swing-rated treaty were a charge of $0.9 million in 2003 and a benefit of $0.4 million in 2002 due to loss development of reinsured losses compared to our prior estimates. Generally, losses covered by the swing-rated treaty are in the range excess of $500,000 to $1 million. Loss development results from the re-estimation and settlement of individual losses. The 2003 change is due to an increase in the estimate of losses covered by the swing-rated treaty in the 1997 and 1999 years. The 2002 change is primarily reflective of the favorable loss development in the 1995, 1997 and 1998 coverage years. As claims are brought to conclusion, each year there are fewer outstanding claims in the years covered by this reinsurance treaty. While the potential for loss development impacting this reinsurance coverage is reduced each year as the inventory of open claims is reduced, until all claims covered by the treaty are closed the potential remains for changes from current estimates. As of December 31, 2003, there are 36 open claims in the years covered by swing-rated reinsurance compared to 48 open claims as of December 31, 2002. The liability "retrospective premiums accrued under reinsurance treaties" increased to $1.8 million at December 31, 2003 from $0.6 million at December 31, 2002.
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.
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% ======= ======= ======= =======
Net investment income increased by $1.3 million, or 22%, for the year ended December 31, 2004 compared to the prior year reflecting a higher base of average invested assets partially offset by a decrease in yields. Net investment income for the year ended December 31, 2004 was $7.3 million compared to $6.0 million for the year ended December 31, 2003. Average invested assets, which include cash equivalents, increased by $40.4 million, or 26%, to $194.1 million for the year ended December 31, 2004, due to the proceeds from the mid-2003 issuance of stock and cash from operations. The investment portfolio continues to overweight mortgage-backed securities, and maintains an allocation to common stocks as part of the strategy to protect the portfolio in a rising interest rate environment. The average effective yield was approximately 3.7% for the year ended December 31, 2004 and 3.9% for the year ended December 31, 2003. The tax equivalent yield was approximately 4.2% at December 31, 2004 and 4.4% at December 31, 2003. The change in investment yields is reflective of the market change in interest rates in 2004 compared to 2003 as well as the allocation to lower-yielding common stocks.
Net realized investment gains were $475,000 for the year ended December 31, 2004 compared to net realized investment gains of $1.9 million for the year ended December 31, 2003. The 2004 gains resulted from routine portfolio management activity, partially offset by the recognition of an other-than- temporary impairment of $15,000 on an investment in common stock. The circumstance giving rise to the other-than-temporary impairment charge was a decline in the value of the stock in 2004, which we do not expect to be temporary based on available financial information of the issuer.
Revenue for practice management and related services is comprised of fees for the following categories of services provided: practice management; accounting; tax and personal financial planning; retirement plan accounting and administration; and other services.
Practice management and related revenues decreased by $0.5 million, or 10.2%, to $4.4 million for the year ended December 31, 2004, from $4.9 million for the year ended December 31, 2003. 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 assignments in the HealthCare Consulting division compared to 2003.
The resolution of some of the claims reported to us is determined through a trial. Following is a summary of the trial results for each period.
Of the seven plaintiff verdicts in 2004, all were awarded in excess of our applicable retention limits. Under the clash protection provided by our reinsurance program, our exposure to the retention limit was limited in three of the seven verdicts. Of the 11 plaintiff verdicts in 2003, five verdicts were awarded in excess of our applicable retention limits. Under the clash protection provided by our reinsurance program, our exposure to the retention limit was limited in three of the five verdicts. Of the five plaintiff verdicts in 2002, three verdicts were awarded in excess of our $500,000 retention.
Prior year development results from the re-estimation and resolution of individual losses not covered by reinsurance, which are generally losses under $500,000 for losses reported prior to 2003 and under $1 million for losses reported in 2003. In 2004 we experienced unfavorable development of $17.1 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 development in 2004, which is comprised of adverse development in the 2001, 2002 and 2003 report years, include additional information on claims originally reported in prior years and interpretation of emerging settlement trends in all our market areas.
The underwriting expense ratio decreased to 19.0% for the year ended December 31, 2004 from 21.2% for the year ended December 31, 2003. Premiums increased proportionately more than underwriting expenses, resulting in a decrease in the underwriting expense ratio. Underwriting expenses increased $2.6 million to $12.6 million for the year ended December 31, 2004 from $10.0 million for the year ended December 31, 2003. The 26% increase in underwriting expenses was primarily attributable to the growth in expenses, consisting primarily of commissions, directly related to the expansion in business, consistent with the growth in premium.
The statutory combined ratio was 126.5% for the year ended December 31, 2004, and 129.4% for the year ended December 31, 2003. This decrease stems from the same factors noted previously.
