The following table sets forth the facilities leased by us at December 31, 2003, along with the applicable lease expiration date:
(2) In calculating GAAP underwriting ratios, renewal credits are considered a reduction of premium income. In addition, earned premium is used to calculate the GAAP loss and underwriting expense ratios. For statutory purposes, renewal credits are not considered a reduction in premium income, and written premiums are used to calculate the statutory underwriting expense ratio. Due to these differences in treatment, GAAP combined ratios can differ significantly from statutory combined ratios. See Note 11 to the consolidated financial statements for a discussion of the differences between statutory and GAAP reporting.
Premium income. Gross premiums written represent the amounts billed to policyholders. Gross premiums written are reduced by premiums ceded to reinsurers and renewal credits in determining net premiums written. Premiums ceded to reinsurers represent the cost to us of reducing our exposure to medical professional liability losses by transferring agreed upon insurance risks to reinsurers through a reinsurance contract or treaty. Renewal credits are reductions in premium billings to renewing policyholders. Net premiums written are adjusted by any amount which has been billed but not yet earned during the period in arriving at earned premiums. Extended reporting endorsements premium is earned in the same period it is written. For several large groups of policyholders, we have insurance programs where the premiums are retrospectively determined based on losses during the period. Under all of the current programs, the full premium level is determined and billed at the inception of the policy term. The premium level could potentially be reduced and a premium refund made if the program loss experience is favorable. Premiums billed under retrospective programs are recorded as premiums written, while premium refunds accrued under retrospective programs are recorded as unearned premiums. Under retrospective programs, premiums earned are premiums written reduced by premium refunds accrued. Premium refunds are accrued to reflect the risk-sharing program results on a basis consistent with the underlying loss experience. The program loss experience is that which is included in the determination of our losses and loss adjustment expenses (LAE). As described more fully below, one component of the expense for losses and LAE is the estimate of future payments for claims and related expenses of adjudicating claims.
individual case. The timing of establishing case reserves follows established protocols based on the underlying facts and circumstances on a case by case basis. Specific factors considered include: the claimants assertion of loss; the amount of documented damages asserted; an expert medical assessment; the jurisdiction where the incident occurred; our experience with any similar cases in the past; as well as any other factors pertinent to the specific case.
Each quarter, the aggregate of case reserves by report year is compiled and subjected to extensive analysis. Semiannually, our independent actuary performs an actuarial valuation of reserves based on the data comprising our detailed claims experience since inception.
The actuarial valuation entails application of various statistically based actuarial formulae, an analysis of trends, and a series of judgments to produce an aggregate estimate of our liability at the balance sheet date. Specific factors included in the estimation process include: the level of case reserves by jurisdiction by report year; the change in case reserves between each evaluation date; historical trends in the development of our initial case reserves to final conclusion; expected losses and LAE levels based on past experience relative to the level of premium earned; reinsurance treaty terms; and any other pertinent factors that may arise.
Our ultimate liability will be known after all claims are closed, which is likely to be several years into the future. For example, as of December 31, 2003, the oldest report date of an open claim is 1993. Incurred losses for each report year will develop with a change in estimate in each subsequent calendar year until all claims are closed for that report year. Loss development could potentially have a significant impact on our results of operations. Developments changing the ultimate aggregate liability as little as 1% could have a material impact on our reported operating results.
The inherent uncertainty in establishing reserves is relatively greater for companies writing long-tail medical professional liability business. Each claim reported has the potential to be significant in amount. For the three-year period ended December 31, 2003, the average indemnity payment per paid closed claim was $306,000 with total indemnity payments of $22.2 million, $12.9 million and $14.0 million for the years ended December 31, 2003, 2002 and 2001, respectively. The cost of individual indemnity payments over this three-year period ranged from $1,000 to $2.2 million. Due to the extended nature of the claim resolution process and the wide range of potential outcomes of professional liability claims, established reserve estimates may be adversely impacted by: judicial expansion of liability standards; unfavorable legislative actions; expansive interpretations of contracts; inflation associated with medical claims; lack of a legislated cap on non-economic damages; and the propensity of individuals to file claims. These risk factors are amplified given the increase in new business written in new markets because there is limited historical data available which can be used to estimate current loss levels. We refine reserve estimates as experience develops and additional claims are reported or existing claims are closed; adjustments to losses reserved in prior periods are reflected in the results of the periods in which the adjustments are made.
Losses and LAE reserve liabilities as stated on the balance sheet are reported gross before recovery from reinsurers for the portion of the claims covered under the reinsurance program. Losses and LAE expenses as reported in the statement of operations are reported net of reinsurance recoveries.
entering into a reinsurance agreement with other insurance enterprises or reinsurers. We pay or cede part of our policyholder premium to reinsurers. The reinsurers in return agree to reimburse us for a specified portion of any claims covered under the reinsurance contract. While reinsurance arrangements are designed to limit losses from large exposures and to permit recovery of a portion of direct losses, reinsurance does not relieve us of liability to our insureds.
