The results of our fully-insured and self-insured dental segments are measured by gross profit. We do not measure the results of our corporate, all other segment. We do not allocate investment and other income, insurance expenses, interest expense or other assets or liabilities to our fully-insured and self-insured segments. These items are retained in our corporate, all other segment. Our segments do not share overhead costs and assets.
In our markets, there has been limited growth in recent years in the number of individuals enrolled in dental benefit plans. However, there has been a shift of membership out of the more expensive dental indemnity products into the dental PPO products that offer both less expensive in-network benefits and out-of-network benefits. At the same time, members have migrated away from dental HMO products with very limited provider networks. While these dental HMO products are the least expensive, employers and members have focused their attention on the dental PPO products that offer broad provider access with the cost control associated within a contracted provider network for the in-network portion of the dental services rendered.
We had a net income of approximately $552,000 for the year ended December 31, 2011 compared to a net income of approximately $12,000 for the year ended December 31, 2010. This increase in net
income is primarily the result of 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 approximately $791,000, to $62,351,000 in 2011 from $63,142,000 in 2010. This increase in gross margin of approximately $1,503,000 was offset by an increase in insurance expenses of $659,000, to $13,177,000 in 2011 from $12,518,000 in 2010. Our ratio of insurance expense to total premium revenue (“insurance expense ratio”) increased to 17.3% in 2011 from 16.6% in 2010.
Our dental and vision products grew by approximately 2,800 members, or 1.0%, from 287,900 members at December 31, 2010 to 290,700 members at December 31, 2011. This membership increase from December 31, 2010 is due to an increase in self-insured dental membership of approximately 4,200 members and an increase in corporate, all other membership of approximately 2,900 members, offset by a decrease in fully-insured membership of approximately 4,300 members. The decrease in fully-insured membership is primarily due to fully-insured dental HMO groups and fully-insured dental PPO groups that did not renew with the Company in 2011. Many of these groups changed their dental benefits as a result of corporate consolidations.
The following table shows membership totals and revenues and expenses for our three business segments for the years ended December 31, 2011 and 2010 (dollars in thousands):
Basic income (loss) per redeemable common share was $61.82 and $(3.74) at December 31, 2011 and 2010, respectively. The increase in net income per redeemable common share 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. This increase in gross margin of approximately $1,503,000 was offset by an increase in insurance expenses of $659,000 to $13,177,000 in 2011 from $12,518,000 in 2010. Our ratio of insurance expense to total premium revenue (“insurance expense ratio”) increased to 17.3% in 2011 from 16.6% in 2010.
Our fully-insured membership decreased approximately 4,300 in 2011. This membership decrease is primarily attributable to a decrease of approximately 2,900 fully-insured dental HMO members, a decrease of approximately 900 fully-insured dental PPO 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 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. The decrease in fully-insured dental PPO membership of 900 members is due the loss of approximately 5,100 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 Dayton and Columbus, Ohio markets and the Central Kentucky market of approximately 4,200 members in 2011.
Fully-insured dental premium increased approximately $54,000 in 2011 compared to 2010. Fully-insured dental premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $1,450,000 in fully-insured dental premium revenue. A decrease in fully-insured membership in 2011 resulted in a decrease in fully-insured dental premiums of approximately $1,396,000. This decrease is also due to the decrease in fully-insured dental HMO membership that has slightly higher premium rates than the fully-insured dental PPO product.
Total self-insured revenue increased approximately $628,000 in 2011 compared to 2010. Self-insured dental revenue increased by approximately $1,079,000 due to new self-insured sales. This self-insured revenue increase was offset by a decrease of approximately $451,000 due to a decrease in the self-insured claims revenue on a per member per month basis as a result of lower dental service utilization. Approximately $147,000 of this decrease was the result of run-out claims in 2010 for a larger employer group that was self-insured in 2009 and converted to fully-insured effective January 1, 2010 that did not recur in 2011. The self-insured segment revenue has two components:
Self-Insured ASO Fees-Self-insured ASO fees increased approximately $35,000, or 3.0%, to $1,208,000 in 2011 from $1,173,000 in 2010. Approximately $55,000 of this increase is attributable to the self-insured product sales. This increase was offset by a decrease of approximately $20,000 due to a small decrease in average self-insured ASO fee rates.
