Headquartered in Cincinnati, Ohio, Dental Care Plus Group offers to employer groups of all sizes dental HMO, dental PPO, dental indemnity and vision PPO benefit plans and related services. As of December 31, 2012, we had approximately 299,800 members in our dental and vision benefit programs with approximately 2,652 dentists participating in our dental HMO provider network and approximately 2,892 dentists participating in our dental PPO provider network.
Historically, healthcare services expense has generally increased for both the fully-insured dental segment and the self-insured dental segment. We have and continue to review and adjust our provider fee schedules where appropriate. In 2011, insurance expenses increased by approximately 3.5% compared to 2010. In 2012, insurance expenses increased by approximately 11.4% compared to 2011. Other important factors that have an impact on our profitability are both the competitive pricing environment and market conditions. With respect to pricing, there is a tradeoff between sustaining or increasing underwriting margins versus increasing enrollment. With respect to market conditions, economies of scale have an impact on our administrative overhead. As a result of a decline in preference for more closely managed dental HMO products, dental costs have become increasingly comparable among our larger competitors. Product design and consumer involvement have become more important drivers of dental services consumption, and administrative expense efficiency is becoming a more significant driver of margin sustainability. Consequently, we continually evaluate our administrative expense structure and attempt to realize administrative expense savings principally through technology improvements.
Our ratio of healthcare services expense to premium revenue (“loss ratio”) decreased by 2.3%, to 79.5% in 2012 from 81.8% in 2011. This loss ratio decrease is primarily due to an increase in fully-insured premium rates in 2012 compared to 2011, improved underwriting practices and a decrease in fully-insured healthcare services expense on a per member per month basis as a result of implementing a provider withhold on the dental PPO product effective April 1, 2011. The fully-insured dental HMO/IND and fully-insured dental PPO segments together represent approximately 69.0% of our total dental business.
Our fully-insured dental HMO/IND membership increased approximately 1,900 in 2012. This membership increase is primarily attributable to an increase of approximately 2,400 fully-insured dental HMO members, offset by a decrease of approximately 500 fully-insured dental indemnity members underwritten by Dental Care Plus, Inc. (“DCP”). The increase in fully-insured dental HMO membership of 2,400 members is due to new sales in the Cincinnati and Northern Kentucky markets of approximately 12,100 members during 2012, offset by the loss of approximately 9,700 members with employer groups that did not renew with the Company or reduced employee counts of retained employer groups. A significant portion of the fully-insured dental HMO membership losses were the result of not renewing certain employer groups that did not accept the premium rate increases we proposed to move them to profitability. In addition, some of these membership losses were due to corporate acquisitions where our employer group customers moved to the new parent company benefit plans.
Fully-insured dental HMO/IND healthcare services expense decreased by $64,000, or 0.2%, to $33,399,000 in 2012 from $33,463,000 in 2011. This decrease is attributable to a decrease in fully-insured dental HMO/IND healthcare services expense on a per member per month basis of approximately $489,000, or 1.5%, in 2012 for both existing and new fully-insured dental HMO/IND membership. This decrease was offset by an increase in fully-insured dental HMO/IND healthcare services expense of approximately $425,000 due to an increase in fully-insured dental HMO/IND member months of 1.3% in 2012 compared to 2011.
Self-insured healthcare services expense increased by approximately $629,000, or 3.1%, in 2012. An increase of 2.3% in self-insured member month volume in 2012 compared to 2011 resulted in an increase in self-insured healthcare services expense of approximately $468,000. Self-insured dental healthcare services expense increased by approximately $161,000 due to an increase in dental service utilization level by our self-insured members in 2012 compared to 2011.
The following table shows membership totals and revenues and expenses for our four business segments for the years ended December 31, 2011 and 2010 (dollars in thousands):
Net income (loss) was approximately $591,000 and $(89,000) for 2011 and 2010, respectively. The increase in net income primarily resulted from an increase in premium revenue of approximately $712,000, to $76,227,000 in 2011 from $75,515,000 in 2010 and a decrease in healthcare services expense of $791,000, to $62,351,000 in 2011 from $63,142,000 in 2010. The resulting increase in gross margin of approximately $1,503,000 was offset by an increase in insurance expenses of $445,000, to $13,117,000 in 2011 from $12,672,000 in 2010. Our ratio of insurance expense to total premium revenue (“insurance expense ratio”) increased to 17.2% in 2011 from 16.8% in 2010.