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.
Investment portfolio. Our investment portfolio is composed principally of fixed maturity securities classified as available-for-sale. All securities with gross unrealized losses at the balance sheet date are evaluated for evidence of other-than-temporary impairment on a quarterly basis. We write down to fair value any security with an impairment that is deemed to be other-than-temporary in the period the determination is made. The assessment of whether such impairment has occurred is based on management's case-by-case evaluation of the underlying reasons for the decline in fair value. Management considers a wide range of factors and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Factors considered in the evaluation include but are not limited to: (1) interest rates; (2) market-related factors other than interest rates; and (3) financial conditions, business prospects and other fundamental factors specific to the securities issuer. Declines attributable to issuer fundamentals are reviewed in further detail. We have a security monitoring process which includes quarterly review by an investment committee comprised of members of our Board of Directors and representatives of policyholders. Our CEO and CFO also participate in the committee meetings in which our professional investment advisors review with the committee and management the analysis prepared by our investment manager of each security that has certain characteristics, reviewing deterioration of the financial condition of the issuer; the magnitude and duration of unrealized losses; and the credit rating and industry of the issuer. The primary factors considered in evaluating whether a decline in value is other-than-temporary include: the length of time and the extent to which the fair value has been less than cost; the financial condition and near-term prospects of the issuer; whether the issuer is current on contractually obligated
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.
claims severity. The realization of this prediction throughout 2001 and 2002 ultimately resulted in the change in the entire medical professional liability insurance market as a number of the insurance providers experienced adverse financial results and subsequently withdrew from the market.
The adverse verdict in the hospital premium collection litigation is unfortunate. We believe that the verdict was wrong. Since we believe the verdict was unfounded, we have not accrued any potential loss from this litigation.
CONSOLIDATED NET INCOME Years ended December 31, 2003, 2002 and 2001
Net income was a loss of $4.2 million for the year ended December 31, 2003 compared to income of $742,000 for the year ended December 31, 2002. 2003 results were negatively impacted by adverse development of claims originally reported in earlier years.
The operating results of our insurance segment for the year ended December 31, 2003 were primarily driven by growth in new business written and the increase in the estimate of loss reserves for claims reported in prior years. For the year, new business premium written was $10.5 million compared to $12.7 million for 2002. The new business written coupled with the increased premium rates resulted in a 57% increase in net premiums earned. The strain on current period earnings as a result of the large increase in new business written, combined with investment yield declines, resulted in pressure on short-term profitability. While the cost for claims reported in 2003 increased due to the rise in exposures, the development of losses for claims originally reported in 2001 and 2002 reduced pre-tax earnings for 2003. The re-estimation of losses was driven by two primary factors - increases in the estimate of direct losses, primarily in Virginia for the 2001 and 2002 report years, and a change in estimate of the level of reinsurance to be recovered for the losses reported in the years 2000, 2001 and 2002.
Three months ended December 31, 2003 compared to three months ended December 31,
The operating results of our insurance segment for the year ended December 31, 2002 were primarily driven by the following factors. We continued to experience a significant increase in new business written in 2002. For the year, new business written (excluding the 100% ceded HCA program), was $12.7 million, up $0.5 million or 4%, from $12.2 million for 2001. The rise in new business written coupled with the increased premium rates resulted in a 46% increase in net premiums earned. The strain on current period earnings as a result of the large increase in new business written, combined with investment yield declines, resulted in pressure on short-term profitability. While the cost for claims reported in 2002 increased due to the rise in exposure, the development of losses for claims originally reported in 2000 and 2001 reduced pre-tax earnings for 2002.
Three months ended December 31, 2002 compared to three months ended December 31,
Net income for the fourth quarter of 2002 was $801,000 compared to a net loss of $312,000 in the fourth quarter of 2001. The 2002 fourth quarter result includes realized investment gains, net of tax, of $312,000 compared to realized investment losses, net of tax, of $312,000 in the fourth quarter of 2001. The pre-tax operating result for the insurance segment was income of $677,000 in 2002 compared to $228,000 in 2001, respectively. For the practice management services segment, the fourth quarter result for 2002 was pre-tax income of $37,000 compared to a pre-tax loss of $159,000 for the fourth quarter of 2001.
Net premiums earned increased by $17.2 million, or 57.1%, to $47.3 million for the year ended December 31, 2003 from $30.1 million for the year ended December 31, 2002. The increase reflects the $16.9 million growth in gross earned premiums supplemented by the lower reinsurance premiums ceded in 2003 compared to 2002.
