EXHIBIT 99.2
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PRO FORMA VALUATION REPORT
FOR SECOND STEP CONVERSION
NCRIC GROUP, INC.
Washington, DC
Dated As Of:
March 11, 2003
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Prepared By:
RP Financial, LC.
1700 North Moore Street
Suite 2210
Arlington, Virginia 22209
RP FINANCIAL, LC.
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Financial Services Industry Consultants
March 11, 2003
Board of Directors
NCRIC, A Mutual Holding Company
NCRIC Holdings, Inc.
NCRIC Group, Inc.
1115 30th Street, N.W.
Washington, DC 20007
Members of the Board:
At your request, we have completed and hereby provide an independent
appraisal ("Appraisal") of the estimated pro forma market value of the Common
Stock which is to be offered in connection with the reorganization described
below. This Appraisal may be relied upon by the Department of Insurance and
Securities Regulation of the District of Columbia (the "Department") in its
review of the reorganization. This appraisal is furnished pursuant to the laws
of the District of Columbia, including Chapters 7 and 9 of Title 31 of the
District of Columbia Code.
Description of Plan of Conversion and Reorganization
In January 2003, the Board of Directors of NCRIC, A Mutual Holding Company
(the "MHC") and its subsidiaries, NCRIC Holdings, Inc. ("NCRIC Holdings") and
NCRIC Group, Inc. ("NCRIC" or the "Company") adopted the Plan of Conversion and
Reorganization (the "Plan"). NCRIC is the majority-owned subsidiary of NCRIC
Holdings which is itself, wholly-owned by the MHC, a District of Columbia
chartered mutual holding company. Currently, the NCRIC Holdings owns 2,220,000
shares of NCRIC's common stock outstanding, or 59.9%, with the remaining
1,488,399 shares, or 40.1%, owned by public shareholders. The MHC currently owns
100% of NCRIC Holdings.
In connection with the Plan, NCRIC will be reorganized as a Delaware
corporation. In conjunction with the mutual-to-stock conversion, the MHC and
NCRIC Holdings will merge with and into the Company and NCRIC will sell the
59.9% ownership interest in the MHC to members and the public through
Subscription and Community offerings (i.e., the "second step conversion" or
"conversion"), based on the appraised value. The proceeds of the Subscription
and Community offerings will be retained as capital by NCRIC and its
subsidiaries. Concurrent with the second step conversion, the MHC will be merged
into NCRIC Group, Inc., with NCRIC Group, Inc., being the surviving corporation.
Upon completion of the conversion, 100% of the shares will be owned by public
shareholders.
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Washington Headquarters
Rosslyn Center Telephone: (703) 528-1700
1700 North Moore Street, Suite 2210 Fax No.: (703) 528-1788
Arlington, VA 22209 Toll-Free No.: (866) 723-0594
www.rpfinancial.com E-Mail: mail@rpfinancial.com
Board of Directors
March 11, 2003
Page 2
NCRIC will retain up to 25% of the net second step offering proceeds, and
the balance will be downstreamed to NCRIC, Inc., its wholly-owned insurance
subsidiary. The net proceeds at NCRIC and the insurance subsidiaries will
initially be invested into short-term investments pending longer-term
deployment. NCRIC's activities are expected to be consistent with the past.
It is anticipated that the public shares will be issued to: (1) Members of
the MHC as of May 6, 2003; (2) NCRIC Group's employee benefit plans, including
the ESOP and Stock Award Plan; and (3) directors, officers and employees of
NCRIC who are not entitled to purchase shares in Category (1). Any shares that
are not sold in the Subscription offering may be offered in the Community
offering. Preference in the Community Offering will be given to: (i) persons who
are policyholders of NCRIC, Inc., who are not members entitled to purchase
shares of common stock in category (1) above; (ii) policyholders of Commonwealth
Medical Liability Insurance Company; and (iii) existing stockholders of NCRIC
Group. The community offering may begin concurrently with, during or promptly
after the subscription offering. The Company also may offer shares of common
stock not purchased in the subscription offering or community offering through a
"syndicated community offering" managed by Sandler O'Neill & Partners, L.P.
RP Financial, LC.
RP Financial, LC. ("RP Financial") is a financial consulting firm serving
the financial services industry nationwide that, among other things, specializes
in financial valuations and analyses of business enterprises and securities,
including the pro forma valuation for companies undertaking the demutualization
process including mutual savings institutions and insurance companies. The
background and experience of RP Financial is detailed in Exhibit V-1. We believe
that, except for the fee we will receive for our appraisal, we are independent
of NCRIC and the other parties engaged by the Company to assist in the stock
issuance process.
Valuation Methodology
In preparing our appraisal, we have reviewed the related applications,
including the prospectus as filed with the Securities and Exchange Commission
("SEC") and the Department. We have conducted a financial analysis of the
Company that has included a review of its audited financial information for
fiscal years ended December 31, 1998 through 2002 and unaudited financial and
other information through December 31, 2002 and due diligence related
discussions with the Company's management and directors; Deloitte & Touche, the
Company's independent auditor; Luse Gorman Pomerenk & Schick, P.C., PLLC, the
Company's counsel in conjunction with the Reorganization and offering;
Tillinghast Towers Perrin, the Company's actuary; and Sandler O'Neill &
Partners, L.P., the financial and marketing advisor in connection with NCRIC's
stock offering. All conclusions set forth in the Appraisal were reached
independently from such discussions. In addition, where appropriate, we have
considered information based on other available published sources that we
believe are reliable. While we
Board of Directors
March 11, 2003
Page 3
believe the information and data gathered from all these sources are reliable,
we cannot guarantee the accuracy and completeness of such information.
We have investigated the competitive environment within which the Company
operates and have assessed the Company's relative strengths and weaknesses. We
have kept abreast of the changing regulatory and legislative environment for
insurance companies, including those with a similar line of business, and
analyzed the potential impact on the Company and the industry as a whole. We
have analyzed the potential effects of the Reorganization and stock offering on
the Company's operating characteristics and financial performance as they relate
to the pro forma market value. We have reviewed the economy in the Company's
primary market area and have compared the Company's financial performance and
condition with publicly-traded insurance companies sharing similar lines of
business. We have reviewed conditions in the securities markets in general and
in the market for insurance company stocks in particular, including the market
for existing insurance companies, the market for shares issued in secondary
offerings by other comparable insurers, and the market for the newly issued
stock offered by demutualized insurance companies. We have also considered the
expected market for NCRIC's public shares. We have excluded from such analyses
insurers subject to announced or rumored acquisition, and/or those institutions
that exhibit other unusual characteristics.
Our Appraisal is based on the Company's representation that the information
contained in the regulatory applications and additional information furnished to
us by the Company, its independent auditors and actuaries, legal counsel and
other authorized agents are truthful, accurate and complete. We did not
independently verify the financial statements and other information provided by
the Company, its independent auditors and actuaries, legal counsel and other
authorized agents nor did we independently value the assets or liabilities of
the Company. The valuation considers the Company only as a going concern and
should not be considered as an indication of the Company's liquidation value.
Our appraised value is predicated on a continuation of the current
operating environment for the Company and for all insurance companies and their
holding companies. Changes in the local, state and national economy, the
legislative and regulatory environment for insurance companies and medical
professional liability insurers, the stock market, interest rates, and other
external forces (such as natural disasters or significant world events) may
occur from time to time, often with great unpredictability, and may materially
impact the value of insurers as a whole or NCRIC's value alone. It is our
understanding that there are no current or long-term plans for pursuing for
selling control of NCRIC following the completion of the second step stock
offering. To the extent that such factors can be foreseen, they have been
factored into our analysis.
Pro forma market value is defined as the price at which NCRIC's stock,
immediately upon completion of the offering, would change hands between a
willing buyer and a willing seller, neither being under any compulsion to buy or
sell and both having reasonable knowledge of relevant facts.
Board of Directors
March 11, 2003
Page 4
Valuation Conclusion
It is our opinion that, based on market prices as of March 11, 2003 and
NCRIC's financial statements through December 31, 2002, the estimated aggregate
pro forma valuation of the shares to be issued in the conversion, including (1)
newly-issued shares representing the MHC's ownership interest in NCRIC and (2)
exchange shares to be issued to existing public shareholders of the Company, was
$50,113,500 at the midpoint, equal to 5,011,350 shares at a per share value of
$10.00. Based on this valuation and taking into account the ownership interest
represented by the shares owned by the MHC, the midpoint of the offering range
was $30,000,000, equal to 3,000,000 shares at a per share value of $10.00. The
offering range includes a minimum offering value of $25,500,000, equal to
2,550,000 shares at $10.00 per share (85.0% of the midpoint) and a maximum
offering value of $34,500,000, equal to 3,450,000 shares at $10.00 per share
(115.0% of the midpoint). If warranted by market conditions, the Company may
sell conversion stock up to a supermaximum value of $39,675,000, equal to
3,967,500 shares at $10.00 per share, without requiring a resolicitation.
Establishment of the Exchange Ratio
The Plan of Conversion and Reorganization provides that the minority
stockholders are entitled to exchange their shares of the Company's common stock
for newly issued shares of the Company as a fully converted company. The Board
of Directors has independently established a formula to determine the exchange
ratio. The formula has been designed to preserve the current aggregate public
ownership percentage in Company equal to 40.14% as of March 11, 2003. Pursuant
to this formula, the exchange shares to be received by the existing minority
shareholders of Company will be determined at the end of the offering based on
the total number of shares sold in the Subscription and Community offerings.
Pursuant to this formula, the exchange ratio for the minority shareholders would
be 1.1486 shares, 1.3514 shares, 1.5541 shares and 1.7872 shares at the minimum,
midpoint, maximum and supermaximum of the offering range, respectively. RP
Financial expresses no opinion on the proposed exchange of newly issued shares
for the shares held by the minority stockholders or on the proposed exchange
ratio.
Limiting Factors and Considerations
Our valuation is not intended, and must not be construed, as a
recommendation of any kind as to the advisability of purchasing shares of the
common stock. Moreover, because such valuation is necessarily based upon
estimates and projections of a number of matters, all of which are subject to
change from time to time, no assurance can be given that persons who purchase
shares of common stock in the conversion will thereafter be able to buy or sell
such shares at prices related to the foregoing valuation of the estimated pro
forma market value thereof. The appraisal does not take into account any trading
activity with respect to the purchase and sale of common stock in the secondary
market, and reflects only a valuation range as of this date for the pro forma
market value of NCRIC immediately upon issuance of the stock.
Board of Directors
March 11, 2003
Page 5
RP Financial's valuation was determined based on the financial condition,
operations and shares outstanding of NCRIC as of December 31, 2002, the date of
the financial data included in the prospectus. The proposed exchange ratio to be
received by the current public stockholders of NCRIC and the exchange of the
public shares for newly issued shares of NCRIC common stock as a full public
company was determined independently by the Boards of Directors of the MHC and
NCRIC Group, Inc. RP Financial expresses no opinion on the proposed exchange
ratio to public stockholders or the exchange of public shares for newly issued
shares.
RP Financial is not a seller of securities within the meaning of any
federal and state securities laws and any report prepared by RP Financial shall
not be used as an offer or solicitation with respect to the purchase or sale of
any securities. RP Financial maintains a policy which prohibits RP Financial,
its principals or employees from purchasing stock of its client institutions.
At NCRIC's request, the valuation will be updated and such updates will
consider, among other things, any developments or changes in the Company's
financial performance and condition, management policies, and current conditions
in the equity markets for the shares of insurers. These updates may also
consider changes in other external factors which impact value including, but not
limited to: various changes in the legislative and regulatory environment, the
stock market and interest rates. Should any such new developments or changes be
material, in our opinion, to the valuation of the shares, appropriate
adjustments to the estimated pro forma market value will be made. The reasons
for any such adjustments will be explained in the update at the date of the
release of the update.
Respectfully submitted,
RP FINANCIAL, LC.
/s/ Ronald S. Riggins
Ronald S. Riggins
President and Managing Director
/s/ James P. Hennessey
James P. Hennessey
Senior Vice President
RP Financial, LC.
TABLE OF CONTENTS
NCRIC GROUP, INC.
Washington, DC
PAGE
DESCRIPTION NUMBER
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CHAPTER ONE OVERVIEW AND FINANCIAL ANALYSIS
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Company Overview 1.1
Plan of Conversion and Reorganization 1.6
Reasons for the Second Step Conversion 1.7
Strategic Overview 1.7
Balance Sheet Trends 1.11
Income and Expense Trends 1.20
Claims and Risk Exposure 1.30
Reinsurance 1.32
Subsidiaries 1.33
Legal Proceedings 1.35
CHAPTER TWO MARKET ENVIRONMENT
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Introduction 2.1
Medical Professional Liability Insurance Market Overview 2.1
Cyclical Nature of Insurance Underwriting 2.2
Frequency and Severity of Medical Professional Liability Claims 2.3
Impact of Current Market on Medical Professional Liability Insurers 2.5
Availability of Coverage and Premium Rate Increases 2.7
Summary 2.8
CHAPTER THREE PEER GROUP ANALYSIS
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Peer Group Selection 3.1
Financial Condition 3.5
Income and Expense Components 3.10
Analysis of Risk Factors 3.15
Summary 3.17
RP Financial, LC.
TABLE OF CONTENTS
NCRIC GROUP, INC.
Washington, DC
(continued)
PAGE
DESCRIPTION NUMBER
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CHAPTER FOUR VALUATION ANALYSIS
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Introduction 4.1
RP Financial Approach to the Valuation 4.1
Valuation Analysis 4.2
1. Financial Condition 4.2
2. Profitability, Growth and Viability of Earnings 4.3
3. Risk Assessment 4.4
4. Primary Market and Growth 4.5
5. Dividends 4.5
6. Liquidity of the Shares 4.6
7. Marketing of the Issue 4.6
A. The Public Market 4.7
B. The New Issue Market 4.8
C. Secondary Offering by ProAssurance, Inc. 4.11
D. Second Step Conversions by Thrift Mutual Holding Companies 4.12
E. Trading in NCRIC Group's Stock 4.15
8. Organization and Management 4.15
9. Regulatory Environment 4.16
Summary of Adjustments 4.16
Valuation Approaches 4.17
Valuation Conclusion 4.21
Establishment of the Exchange Ratio 4.22
RP Financial, LC.
LIST OF TABLES
NCRIC GROUP, INC.
Washington, DC
TABLE
NUMBER DESCRIPTION PAGE
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1.1 Historical Balance Sheets 1.12
1.2 Investment Portfolio Summary 1.16
1.3 Historical Income Statements as a Percent of Average Assets 1.23
1.4 Historical Income Statements as a Percent of Total Revenues 1.24
1.5 Reinsurance Data as of December 31, 2002 1.33
2.1 Market Share by Jurisdiction Based on Premiums Written as of 2001 2.1
2.2 Settlement Negotiations for Medical Malpractice from 1994-2000 2.4
2.3 National Loss Ratio Since 1991 and Loss Ratio Chart 2.6
3.1 Peer Group of Publicly-Traded Insurance Companies 3.3
3.2 Balance Sheet Composition 3.6
3.3 Balance Sheet Growth Rates 3.9
3.4 Income and Expenses as a Percent of Average Assets 3.11
3.5 Income and Expenses as a Percent of Revenues 3.12
3.6 Analysis of Risk Factors 3.16
4.1 Dow Jones Industrial Index and S&P Insurance Index 4.8
4.2 Selected Demutualization Transactions 4.10
4.3 Key Characteristics of ProAssurance Secondary Stock Offering 4.13
4.4 Pro Forma Pricing Characteristics of Second Step Conversions by
Savings Institutions Since 2000 4.14
4.5 Public Market Pricing 4.23
RP Financial, LC.
Page 1.1
I. OVERVIEW AND FINANCIAL ANALYSIS
Company Overview
NCRIC Group, Inc. ("NCRIC" or the "Company"), a District of Columbia
corporation, is a holding company that owns NCRIC, Inc., a medical professional
liability insurance company, and NCRIC MSO, Inc., a physician practice
management and financial services company. The principal operations of NCRIC,
Inc. and NCRIC MSO are conducted in the District of Columbia, Maryland,
Virginia, West Virginia, Delaware and North Carolina. The geographic territory
covered by the company's operations is reflected in the map below.
[MAP]
RP Financial, LC.
Page 1.2
NCRIC Group was organized in December 1998 in connection with the
reorganization of National Capital Reciprocal Insurance Company into a mutual
holding company structure (the "Reorganization"). NCRIC, A Mutual Holding
Company (the "MHC") owns all of the outstanding shares of NCRIC Holdings, Inc.
("NCRIC Holdings"), which prior to July 29, 1999, owned all of the outstanding
shares of NCRIC Group. Effective July 29, 1999, NCRIC Group completed a public
offering (the "Stock Offering") and issued 2,220,000 shares of the common stock,
to NCRIC Holdings and 1,480,000 shares of the common stock in a subscription and
community offering at a price of $7.00 per share. NCRIC Group owns all of the
outstanding shares of NCRIC, Inc. and NCRIC MSO. As of December 31, 2002, the
MHC owned 100% of NCRIC Holdings, which owned 2,220,000 shares of NCRIC's common
stock outstanding, or 59.9%, with the remaining 1,488,399 shares, or 40.1% owned
by public shareholders. The current corporate organization, illustrated on the
following page, reflects the mutual holding structure.
At December 31, 2002, NCRIC had total assets of $203 million. At the same
date, the Company had total equity of $47.8 million, equal to 23.6% of assets,
and tangible equity (net of goodwill) equal to $41 million, or 20.0% of total
assets. For the twelve months ended December 31, 2002, NCRIC reported gross
revenues of $42 million, and net income of $742,000, or 0.41% of a return of
average assets ("ROAA") and a 1.74% net profit margin.
Insurance Operations
NCRIC, Inc. was organized in 1980 as National Capital Reciprocal
Insurance Company, a reciprocal insurance company (i.e., as an unincorporated
association with no capital stock issued and controlled by its members, i.e.,
policyholders (also known as insureds), and was reorganized into its current
structure in 1998. NCRIC, Inc. specializes in writing medical professional
liability coverage for healthcare providers in the District of Columbia and
Maryland. NCRIC, Inc.'s wholly owned subsidiary, Commonwealth Medical Liability
Insurance Company ("CML"), sells medical professional liability insurance to
healthcare providers in Virginia, Maryland, West Virginia, and Delaware. CML's
policies closely resemble NCRIC's policies except that insureds of CML do not
become members of the MHC.
RP Financial, LC.
Page 1.3
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NCRIC, A Mutual Holding Company
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|
100% of shares |
|
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NCRIC Holdings, Inc.
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|
| 60% of shares
|
|
| Currently
-------------------- 40% of -------------------
shares
NCRIC Group, Inc ------ Public Stockholders
100% of
-------------------- shares after -------------------
2nd step
|
|
|
|
|
|------------------------|
| |
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NCRIC, Inc. NCRIC MSO, Inc. d/b/a
Healthcare Consulting
------------------ ---------------------
| |
| -----------------
| NCRIC Physicians
| Organization, Inc.
| ------------------
|
|
|-------------------|------------------|----------------------|
| | | |
- ------------------- ---------------- ----------------------- ---------------
National Capital NCRIC Insurance Commonwealth Medical American Captive
Insurance Brokerage Agency Liability Insurance Co. Corp.
- ------------------- ---------------- ----------------------- ----------------
Note: As a result of the 2nd step conversion, the corporate organization will
be simplified as MHC and Holdings (shaded boxes) will be collapsed into
NCRIC Group.
Created by Washington, D.C. based physicians in 1980 when medical
professional liability insurance was either unavailable or prohibitively
expensive, NCRIC has provided high quality insurance products to its insureds in
the District of Columbia. To date, the District of Columbia has rejected tort
reform and has the highest cumulative average medical professional liability
jury awards of any jurisdiction in the United States. NCRIC's management
believes the
RP Financial, LC.
Page 1.4
Company's success rests, among other factors, on its ability to
successfully litigate claims, reduce its insureds' loss exposure through
effective risk management and provide its insureds with individualized service.
The success which NCRIC has had to date is evidenced by data showing that 98% of
NCRIC's insureds renewed their policies in 2002. NCRIC believes that it has
prospered notwithstanding the highly cyclical nature of the business through a
high level of management expertise and by providing its insureds with quality
consistent service at a competitive price. As of December 31, 2002, NCRIC and
CML had 101 employees.
According to A.M. Best Company, in 2002 53% of the premiums written for
physician and hospital professional liability insurance in the District of
Columbia were written by NCRIC. In addition, during the year ended December 31,
2002, NCRIC generated 58% of its premiums in Maryland, Virginia, West Virginia,
and Delaware. NCRIC's market share, based on the 2002 data, is 5% or less in
each of these markets. As of December 31, 2002, NCRIC had approximately 3,785
medical professional liability policies outstanding in all of its markets. The
majority of NCRIC's premiums are generated from individual and small-group
practices, but it also has risk sharing programs with groups of physicians
sponsored by metropolitan Washington, D.C. area hospitals. NCRIC markets
products directly to physician clients. NCRIC also markets products through
independent brokers and agents who produced 90% of new premiums written in 2002
as compared to 59% in 2000. The number of NCRIC, Inc., insureds by jurisdiction,
including CML, are reflected in the schedule below.
NCRIC Group, Inc.
Policyholders by Jurisdiction
As of December 31, 2002
Total Policyholders
Number % of Total
District of Columbia 1,233 32.6%
Maryland 597 15.8
Virginia 1,379 36.4
West Virginia 388 10.3
Delaware 188 5.0
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Total Insureds 3,785 100.0%
Source: Internal financial reports.
RP Financial, LC.
Page 1.5
NCRIC, Inc. and its insurance subsidiaries are subject to the laws and
regulations of each of the jurisdictions in which it is licensed to do business.
NCRIC, Inc.'s primary regulator is the Department of Insurance and Securities
Regulation of the District of Columbia (the "Department").
NCRIC is rated A- (Excellent) by A.M. Best Company, Inc. ("A.M. Best").
In addition, CML is currently rated A- by A.M. Best.
Practice Management and Financial Services
The Company has grown and expanded revenue sources, both in terms of the
number of insureds as well as the types of activities in which it engages. In
this regard, in the mid 1990s, NCRIC commenced a comprehensive review of
operations, strengths and weaknesses, and external factors impacting the
business, with the objective of charting a course for the future. The strategic
plan was designed to address the significant changes in the health care
environment in recent years and expected trends, particularly those factors
related to the emergence of managed care which negatively impacted the practice
of private physicians. In this regard, physicians found it more difficult to
maintain a private practice, forcing many to join or contractually affiliate
with managed care organizations, healthcare delivery systems or practice
management organizations, a trend which diminished revenues for medical
professional liability insurance companies. In addition, the consolidation
reduced primary medical professional liability insurance premiums paid by
healthcare systems, as larger healthcare systems generally retain more risk by
accepting higher deductibles and self-insured retentions or form their own
captive insurance companies.
To adjust to the economic pressures described above, physicians with
private practices are seeking organizations that can help them achieve greater
efficiencies and profitability without relinquishing control and ownership of
their practice. Accordingly, in 1997, the Company formed a management services
organization subsidiary, NCRIC MSO, Inc. (the "MSO"), to provide physicians with
the staff, skills, information and technology to enhance management efficiencies
and control physician overhead. The MSO's services are designed to enhance
physician profitability and reduce liability risk, thus reducing loss risk, and
present opportunities to cross-sell other products and services to physicians,
including those not insured
RP Financial, LC.
Page 1.6
by NCRIC. Moreover, the operations of the MSO can potentially provide an
additional sales channel for NCRIC's core insurance products. The recent
recessionary environment has led to a diminished volume of MSO clients and
related revenue.
Following due diligence in 1998, NCRIC selected a joint venture partner
in HealthCare Consulting, HCI Ventures and Employee Benefits Services to enhance
the ability of the MSO to meet its targeted objectives. In order to
substantially accelerate its entry into the practice management, financial
services and employee benefits markets, NCRIC acquired HealthCare Consulting,
HCI Ventures and Employee Benefits Services in January of 1999. Today, NCRIC
provides practice management and financial services to approximately 1,000
physicians throughout the Mid-Atlantic area of Virginia, North Carolina and the
District of Columbia. Since the acquisition, the MSO has been doing business as
HealthCare Consulting and Employee Benefit Services.
