In 2003, the Company acquired its headquarters building and incurred approximately $1,800 of indebtedness in connection with such acquisition.
Our strategy to drive profitability focuses on providing solutions for employers to the rising cost of dental care through leveraging our growing networks of participating dentists and deploying a variety of products that give employer groups and members more choices than only our dental HMO plans. Additionally, we have increased the diversification of our membership base, not only through our newer products, but also by entering new geographic territories. While we expect our dental PPO and indemnity products to be important drivers of growth in the years ahead, we expect to migrate a substantial number of members from those products to our flagship Dental Care Plus HMO products.
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 as well. 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.
In our original eight county service area, our dental HMO provider network includes approximately 90% of the dental providers in the market. In that market our dental HMO provides the broad provider access of a dental PPO along with effective utilization and cost control features. Because of the broad provider network, our fully-insured dental HMO is priced higher than other dental HMOs and has premium rates more equivalent to competitor dental PPOs.
Selling, general and administrative expenses increased significantly in 2005, 2006 and 2007 in connection with our expansion into Dayton, Ohio and Central Kentucky with new dental indemnity and dental PPO products and the Adenta product. We also incurred additional expenses in 2005 preparing to implement the new dental benefits administration and billing system that became operational in February of 2006.
Corporate, All Other membership increased by approximately 9,900 members, or 57.9%, from approximately 17,100 members at December 31, 2006 to approximately 27,000 members at December 31, 2007. Dental indemnity membership increased by approximately 1,100 members, or 29.7%, from approximately 3,700 members at December 31, 2006 to approximately 4,800 members as of December 31, 2007. These dental indemnity members represent in-area members whose dentists are outside of the Dental Care Plus provider network and out-of-area members for employer groups based in Ohio and Kentucky. Our ability to offer dental indemnity coverage has allowed us to sell dental benefits to employer groups that want access to out-of-network providers in our market areas and employer groups with out-of-area employees. Fully-insured dental PPO membership increased by approximately 6,400 members, or 71.9%, from approximately 8,900 members at December 31, 2006 to approximately 15,300 members at December 31, 2007. Approximately 5,600 members fully-insured dental PPO members converted from the Adenta dental product. Fully-insured vision membership increased by approximately 2,400 members, or 53.3%, from approximately 4,500 members at December 31, 2006 to approximately 6,900 members at December 31, 2007. Except for approximately 6,100 Dental Care Plus dental PPO members and approximately 800 Dental Care Plus dental indemnity members at December 31, 2007, the fully-insured dental indemnity, dental PPO and vision products are all underwritten by third party insurance carriers.
Corporate, All Other premium revenue is derived from our fully-insured dental indemnity product, our fully-insured dental PPO products and our fully-insured vision product. In aggregate, Corporate, All Other premium
revenue increased by approximately $1,242,000, or 279.7%, from approximately $444,000 in 2006 to approximately $1,686,000 in 2007.
Our fully-insured dental PPO premium revenue increased by $879,000, or 406.9%, from approximately $216,000 in 2006 to approximately $1,095,000 in 2007. The DCP fully-insured dental PPO was introduced in the third quarter of 2006. In 2006, the Company entered into a quota share group dental reinsurance agreement with a third party insurance company. The third party insurance company has agreed to indemnify DCP relative to its share of the insurance risk. This group dental reinsurance agreement applies to certain group dental PPO policies underwritten by DCP in our expansion markets. The fully-insured PPO premium revenue for the portion retained by DCP increased by approximately $860,000, from approximately $53,000 in 2006 to approximately $913,000 in 2007.
Fully-insured healthcare services expense increased approximately $58,000, or 0.2%, from approximately $30,178,000 in 2006 to approximately $30,236,000 in 2007. This increase is primarily attributable to the provider fee schedule increase implemented at the beginning of 2007 offset by the 2.5% decrease in fully-insured dental membership in 2007. On a per member per month basis, fully-insured healthcare services expense decreased by 1.5% in 2007 compared to 2006. Given the fee schedule increase effective January 1, 2007, there was a slight decrease in utilization on a per member per month basis and a less expensive mix of services provided in 2007 compared to 2006 primarily due to the shift of two employer groups with higher than average healthcare services expense on a per-member-per-month basis out of the fully-insured product line. The fully-insured healthcare services expense attributable to the Adenta membership was approximately $245,000 for 2006. There was no healthcare services expense attributable to Adenta membership in the 2007.