Direct ............... $ 618 $ 2,309 Agent ................ 9,900 10,391 HCA .................. 0 793 ------- ------- $10,518 $13,493 ======= =======
Premium collection litigation. During 2000, it was determined that one of NCRIC's hospital-sponsored retrospective programs would not be renewed. In accordance with the terms of the contract, NCRIC billed the hospital sponsor, Columbia Hospital for Women Medical Center, Inc., for premium due based on the actual accumulated loss experience of the terminated program. Because the original 2000 bill was not paid when due, we initiated legal proceedings to collect. As of December 31, 2003 the amount due to NCRIC for this program was $3.0 million. NCRIC has accrued no amount of net receivable due to the pending litigation and questionable collectability.
Reinsurance premiums ceded increased by $6.7 million to $14.0 million for the year ended December 31, 2002 from $7.3 million for the year ended December 31, 2001. The increase was primarily the result of the increase in gross premiums earned. Reinsurance premiums are affected by current year premiums payable to the reinsurers, as well as the retrospective adjustments to accruals for prior year premiums.
Net premiums earned increased by $9.5 million, or 46%, to $30.1 million for the year ended December 31, 2002 from $20.6 million for the year ended December 31, 2001. The increase reflects the $15.9 million growth in gross earned premiums and the lower renewal credits partially offset by the $6.7 million higher reinsurance premiums in 2002 compared to 2001.
In 2002, we initiated a program to provide insurance coverage to physicians at four HCA hospitals in West Virginia. Under this arrangement, we cede 100% of the insurance exposure to a captive insurance company affiliated with the sponsoring hospitals. We receive a ceding commission for providing complete policy underwriting, claims and administrative services for these policies. While accounting standards require the premium written to be included as a part of our direct written premium, we have no net written nor net earned premium from this program.
American Captive Corporation (ACC), our subsidiary, developed its first protected-cell captive, the Princeton Community Hospital Cell (West Virginia), in 2002. In anticipation of the initiation of the Princeton Cell within ACC, some insurance was underwritten by us during 2002 for policies that will be 100% reinsured by the Princeton Cell when it becomes active. The premium amounts for these policies are separately identified in the following table to aid comparisons. As of December 31, 2003 it was determined that this cell would not become operational.
Direct ................. $ 2,309 $ 1,206 Agent .................. 9,988 10,964 HCA .................... 793 -- Princeton Cell ......... 403 -- ------- ------- $13,493 $12,170 ======= =======
Net investment income increased by $93,000, or 2%, for the year ended December 31, 2003 compared to the prior year reflecting a higher base of average invested assets partially offset by a decrease in yields. Net investment income for the year ended December 31, 2003 was $6.0 million compared to $5.9 million for the year ended December 31, 2002. Average invested assets, which include cash equivalents, increased by $42.3 million, or 38%, to $153.7 million for the year ended December 31, 2003, due to the proceeds from the issuance of stock and cash from operations. New investments were primarily directed to mortgage-backed securities; in addition, the investment portfolio added an allocation to common stocks as part of the strategy to protect the portfolio in a rising interest rate environment. The average effective yield was approximately 3.9% for the year ended December 31, 2003 and 5.3% for the year ended December 31, 2002. The tax equivalent yield was approximately 4.4% at December 31, 2003 and 5.9% at December 31, 2002. The change in investment yields is reflective of the market change in interest rates in 2003 compared to 2002 as well as being reflective of the new allocation to lower-yielding common stocks and the portfolio restructuring executed in the first half of 2003. Securities sold as a part of the restructuring generally had above market coupon rates and were therefore sold at gains. New securities acquired brought current market rate yields into the portfolio, thereby reducing the overall portfolio yield.
Net realized investment gains were $1.9 million for the year ended December 31, 2003 compared to net realized investment losses of $131,000 for the year ended December 31, 2002. The 2003 gains resulted from portfolio restructuring implemented by our new fixed income investment portfolio manager to replace weak credits with stronger rated bonds as well as from routine portfolio management activity, partially offset by the recognition of an other than temporary impairment loss of $135,000 on an investment in common stock. The circumstance giving rise to the other-than-temporary impairment charge was a sharp decline in the value of the stock in 2003, which we do not expect to be temporary based on available financial information of the issuer. 2002 realized losses included an other-than-temporary impairment charge of $557,000 for a fixed maturity security issued by WorldCom.
Practice management and related revenues decreased by $0.9 million, or 15.5%, to $4.9 million for the year ended December 31, 2003, from $5.8 million for the year ended December 31, 2002. This revenue consists of fees generated by NCRIC MSO through its HealthCare Consulting and Employee Benefits Services divisions. The decreased revenue was primarily a result of a reduced level of non-recurring and recurring assignments in the HealthCare Consulting division compared to 2002. Additionally, in the later part of 2003 there was some loss of clients and revenue resulting from the departure from NCRIC of two consultants.