Plan of Conversion and Reorganization
NCRIC is the majority-owned subsidiary of NCRIC Holdings, which is itself,
wholly-owned by the MHC, a District of Columbia chartered mutual holding
company. Currently, the NCRIC Holdings owns 2,220,000 shares of NCRIC's common
stock outstanding, or 59.9%, with the remaining 1,488,399 shares, or 40.1%,
owned by public shareholders. The MHC currently owns 100% of NCRIC Holdings.
In connection with the Plan of Conversion and Reorganization, NCRIC will be
reorganized as a Delaware corporation. In conjunction with the mutual-to-stock
conversion, the MHC and NCRIC Holdings will merge with and into the Company and
NCRIC will sell the 59.9% ownership interest in the MHC to members and the
public through Subscription and Community offerings (i.e., the "second step
conversion" or "conversion"), based on the appraised value. The proceeds of the
Subscription and Community offerings will be retained as capital by NCRIC and
its subsidiaries.
NCRIC will retain up to 25% of the net second step offering proceeds, and
the balance will be downstreamed to NCRIC, Inc. and CML. The net proceeds at
NCRIC and the insurance subsidiaries will initially be invested into short-term
investments pending longer-term deployment. NCRIC's activities are expected to
be consistent with the past.
RP Financial, LC.
Page 1.7
Further details of the stock conversion will be set forth in the NCRIC's
conversion application and plan of conversion.
Reasons for the Second Step Conversion
The Board believes continued geographic expansion outside of the Company's
traditional markets in the District of Columbia, diversification of products and
services, ability to maintain an efficient level of operation and attract
quality management and staff are keys to NCRIC's ability to survive and prosper
in the rapidly evolving and highly competitive environment. Accordingly, the
following specific benefits were important considerations in the Board of
Directors to proceed with the conversion:
. Provide capital to grow in a "hard" insurance market (i.e., a market
where premium rates are rising and many competitors are withdrawing
due to capital and earnings constraints);
. Enhance operational flexibility and improve financial capability to
compete more effectively with other insurance companies and other
types of financial services organizations;
. Support future strategic transactions, including potential
acquisitions;
. Enhance the ability to use NCRIC's stock, in addition to cash, as
consideration for strategic acquisitions;
. Enhance the ability to access the public capital markets;
. Enhance the ability of NCRIC to attract, motivate and retain highly
qualified employees through the use of stock-based compensation
programs; and
. Enhance the liquidity of the common stock.
Strategic Overview
History of NCRIC
The Company was formed in 1980 to address rapidly escalating medical
professional liability costs for physicians in the District. Claims-related
losses in the mid- to late-1980s were greater than anticipated, impairing the
Company's earnings. At that time, NCRIC addressed the
RP Financial, LC.
Page 1.8
weakened financial condition by raising the premium structure and adjudicating
claims aggressively.
Commencing in the early 1990s, NCRIC began diversifying operations
modestly, including the formation of an insurance brokerage subsidiary (National
Capital Insurance Brokerage, Ltd., or "NCIB") and acquisition of an insurance
agency subsidiary (NCRIC Insurance Agency, Inc., or "NIA"). The insurance
brokerage subsidiary was formed primarily for the purpose of reducing
reinsurance-related commissions, while the insurance agency was purchased in an
attempt to provide other insurance-related products to physician policyholders,
such as life and health insurance.
Also, NCRIC pursued geographic diversification in response to market
conditions prevailing in the District by expanding into Maryland and, through
the establishment of CML, into Virginia. Reasons for geographic diversification
included: (1) the lack of tort reform in the District, which has resulted in
escalating premiums for policyholders as well as loss and loss adjustment
expenses ("LAE") for NCRIC; (2) on-going population and business shrinkage in
the District, which led to a shrinking base of physicians as well; and (3) the
rapid expansion of managed care, which reduced the pool of potential
policyholders (large managed care organizations may be self-insured, operate
captive insurers and/or purchase medical professional liability insurance for
employee physicians on a large-scale basis).
In 1993, the Company repaid subordinated surplus loan debentures, which
were utilized to capitalize NCRIC upon formation, which enabled the
establishment of a discretionary renewal premium dividend credit, which gave
NCRIC a competitive advantage. To assist in customer retention, NCRIC
established the NCRIC Physicians Organization ("NCRIC PO") in 1994, which is a
coalition of physicians working together with hospitals and ancillary providers
to provide a health care structure to assist insured physicians to more
effectively compete against managed care. The NCRIC PO provides the benefits of
a managed care network while leaving health care decisions in the physicians'
hands.
In 1996, NCRIC commenced a comprehensive review of operations, strengths
and weaknesses, and external factors impacting the business, with the objective
of charting a course for the future. The strategic plan was designed to address
the significant changes in the health
RP Financial, LC.
Page 1.9
care environment in recent years and expected trends, particularly those factors
related to the emergence of managed care which negatively impacted the practice
of private physicians. In this regard, physicians found it more difficult to
maintain a private practice, forcing many to join or contractually affiliate
with managed care organizations, healthcare delivery systems or practice
management organizations, a trend which diminished revenues for medical
professional liability insurance companies. In addition, ongoing consolidation
in the marketplace has reduced primary medical professional liability insurance
premiums paid by healthcare systems, as larger healthcare systems generally
retain more risk by accepting higher deductibles and self-insured retentions or
form their own captive insurance companies.
In the face of such risks, NCRIC identified opportunities to diversify
revenues, capitalize on the loyalty of insured physicians and the physicians'
desire to remain independent. The broad goals of NCRIC's long-term business plan
goals established then, and which remain in place to this day, are as follows.
1. Increase financial strength and stability through strategies
consistent with the needs of health care providers and pursue
opportunities in both insurance and non-insurance ventures.
2. Pursue revenue growth through retention, direct and agent produced
new business and corporate diversification.
3. Provide personal, responsive policyholder services while developing
new innovative tools to meet the changing needs of health care
providers and strategic partners.
4. Create strategies, products and partnerships with organizations that
support health care (hospitals, managed care organizations, etc.)
and diversify into new products and geographic territories.
5. Improve the Company's working environment through employee education
and development.
6. Continue to expand established role as a corporate leader in the
metropolitan area civic community.
The long-term strategic plan developed in 1996 remains in place to this
day. Since 1996, NCRIC has significantly expanded its markets and now offers
medical professional liability insurance in Virginia, West Virginia and
Delaware, as well as its traditional markets of
RP Financial, LC.
Page 1.10
Maryland and the District of Columbia. Additionally, NCRIC has substantially
expanded its products through the acquisition which substantially expanded the
geographic footprint and overall revenues of the NCRIC MSO. NCRIC also bolstered
its capital position and ability to expand through the mutual holding company
reorganization and minority stock offering completed in 1999, and will further
enhance its capitalization through the planned second step stock offering.
Recent Trends in the Medical Professional Liability Insurance Market
There currently is a third medical professional liability crisis in as
many decades. Medical professional liability insurance premiums, which had been
stable or rising in line with inflationary pressures for over a decade, are
rising across the country, in some areas dramatically. In addition, many
insurance companies are reducing coverage or withdrawing completely from the
malpractice market. This is leaving doctors in certain areas of the country,
especially those practicing in high risk specialties (e.g., obstetrics,
orthopedics, neurosurgery), facing extremely high insurance premiums, unable to
find coverage at any price, or having to opt for the most expensive coverage of
last resort. There are also frequent reports of doctors retiring or moving to
other states, dropping high-risk patients and procedures, and practicing
defensive medicine.
The rising cost of medical professional liability insurance primarily
stems from a variety of factors which have impacted the market including the
following:
. Increasing claims severity (including the cost of defending
claims), as well as an increase in the frequency of claims, both
on a national basis and within NCRIC's market; and
. The contraction of market capacity caused by claims losses
experienced by medical professional liability insurance
providers, as well as by rising reinsurance costs, and adverse
trends in the capital markets (i.e., losses in the stock market
which have caused losses in the equity portfolios of insurers as
well as a falling interest rate environment which has diminished
interest income earned within the bond portfolios of insurers).
NCRIC has found that as a result of the current crisis, the level of
competition has lessened as providers pull out of markets in which it operates
or substantially reduce their
RP Financial, LC.
Page 1.11
exposure. In this regard, companies such as St. Paul Insurance, which was
formerly the largest provider of medical professional liability insurance
nationally has pulled out of the market entirely. The failure of other companies
such as PHICO and MIIX Group have provided NCRIC with marketing opportunities
and greater pricing power in many of the markets where it operates. These
factors, coupled with NCRIC's strong financial condition and the opportunities
for growth in the current "hard" market has led the Company to raise additional
capital, both through the recent $15 million trust preferred securities offering
and the planned second step stock offering to provide the capital base and
organizational structure to pursue growth opportunities at this unique time.
Balance Sheet Trends
This valuation analysis is based on NCRIC's financial statements pursuant
to Generally Accepted Accounting Principles ("GAAP"), which is the method of
financial reporting required by the Securities and Exchange Commission ("SEC").
The Company also prepares financial reports in accordance with Statutory
Accounting Practices ("SAP") pursuant to Department regulations. The majority of
the financial information analyzed herein is GAAP; where appropriate, however,
we reference SAP financial data.
Growth Trends
NCRIC's balance sheet growth has been strong over the last four fiscal
years, with assets increasing at a more rapid pace over the most recent twelve
month period (see Table 1.1 for details). Strong asset growth has been fueled by
expansion of overall business volumes, including growth in premium revenues.
Overall, the Company's total assets increased 43.8% from the end of fiscal 1999
to the end of fiscal 2002, to equal $202.7 million. The composition of assets
has been subject to moderate change with investment securities diminishing in
conjunction with the proportionate growth of cash balances and reinsurance
assets. Additionally, goodwill increased in fiscal 2000 and 2001, as a result of
additional cash payments made in conjunction with the acquisition of Health Care
Consulting.
Liabilities also reflect growth over the most recent four fiscal
years, increasing from $105.2 million to $154.9 million between fiscal year end
1999 and 2002, with the growth
RP Financial, LC.
Page 1.12
Table 1.1
NCRIC Group, Inc.
Historical Balance Sheets
As of the Fiscal Year Ended December 31,
---------------------------------------------------------------------------
1999 2000 2001 2002
----------------- ----------------- ----------------- -----------------
% of % of % of % of
Amount Assets Amount Assets Amount Assets Amount Assets
------ ------ ------ ------ ------ ------ ------ ------
($000) (%) ($000) (%) ($000) (%) ($000) (%)
ASSETS
------
INVESTMENTS:
Securities Available for Sale, At Fair Value:
Bonds and U.S. Treasury Notes $ 90,937 64.52% $ 91,482 62.72% $ 96,723 60.08% $114,696 56.59%
Equity Securities 4,155 2.95% 6,563 4.50% 6,402 3.98% 5,424 2.68%
-------- ------ -------- ------ -------- ------ -------- ------
Total Securities Available for Sale $ 95,092 67.47% $ 98,045 67.22% $103,125 64.05% $120,120 59.26%
OTHER ASSETS:
Cash and Cash Equivalents 5,407 3.84% 3,972 2.72% 7,565 4.70% 10,550 5.21%
Reinsurance Recoverable 26,627 18.89% 27,549 18.89% 30,077 18.68% 43,231 21.33%
Goodwill 4,928 3.50% 6,218 4.26% 7,291 4.53% 7,291 3.60%
Premiums and Accounts Receivable - 0.00% 3,438 2.36% 4,802 2.98% 9,471 4.67%
Deferred Federal Income Taxes 3,298 2.34% 1,918 1.31% 2,482 1.54% 3,789 1.87%
Other Assets 5,595 3.97% 4,724 3.24% 5,660 3.52% 8,229 4.06%
-------- ------ -------- ------ -------- ------ -------- ------
TOTAL ASSETS $140,947 100.00% $145,864 100.00% $161,002 100.00% $202,687 100.00%
======== ====== ======== ====== ======== ====== ======== ======
LIABILITIES & EQUITY
--------------------
LIABILITIES:
Losses and Loss Adjustment Expenses:
Losses $ 56,462 40.06% $ 55,785 38.24% $ 56,802 35.28% $ 70,314 34.69%
Loss Adjustment Expenses 27,820 19.74% 25,349 17.38% 27,758 17.24% 33,708 16.63%
-------- ------ -------- ------ -------- ------ -------- ------
Total Losses and Loss Adjustment Expenses $ 84,282 59.80% $ 81,134 55.62% $ 84,560 52.52% $104,022 51.32%
Other Liabilities:
Retrospective Premium Accrued Under Reinsurance
Treaties 7,164 5.08% 5,478 3.76% 2,408 1.50% 607 0.30%
Unearned Premiums 8,898 6.31% 11,472 7.86% 17,237 10.71% 24,211 11.95%
Advance Premium - 0.00% 766 0.53% 4,138 2.57% 2,971 1.47%
Reinsurance Premium Payable - 0.00% 804 0.55% 2,452 1.52% 5,045 2.49%
Bank Debt - 0.00% - 0.00% 1,662 1.03% 995 0.49%
Trust Preferred Securities - 0.00% - 0.00% - 0.00% 15,000 7.40%
Other Liabilities 4,808 3.41% 4,761 3.26% 4,091 2.54% 2,019 1.00%
-------- ------ -------- ------ -------- ------ -------- ------
TOTAL LIABILITIES $105,152 74.60% $104,415 71.58% $116,548 72.39% $154,870 76.41%
STOCKHOLDER'S EQUITY $ 35,795 25.40% $ 41,449 28.42% $ 44,454 27.61% $ 47,817 23.59%
TOTAL LIABILITIES & STOCKHOLDER'S EQUITY $140,947 100.00% $145,864 100.00% $161,002 100.00% $202,687 100.00%
======== ====== ======== ====== ======== ====== ======== ======
Source: NCRIC and subsidiaries audited financial statements.
RP Financial, LC.
Page 1.13
primarily reflecting the increase in the value of insurance in force as well as
overall premium revenues and the level of loss reserves and loss adjustment
expenses ("LAE"). The composition of liabilities also reflects considerable
change since fiscal 1999 as a result of: (1) the balance of funds held for
Retrospective Premiums Accrued sharply declined, as the Company's prior
reinsurance contract terminated as of December 31, 2002; (2) unearned premiums
increased, reflecting expanded overall premium revenues and as the timing of the
termination of its insurance contracts with the policyholders was spread more
evenly throughout the year; and (3) the Company issued $15 million of trust
preferred securities in December 2002.
Stockholders' equity has grown since fiscal 1999, reflecting
profitable operations and a generally declining interest rate environment which
has resulted in an increase in the value of the fixed income investment
portfolio designated as available-for-sale ("AFS"). This latter factor has
bolstered the Company's comprehensive income. As a result, equity has increased
from $35.8 million as of December 31, 1999, to $47.8 million, equal to 23.59% of
assets, as of December 31, 2002. On a tangible basis at the same date, the
tangible equity of $40.5 million represented 19.99% of assets.
As the Company continues to expand - through expansion of product
lines in existing markets, entry into new markets through acquisitions or
employment of alternative delivery channels - the balance sheet is expected to
grow accordingly. The capital raised in the stock offering will cause a
significant increase in total assets which is expected to further facilitate
NCRIC's ability to expand and diversify business lines.
The following discussion addresses the major balance sheet items in
terms of characteristics, composition and trends.
Investment Securities
Investment decisions are made on a discretionary basis by a third
party investment manager (Standish Mellon Asset Management, LLC) retained by
NCRIC, who complies with the investment policies established by the Board of
Directors. Oversight of the third party investment manager is provided by the
Company's management as well as a third party advisor.
The investment policy is designed to support the insurance and
business needs of the various subsidiary companies and the Company as a whole.
NCRIC's investment policy is
RP Financial, LC.
Page 1.14
relatively conservative and has placed primary emphasis on investment grade,
fixed maturity securities and the maximization of after-tax yields. Fixed income
securities must be rated "A" or higher by Moody's or Standard & Poors at the
time of purchase and the average quality of the portfolio must be at least "AA".
There is no limitation on the maturity of any individual investment, but no more
than 25% of the portfolio may be invested in maturities over 15 years. In the
case of mortgage-backed and asset-backed securities, the average life of the
instruments will apply rather than the stated final maturity for purposes of
this 25% limitation. The Company generally seeks to limit interest rate risk by
evaluating the portfolio on a duration basis. As of December 31, 2002, the
average modified duration of the portfolio was 4.4 years. The specific
objectives of the Company's investment policy are as follows:
1. Increasing investment income to reduce the cost of insurance
for policyholders;
2. Funding the claim liabilities of the Company;
3. Protecting equity in order to maintain or increase the
stability and achieve a favorable rating from ratings
organization; and
4. Maximizing after-tax investment return.
The following table reflects the investment quality distribution of
NCRIC's fixed maturity investments at December 31, 2002.
Type/Ratings of Investment Percentage
-------------------------- ----------
Treasury/Agency 34.4%
AAA 29.8
AA 9.8
A 19.7
BBB 6.1
B 0.2
As of December 31, 2002, NCRIC's investment portfolio of $120.1 million,
equal to 59.26% of assets, was comprised of $120.1 million of fixed income
securities (all classified AFS to maximize flexibility) and $5.4 million of
equity securities (primarily consisting of preferred stocks). Over the last four
fiscal years, the structure of the investment portfolio has changed modestly as
the Company emphasized after-tax yields in formulating the investment strategy,
RP Financial, LC.
Page 1.15
which led to an increased level of tax-advantaged securities as well as
corporate securities. Table 1.2 reflects the composition of the investment
portfolio since December 31, 1999.
NCRIC may increase the risk profile of the investment portfolio,
within the constraints imposed by the investment policy, as the current interest
low rate environment has impaired diminished the average yield of the portfolio
and the potential for additional capital gains. In this regard, NCRIC is
evaluating the merits of investing a greater proportion of its investment
portfolio into a diversified mix of equity investments with the objective of
enhancing the long-term returns on the portfolio.
Cash and Cash Equivalents
Cash and cash equivalents are generally maintained at moderate levels
and fluctuate based on the timing of cash inflows and the Company's cash needs.
As of December 31, 2002, NCRIC's balance of cash and cash equivalents totaled
$10.6 million, equal to 5.2% of total assets.
Reinsurance Recoverable
The Company establishes a reinsurance recoverable asset reflecting the
actuarial established value of funds to be recovered from reinsurance treaties
(or contracts) pursuant to SFAS No. 113. As of December 31, 2002, the
reinsurance recoverable assets totaled $43.2 million, equal to 15.2% of total
assets. The reinsurance recoverable assets are reviewed at least semi-annually
by both management and the independent actuaries, as well as by Deloitte &
Touche, LLP. Management believes that all of the reinsurance recoverable assets
are collectible in full.
Goodwill
Goodwill has historically been a limited for NCRIC but increased in
fiscal 2000 and 2001 as additional cash payments were made to the former
principals of HealthCare Consulting, Inc., which was acquired in 1999. The
entire consideration has been paid and no additional goodwill will be booked
from this transaction in future years. Pursuant to SFAS No. 141, the Company has
ceased amortizing goodwill as of the fiscal 2001 year end and is periodically
evaluating the remaining unamortized goodwill balance for impairment.
RP Financial, LC.
Page 1.16
Table 1.2
NCRIC Group, Inc.
Investment Portfolio Summary
As of December 31,
-------------------------------------------------------------------------------------
1999 2000 2001 2002
------------------ ------------------- ------------------- -------------------
($000) (%) ($000) (%) ($000) (%) ($000) (%)
U.S. Government and Agencies $13,221 13.90% $13,513 13.78% $ 4,761 4.62% $ 27,952 23.27%
Corporate 26,262 27.62% 30,719 31.33% 43,405 42.09% 33,759 28.10%
Tax-Exempt Obligations 13,791 14.50% 16,010 16.33% 19,804 19.20% 32,704 27.23%
Asset and Mortgage-Backed Securities 37,663 39.61% 31,240 31.86% 28,753 27.88% 20,281 16.88%
------- ------ ------- ------ -------- ------ -------- ------
Bond Portfolio $90,937 95.63% $91,482 93.31% $ 96,723 93.79% $114,696 95.48%
Equity Securities 4,155 4.37% 6,563 6.69% 6,402 6.21% 5,424 4.52%
------- ------ ------- ------ -------- ------ -------- ------
Total Investment Portfolio $95,092 100.00% $98,045 100.00% $103,125 100.00% $120,120 100.00%
Source: Audited and unaudited financial reports.
RP Financial, LC.
Page 1.17
Premiums and Accounts Receivable
Premiums and accounts receivable reflect the premium balance due on
policies in effect on which premiums have yet to be collected. The balance of
premiums receivable fluctuates throughout the year but generally have been
trended upward reflecting the growth in business volumes.
Deferred Federal Income Taxes
Deferred federal income taxes totaled $3.8 million, equal to 1.9% of
total assets as of December 31, 2002, and is principally related to the accrual
of losses and loss adjusted expenses ("LAE") for book purposes, which will only
be realized in the future for tax purposes. Other significant timing differences
between the GAAP books and tax liability exist with respect to unearned
premiums, unrealized losses on AFS securities, net operating loss carryforwards
and deferred policy acquisition costs.
Other Assets
The Company's other assets primarily consists of property and
equipment, and various other miscellaneous accruals and assets.
Losses and Loss Adjustment Expenses
Losses and LAE comprise the largest segment of NCRIC's liabilities,
equal to $104.0 million, or 51.3% of assets, as of December 31, 2002. The loss
reserves have been increasing in dollar terms but decreasing as a percent of
assets over the last several years reflecting: (1) the actual loss development
in recent periods has been relatively unfavorable; (2) implementation of more
stringent underwriting standards, particularly in the medical professional
liability area; and (3) management's intention to maintain a conservative level
of loss reserves.
NCRIC determines the level of the loss and LAE reserves monthly and
the reserve balances are reviewed periodically by the Company's independent
actuary. The reserve levels are established based on a projection of the
ultimate losses through an actuarial analysis of the Company's claims history
and other medical professional liability insurers, subject to adjustments deemed
appropriate by management and the actuaries to account for changing
RP Financial, LC.
Page 1.18
circumstances. Included in the claims history are losses and LAE paid by the
Company in prior periods and case reserves for anticipated losses and LAE
developed by the Company's claims department as claims are reported and
investigated. Since medical professional liability insurance is a long-tail line
of business for which the initial loss and LAE estimates may be adversely
impacted by events occurring long after the reporting of the claim, such as
sudden severe inflation or adverse judicial or legislative decisions, management
has indicated it seeks to establish loss and LAE reserves pursuant to its
conservative guidelines.
Retrospective Premiums Accrued
Retrospective Premiums Accrued equaled $607,000, or 0.3% of total
assets as of December 31, 2002, and represents management's estimates of future
premiums due under its reinsurance treaties. The balance of funds held for
Retrospective Premiums Accrued sharply declined as the Company's reinsurance
contract terminated as of December 31, 2002.
Unearned and Advance Premiums
Unearned and advance premiums consist of premiums collected for
insurance coverage to be rendered over the balance of the life of the policy,
which is generally a one year term for the Company. As of December 31, 2002,
unearned premiums and advance premiums totaled $24.2 million and $3.0 million,
respectively. Unearned premiums have been increasing over the last several years
as overall premium revenues have increased, and as the Company's policy renewal
dates have become spread more evenly throughout the fiscal year.
Reinsurance Premium Payable
Reinsurance premiums payable equaled $5.0 million, or 2.49% of total
assets as of December 31, 2002, and represents management's estimates of future
premiums due pursuant to reinsurance treaties. Management continually evaluates
the adequacy of the reinsurance liabilities.
Bank Debt
During March 2001, SunTrust Bank loaned NCRIC $1,000,000 at an annual
rate equal to LIBOR plus 1.75% to finance the scheduled 2001 contingency payment
in
RP Financial, LC.
Page 1.19
conjunction with the HealthCare Consulting acquisition. During June 2001, the
MSO borrowed $1,971,000 from SunTrust Bank to finance these payments. The
outstanding debt from the first quarter of 2001 was repaid with a portion of
this loan. The term of the loan is three years at a floating rate of LIBOR plus
2.75%.