Corporate, All Other healthcare services expense is limited to the healthcare services expense related to the fully-insured Dental Care Plus dental PPO product that was introduced in the third quarter of 2006 and the fully-insured Dental Care Plus dental indemnity product that was introduced in the fourth quarter of 2007. The fully-insured Dental Care Plus dental PPO healthcare services expense for the portion of the risk retained by DCP increased by approximately $718,000, from approximately $40,000 in 2006 to approximately $758,000 in 2007. The fully-insured Dental Care Plus dental indemnity healthcare services expense increased by approximately $243,000, from $0 in 2006 to approximately $243,000 in 2007. Because our other dental indemnity, dental PPO and vision PPO products are underwritten by third party insurance carriers, we do not recognize any premium revenue or healthcare services expense associated with these products.
Consolidated selling, general and administrative, or SG&A, expenses increased approximately $1,394,000, or 14.3%, from approximately $9,755,000 in 2006 to approximately $11,149,000 in 2007. Total SG&A expenses as a percentage of total premium revenue, or SG&A expense ratio, was 18.6% for 2007, decreasing 30 basis points from the 2006 ratio of 18.9%. Salaries and benefits increased by approximately $649,000 due to the addition of sales & marketing and provider relations staff for the expansion in the Dayton, Louisville and Lexington markets as well as additional operational and finance staff to support our expanded activities. Commissions expense increased approximately $525,000 due to the increases in membership and the fact that the prevailing commission rates in the Kentucky markets are higher than the prevailing rates in Southwestern Ohio. Depreciation and amortization expense for 2007 decreased approximately $211,000, or 34.2%, compared to 2006. These decreases were due primarily to a decrease in the amortization of the identifiable assets acquired in the acquisition of Adenta after the write down of the intangible asset associated with the Adenta network lease contract with Humana Dental in July of 2006. In 2007, board of directors expense increased approximately $180,000, or 52.3%, from approximately $344,000 in 2006 to approximately $524,000 in 2007 as a result of director compensation increases and additional board committee meetings. The remaining amount of approximately $251,000 is due to various operating expense increases in 2007 as compared to 2006.
Our effective tax rate for 2007 of 34.1% decreased 11.4% compared to the 45.5% effective tax rate in 2006. Our 2007 effective tax rate is lower than the federal statutory rate due to a decrease in applicable state and local taxes, release of the FIN 48 reserve due to settlement of state income taxes and the elimination of certain non-deductible reorganization costs associated with acquiring the Dental Care Plus Life Insurance license that were no longer applicable during 2007.
See Note 6 to the consolidated financial statements included in Item 8 - Financial Statements and Supplementary Data for a complete reconciliation of the federal statutory rate to the effective tax rate.
Corporate all other, membership increased by approximately 11,000 members, or 180.3%. The increase is primarily attributable to the increase membership in our dental PPO product from approximately 2,400 members at December 31, 2005 to 8,900 members at December 31, 2006. Dental indemnity membership increased 36.8%, to approximately 3,700 members at December 31, 2006 from approximately 2,600 members at December 31, 2005. The dental indemnity members represent the out-of-area members for employer groups based in Ohio and Kentucky. The remaining increase is attributed to an increase in the membership in the fully-insured Vision Care Plus product from approximately 1,100 at December 31, 2005 to approximately 4,500 at December 31, 2006. Except for approximately 1,000 Dental Care Plus dental PPO members at December 31, 2006, the dental indemnity product, the dental PPO product and the fully-insured vision product are all underwritten by third party insurance carriers.
Fully-insured dental HMO premium revenue increased approximately $3.0 million, or 8.6%, in 2006 as compared to 2005. This premium revenue increase is attributable a shift of membership volume from the Adenta dental HMO product to the Dental Care Plus dental HMO product with higher premium rates and increases in negotiated premium rates with employer groups at their annual renewals.