Practice management and related revenues decreased by $356,000, or 6%, to $5.8 million for the year ended December 31, 2002, from $6.2 million for the year ended December 31, 2001. This revenue consists of fees generated by NCRIC MSO through its HealthCare Consulting and Employee Benefits Services divisions. The decreased revenue was a result of a reduced level of non-recurring consulting assignments in the HealthCare Consulting division compared to 2001.
installment payment option to our insureds. As a result, the revenue generated by service fees on installment payments grew throughout 2002 compared to 2001.
Year Ended December 31, ---------------------------- 2003 2002 2001 ------ ------ ------
Losses and LAE ratio: Current year losses ............. 94.3% 79.9% 111.9% Prior years loss development .... 12.5 9.2 (20.4) ------ ------ ------ Total losses and LAE ratio ....... 106.8 89.1 91.5 Underwriting expense ratio ....... 21.2 27.2 23.7 ------ ------ ------ Combined ratio ................... 128.0% 116.3% 115.2% ====== ====== ======
loss development for the 1996 and 1999 loss years, more than offset by adverse development in the 1998, 2000 and 2001 loss years.
Current year losses ................. 108.2% 77.4% Prior years loss development ........ 48.4% 11.4% --------- --------- Total losses and LAE ratio ............ 156.6% 88.8% Underwriting expense ratio ............ 22.3% 21.8% --------- --------- Combined ratio ........................ 178.9% 110.7% ========= =========
o lower estimate of reinsurance to be recovered on losses in the 2000, 2001 and 2002 report years across all territories.
Evaluations of individual claims are updated when additional information on each case is determined, often as a part of the preparation for trial. Case reserves on individual claims are raised when new information indicates a greater loss exposure. Actuarial reserves are established based on case reserves combined with historical loss development trends. The upward development in the fourth quarter on case reserves of individual claims was not consistent with
trends experienced previously. Therefore, in addition to the recognition of the upward development on individual claims, the actuarial estimates of losses were increased.
The statutory combined ratio was 111.8% for the year ended December 31, 2002, and the same for the year ended December 31, 2001. This includes a slight decrease in the loss ratio offset by a slight increase in the expense ratio, reflecting the same premium, loss and expense factors noted previously.
At December 31, --------------------- 2003 2002 -------- -------- (in thousands) Liability for: Loss ............................... $ 87,778 $ 70,314 Loss adjustment expense ............ 38,213 33,708 -------- -------- Total liability ..................... $125,991 $104,022 ======== ========
Underwriting expenses increased $3.3 million, or 67%, to $8.2 million for the year ended December 31, 2002 from $4.9 million for the year ended December 31, 2001. The increase in expenses primarily stems from the increase in new business, particularly agent produced business, through increases in commissions, travel, and other underwriting costs. These expenses were partially offset by an increase in ceding allowances as a result of the increase in premiums earned. Underwriting expenses also increased due to legal fees incurred for the collection
litigation initiated by us and for the $1.2 million addition to the allowance for uncollectible premiums, as more fully discussed in the section "Net Premiums Earned." In addition, we received guaranty fund assessments totaling $355,000 stemming from the insolvency of PHICO Insurance Company. There is the possibility we could be assessed additional amounts in the future. However, since the amount of any potential future assessment is not reasonably estimable at this time, no additional expense accrual has been recorded.
In April 2001, we announced the formation of ACC, a wholly owned subsidiary and the first captive insurance company to be licensed in the District of Columbia under the Captive Insurance Act of 2000. As a captive insurance company, ACC was established to provide an alternative risk-financing vehicle for affinity groups. The captive program is marketed to organizations and groups wishing to finance and manage their own risk. During 2003, ACC incurred $151,000 in expenses. As of December 31, 2003, ACC does not have any active protected cells.
Other expenses of $1.4 million for the year ended December 31, 2002 increased $160,000, or 13% compared to the year ended December 31, 2001. Expense increases are for captive business development costs and holding company operations.
Our effective tax rate is lower than the federal statutory rate principally due to nontaxable investment income.
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.
The tax benefit for the year ended December 31, 2003 was $2.7 million compared to $0.3 million for the year ended December 31, 2002. A federal tax benefit was incurred in 2003 due primarily to the pre-tax loss. In addition, the effective tax benefit rate improved by 6% due to tax exempt income.
The tax benefit for the year ended December 31, 2002 was $322,000 compared to tax expense of $597,000 for the year ended December 31, 2001. The Federal corporate income tax rate of 34% was adjusted to an effective tax benefit rate of 77% for the year ended December 31, 2002 due to tax-exempt income and nontaxable dividends.
Financial condition and capital resources. We are a stock holding company whose operations and assets primarily consist of our ownership of NCRIC, Inc. and NCRIC MSO, Inc. We assist our subsidiaries in their efforts to compete effectively and create long-term growth. As a part of this strategy, we may seek to take advantage of acquisition opportunities and alternative financing.
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.