Our fully-insured dental HMO/IND membership decreased approximately 3,400 in 2011. This membership decrease is primarily attributable to a decrease of approximately 2,900 fully-insured dental HMO members and a decrease of approximately 500 fully-insured dental indemnity members underwritten by Dental Care Plus, Inc.
(“DCP”). The decrease in fully-insured dental HMO membership of 2,900 members is due to the loss of approximately 12,400 members with employer groups that did not renew with the Company or reduced employee counts of retained employer groups, offset by new sales in the Cincinnati and Northern Kentucky markets of approximately 9,500 members during 2011. A significant portion of the fully-insured dental HMO membership losses were the result of corporate acquisitions where our employer group customers moved to the new parent company benefit plans.
Our self-insured dental membership increased by approximately 4,200 members in 2011. This increase is primarily due to the addition of new self-insured dental HMO and dental PPO employer groups in the Southwest Ohio and Northern Kentucky markets, as well as an increase in membership of existing employer groups in the last twelve months.
Fully-insured dental PPO premium increased approximately $173,000 in 2011 compared to 2010. Fully-insured dental PPO premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $415,000 in fully-insured dental PPO premium revenue. A decrease in fully-insured dental PPO membership in 2011 resulted in a decrease in fully-insured dental PPO premiums of approximately $242,000. The fully-insured dental PPO segment represented approximately 12.5% of our total dental business in 2011.
Corporate, all other premium revenue is primarily derived from the non-DCP dental indemnity product, dental PPO product and vision product underwritten by third party insurance carriers. In aggregate, corporate, all other premium revenue increased by approximately $30,000, or 6.5%, to $493,000 in 2011 from $463,000 in 2010.
Investment income decreased approximately $4,000, or 3.5%, to $111,000 in 2011 from $115,000 in 2010. This decrease is the result of funds that were invested in low yield money market investments during the transition from short duration to medium duration corporate bond investments in 2011. In 2010, we invested in short duration investment grade corporate bonds, Federal Deposit Insurance Corporation (“FDIC”) insured certificates of deposit and money market funds. In 2011, we invested in medium duration investment grade corporate bonds, FDIC insured certificates of deposit and money market funds.
Fully-insured dental HMO/IND healthcare services expense decreased by $575,000, or 1.7%, to $33,463,000 in 2011 from $34,038,000 in 2010. This decrease is attributable to a decrease in fully-insured dental HMO/IND healthcare services expense of approximately $923,000 due to a decrease in fully-insured dental HMO/IND member months of 2.7% in 2011 compared to 2010. This decrease was offset by an increase in fully-insured dental HMO/IND healthcare services expense of approximately $348,000 resulting from an increase in
fully-insured dental HMO/IND healthcare services expense on a per member per month basis of approximately 1.0% in 2011 for both existing and new fully-insured dental HMO/IND membership.
Consolidated insurance expenses increased approximately $445,000 in 2011. Total insurance expenses as a percentage of total premium revenue, or the insurance expense ratio, was 17.2% for 2011, increasing 0.4% from the 2010 ratio of 16.8%. Board of Director expense increased by approximately $300,000, or 100%, primarily due to a 50% increase in total director compensation including cash and deferred share awards compensation as a result of additional share awards and an increase in the book value of redeemable common shares. There was a 50% reduction to director compensation, approved by the Board, in 2010. In addition, advertising expense in 2011 increased by approximately $57,000, or 52.0%, as advertising programs were reinitiated in 2011 after having been forgone in 2010 as part of an initiative to reduce discretionary expenses. Professional consulting expense increased by approximately $156,000, or 75.1%, as a result of proceeding with discretionary projects in 2011 that were delayed in 2010. Salaries and benefits increased by approximately $80,000, primarily as a result of higher management bonuses in 2011 compared to 2010. Commissions expense increased approximately $51,000, or 1.6%, due to the increase in total premium revenue in 2011 compared to 2010.