Trust Preferred Securities
On December 4, 2002, NCRIC completed the private placement sale of $15
million of 30 year floating rate trust preferred securities. The terms of the
trust preferred securities provide NCRIC with the right to call the securities
at par after five years from the date of issuance. The interest rate on the
securities is floating at three-month LIBOR plus 400 basis points. The initial
rate was set at 5.42%. NCRIC contributed $13.5 million of the funds raised to
the statutory surplus of its insurance subsidiaries and the funds were
reinvested pursuant to the general investment philosophy and investment
portfolio guidelines. The objective of the debt issuance was primarily two-fold:
(1) to provide capital to the insurance subsidiaries with the objective of
expanding premium revenues and market share over the near term when insurance
premium rates are believed to be profitable; and (2) to provide capital to
enable NCRIC Group to reduce its reliance on reinsurance through greater risk
retention during a period when reinsurance is perceived to be costly. The
remaining funds from the offering will be retained by NCRIC Group to be
available to meet future debt service requirements.
Other Liabilities
Other liabilities are relatively modest and consist of a small amount
of other miscellaneous liabilities, totaling $2.0 million, equal to 1.0% of
assets as of December 31, 2002.
Capital
Earnings since the end of fiscal 1999 have led to GAAP equity growth
to $47.8 million, equal to 23.6% of assets as of December 31, 2002. The addition
of the offering proceeds will serve to further strengthen NCRIC's capital
position and facilitate the expansionary business plan. As of December 31, 2002,
goodwill totaled $7.3 million, which reduced the tangible equity balance to
$40.5 million, equal to 20.0% of assets. Accumulated comprehensive income
increased reported equity levels by $2.8 million as of December 31,
RP Financial, LC.
Page 1.20
2002. The comprehensive income has increased over the last several years
primarily owing to the trend toward decreasing interest rate levels which has
positively impacted the market value of the large portfolio of fixed income
securities classified AFS.
NCRIC maintains capital surpluses relative to minimum regulatory
requirements (SAP basis). The schedule below sets forth NCRIC's risk-based
capital position as of the end of the last three fiscal years.
Total Adjusted Capital Relative to Authorized Control Level
Statutory Accounting Practices Basis
Authorized Control Level Total
Risk-Based Capital Adjusted Capital
------------------ ----------------
NCRIC CML NCRIC CML
----- --- ----- ---
($Mil) ($Mil) ($Mil) ($Mil)
December 31, 2002 $6.7 $0.49 $44.3 $4.7
December 31, 2001 4.7 0.17 32.8 4.3
December 31, 2000 3.7 0.19 29.8 4.5
Source: Prospectus.
Income and Expense Trends
The Company's revenues and expenses reflect significant growth as a result
of considerable expansion within the insurance line of business, primarily
outside of the District of Columbia, due in part to contraction of medical
professional liability carriers in regions outside of Washington, DC.
Additionally, significant premium rate increases which averaged 14% in fiscal
2002 have also been a factor in the growth of overall premium revenues.
Moreover, growth in premium revenues is expected to continue as the Company
continues to expand geographically and has increased premium rates again for
policies coming up for renewal in fiscal 2003, with such rate increases
reflecting both increasing frequency and severity of losses. The schedule below
provides information regarding the change in gross premiums written by NCRIC
between fiscal 2001 and fiscal 2002, and reflects that much of the premium
growth has occurred in Virginia, West Virginia and Delaware where the Company
has traditionally maintained a more limited market presence.
RP Financial, LC.
Page 1.21
NCRIC Group, Inc.
Premium Revenue Growth By State
Percentage Increase in Premiums
-------------------------------
Fiscal 2001 Fiscal 2002
----------- -----------
District of Columbia 11% 25%
Maryland 18 8
Delaware 12 79
West Virginia 20 166
Virginia 18 89
Note: Reflects impact of growth in terms of both policyholders and premium
rates.
NCRIC Group, Inc.
Gross Premium Written By State
12 Months Ended December 31,
----------------------------------------
2001 2002
----------------- ------------------
% of % of
Amount Total Amount Total
------ ----- ------ -----
($Mil) (%) ($Mil) (%)
District of Columbia $17,486 51% $21,796 42%
Virginia 7,853 23 14,863 29
Maryland 5,236 15 5,663 11
West Virginia 2,886 8 6,492 13
WV - HCA -- -- 793 1
WV - Princeton -- -- 403 1
Delaware 998 3 1,789 3
------- --- ------- ---
Total $34,459 100% $51,799 100%
Over the long-term, NCRIC's management views the considerable expansion of
premium revenues, particularly outside of the District of Columbia, as being
favorable to the Company's long-term earnings prospects. In this regard, the
distribution of premiums written throughout a wider geographic area will
facilitate the overall risk diversification of the Company. Moreover, premium
rate increases applied in fiscal 2002 and again in the upcoming year are
expected to result in greater profitability of the insurance segment,
particularly as the Company has become more stringent in the risks it is
underwriting. The Company also recently renegotiated its reinsurance treaty with
the new treaty taking effect as of January 1, 2003. As a result of the expanded
regulatory capital base generated through the private placement of trust
preferred
RP Financial, LC.
Page 1.22
securities and the capital which NCRIC intends to raise in the upcoming second
step stock offering, the Company negotiated a new reinsurance treaty wherein it
has a assumed a higher level of risk retention vis-a-vis the prior fixed rated
treaty. Management believes that the prior treaty was highly profitable for its
reinsurers and that by retaining a greater level of risk in the future, it will
increase the Company's overall profitability while increasing the risk exposure
relatively modestly.
Notwithstanding the notable geographic expansion and growth in overall
premium revenues, NCRIC's net earnings have declined over the last several
fiscal years owing to several factors. NCRIC has experienced increased frequency
and severity of claims in the development of losses on claims reported in prior
years. While the recent rate increases implemented by NCRIC are believed to
enhance the profitability of future underwriting, their impact on the
profitability of underwriting operations of the last several years has been
limited. Additionally, NCRIC was required to establish a $1.2 million reserve on
a premium receivable which it determined to be uncollectible in fiscal 2002.
NCRIC's profitability has been also adversely affected by the declining interest
rate environment which has reduced the level of investment income as securities
within the laddered investment portfolio have matured with such funds reinvested
in lower yielding securities available as interest rates declined.
Net income decreased from $3.5 million, or 2.44% of average assets, in
fiscal 2000, to $742,000, or 0.23% of average assets, in fiscal 2002, providing
for an after-tax profit margin of 1.74%. The Company's recent operations
reflected as a percent of average assets and total revenues are included as
Table 1.3 and 1.4, respectively.
Premium Income
Net premiums earned have increased substantially since fiscal 1999,
primarily reflecting the impact of growth of new business outside of the
District of Columbia and Maryland. Additionally, premium rate increases have
also been an important factor in the growth of premium income. Overall, net
premiums earned have more than doubled since fiscal 2000, to total $30.1 million
in fiscal 2002, equal to 16.55% of average assets and 70.5% of total revenues.
The schedule below reflects that most new premiums written have been generated
through independent agents, primarily in Virginia, Delaware and West Virginia.
The majority of
RP Financial, LC.
Page 1.23
Table 1.3
NCRIC Group, Inc.
Historical Income Statements as a Percent of Average Assets
For the Twelve Months Ended
--------------------------------------------------------------------------------------
December 31, 1999 December 31, 2000 December 31, 2001 December 31, 2002
--------------------- --------------------- --------------------- --------------------
% of Avg. % of Avg. % of Avg. % of Avg.
Amount Assets Amount Assets Amount Assets Amount Assets
------ ------ ------ ------ ------ ------ ------ ------
($000) (%) ($000) (%) ($000) (%) ($000) (%)
REVENUES:
Net Premiums Earned $14,666 10.66% $14,611 10.19% $20,603 13.43% $30,098 16.55%
Net Investment Income 6,089 4.42% 6,407 4.47% 6,136 4.00% 5,915 3.25%
Net Realized Investment Losses (71) -0.05% (5) 0.00% (278) -0.18% (131) -0.07%
Practice Management and Related Income 4,576 3.32% 5,317 3.71% 6,156 4.01% 5,800 3.19%
Other Income 373 0.27% 470 0.33% 602 0.39% 1,013 0.56%
------- ----- ------- ----- ------- ----- ------- -----
Total Revenues 25,633 18.62% 26,800 18.69% 33,219 21.65% 42,695 23.48%
EXPENSES:
Losses and Loss Adjustment Expenses $12,867 9.35% $11,946 8.33% $18,858 12.29% $26,829 14.75%
Underwriting Expenses 3,010 2.19% 3,591 2.50% 4,877 3.18% 8,168 4.49%
Practice Management and Related Expenses 4,845 3.52% 4,970 3.47% 6,063 3.95% 5,811 3.20%
Other Expenses 1,439 1.05% 1,237 0.86% 1,245 0.81% 1,467 0.81%
------- ----- ------- ----- ------- ----- ------- -----
Total Expenses 22,161 16.10% 21,744 15.16% 31,043 20.23% 42,275 23.25%
------- -----
INCOME BEFORE INCOME TAXES $ 3,472 2.52% $ 5,056 3.53% $ 2,176 1.42% $ 420 0.23%
INCOME TAX (BENEFIT) PROVISION: $ 967 0.70% $ 1,561 1.09% $ 597 0.39% $ (322) -0.18%
NET INCOME $ 2,505 1.82% $ 3,495 2.44% $ 1,579 1.03% $ 742 0.41%
======= ===== ======= ===== ======= ===== ======= =====
Combined Ratio:
Expense Ratio 20.52% 24.58% 23.67% 27.14%
Loss Ratio 87.73% 81.76% 91.53% 89.14%
------- ------- ------- -------
Combined Ratio 108.26% 106.34% 115.20% 116.28%
Source: NCRIC and subsidiaries audited and unaudited financial statements.
RP Financial, LC.
Page 1.24
Table 1.4
NCRIC Group, Inc.
Historical Income Statements as a Percent of Average Assets
For the Twelve Months Ended
--------------------------------------------------------------------------------------
December 31, 1999 December 31, 2000 December 31, 2001 December 31, 2002
--------------------- --------------------- --------------------- --------------------
% of Avg. % of Avg. % of Avg. % of Avg.
Amount Assets Amount Assets Amount Assets Amount Assets
------ ------ ------ ------ ------ ------ ------ ------
($000) (%) ($000) (%) ($000) (%) ($000) (%)
REVENUES:
Net Premiums Earned $14,666 57.22% $14,611 54.52% $20,603 62.02% $30,098 70.50%
Net Investment Income 6,089 23.75% 6,407 23.91% 6,136 18.47% 5,915 13.85%
Net Realized Investment Losses (71) -0.28% (5) -0.02% (278) -0.84% (131) -0.31%
Practice Management and Related Income 4,576 17.85% 5,317 19.84% 6,156 18.53% 5,800 13.58%
Other Income 373 1.46% 470 1.75% 602 1.81% 1,013 2.37%
------- ------ ------- ------ ------- ------ ------- ------
Total Revenues 25,633 100.00% 26,800 100.00% 33,219 100.00% 42,695 100.00%
EXPENSES:
Losses and Loss Adjustment Expenses $12,867 50.20% $11,946 44.57% $18,858 56.77% $26,829 62.84%
Underwriting Expenses 3,010 11.74% 3,591 13.40% 4,877 14.68% 8,168 19.13%
Practice Management and Related Expenses 4,845 18.90% 4,970 18.54% 6,063 18.25% 5,811 13.61%
Other Expenses 1,439 5.61% 1,237 4.62% 1,245 3.75% 1,467 3.44%
------- ------ ------- ------ ------- ------ ------- ------
Total Expenses 22,161 86.45% 21,744 81.13% 31,043 93.45% 42,275 99.02%
------- ------
INCOME BEFORE INCOME TAXES $ 3,472 13.55% $ 5,056 18.87% $ 2,176 6.55% $ 420 0.98%
INCOME TAX (BENEFIT) PROVISION: $ 967 3.77% $ 1,561 5.82% $ 597 1.80% ($322) -0.75%
NET INCOME $ 2,505 9.77% $ 3,495 13.04% $ 1,579 4.75% $ 742 1.74%
======= ====== ======= ====== ======= ====== ======= ======
Combined Ratio:
Expense Ratio 20.52% 24.58% 23.67% 27.14%
Loss Ratio 87.73% 81.76% 91.53% 89.14%
------- ------- ------- -------
Combined Ratio 108.26% 106.34% 115.20% 116.28%
Source: NCRIC and subsidiaries audited and unaudited financial statements.
RP Financial, LC.
Page 1.25
NCRIC's agent generated premium revenues are derived from approximately 8 to 10
independent agencies.
NCRIC Group, Inc.
New Premium Written
(in thousands)
12 Months Ended December 31,
----------------------------
2001 2002
---- ----
($000) ($000)
Direct $ 1,206 $ 2,309
Agent 10,964 9,988
HCA -- 793
Princeton -- 403
------- -------
Total $12,170 $13,493
Net Investment Income
Net investment income consists of dividends and interest on invested
assets. Over the last four fiscal years, net investment income has decreased,
notwithstanding substantial growth of invested assets. In this regard, the
revenue contribution relative to average assets and total revenues has declined,
which is reflective of the dramatically lower yields available on newly invested
assets in today's low interest rate environment. Specifically, the average
effective yield was approximately 6.31% for the year ended December 31, 2000,
and has declined to 5.33% for the fiscal year ended December 31, 2002. The tax
equivalent yield was approximately 6.72% at December 31, 2000, and had declined
to 5.94% at December 31, 2002.
Given that market interest rate levels are currently at their lowest
levels in more than 40 years, investment income will continue to be subject to
downward pressure in the future as relatively high yielding investments
currently in the portfolio mature. Such downward pressure will be mitigated by
expected premium growth, which will provide the Company with new cash to
reinvest.
Net Realized Investment Losses
Historically, investment gains and losses have not been a significant
factor as the investment portfolio is managed with a long-term perspective, and
the Company does not
RP Financial, LC.
Page 1.26
actively engage in trading or seek to realize short-term gains at the expense of
long-term earnings. However, during the second quarter of 2002, NCRIC determined
that the $650,000 of WorldCom bonds which it owned had suffered an "other than
temporary" decline in value under the provisions of SFAS 115, and accordingly
reflected the reduction as a loss in the income statement rather than a
reduction in market value in accumulated other comprehensive gain. The impact of
the loss on the WorldCom bonds was substantially offset by gains on other
securities sold in the last half of fiscal 2002, such that the net realized
investment loss for fiscal 2002, totaled $131,000, equal to 0.07% of average
assets and 0.31% of total revenues.
Practice Management Income
Practice management income reflected growth from fiscal 1999 to fiscal
2001, increasing from $4.6 million to $6.2 million. During this period, the
increased revenue was a result of the MSO's focused efforts on new business
development through the addition of new clients in both recurring business and
one-time consulting assignments and the increase in consulting rates in fiscal
2001.
NCRIC experienced a reduction in practice management revenue in fiscal
2002 to $5.8 million, which represents a 6% reduction relative to the $6.2
million total revenue figure reported in fiscal 2001. NCRIC attributes the
reduction in practice management income in fiscal 2002, primarily to lower
revenues generated through one-time consulting engagements. In this regard, many
solo and small-group physician practices have less discretionary income in the
current market environment than in prior years as insurance company/Medicare
reimbursements have tightened while at the same time, the costs related to their
medical practices have continued to escalate.
Revenue for practice management and related services is comprised of
fees for the services shown in the following schedule.
RP Financial, LC.
Page 1.27
NCRIC Group, Inc.
Composition of Practice Management and Related Service Revenues
Year Ended December 31,
------------------------
2000 2001 2002
---- ---- ----
Practice management 44% 43% 38%
Accounting 28 26 31
Tax & personal financial planning 11 12 12
Retirement plan accounting & administrative 13 13 13
Other 4 6 6
- - -
---- ---- ----
Total 100% 100% 100%
Other Income
Other income consists of other miscellaneous fees, including revenues
from subsidiaries. For the twelve months ended December 31, 2002, other income
totaled $1.0 million, equal to 0.56% of average assets and 2.37% of total
revenues. The level of other income reflects a growth trend which management
attributes to increased brokerage reinsurance treaty commission income generated
by higher reinsurance premiums ceded and from service fees generated by the
installment payments premiums for insurance policies (the Company offers an
installment payment option to its policyholders charging a fee for the service).
Losses and Loss Adjustment Expenses
Losses and LAE expenses diminished modestly in fiscal 2000, primarily
as a result of favorable loss development for prior periods but have
subsequently increased significantly to a historical high on a dollar basis in
2002. The increase in losses and LAE is the result of expansion of insurance in
force coupled with rising frequency and severity of losses from prior years. For
the twelve months ended December 31, 2002, losses and LAE expenses totaled $26.8
million, equal to 14.8% of average assets and 62.8% of total revenues.
NCRIC's loss ratio (i.e., losses as a percent of net premiums earned)
reflects the impact of the aforementioned trends. The loss ratio decreased in
fiscal 2000 relative to the level reported in fiscal 1999 (from 87.73% to
81.76%) as the Company experienced a relatively benign environment and favorable
loss development. By comparison, the loss ratio was much higher in fiscal 2001,
equaling 91.53%, while decreasing modestly to 89.14% in fiscal 2002.
RP Financial, LC.
Page 1.28
The modest improvement in the loss ratio in the most recent fiscal year reflects
the benefit of increased premium rate levels and a moderation of claims
frequency.
The Company believes that it has taken several steps which may likely
continue to improve NCRIC's loss ratio and overall profitability in the future.
In this regard, recent premium rate increases have yet to be fully realized into
premium revenues on a trailing twelve month basis. Additionally, in view of the
current market environment for medical professional liability insurance, NCRIC
has been very selective with respect to its underwriting and has been highly
focused on risk-adjusted returns such that the Company is adequately compensated
for the risks it insures. Steps taken to achieve these strategic goals include
reunderwriting every renewal, employing additional qualified underwriters, and
seeking appropriate premium rate increases. Additionally, NCRIC believes it has
been relatively conservative in establishing loss reserves, particularly in new
markets where the Company's data with regard to historical loss experience is
limited or non-existent.
Other Underwriting Expenses
Other underwriting expenses consist of all the other administrative
expenses directly related to underwriting insurance (excluding losses and LAE).
Other underwriting expenses were relatively low in fiscal 1999 and fiscal 2000
as the Company had yet to fully embark on its geographic expansion strategy.
With the emergence of the "hard" market for medical professional liability
insurance at the end of fiscal 2000 and into fiscal 2001, NCRIC sought to expand
in all of its markets, but particularly those markets where there was a material
contraction in competing insurance providers. Accordingly, the Company realized
growth in underwriting expenses as it sought to increase its overall business
volumes.
Accordingly, over the last several fiscal years, total expenses as
well as the expense ratio reported by NCRIC have been subject to increase as a
result of: (1) the effort to expand the insurance segment of NCRIC's business,
both with respect to the overall number of policies in force and geographically;
(2) geographic expansion outside of the District of Columbia and Maryland where
NCRIC underwrites many of its policies directly has led to an increase in agent
commissions; (3) NCRIC recorded a $1.2 million valuation allowance on a premium
receivable which it determined to be uncollectible in fiscal 2002, and which is
reflected in its underwriting
RP Financial, LC.
Page 1.29
expenses; and (4) guaranty fund assessments of $160,000 in fiscal 2001 and
$228,000 in fiscal 2002 resulting from the insolvency of Reliance Insurance
Company and PHICO Insurance, respectively.
Paralleling trends with respect to the loss ratio, the expense ratio
(i.e., other underwriting expenses as a percent of net premiums earned)
increased from 20.52% in fiscal 1999, to 27.14% for the twelve months ended
December 31, 2002. As a result, the combined ratio (the sum of the loss and
expense ratio) also showed an adverse trend, and equaled 116.3% for the twelve
months ended December 31, 2002. A combined ratio below 100% generally shows an
underwriting profit and a combined ratio in excess of 100% shows an underwriting
loss. The Company's combined ratio in excess of 100% indicates that it relies
heavily on investment and other income to support earnings.
Practice Management Expenses
Practice management expenses reflected growth from fiscal 1999 to
fiscal 2001, increasing from $4.8 million to $6.1 million. During this period,
the increase in costs were the result of the MSO's focused efforts on new
business development through the addition of new clients in both recurring
business and one-time consulting assignments and the increase in consulting
rates in fiscal 2001.
Practice management expenses decreased in fiscal 2002 relative to the
level reported in fiscal 2001, and equaled $5.8 million, or 3.20% of average
assets and 13.61% of total revenues. The reduction is attributable to the
cessation of goodwill amortization with the implementation of SFAS 142 beginning
January 1, 2002; goodwill amortization totaled $388,000 in 2001. This decrease
was partially offset by expense increases in the first nine months of 2002 for
integration costs and transition of client service for two of the former owners
as they moved toward the expiration of their employment contracts at the end of
2002.
Other Expenses
Other expenses include amounts for subsidiary and holding company
operations, which are not directly related to the issuance of medical
professional liability insurance or
RP Financial, LC.
Page 1.30
practice management operations. For the twelve months ended December 31, 2002,
other expenses totaled $1.5 million, equal to 0.81% of average assets and 1.46%
of total revenues.
Income Taxes
The Company is in a fully taxable position with respect to federal
income taxes. Given NCRIC's investment policies which emphasize after-tax yield,
the Company's effective tax rate for the period from fiscal 1999 to fiscal 2001
ranged between 27 and 31%. The Company recorded a net tax benefit in fiscal 2002
of $322,000, notwithstanding a positive pre-tax net income of $420,000. The tax
benefit reported in the most recent fiscal year is attributable to the impact of
tax-advantaged securities in NCRIC's portfolio which created a tax loss for the
year, notwithstanding positive pre-tax income reported for financial reporting
purposes.
Claims and Risk Exposure
In evaluating the Company's potential loss exposure, it is important to
note that approximately 33% of NCRIC's insureds practice in the District of
Columbia. In this regard, the District has not passed tort reform legislation
with respect to medical professional liability and jury awards can sometimes be
substantial. Although the Company seeks to quantify such risks through actuarial
analyses of losses and LAE, while also minimizing the risk of loss through
reinsurance, the Company's business concentration in the District presents a
risk element not necessarily present in the operations of companies operating in
other jurisdictions which have experienced tort reform or which have histories
of more favorable jury verdicts with respect to related litigation. Likewise,
Delaware has not implemented any tort reform measures while Maryland and West
Virginia have implemented non-economic caps on damage awards. Importantly,
Virginia, which represents a significant growth area for the Company, has a full
cap on damage awards, including both economic and non-economic caps. NCRIC has
been seeking to diversify its medical professional liability insurance business
to other jurisdictions, both with the objective of expanding the potential
market for its insurance products and as a means of reducing the Company's risk
exposure, particularly with regard to the District of Columbia.
The Company seeks to minimize its risk through an effective claims
management process, including early evaluation, aggressive management and
vigorous defense of claims.
RP Financial, LC.
Page 1.31
The Company also seeks to expediently resolve cases where the claim is judged to
be meritorious. The Company maintains a staff of claims investigators to
evaluate and manage the claims process. Additionally, the Company utilizes law
firms experienced in medical professional liability defense litigation and
experts knowledgeable in the various medical specialties.
In order to improve the claims management process, NCRIC has acquired and
implemented a data management system which allows the Company to efficiently
track cases and monitor attorney's and other professional fees. The Company
believes it has been relatively successful in the management of claims which
provides the dual benefit of minimizing losses for NCRIC while enhancing
marketing efforts (success in adjudicating claims is particularly important in
the medical professional liability sector where professional reputations may
hinge on a case).
The Company attributes its relative success in adjudicating claims to the
experience of the claims department and knowledge of the judicial systems in the
markets where it operates. Importantly, unlike other areas of NCRIC's operations
which are relatively centralized, NCRIC's claims management is somewhat
decentralized with individuals within the Company specializing in claims within
certain jurisdictions. In this regard, NCRIC has established a claims management
office in Richmond, Virginia to manage claims in Virginia outside of the
Washington, DC area, and may likely establish other regional offices in Delaware
and West Virginia as the level of claims expands in these newer markets.
The Company believes it has been relatively successful in the management of
claims. Since 2000, the 58 claims that went to trial led to 33 defense verdicts
(57%) and 15 plaintiff verdicts (26%), with the balance of the cases resulting
in mistrials or hung juries. As of December 31, 2002, the Company had
approximately 517 open cases with an average of 65 cases being handled by each
claims representative.
The Company attributes its relative success in adjudicating claims to the
experience of the claims department, its knowledge of the judicial systems in
the Washington metropolitan area, and the employment of local qualified experts.
The Company's on-going efforts to expand geographically into such states as
Delaware and West Virginia may subject it to a greater level of
RP Financial, LC.