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.
Fully-insured healthcare services expense decreased approximately $1,310,000 in 2011 compared to 2010. The introduction of the 10% provider withhold on the in-network portion of the dental PPO was the primary factor that resulted in a decrease in fully-insured dental healthcare services expense of approximately $148,000. A decrease in fully-insured membership in 2011 compared to 2010 resulted in a decrease in fully-insured dental healthcare services expense of approximately $1,162,000. The fully-insured segment represents approximately 68.4% of our total dental premium.
Consolidated insurance expenses increased approximately $659,000 in 2011. Total insurance expenses as a percentage of total premium revenue, or the insurance expense ratio, was 17.2% for 2011, increasing 0.6% from the 2010 ratio of 16.6%. 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. 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
The following table shows membership totals and revenues and expenses for our three business segments for the years ended December 31, 2010 and 2009 (dollars in thousands):
Basic loss per redeemable common share was $(3.74) and $(37.27) at December 31, 2010 and 2009, respectively. The increase in net income on redeemable common shares primarily resulted from a decrease in total insurance expense as a percentage of total premium revenue to 16.6% in 2010 from 18.1% in 2009 that was offset in part by an increase in healthcare services expense as a percentage of total premium revenue to 83.6% in 2010 from 82.7% in 2009.
product to our fully-insured dental HMO product effective January 1, 2010. An increase in fully-insured dental healthcare services of $895,000 is primarily the result of an increase in fully-insured dental healthcare services expense on a per member per month basis of approximately 2.1% in 2010 for both our new and existing fully-insured membership. One cause of this increase was the conversion of a large employer group with higher dental healthcare services expense on a per member per month basis from our self-insured dental HMO product to our fully-insured dental HMO product effective January 1, 2010. Another cause of this increase was the high level of out-of-network dental healthcare services expense on a per member per month basis for our fully-insured dental PPO product. The fully-insured segment represents approximately 68.6% of our total dental business.
Fully-insured dental indemnity healthcare services expense increased by $144,000, or 11.4%, to $1,406,000 from $1,262,000 in 2009. Approximately $68,000 of this increase is attributable to the 5.4% increase in fully-insured dental indemnity member months in 2010 compared to 2009. Approximately $76,000 of this increase is attributable to an increase in fully-insured dental indemnity healthcare services expense on a per member per month basis of approximately 5.7% in 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 $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 and lower 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. Cash decreased approximately $708,000, or 10.5%, for the year ended December 31, 2010 to approximately $6.1 million at December 31, 2010 from approximately $6.8 million at December 31, 2009. This cash decrease is primarily due to an increase in our investments in investment grade corporate bonds. The change in cash for the years ended December 31, 2011, 2010 and 2009 is summarized as follows (in thousands):
accounts receivable of approximately $6,842,000 was offset by a decrease in unearned premium revenue of $7,074,000, resulting in a net cash decrease of $232,000. 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 capitalizing non-cancelable contracts. Most of our contracts are one year in duration; however we 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.
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.
In 2010, we paid approximately $120,000 of our outstanding mortgage balance and borrowed $20,000 on our revolving note collateralized by our office building. During 2010, we repurchased redeemable common shares of $61,000, which was offset by the issuance of redeemable common shares and provider preferred shares related to our 2010 share offerings of $18,000 and the issuance of institutional preferred shares of $300,000.
Our mortgage note matures in June 2013. The note requires us to make principal payments of $10,000 per month, and bears interest at a variable rate of 30-day LIBOR plus 1.75%. At the maturity date of the mortgage note in 2013, the expected outstanding balance of the note of $600,000 must be repaid or refinanced. Our revolving note matures on December 15, 2012 and requires us to make monthly interest payments at a variable rate of 30-day LIBOR plus 1.75%.