Our primary sources of cash are premiums, ASO fees, investment and other income, as well as the proceeds from the maturity or sale of our investment securities, from the sale of redeemable common and preferred shares, and from borrowings. Our primary uses of cash include disbursements for claims payments, insurance expense, interest expense, taxes, purchases of investment securities, capital expenditures, redeemable common shares redemptions, dividends, and payments on borrowings. Because premiums are collected in advance of claims payments, our business should normally produce positive operating cash flows during a period of increasing enrollment. Conversely, cash flows would be negatively impacted during a period of shrinking enrollment. Cash increased $1,554,000, or 22.3%, for the year ended December 31, 2012 to approximately $8.5 million at December 31, 2012 from approximately $7.0 million at December 31, 2011. This cash increase is primarily the result of improved profitability due to a lower fully-insured loss ratio in 2012. This loss ratio decrease is primarily due to an increase in fully-insured dental HMO/ IND and fully-insured dental PPO premium rates in 2012 compared to 2011, improved underwriting practices, and a decrease in fully-insured dental HMO/IND healthcare services expense on a per member per month basis as a result of a decrease in fully-insured dental HMO/IND dental services utilization. Cash increased approximately $915,000, or 15.1%, for the year ended December 31, 2011 to approximately $7.0 million at December 31, 2011 from approximately $6.1 million at December 31, 2010. This cash increase is primarily the result of a lower fully-insured loss ratio offset by higher insurance expense as a percentage of premium in 2011. This loss ratio decrease is primarily due to an increase in fully-insured premium rates in 2011 compared to 2010, improved underwriting practices, and a decrease in fully-insured healthcare services expense on a per member per month basis as a result of implementing a provider withhold on the dental PPO product effective April 1, 2011. The change in cash for the years ended December 31, 2012, 2011 and 2010 is summarized as follows (in thousands):
In 2012, we generated approximately $1,362,000 of cash from operating activities. This level of cash flow from operating activities is similar to the cash flow generated from operating activities in 2011. We had net income of approximately $1,318,000 in 2012 compared to net income of $591,000 in 2011. During 2012, we paid approximately $1,110,000 in federal tax payments as compared to $95,000 in 2011. In addition to our 2012 net income, we had non-cash depreciation and amortization expense of approximately $288,000 and an increase in deferred compensation liabilities of $542,000. The increase in deferred compensation liabilities is primarily due to the 16% increase in the book value of the common shares during 2012. These sources of cash were offset by cash uses such as a decrease in the claims payable liability of approximately $665,000. A decrease in unbilled accounts receivable of approximately $2,623,000 was offset by a decrease in unearned premium revenue of $2,665,000, resulting in a net cash decrease of $42,000. This cash decrease is attributable to a decrease in unearned premium revenue received in advance. Unbilled accounts receivable and unearned premium revenue are recorded primarily as the result of non-cancelable short-term insurance contracts. Most of our contracts are one year in duration; however, we occasionally enter into multi-year contracts that tend to be for larger groups. As a result, depending on the timing of large group renewals, the unbilled accounts receivable and unearned premium revenue can experience large fluctuations from period to period.
In 2010, we generated approximately $876,000 of cash from operating activities. This level of cash flow from operating activities is higher than the cash flow generated from operating activities in 2009. We had a net loss of approximately $89,000 in 2010 compared to net loss of $289,000 in 2009. Sources of cash include: non-cash depreciation and amortization expense of approximately $505,000, an increase in deferred compensation liabilities of $132,000, an increase in claims payable of $460,000, and an increase in unearned premium of $8,572,000 that was offset by an increase in unbilled accounts receivable of $8,076,000. Both unbilled accounts receivable and unearned premium increased as a result of the conversion of a large employer group from the self-insured segment to the fully-insured segment and the renewal of a large employer group on a multi-year contract, both effective January 1, 2010. The increase in our claims payable is primarily due to the fact that there was a significant increase in fully-insured membership at December 31, 2010 compared to December 31, 2009. These sources of cash were offset by cash uses such as an increase in accounts receivable of approximately $95,000, an increase in deferred policy acquisition costs of $723,000 and an increase in other assets of $99,000.