Page 1.32
risk as it expands in markets with which it is less familiar, although the tort
reform in target expansion markets may limit such risk.
Reinsurance
NCRIC follows customary industry practice by reinsuring a portion of its
risk. The Company's general philosophy with respect to reinsurance is to cede
principally to reduce net liability on individual risks and to provide
protection against large losses. During fiscal years 2001 and 2002, NCRIC ceded
$7.3 million and $14.0 million of earned premiums to reinsurers for reinsurance
coverage, reflecting both premiums ceded for prior and current year coverage.
NCRIC generally establishes reinsurance premium accruals based on adverse loss
scenarios resulting in the recapture of a portion of premiums ceded if favorable
loss development is realized, pursuant to the swing rated reinsurance contracts.
NCRIC recently negotiated a new reinsurance treaty which took effect as of
January 1, 2003, to replace the prior reinsurance treaty which expired as of
December 31, 2002. Under the prior reinsurance arrangement, which was a fixed
rate program, NCRIC was reinsured for losses in excess of $500,000 per claim on
an excess of loss basis up to $1,000,000 per risk. The Company also purchased
clash coverage to minimize risk per incident (i.e., two NCRIC insureds involved
in a claim on a single incident). NCRIC has also purchased coverage for
catastrophic losses in excess of $11 million, believing that the relatively
small cost of the coverage is more than offset by the potential benefit of
protection against losses which could impact the viability of the Company
(considered unlikely). The reinsurance treaty that took effect as of January 1,
2003 and which will remain in effect through December 31, 2005, provides for
substantially the same terms except that NCRIC has increased its risk retention
to $1 million per claim. NCRIC's management believes that the greater level of
risk retention pursuant to the current reinsurance treaty will enhance the
Company's overall profitability as such coverage was very costly in the current
"hard" market. Moreover, NCRIC's stronger capitalization, both as a result of
the recent trust preferred securities issuance and the forthcoming second step
stock offering provide an enhanced capital base with which to safely assume such
risks.
The Company maintains reinsurance with financially stable reinsurers. The
Company annually reviews and analyzes the financial stability of reinsurers,
including a ratings analysis of
RP Financial, LC.
Page 1.33
each reinsurer participating in a reinsurance contract. On the basis of this
review, the Company concluded there was no material risk of not being paid by
reinsurers. To date, the Company has not experienced any significant
difficulties in collecting reinsurance recoverables. Data pertaining to the
Company's principal reinsurers as of December 31, 2002 is set forth in Table
1.5.
Table 1.5
NCRIC Group, Inc.
Reinsurance Data as of December 31, 2002
A.M. Best Reinsurance
Reinsurer Rating Recoverable
--------- ------ -----------
($000)
Lloyd's of London syndicates (1) $25,846
Hanover Reinsurance B++u(2) 4,091
CNA Reinsurance of London Limited (3) 3,102
Unionamerica Insurance B+ 1,948
Transatlantic A++ 3,491
5 other reinsurers Various 4,753
-----
Total $43,231
(1) Please provide which syndicate.
(2) u=under review.
(3) Not found.
Source: Prospectus.
Subsidiaries
In addition to NCRIC, Inc., CML, and NCRIC MSO operations, NCRIC has a
captive insurance operation, a reinsurance brokerage operation, an insurance
agency, and a physicians organization.
American Captive Corporation
American Captive Corporation ("ACC"), was established in April 2001 as
the first captive insurance company to be licensed in the District of Columbia
under the Captive Insurance Act of 2000, and is authorized to form independent
protected cells to accommodate
RP Financial, LC.
Page 1.34
affinity groups seeking to manage their own risk through an alternative risk
transfer structure. In 2001, ACC was engaged in establishing the foundation for
development of captive management operations. In February 2002, NCRIC announced
formation of a joint venture with Risk Services, LLC, to form National Capital
Risk Services to offer a complete range of alternative risk transfer services to
healthcare clients throughout the nation.
National Capital Insurance Brokerage, Ltd.
National Capital Insurance Brokerage, Ltd ("NCIB") was formed in 1984 to
serve as NCRIC's domestic reinsurance broker. NCIB has retained commission
income that would otherwise have been paid to outside reinsurance brokers. This
income has been used by NCRIC to offset other operating expenses. NCIB has also
played a critical role in structuring NCRIC's reinsurance program to provide
effective and comprehensive reinsurance coverage without reducing NCRIC's
profitability.
NCRIC Insurance Agency, Inc.
NCRIC Insurance Agency ("NIA") was organized as a wholly-owned
subsidiary of NCRIC during 1989. NIA offers life, health and disability
insurance as well as property and casualty insurance products. NIA had
commission income of $25,000 in fiscal 2002 compared to $56,000 in 2001 and
$80,000 in 2000. NIA offers its products in the same markets as NCRIC. As an
insurance agent, NIA receives commissions for business it places for insurance
companies it represents. NIA markets insurance products not underwritten by
NCRIC, which permits NCRIC's core insureds to obtain a wider range of insurance
products through NCRIC.
NCRIC Physicians Organization, Inc.
NCRIC Physicians Organization, Inc. ("NCRIC PO") was organized in 1994,
as a wholly-owned subsidiary of NCRIC MSO. NCRIC PO manages a coalition of
physicians which is organized to contract with managed care payers as an
exclusive healthcare provider network. NCRIC PO ended all of its contracts in
1999 and formed an agreement with American Medical Security, AMS, to provide its
network to a developing PPO health plan by AMS for the Washington, D.C.
metropolitan area. NCRIC PO reached a settlement with AMS, effective October 1,
1999, that will provide NCRIC Physicians Organization with $6,000 per month over
a
RP Financial, LC.
Page 1.35
five-year period. The monthly fee of $6,000 is reduced by $0.75 for each
subscriber who enrolls in the network plan.
Legal Proceedings
Other than the routine legal proceedings that occur in the Company's
ordinary course of business, the Company is not involved in litigation which is
expected to have a material impact on financial condition or operations.
RP Financial, LC.
Page 2.1
II. MARKET ENVIRONMENT
Introduction
Established in 1980, NCRIC was formed in an attempt by physicians
practicing in Washington, DC, under the auspices of the Medical Society of the
District of Columbia, to address the problem of rapidly escalating medical
professional liability costs. Since that time, NCRIC has sought to expand its
business, both by increasing the number of insureds and by expanding and
diversify its products and services. The Company believes that it maintains the
largest market share for medical professional liability insurance in the
District, with a total of 3,785 insured physicians, and a relatively strong and
growing market share in Maryland, particularly Montgomery County, as well as
Virginia. Additionally, the Company believes there are significant opportunities
for growth as it has recently commenced offering its insurance products in
Delaware and West Virginia. Based on data provided by A.M. Best Company, Inc.
for 2001, NCRIC had a 53% market share in the District, and a comparatively
lower share of the market in the other jurisdictions where it operates as noted
in Table 2.1 below.
Table 2.1
NCRIC Group, Inc.
Market Share by Jurisdiction Based on Premiums Written As of 2001
Market Share
% of Total
----------
District of Columbia 53%
Maryland 4
Virginia 5
West Virginia 4
Delaware 5
Source: A.M. Best.
Medical Professional Liability Insurance Market Overview
The United States is going through its third medical professional liability
crisis in as many decades. Medical professional liability insurance premiums,
which had been stable or
RP Financial, LC.
Page 2.2
rising in line with inflationary pressures for over a decade, are rising across
the country, in some areas dramatically. In addition, many insurance companies
are reducing coverage or withdrawing completely from the medical professional
liability market. This is leaving doctors in certain areas of the country,
especially those practicing in high risk specialties (e.g., obstetrics,
orthopedics, neurosurgery), facing extremely high insurance premiums, unable to
find coverage at any price, or having to opt for the most expensive coverage of
last resort. There are also frequent reports of doctors retiring or moving to
other states, dropping high-risk patients and procedures, and practicing
defensive medicine.
The rising cost of medical professional liability insurance primarily stems
from a variety of factors which have impacted the market including the
following:
. Increasing claims severity (including the cost of defending claims),
as well as an increase in the frequency of claims, both on a national
basis and within NCRIC's market; and
. The contraction of market capacity caused by claims losses experienced
by medical professional liability insurance providers, as well as by
rising reinsurance costs, and adverse trends in the capital markets
(i.e., losses in the stock market which have caused losses in the
equity portfolios of insurers as well as a falling interest rate
environment which has diminished interest income earned within the
bond portfolios of insurers).
Cyclical Nature of Insurance Underwriting
Insurance underwriting practices are cyclical with periodic adjusting of
rates after the fact to reflect actual losses during a given period. The
premiums are invested and the return on investment is factored in as part of an
insurer's profits and losses. During times of high interest rates or a strong
stock market, insurance companies keep their premiums low in order to remain
competitive, increase their market share, and acquire revenue to invest. This is
possible because their income is augmented from the high rate of return on
investments. A downturn in the stock market or a drop in interest rates results
in a lower rate of return on investments and leads to an increase in premiums.
After premium increases in the 1970s and again in the 1980s, the medical
professional liability market remained relatively stable through the economic
boom years of the 1990s.
RP Financial, LC.
Page 2.3
During this period, medical professional liability insurance was relatively
profitable, and new companies entered the market seeking to compete based
primarily on the basis of offering low premium rates. Additionally, the medical
professional liability market includes a large number of mutual companies,
primarily run by physicians for the benefit of physicians; physician managed
mutual have typically sought to expand with the objective of providing low-cost
medical professional liability insurance policies to doctors. The foregoing
factors combined to create a price war for new customers, prompting many
insurers to sell medical professional liability coverage, which with the benefit
of hindsight, were at rates too low to cover the costs of subsequent claims.
When the stock market became bearish, exacerbated by the September 11/th/
terrorist attacks, many of these companies suffered large losses and either went
out of business, drastically raised premiums, or stopped offering medical
professional liability insurance. The departure of St. Paul Companies, the
single largest carrier of medical professional liability insurance in the
country, was a serious blow that has created an availability crisis that
affected many practitioners around the country. Additionally, other carriers in
the Company's markets have become insolvent (i.e., PHICO and MIIX Group, for
example) or have retrenched from the market (i.e., Fireman's Fund in Delaware).
Frequency and Severity of Medical Professional Liability Claims
During each of the prior crises in the medical professional liability
insurance sector, the principal factor leading to the increase in premium rates
was attributable to much higher rates of litigation and expanded costs related
to defending policyholders and settling claims. The current crisis has been
caused by these same factors as noted in Table 2.2 below. In this regard, data
compiled by Jury Verdict Research, a leading firm, shows that the median jury
award for medical malpractice was $1 million in 2000, as compared to $700,000 in
1999 and $500,000 in 1995. Other key statistics reflecting in the increase in
frequency and severity of claims are described below.
. The size of jury awards in medical malpractice rose 43% from 1999 to
2000. The highest median award was childbirth cases at $2.05 million.
. Three of the top ten jury verdicts for 2001 were nursing home or
medical malpractice awards
RP Financial, LC.
Page 2.4
. The pay-out pattern is shortening which, coupled with diminishing
investment returns has impacted the earnings of medical professional
liability insurers. Specifically, the median number of months from
incident to trial date has decreased from 61 months in 1994 to 45
months in 2000.
. The Physicians Insurance Association of America ("PIAA"), the trade
group representing physician insurers, has compiled data in its 2002
Annual Report showing the average indemnity payment in 2001 was
$310,215, as compared to $196,408 in 1996.
. The PIAA 2002 Annual Report also showed that indemnity and expense
costs for claims have doubled in the past decade.
Table 2.2
NCRIC Group, Inc.
Settlement Negotiations for Medical Malpractice from 1994-2000
Final Final Award
Year Demand Offer Median
---- ------ ----- ------
1994 $270,000 $55,000 $ 362,500
1995 350,000 100,000 500,000
1996 257,500 100,000 474,536
1997 300,000 100,000 503,000
1998 300,000 100,000 733,900
1999 400,000 75,000 700,000
2000 562,500 80,000 1,000,000
Source: Jury Verdict Research, Horsham, Pennsylvania
RP Financial, LC.
Page 2.5
Compensatory Award Medians, Year by Year
[GRAPH]
1994 $ 362,500
1995 $ 500,000
1996 $ 474,536
1997 $ 503,000
1998 $ 733,900
1999 $ 700,000
2000 $1,000,000
Source: LRP Publications 2002.
Impact of Current Market on Medical Professional Liability Insurers
As described above, the rising frequency and severity of losses has had a
significant impact on medical professional liability insurers. In this regard,
medical professional liability insurance is a long-tail line of business for
which the costs of a claim may take years to develop. Thus, the higher frequency
and severity of claims now being recognized were for claims years where premiums
were relatively low, which has significantly impaired the profitability of
virtually all medical professional liability insurers.
The impact of the increasing expense of claims is evidenced in the loss
ratio. Based on data provided by the National Association of Insurance
Commissioners ("NAIC"), the industry loss ratio for medical professional
liability insurance has increased from 54.17% in 1997 to 97.73% in 2001. Table
2.3 provides data on an annual basis and a chart showing the national
RP Financial, LC.
Page 2.6
Table 2.3
NCRIC Group, Inc.
National Loss Ratio Since 1991
-----------------------------------------------------------------------
DIRECT DIRECT DIRECT
PREMIUM PREMIUM LOSSES LOSS
YEAR WRITTEN EARNED INCURRED RATIO
-----------------------------------------------------------------------
1991 5,041,116,742 4,974,652,480 2,815,117,139 56.59
1992 5,336,077,118 5,229,476,485 4,039,426,016 77.24
1993 5,451,861,069 5,254,614,981 3,525,005,041 67.08
1994 6,128,761,613 5,986,568,310 3,181,523,258 53.14
1995 6,174,433,133 6,137,209,298 3,330,613,605 54.27
1996 6,087,248,243 6,027,958,481 3,632,388,312 60.26
1997 5,949,762,287 5,949,688,215 3,222,735,496 54.17
1998 6,212,462,137 6,218,164,376 4,457,099,226 71.68
1999 6,181,174,156 6,167,948,760 4,659,896,010 75.55
2000 6,428,278,303 6,373,039,337 5,098,753,650 80.01
2001 7,602,831,870 7,033,569,527 6,874,050,778 97.73
-----------------------------------------------------------------------
MEAN 6,054,000,606 5,941,171,841 4,076,055,321 68.61
MEDIAN 6,128,761,613 6,027,958,481 3,632,388,312 60.26
-----------------------------------------------------------------------
Loss Ratio
[GRAPH]
RP Financial, LC.
Page 2.7
loss ratio since 1991 as well as the loss ratio for the five jurisdictions where
NCRIC underwrites insurance.
Importantly, the increasing losses have had a dramatic impact on the
availability of medical professional liability insurance. In this regard, in
December 2001, St. Paul Companies which had been the largest medical
professional liability carrier in the U.S. operating in 45 states, announced its
decision to no longer offer medical liability insurance coverage. At its peak,
St. Paul Companies covered 9% of the country's doctors, or over 40,000 doctors,
750 hospitals and 73,000 other health care providers. The schedule below
provides information showing how major carriers of medical professional
liability insurance have been impacted by rising losses, either through
downgrading of their rating, withdrawal from the market or insolvency.
NCRIC Competitors
. MIIX downgraded to C+ to unrated (only writing in New Jersey)
. Princeton downgraded to B+ (only writing in New Jersey)
. St. Paul/MMI - pulled out of healthcare
. Fireman's Fund - healthcare program exit
. PHICO - in liquidation
. Reliance - liquidated
. Doctors Insurance Reciprocal - in liquidation
Other Insurers
. TIG downgraded to B++
. SCPIE downgraded to B+
. TVIR downgraded to B-- to not rated (not followed)
. Union America - exited marketplace
. CAN Re - exited marketplace
. Travelers/Gulf - healthcare program exit
. Kemper - healthcare program exit
. Frontier - under regulatory supervision
. Legion - under regulatory supervision
. FPIC - downgraded to B++
. Zurich - downgraded to A
. ERC/Med Pro - downgraded to A+
Availability of Coverage and Premium Rate Increases
The increasing cost of policy claims coupled with the financial distress of
many insurers, which has led to their retrenchment or withdrawal from the
business or certain market segments,
RP Financial, LC.
Page 2.8
has led to a substantial increase in premium rates. Importantly, rate increases
have been highest in markets without tort reform. The increasing cost of
insurance and in some cases, the inability of physicians to obtain adequate
coverage, has created an availability crisis in certain section of the U.S. The
map below provides details regarding the availability and cost of medical
professional liability insurance by jurisdiction, as determined by the American
Medical Association.
[MAP]
Source: AMA written statement to Health Subcommittee-July 17, 2002
Summary
NCRIC has responded to recent trends within the industry in several ways.
First, in recognition of the sharp increase in the severity of losses, the
weighted average increase on NCRIC's base premium was 15.8% commencing in
January 2002, and 29.2% commencing in January 2003. While the near term impact
of these rate increases has not been fully reflected in earnings, the premium
rate increases should serve to increase future profitability as they are fully
realized into net premiums earned, offset to the extent losses may also
increase. Additionally,
RP Financial, LC.
Page 2.9
NCRIC believes it will be able to expand significantly in markets such as
Virginia (market share is currently 5%) as three major providers including the
largest in the state are no longer providing coverage leaving up to 30% of the
market open. Similarly, there have been withdrawals by major competitors in
Maryland and Delaware which, coupled with the ability to expand as a result of
its strong capitalization, may likely enhance future premium revenues and
earnings.
RP Financial, LC.
Page 3.1
III. PEER GROUP ANALYSIS
The applicable valuation technique is the pro forma market value
approach, whereby the pro forma market value of NCRIC is derived based on the
market pricing of a group of publicly-traded insurance companies sharing
reasonably comparable characteristics. This chapter presents an analysis of
NCRIC's operations versus a group of comparable companies (the "Peer Group")
selected from the universe of all publicly-traded insurance companies which
share reasonably comparable characteristics. Factors affecting the Company's pro
forma market value, such as financial condition, operating performance, exposure
to risk and liquidity of the stock, can be readily assessed in relation to the
Peer Group. Current market pricing of the Peer Group, subject to adjustments to
account for fundamental differences between NCRIC and the Peer Group, will then
be used as a basis for the valuation of NCRIC's to-be-issued common stock.
Peer Group Selection
We consider the appropriate Peer Group to be comprised of only those
publicly-traded insurance companies whose common stock is either listed on a
national exchange or is NASDAQ listed, since the market for companies trading in
this fashion is generally regular and reported. We believe non-listed companies
are inappropriate since the trading activity for thinly-traded stocks is
typically highly irregular in terms of frequency and price and may not be a
reliable indicator of market value. We have excluded from the Peer Group those
companies under acquisition and/or those companies whose market prices appear to
be distorted by speculative factors or unusual operating conditions.
Ideally, the Peer Group should be comprised of publicly-traded medical
professional liability insurers with comparable financial characteristics.
However, the number of medical professional liability monoline insurers is
limited. In this regard, we identified four publicly-traded companies generating
a majority of their premium income from medical professional liability
insurance. None of the Peer Group companies had comparable market concentration
in the District. While we believe these four companies are useful in deriving
value for NCRIC, any
RP Financial, LC.
Page 3.2
unusual operating, financial or trading characteristics of any one Peer Group
member may have undue influence on the Peer Group average or median ratios.
Accordingly, we expanded the Peer Group to include three companies
actively engaged in underwriting workers' compensation insurance given important
similarities between the medical professional liability and workers'
compensation insurance business lines. The similarities between medical
professional liability and workers' compensation insurance include: (1) both are
commercial business lines; (2) both are long-tail line businesses, wherein
claims for a given policy year may not be paid until a considerable period has
elapsed; (3) claims related litigation may extend for a considerable period time
and involve significant expense; and (4) both have a high severity of claims.
Additionally, like the medical professional liability sector, the workers'
compensation insurance sector has been impacted by rising frequency and severity
of claims, and weakening of overall earnings levels, which enhances its
comparability to NCRIC's primary business line.
Table 3.1 lists certain key characteristics of the Peer Group
companies. A summary of each of the Peer Group companies is provided below.
. American Physicians Capital, Inc., or APCapital, is an insurance
holding company which focuses its insurance underwriting activities
on medical professional liability insurance through its
subsidiaries American Physicians Assurance Corporation, or
APAssurance (formerly Mutual Insurance Corporation Of America, or
MICOA), Insurance Corporation of America and APSpecialty Insurance
Corporation (formerly RML Insurance Company). The Company
underwrites medical professional and hospital professional
liability policy coverages for physicians and physician medical
groups, clinics and other providers in the health care industry.
APCapital also provides workers' compensation insurance and focuses
its efforts on eight workers' compensation business niches: health
care, light to medium manufacturing, restaurants, educational
services, non-profit organizations, specialty trade contractors,
wholesalers, and auto related sales and services. On a limited
basis, APCapital offers health insurance coverage, primarily to
customers of its other insurance products. APCapital insured
approximately 12,500 physicians in 14 states throughout the United
States, with a concentration in the Midwest as of December 31,
2001.
RP Financial, LC.
Page 3.3
RP Financial, LC.
Financial Services Industry Consultants
Table 3.1
Peer Group of Publicly-Traded Insurance Companies
General Characteristics
Trailing
12 Months(1)
---------------------
Property/Casualty Total Policy Total
Ticker Company Exchange Lines of Business Assets Revenues Revenues
- ------ ------- -------- ----------------- ------ -------- --------
($Mil) ($Mil) ($Mil)
NCRI NCRIC Group, Inc. NASDAQ Professional Liability $ 203 $ 30 $ 43
ACAP American Physicians Capital, Inc. NASDAQ Professional Liability $ 1,059 $ 228 $ 273
AGGI Argonaut Group, Inc. NASDAQ Workers' Comp. 1,996 353 427
FPIC FPIC Insurance Group, Inc. NASDAQ Professional Liability 1,026 156 222
PRA ProAssurance, Inc. NYSE Professional Liability 2,586 461 524
RTWI RTW, Inc. NASDAQ Workers' Comp. 206 62 70
SKP SCPIE Holdings Inc. NYSE Professional Liability 1,064 286 339
ZNT Zenith National Insur. Corp. NYSE Workers' Comp. 1,616 532 582
Medical Malpractice/
Workers Comp. As of 3/11/03
---------------------
Premium/Total Common Market
Ticker Company Policy Revenues(1) Stock Price Value
- ------ ------- ----------------- ----------- ---------
(%) ($) ($Mil)
NCRI NCRIC Group, Inc. 100% $16.02 $ 24 (2)
ACAP American Physicians Capital, Inc. 90% $19.40 $ 169
AGGI Argonaut Group, Inc. 31% 12.42 268
FPIC FPIC Insurance Group, Inc. N.A. (3) 7.55 71
PRA ProAssurance, Inc. 69% 22.81 650
RTWI RTW, Inc. N.A. (4) 2.30 24
SKP SCPIE Holdings Inc. 100% (5) 5.94 55
ZNT Zenith National Insur. Corp. 91% 20.26 380
(1) Based on financial data for the 12 months ended 12/31/02, for NCRIC and
annualized for the 9 months ended 9/30/02 for several of the Peer Group
companies.
(2) Reflects the value of minority shares held by the public.
(3) Data is not publicly available but medical malpractice premium revenues
accounts for a majority of the total.
(4) Data is not publicly available but workers compensation insurance accounts
for a majority of the total.
(5) Approximate. Includes reinsurance premiums for medical professional
liability policies issued to other insurers.
Source: SNL Financial's Insurance Quarterly Report and corporate reports.
RP Financial, LC.
Page 3.4
. Argonaut Group, Inc. is a national provider of specialty insurance
products focused on high quality customer service for specific
niches of property-casualty insurance. Argonaut Group has four
primary product lines: excess and surplus lines, specialty
commercial, specialty workers' compensation, and public entity.
Workers' compensation accounted for approximately 31% of premiums
in fiscal 2001.
. FPIC Insurance Group, Inc. ("FPIC") is the holding company for
Florida Physicians Insurance FPIC, Inc. FPIC is the largest
provider of medical professional liability insurance in Florida,
based on the total number of physicians and dentists insured. Its
principal subsidiaries are Florida Physicians Insurance FPIC, Inc.
(FPIC), Anesthesiologists' Professional Assurance FPIC (APAC) and
Employers Mutual Inc. (EMI). FPIC has three main operating
segments: insurance, reciprocal management and third party
administration. Through the insurance segment, FPIC specializes in
professional liability insurance products and services for
physicians, dentists, other healthcare providers and attorneys.
