The financial statements and data presented herein have been prepared in accordance with GAAP, unless otherwise noted. GAAP differs from statutory accounting practices used by regulatory authorities in their oversight responsibilities of insurance companies. See Note 11 to the consolidated financial statements for a reconciliation of our net income and equity between GAAP and statutory accounting bases.
Under our current primary reinsurance contract, the premium ceded to the reinsurers is based on a fixed rate applied to policy premium for that coverage layer. During the year, estimated premium payments are made to the reinsurers, and a final adjustment is made at the end of the year to reflect actual premium earned in accordance with the treaty. For the years through 2002, we retained risk exposure up to $500,000 for each and every claim. Beginning January 1, 2003, the retention level increased to $1,000,000 for each and every claim.
The basic steps involved in the goodwill impairment test are (1) identification of the reporting unit to be tested; and (2) calculation of the current fair value of the reporting unit and comparing it to the carrying value. If the current fair value of the reporting unit exceeds the carrying value, goodwill is not impaired. Because the acquired divisions are not publicly traded, a discounted cash value calculation is used to determine the current fair value of the unit.
On March 4, 2005 we announced that the financial rating of our primary insurance subsidiary, NCRIC, Inc., was changed by A.M. Best Company from "A-" (Excellent) to "B++" (Very Good) with negative implications. The action by A. M. Best followed announcement of our fourth quarter and year-end 2004 results of a net loss of $8.3 million and $7.1 million, respectively. The results were driven primarily by adverse development on claims reported in prior years. The rating will remain under review pending A. M. Best's review of NCRIC, Inc.'s loss reserves, completion of the transaction and discussions with management.
December 31, 2004 and $1.1 million for the year ended December 31, 2003, decreasing primarily due to a return of premium under the terms of the retrospective rating program. Gross premiums written also include $7.5 million in 2004 and $3.2 million in 2003 for extended reporting endorsements. Gross premiums written on excess layer coverage increased $3.1 million to $13.3 million for the year ended December 31, 2004 from $10.2 million for the year ended December 31, 2003.
The losses and LAE reserve liabilities for unpaid claims as of each period are as follows:
Each case represents claims against one or more policyholders relating to a single incident. Losses in the medical professional liability industry can take up to eight to ten years, or occasionally more, to fully resolve. Amounts are not due from the reinsurers until we pay a claim. We believe that all of our reinsurance recoverables are collectible. See "Business - Reinsurance" for a discussion on the reinsurance program.
The increase in the deferred income tax asset to a balance of $8.4 million as of December 31, 2004 resulted from the growth of the insurance business, particularly in unearned premiums and loss reserves where the timing of recognition for financial statement and tax return reporting differ and from the tax benefits, NOLs and minimum tax credits, associated with the net loss for the year 2004.
Operating leases consist of office rental commitments. The table excludes purchase obligations which consist of routine acquisitions of office supplies which represent minimal commitments generally spanning one month or less. As an insurance company, we have liabilities for losses and related loss adjustment expenses in the normal course of business. Since these liabilities arise due to contractual obligations under the insurance policies we issue, estimates of the amounts to be paid at undetermined future dates are included in this table. Interest on long-term debt is variable rate and therefore is not included in this table.
On December 4, 2002, the Company formed NCRIC Statutory Trust I for the purpose of issuing $15,000,000 in trust preferred securities in a pooled transaction to unrelated investors. (See Note 5.)
The Company protects itself from excessive losses by reinsuring certain levels of risk in various areas of exposure. Amounts recoverable from reinsurance are estimated in a manner consistent with the liability for loss and loss adjustment expenses associated with the reinsured loss.
New Accounting Pronouncements - In July 2004, the Emerging Issues Task Force of the Financial Accounting Standards Board (FASB) 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 03-1, 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.
For the Year Ended December 31, ------------------------------- 2004 2003 2002 ------- ------- -------
The acceleration of vesting eliminates future compensation expense the Company would otherwise recognize in its future income statements with respect to these options after FASB Statement No. 123R, Share-Based Payment, becomes effective in 2005. The pro forma note disclosure in Note 1 includes the maximum amount of expense which would have been reported in future years.
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 17, 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 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 incurred for this litigation for the years ended December 31, 2004, 2003, and 2002 were $734,000, $399,000, and $365,000. Expenses associated with securing the $19.5 million appellate bond and associated letter of credit were $261,000 in 2004.
(1) Original cost of equity securities, and, as to fixed maturities, original costs reduced by repayments and adjusted for amortization of premiums or accrual of discounts.