In 2010, we invested approximately $151,000 in building improvements, office equipment and computer equipment and software. In December of 2010, we entered into a sale-leaseback transaction with a leasing company where we received approximately $323,000 in cash in exchange for certain fixed assets on our balance sheet and subsequently entered into a capital lease agreement whereby we are obligated to pay lease payments totaling $339,000 related to these assets over a three year period. Also in 2010, approximately $5.4 million of our investments in FDIC insured certificates of deposit and money market funds either matured or were liquidated to fund operations. We also invested approximately $7.3 million in additional FDIC insured certificates of deposit, investment grade corporate bonds and money market funds. Collectively, this resulted in a decrease in cash from investment activities of approximately $1.7 million.
A summary of our future commitments as of December 31, 2012 is as follows:
As of December 31, 2012, we believe our most significant other commitments are:
Redeemable Common Shares-Pursuant to the Company’s Amended and Restated Code of Regulations, dentist have the right to require the Company to repurchase such dentist’s common shares on the term contained in the Code of Regulations. In 2013, we expect to pay approximately $160,000 in redeemed common shares.
In July 2012, we renewed an annually renewable agreement with a commercial bank for a $500,000 working capital line of credit. Interest was at a variable rate of LIBOR plus 2.50% and was 2.57% at December 31, 2012. The Company did not have any interest expense for the line of credit in 2012, 2011 or 2010. As of December 31, 2012 and 2011, there was no amount outstanding on this line of credit.
In August 2012, we renewed an annually renewable agreement with a commercial bank for a $960,000 working capital line of credit, and the commercial bank also issued an irrevocable letter of credit in the amount of $40,000. Interest was payable at a variable rate of LIBOR plus 2.50% and was 2.57% at December 31, 2012. The Company did not have any interest expense for the line of credit in 2012 or 2011. As of December 31, 2012 and 2011, there was no amount outstanding on this line of credit.
We maintained aggregate statutory capital and surplus of approximately $7.4 million as of December 31, 2012 and were in compliance with applicable statutory requirements. Although the minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements can vary significantly from state to state. Given our anticipated premium growth in 2013 resulting from the expansion of our networks and membership, capital requirements will increase. We expect to fund these increased requirements through the retention of earnings and capital raised in future redeemable common and preferred share offerings.
Most states rely on risk-based capital requirements, or RBC, to define the required levels of equity. RBC is a model developed by the NAIC to monitor an entity’s solvency. This calculation indicates recommended
The fair market value of the variable-to-fixed interest rate swap contract (net of income tax effects) decreased by $20,339 due to a slight decrease in prevailing interest rates at the end of December 2012. The fair market value of the variable-to-fixed interest rate swap contract (net of income tax effects) increased by $7,448 at December 31, 2011 due to an increase in prevailing interest rates during 2011 as compared to 2010. The fair market value of the variable-to-fixed interest rate swap contract (net of income tax effects) decreased by $2,644 at December 31, 2010 due to a slight decrease in prevailing interest rates during 2010. The fair market value of the variable-to-fixed interest rate swap contract was a liability of $41,275 and $16,354 and is included in other payables and accruals at December 31, 2012 and 2011, respectively.
When developing our estimate for claims payable liability as of December 31, 2012, we considered actual paid claim data from January 2013. As a result, we are able to use the completion factors approach for all historical months in 2012, including December 2012. The table below illustrates how our operating results are impacted when there is a variance between estimated claims expense and actual claims expense. The table shows the sensitivity of the estimated fully-insured incurred claims payable liability to fluctuations in the expected
(a) Reflects estimated potential changes in incurred claims payable liability caused by changes in completion factors for all months prior to December 31, 2012.