Current year losses in the fourth quarter of 2004 totaled $14.1 million, increasing over the level of the fourth quarter of 2003 and over the level of the prior quarters of 2004. The higher level of current year losses primarily reflects reserves for losses incurred but not reported on extended reporting endorsements issued and was
established with consideration to the prior year loss development trends that emerged during the year-end actuarial valuation. The loss ratio on current year losses at 79.1%, lower than in previous quarters in 2004, reflects the reduced claims frequency in the quarter.
Development on losses reported in prior years totaled $15.6 million in the fourth quarter of 2004. This adverse loss development emerged during the fourth quarter from two primary sources:
o upward development on claims in the 2001, 2002 and 2003 report years; and
o a lower estimate of reinsurance to be recovered on losses in the 2001 and 2002 report years.
In the market territories outside of the District of Columbia, or our expansion market areas, our experience covers a time-period insufficient to make a complete determination on severity trends. In these new market areas, we carefully evaluate developing data to identify and recognize emerging trends as soon as possible.
The statutory combined ratio was 129.4% for the year ended December 31, 2003, and 111.8% for the year ended December 31, 2002. This increase stems from the same factors noted previously.
Evaluations of individual claims are updated when additional information on each case is determined, often as a part of the preparation for trial. Case reserves on individual claims are raised when new information indicates a greater loss exposure. Actuarial reserves are established based on case reserves combined with historical loss development trends. The upward development in the fourth quarter on case reserves of individual claims was not consistent with trends experienced previously. Therefore, in addition to the recognition of the upward development on individual claims, the actuarial estimates of losses were increased.
Reinsurance recoverable on losses ... $ 44,846 $ 48,100 ======== ========
Underwriting expenses increased $2.6 million, or 26%, to $12.6 million for the year ended December 31, 2004 from $10.0 million for the year ended December 31, 2003. 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, legal fees incurred included $525,000 for the collection litigation initiated by us as more fully discussed in the section "Net Premiums Earned," and $613,000 of expense resulting from a fraudulent act of a former sales agent.
Interest expense incurred is for the debt service on the Trust Preferred Securities issued in December, 2002. The stated annual interest rate is 400 basis points over LIBOR, adjusted quarterly.
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%.
In 2001 we formed ACC, a wholly owned captive insurance company subsidiary, to provide an alternative risk-financing vehicle for affinity groups. The captive program is marketed to organizations and groups wishing to finance and manage their own risk. During 2004, ACC incurred $163,000 in expenses. As of December 31, 2004, ACC does not have any active protected cells.
Other expenses of $2.5 million for the year ended December 31, 2004 compares to other expense of $1.7 million for the year ended December 31, 2003. The primary component of the expense increase is $619,000 for post-trial expenses for the premium collection litigation. The remainder of the increase is for holding company operations.
Our net deferred tax assets are created by temporary differences that will result in tax benefits in future years due to the differing treatment of items for tax and financial statement purposes. The primary difference is the requirement to discount or reduce loss reserves for tax purposes because of their long-term nature. Additionally, the deferred income tax asset includes $1.9 million for net operating loss carryforwards, NOLs, which are available to reduce tax return taxable income in future years.
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. As part of the conversion, 2,778,144 shares were issued to the former public stockholders of NCRIC Group. The exchange ratio was 1.8665 new shares for each share of NCRIC Group held by public stockholders as of the close of business on June 25, 2003. Accordingly, after the conversion, NCRIC Group had 6,921,845 shares outstanding.
Liquidity. The primary sources of our liquidity are insurance premiums, net investment income, practice management and financial services fees, recoveries from reinsurers and proceeds from the maturity or sale of invested assets. Funds are used to pay losses and LAE, operating expenses, reinsurance premiums, taxes, and to purchase investments.
Comprehensive income was a loss of $6.5 million for the year ended December 31, 2004 compared to a loss of $5.6 million for the year ended December 31, 2003. The decrease in comprehensive income results from the $7.1 million net loss, partially offset by the $648,000 increase in net unrealized investment gains for the year ended December 31, 2004.
Financial condition and capital resources. We invest our positive cash flow from operations primarily in investment grade, fixed maturity securities. As of December 31, 2004, the carrying value of the securities portfolio was $202.3 million, compared to a carrying value of $174.4 million at December 31, 2003. The portfolios were invested as follows:
U.S. Government and agencies ........... 18% 17% Asset and mortgage-backed securities ... 24 31 Tax exempt securities .................. 21 21 Corporate bonds ........................ 25 24 Equity securities ...................... 12 7 ---- ---- 100% 100% ==== ====
We are required to pay aggregate annual salaries in the amount of $966,400 to four persons under employment agreements.