FPIC's reciprocal management segment provides management services
and brokerage and administration services for reinsurance programs
and the placement of annuities in structured settlements. In
addition, FPIC's third party administration segment markets and
administers self-insured and fully insured plans for both large and
small employers, including group accident and health insurance,
workers' compensation and general liability and property insurance.
. ProAssurance, Inc. is an insurance holding company which provides
medical professional liability protection to physicians, hospitals,
dentists, and managed care and health care organizations through
programs which coordinate traditional insurance with effective
clinical risk management. While professional liability insurance
for physicians and their related practice entities is the principal
product offered by ProAssurance, it has undertaken to develop other
insurance products necessitated by changes in the health care
industry. ProAssurance has two reportable industry segments:
professional liability insurance and personal lines insurance.
ProAssurance has an active presence in the south, southwest and
midwest.
. RTW, Inc. provides comprehensive management products and services
to employers for workers' compensation products in Minnesota,
Wisconsin, South Dakota, Colorado, Illinois, Kansas, Michigan,
Indiana, Connecticut, New Hampshire, Rhode Island and Maine. RTW
has developed a proprietary management approach to reduce wage
replacement costs and medical expenses resulting from workplace
injuries by returning injured employees to work as soon as possible
and by actively managing all the participants in the workers'
compensation system. Workers' compensation insurance premiums
account for the substantial majority of net premium revenues.
RP Financial, LC.
Page 3.5
. SCPIE Holdings, Inc. is a provider of medical professional
liability insurance and related liability insurance products to
physicians, healthcare facilities and others engaged in the
healthcare industry. Since August 1999, SCIPIE Holdings has also
been actively engaged in developing a diverse portfolio of assumed
reinsurance treaties to complement its direct insurance business.
Reinsurance treaties have principally included professional and
automobile liability coverages, commercial and residential property
risks, accident and health and workers' compensation coverages, and
a broad spread of marine insurance. SCIPIE Holdings believes it is
the second largest provider of medical professional liability
insurance in California based on the level of direct premiums
written.
. Zenith National Insurance Corp. and its subsidiaries conduct
business principally in the property and casualty insurance
industry. Workers' compensation insurance comprise the largest
single segment of business (91% of net premium revenues in fiscal
2001) followed by its reinsurance business line. Zenith National
Insurance Corp. also offers other property-casualty lines including
automobile, homeowners, farmowners, commercial coverages and health
insurance. Zenith National also conducts real estate operations
through a wholly-owned subsidiary that develops land and constructs
single family houses in the Las Vegas, Nevada area.
The following sections present a comparison of NCRIC's financial
condition, income and expense trends, and a risk assessment versus the latest
reported data by the Peer Group. The conclusions drawn from the comparative
analysis are then factored into the valuation analysis discussed in the final
chapter.
Financial Condition
Cash and Investments
Overall, the balance sheet composition of NCRIC and the Peer Group
were relatively comparable (see Table 3.2). Cash and investments comprised the
bulk of assets for both the Company and the Peer Group, and NCRIC maintained a
slightly higher proportion of cash and investments, 64.5% versus 63.0% for the
Peer Group. The Company's cash position was recently enhanced though the
issuance of trust preferred securities in December 2002, which provided
approximately $15 million of cash for reinvestment. The Company's cash and
investments are anticipated to increase following the stock offering pending
longer-term deployment.
RP Financial, LC.
Page 3.6
RP Financial, LC.
Financial Services Industry Consultants
Table 3.2
Balance Sheet Composition
Peer Group Analysis
For the Most Recent Twelve Month Period(1)
Peer Group Companies
------------------------------------------------------
Professional Liability Peer Group
------------------------------------------------------
American FPIC
NCRIC Peer Group Physicians Insurance Pro SCPIE
Group, Inc. ------------------ Capital, Inc. Group Assurance Holdings, Inc.
Peer Group Ticker Symbol 12/31/2002 Average Median ACAP FPIC PRA SKP
---------- ------- -------- ---- ---- --- ---
Primary Insurance Line PL PL PL PL PL
Balance Sheet
- -------------
Cash & Investments 64.47% 63.01% 63.90% 75.70% 52.97% 72.07% 72.51%
Reinsurance Assets 21.33% 18.35% 16.77% 9.27% 25.19% 17.79% 8.10%
Deferred Policy Acqstn. Costs 0.00% 0.91% 0.51% 0.00% 0.50% 0.00% 2.10%
Intangibles 4.67% 1.43% 0.93% 0.00% 2.11% 0.93% 0.52%
Separate Accounts 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Other Assets 9.53% 16.30% 17.16% 15.04% 19.22% 9.21% 16.76%
----- ------ ------ ------ ------ ----- ------
Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Policy Reserves 64.74% 72.14% 71.14% 69.97% 62.75% 75.56% 72.67%
Debt 0.49% 1.66% 0.97% 0.60% 5.14% 3.06% 0.00%
Other Liabilities 3.79% 5.68% 2.96% 2.96% 15.43% 1.88% 2.59%
----- ----- ----- ----- ------ ----- -----
Total Liabilities 69.02% 79.47% 78.26% 73.53% 83.33% 80.51% 75.26%
Minority Interest 0.00% 0.15% 0.00% 0.00% 0.00% 1.04% 0.00%
Redeemable Pfd. Equity 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Trust Preferred Securities 7.40% 0.58% 0.00% 0.00% 0.00% 0.00% 0.00%
Preferred Equity 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Common Equity 23.59% 19.65% 19.91% 26.47% 16.67% 17.41% 24.74%
------ ------ ------ ------ ------ ------ ------
Total Equity 23.59% 19.65% 19.91% 26.47% 16.67% 17.41% 24.74%
Tangible Equity 18.92% 18.21% 16.59% 26.47% 14.56% 16.49% 24.21%
----------------------------------
Workers Compensation Peer Group
----------------------------------
Argonaut Zenith
Group RTW, Inc. National
Peer Group Ticker Symbol AGII RTWI ZNT
---- ---- ---
Primary Insurance Line WC WC WC
Balance Sheet
- -------------
Cash & Investments 59.83% 44.11% 63.90%
Reinsurance Assets 13.20% 38.13% 16.77%
Deferred Policy Acqstn. Costs 2.40% 0.51% 0.83%
Intangibles 5.14% 0.00% 1.33%
Separate Accounts 0.00% 0.00% 0.00%
Other Assets 19.43% 17.24% 17.16%
------ ------ ------
Total Assets 100.00% 100.00% 100.00%
Policy Reserves 71.14% 85.80% 67.10%
Debt 0.00% 0.97% 1.81%
Other Liabilities 7.13% 2.63% 7.11%
----- ----- -----
Total Liabilities 78.26% 89.41% 76.03%
Minority Interest 0.00% 0.00% 0.00%
Redeemable Pfd. Equity 0.00% 0.00% 0.00%
Trust Preferred Securities 0.00% 0.00% 4.07%
Preferred Equity 0.00% 0.00% 0.00%
Common Equity 21.74% 10.59% 19.91%
------ ------ ------
Total Equity 21.74% 10.59% 19.91%
Tangible Equity 16.59% 10.59% 18.58%
(1) Reflects results for the twelve months ended December 31, 2002 for NCRIC
and the latest available date for the Peer Group.
Source: Audited and unaudited financial statements, corporate reports and
offering circulars.
The information provided in this table has been obtained from sources we
believe are reliable, but we cannot guarantee the accuracy or
completeness of such information.
RP Financial, LC.
Page 3.7
Reinsurance Assets
Reinsurance assets comprised the predominant portion of other assets for
the Company and the Peer Group, totaling 21.3% and 18.4% of assets,
respectively. The slightly higher level of reinsurance assets is partially
attributable to the Company's comparatively smaller size and capital base as
measured in dollar terms, which increases the requirement for obtaining
reinsurance. The future level of reinsurance assets may diminish for NCRIC in
comparison to the Peer Group as NCRIC has recently increased the level of risk
retention pursuant to its current reinsurance treaty.
Other Assets
Other miscellaneous assets, including intangibles and separate accounts,
equaled 14.2% of assets for the Company and 17.7% of assets for the Peer Group
on average. Both NCRIC and the Peer Group maintained a moderate level of
intangible assets (4.7% of assets for NCRIC versus an average of 1.4% for the
Peer Group).
Liabilities
The level of policy reserves, which includes all loss reserves and LAE,
for NCRIC and the Peer Group, approximated 64.7% and 72.1% of assets,
respectively. NCRIC has only a modest level of debt utilized in connection with
the acquisition of HealthCare Consulting, while the Peer Group's debt balance is
modestly higher (1.7% on average). Other liabilities for NCRIC (4.3% of assets)
fell short of the Peer Group average (7.3% of assets).
Trust Preferred Securities
The Company recently completed the issuance of trust preferred
securities to accomplish the following objectives: (1) to provide capital to the
Company's insurance subsidiaries with the objective of expanding premium
revenues and market share over the near term when insurance premium rates are
believed to be profitable; and (2) to provide capital to enable NCRIC Group to
reduce its reliance on reinsurance through greater risk retention during a
period when reinsurance is perceived to be costly. As of December 31, 2002,
trust preferred securities equaled 7.4% of assets for NCRIC but were at modest
levels for the Peer Group (0.6% of assets).
RP Financial, LC.
Page 3.8
Equity
NCRIC's equity base of 23.6% was above the Peer Group's average equity
ratio of 19.7%, on a pre-offering basis. NCRIC operates with a modestly higher
level of intangible assets. Accordingly, the Company's tangible equity, equal to
18.9% of assets compared relatively closely to the Peer Group average of 18.2%
of assets. With the addition of the stock proceeds from the conversion, the
Company's pro forma equity and tangible positions will be bolstered and
substantially exceed the Peer Group averages and medians.
The increase in the Company's equity position to be realized from the
stock offering will serve to enhance future earnings potential that may be
realized through growth. However, at the same time, the Company's higher pro
forma equity position is anticipated to result in a decline in return on equity
over the near term. Both the Company's and the Peer Group's equity ratios
reflected equity surpluses relative to statutory requirements.
Growth Rates
NCRIC's balance sheet expansion reflected asset growth of 25.9% for the
twelve months ended December 31, 2002, versus an average and median of 8.5% and
6.7%, respectively, for the Peer Group for the most recent 12 months for which
data is publicly available (see Table 3.3). The Company's higher growth reflects
NCRIC's strong financial condition and efforts to expand in response to its
perceived ability to profitably underwrite new business, particularly in markets
where competing providers have contracted or withdrawn entirely in certain
circumstances. By comparison, the majority of the Peer Group companies (four out
of seven) have reported operating losses for the most recent twelve month period
and the resulting erosion of capital, coupled with unfavorable market
conditions, has led to their comparatively moderate balance sheet growth.
Equity growth for the last 12 months for the Company and the Peer Group
equaled 7.6% versus a 10.5% reduction for the Peer Group on average (8.7%
shrinkage based on the median). Importantly, five out of the seven Peer Group
companies reported erosion of their capital positions which is reflective of
their operating losses and the difficult operating conditions in the industry
overall. Following the second step conversion offering, the Company's equity
growth rate can be expected to decline initially until the new equity can be
RP Financial, LC.
Page 3.9
RP Financial, LC.
Financial Services Industry Consultants
Table 3.3
Balance Sheet Growth Rates
Peer Group Analysis
For the Most Recent Twelve Month Period(1)
Peer Group Companies
---------------------------------------------------------------------------
Professional Liability Peer Group Workers Compensation Peer Group
------------------------------------------- -------------------------------
NCRIC American FPIC SCPIE
Group, Peer Group Physicians Insurance Pro Holdings, Argonaut Zenith
Inc. ----------------- Capital, Inc. Group Assurance Inc. Group RTW, Inc. National
Peer Group Ticker Symbol 12/31/2002 Average Median ACAP FPIC PRA SKP AGII RTWI ZNT
---------- ------- -------- ---- ---- --- --- ---- ---- ---
Primary Insurance Line PL PL PL PL PL WC WC WC
Annual Growth Rates (1)
- -----------------------
Cash & Investments 18.05% 5.08% 6.52% 6.52% 13.36% 11.73% 0.54% 1.82% -8.01% 9.60%
Reinsurance Assets 43.73% 21.66% 2.34% 2.34% 112.24% 7.35% 40.72% -5.01% 0.50% -6.55%
Deferred Policy Acqstn.
Costs N.M. -6.75% -7.80% -100.00% -35.49% N.M. 10.36% 131.88% -39.49% -7.80%
Intangibles 0.00% -34.17% -1.07% -100.00% -66.22% N.M. -3.76% 0.20% N.M. -1.07%
Separate Accounts N.M. N.M. 0.00% N.M. N.M. N.M. N.M. N.M. N.M. N.M.
Other Assets 66.02% 21.11% 30.05% -3.98% 77.02% -21.71% 34.35% 30.05% 32.33% -0.30%
Total Assets 25.89% 8.50% 6.66% 1.93% 30.75% 7.71% 7.75% 6.66% 0.23% 4.48%
Policy Reserves 23.85% 16.99% 12.32% 6.28% 36.07% 12.32% 27.38% 8.64% 21.69% 6.55%
Debt -40.13% -41.71% -11.76% -11.36% -10.70% -11.76% -100.00% N.M. -55.56% -60.88%
Other Liabilities -14.30% 12.92% 13.31% 13.31% 189.77% -53.06% -32.64% 21.73% -66.97% 18.31%
Total Liabilities 20.01% 14.57% 9.71% 6.38% 45.67% 7.70% 18.42% 9.71% 10.84% 3.26%
Minority Interest 0.00% 15.43% 0.00% N.M. N.M. 15.43% N.M. N.M. N.M. N.M.
Redeemable Pfd. Equity 0.00% N.M. 0.00% N.M. N.M. N.M. N.M. N.M. N.M. N.M.
Trust Preferred Securities N.M. 0.08% 0.00% N.M. N.M. N.M. N.M. N.M. N.M. 0.08%
Preferred Equity N.M. N.M. 0.00% N.M. N.M. N.M. N.M. N.M. N.M. N.M.
Common Equity and Ret.
Earn. 7.56% -10.50% -8.69% -8.69% -13.52% 1.30% -15.43% -3.06% -44.57% 10.45%
Total Equity 7.56% -10.50% -8.69% -8.69% -13.52% 1.30% -15.43% -3.06% -44.57% 10.45%
(1) Reflects results for the twelve months ended December 31, 2002 for NCRIC
and the latest available date for the Peer Group.
Source: Audited and unaudited financial statements, corporate reports and
offering circulars.
The information provided in this table has been obtained from sources we
believe are reliable, but we cannot guarantee the accuracy or
completeness of such information.
RP Financial, LC.
Page 3.10
more fully deployed, primarily though expansion of underwriting within NCRIC's
insurance business segment.
Income and Expense Components
NCRIC's recent financial performance compares favorably to the Peer Group
average. In this regard, while NCRIC's operations have been negatively impacted
by adverse industry trends (i.e., rising frequency and severity of losses
coupled with diminishing investment income), it has been less impacted than the
Peer Group companies. Overall, the Company operates with a favorable loss ratio,
which coupled with a relatively similar expense ratio, provides for a favorable
combined ratio.
The aggregate level of revenues and expenses as a percent of average
assets was comparatively lower for NCRIC. In this regard, total revenues equaled
23.48% for NCRIC versus an average of 27.62% of average assets for the Peer
Group (see Table 3.4). In contrast, pre-tax expenses equaled 23.25% for the
Company and 29.03% of average assets for the Peer Group. We attribute this
difference primarily to: (1) the Company's strong focus on medical professional
liability insurance which is a long tail line of business which thus facilitates
the build-up of invested assets; and (2) NCRIC's focus on underwriting insurance
for policyholders with lower risk profiles.
Income and expense expressed as a percent of revenues indicate relative
comparability to the Peer Group, with the principal difference being NCRIC's
comparatively higher policy expenses and lower other expenses (see Table 3.5).
Revenues
Policy revenues (i.e., net premiums earned) represented the largest
revenue source for both the Company and the Peer Group, equal to 16.55% and
22.86% of assets, respectively. The next largest revenue source was investment
income, which equaled 3.25 and 3.13% of assets, respectively, for the Company
and the Peer Group. NCRIC's slightly higher ratio of investment income is
reflective of the moderately higher level of invested assets reported for the
Company.
RP Financial, LC.
Page 3.11
RP Financial, LC.
Financial Services Industry Consultants
Table 3.4
Income and Expenses as a Percent of Average Assets
Peer Group Analysis
For the Most Recent Twelve Month Period(1)
----------------------------------------------------
Peer Group Companies
----------------------------------------------------
Professional Liability Peer Group
----------------------------------------------------
American FPIC
NCRIC Peer Group Physicians Insurance Pro SCPIE
Group, Inc. ------------------ Capital, Inc. Group Assurance Holdings, Inc.
Peer Group Ticker Symbol 12/31/2002 Average Median ACAP FPIC PRA SKP
---------- ------- -------- ---- ---- --- ---
Primary Insurance Line PL PL PL PL PL
Income Statement
- ----------------
Policy Revenues 16.55% 22.86% 19.96% 22.36% 19.96% 19.59% 30.79%
Net Investment Income 3.25% 3.13% 3.19% 4.32% 2.57% 3.36% 3.35%
Net Realized Gains -0.07% 0.35% 0.40% -0.09% 0.40% -0.60% 0.70%
Non-Recurring Revenues 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Other Revenues 3.75% 1.28% 0.21% 0.04% 4.13% 0.28% 0.21%
------- ------- ------- ------- ------- ------- -------
Total Revenues 23.48% 27.62% 26.63% 26.63% 27.06% 22.63% 35.06%
Policy Expenses 14.75% 22.06% 18.69% 22.97% 17.74% 18.69% 35.51%
Other Expenses 8.50% 6.64% 7.19% 5.04% 7.24% 3.86% 8.26%
Interest Expense 0.00% 0.19% 0.11% 0.04% 0.63% 0.14% 0.02%
Non-Recurring Expenses 0.00% 0.14% 0.00% 0.00% 0.08% 0.00% 0.00%
----- ------- ------- ------- ------- ------- -----
Total Expenses 23.25% 29.03% 25.69% 28.05% 25.69% 22.69% 43.79%
Net Income Before Taxes 0.23% -1.42% -0.05% -1.42% 1.37% -0.05% -8.74%
Provision for Taxes -0.18% 0.19% 0.37% -0.53% 0.56% -0.30% -3.13%
------- ------- ------- ------- ------- ------- -------
Net Inc. Before Adj. & Min. Int. 0.41% -1.61% 0.24% -0.89% 0.81% 0.24% -5.61%
Plus: After-Tax Adjustments 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Less: Minority Interest Exp. 0.00% -0.02% 0.00% 0.00% 0.00% -0.12% 0.00%
------- ------- ------- ------- ------- ------- -------
Net Income Before Extraordinary 0.41% -1.63% 0.12% -0.89% 0.81% 0.12% -5.61%
Extraordinary Items 0.00% -0.62% 0.00% -0.86% -3.64% 0.07% 0.00%
------- ------- ------- ------- ------- ------- -------
Net Income (ROA) 0.41% -2.25% -1.76% -1.76% -2.83% 0.19% -5.61%
Return on Average Equity (ROE) 1.61% -14.78% -6.29% -6.29% -14.18% 1.07% -21.35%
Combined Ratio Analysis (2)
- ---------------------------
Loss Ratio 89.14% 97.66% 95.39% 102.75% 88.89% 95.39% 115.33%
Expense Ratio 27.14% 27.69% 26.82% 22.53% 36.26% 19.72% 26.82%
------- ------- ------- ------- ------- ------- -------
Combined Ratio 116.28% 125.35% 125.15% 125.28% 125.15% 115.11% 142.15%
Pre-Tax Underwriting Profit Margin (2) -16.28% -25.35% -25.15% -25.28% -25.15% -15.11% -42.15%
Pre-Tax Operating Profit Margin (2) 1.17% -5.24% -0.24% -5.33% 5.07% -0.24% -24.93%
-----------------------------------
Workers Compensation Peer Group
-----------------------------------
Argonaut Zenith
Group RTW, Inc. National
Peer Group Ticker Symbol AGII RTWI ZNT
---- ---- ---
Primary Insurance Line WC WC WC
Income Statement
- ----------------
Policy Revenues 19.22% 14.39% 33.70%
Net Investment Income 2.83% 2.27% 3.19%
Net Realized Gains 0.99% 0.85% 0.21%
Non-Recurring Revenues 0.00% 0.00% 0.00%
Other Revenues 0.00% 0.00% 4.28%
------- ------- -------
Total Revenues 23.04% 17.51% 41.39%
Policy Expenses 14.52% 18.15% 26.82%
Other Expenses 7.19% 1.71% 13.22%
Interest Expense 0.00% 0.11% 0.36%
Non-Recurring Expenses 0.00% 0.93% 0.00%
------- ------- -------
Total Expenses 21.71% 20.90% 40.40%
Net Income Before Taxes 1.33% -3.39% 0.99%
Provision for Taxes 0.40% 3.98% 0.37%
------- ------- -------
Net Inc. Before Adj. & Min. Int. 0.93% -7.38% 0.63%
Plus: After-Tax Adjustments 0.00% 0.00% 0.00%
Less: Minority Interest Exp. 0.00% 0.00% 0.00%
------- ------- -------
Net Income Before Extraordinary 0.93% -7.38% 0.63%
Extraordinary Items 0.00% 0.00% 0.06%
------- ------- -------
Net Income (ROA) 0.93% -7.38% 0.69%
Return on Average Equity (ROE) 3.94% -70.14% 3.50%
Combined Ratio Analysis (2)
- ---------------------------
Loss Ratio 75.57% 126.07% 79.58%
Expense Ratio 37.39% 11.90% 39.23%
------- ------- -------
Combined Ratio 112.96% 137.97% 118.81%
Pre-Tax Underwriting Profit Margin (2) -12.96% -37.97% -18.81%
Pre-Tax Operating Profit Margin (2) 5.76% -19.39% 2.39%
(1) Reflects results for the twelve months ended December 31, 2002 for NCRIC
and the latest available date for the Peer Group.
(2) Excludes practice management income and expense for NCRIC Group.
Source: Audited and unaudited financial statements, corporate reports and
offering circulars.
RP Financial, LC.
Page 3.12
RP Financial, LC.
Financial Services Industry Consultants
Table 3.5
Income and Expenses as a Percent of Revenues
Peer Group Analysis
For the Most Recent Twelve Month Period(1)
Peer Group Companies
--------------------------------------------------------
Professional Liability Peer Group
----------------------------------------------------
American
Physicians FPIC
NCRIC Peer Group Capital, Insurance Pro SCPIE
Group, Inc. -------------------- Inc. Group Assurance Holdings, Inc.