Total self-insured revenue increased approximately $3.4 million, or 34.3%, in 2006 as compared to 2005. This increase is attributable to the 35.9% increase in self-insured HMO membership and a provider fee schedule increase implemented at the beginning of 2006. The self-insured segment revenue has two components:
Self-insured healthcare services expense increased approximately $3.2 million or 37.8%, in 2006 as compared to 2005. This increase is attributable to both the increase in self-insured dental HMO membership and the provider fee schedule increase implemented at the beginning of 2006. Member utilization remained relatively constant between 2005 and 2006.
Consolidated selling, general and administrative expenses increased approximately $1.7 million, or 21.7%, in 2006 as compared to 2005. Salaries and benefits increased by approximately $420,000 due to the addition of sales & marketing and provider relations staff for the expansion in the Dayton, Louisville and Lexington markets as well as additional operational and finance staff to support our expanded activities. Commissions expense increased approximately $326,000 due to the increases in membership and the fact that the prevailing commission rates in the Kentucky markets are higher than the prevailing rates in Southwestern Ohio. Professional services expense increased approximately $291,000, or 35.5%. This increase was primarily due to the an increase in legal and accounting expense associated with becoming a SEC reporting company. Depreciation and amortization expense increased approximately $301,000, or 95.6%, to approximately $616,000 in 2006 from approximately $315,000 in 2005. This increase was due to the amortization of the identifiable assets acquired in the acquisition of Adenta. Amortization recorded in 2006 includes an impairment charge recorded in July of approximately $128,000 to eliminate the remaining balance associated with the Humana Dental network lease agreement intangible asset. See Note 3 of the consolidated financial statements included in Item 8. In 2006, computer maintenance expensed increased approximately $108,000 due to the monthly service agreement for the new dental administration software that was implemented in February 2006. Board of Directors fees increased approximately $115,000 as a result of the new DCP Holding Company Deferred Compensation Plan as well as an additional director added in 2006. The remaining amount of approximately $139,000 is due to various operating expense increases in 2006 as compared to 2005.
Our primary sources of cash are premiums, ASO fees, investment and other income, as well as the proceeds from the sale or maturity of our investment securities and from borrowings. Our primary uses of cash include disbursements for claims payments, selling, general and administrative expenses, interest expense, taxes, purchases of investment securities, capital expenditures, acquisitions, and payments on borrowings. Because premiums are collected in advance of claims payments, our business should normally produce positive cash flows during a period of increasing enrollment. Conversely, cash flows would be negatively impacted during a period of shrinking enrollment. Cash decreased approximately $700,000, or 11.3%, for the year ended December 31, 2007 to approximately $5.5 million at December 31, 2007 from approximately $6.2 million at December 31, 2006. Cash increased approximately $600,000 or 10.7%, to approximately $6.2 million at December 31, 2006 from approximately $5.6 million at December 31, 2005. The change in cash for the years ended December 31, 2006, 2005 and 2004 is summarized as follows (in thousands):
In 2007, we invested approximately $137,000 in building improvements, office equipment and computer equipment. Also in 2007, approximately $1.2 million of our investments matured, and we reinvested the proceeds in additional investments.
In 2007, we paid $120,000 of our outstanding mortgage balance, approximately $210,000 in capital lease payments for our dental administration software, and approximately $55,000 of the principal balance of the Adenta debt assumed in 2005. During 2006, we repurchased redeemable common shares with a value of approximately $62,000, which was offset by the issuance of redeemable commons shares with a value of approximately $266,000. There were no new financing commitments executed in 2007.
In 2006, we paid $120,000 of our outstanding mortgage balance, $171,000 in capital lease payments for our dental administration software, and $95,000 of the principal balance of the Adenta debt assumed in 2005. During 2006, we repurchased redeemable common shares with a value of approximately $141,000, which was partially offset by the issuance of redeemable commons shares with a value of approximately $35,000. There were no new financing commitments executed in 2006.
In 2005, we refinanced approximately $190,000 of debt we assumed in the acquisition of Adenta under more favorable terms and conditions with a commercial bank in Ohio. We also paid $120,000 of our outstanding mortgage balance, $171,000 in capital lease payments for our new dental administration software, and $92,000 of the principal balance of the assumed Adenta debt. This represents a total payment of approximately $383,000 in debt and capital lease obligations in 2005.