Our accounting for income taxes requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that are recognized in our consolidated financial statements in different periods than those in which the events are recognized in our tax returns. The measurement of deferred
tax liabilities and assets is based on current tax laws as of the balance sheet date. We record a valuation allowance related to deferred tax assets in the event that available evidence indicates that the future tax benefits related to deferred tax assets may not be realized. A valuation allowance is required when it is more likely than not that the deferred tax assets will not be realized. Our determination of whether a valuation allowance is required is subject to change based on future estimates of the recoverability of our net deferred tax assets.
In December 2011, the FASB issued updated guidance on the presentation of comprehensive income that was issued by the FASB in June 2011 effective prospectively for fiscal years beginning after December 15, 2011. The June 2011 guidance requires entities to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single, continuous statement of comprehensive income or in two separate but consecutive statements. The updated December 2011 guidance defers these changes that relate to the presentation of adjustments between other comprehensive income and net income. The Company has adopted the new guidance and has elected to present one continuous consolidated statement of comprehensive income (loss). This did not have a material impact on the consolidated financial statements.
To the Board of Directors and Shareholders of DCP Holding Company:
We have audited the accompanying consolidated balance sheets of DCP Holding Company and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of comprehensive income (loss), redeemable shares and shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedules included in Item 15(a)2. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Basis of Presentation-The accompanying consolidated financial statements include the accounts of the Company and subsidiaries, each of which is wholly-owned, and have been prepared in conformity with accounting principles generally accepted in the United States of America. All intercompany accounts and balances have been eliminated in consolidation. The Company presents its financial statements to conform with Article 7 of the Securities and Exchange Commission Regulation S-X pursuant to Section 13-15(d) of the Securities Exchange Act of 1934.
Adopted Accounting Standards-Effective January 1, 2012, the Financial Accounting Standards Board (“FASB”) amended the guidance for deferred acquisition costs and requires that only incremental direct costs of
successful contract acquisition be capitalized. These incremental direct costs are those that are essential to the contract transaction and would not have been incurred had the contract transaction not occurred. On January 1, 2012, the impact of adoption on redeemable shares and beginning shareholders’ equity totaled approximately $125,000, net of tax. The Company has applied the retrospective method for financial statement presentation and note disclosures for the prior periods reported.
Cash and Cash Equivalents-The Company defines cash as cash held in operating accounts at financial institutions. The Company considers highly liquid investments with maturities of three months or less at the date of acquisition as cash equivalents in the accompanying consolidated financial statements. These are carried at cost, which approximates fair value.
Management follows a consistent and systematic process for recognizing impairments on securities that sustain other-than-temporary declines in value. The decision to record an other-than-temporary impairment for a security incorporates both quantitative criteria and qualitative information. The Company considers the severity of the loss on a security, duration of loss, duration of the investment, credit rating of the security, as well as payment performance and the Company’s intent or requirement to sell the investment before recovery when determining whether any impairment is other than temporary. The Company’s impairment policy for fixed-maturity securities states that other-than-temporary impairment is considered to have occurred if (1) the Company intends to sell the impaired fixed maturity security; (2) it is more likely than not that the Company will be required to sell the fixed maturity security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis.
State Guarantee Fund Deposits-The Company maintains funds on deposit with state insurance departments in those states where the Company is licensed to do business. These funds amounted to approximately $280,000 and $285,000 at December 31, 2012 and 2011, respectively. These funds are restricted and not available to the Company for normal operations and are included in other assets in the accompanying consolidated balance sheets.
Goodwill and Intangible Assets-Goodwill arises in business combinations when the purchase price of net assets less liabilities assumed acquired exceeds the fair value. As with tangible and other intangible assets, periodic impairment reviews are required, at least annually, as well as when events or circumstances change. Management uses judgment in assessing goodwill for impairment. Management reviews the recorded value of our goodwill annually, or sooner if events or changes in circumstances indicate that the carrying amount may exceed fair value. Professional judgment is exercised in determining future cash flows, timing and business valuation comparables or selecting discount rates to be used in any valuation assessments.