Peer Group Ticker Symbol 12/31/2002 Average Median ACAP FPIC PRA SKP
---------- ------- ------ ---- ---- --- ---
Primary Insurance Line PL PL PL PL PL
Income Statement
- ----------------
Policy Revenues 70.50% 82.74% 83.42% 83.96% 73.77% 86.56% 87.84%
Net Investment Income 13.85% 11.87% 12.30% 16.23% 9.48% 14.82% 9.57%
Net Realized Gains -0.31% 1.45% 1.48% -0.33% 1.48% -2.63% 1.99%
Non-Recurring Revenues 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Other Revenues 15.95% 3.95% 0.61% 0.13% 15.27% 1.25% 0.61%
------ ------ ------ ------ ------ ------ ------
Total Revenues 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Policy Expenses 62.84% 81.03% 82.57% 86.27% 65.57% 82.57% 101.30%
Other Expenses 36.18% 22.74% 23.56% 18.92% 26.74% 17.07% 23.56%
Interest Expense 0.00% 0.66% 0.60% 0.13% 2.32% 0.60% 0.07%
Non-Recurring Expenses 0.00% 0.80% 0.00% 0.00% 0.29% 0.00% 0.00%
------ ------ ------ ------ ------ ------ ------
Total Expenses 99.02% 105.24% 100.24% 105.33% 94.93% 100.24% 124.93%
Net Income Before Taxes 0.98% -5.24% -0.24% -5.33% 5.07% -0.24% -24.93%
Provision for Taxes -0.75% 2.18% 0.88% -1.97% 2.08% -1.32% -8.92%
------ ------ ------ ------ ------ ------ ------
Net Inc. Before Adj. & Min. Int. 1.74% -7.42% 1.08% -3.35% 2.99% 1.08% -16.01%
Plus: After-Tax Adjustments 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Less: Minority Interest Exp. 0.00% -0.08% 0.00% 0.00% 0.00% -0.55% 0.00%
------ ------ ------ ------ ------ ------- ------
Net Income Before Extraordinary 1.74% -7.49% 0.53% -3.35% 2.99% 0.53% -16.01%
Extraordinary Items 0.00% -2.32% 0.00% -3.24% -13.47% 0.32% 0.00%
------ ------ ------ ------ ------ ------ ------
Net Income 1.74% -9.81% -6.59% -6.59% -10.48% 0.85% -16.01%
Return on Average Equity 1.61% -14.78% -6.29% -6.29% -14.18% 1.07% -21.35%
Combined Ratio Analysis
- -----------------------
Loss Ratio 89.14% 97.66% 95.39% 102.75% 88.89% 95.39% 115.33%
Expense Ratio 27.14% 27.69% 26.82% 22.53% 36.26% 19.72% 26.82%
------ ------ ------ ------ ------ ------ ------
Combined Ratio 116.28% 125.35% 125.15% 125.28% 125.15% 115.11% 142.15%
Pre-Tax Underwriting Profit Margin -16.28% -25.35% -25.15% -25.28% -25.15% -15.11% -42.15%
Pre-Tax Operating Profit Margin 1.17% -5.24% -0.24% -5.33% 5.07% -0.24% -24.93%
----------------------------------
Workers Compensation Peer Group
--------------------------------
Argonaut Zenith
Group RTW, Inc. National
Peer Group Ticker Symbol AGII RTWI ZNT
---- ---- ---
Primary Insurance Line WC WC WC
Income Statement
- ----------------
Policy Revenues 83.42% 82.22% 81.42%
Net Investment Income 12.30% 12.95% 7.71%
Net Realized Gains 4.28% 4.83% 0.51%
Non-Recurring Revenues 0.00% 0.00% 0.00%
Other Revenues 0.00% 0.00% 10.35%
------ ------ ------
Total Revenues 100.00% 100.00% 100.00%
Policy Expenses 63.05% 103.65% 64.80%
Other Expenses 31.19% 9.78% 31.94%
Interest Expense 0.00% 0.65% 0.87%
Non-Recurring Expenses 0.00% 5.30% 0.00%
------ ------ ------
Total Expenses 94.24% 119.39% 97.61%
Net Income Before Taxes 5.76% -19.39% 2.39%
Provision for Taxes 1.73% 22.76% 0.88%
------ ------ ------
Net Inc. Before Adj. & Min. Int. 4.03% -42.14% 1.51%
Plus: After-Tax Adjustments 0.00% 0.00% 0.00%
Less: Minority Interest Exp. 0.00% 0.00% 0.00%
------ ------ ------
Net Income Before Extraordinary 4.03% -42.14% 1.51%
Extraordinary Items 0.00% 0.00% 0.15%
------ ------ ------
Net Income 4.03% -42.14% 1.66%
Return on Average Equity 3.94% -70.14% 3.50%
Combined Ratio Analysis
- -----------------------
Loss Ratio 75.57% 126.07% 79.58%
Expense Ratio 37.39% 11.90% 39.23%
------ ------ ------
Combined Ratio 112.96% 137.97% 118.81%
Pre-Tax Underwriting Profit Margin -12.96% -37.97% -18.81%
Pre-Tax Operating Profit Margin 5.76% -19.39% 2.39%
(1) Reflects results for the twelve months ended December 31, 2002 for NCRIC and
the latest available date for the Peer Group.
(2) Excludes practice management income and expense for NCRIC Group.
Source: Audited and unaudited financial statements, corporate reports and
offering circulars.
The information provided in this table has been obtained from sources
we believe are reliable, but we cannot guarantee the accuracy or
completeness of such information.
RP Financial, LC.
Page 3.13
Gains and other miscellaneous income sources were limited for both, but
were more significant for the Peer Group. Overall, the Company reported
investment losses equal to 0.07% of assets versus investment gains averaging
0.35% on average for the Peer Group. While NCRIC's investment gains and losses
were low on a net basis, sales activity within the portfolio was high by
historical standards as losses realized on WorldCom bonds and other investments
were substantially offset by gains realized on the sale of other securities.
Other income was higher for NCRIC (3.75% of assets for the Company versus 1.28%
of assets for the Peer Group), reflecting the proportionately larger
contribution of NCRIC's practice management services to overall revenues.
Expenses
Offsetting the Company's modestly lower level of policy revenues were
higher policy expenses relative to the Peer Group, both as a percent of average
assets and total revenues. Specifically, policy expenses (i.e., losses and LAE)
equaled 14.75% of average assets and 62.84% of total revenues for NCRIC versus
22.06% of average assets and 81.03% of total revenues for the Peer Group on
average. Meanwhile, other expenses, primarily comprised of underwriting and
other expenses, equaled 8.50% of average assets (36.18% of revenues) for the
Company, which was above the average of 6.64% of average assets (22.74% of total
revenues) for the Peer Group. The higher level of underwriting and other expense
for NCRIC (i.e., expenses other than policy-related costs) is reflective of the
large degree of revenue diversification represented by NCRIC MSO, which inflates
the Company's overall cost structure in comparison to the Peer Group (who on
average appear to have undertaken a lower level of revenue diversification
outside of their respective core insurance underwriting businesses).
Loss Ratio
As referenced previously, a significant factor leading to NCRIC's higher
operating returns is its comparatively lower loss ratio (policy expenses as a
percent of net premiums earned), equal to 89.14% for NCRIC versus an average of
97.66% for the Peer Group. The lower loss ratio may be attributable to adverse
industry trends including increasing claims severity (including the cost of
defending claims), as well as an increase in the frequency of claims. While such
trends have impacted NCRIC's operating results, NCRIC's insurance
RP Financial, LC.
Page 3.14
operations appear to have been less impacted than many other insurers, both
inside and outside of its market. Additionally, NCRIC has been aggressive in
raising premium rates over the last several years, which has tended to diminish
the impact of rising policy expenses on the loss ratio.
Expense Ratio
The Company's expense ratio for the most recent twelve month period,
equal to 27.14%, approximated the range exhibited by the Peer Group average
(27.69%) and median (26.82%). As discussed in Section One, NCRIC's total
expenses as well as the expense ratio have been subject to increase as a result
of the following: (1) the effort to expand the insurance segment of NCRIC's
business, both with respect to the overall number of policies in force and
geographically; (2) geographic expansion outside of the District of Columbia and
Maryland where NCRIC underwrites many of its policies directly has led to an
increase in agent commissions; (3) NCRIC recorded a $1.2 million valuation
allowance on a premium receivable which it determined to be uncollectible in
fiscal 2002, and which is reflected in its underwriting expenses; and (4)
guaranty fund assessments of $160,000 in fiscal 2001 and $228,000 in fiscal 2002
resulting from the insolvency of Reliance Insurance Company and PHICO Insurance,
respectively.
Combined Ratio
The combined ratio, reflecting the sum of the loss and expense ratios,
indicates that both NCRIC and the Peer Group report losses on underwriting
operations, but that NCRIC's losses on underwriting operations are lower.
Specifically, NCRIC's combined ratio of 116.28% was below the Peer Group average
of 125.35%. NCRIC's lower combined ratio is primarily reflective of the
Company's stronger core earnings in comparison to the Peer Group.
Profit Margins
The Company's profitability, as measured by the pre-tax underwriting
profit margin and pre-tax operating profit margin, also reflect NCRIC's stronger
profitability. The pre-tax underwriting loss equaled 16.28% for the Company
versus an average loss of 25.35% for the Peer Group. The Company reported a
positive pre-tax operating margin of 1.17% as compared to the average of loss of
5.24% reported by the Peer Group. As referenced earlier, the
RP Financial, LC.
Page 3.15
Company's operating results are supported by its favorable loss ratio and
slightly higher level of investment income. Additionally, the operations of the
practice management segment also contribute modestly to NCRIC's overall
profitability.
Taxes
The Company recorded a net tax benefit in fiscal 2002 equal to 0.75% of
assets, notwithstanding a positive pre-tax net income. The tax benefit reported
in the most recent fiscal year is attributable to the impact of tax advantaged
securities in the Company's portfolio, which created a tax loss for the year,
notwithstanding positive pre-tax income levels reported for financial reporting
purposes. Conversely, the Peer Group reported a tax benefit as a result of
operating losses on average. The Peer Group reported an average tax benefit
equal to 31%; NCRIC believes that the Company's effective tax rate may likely
range from 25 to 35% of pre-tax income in the future, which approximates the
range for the period from fiscal 1999 to fiscal 2001.
Analysis of Risk Factors
Table 3.6 reflects a summary of risk factors for NCRIC in relation to the
Peer Group. As discussed previously, NCRIC operates with a lower loss ratio
(89.1% for the Company versus 97.7% for the Peer Group), while losses and LAE
for the most recent twelve month period are relatively lower in comparison to
policy reserves (20.5% for NCRIC versus an average of 30.8% for the Peer Group).
Policy reserves as a percent of equity and assets are slightly below the Peer
Group average while the tangible equity/assets ratio is above the Peer Group
average, even on a pre-offering basis.
The one area of underwriting risk to which the Company is subject to
greater exposure is the Company's concentration in the District, a jurisdiction
which has not experienced tort reform and where damage awards are typically high
in comparison to areas of the country where the Peer Group companies operate. At
the same time, such risks are mitigated by the experience that NCRIC has in this
market coupled with historical and anticipated premium growth outside of the
District.
RP Financial, LC.
Page 3.16
RP Financial, LC.
- -----------------
Financial Services Industry Consultants
Table 3.6
Analysis of Risk Factors
Peer Group Analysis
For the Most Recent Twelve Month Period
Peer Group Companies
-------------------------------------------------
Professional Liability Peer Group
-------------------------------------------------
American
Physicians FPIC
NCRIC Peer Group Capital, Insurance Pro SCPIE
Group, Inc. -------------------- Inc. Group Assurance Holdings, Inc.
Peer Group Ticker Symbol 12/31/2002 Average Median ACAP FPIC PRA SKP
---------- ------- -------- ---- ---- --- ---
Primary Insurance Line PL PL PL PL PL
Losses and LAE as a % of (1)
- ----------------------------
Net Premiums Earned (Loss Ratio) 89.14% 97.66% 95.39% 102.75% 88.89% 95.39% 115.33%
Policy Reserves 20.45% 30.83% 26.77% 32.67% 24.26% 26.77% 47.96%
Policy Reserves as a % of
- -------------------------
Assets 64.74% 72.14% 71.14% 69.97% 62.75% 75.56% 72.67%
Equity 274.44% 406.10% 337.07% 264.34% 376.36% 433.95% 293.78%
A.M. Best, Inc. Rating(2) A- B++ A- A- B++ A- B+
-------------------------------------------
Workers Compensation Peer Group
-------------------------------------------
Argonaut Zenith
Group RTW, Inc. National
Peer Group Ticker Symbol AGII RTWI ZNT
---- ---- ---
Primary Insurance Line WC WC WC
Losses and LAE as a % of (1)
- ----------------------------
Net Premiums Earned (Loss Ratio) 75.57% 126.07% 79.58%
Policy Reserves 21.01% 22.08% 41.05%
Policy Reserves as a % of
- -------------------------
Assets 71.14% 85.80% 67.10%
Equity 327.26% 809.97% 337.07%
A.M. Best, Inc. Rating(2) A B- A-
(1) Excludes practice management income and expense for NCRIC.
(2) Average and medians are calculated by assigning numbers to each of Best's
ratings, calculating the average and median for the Peer Group, and converting
those numbers back to the applicable Best's rating.
Source: Audited and unaudited financial statements, corporate reports and
offering circulars, A.M. Best website.
The information provided in this table has been obtained from sources we
believe are reliable, but we cannot guarantee the accuracy or
completeness of such information.
RP Financial, LC.
Page 3.17
NCRIC is rated "A-" by A.M. Best, Inc., a nationally recognized insurance
company ratings firm. This rating is superior to three of the Peer Group
companies, and comparable or below the remaining four companies. On average, the
Peer Group companies A.M. Best rating are relatively comparable to NCRIC's "A-"
rating.
Summary
Based on the above analysis, RP Financial concluded that the Peer Group
forms a reasonable basis for determining the pro forma market value of NCRIC.
Areas where substantial differences exist will be further addressed in the
valuation section to follow.
RP Financial, LC.
Page 4.1
IV. VALUATION ANALYSIS
Introduction
This chapter presents the valuation analysis and methodology used to
determine NCRIC's estimated pro forma market value. The valuation utilizes the
market value approach to value incorporating the selection of the Peer Group,
fundamental analysis on both the Company and the Peer Group, and determination
of the Company's pro forma market value utilizing the market value approach.
RP Financial Approach to the Valuation
Employing the principles embodied in the pro forma market value
approach, the valuation incorporates a detailed analysis based on the Peer
Group, discussed in Chapter III, which constitutes "fundamental analysis"
techniques. The valuation incorporates a "technical analysis" of recently
completed stock offerings of other demutualized insurance companies, including
the aftermarket trading of such offerings. In this regard, there has been
limited activity with respect to insurance company demutualizations pursuant to
the subscription model, so this analysis is given limited consideration in our
overall valuation conclusion. It should be noted that these valuation analyses,
based on either the Peer Group or recent insurance company demutualizations,
cannot possibly fully account for all the market forces which impact trading
activity and pricing characteristics of a stock on a given day.
The pro forma market value determined herein is a preliminary value
for the Company's to-be-issued stock. Throughout the process, at the request of
the Board of Directors, RP Financial will: (1) review changes in the Company's
operations and financial condition; (2) monitor the Company's operations and
financial condition relative to the Peer Group to identify key fundamental
changes; (3) monitor the external factors affecting value including, but not
limited to, local and national economic conditions, interest rates, and the
stock market environment, including the market for insurance stocks generally
and medical professional liability and workers' compensation insurers
specifically; and (4) monitor pending insurance company demutualizations, if
any. If material changes should occur prior to closing the offering,
RP Financial, LC.
Page 4.2
RP Financial will, at the request of NCRIC, evaluate if updated valuation
reports of the Company should be prepared reflecting such changes and their
related impact on value, if any. RP Financial will also prepare a final
valuation update at the closing of the offering to determine if the prepared
valuation analysis and resulting range of value continues to be appropriate.
The appraised value determined herein is based on the current market
and operating environment for the Company and for all insurance companies.
Subsequent changes in the local and national economy, the legislative and
regulatory environment, the stock market, interest rates, and other external
forces (such as natural disasters or major world events), which may occur from
time to time (often with great unpredictability) may materially impact the
market value of all insurance company stocks, including NCRIC, the market value
of the stocks of medical professional liability insurers, or NCRIC's value
alone. To the extent a change in factors impacting the Company's value can be
reasonably anticipated and/or quantified, RP Financial will incorporate the
estimated impact into the valuation analysis.
Valuation Analysis
A fundamental analysis discussing similarities and differences relative
to the Peer Group was presented in Chapter III. The following sections summarize
the key differences between the Company and the Peer Group and how those
differences affect the pro forma valuation. Emphasis is placed on the specific
strengths and weaknesses of the Company relative to the Peer Group in such key
areas as financial condition, profitability, growth and viability of earnings,
risk, primary market, dividends, liquidity of the shares, marketing of the
issue, management, and the effect of government regulations and/or regulatory
reform. We have also considered the market for insurance company stocks, in
particular new issues, to assess the impact on value of NCRIC coming to market
at this time.
1. Financial Condition
The financial condition of a company is an important determinant in pro
forma market value, because investors typically look to such factors as
liquidity, capital and balance sheet composition in assessing investment
attractiveness. The similarities and differences in the financial condition are
noted below:
RP Financial, LC.
Page 4.3
. Balance Sheet Composition. NCRIC maintains a higher ratio of cash
and investments reflecting, in part, the impact of the recent
issuance of trust preferred securities by the Company. Moreover,
investment assets will increase for NCRIC in comparison to the
Peer Group with the infusion of cash capital in conjunction with
the stock conversion offering. Reinsurance assets are higher for
the Company reflecting the Company's smaller size and capital base
in comparison to the Peer Group. The reserve ratio is modestly
lower for NCRIC while NCRIC's balance sheet reflects a greater
level of debt following the issuance of trust preferred securities
in December 2002.
. Balance Sheet Liquidity. NCRIC's slightly higher proportional
level of cash and investments, all of which are classified as
available for sale, coupled with the infusion of the stock
proceeds provides greater comparative balance sheet liquidity.
Moreover, the ability to raise additional liquidity and/or capital
will be enhanced as a result of the increased capitalization and
full stock corporate structure resulting from the second step
conversion.
. Equity Capital. Currently, the Company operates with a comparable
tangible equity ratio in comparison to the Peer Group average. The
Company's much greater pro forma capital will provide greater
opportunities for growth. At the same time, the higher equity will
also initially reduce its present return on equity, but given its
profitable position, its pro forma ROE will continue to compare
favorably.
On balance, we believe a moderate upward adjustment for the Company is
warranted for financial condition.
2. Profitability, Growth and Viability of Earnings
Earnings are a key factor in determining pro forma market value, as the
level and risk characteristics of a company's earnings stream and the prospects
and ability to generate future earnings heavily influence the multiple the
investment community will pay for earnings. The major factors considered in the
valuation are described below.
. Reported Earnings. NCRIC reported higher profitability, both in
terms of the return on assets and return on equity measures, and
as measured by the combined, underwriting and operating margins.
In this regard, four of the seven Peer Group companies reported
operating losses for the most recent twelve month period while the
remaining three companies reported relatively modest
profitability. While NCRIC and all the Peer Group companies have
been impacted by the difficult market conditions
RP Financial, LC.
Page 4.4
prevailing in the property and casualty markets generally, and
particularly the professional liability and workers' compensation
sectors, NCRIC will compare favorably on a pro forma basis
relative to the whole group.
. Earnings Growth Potential. Several factors were considered in
assessing earnings growth potential, beyond the initial
reinvestment of proceeds into investment securities. The higher
expected pro forma capital position is expected to enable the
Company to undertake future expansion, diversification and
acquisitions in the future. In particular, NCRIC's comparably
stronger capital in relation to the Peer Group will enhance the
ability to expand while raising premium rates to profitable
levels, particularly in targeted markets where other competitors
are retrenching or withdrawing entirely. Practice management
revenues comprise a greater portion of overall revenues for NCRIC
than the Peer Group which may dampen earnings growth given the
economic pressures which many physician practices are currently
experiencing. Overall, we believe the Company's strong capital
position, coupled with the impact of expansion and recent rate
increases, among other factors, enhances NCRIC's earnings growth
potential relative to the Peer Group.
. Return on Equity. Four of the seven Peer Group companies have
reported losses for the most recent twelve month period. While the
Peer Group is estimated to have stronger earnings and ROE based on
the consensus of analyst's estimated earnings, such estimates have
historically been volatile and subject to change based on changing
market conditions. Over the near term, prior to expected growth
and full employment of the capital raised in the second step
conversion offering, NCRIC's ROE will initially be depressed
vis-a-vis the ratio which would have been reported absent the
capital raised in the conversion, but it still compares favorably
to the overall peer group.
Overall, we concluded a moderate upward valuation adjustment for
profitability, growth and viability of earnings was appropriate.
3. Risk Assessment
NCRIC operates with a favorable loss ratio while policy expenses as a
percent of average assets are comparable to the Peer Group average. Policy
reserves as a percent of equity and assets are slightly below the Peer Group
average. NCRIC's A.M. Best ratings were consistent with the ratings range of the
Peer Group, generally falling within the middle of the range. Management has
indicated that policy reserves are at the upper end of the actuarial range, and
historically, has realized through favorable loss development relative to
reserves.
RP Financial, LC.
Page 4.5
A material portion of the Company's revenues are derived from
physicians in the District of Columbia, where efforts to introduce tort reform
have not been successful to date, and there is a high frequency and severity of
claims in relation to the national average. At the same time, the Company is
familiar with the risks in its market and has put processes and procedures in
place to mitigate such risks. The Company has increased its risk retention
pursuant to its recently negotiated reinsurance treaty which may enhance
profitability while potentially increasing earning volatility in comparison to
the Peer Group.
On balance, we believe a slight upward adjustment is warranted for this
factor.
4. Primary Market and Growth
NCRIC is believed to be the leading medical professional liability
insurer in Washington, D.C. but faces a shrinking market. While suburban areas
have been growing at a considerably faster pace, the Company's market share in
those areas is comparatively smaller. In response to the foregoing
characteristics, as well as fundamental changes occurring in the healthcare
market, the Company is actively expanding geographic markets served as well as
revenue sources. As discussed in the section addressing the comparative balance
sheet and operations of NCRIC and the Peer Group companies, NCRIC has achieved
higher growth in assets and overall revenues over the last several years.
Importantly, such growth has been facilitated by withdrawal from the market by
several major competitors and retrenchment (i.e., many insurers are not
accepting new customers or otherwise shrinking) by many others.
On balance, we believe a moderate upward adjustment is warranted for
this factor.
5. Dividends
While the Board has not yet adopted a cash dividend policy, NCRIC's pro
forma capitalization and profitability appear to position the Company to have
greater capacity to pay cash dividends. The Company's dividend policy will be
based on a number of factors, including investment opportunities, growth
objectives, financial condition, profitability, tax considerations, capital
requirements, regulatory limitations, stock market characteristics and general
economic conditions.
RP Financial, LC.
Page 4.6
Only one of the Peer Group companies pay a regular cash dividend
(SCIPIE Holdings pays a $0.40 per share annual dividend which translates into a
6.73% dividend yield). On balance, we believe that NCRIC's higher current
earnings level and stronger capitalization on a pro forma basis will enhance its
dividend paying capacity in relation to the Peer Group. Primarily as a result of
the Company's greater capacity to pay a dividend and taking into consideration
that only Peer Group company has a regular dividend policy in place, we
concluded that a slight upward adjustment was warranted for purposes of
dividends relative to the Peer Group.
6. Liquidity of the Shares
The Peer Group is by definition composed of companies that are traded
in the public markets, and all of the Peer Group members trade on either the New
York exchange or the NASDAQ system. Typically, the number of shares outstanding
and market capitalization provides an indication of how much liquidity there
will be in a particular stock. The market capitalization of the Peer Group
companies ranged from $24 million to $650 million as of March 11, 2003, with
average and median market values of $231 and $169 million, respectively. The
shares issued and outstanding to shareholders of the Peer Group members ranged
from approximately 8.7 to 28.5 million, with average and median shares
outstanding of approximately 15.2 million and 10.3 million, respectively. The
Company's stock offering is expected to result in public shares outstanding and
market capitalization which will be below the range exhibited by the Peer Group
average and median. Additionally, the number of shares outstanding will be lower
than all of the Peer Group companies on an individual basis while the pro forma
market capitalization will be below all but one of the Peer Group companies on
an individual basis. Overall, we concluded that a moderate downward adjustment
was warranted for this factor.
7. Marketing of the Issue
Two separate markets exist for insurance company stocks: (1) the
after-market for public companies in which trading activity is regular and
investment decisions are made based upon financial condition, earnings, capital,
ROE, dividends and future prospects; and (2) the new issue market in which
demutualizing insurers are evaluated on the basis of the same factors but on a
pro forma basis without the benefit of prior operations as a publicly-held
company and stock
RP Financial, LC.
Page 4.7
trading history. Both of these markets were considered in the valuation of the
Company's to-be-issued stock.
A. The Public Market
The value of publicly-traded insurance company stocks, i.e., those
which are listed on an exchange or on NASDAQ, is easily measurable, and is
tracked by investment firms, related organizations and by electronic means. In
general, the stocks of insurance companies react to market stimuli such as
interest rates, inflation, perceived industry health, projected rates of
economic growth, regulatory issues and stock market conditions in general.
In terms of assessing general stock market conditions, the major
stock exchange indices declined for a third consecutive year during 2002, with
the Dow Jones Industrial Average ("DJIA") posting its worst year since 1977.
Notable factors that contributed to the decline in the broader stock market
included corporate fraud, a weak economic recovery and disappointing earnings.
Geopolitical tensions added to the selling pressure, particularly during the
latter part of 2002 amid escalating war talk with Iraq. The weak economy and
fraudulent accounting combined to produce seven of the twelve largest U.S.
bankruptcies ever in 2002, including such names WorldCom, the biggest bankruptcy
of all time based on assets, Enron Corp., Conseco Inc. UAL Corp. and Kmart Corp.