The payment of dividends to us by NCRIC, Inc. is subject to limitations imposed by the District of Columbia Holding Company System Act of 1993. Under the DC Holding Company Act, NCRIC, Inc. must seek prior approval from the Commissioner to pay any dividend which, combined with other dividends made within the preceding 12 months, exceeds the lesser of (A) 10% of the surplus at the end of the prior year or (B) the prior year's net income excluding realized capital gains. Net income, excluding realized capital gains, for the two years preceding the current year is carried forward for purposes of the calculation to the extent not paid in dividends. The law also requires that an insurer's statutory surplus following a dividend or other distribution be reasonable in relation to the insurer's outstanding liabilities and adequate to meet its financial needs. The District of Columbia permits the payment of dividends only out of unassigned statutory surplus. As of December 31, 2003, NCRIC, Inc. had approximately $70 million of unassigned statutory surplus. Any dividend payment by NCRIC, Inc. would require the approval of the Commissioner.
2003............. $20.6 million 2002............. $ 3.4 million 2001............. $ 8.3 million
Comprehensive income was a loss of $5.6 million for the year ended December 31, 2003 compared to income $3.1 million for the year ended December 31, 2002. The decrease in comprehensive income results from the $1.3 million decrease in net unrealized investment gains, combined with the $4.2 million net loss for the year ended December 31, 2003 compared to the net income of $0.7 million for the year ended December 31, 2002.
U.S. Government and agencies ........... 17% 23% Asset and mortgage-backed securities ... 31 28 Tax exempt securities .................. 21 27 Corporate bonds ........................ 24 17 Equity securities ...................... 7 5 --- --- 100% 100% === ===
At December 31, 2003, our portfolio included total gross unrealized gains of $3.8 million, or 2% of the $174.4 million carrying value of the portfolio, and total unrealized losses of $1.6 million, or less than 1% of the carrying value of the portfolio. The total unrealized losses are comprised of 219 different securities, including nine Treasury Note issues, 200 corporate debt and municipal bonds (all of which are investment grade), with lengths of time to maturity ranging from two to 35 years, and ten equity issues. All of the fixed maturity securities are meeting and are expected to continue to meet all contractual obligations for interest payments.
At December 31, 2003, the aggregate fair value of the securities with unrealized losses was $81.0 million, or 98% of the aggregate carrying value of those securities of $82.6 million. The largest single security with an unrealized loss at December 31, 2003 relates to a FNMA pool which matures in 2033 and carries a coupon rate of 5.5%. The unrealized pre-tax loss relating to this security is approximately $75,000 based on the fair value of $5.8 million at December 31, 2003. Unrealized losses related to other securities are not individually significant, nor is there any concentration of unrealized losses with respect to the type of security or industry.
The following table displays characteristics of the securities with an unrealized loss in value as of December 31, 2003. No concentrations of industries exist in these securities.
The following table displays the maturity distribution of those fixed maturity securities with an unrealized loss in value as of December 31, 2003:
We are required to pay aggregate annual salaries in the amount of $992,250 to four persons under employment agreements.
Our stockholders' equity totaled $78.0 million at December 31, 2003 and $47.8 million at December 31, 2002. The $30.2 million increase for the year ended December 31, 2003 was due primarily to $35.8 million of net proceeds from the issuance of common stock, partially reduced by the net loss of $4.2 million and the reduction of $1.3 million in net unrealized investment gains.
Interest rate changes expose us to market risk on our investment portfolio. This market risk is the potential for financial losses due to the decrease in the value or price of an asset resulting from broad movements in prices, such as interest rates. In general, the market value of our fixed maturity portfolio increases or decreases in an inverse relationship with fluctuation in interest rates. In addition, our net investment income increases or decreases in a direct relationship with interest rate changes on monies re-invested from maturing securities and investments of positive cash flow from operating activities.
NCRIC Group and its subsidiaries file a consolidated income tax return with the Internal Revenue Service. Tax years 2000, 2001 and 2002 are open but not currently under audit. In 2000 the Internal Revenue Service approved a change in accounting method for us relative to the timing of revenue recognition for tax purposes.
statements prepared in accordance with GAAP, which have been included in this document and filed with the Securities and Exchange Commission. The effect on our statutory surplus on January 1, 2001 was an increase of $1.6 million. This increase is mainly due to the effect of accounting changes related to the implementation of deferred taxes and the removal of the excess of statutory reserves over statement reserves penalty, offset by charges to surplus for overdue receivables.
We have audited the accompanying consolidated balance sheets of NCRIC Group, Inc. and Subsidiaries (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ending December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
NCRIC GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2003 AND 2002 (IN THOUSANDS, EXCEPT FOR SHARE DATA) - --------------------------------------------------------------------------------
NCRIC GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (IN THOUSANDS, EXCEPT PER SHARE DATA) - --------------------------------------------------------------------------------
NCRIC GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (IN THOUSANDS) - --------------------------------------------------------------------------------
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.