The following table summarizes our contractual obligations as of December 31, 2004, in thousands:
Over One Over three More year one year years to than or to three five five Total less years years years -------- -------- -------- -------- -------- Long-term debt $ 15,000 $ -- $ -- $ -- $ 15,000 Losses & LAE 153,242 47,731 71,202 24,510 9,799 Operating leases 2,965 917 1,779 269 -- -------- -------- -------- -------- -------- $171,207 $ 48,648 $ 72,981 $ 24,779 $ 24,799 -------- -------- -------- -------- --------
NCRIC Group and its subsidiaries file a consolidated income tax return with the Internal Revenue Service. Tax years 2001, 2002 and 2003 are open but not currently under audit.
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 and 2004 of NCRIC, Inc. include the impact of the merged business of CML.
Authorized control level Total risk-based capital adjusted capital ------------------ ---------------- NCRIC, NCRIC, Inc. CML Inc. CML ------ ----- ------ ----- (in millions) December 31, 2004 .......... $13.8 -- $63.0 -- December 31, 2003 .......... $10.5 -- $70.4 -- December 31, 2002 .......... $ 6.7 $0.49 $44.3 $ 4.7
NCRIC GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002 (IN THOUSANDS, EXCEPT PER SHARE DATA) - --------------------------------------------------------------------------------
NCRIC GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------
Organization and Basis of Reporting - NCRIC, Group, Inc. (the Company) is a healthcare financial services organization that provides individual physicians and groups of physicians and other healthcare providers with professional liability insurance and practice management services through its subsidiary companies.
On June 24, 2003, a plan of conversion and reorganization was approved by the members of NCRIC, A Mutual Holding Company and by the shareholders of NCRIC Group, Inc. In the conversion and related stock offering, NCRIC, A Mutual Holding Company offered for sale its 60% ownership interest in NCRIC Group, Inc. As a result of the conversion and stock offering, NCRIC, A Mutual Holding Company ceased to exist, and NCRIC Group, Inc. became a fully public company. (See Note 2.)
The Company also provides (i) practice management services, accounting and tax services, and personal financial planning services to medical and dental practices and (ii) retirement planning services and administration to medical and dental practices and certain other businesses throughout the mid-Atlantic region.
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP), which differ from statutory accounting practices prescribed or permitted for insurance companies by regulatory authorities.
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 each of the years ended December 31, 2004 and 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 $15,000 and $135,000 during 2004 and 2003, respectively. In the third quarter of 2004, the Company recorded a pre-tax impairment of $24,000 on a fixed-income security. The security was subsequently sold in the fourth quarter.
In the second quarter of 2002, the Company recorded a pre-tax impairment loss of $557,000 on fixed-income securities. These securities were subsequently sold during 2002.
NCRIC's goodwill asset resulted from the 1999 acquisition of three businesses, which now operate as divisions of the Practice Management Services Segment. NCRIC Group, Inc. completed its initial goodwill impairment testing under SFAS 142 as of March 31, 2002 and tests goodwill for impairment on a quarterly basis. The goodwill asset was not impaired as of the date of implementation of SFAS 142, nor was it impaired as of December 31, 2004. Goodwill is reported net of accumulated amortization of $909,000 as of December 31, 2004 and 2003.
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 $2.7 million and $2.4 million as of December 31, 2004 and 2003, respectively, and are reported as a component of other assets. Since NCRIC's insurance policies are generally written for a term of one year, the entire year-end balance is amortized in the following year. Amortization of acquisition costs is reported as a component of underwriting expense.
Property and Equipment - Fixed assets are recorded at cost and reported as a component of other assets. Depreciation is recorded using the straight-line method over estimated useful lives ranging from three to five years for computer software and equipment and furniture and fixtures and ten years for leasehold improvements. The balances of fixed assets of $2.6 million and $2.1 million as of December 31, 2004 and 2003, respectively, are net of accumulated depreciation of $3.0 million and $2.5 million. Depreciation expense for the years ended December 31, 2004, 2003, and 2002 was $646,500, $559,800, and $457,700.
Liabilities for Losses and Loss Adjustment Expenses - Liabilities for losses and loss adjustment expenses are established on the basis of reported losses and loss adjustment expenses and a provision for losses incurred but not reported. These amounts are based on management's estimates and are subject to risks and uncertainties. As facts become known, adjustments to these estimates are reflected in earnings.
taxes. Under this method, deferred income taxes are recognized for tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The Company files a consolidated Federal income tax return.
