Description

NCRIC Group is a small DC-based medical malpractice insurer which is 60% owned by NCRIC, a mutual holding company (MHC). The balance of the stock is trading publicly at;

92% of book value
45% of estimated of 2nd stage value
37% of remutualization value at book

I believe that NCRIC should trade at between $16 and $20 per share, based on a discount to likely 2nd stage pricing.


NCRIC was created by DC physicians in 1980 during a previous crunch in the med mal market. They survived the early 80’s and have prospered writing primarily in DC (I don’t have figures, but they have one of the more hostile litigation environments in terms of average jury awards). In July 1999 the MHC sold 1,480,000 shares to the public, (222,000 shares went into the ESOP and stock plans) and continues to hold 2,220,000. NCRIC is primarily a medical malpractice insurer, which began adding practice management and financial services (through NCRIC MSO) to its offering in 1997.

INSURANCE OPERATIONS
NCRIC writes direct in Washington DC, where it has 50% of the direct market – this is probably the most profitable ground for growing the services side of the business. DC accounts for 50% of premium written – about 75% of premium earned in 2001). While there is no breakdown, the company cites a static market share and a 98% retention rate since 1998.
CML, a wholly owned subsidiary of NCRIC writes brokered policies in Virginia, Maryland, West Virginia, and Delaware (<3% market share in each). This has growth from 12% of premiums written in 1999 to 50% in 2001. Total new business written in 2001 was $12.2m ($4.4m in 2000). Management continue to be keen to grow business outside DC.

Obviously there are going to be some concerns about the medical malpractice sector in the current environment, so I’ll follow up this piece with a couple of postings as to why I think this business is solid and worth at least book. Briefly the points are;

- policies on “claims made” basis
- pricing up only 21% in DC (up to 30% in new markets)
- focussed niche players are what has made life so difficult for nationals like St Paul
- prior year reserves have already been boosted by $20m, on ~$85m of reserves, in the last 3 years (1999, $11.1m; 2000, $5.2m; 2001 $4.2m). It’s unclear whether this indicates that they’ve been more on the ball than others.

PRACTICE MANAGEMENT OPERATIONS
The company acquired Healthcare Consulting in 1999 for $8.5m to expand its practice management business. Revenue was $6.2m vs $5.2 in 2000 was pre-tax income of $0.09m and $0.35m respectively. Revenue is 50% practice management (regulatory compliance, general consulting), 30% accounting and the balance tax, financial planning, etc.
Management claim that ramp costs for new business are keeping the business at breakeven while revenue is growing. There isn’t enough available information to check this directly, but $3m of the purchase price was in contingent performance payments, the second of which was accelerated in June 2001. Given the existing DC salesforce and current revenue, an $8.5m valuation for the business is still a bit of a stretch, but represents just over $2 of the book value per share so I’ll leave it be.

OTHER
In April 2001 NCRI established American Captive Corporation, a DC- licensed captive which is now being marketing with Risk Services, LLC. The captive offers ‘protected cells’ - along the lines of a rent-a-captive.
To date no protected cells have been established

INVESTMENTS
Not great. These are currently run by Zurich Insurance Asset Management. In the last 2 years they have lost $0.7m on an Osprey bond and lost about $0.8m on a Xerox bond. Otherwise basic fixed interest including (40% corporates) and 6% equities.

MANAGEMENT
The Board is primarily comprised of physicians (with NCRIC policies) – management have medical insurance backgrounds.
Proceeds of the initial offering were largely used to cover the cost of acquiring the Healthcare Consulting. There has been no significant share repurchase and management were looking for a merger with another mutual.
Management have recently indicated that they no longer believe a merger with another mutual insurer is possible and are appear to be working towards a second-stage offering – with likely share repurchases until then

Directors & officers (including ESOP) hold 7.6% of the stock – the CEO, COO and Chairman are the only individuals with decent amounts of stock. Not as much as you'd like to see, but they'll certainly make a few million in either a remutualization of second-stage.

VALUATION
I’ve used a book value metric in the calculations – basically assuming that the insurance are adequately reserved (and ignoring future growth prospects) and the consulting business is worth what has been paid for it. I think the business should trade at a premium to its peers, due to the DC book (which comprises the bulk of its reserves).
The company has $7m in cash and about $2m in long term debt, so the only real leverage is the insurance reserves.

The Service Bancorp (SERC) and Charter Financial (CHFN)write-ups have laid out the advantages of the MHC structure and the possible end-game scenarios (remutualization and second-stage offerings), so I won’t go into them in detail again. Suffice it to say, that until any of these transactions take place, the company’s value accrues largely to the holders of 40.7% of shares publicly held (ie, those not held by the MHC).

current price $11.00
current book $12.00
remutualised book $29.50 (management have indicated this is now unlikely)

The book value following a second stage offering is dependant on the pricing of the offering. For thrifts numbers have been something like 70-130% of book. There’s not a boom in the sector, so something like 70-80% seems reasonable (and in line with the original IPO)

Book value after second stage
at 100% is $29.50
at 90% is $28.45
at 80% is $27.40
at 70% is $26.40
at 60% is $25.30
at 50% is $24.30

So a book value after second stage of $27 is reasonable. This isn’t going to happen immediately – the market isn’t favourable and there is the need to get approval from the DC Commissioner for the full demutualization. In the mean time any sharebuybacks and retained earnings will add further value.

Given the uncertainties, a 2 year timeframe is probably realistic for more than a 55%p.a. return, increased by earnings and any share repurchases in the interim.

Catalyst

Management’s indication they are no longer seeking a merger and are examining a more straight forward second-stage. The first concrete evidence is likely to be the announcement of a share repurchase.