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%.
Based on historical experience, the Board may authorize an aggregate provider withhold payment between 0% and 45% of the approximate $5.5 million provider withhold expected for 2008, or a maximum of $2.5 million. We also expect that the Board may authorize aggregate provider withhold payments for calendar years 2009 through 2011 in amounts between 0% and 45% of the total provider withhold amounts for those years and that the level of provider withhold payments for 2009 through 2011 could be greater than 45% depending upon the Company’s performance. 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 increase or decrease in dental service utilization by our dental members.
Our swap interest payments are based on a fixed rate of 4.95%. We estimate that we will receive swap interest payments totaling approximately $212,000 based on a variable rate of LIBOR plus 1.75% or 6.07%, as of December 31, 2007.
This decrease in cash and short term investments from December 31, 2006 to December 31, 2007 is primarily due to the cash used in operating, investing and financing activities of approximately $398,000, $126,000 and $182,000, respectively. In addition to this decrease in cash and short term investments of approximately $706,000, there was a shift of approximately $200,000 in FDIC insured certificate of deposit investment from short term investments to long term investments during this period.
We operate as a holding company in a highly regulated industry. We are primarily dependent upon management fees that we receive from our subsidiaries. We receive over 97% of our management fees from our subsidiary Dental Care Plus. We also receive dividends from our subsidiaries from time to time. The dividends from our subsidiary, Dental Care Plus, are subject to regulatory restrictions.
We maintained aggregate statutory capital and surplus of approximately $4.7 million as of December 31, 2007 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 2008 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, investment in Dental Care Plus of the earnings of other subsidiaries 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 National Association of Insurance Commissioners 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.
The differences between our net income and comprehensive income include the changes in the unrealized gains or losses on marketable securities and changes in the fair value of our interest rate swap agreement. For the years ended December 31, 2007, 2006 and 2005, respectively, such changes increased or (decreased), net of related income tax effects, by the following amounts:
Goodwill arises in business combinations when the purchase price of assets acquired exceeds the appraised 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. We review the recorded value of our goodwill annually or sooner if events or changes in circumstances indicate that the carrying amount may exceed fair value. The review for impairment requires management to predict the estimated cash flows that will be generated by the long-lived asset over its remaining estimated useful life. Considerable judgment must be exercised in determining future cash flows and their timing and, possibly, choosing business value comparables or selecting discount rates to be used in any value computations.
Between December 31, 2006 and December 31, 2007, our IBNR estimate decreased by approximately $329,000 or 21.7%, primarily due to a fully-insured membership decrease of 2.5%, a slight decrease in utilization on a per member per month basis and a less expensive mix of services provided in 2007 compared to 2006 primarily due to the shift of two employer groups with higher than average healthcare services expense on a per-member-per-month basis out of the fully-insured product line. Reported claims in process decreased by approximately $892,000, or 59.4%, from December 31, 2005 to December 31, 2006 due to a decrease in the number of days of reported claims in process from 14 days at December 31, 2006 to 4 days at December 31, 2007. The number of days of reported claims in process at year end varies with the timing of our bi-weekly provider claim payment cycle. In 2007, we had a bi-weekly claim payment to providers on December 31, 2007 that cleared out the majority of the reported claims in process at year end. Other healthcare services expense payable decreased by approximately $276,000, primarily due to the fact that the unpaid provider withhold payment of $650,000 at December 31, 2007 that was authorized by our Board of Directors in December of 2007 was $250,000 less than the comparable unpaid provider withhold amount of $900,000 at December 31, 2006.
The table set forth 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 and claims trend factors that were used to estimate the claims payable liability as of December 31, 2007 within variance ranges historically experienced.
Premium revenue is recognized in the period during which dental or vision coverage is provided to the covered individuals. Payments received from customers in advance of the related period of coverage are reflected on the accompanying consolidated balance sheet as unearned premium revenue.