Revenue Recognition - Premium revenue is earned pro rata over the terms of the policies. The portion of premiums that will be earned in the future are deferred and reported as unearned premiums. Premiums received prior to the term of policy coverage are excluded from premium revenue and reported as advance premium.
Practice management revenue is recognized as services are performed under terms of management and other contracts. Revenue is generally billed in the month following the performance of related services.
Stock-based Compensation - As of December 31, 2004 and 2003 the Company has a stock option plan, which is described more fully in Note 10. NCRIC Group, Inc. accounts for compensation cost using the intrinsic value based method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, no compensation expense was recognized since the stock options granted were at an exercise price equal to the fair market value of the common stock on the date the options were granted.
the requirements of SFAS 123R to comply with the new pronouncement by the third quarter of 2005.
As part of the conversion, 2,778,144 shares were issued to the former public stockholders of NCRIC Group, Inc. The exchange ratio was 1.8665 new shares for each share of NCRIC Group, Inc. held by public stockholders as of the close of business on June 25, 2003. Accordingly, after the conversion, the Company had 6,921,845 shares outstanding immediately following the offering. For the earnings per share calculations, the share amounts for periods prior to the conversion and stock offering have been revised to reflect the share exchange ratio applied in the conversion. The issuance of the shares of common stock in the subscription and community offering and in the exchange offering to existing stockholders was registered on Form S-1 filed with the SEC (No. 333-104023), which registration statement was declared effective on May 14, 2003.
o the remaining amount has been retained for general corporate purposes.
Issued in the conversion and stock offering 4,144 Issued to existing public shareholders of NCRIC Group 2,778 ------ Total shares issued June 25, 2003 6,922 ESOP loan shares (270) Stock Award Plan loan shares (179) ------ Net shares outstanding as of June 25, 2003 6,473 ======
The following tables show the cost or amortized cost and fair value of investments (in thousands):
The amortized cost and fair value of debt securities at December 31, 2004 and 2003 are shown by maturity (in thousands). Actual maturities will differ from contractual maturities
Proceeds from bond maturities and redemptions of available-for-sale investments during the years ended December 31, 2004, 2003, and 2002, were $67.9 million, $138.6 million, and $39.0 million, respectively. Gross gains of $917,000, $3,441,000, and $1,437,000, and gross losses of $442,000, $1,511,000, and $1,568,000, were realized on security sales, redemptions and impairments during years ended December 31, 2004, 2003, and 2002, respectively.
The following table displays the maturity distribution of those fixed maturity securities with an unrealized loss in value as of December 31, 2004:
Activity in the liabilities for losses and loss adjustment expenses is summarized as follows (in thousands):
The average interest rate was 5.54%, 5.31% and 5.42% and interest of $857,000, $826,000 and $62,000 was incurred for the years ended December 31, 2004, 2003 and 2002, respectively. Issuance costs of $451,000 were incurred related to the TPS and included in other assets. Issuance costs are being amortized over 30 years as a component of other expense.
The Company is liable in the event the reinsurers are unable to meet their obligations under these contracts. NCRIC, Inc. holds letters of credit executed by reinsurers in the amount of $6.2 million and $1.3 million at December 31, 2004 and 2003, respectively. Such letters of credit are issued as security against ceded losses recoverable in the future.
For the Year Ended December 31, ------------------------------- 2004 2003 2002 ------- ------- ------- Federal: Current $(1,375) $(1,919) $ 2,214 Deferred (3,407) (831) (2,501) ------- ------- ------- (4,782) (2,750) (287) State: Current 2 50 (28) Deferred (24) 6 (7) ------- ------- ------- (22) 56 (35) ------- ------- ------- Total benefit $(4,804) $(2,694) $ (322) ======= ======= =======
Weighted average common shares outstanding - basic 6,357 6,486 6,639 Dilutive effect of stock options -- -- 140 ------- ------- -------
Earnings per share is calculated by dividing the net income by the weighted average shares outstanding for the period. Incremental shares are not included in 2004 and 2003 because they would be anti-dilutive. The share amounts for periods prior to the conversion and stock offering have been revised to reflect the share exchange ratio applied in the conversion.
NCRIC entered into an operating lease for office space located in Washington, D.C., effective on April 15, 1998. The lease terms are for ten years with a monthly base rent of $35,000 and a 2.0% annual escalator. During 2003, the Company entered in to an operating lease for additional office space in Washington, D.C. The lease term is for 54 months with a monthly base rent of $14,000 and a 2.5% annual escalator. The Company also maintains office space in Wilmington, Delaware, Lynchburg and Richmond, Virginia as well as in Greensboro, North Carolina.