In December of each year our Board evaluates the projected pre-tax income of our dental HMO and dental PPO plans, capital and surplus requirements prescribed by the Ohio Department of Insurance and factors
The Board may authorize aggregate provider withhold payments in amounts between 0% and 45% of the total provider withhold returns for future years in relation to the total provider withhold amount for those years. However, the Board will not authorize an aggregate provider withhold payment for any year that would result in an operating loss for the year in review. These forecasted amounts are based on projections of future claims revenues and certain planning assumptions and estimates currently being made with respect to future application of the factors historically considered by the Board in making its determination to authorize the payment of withhold amounts. These planning assumptions reflect management’s current expectations and views about future events and are subject to risks, uncertainties and other factors that could cause actual withhold payment amounts to differ materially from these stated assumptions. Important factors that could cause actual results to differ materially from those being planned for, include, among others: claims exceeding or not meeting our estimates, a threatened or actual downgrade in our financial strength rating, the loss of a significant customer or broker, the loss of a large employer group and an unexpected change in dental service utilization by our dental members.
A mortgage note, secured by the land and the office building, bears interest based on the 30-day LIBOR rate plus 1.75% and was 2.03% and 2.01% at December 31, 2011 and 2010, respectively. At the maturity date of the mortgage note in 2013, the expected outstanding balance of the note of $600,000 must be repaid or refinanced.
Deferred Compensation-We expect to pay our deferred compensation liability to the Company directors and employees as they retire or otherwise terminate their association with the Company in future years.
Our consolidated cash and short term investments were approximately $7.3 million at December 31, 2011. Our consolidated cash and short term investments increased by approximately $300,000 from approximately $7.0 million as of December 31, 2010.
In July 2011, 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 2.88% at December 31, 2011. The Company did not have any interest expense for the line of credit in 2011 or 2010. As of December 31, 2011 and 2010, there was no amount outstanding on this line of credit.
On December 16, 2011, we renewed our revolving note with a commercial bank in the amount of $750,000 collateralized by a second mortgage on our office building. As of December 31, 2011, there was a principal balance outstanding of $650,000 related to this revolving note. This revolving note matures on December 15, 2012, is annually renewable and requires us to make monthly interest payments at a variable rate of 30-day LIBOR plus 1.75%. Under this revolving note, we are required to have a minimum tangible net worth equal to or greater than $2,500,000 at the end of each fiscal year, and we were in compliance with this covenant at December 31, 2011. We intend to renew this revolving note in December 2012.
We believe our cash, short term investments and working capital lines of credit together are sufficient to meet our short term and long term liquidity needs. We are obligated to make payments related to our contractual obligations such as our building mortgage and our operating leases and other commitments (see contractual obligations and other commitments). We will also be obligated in certain circumstances to repurchase the redeemable shares of our provider shareholders who die, are permanently disabled, or retire. Our Board of Directors establishes limitations on the amount of share redemptions each year. While we are not able to estimate future redeemable share redemptions, we repurchased approximately $128,000, $61,000, and $172,000 of redeemable common shares in the years ended December 31, 2011, 2010, and 2009, respectively. We believe our cash balances, available-for-sale investment securities, operating cash flows, and borrowing capacity, taken together, provide adequate resources to fund ongoing operating and regulatory requirements and fund future expansion opportunities and capital expenditures in the foreseeable future.
We maintained aggregate statutory capital and surplus of approximately $6.1 million as of December 31, 2011 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 2012 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 minimum levels of required capital and surplus and signals regulatory measures should actual surplus fall below these recommended levels. RBC has been adopted by Ohio, Kentucky and Indiana, the three states in which we currently do business. We file our annual statement and RBC reporting with the Ohio Department of Insurance and the NAIC. Dental Care Plus’s statutory annual statements for the year ended December 31, 2011 filed with the Ohio Department of Insurance reflected total adjusted capital in excess of Company Action Level RBC.
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 (net of income tax effects) increased by $9,462 at December 31, 2009 due to an increase in prevailing interest rates during 2009. The fair market value of the variable-to-fixed interest rate swap contract was a liability of $16,354 and $27,639 and is included in other payables and accruals at December 31, 2011 and 2010, respectively.