Healthcare services expense is recognized on a monthly basis. In the case of the fully-insured dental HMO 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 HMO segment, the healthcare services expense is based solely on the paid claims for the self-insured membership. We deduct a provider withhold from the claim payments to providers equal to 10% of the allowed amount according to the provider fee schedule. At the end of each year, our Board of Directors determines, in its sole discretion, how much if any of the provider withhold can 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.
Effective January 1, 2007 the Company adopted FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”. FIN 48 is an interpretation of SFAS No. 109. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115”. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with few exceptions. SFAS 159 also establishes presentation and disclosure requirements to facilitate comparisons between companies that choose different measurement attributes for similar assets and liabilities. The requirements of SFAS No. 159 will be effective for the Company beginning January 1, 2008. The Company does not expect SFAS No. 159 to have a material effect on our results of operations or financial position.
In December 2007, the FASB issued SFAS No. 141 (revised), “Business Combinations”. SFAS No. 141(R) changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for preacquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, except for certain tax adjustments for prior business combinations. Accordingly, we will adopt this statement on January 1, 2009. The Company is evaluating the effect SFAS No. 141(R) will have on our consolidated financial position and results of operations.
As discussed in Note 8, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, on January 1, 2006 and, as discussed in Note 1, the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007.
Share figures reflect the effects of a 5 for 1 stock dividend effective to shareholders of record on August 31, 2005.
For Each of the Three Years in the Period Ended December 31,
As of December 31, 2007 and 2006 and for Each of the Three Years in the Period
On December 18, 2006, the Ohio Department of Insurance approved Dental Care Plus, Inc.’s application for a life and health insurance license. As an Ohio-domiciled insurance company dually licensed as a life and health insurer and a specialty health insuring corporation, Dental Care Plus is now able to underwrite dental indemnity, dental PPO, dental HMO, and vision benefit products as well as other life and health oriented products in Ohio. As of October 1, 2007, the Company transitioned the majority of its employer groups with dental indemnity products underwritten by a third party insurance carrier to dental indemnity products underwritten by Dental Care Plus.
Investments - The Company places its investments primarily in certificates of deposit. The Company classified all investments as available-for-sale. Such investments are recorded at fair value, with unrealized gains and losses recorded as a component of other comprehensive income. The Company recognizes gains and losses when these securities mature or are sold using the specific identification method.
Property, Plant, and Equipment - Property, plant, and equipment is carried at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the
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 non-current funds amounted to approximately $277,000 and $357,000 at December 31, 2007 and 2006, respectively. These funds are restricted and not available to the Company for normal operations and are included in other non-current assets in the accompanying consolidated balance sheets.
Redeemable Common Shares - The Company’s Class A and Class B redeemable common shares are owned by participating providers and Company directors. Only participating providers in the original eight county area are eligible to own Class A voting redeemable common shares (See Note 10). All participating providers, Company directors and Company employees are eligible to own the Class B non-voting redeemable common shares. As of December 31, 2005 to comply with the requirements of EITF D-98, the Company changed its reporting related to its redeemable common shares as a result of becoming a Securities and Exchange Commission registrant. The Company’s Class A and Class B common shares are now considered to be redeemable common 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 now records Class A and Class B common shares as Redeemable Common Shares in the consolidated balance sheets outside of shareholders’ equity at the redemption value of the common shares. Accordingly, the Company records any net income (loss) or other comprehensive income (loss) that formerly was recorded as a change to retained earnings as a change to the redemption value of the Redeemable Common Shares to accrete the carrying value of the Redeemable Common Shares 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 security.
Self-Insured - The Company provides access to its provider network for an administrative fee, generally to “self-insured” groups. During the years ended December 31, 2007, 2006, and 2005, the Company provided service to approximately 84,000, 62,000, and 46,000 self-insured participants and provided approximately 927,000, 669,000, and 518,000, respectively, of self insurance participant months of coverage. Self-insured premium revenue is based on the claims incurred by self-insured members in accordance with agreements with self-insured employers. The Company has no underwriting risk arising from the provision or cost of any services provided to the self-insured groups. Consistent with provisions of EITF 99-19, “Recording Revenue Gross as a Principal Versus Net as an Agent,” the Company recognizes and records self-insured premium on a gross basis because: (i) the Company is the primary obligor in the contractual relationship, (ii) the Company establishes the pricing for the services provided, (iii) the Company controls the relationship with the dental service providers, and (iv) the Company has credit risk in these contractual relationships. Self-insured premium revenue is recorded when the self-insured claims are incurred. Amounts withheld on claims processed for self-insured contracts and under third-party administration arrangements amounted to approximately $1,880,000, $1,199,000, and $952,000 for the years ended December 31, 2007, 2006 and 2005, respectively, and is included in premium revenue in the accompanying consolidated statements of income.