As of December 31, 2004, the future minimum annual commitments under noncancellable leases are as follows:
Rent expense during the years ended December 31, 2004, 2003, and 2002 was $950,000, $721,000, and $634,000, respectively.
NCRIC has established seven 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, 2004, and 2003 these letters of credit totaled $11.2 million and $4.8 million, respectively.
The Company and its subsidiaries have entered into four employment agreements with certain key employees. These agreements include covenants not to compete and provide for aggregate annual compensation of $966,400 through December 31, 2005.
NCRIC MSO, Inc. (NCRIC MSO), the practice management services segment of NCRIC Group, Inc. provides medical practice management services primarily to private practicing physicians. In June 2001, NCRIC MSO borrowed $1,971,000 from SunTrust Bank to finance payments made in accordance with the purchase of HealthCare Consulting, Inc., HCI Ventures, LLC, and Employee Benefits Services, Inc. In September, 2002, the Company pledged securities to collateralize this loan lowering the interest rate from a floating rate of LIBOR plus two and three-quarter percent to plus one and one-half percent. The term of the loan is 3 years. 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.
Weighted Weighted Average Average Exercise Exercise Shares Price Exercisable Price -------- -------- ----------- --------
December 31, 2001 74,000 $ 7.00 49,333 $ 7.00 Vested -- $ -- 24,667 $ 7.00 -------- -------- -------- -------- December 31, 2002 74,000 $ 7.00 74,000 $ 7.00
Stock Conversion 64,123 $ 3.75 64,123 $ 3.75 Granted 392,615 $ 10.90 -- -- Exercised (10,359) $ 3.75 (10,359) $ 3.75 Forfeited (3,453) $ 3.75 (3,453) $ 3.75
-------- -------- -------- -------- December 31, 2003 516,926 $ 9.18 124,311 $ 3.75
Employee Stock Ownership Plan - NCRIC Group, Inc. has an Employee Stock Ownership Plan (ESOP) for employees who have attained age 21 and completed one year of service. As part of the 1999 stock offering, the ESOP borrowed $1.0 million from NCRIC Group, Inc. to purchase 148,000 shares (276,247 shares on a converted basis), which are held in a trust account for allocation among participants as the loan is repaid. For shares allocated to the accounts of the ESOP participants as the result of payments made to reduce the ESOP loan, the compensation charge is based upon the average fair value of the shares over the service period. Scheduled loan repayments on December 31, 2004, 2003, and 2002 have been made. During the years ended December 31, 2004, 2003, and 2002 contributions were made to the plan of $188,700, $207,200 and $162,800 respectively.
Executive Deferred Compensation Plan - In 2003, NCRIC established a deferred compensation plan which is a non-qualified, unfunded plan under which the directors and officers of NCRIC Group may defer a portion of their compensation. The Company will provide a match for deferrals of 5% of compensation for officers. Deferred amounts are credited with interest at the rate of 6% per year. The matching expense under this plan totaled $57,000 and $49,000 for the years ended December 31, 2004 and 2003, respectively.
STOCKHOLDERS' EQUITY - GAAP BASIS $ 72,015 $ 77,979 $ 47,817 ======== ======== ========
NET (LOSS) INCOME - GAAP BASIS $ (7,120) $ (4,218) $ 742 ======== ======== ========
As of December 31, 2004, 2003, and 2002, 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.
NCRIC MSO rented an office building for one of its divisions from a partnership whose partners are HealthCare Consulting senior executives. The lease terminated October 31, 2002. For this property, NCRIC MSO paid approximately $57,000 in rent for the year ended December 31, 2002.
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
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE I SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2004 (IN THOUSANDS) - --------------------------------------------------------------------------------
NOTES TO CONDENSED FINANCIAL STATEMENTS NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
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 NCRIC, A Mutual Holding Company offered for sale its 60% ownership interest in NCRIC Group, Inc. As a result of the conversion and stock offering, NCRIC, A Mutual Holding Company ceased to exist, and NCRIC Group, Inc. became a fully publicly-owned company. See Note 2 of the Notes to the Financial Statements.
In Group's financial statements, investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since date of reorganization plus unrealized gains and losses of subisidiaries' investments.
See Note 5 of the Notes to the Consolidated Financial Statements.
For information on the subsequent event, see Note 15 of the Notes to the Consolidated Financial Statements.
BALANCE AT CHARGED TO BALANCE BEGINNING COSTS AND AT END DESCRIPTION OF YEAR EXPENSES DEDUCTIONS OF YEAR ----------- ------- -------- ---------- ------- Allowance for Doubtful Accounts $1,882 $ 108 $ (136) $1,854
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE VI SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE COMPANIES FOR THE YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------