We develop our estimate for claims payable liability using actuarial methodologies primarily based on historical claim payments and claim receipt patterns, as well as historical dental cost trends. Depending on the period for which incurred claims are estimated, we apply a different method in determining our estimate. Throughout the year, we use both the “completion factors” and the “claims trend factor” to estimate our claims payable liability. On a quarterly basis, for periods prior to the most recent month, we calculate “completion factors” which indicate the percentage of claims payable estimated for a prior period that have been paid as of the end of the current reporting period. We use the completion factors to determine historical patterns over a rolling 12-month period, made consistent period over period with making adjustments for known changes in claim inventory levels and known changes in claim payment processes. Then, for the most recent month, we calculate a “claims trend factor” that estimates incurred claims primarily from a trend analysis based upon per member per month claims trends developed from our historical experience in the preceding months, adjusted for known provider contracting changes, changes in benefit levels and seasonality. We have consistently applied the key actuarial methodologies used by management to estimate the IBNR and reported claims in process components of our claims payable liability.
When developing our estimate for claims payable liability as of December 31, 2011, we considered actual paid claim data from January 2012. As a result, we are able to use the completion factors approach for all historical months in 2011, including December 2011. 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 completion factors that were used to estimate the claims payable liability as of December 31, 2011 within variance ranges historically experienced. Based on historical experience, the completion factors we use to estimate outstanding IBNR and reported claims in process are highly reliable for predicting actual claims paid at future times, with a variance range of approximately one-half of one percent, plus or minus.
Healthcare services expense is recognized on a monthly basis. In the case of the fully-insured dental segment, healthcare services expense is calculated by taking the paid claims associated with the fully-insured membership and adjusting this amount for the change in the claims payable liability determined using the actuarial estimates discussed above. For the self-insured dental segment, the healthcare services expense is based solely on the paid claims for the self-insured membership. In most cases, our reimbursement to our participating providers for covered dental services under the dental HMO are subject to a 10% withhold. Our reimbursement to our participating providers for in-network covered dental services under the dental PPO also became subject to a 10% withhold effective April 1, 2011. The amounts withheld are not retained in a separate fund and we have no obligation to pay any portion of the amounts withheld to the providers. At the end of each year, our Board of Directors determines, in its sole discretion, how much if any of the provider withhold is to be paid out to participating providers. Provider withhold payments authorized by our Board during the fiscal year are recorded as an increase to healthcare services expense.
In October 2010, the Financial Accounting Standards Board (“FASB”) issued guidance that amends Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. The guidance modifies the definitions of the type of costs incurred by insurance entities that can be capitalized in the successful acquisition of new and renewal contracts. The guidance requires incremental direct costs of successful contract acquisition as well as certain costs related to underwriting, policy issuance and processing, medical and inspection and sales force contract selling for successful contract acquisition to be capitalized. These incremental direct costs and other costs are those that are essential to the contract transaction and would not have been incurred had the contract transaction not occurred. The effective date is for reporting periods beginning after December 15, 2011. The Company plans to apply the retrospective method when adopting the guidance on January 1, 2012. The
In May 2011, the FASB issued guidance related to amendments to certain measurement principles and disclosures regarding fair value measurements. The amendments in this update improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011. The adoption of the guidance will have no significant effect on the consolidated financial statements and related disclosures.
We have audited the accompanying consolidated balance sheets of DCP Holding Company and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholders’ equity, redeemable shares and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2011. 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.
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2011
AS OF DECEMBER 31, 2011 AND 2010 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2011
DCP Holding Company (the “Company”) is the parent holding company of three wholly-owned subsidiaries which include Dental Care Plus, Inc., an Ohio corporation, Insurance Associates Plus, Inc., an Ohio corporation, and Adenta, Inc., a Kentucky corporation. The Company is primarily owned and controlled by 596 dentists who participate in our Dental Care Plus products. The Company is also partially owned by retired dentists, Company board members and employees who hold non-voting redeemable common shares and by an institutional investor that holds non-voting redeemable preferred shares. The Company offers to employer groups of all sizes dental health maintenance organization (“HMO”), participating provider organization (“PPO”) and indemnity plans and vision benefit plans. As of December 31, 2011, we had approximately 268,600 members in our dental benefits plans with 2,518 dentists participating in our dental HMO network and 2,763 dentists participating in our dental PPO network. Effective June 1, 2011, the Company entered into a network leasing agreement with a national dental network management company that has one of the largest networks of dentists under contract in the United States. With this network leasing agreement, Dental Care Plus dental PPO members now have access to approximately 2,200 additional dentists in the Company’s operating territory and approximately 37,200 additional dentists throughout the United States. In addition, we had approximately 22,100 members in our vision benefit plans.