Deferred Acquisition Costs-Deferred acquisition costs are those incremental direct costs related to the successful acquisition of new and renewal business. These incremental direct costs are those that are essential to the contract transaction and would not have been incurred had the contract transaction not occurred. Such incremental direct costs include commissions, costs of contract issuance and underwriting, premium taxes and other costs the Company incurs to acquire successful new business or renew existing business. The Company defers policy acquisition costs and amortizes them over the estimated life of the contracts, which are short-duration in nature, in proportion to premiums earned. The Company capitalized deferred acquisition costs of approximately $3,368,000, $3,401,000, and $4,363,000 and amortized approximately $3,592,000, $3,921,000 and $3,487,000 of these capitalized costs for the years ended December 31, 2012, 2011 and 2010, respectively. The amortization of these costs are recorded in commission expenses and other acquisition costs included in the consolidated statements of comprehensive income (loss).
Purchase Agreement”) with an investor. Pursuant to the 2010-Stock Purchase Agreement, the investor agreed to purchase 300 Shares at a purchase price of $1,000 per share, with an aggregate purchase price of $300,000. The annual dividend payable on each Share is 5% of the book value at the beginning of the dividend period.
Healthcare Services Expense-The Company compensates its providers based on contractual reimbursement for various services. With respect to the dental HMO product and, effective April 1, 2011, the in-network portion of the dental PPO product, the Company generally retains 10% of this reimbursement (including payments on self-insured claims) in accordance with the Company’s provider agreements. Healthcare services expense is recorded net of any amounts withheld in the accompanying consolidated statements of comprehensive income (loss). Under the terms of the Company’s provider agreements, the Company is not obligated to return to providers any amounts withheld. Withheld amounts are retained by the Company but not reserved or retained in a separate fund. Participating providers have no interest in the amounts withheld, unless the Company’s Board authorizes an amount to be paid to the providers.
The Company incurred claim costs related to dental care providers amounting to approximately $63,736,000, $62,351,000, and $63,142,000, for the years ended December 31, 2012, 2011 and 2010, respectively.
Federal Income Tax-Deferred federal income tax is provided for the accompanying consolidated financial statements for the tax effects of temporary differences between the carrying values and tax bases of assets and liabilities. Differences result primarily from items such as accrued commissions, deferred compensation, unearned premiums, depreciation, deferred acquisition costs and unrealized gains on investments.
Concentrations of Credit Risk-Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of premiums receivable. Other than as discussed below, concentrations of credit risk with respect to premiums receivable are limited because of the large number of employer groups comprising the Company’s client base and contracts are cancelled if premiums are not paid within 90 days.
At December 31, 2012 and 2011, premium receivables did not have any balance greater than 10% of the total balance from any one customer.
In February 2013, the FASB issued new guidance regarding comprehensive income for amounts reclassified out of other comprehensive income (loss) effective prospectively for fiscal years beginning after December 15, 2012. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income (“AOCI”) by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. The Company is currently evaluating the impact of this guidance on its consolidated financial statements and related disclosures.
In December 2011, the FASB issued guidance regarding balance sheet offsetting disclosures, effective for reporting periods beginning on or after January 1, 2013. The guidance will be applied retrospectively for all comparative periods presented. The guidance requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effects of those arrangements on its financial position. Entities are required to disclose both gross information and net information about both
At December 31, 2012, the Company has forty-four investment grade corporate bonds, which consist of thirty-six different securities each with a credit rating of A- or better and eight securities that had a credit rating of between BB+ and BBB+. The weighted average yield-to-book value of our investment grade corporate bonds was approximately 4.02% at December 31, 2012. The weighted average maturity of our investment grade corporate bonds was 7.76 years at December 31, 2012. The unrealized gains and losses on available-for-sale investment are due to a change in fair value for these investments caused primarily by changes in prevailing interest rates since they were purchased. There were approximately $40,000 and $17,000 of realized gains related to investments for the years ended December 31, 2012 and 2011, respectively.