Through its property-casualty insurance company subsidiaries, NCRIC, Inc. and Commonwealth Medical Liability Insurance Company (CML), the Company provides comprehensive professional liability and office premises liability insurance under nonassessable policies to physicians having their principal practice in the District of Columbia, Maryland, Virginia, West Virginia, or Delaware. Effective December 31, 2003, the Insurance Commissioner of the District of Columbia approved the statutory merger of NCRIC, Inc. and CML. As a result, the assets, liabilities and policyholder obligations of CML were transferred, at book value, to NCRIC, Inc. and CML ceased to exist as a separate entity.
Cash Equivalents - For purposes of reporting cash flows, the Company considers short-term investments purchased with an initial maturity of three months or less to be cash equivalents.
sold during 2002. Additionally, in 2001, the Company determined that an equity security experienced an other-than-temporary impairment. Accordingly, the Company recorded a pre-tax impairment loss of $300,000 in 2001 relating to that investment.
NCRIC's goodwill asset resulted from the 1999 acquisition of three businesses, which now operate as divisions of the Practice Management Services Segment. NCRIC Group, Inc. completed its initial goodwill impairment testing under SFAS 142 and concluded that the goodwill asset was not impaired as of the date of implementation of SFAS 142, nor was it impaired as of December 31, 2003. Goodwill is reported net of accumulated amortization of $909,000 as of December 31, 2003 and 2002.
Property and Equipment - Fixed assets are recorded at cost and reported as a component of other assets. Depreciation is recorded using the straight-line method over estimated useful lives ranging from three to five years for computer software and equipment and furniture and fixtures and ten years for leasehold improvements. The balances of fixed assets of $2.1 million and $2.0 million as of December 31, 2003 and 2002, respectively, are net of accumulated depreciation of $2.5 million and $1.9 million.
Income Taxes - The Company uses the asset and liability method of accounting for income
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.
Stock-based Compensation - As of December 31, 2003 and 2002 the Company has a stock option plan, which is described more fully in Note 10. NCRIC Group, Inc. accounts for compensation cost using the intrinsic value based method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, no compensation expense was recognized since the stock options granted were at an exercise price equal to the fair market value of the common stock on the date the options were granted.
As part of the conversion, 2,778,144 shares were issued to the former public stockholders of NCRIC Group, Inc. The exchange ratio was 1.8665 new shares for each share of NCRIC Group, Inc. held by public stockholders as of the close of business on June 25, 2003. Accordingly, after the conversion, the Company had 6,921,845 shares outstanding immediately following the offering. For the earnings per share calculations, the share amounts for periods prior to the conversion and stock offering have been revised to reflect the share exchange ratio applied in the conversion. Prior year share data within the consolidated balance sheet has not been revised for the exchange ratio applied in the conversion. The issuance of the shares of common stock in the subscription and community offering and in the exchange offering to existing stockholders was registered on Form S-1 filed with the SEC (No. 333-104023), which registration statement was declared effective on May 14, 2003.
ESOP loan (2,072) Stock Award Plan loan (1,657) -------- Net proceeds as adjusted $ 35,784 ========
The composition of shares after the second step conversion and public offering is as follows (in thousands):
Issued in the conversion and stock offering 4,144 Issued to existing public shareholders of NCRIC Group 2,778 ------ Total shares issued June 25, 2003 6,922
The amortized cost and fair value of debt securities at December 31, 2003 and 2002 are shown by maturity (in thousands). Actual maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
Proceeds from bond maturities and redemptions of available for sale investments during the years ended December 31, 2003, 2002, and 2001, were $138.6 million, $39.0 million, and $22.0 million, respectively. Gross gains of $3,441,000, $1,437,000, and $787,000, and gross losses of $1,511,000, $1,568,000, and $1,065,000, were realized on security sales, redemptions and impairments during years ended December 31, 2003, 2002, and 2001, respectively.
Total investment income earned 6,438 6,295 6,449 Investment expenses (430) (380) (313) ------- ------- ------- Net investment income $ 6,008 $ 5,915 $ 6,136 ======= ======= =======
Liabilities for unpaid losses and loss adjustment expenses (LAE) represent an estimate of the ultimate net cost of all losses that are unpaid at the balance sheet date and are based on the loss and loss adjustment expense factors inherent in the Company's experience and expectations. Estimation factors used by the Company reflect current case-basis estimates, supplemented by industry statistical data, and give effect to estimates of trends in claim severity and frequency. These estimates are continually reviewed, and adjustments, reflected in current operations are made as deemed necessary.