The accounting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The accompanying consolidated financial statements include estimates for items such as claims payable, deferred acquisition costs, income taxes and various other liability accounts. Actual results could differ from those estimates. Policies that affect the more significant elements of the consolidated financial statements are summarized below.
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.
Investments-The Company invests in certificates of deposit, investment grade corporate bonds and money market funds. The Company classifies all certificates of deposit investments and the money market funds as available-for-sale. In August 2011, the Company engaged a fixed income portfolio manager to manage the Company’s investment grade corporate bonds, under the Company’s direction, in order to maximize investment returns. With a revised investment strategy, the Company considered the available-for-sale classification to be more appropriate and began classifying all investment grade corporate bonds as available-for-sale. Such certificates of deposit, investment grade corporate bonds and money market funds investments are recorded at fair value, with unrealized gains and losses recorded as a component of other comprehensive income (loss.) Prior to August 2011, the Company classified all investment grade corporate bonds as held-to-maturity. Held-to-maturity investments were recorded at amortized cost. The amortized cost of held-to-maturity investments was adjusted for amortization of premiums and accretion of discounts to maturity using the effective-yield method of amortization. Such amortization was included in investment income. As of the date the investments were transferred, the investments had a carrying value of $2,710,273 and a net unrealized gain of $41,987. The Company recognizes gains and losses when these securities mature or are sold using the specific identification method.
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 $285,000 and $278,000 at December 31, 2011 and 2010, 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.
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.
Redeemable Provider Preferred Shares-The Board of Directors (“Board”) authorized and approved for issuance Provider Preferred Shares-2009 Series (“Provider Preferred Shares”) that includes 5,000 preferred shares of the 100,000 preferred shares authorized. These Provider Preferred Shares may only be purchased by participating dentists in the Company’s dental plans or retired participating dentists that own at least 12 redeemable Common Shares (Class A and/or B). The Provider Preferred Shares are considered to be redeemable preferred shares due to the fact that the shareholders have the option to require the Company to repurchase these shares upon their death, permanent disability or retirement. The Company records the Provider Preferred Shares as redeemable Provider Preferred Shares in the consolidated balance sheets outside of shareholders’ equity at the redemption value of the preferred shares. Accordingly, Provider Preferred Shares are participating securities that share in the net income (loss) or other comprehensive income (loss) as a change to the redemption value of the redeemable Provider Preferred Shares to accrete (dilute) the carrying value to the redemption value at the end of each reporting period. Under this method, the end of the reporting period is treated as if it were also the redemption date for the securities. 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. At December 31, 2011, there were no outstanding shares.
Redeemable Institutional Preferred Shares-In 2010, the Board of Directors approved the issuance of Redeemable Institutional Preferred Shares (“the Shares”) consisting of 300 preferred shares of the 100,000 authorized. On July 21, 2010, the Company entered into a Preferred Stock Purchase Agreement (the “Stock Purchase Agreement”) with an investor. Pursuant to the 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. Accordingly, Institutional Preferred Shares are participating securities that share in the net income (loss) or other comprehensive income (loss) as a change to the redemption value of the redeemable Institutional Preferred Shares to accrete (dilute) the carrying value to the redemption value at the end of each reporting period. Under this method, the end of the reporting period is treated as if it were also the redemption date for the securities.
Fully-Insured-Membership contracts are written on an annual basis and are subject to cancellation by the employer group upon thirty days written notice. The Company’s unearned premium revenue was approximately $22,457,000 and $29,531,000 at December 31, 2011 and 2010, respectively, and relates to the estimated premium revenue associated with the remaining contract periods. Related amounts recorded in unbilled accounts receivable were approximately $21,219,000 and $28,061,000 at December 31, 2011 and 2010, respectively. Premiums are due monthly in advance and are recognized evenly as revenue during the period in which the Company is obligated to provide services to members. Any amounts not received by the end of a reporting period are recorded as accounts receivable by the Company. Any premiums received prior to the beginning of a reporting period are recognized as premiums received in advance and are included in unearned premium revenue in the accompanying consolidated balance sheets. Premiums received in advance were approximately $1,237,000 and $1,470,000 at December 31, 2011 and 2010, respectively. Management has determined that as of December 31, 2011 and 2010, respectively, no premium deficiency reserve is required. The Company’s premium deficiency reserve analysis includes an allocation of investment income. Enrollment changes not yet reflected on employer group invoices, also known as retroactive membership adjustments, are estimated based on available data.