Investments classified at December 31, 2012 and 2011, as fixed maturities and short-term investments were as follows:
Share-based compensation cost is measured at the grant date based on the fair value of the liability awards and is recognized as expense ratably over the vesting periods and is included in other insurance expense in the consolidated statements of comprehensive income (loss). The fair value of the liability awards is remeasured at the end of each reporting period through the remaining vesting period with the change in fair value recognized in earnings currently.
The deferred compensation expense related to these awards is recorded ratably during the applicable vesting period. The Company recorded deferred compensation expense of approximately $466,000, $288,000, and $27,000, related to deferred share awards and the change in the value of phantom shares for the years ended December 31, 2012, 2011 and 2010, respectively. As of December 31, 2012, there is approximately $403,000 of total unrecognized compensation cost related to approximately 539 non-vested awards under the Plans. That cost is expected to be recognized over a weighted average period of 1.62 years.
The expected fair value of the awards is calculated by applying the three year historical average trend rate of the book value per redeemable common share over the respective vesting period. The weighted average grant date fair value of the awards granted in the years ended December 31, 2012 and 2011 were $743 and $639, respectively. At December 31, 2012 and 2011, the deferred compensation liability was approximately $1,613,000 and $1,196,000, respectively.
The maximum aggregate number of share based awards that may be issued under the Plans are 15,000 Class B Common Shares. In 2012, the non-employee members of the Board were granted a total of 165 share based awards. In 2012, key employees were granted 466 share awards. As of December 31, 2012, the Company granted a total of 2,108 share awards, net of forfeitures and rescinded share awards.
When Redeemable Common shares are offered by the Company, providers in the Company’s service area have the option to purchase one share of voting Class A Redeemable Common Shares of the Company. Only participating providers in our service area that includes Ohio and Kentucky are eligible to own Class A voting redeemable common shares. All participating providers along with Company directors and employees have the option to purchase one or more non-voting Class B Redeemable Common Shares of the Company, when offered. Accordingly, prospective shareholders may make a subscription payment per share equal to the book value of a common share, which was approximately $815 and $687 at December 31, 2012 and 2011, respectively. In 2012, the Company declared and paid a $21.00 per share dividend for all Class A and Class B Redeemable Common Shareholders totaling approximately $177,000. No dividends were declared or paid in 2011 or 2010.
The Board of Directors authorized and approved the issuance of Redeemable Institutional Preferred Shares (“the Shares”) consisting of a total of 1,300 preferred shares issued of the 100,000 authorized. In 2010, the Company entered into a Preferred Stock Purchase Agreement with an investor for 300 Shares at a purchase price of $1,000 per share. In 2012, the Company entered into an additional Stock Purchase Agreement with an investor for 1,000 Shares at a purchase price of $1,000 per share. The annual dividend payable on each Share is 5% of the book value at the beginning of the dividend period. As of December 31, 2012, 2011, and 2010, dividends declared were approximately $67,000, $16,000, and $7,000, respectively. As of December 31, 2012, 2011, and 2010, dividends paid were approximately $83,000, $7,000, and zero respectively.
The Board authorized and approved for issuance the Provider Preferred Shares-2009 Series that includes 5,000 preferred shares of the 100,000 authorized. Redeemable Provider Preferred Shares are entitled to a cumulative cash dividend equal to 5% of the year end book value of the redeemable Provider Preferred Shares. During 2011, the Company exchanged an aggregate of 330 Class B Redeemable Common Shares for all outstanding Provider Preferred Shares and additional cash consideration of approximately $22,000. There were zero issued and outstanding at December 31, 2012 and 2011, respectively. No dividends were declared in 2012 or 2011. In 2010, the Company declared and paid a dividend of approximately $10,000.
Dividend restrictions vary among the subsidiaries. Dental Care Plus is restricted by regulatory requirements of its domiciliary state, which limit by reference to statutory net income and net worth, the dividends that can be paid without prior regulatory approval. Dividends paid by Dental Care Plus cannot, without prior approval of the Ohio Department of Insurance, exceed in any one year the lesser of: (i) 10% of net worth (as of the preceding December 31), or (ii) net income for the prior year, and only if net worth exceeds $250,000 and only out of unassigned surplus. In December 2012, Dental Care Plus declared and paid a dividend to the Company totaling $360,000. There were no dividends declared or paid by any subsidiaries during 2011 or 2010. During 2013, the total dividend that the Dental Care Plus subsidiary may declare without prior regulatory approval is approximately $740,000.