The financial services sector was also hurt by scandal and fraud, especially
with respect to some of the large money center banks such as Citigroup Inc. and
J.P. Morgan Chase & Co. Additionally, there have been some notable insolvencies
within the insurance sector with the bankruptcy of Conseco being the most
prominent. Within the medical professional liability sector, The MIIX Group has
recently been restructured as a management company while a number of mutuals
which dominate this industry have become insolvent (i.e., PHICO and Doctors
Insurance Reciprocal) or had their ratings substantially downgraded.
The lackluster performance of the economy couple with a tense
international environment including a looming war with Iraq and heightening
tensions on the Korean peninsula continued to weigh heavy on the equity markets
during the first two months in 2003. In this regard, the major market indices
including the DJIA, the S&P 500 Index and the NASDAQ Index all traded lower
during the first two months of 2003.
RP Financial, LC.
Page 4.8
On March 11, 2003, the DJIA closed at 7524.06, a decrease of 10% since
the beginning of the year and 29% below its close one year earlier (see the
chart included as Table 4.1).
Similar to the overall stock market, the stocks of insurance company
stocks have generally traded lower over the past year. The lackluster economy,
which has dampened demand, coupled with an increasing loss and combined ratio
has led to weakness in the sector. Additionally, investment earnings continue to
weaken in response to interest rate reductions by the Federal Reserve.
Table 4.1
Dow Jones Industrial Index and S&P Insurance Index
[GRAPH]
B. The New Issue Market
In addition to stock market conditions for insurers in general, the
new issue market for demutualizing insurers is also an important consideration
in determining the Company's pro forma market value. The new issue market is
separate and distinct from the market for seasoned stock insurers in that the
pricing ratios (primarily price/book and
RP Financial, LC.
Page 4.9
price/earnings) for demutualizing issues are computed on a pro forma basis,
specifically: (1) the numerator and denominator are both impacted by the stock
offering amount, unlike existing stock issues in which price change affects only
the numerator; and (2) the pro forma pricing ratio incorporates assumptions
regarding source and use of proceeds, effective tax rates, stock plan purchases,
etc. which impact pro forma financials, whereas pricing for existing issues are
based on reported financials. The distinction between pricing of demutualizing
and existing issues is perhaps no clearer than in the case of the price/tangible
book ("P/TB") ratio in that the P/TB ratio of a demutualizing insurer,
particularly those employing the thrift subscription method, will typically
result in a discount to tangible book value as it is mathematically impossible
for a converting company with positive equity to be priced at a premium to book
value
Given the relatively unique characteristics of a
demutualization of an insurance company, we believe it is appropriate to
consider the characteristics of comparable recent transactions. The number of
demutualized insurance company issues which are publicly traded is relatively
limited. Table 4.2 shows the financial and pricing characteristics of selected
demutualized insurers completing their demutualization transactions since 1995.
We have also included comparable ratios for Mutual Assurance, Inc., which was
demutualized in 1991, since it is a medical professional liability specialist
and included in the Peer Group (currently known as ProAssurance, Inc.). The
average and median pro forma P/TB ratios for the nine property and casualty
insurers completing demutualizations was 95.9% and 72.3%, respectively. The
average and median pro forma price/earnings ("P/E") based on core earnings
equaled 9.6 times and 8.9 times, respectively.
The most recent completed demutualization involved Prudential
Financial, Inc. which completed its offering in December 2001, raising $3.4
billion of common equity at an issue price of $27.50 per share while
distributing 582.8 million shares to policyholders. Prudential Financial's pro
forma price/book ("P/B") and P/E ratios equaled 79.8% and 13.0 times,
respectively, and the issue closed at $29.30 per share on the first day of
trading and $30.17 per share after the first week of trading.
As detailed in Table 4.2 and summarized in the schedule below,
there have been five demutualizations of medical professional liability insurers
since 1991 which were subsequently publicly traded. Mutual Assurance
demutualized with a relatively high pro forma
RP Financial, L.C.
Page 4.10
RP Financial, LC.
Financial Services Industry Consultants
Table 4.2
Selected Demutualization Transactions
Offering Values Over $10 Million for US Headquartered Companies
AM Demutual Aggregate Value Shares Issued
--------------- --------------------------
Best Deal Structure Demut Initial Shrs. Dist Exrcs
--------------
Rating Main IPO Closing Mkt Gross To Offerin Over- Issue
Ticker Company @ IPO Lines Form Struct. Date Cap Prcds Insureds(6) Shares allot. Price
- ------ ------- ----- ----- ---- ------- ---- ------ ------ ------------ ------- ------ -----
($Mil) ($Mil) (000) (000) ($)
Property & Casualty
- -------------------
ACAP AP Capital, Inc., MI(1) A- Med Liab Full Subscr 12/08/00 $ 155 $ 145 - 11,450 Yes $ 13.50
MHU The MIIX Grp, Inc., NJ A Med Liab Full Distribution 08/04/99 $ 218 $ 47 12,669 3,450 Yes $ 13.50
NCRI NCRIC Grp, Inc., DC (2) A- Med Liab MHC Subscr 07/29/99 $ 26 $ 10 - 1,480 No $ 7.00
SHSE Summit Hldgs SE, FL (3) N/A Wrkr Cmp Full Pfd/Com 05/01/97 $ 63 $ 63 - 5,750 Yes $ 11.00
OGGI Old Guard Grp, Inc., PA A- P/C-Mix Full Subscr 02/01/97 N.A. $ 40 - 3,955 No $ 10.00
SKP SCPIE Hldgs, CA A Med Liab Full Distribution 01/01/97 $ 224 $ 42 9,995 2,300 Yes $ 18.25
FFH Farm Fam Hldgs, Inc., NY A- P/C-Agr Full Distribution 07/01/96 $ 85 $ 48 2,254 3,000 Yes $ 16.00
AFC Allmerica Fin Corp., MA A+ PC-Mix Full Distribution 10/16/95 $ 1,053 $ 265 37,498 12,636 Yes $ 21.00
MAI Medical Assur, Inc., AL NA Med Liab Full (4) 09/01/91 N.A. $ 81 (4) 7,818 Yes $ 6.50
Life and Health
- ---------------
PRU Prudential Financial, Inc.(7) A Life/Hlth Full Distribution 12/13/01 $16,027 $3,479 582,800 126,500 Yes $ 27.50
ATH Anthem, Inc. A- Life/Hlth Full Distribution 10/30/01 $ 3,711 $1,987 47,888 55,200 Yes $ 36.00
PFG Principal Financial Group A+ Life/Hlth Full Distribution 10/23/01 $ 6,943 $2,128 260,314 115,000 Yes $ 18.50
PNX The Pheonix Cos., NY A Life/Hlth Full Distribution 06/20/01 $ 1,838 $ 854 56,200 48,800 No $ 17.50
JHF J Hancock Fin Srvcs, NY A++ Life/Hlth Full Distribution 01/27/00 $ 5,899 $1,994 229,700 117,300 Yes $ 17.00
MET MetLife, Inc., NY (5) A+ Life/Hlth Full Distribution 04/05/00 $11,203 $4,165 493,903 292,300 Yes $ 14.25
SFG StanCorp Fin Grp, OR A Life/Hlth Full Distribution 04/21/99 $ 806 $ 361 18,718 15,209 Yes $ 23.75
MNY MONY Grp, Inc., NY A- Life/Hlth Full Distribution 11/11/98 $ 1,063 $ 304 34,300 12,938 Yes $ 23.50
GUAR Guarantee Life Cos., NE A Life/Hlth Full Distribution 12/01/95 $ 130 $ 37 7,069 2,875 Yes $ 13.00
After-Market
Price Change
Pro Forma Financial Ratio Pro Forma Pricing Ratios Vs. IPO Price
---------------------------- -------------------------------------------- ---------------
Ticker Company E/A Tg. E/ROA ROE P/E P/CE P/B P/TB P/Rev P/A % % %
- ------ ------- ---- ---- ----- --- ---- --- ---- ----- --- -- -- -- --
(%) (%) (%) (%) (x) (x) (%) (%) (%) (%) (%) (%) (%)
Property & Casualty
- -------------------
ACAP AP Capital, Inc., MI(1) 38.1% 36.3% 1.80% 4.74% 3.6x 8.9x 42.9% 45.0% 69.7% 16.1% 1% 13% 26%
MHU The MIIX Grp, Inc., NJ 21.0% 21.0% 1.82% 8.67% 7.0x 17.5x 58.6% 58.6% 82.2% 12.6% 13% 25% 21%
NCRI NCRIC Grp, Inc., DC (2) 26.8% 24.1% 2.00% 7.45% 9.2x 9.2x 68.5% 78.7% 103.4% 18.4% 8% 9% 11%
SHSE Summit Hldgs SE, FL (3) 15.9% 7.5% 1.72% 10.82% 6.5x 6.5x 92.1% 267.6% 37.4% 11.8% 31% 34% 68%
OGGI Old Guard Grp, Inc., PA 39.4% 39.4% 1.89% 4.78% N.M. 12.3x 59.0% 59.0% 61.7% 40.6% 44% 39% 46%
SKP SCPIE Hldgs, CA 39.3% 39.3% 3.46% 8.79% 8.3x 8.3x 72.2% 72.2% 129.7% 28.4% 14% 18% 21%
FFH Farm Fam Hldgs, Inc., NY 36.5% 36.5% 3.11% 8.52% 9.8x 10.4x 83.3% 83.3% 62.3% 30.4% 8% 19% 14%
AFC Allmerica Fin Corp., MA 8.2% 8.2% 0.76% 9.27% 7.8x 7.3x 72.3% 72.3% 32.7% 6.1% 21% 24% 18%
MAI Medical Assur, Inc., AL 29.1% 29.1% 5.20% 20.54% 6.1x 6.1x 126.0% 126.0% NA 31.6% 2% 3% 2%
Life and Health
- ---------------
PRU Prudential Financial, Inc. 7.0% 7.0% 0.44% 6.36% 13.0x 13.0x 79.8% 79.8% 59.0% 5.5% 7% 10% 12%
ATH Anthem, Inc. 32.5% 24.7% 5.72% 17.62% 10.6x 10.6x 186.6% 245.2% 35.7% 60.6% 14% 22% 41%
PFG Principal Financial Group 7.9% 6.5% 5.50% 6.94% 14.6x 14.6x 100.8% 123.2% 80.3% 8.0% 14% 19% 21%
PNX The Pheonix Cos., NY 11.2% 7.1% 0.44% 4.39% 19.7x 19.7x 76.9% 121.7% 61.4% 8.6% -4% 0% 1%
JHF J Hancock Fin Srvcs, NY 8.6% 8.6% 0.60% 6.96% 12.0x 12.0x 83.8% 83.8% 77.3% 7.2% 4% 0% -3%
MET MetLife, Inc., NY (5) 6.2% 5.9% 0.41% 6.62% 11.8x 11.8x 77.7% 77.7% 44.1% 5.0% 9% 14% 23%
SFG StanCorp Fin Grp, OR 16.6% 16.6% 1.43% 8.61% 10.2x 10.2x 88.4% 88.4% 62.9% 14.7% -3% -2% -3%
MNY MONY Grp, Inc., NY 6.9% 6.9% 0.52% 7.55% 8.3x 8.3x 62.5% 62.5% 53.8% 4.3% 20% 31% 21%
GUAR Guarantee Life Cos., NE 15.4% 15.4% 1.04% 6.75% 9.5x 9.5x 64.9% 64.9% 45.8% 10.1% 22% 24% 27%
(1) Core earnings and ROA and ROE ratios reflect adjustment to exclude a
significant one-time income tax recovery.
(2) Approximately 2.22 million shares were issued to the MHC concurrent with
the subscription and public offering.
(3) $16.4 million of preferred stock was distributed to the mutual
policyholders.
(4) Reflects pricing of shares in the public offering. Shares distributed to
policyholders totaled 6.1 million and 2.0 million; additional shares were
subscribed for at a price of $10.00 per share.
(5) Excludes concurrent offering of 17.5 million equity security units for a
gross offering of $875 million, plus a full overallotment of $131.5 million
(consists of contract to purchase shares and an 8% capital security issued
by a MetLife trust.
(6) The demutualization transaction may have also included cash payments to
some or all policyholders.
(7) Earnings reflects analyst's consensus estimates of approximately $2.20 per
share for fiscal 2002, which equals approximately $1.3 billion.
RP Financial, LC.
Page 4.11
P/B ratio (126.0%) but at a low pro forma P/E multiple (6.07 times). The most
recent demutualization, and perhaps the most relevant transaction since it was
consummated pursuant to the subscription conversion model, was undertaken by AP
Capital. AP Capital completed its offering in December 2000 at a level of 3.6
times earnings, 8.9 times core earnings, and 45.0% of pro forma tangible book
value.
Pro Forma Pricing of Demutualizing
Medical Professional Liability Insurers
(Includes Publicly-Traded Companies Only)
At Initial Public Offering
-----------------------------
Issue Date P/TB P/Core Price
---------- ---- ------ -------
Completed
- ---------
AP Capital Dec. 8, 2000 45.0% 8.9x $13.50
The MIIX Group August 1999 58.6% 17.5x $13.50
NCRIC Group July 1999 78.7% 9.2x $ 7.00
SCPIE Holdings (SKP) Jan. 1997 72.2% 8.3x $18.25
Mutual Assurance, Inc. (MAIC) Sept. 1991 126.0% 6.1x $ 6.50
Source: Public filings and RP Financial calculations.
C. Secondary Offering by ProAssurance, Inc.
The second step stock offering of a converting mutual insurance
holding company is somewhat different than the full conversion transactions
cited above. In this regard, NCRIC has already sold a portion of the stock to
the public (approximately 40% is currently in public hands) and thus, will sell
only the 60% of the shares currently held by the MHC. Thus, the second step
conversion transaction has characteristics which are similar to a secondary
offering of common stock by an existing public company. Given these the
similarity between the second step transaction of a mutual holding company and a
secondary offering of an existing public company, we believe that the
methodology employed by the investor community to evaluate the public shares
being sold by the MHC may be similar to the methodology employed to evaluate a
secondary offering by an insurance company.
One of the Peer Group companies, ProAssurance, Inc., has
recently completed a secondary offering of common stock. It is our understanding
that ProAssurance raised the new
RP Financial, LC.
Page 4.12
capital with many of the same objectives as NCRIC; to provide the capital to
grow at a time when premiums rates are rising and many competitors are
retrenching or withdrawing from certain markets altogether as a result of rising
losses. ProAssurance completed its secondary offering on November 7, 2002, with
the overallotment provision exercised as of December 4, 2002. The offering was
completed at the market price as of the close of trading as of November 7, 2002
(i.e., there was not discount to the market price) and resulted in the issuance
of 3.0 million shares at a price of $16.55 per share, providing gross proceeds
of $50.1 million (see Table 4.3 for details). The new shares issued represented
11.7% of the pre-offering shares and were sold at 25.5 times analyst's estimated
earnings for fiscal 2003 and at a pro forma price/tangible book value ratio
equal to 106.1%. Importantly, notwithstanding the issuance of the shares,
ProAssurance's stock price has subsequently trended upward, and closed at $22.81
per new share as of March 11, 2003, which represents a 38% increase from the
date the secondary offering was completed.
D. Second Step Conversions by Thrift Mutual Holding Companies
Many thrift institutions have reorganized into the mutual
holding company structure since 1988, and the first second step stock offering
was completed in 1994. Since that time, a total of 46 mutual thrift holding
companies have completed a second step conversion. Given the large number of
such transactions and the fact that they occur on a regular basis, can provide
useful insights into NCRIC's forthcoming second step transaction as we believe
the investor community will apply a similar valuation methodology as it employs
in evaluating second step transactions by thrift institutions.
Table 4.4 sets forth the key characteristics of second step
conversion transactions by thrift institutions since the beginning of 2000. Most
recently, four second step conversion transactions were completed in early 2003,
and reflected average pricing ratios equal to 99.2% of pro forma book value and
17.1 times earnings. Importantly, the second step conversions by thrift
institutions are typically completed at relatively high P/B ratios in comparison
to full conversion transactions as the amount of capital raised is typically
lower (since only a fraction of the shares are sold to the public) which
provides for the ability to increase ROE more rapidly.
RP Financial, LC.
Page 4.13
Table 4.3
Key Characteristics
ProAssurance Secondary Stock Offering
Offering Gross
Shares Offered and Gross Proceeds Shares Price Proceeds
- --------------------------------- ------ ----- --------
(000) ($) ($000)
Offering Shares Issued at Closing 2,650 $16.55 $43,858
Over-Allotment Option 375 $16.55 $ 6,206
----- ------ -------
Total Shares Issued 3,025 $16.55 $50,064
Shares Sold % of Pre-Offering Shares
- ------------------------------------
New Shares Sold to the Public 10.25%
Over-Allotment Option 1.45%
------
Total Shares Sold 11.70%
Pro Forma Pricing Ratios
- ------------------------
Pro Forma P/E - Reported Earnings 36.78x
Pro Forma P/E - Analyst Estimated Earnings 25.46x
Pro Forma P/B 100.9%
Pro Forma P/TB 106.1%
GRAPH
RP Financial, LC.
Page 4.14
Table 4.4
Pro Forma Pricing Characteristics
Second Step Conversions By Savings Institutions Since 2000
====================================================================================================================
Institutional Information Pre-Conversion Data Offering Information Insider Purchases(3)
-----------------------------
Financial Info. Asset Quality
- --------------------------------------------------------------------------------------------------------------------
Benefit Plans
-------------
Conversion Equity/ NPAs/ Res. Gross % of Exp./ Recog. Mgmt.&
Institution State Date Ticker Assets Assets Assets Cov. Proc. Mid. Proc. ESOP Plans Dirs.
- ----------- ----- ---- ------ ------ ------ ------ ---- ----- ---- ----- ---- ----- -----
($Mil) (%) (%)(2) (%) ($Mil.) (%) (%) (%) (%) (%)
- --------------------------------------------------------------------------------------------------------------------
First Niagara Fin.
Group, Inc. NY* 01/21/03 FNFC $3,291 10.02% 0.42% 102% 410.0 100% N.A. 5.0% 4.0% 0.3%
Wayne Savings
Bncshrs, Inc. OH* 01/09/03 WAYN 337 8.02% 0.89% 22% 20.4 100% 7.3% 8.0% 4.0% 4.5%
Sound Federal
Bancorp, Inc. NY 01/07/03 SFFS 673 9.84% 0.16% 268% 77.8 132% 2.3% 8.0% 4.0% 0.9%
Bridge Street
Financial, Inc. NY* 01/06/03 OCNB 179 9.58% 0.45% 133% 15.1 104% 4.2% 0.0% 4.0% 1.4%
- --------------------------------------------------------------------------------------------------------------------
Averages - 2003: $ 426 9.71% 0.31% 201% $ 46.5 118% 3.2% 4.0% 4.0% 1.2%
Medians - 2003: $ 426 9.71% 0.31% 201% $ 46.5 118% 3.2% 4.0% 4.0% 1.2%
- --------------------------------------------------------------------------------------------------------------------
Citizens South
Banking Corp. NC* 10/01/02 CSBC 439 9.94% 0.71% 96% 52.6 132% 2.4% 2.0% 4.0% 2.6%
Brookline Bancorp,
Inc. MA* 07/10/02 BRKL 1,138 26.20% 0.14% 190% 337.2 132% 1.3% 0.0% 4.0% 0.6%
Willow Grove
Bancorp, Inc. PA* 04/04/02 WGBC 644 9.78% 0.75% 93% 64.1 132% 2.5% 8.0% 4.0% 1.8%
- --------------------------------------------------------------------------------------------------------------------
Averages - 2002: $ 740 15.31% 0.53% 126% $151.3 132% 2.1% 3.3% 4.0% 1.7%
Medians - 2002: $ 644 9.94% 0.71% 96% $ 64.1 132% 2.4% 2.0% 4.0% 1.8%
- --------------------------------------------------------------------------------------------------------------------
PHSB Financial Corp. PA* 12/21/01 PHSB 290 11.55% 0.19% 269% $ 22.0 112% 3.7% 8.0% 4.0% 2.3%
Fidelity Bankshares,
Inc. FL* 05/15/01 FFFL 1,924 4.83% 0.26% 98% $ 87.0 112% 2.3% 6.0% 4.0% 0.8%
- --------------------------------------------------------------------------------------------------------------------
Averages - 2001: $1,107 8.19% 0.23% 184% $ 54.5 112% 3.0% 7.0% 4.0% 1.6%
Medians - 2001: $1,107 8.19% 0.23% 184% $ 54.5 112% 3.0% 7.0% 4.0% 1.6%
- --------------------------------------------------------------------------------------------------------------------
FloridaFirst
Bancorp, Inc. FL 12/22/00 FFBK $ 582 10.49% 0.17% 438% $ 31.5 115% 3.5% 8.0% 4.0% 2.5%
Finger Lakes
Financial Corp. NY 11/13/00 FLBC 307 6.43% 0.23% 337% 16.2 122% 5.3% 8.0% 4.0% 4.0%
Waypoint Financial
Corp. PA* 10/12/00 WYPT 4,518 6.01% 0.38% 127% 195.5 85% 5.7% 8.0% 0.0% 2.0%
Averages - 2000: $1,802 7.64% 0.26% 301% $ 81.1 107% 4.8% 8.0% 2.7% 2.8%
====================================================================================================================
Medians - 2000: $ 582 6.43% 0.23% 337% $ 31.5 115% 5.3% 8.0% 4.0% 2.5%
====================================================================================================================
======================================================================================================
Institutional Information Pro Forma Data
---------------------------------------------
Pricing Ratios(4) Financial Charac.
- ------------------------------------------------------------------------------------------------------
Elapsed
Conversion Core IPO Time as
Institution State Date Ticker P/TB P/E(5) P/A ROA TE/A ROE Price an MHC
- ----------- ----- ---- ------ ---- ------ --- --- ---- --- ----- --------
(%) (x) (%) (%) (%) (%) ($) (Months)
- ------------------------------------------------------------------------------------------------------
First Niagara Fin.
Group, Inc. NY* 01/21/03 FNFC 124.8% 19.5x 19.4% 1.0% 15.5% 6.4% $10.00 nm
Wayne Savings
Bncshrs, Inc. OH* 01/09/03 WAYN 89.4% 17.7x 11.0% 0.6% 12.3% 4.6% 10.00 nm
Sound Federal
Bancorp, Inc. NY 01/07/03 SFFS 110.9% 16.1x 17.9% 1.1% 16.1% 6.9% 10.00 51
Bridge Street
Financial, Inc. NY* 01/06/03 OCNB 87.4% 18.1x 13.9% 0.8% 16.1% 4.8% 10.00 42
- ------------------------------------------------------------------------------------------------------
Averages - 2003: 99.2% 17.1x 15.9% 0.9% 16.1% 5.8% $10.00 46
Medians - 2003: 99.2% 17.1x 15.9% 0.9% 16.1% 5.8% $10.00 46
- ------------------------------------------------------------------------------------------------------
Citizens South
Banking Corp. NC* 10/01/02 CSBC 108.7% 23.6x 18.6% 79.0% 17.1% 4.6% 10.00 54
Brookline Bancorp,
Inc. MA* 07/10/02 BRKL 94.9% 22.1x 40.2% 1.8% 42.4% 4.3% 10.00 52
Willow Grove
Bancorp, Inc. PA* 04/04/02 WGBC 96.6% 24.1x 16.1% 0.7% 16.7% 4.0% 10.00 39
- ------------------------------------------------------------------------------------------------------
Averages - 2002: 100.1% 23.3x 25.0% 27.2% 25.4% 4.3% $10.00 48
Medians - 2002: 96.6% 23.6x 18.6% 1.8% 17.1% 4.3% $10.00 52
- ------------------------------------------------------------------------------------------------------
PHSB Financial Corp. PA* 12/21/01 PHSB 67.2% 14.6x 11.3% 0.8% 16.9% 4.6% $10.00 53
Fidelity Bankshares,
Inc. FL* 05/15/01 FFFL 93.1% 19.9x 7.9% 0.4% 8.3% 4.7% 10.00 88
- ------------------------------------------------------------------------------------------------------
Averages - 2001: 80.2% 17.3x 9.6% 0.6% 12.6% 4.7% $10.00 71
Medians - 2001: 80.2% 17.3x 9.6% 0.6% 12.6% 4.7% $10.00 71
- ------------------------------------------------------------------------------------------------------
FloridaFirst
Bancorp, Inc. FL 12/22/00 FFBK 63.8% 12.2x 9.1% 0.7% 14.2% 5.2% $10.00 21
Finger Lakes
Financial Corp. NY 11/13/00 FLBC 72.9% 16.4x 7.5% 0.5% 10.3% 4.5% 7.00 72
Waypoint Financial
Corp. PA* 10/12/00 WYPT 97.6% 12.0x 8.3% 0.7% 8.4% 8.1% 10.00 81
Averages - 2000: 78.1% 13.5x 8.3% 0.7% 11.0% 5.9% $ 9.00 58
======================================================================================================
Medians - 2000: 72.9% 12.2x 8.3% 0.7% 10.3% 5.2% $10.00 72
======================================================================================================
Note: * - Appraisal performed by RP Financial; "NT" - Not Traded; "NA" - Not
Applicable, Not Available.