Incurred losses related to prior years represents development of net losses incurred in prior years. This development results from the re-estimation and settlement of individual losses not covered by reinsurance, which are generally losses under $500,000. The 2003 change stems from adverse development on losses, primarily those reported initially in 2002 and 2001 in Virginia, as well as from a change in estimate of the amount of reinsurance recoverable. The 2002 change is primarily reflective of adverse loss development for the 2001 and 2000 loss years, partially offset by favorable development in the 1999 and 1996 loss years; whereas, the 2001 change is primarily reflective of the favorable loss development for the 1994, 1996, 1998 and 1999 loss years, partially offset by adverse development in the 1995 loss year. The change in development over the three-year period ended December 31, 2003, reflects a continuing increase in severity caused by the growing size of plaintiff verdicts and settlements.
The TPS have a maturity of thirty years, and bear interest at an annual rate equal to three-month LIBOR plus 4.0%, payable quarterly beginning March 4, 2003. Interest is adjusted on a quarterly basis provided that prior to December 4, 2007, this interest rate shall not exceed 12.5%. The Company may defer payment of interest on the TPS for up to 20 consecutive quarters. The TPS are callable by the Company at par beginning December 4, 2007.
The average interest rate was 5.31% and 5.42% and interest of $826,000 and $62,000 was incurred for the years ended December 31, 2003 and 2002, respectively. Issuance costs of $451,000 were incurred related to the TPS and included in other assets. Issuance costs are being amortized over 30 years as a component of other expense.
The Company is liable in the event the reinsurers are unable to meet their obligations under these contracts. NCRIC, Inc. holds letters of credit executed by reinsurers in the amount of $1.3 million at December 31, 2003 and 2002. Such letters of credit are issued as security against ceded losses recoverable in the future.
Deferred tax liabilities Unrealized gain on investments (753) (1,446) Deferred policy acquisition costs (802) (503) Depreciation and amortization (64) -- Other (96) (4) ------- ------- (1,715) (1,953) ------- -------
The income tax (benefit) provision consists of the following (in thousands):
Earnings per share is calculated by dividing the net income by the weighted average shares outstanding for the period. Incremental shares are not included in 2003 because they would be anti-dilutive. The share amounts for periods prior to the conversion and stock offering have been revised to reflect the share exchange ratio applied in the conversion. Prior year share data within the consolidated balance sheet has not been revised for the exchange ratio applied in the conversion.
NCRIC entered into an operating lease for office space located in Washington, D.C., effective on April 15, 1998. The lease terms are for ten years with a monthly base rent of $35,000 and a 2.0% annual escalator. During 2003, the company entered in to an operating lease for additional office space in Washington, D.C. The lease term is for 54 months with a monthly base rent of $14,000 and a 2.5% annual escalator. The Company also maintains office space in Lynchburg and Richmond, Virginia as well as in Greensboro, North Carolina.
As of December 31, 2003, the future minimum annual commitments under noncancellable leases are as follows:
2004 $ 859,000 2005 867,000 2006 887,000 2007 883,000 2008 and thereafter 269,000 ---------- $3,765,000 ==========
Rent expense during the years ended December 31, 2003, 2002, and 2001 was $721,000, $634,000, and $662,000, respectively.
In June 2001, NCRIC MSO, Inc. borrowed $1,971,000 from SunTrust Bank to finance payments made in accordance with the purchase of HealthCare Consulting, Inc., HCI
NCRIC MSO sponsored two plans for its employees. The first plan was a defined contribution money purchase plan in which employees who are 21 years or older and have two years of service are eligible to participate. Under the plan, NCRIC MSO contributed 3% of each participant's total annual compensation. All contributions are 100% vested. The contribution by NCRIC MSO for the year ended December 31, 2001, was $67,000.
The second plan was a defined contribution 401(k) profit-sharing plan. Employees who were 21 years or older and had one year of service were eligible for participation in the plan. Employees could elect to contribute up to 15% of total compensation. All contributions were 100% vested. NCRIC MSO was not required to make matching contributions to the plan, but could make discretionary contributions. No contribution was made for the year ended December 31, 2001.
NCRIC Group accounts for compensation cost using the intrinsic value based method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no compensation expense was recognized since the stock options granted were at an exercise price equal to the fair market value of the common stock on the date the options were granted. Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, requires disclosure of the pro forma net income and earnings per share as if the Company had accounted for its stock options under the fair value method defined in that Statement.
A summary of the status of the stock option plan as of December 31, 2003 and changes during the year is presented below:
Stock conversion 64,123 $ 3.75 64,123 $ 3.75 Granted 392,608 $10.90 -- -- Exercised (10,359) $ 3.75 (10,359) $ 3.75 Forfeited (3,453) $ 3.75 (3,453) $ 3.75 -------- ------ -------- ------
Employee Stock Ownership Plan - NCRIC Group, Inc. has an Employee Stock Ownership Plan (ESOP) for employees who have attained age 21 and completed one year of service. As part of the 1999 stock offering, the ESOP borrowed $1.0 million from NCRIC Group, Inc. to purchase 148,000 shares, 276,247 shares on a converted basis, which are held in a trust account for allocation among participants as the loan is repaid. For shares allocated to the accounts of the ESOP participants as the result of payments made to reduce the ESOP loan, the compensation charge is based upon the average fair value of the shares over the service period. Scheduled loan repayments on December 31, 2003, 2002, and 2001 have been made. During the years ended December 31, 2003, 2002, and 2001 contributions were made to the plan of $207,200, $162,800 and $120,000, respectively.