Required principal repayments under the mortgage loan payable are as follows:
In December 2012, the Company entered into an interest rate swap agreement (“Agreement”) (cash flow hedge) with an original notional amount of $1,340,000. The Agreement is used to manage the Company’s interest rate risk. The swap agreement effectively changed the interest rate related to the Company’s 2012 refinanced mortgage note with a commercial bank from a variable rate based on the 30-day LIBOR rate plus 1.95% to a fixed rate of 3.90% for the 10-year period through December 22, 2022. The Company’s risk management policy is to not enter into derivatives for speculative purposes. The notional amount decreases in direct correlation to the principal reduction of the mortgage. The Company believes that the risk of nonperformance by the counter party in conjunction with this arrangement is not material to the financial statements. The fair value of this Agreement at December 31, 2012 was a liability of approximately $41,000. This amount is included in other payables and accruals in the accompanying consolidated balance sheets. The agreement will terminate upon maturity of the mortgage loan payable (Note 10).
In 2003, the Company previously entered into an interest rate swap agreement (“2003-Agreement”) (cash flow hedge) with an original notional amount of $1,500,000. The swap agreement effectively changed the interest rate related to $1,500,000 of the Company’s $1,800,000 previous mortgage note with a commercial bank from a variable rate based on the 30-day LIBOR rate plus 1.75% to a fixed rate of approximately 4.95%. The 2003-Agreement terminated in December 2012 when the Company refinanced the mortgage note (Note 10). Upon termination of the 2003-Agreement, the Company realized a loss of approximately $5,900, which is included in realizable gains (losses) on investments, net in the accompanying consolidated statements of comprehensive income (loss).
The amount included in other comprehensive income (loss) related to the interest rate swaps were $(20,339), $7,448, and $(2,644), net of income tax expense (benefit) of $(10,479), $3,837, and $(1,362) during 2012, 2011 and 2010, respectively.
Litigation-In the normal course of business, the Company is subject to various regulatory proceedings, lawsuits, claims and other matters. Such matters are subject to many uncertainties and outcomes are not reasonably predictable. In the opinion of the Company’s management, the eventual resolution of such matters for amounts above those reflected in the consolidated financial statements would not have a material adverse effect on the financial condition or results of operations of the Company.
The Company’s providers, who are also shareholders, submitted claims of approximately $37,720,000, $40,218,000 and $41,207,000 in 2012, 2011 and 2010, respectively. The Company had claims payable liability to related party providers of approximately $1,267,000 and $1,815,000 at December 31, 2012 and 2011, respectively.
The following table presents for each of the fair value levels, the Company’s assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2012 and 2011 (amounts in thousands):
year, prorated based on the number of days which the Share was outstanding in the preceding year. In the event of any liquidation, dissolution or winding up of the Company, any merger or consolidation resulting in a change of control of the Company, or any sale, lease, transfer or other disposition of substantially all of the assets of Company, the investor will have the right to receive a cash payment in an amount equivalent to the consideration the investor would have otherwise received if the investor had the ability to convert each Share to 1.2 Class B Common Shares, subject to adjustment. The proceeds of the sale of the Shares will be used to fund the expansion of current dental insurance products into new markets, to fund corporate infrastructure improvements and to increase the capital and surplus of Dental Care Plus, Inc. to support the growth of fully-insured dental insurance premium revenue. The sale of the Shares under the Stock Purchase Agreement closed on January 16, 2013, pursuant to a private sale exempt from registration under Section 4(2) of the Securities Act of 1933, as amended.
On February 13, 2013, the Company’s Board of Directors declared a $32.60 per share dividend for all Class A and Class B redeemable common shareholders of record on February 13, 2013, totaling approximately $272,000 payable on March 15, 2013. With the dividend, the holders of restricted share units will receive an equivalent share based dividend.