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 operations. 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 any amount to be paid to the providers.
Federal Income Tax-Deferred federal income tax is provided in 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 discounting on claims payable, accrued commissions, deferred compensation, unearned premiums, depreciation and deferred acquisition costs.
During 2011, 2010 and 2009, four fully-insured customers accounted for approximately 10%, 10% and 9%, respectively, of the Company’s total revenue. Additionally, two self-insured customers accounted for approximately 11% of the Company’s total revenue during each of the years 2011, 2010 and 2009.
Fair Value of Financial Instruments-Certain financial instruments are required to be recorded at fair value. The Company primarily bases fair value for investments in fixed-maturity securities (including federally-insured certificates of deposits and investment grade corporate bonds) on quoted market prices or on prices from a pricing vendor, an outside resource that supplies global securities pricing, dividend, corporate action and descriptive information to support fund pricing, securities operations, research and portfolio management. The Company obtains and reviews the pricing service’s valuation methodologies and validates these prices using various inputs, including quotes from other independent regulatory sources. When deemed necessary, the Company validates prices by replicating a sample using a discounted cash flow model. Changes in assumptions or estimation methods could affect the fair value estimates.
New Accounting Standards-In October 2010, the Financial Accounting Standards Board (“FASB”) issued guidance that amends Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. The guidance modifies the definitions of the type of costs incurred by insurance entities that can be capitalized in the
successful acquisition of new and renewal contracts. The guidance requires incremental direct costs of successful contract acquisition as well as certain costs related to underwriting, policy issuance and processing, medical and inspection and sales force contract selling for successful contract acquisition to be capitalized. These incremental direct costs and other costs are those that are essential to the contract transaction and would not have been incurred had the contract transaction not occurred. The effective date is for reporting periods beginning after December 15, 2011. The Company plans to apply the retrospective method when adopting the guidance on January 1, 2012. The Company estimates that the adoption of the guidance will result in a decrease in the deferred acquisition cost asset and total redeemable preferred and common shares of approximately $125,000, net of tax, at adoption on January 1, 2012.
In December 2011, the FASB issued guidance on the deferred presentation of comprehensive income that was issued by the FASB in June 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 reclassification adjustments. The deferral of those changes allows the FASB time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income for all periods presented. The Company will continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before the new guidance is effective for interim and annual reporting periods beginning after December 15, 2011. The guidance has not yet been adopted and will not have a material impact on the consolidated financial statements.
individual memberships written-off in the year of acquisition) of approximately $53,000 at December 31, 2011 is being amortized over its 11 year useful life in accordance with the Company’s expectation for the membership retention. The remaining weighted-average amortization period for these intangible assets is approximately 10 years. Amortization expense for 2012 through 2016 is expected to be approximately $15,000 each year. Goodwill and intangible assets are included in other assets in the accompanying consolidated balance sheets at December 31, 2011 and 2010.
At December 31, 2011 and 2010, maturity dates for fixed maturity and short-term investments (excluding the money market fund) were:
Investments classified at December 31, 2011 and 2010, as fixed maturities and short-term investments were as follows:
investment before recovery when determining whether any impairment is other than temporary. The Company had no other than temporary impairment charges for the year ended December 31, 2011 and 2010. The Company had no investments in a continuous unrealized loss position for greater than one year as of December 31, 2011 and 2010.
The components of the provision (benefit) for income taxes are summarized as follows as of December 31, 2011, 2010 and 2009, respectively:
Management believes it is more likely than not that deferred tax assets will reduce future income tax payments. Significant factors considered by management in its determination of the probability of the realization of the deferred tax benefits include the historical operating results and the expectations of future earnings. The Company had $122,547, $134,565, and $146,582 of net operating loss carry forwards to utilize in future years at December 31, 2011, 2010, and 2009, respectively. These losses will expire between 2012 and 2024. Net deferred tax assets are included in other assets in the accompanying consolidated balance sheets at December 31, 2011 and 2010.