Stock Award Plans - The Company has established two Stock Award Plans under which certain employees and directors may be awarded restricted common stock vesting over a three to five year period. The trusts established under each of the plans have borrowed funds from the Company to support the purchase of NCRIC Group, Inc. common stock. All of the scheduled loan repayments have been made. In September 2000, the board of directors granted 74,000 shares to certain directors and officers under the original Plan. During August 2003, the Board granted 159,120 shares under the 2003 Stock Award Plan. The Company amortizes compensation expense equal to the fair value of the stock on the date of award evenly over the vesting period. During the years ended December 31, 2003, 2002 and 2001, compensation expense related to the Stock Award Plans was $299,400, $153,800 and $153,800, respectively.
Executive Deferred Compensation Plan - In 2003 NCRIC established a deferred compensation plan which is a non-qualified, unfunded plan under which the Directors and Officers of NCRIC Group may defer a portion of their compensation. The Company will provide a match for deferrals of 5% of compensation for officers. Deferred amounts are credited with interest at the rate of 6% per year. The matching expense under this plan totaled $49,000 for the year ended December 31, 2003.
On February 13, 2004, a District of Columbia Superior Court jury returned a verdict in favor of Columbia Hospital for Women Medical Center, Inc. (CHW) in the premium collection litigation between NCRIC, Inc. and CHW. The verdict came in a civil action stemming from NCRIC, Inc.'s efforts to collect payment for nearly $3 million in premiums that the Company alleges it is owed by CHW under a contract with the hospital that expired in 2000. The jury rejected the claim by NCRIC, Inc. and returned a verdict in favor of CHW counterclaims. The jury awarded $18.2 million in damages to CHW.
The verdict was entered as a judgment on February 20, 2004. On March 5, 2004, NCRIC filed post-trial motions for judgment as a matter of law and, in the alternative, for a new trial. As a result of these post-trial motions, the judgment is not final, and jurisdiction with respect to the verdict remains with the trial judge. In connection with the filing of post-trial motions, NCRIC secured a $19.5 million appellate bond and associated letter of credit. No amounts have been drawn upon the letter of credit as of March 5, 2004. After the post-trial motions have been ruled upon by the judge, any judgment will be entered as final, but subject to appeal. No liability has been accrued in these financial statements for any possible loss arising from this litigation because the judgment is not yet final and remains with the trial judge and, NCRIC believes that it has meritorious defenses and that it is not probable that the preliminary judgment will prevail, nor is any potential final outcome reasonably estimable at this time. Legal expenses to be incurred for this litigation in 2004 are estimated to be approximately $750,000. The expenses associated with the $19.5 million appellate bond and associated letter of credit are estimated to be approximately $300,000. Such expenses are not accrued in the 2003 financial statements.
The following is a summary of unaudited quarterly results of operations for 2003, 2002 and 2001 For the earnings per share calculations, the share amounts for periods prior to the conversion and stock offering have been revised to reflect the share exchange ratio applied in the conversion):
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEET AS OF DECEMBER 31, 2003 AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (IN THOUSANDS) - --------------------------------------------------------------------------------
EXPENSES: Interest expense 826 62 -- Other operating expenses 663 608 875 ------- ------- ------
INCOME BEFORE EQUITY IN UNDISTRIBUTED EARNINGS OF SUBSIDIARIES (202) 1,103 637
NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002 (IN THOUSANDS) - --------------------------------------------------------------------------------
NOTES TO CONDENSED FINANCIAL STATEMENTS NCRIC GROUP, INC. AND SUBSIDIARIES (PARENT ONLY) FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
On June 24, 2003, a plan of conversion and reorganization was approved by the members of NCRIC, A Mutual Holding Company and by the shareholders of NCRIC Group, Inc.(Group). In the conversion and related stock offering, NCRIC, A Mutual Holding Company offered for sale its 60% ownership interest in NCRIC Group, Inc. As a result of the conversion and stock offering, NCRIC, A Mutual Holding Company ceased to exist, and NCRIC Group, Inc. became a fully public company. See Note 2 of the Notes to the Consolidated Financial Statements.
BALANCE AT CHARGED TO BALANCE BEGINNING COSTS AND AT END DESCRIPTION OF YEAR EXPENSES DEDUCTIONS OF YEAR ----------- ------- -------- ---------- ------- Allowance for Doubtful Accounts $1,924 $ 486 $(528) $1,882
NCRIC GROUP, INC. AND SUBSIDIARIES SCHEDULE VI SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE COMPANIES FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (IN THOUSANDS) - --------------------------------------------------------------------------------