(1) Non-OTS regulated thrift.
(2) As reported in summary pages of prospectus.
(3) Reflects purchases in second step offering as reported in prospectus.
(4) Does not take into account the adoption of SOP 93-6.
(5) Excludes impact of special SAIF assessment on earnings.
(6) Latest price if offering less than one week old.
(7) Latest price if offering more than one week but less than one month old.
(8) Simultaneously converted to commercial bank charter.
February 21, 2003
RP Financial, LC.
Page 4.15
E. Trading in NCRIC Group's Stock
Since NCRIC Group's minority stock currently trades under the
symbol "NCRI" on the NASDAQ National Market System, RP Financial also considered
the recent trading activity in the valuation analysis. NCRIC Group had a total
of 3,708,399 shares issued and outstanding at March 11, 2003, of which 1,488,399
were held by public shareholders and were traded as public securities. As of
March 11, 2003, NCRIC Group's closing stock price was $16.02 per share. There
are significant differences between NCRIC Group's minority stock (currently
being traded) and the conversion stock that will be issued by NCRIC Group. Such
differences include different liquidity characteristics (the new conversion
stock will be more liquid owing to larger number of public shares available to
trade), and a different return on equity for the conversion. Since the pro forma
impact has not been publicly disseminated to date, it is appropriate to discount
the current trading level. As the pro forma impact is made known publicly, the
trading level will become more informative.
* * * * * * * * * * *
In determining our valuation adjustment for marketing of the issue, we
considered trends in both the overall market for insurance companies, the new
issue market as well as the market for secondary common stock offerings, both by
comparable insurance companies and thrift mutual holding companies. Taking these
factors and trends into account, RP Financial concluded that a moderate downward
adjustment was appropriate in the valuation analysis for purposes of marketing
of the issue.
8. Organization and Management
Under the current management team, the Company has been effective in
consummating various growth and product diversification strategies while
minimizing risk exposure. The Peer Group companies consist of relatively large
seasoned public companies with relatively deep and competent management teams as
well. However, NCRIC's relatively strong financial performance in the context of
a very difficult market environment, notwithstanding its concentration in the
District, leads us to conclude with a slight upward adjustment for this factor.
RP Financial, LC.
Page 4.16
9. Regulatory Environment
Both NCRIC and the Peer Group companies operate in a regulated industry
with oversight typically provided by state insurance regulators, generally
within the framework of guidelines established by state law and the National
Association of Insurance Commissioners. NCRIC appears to maintain good relations
with its regulators and the Peer Group companies are not subject to operating
restrictions of which we are aware. The one difference noted between NCRIC and
the Peer Group was with respect to the status of tort reform in the District
where there appears to be little if any momentum toward legislative change in
this regard whereas many of the states where the Peer Group companies operate
have approved tort reform measures. Offsetting the impact of this factor is that
most of NCRIC's growth is occurring in jurisdictions outside of the District. In
this regard, Virginia has implemented liability caps and the West Virginia
legislature recent passed a bill that would limit damages in medical malpractice
lawsuits and grant physicians tax credits on high insurance premiums among other
benefits.
On balance, we believe no adjustment is warranted for this factor.
Summary of Adjustments
Overall, based on the factors discussed above, we concluded that the
Company's pro forma market value should be discounted relative to the Peer Group
as follows:
Key Valuation Parameters Valuation Adjustment
Financial Condition Moderate Upward
Profitability, Growth and Viability of Earnings Moderate Upward
Risk Assessment Slight Upward
Primary Market and Growth Moderate Upward
Dividends Moderate Upward
Liquidity of the Shares Moderate Downward
Marketing of the Issue Moderate Downward
Organization and Management Slight Upward
Regulatory Environment No Adjustment
RP Financial, LC.
Page 4.17
Valuation Approaches
In applying the pro forma market value approach, we considered the four key
pricing ratios in valuing NCRIC's to-be-issued stock - price/earnings ("P/E"),
price/book ("P/B"), price/revenue ("P/Rev") and price/assets ("P/A") approaches
- -- all performed on a pro forma basis including the effects of the stock
offering proceeds. In computing the pro forma impact of the second step
conversion and the related pricing ratios, we have incorporated the valuation
parameters disclosed in NCRIC's prospectus for the effective tax rate, offering
expenses and stock benefit plan assumptions (summarized in Exhibits IV-2 and
IV-3). In addition, we have incorporated a 4.50% pre-tax reinvestment rate to
the reinvestable cash proceeds, which is consistent with the anticipated return
based on the near term use of proceeds. The assumptions utilized in the pro
forma analysis in calculating the Company's value pursuant to a second step
conversion transaction are described more fully below.
. Offering Expenses. Total offering expenses have been assumed to range
from $1.3 million at the midpoint to $1.6 million at the supermaximum
of the offering range, consistent with the prospectus.
. Effective Tax Rate. The Company, in consultation with its outside
auditors, has determined the marginal effective tax rate on the net
reinvestment benefit of the offering proceeds to be 34% based on the
statutory Federal income tax rate.
. Reinvestment Rate. The pro forma section in the prospectus
incorporates a 4.50% reinvestment rate on the new cash, which is
equivalent to the approximate rate available in the current market on
the mix of investments in which the Company plans to deploy the
conversion proceeds.
. Stock Benefit Plans. The assumptions for the stock benefit plans,
i.e., the Employee Stock Ownership Plan ("ESOP") and Stock Award Plan
("Stock Award Plan"), are consistent with the disclosure in the pro
forma section of the prospectus. Specifically, the ESOP is assumed to
purchase 5% of the stock in the offering at the initial public
offering price, with the ESOP expensed on a straight-line basis over
20 years. The Stock Award Plan is assumed to purchase 4% of the stock
in the offering at the initial public offering price, with the Stock
Award Plan cost expensed on a straight line basis in conjunction with
the 5 year vesting schedule.
In our estimate of value, we assessed the relationship of the pro forma
pricing ratios relative to the Peer Group and the recent demutualizations.
RP Financial, LC.
Page 4.18
RP Financial's valuation placed an emphasis on the following:
. P/E Approach. The P/E approach is generally the best indicator of
long-term value for a stock. Given the similarities and
notwithstanding the differences between the Company's and the Peer
Group's earnings composition and overall financial condition, the P/E
approach was carefully considered in this valuation. At the same time,
since reported earnings for the Company and the Peer Group have been
adversely impacted by current market conditions, we have been required
to rely on other valuation benchmarks more heavily.
. P/B Approach. P/B ratios have generally served as a useful benchmark
in the valuation of the equity securities of insurance companies,
particularly in the context of an initial public offering, as the
earnings approach involves assumptions regarding the use of proceeds,
potentially over an extended period of time. RP Financial considered
the P/B approach to be a reliable indicator of value given current
market conditions, particularly the market for recent
demutualizations. RP Financial also considered price/tangible book,
which adjusts for intangible assets, particularly goodwill.
. P/Revenues Approach. P/Revenue ratios have also been considered a
benchmark of trading value. A benefit of the revenues approach is that
it is not significantly impacted by the offering proceeds, unlike the
earnings and book value approaches. At the same time, investors tend
to focus more heavily on overall net earnings levels and future
earnings prospects rather than the magnitude of overall revenues.
. P/A Approach. P/A ratios are generally a less reliable indicator of
market value, as investors do not place significant weight on the size
of total assets as a determinant of market value. Investors place
significantly greater weight on book value and earnings, which have
received greater weight in our valuation analysis.
Trading of NCRI stock. Converting institutions generally do not have stock
outstanding. NCRIC, however, has public shares outstanding due to the mutual
holding company form of ownership. Since NCRI is currently traded on the NASDAQ,
it is an indicator of investor interest in NCRIC's conversion stock and
therefore we cannot ignore market expectations. At the same time, the investment
community typically does not have full information access and appraisal
expertise. Based on the March 11, 2003 stock price of $16.02 per share and the
3,708,399 shares of the Company's stock issued and outstanding, the implied
market value of $59.4 million was considered. However, since the post-conversion
stock will have different
RP Financial, LC.
Page 4.19
characteristics than the minority shares today, and since pro forma information
and appraised value determined herein has not been publicly disseminated to
date, the current trading price of NCRI cannot be relied upon as an accurate
determinant of value.
The Company has adopted Statement of Position ("SOP") 93-6, which will
cause earnings per share computations to be based on shares issued and
outstanding excluding unreleased ESOP shares. For purposes of preparing the pro
forma pricing analyses, we have reflected all shares issued in the offering,
including all ESOP shares, to capture the full dilutive impact, particularly
since the ESOP shares are economically dilutive, receive dividends and can be
voted. However, we did consider the impact of the adoption of SOP 93-6 in the
valuation.
Based on the application of the four valuation approaches, taking into
consideration the valuation adjustments discussed above, RP Financial concluded
that, as of March 11, 2003, the aggregate pro forma market value of the
Company's conversion stock was $50,115,500 at the midpoint, equal to 5,011,350
shares at $10.00 per share. The midpoint and resulting valuation range is based
on the sale of a 59.9% ownership interest to the public, which provides for an
$30.0 million public offering at the midpoint value.
1. P/E. The application of the P/E valuation method requires calculating
the Company's pro forma market value by applying a valuation P/E multiple to the
pro forma earnings base. Ideally, the pro forma earnings base is composed
principally of the Company's recurring earnings base, that is, earnings adjusted
to exclude any one-time non-operating items, plus the estimated after-tax
earnings benefit of the reinvestment of net offering proceeds. NCRIC's reported
earnings were $742,000 for the twelve months ended December 31, 2002, which
included a modest amount of investment losses ($131,000), and valuation
allowances established for a delinquent premium receivable ($1.2 million), both
of which we have excluded from the core earnings base on a tax effected basis to
derive a core earnings figure of $1,620,000.
Based on the foregoing, the Company's pro forma P/E multiple pursuant
incorporating the transaction assumptions discussed previously, was 38.45 times,
which is at a premium to the 15.15 times earnings figure reported by the one
Peer Group company reporting a meaningful P/E multiple. Based on core earnings,
NCRIC's pro forma P/E multiple equaled 22.97 times earnings.
RP Financial, LC.
Page 4.20
In light of weakened reported earnings for both NCRIC and the Peer Group,
we have also assessed NCRIC's pro forma P/E multiple based on budgeted earnings
for fiscal 2003 of $2.4 million, in comparison to the forward multiple based on
the analyst's consensus earnings for 2003 for the Peer Group. Specifically,
NCRIC's forward earnings multiple based on budgeted earnings equaled 16.92
times, which is at a premium of 20% relative to the Peer Group average and 60%
relative to the Peer Group median. We believe that the foregoing premiums are
appropriate in view of the relative strength of NCRIC's earnings in comparison
to the Peer Group (four of the seven companies were in a loss position for the
most recent twelve month period) and considering that analyst's estimates are
subject to significant volatility over time in response to changing market
conditions. Additionally, the premium forward earnings multiple for NCRIC takes
into account the fact that the pro forma calculations reflect the initial
reinvestment of the proceeds in investment securities at yields lower than the
anticipated returns from the Company's expansion and growth strategy over the
longer term.
Relative to the medical professional liability specialist sub-group the
Company's pro forma forward earnings multiples are discounted by 2% relative to
the average (17.20 times) and by 17% relative to the median (20.37 times).
Relative to ProAssurance's forward earnings multiple of 20.37 times, the
Company's pro forma forward earnings multiple is discounted by 17%.
2. P/B. The application of the P/B valuation method requires calculating
the Company's pro forma market value by applying a valuation P/B ratio to
NCRIC's pro forma book value. In applying the P/B approach, we also considered
tangible book value (i.e., book value net of intangible assets) because
historically the market has not generally given credit for intangible assets.
At the midpoint value, NCRIC exhibited pro forma reported and tangible P/B
ratios equaled 67.98% and 75.44%, respectively, compared to the Peer Group's
average reported and tangible P/B ratios of 77.95% and 83.73%, respectively.
Accordingly, the Company's pro forma reported and tangible P/B ratios are
discounted by 13% and 10%, respectively.
Relative to the medical professional liability specialist sub-group the
Company's pro forma P/TB ratios are at a premium equal to 12% relative to the
average (P/TB equal to 67.15%)
RP Financial, LC.
Page 4.21
and by 39% relative to the median (P/TB equal to 54.38%). In comparison to
ProAssurance's P/TB ratio of 134.84%, NCRIC is discounted by 44% at the midpoint
of the valuation range.
3. P/Revenues. The P/Revenues valuation methodology determines market
value by applying a valuation P/Revenue ratio to the Company's pro forma
revenues. At the midpoint of the valuation range, NCRIC's value equaled 1.14
times of pro forma revenues. The foregoing P/Revenue ratio is above the range
exhibited by the Peer Group average of 0.55 times and median of 0.60 times.
NCRIC's P/Revenue ratio is relatively comparable to ProAssurance's P/Revenue
ratio of 1.17 times. A benefit of the revenues approach is that it is not
significantly impacted by the offering proceeds, unlike the earnings and book
value approaches. At the same time, we believe that investors tend to focus more
heavily on overall net earnings levels rather than the magnitude of overall
revenues.
4. P/A. The P/A valuation methodology determines market value by
applying a valuation P/A ratio (fully demutualized basis) to the Company's pro
forma asset base. At the midpoint of the valuation range, NCRIC's value equaled
21.92% of pro forma assets. Comparatively, the Peer Group companies exhibited an
average P/A ratio of 14.51%, which implies a 51.1% premium being applied to the
Company's pro forma P/A. NCRIC's P/A ratio at the midpoint is at a 65% premium
relative to the medical professional liability specialist sub-group and at a 13%
discount relative to ProAssurance. We placed less weight on this valuation
methodology, as size is a less important valuation criteria to the investment
community
* * * * * * * * * *
Valuation Conclusion
Based on the foregoing, it is our opinion that, as of March 11, 2003,
the estimated aggregate pro forma market value of NCRIC, inclusive of the sale
of the MHC's ownership interest to the public shareholders was $50,113,500 at
the midpoint. Based on this valuation and the approximate 59.9 ownership
interest being sold in the public offering, the midpoint value of the Company's
stock offering was $30,000,000, equal to 3,000,000 shares at a per share value
of $10.00. The offering range includes a minimum value of $25,500,000, equal to
2,550,000 shares at $10.00 per share (85.0% of the midpoint) and a maximum value
of $34,500,000, equal to
RP Financial, LC.
Page 4.22
3,450,000 shares at $10.00 per share (115.0% of the midpoint). If warranted by
market conditions, the Company may sell conversion stock up to a supermaximum
value of $39,675,000 (15% above the maximum), equal to 3,967,500 shares at
$10.00 per share, without requiring a resolicitation. The pro forma valuation
calculations relative to the Peer Group are shown in Table 4.5 and are detailed
in Exhibit IV-2 and Exhibit IV-3.
Establishment of the Exchange Ratio
The Plan of Conversion and Reorganization provides that the minority
stockholders are entitled to exchange their shares of the Company's common stock
for newly issued shares of Company as a fully converted company. The Board of
Directors has independently established a formula to determine the exchange
ratio. The formula has been designed to preserve the current aggregate public
ownership percentage in Company equal to 40.14% as of March 11, 2003. Pursuant
to this formula, the exchange ratio to be received by the existing minority
shareholders of Company will be determined at the end of the offering based on
the total number of shares sold in the Subscription and Community offerings. As
shown in Table 4.5, the exchange ratio for the minority shareholders would be
1.1486 shares, 1.3514 shares, 1.5541 shares and 1.7872 shares at the minimum,
midpoint, maximum and supermaximum of the offering range, respectively. RP
Financial expresses no opinion on the proposed exchange of newly issued shares
for the shares held by the minority stockholders or on the proposed exchange
ratio.
RP Financial, LC
Table 4.5
Public Market Pricing
NCRIC Group, Inc. and the Peer Group
Prices As of March 11, 2003
Market Capitalization Per Share Data
------------------------ --------------------------------------------------------------
Primary Price/ Shares Market TTM Earnings Book Value TTM
---------------------------- --------------
Ticker Line Share Out. Value Actual Core 2003 Est.(2) GAAP Tang. Rev. Assets
- ------ ------- ------ ------ -------- ------ ------ ------------ ------ ------ ------ -------
($) (000) ($000) ($) ($) ($) ($) ($) ($) ($)
NCRIC Group, Inc. PL
- -----------------
Supermaximum $10.00 6,628 $ 66,275 $0.23 $0.36 $0.48 $12.43 $11.33 $ 6.68 $ 35.79
Maximum $10.00 5,763 $ 57,631 $0.24 $0.39 $0.53 $13.49 $12.22 $ 7.64 $ 40.36
Midpoint $10.00 5,011 $ 50,114 $0.26 $0.44 $0.59 $14.71 $13.26 $ 8.75 $ 45.61
Minimum $10.00 4,260 $ 42,596 $0.29 $0.49 $0.67 $16.36 $14.65 $10.25 $ 52.72
Peer Group Aggregate
- --------------------
Average $12.95 15,219 230,999 ($1.06) ($1.30) $1.06 $18.73 $17.38 $24.30 $ 90.64
Median -- -- -- -- -- -- -- -- -- --
Professional Liability
Peer Group
- ----------------------
Average $13.93 13,980 236,278 ($1.80) ($2.10) $0.81 $22.99 $22.11 $27.91 $108.95
Median -- -- -- -- -- -- -- -- -- --
Workers Compensation
Peer Group
- --------------------
Average $11.66 16,870 223,959 ($0.07) ($0.24) $1.38 $13.04 $11.08 $19.49 $ 66.24
Median -- -- -- -- -- -- -- -- -- --
Professional
Liability Peer Group
- --------------------
ACAP American PL $19.40 8,695 168,683 ($1.98) ($1.98) $0.50 $32.24 $32.24 $32.26 $121.78
Physicians
FPIC FPIC Ins. Grp. PL $ 7.55 9,391 70,902 ($1.56) ($1.56) $1.40 $17.67 $15.54 $23.52 $109.30
PRA Pro Assurance PL $22.81 28,500 650,085 $0.47 $0.59 $1.12 $17.72 $16.92 $19.50 $ 90.74
SKP SCPIE Holdings PL $ 5.94 9,334 55,443 ($4.12) ($5.44) $0.23 $24.34 $23.77 $36.34 $113.97
Workers Compensation
Peer Group
- --------------------
AGII Argonaut Grp. WC $12.42 21,581 $268,036 $0.82 $0.82 $1.53 $20.11 $15.35 $20.35 $ 92.50
RTWI RTW, Inc. Zenith WC $ 2.30 10,262 23,603 ($1.59) ($1.59) $0.70 $ 2.13 $ 2.13 $ 6.03 $ 20.12
ZNT National WC $20.26 18,768 380,240 $0.55 $0.05 $1.92 $16.89 $15.75 $32.09 $ 86.10
Pricing Ratios Dividends
------------------------------------------------------------- ---------------------
Earnings Book Value TTM Amt./ Payout
---------------------------- ----------------
Ticker Actual Core 2003 Est.(2) GAAP Tang. Rev. Assets Share Yield Ratio
- ------ ------ ------ ------------ ------- ------ ----- ------ ----- ----- ------
(x) (x) (x) (%) (%) (x) (%) ($) (%) (%)
NCRIC Group, Inc.
- -----------------
Supermaximum 44.40x 27.96x 21.04x 80.48% 88.30% 1.50x 27.94% $0.00 0.00% 0.00%
Maximum 41.42x 25.39x 18.90x 74.14% 81.81% 1.31x 24.78% $0.00 0.00% 0.00%
Midpoint 38.45x 22.97x 16.92x 67.98% 75.44% 1.14x 21.92% $0.00 0.00% 0.00%
Minimum 35.05x 20.35x 14.82x 61.11% 68.25% 0.98x 18.97% $0.00 0.00% 0.00%
Peer Group Aggregate
- --------------------
Average 15.15x 15.15x 14.05x 77.95% 83.73% 0.55x 14.51% $0.06 0.96% N.M.
Median 15.15x 15.15x 10.55x 61.77% 80.93% 0.60x 13.43% -- -- --
Professional Liability
Peer Group
- ----------------------
Average N.M. N.M. 17.20x 64.01% 67.15% 0.56x 13.30% $0.10 1.68% N.M.
Median N.M. N.M. 20.37x 51.46% 54.38% 0.46x 11.42% -- -- --
Workers Compensation
Peer Group
- --------------------
Average 15.15x 15.15x 9.33x 96.54% 105.83% 0.54x 16.13% $0.00 0.00% N.M.
Median 15.15x 15.15x 9.33x 107.91% 107.91% 0.61x 13.43% -- -- --
Professional
Liability Peer Group
- --------------------
ACAP American N.M. N.M. N.M. 60.18% 60.18% 0.60x 15.93% $0.00 0.00% N.M.
Physicians
FPIC FPIC Ins. Grp. N.M. N.M. 5.39x 42.73% 48.58% 0.32x 6.91% $0.00 0.00% N.M.
PRA Pro Assurance N.M. N.M. 20.37x 128.73% 134.84% 1.17x 25.14% $0.00 0.00% N.M.
SKP SCPIE Holdings N.M. N.M. 25.83x 24.41% 24.99% 0.16x 5.21% $0.40 6.73% N.M.
Workers Compensation
Peer Group
- --------------------
AGII Argonaut Grp. 15.15x 15.15x 8.12x 61.77% 80.93% 0.61x 13.43% $0.00 0.00% N.M.
RTWI RTW, Inc. Zenith N.M. N.M. N.A. 107.91% 107.91% 0.38x 11.43% $0.00 0.00% N.M.
ZNT National N.M. N.M. 10.55x 119.94% 128.66% 0.63x 23.53% $0.00 0.00% N.M.
Based on
Analysts
Consensus (1) Exch. Gross
-------------
Ticker ROA ROE Ratio Proceeds
- ------ ----- ------ ------- --------
(%) (%) (x) ($Mil)
NCRIC Group, Inc.
- -----------------
Supermaximum 1.33% 3.83% 1.7872x $39.68
Maximum 1.31% 3.92% 1.5541x $34.50
Midpoint 1.30% 4.02% 1.3514x $30.00
Minimum 1.28% 4.12% 1.1486x $25.50
Peer Group Aggregate
- --------------------
Average 1.17% 5.95%
Median 1.26% 6.97%
Professional Liability
Peer Group
- ----------------------
Average 0.78% 4.19%
Median 0.82% 3.94%
Workers Compensation
Peer Group
- --------------------
Average 1.94% 9.49%
Median 1.94% 9.49%
Professional
Liability Peer Group
- --------------------
ACAP American 0.41% 1.55%
Physicians
FPIC FPIC Ins. Grp. 1.28% 7.92%
PRA Pro Assurance 1.23% 6.32%
SKP SCPIE Holdings 0.20% 0.95%
Workers Compensation
Peer Group
- --------------------
AGII Argonaut Grp. 1.65% 7.61%
RTWI RTW, Inc. Zenith N.A. N.A.
ZNT National 2.23% 11.37%
(1) Based on analysts consensus estimates for the Peer Group. Assumes NCRIC
Group earns $2.4 million in fiscal 2003 which is consistent with NCRIC's
budget before factoring in the impact of the second step conversion.
Note: TTM = Trailing 12 months.
Source: Audited and unaudited financial statements, corporate reports and
offering circulars.
The information provided in this table has been obtained from sources we
believe are reliable, but we cannot guarantee the accuracy or
completeness of such information.