For the years ended December 31, 2011, 2010 and 2009, the Company did not have any significant uncertain tax positions. The Company is primarily subject to U.S. federal and various U.S. state and local tax authorities. Tax years subsequent to 2007 remain open to examination by the Internal Revenue Service (“IRS”),
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 operations. The fair value of the liability awards are remeasured at the end of each reporting period through the remaining vesting period with the change in fair value recognized in earnings currently.
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. The area we refer to as our service area includes all counties located in Ohio and Kentucky. 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 $702 and $633 at December 31, 2011 and 2010, respectively.
Preferred Stock Purchase Agreement (the “Stock Purchase Agreement”) with an investor. Pursuant to the 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. At December, 31, 2011 and 2010, this dividend payable liability of approximately $16,000 and $7,000 was established in accordance with the Stock Purchase Agreement and is included in other payables and accruals in the accompanying consolidated balance sheets.
The Company has 94,700 remaining preferred shares, without par value. As of December 31, 2011 and 2010, none of these preferred shares were issued or are outstanding. The preferred shares do not have voting rights except to the extent required by law or designated by the Board of Directors.
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. Under these restrictions, no dividends may be paid by Dental Care Plus in 2011 without prior regulatory approval. There were no dividends declared or paid by any subsidiaries during 2011, 2010 or 2009.
GAAP differs in certain respects from the accounting practices prescribed or permitted by state insurance regulatory authorities (“statutory-basis”), a non-GAAP basis of accounting. The statutory-basis net income (loss) for Dental Care Plus was approximately $703,000, $(94,000) and $(374,600) for the years ended December 31, 2011, 2010 and 2009, respectively. Statutory-basis net worth was approximately $6,101,000 and $5,515,000 at December 31, 2011 and 2010, respectively.
In 2003, the Company purchased land and an office building and in connection therewith, the Company executed a mortgage note with a bank, secured by the land and the office building, in the amount of $1,800,000. Interest is payable based on the 30-day LIBOR rate plus 1.75% and was 2.03% and 2.01% at December 31, 2011 and 2010, respectively. At December 31, 2011, the carrying value of the mortgage note of $780,000 approximates fair value. The Company also entered into an interest rate swap agreement that effectively changed the interest rate related to $1,500,000 of the Company’s $1,800,000 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% for the 10-year period through June 12, 2013.
Leases-The Company leases certain equipment and office space under non-cancelable operating leases. Rent expense under all operating leases was approximately $231,000, $198,000 and $176,000 for the years ended December 31, 2011, 2010 and 2009, respectively.
At December 31, 2011, future approximate minimum annual lease payments under non-cancelable operating leases are as follows:
The Company leases space in its building to unrelated parties under non-cancelable leases. Income recorded by the Company under non-cancelable leases amounted to approximately $62,000, $62,000 and $66,000 for the years ended December 31, 2011, 2010 and 2009, respectively. Such amounts are recorded as other income in the accompanying consolidated statements of operations. As of December 31, 2011, approximate future minimum annual lease income under non-cancelable leases are as follows:
The Company manages its business with three reportable segments: fully-insured dental, self-insured dental and corporate, all other. Fully-insured dental consists of the fully-insured dental HMO, fully-insured dental PPO and fully-insured dental indemnity products. Self-insured dental consists of the self-insured dental HMO, self-insured dental PPO and self-insured dental indemnity products. Corporate, all other consists of revenue associated with the Company’s dental indemnity, dental PPO, and vision products underwritten by third-party insurance carriers and certain other corporate activities. These segments are consistent with information used by the Chief Executive Officer (the chief operating decision maker) in managing the business.
Certain assets and liabilities included in other assets are measured at fair value on a non-recurring basis, and therefore, are not included in the table above. These include long-lived assets such as certain property and equipment items, intangible assets and goodwill measured at cost that are written down to fair value during a period as a result of an impairment. For the year ended December 31, 2011 and 2010, there were no assets or liabilities that were required to be measured at fair value on a non-recurring basis.
(a) The sum of quarterly earnings per redeemable common share may not equal the year end earnings per common share due to rounding.
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 4, 2012, pursuant to a private sale exempt from registration under Section 4(2) of the Securities Act of 1933, as amended.