ASO Fees - Third party administration fee revenue (“ASO fees”) is recognized monthly when earned and is normally based on annual contracts with the self-insured groups. ASO fees are charged to self-insured employer groups monthly on a per subscriber per month basis. ASO fees also include the administrative fees the Company earns relative to the dental PPO and vision products that are underwritten by third party insurance carriers.
Management’s estimates of dental services provided are based on the Company’s historical experience and current trends, with assistance from the Company’s consulting actuary. Estimated dental claims payable are reviewed regularly by management and are adjusted based on current information, such as actual paid claims data, dental utilization statistics and other pertinent information. However, final claim payments may differ from the established reserves. Any resulting adjustments are reflected in current operations.
The Company incurred claim costs related to dental care providers amounting to approximately $48,153,000, $42,026,000, and $36,249,000 for the years ended December 31, 2007, 2006, and 2005, respectively. These costs include approximately $38,941,000, $36,972,000, and $33,476,000 of claims incurred by participating providers who are also holders of redeemable common shares in 2007, 2006, and 2005, respectively. These incurred claim costs also include provider withhold return expense of $650,000, $900,000, and $610,000 in 2007, 2006 and 2005, respectively.
Reinsurance - In the normal course of business, the Company cedes portions of its written premium revenue. As such, the Company limits its loss exposure to that portion of the insurable risk that it retains. However, if a reinsurer fails to honor its obligations, the Company could suffer additional losses as the reinsurance contracts do not relieve the Company of its obligations to policyholders. Dental insurance premiums ceded were approximately $228,000 and $13,000 for the years ended December 31, 2007 and 2006, respectively. The healthcare services expense ceded was approximately $189,000 and $10,000 for the years ended December 31, 2007 and 2006, respectively. As of December 31, 2007 the Company has approximately $26,500 of reinsurance recoverable and prepaid reinsurance premium net of reinsurance payable, which is included in accounts receivable.
Non-Operating Income - Investment income of approximately $269,000, $198,000, and $104,000 during 2007, 2006, and 2005, respectively, is comprised of approximately $175,000, $73,000, and $42,000 of interest income earned from cash in operating accounts in 2007, 2006 and 2005, respectively, and approximately $94,000, $125,000, and $62,000 of investment income earned from short-term and long-term investments in 2007, 2006, and 2005, respectively.
Effective January 1, 2007 the Company adopted FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”. FIN 48 is an interpretation of SFAS No. 109, “Accounting for Income Taxes”. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. This Interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
Fair Value of Financial Instruments - The Company bases the fair value for the investments available-for-sale and the fair value of the interest rate swap on quoted market prices. The Company estimates the fair value of the mortgage obligation using a discounted cash flow calculation. The Company believes the fair value of the capital lease obligation approximates the present value of minimum lease payments at December 31, 2007 and 2006.
New Accounting Standards - In September 2006, SFAS No. 157, Fair Value Measurements, was issued. This statement provides a new definition of fair value that serves to replace and unify old fair value definitions so that consistency on the definition is achieved, and the definition provided acts as a modification of the current accounting presumption that a transaction price of an asset or liability equals its initial fair value. The statement also provides a fair value hierarchy used to classify source information used in fair value measurements that places higher importance on market based sources. New disclosures of assets and liabilities measured at fair value based on their level in the fair value hierarchy are required by this statement. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Two FASB Staff Positions on SFAS No. 157 were subsequently issued. On February 12, 2007, FSP No. 157-2 delayed the effective date of this SFAS No. 157 for non-financial assets and non-financial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. This FSP is effective for fiscal years beginning after November 15, 2008. On February 14, 2007, FSP No. 157-1 excluded FASB No. 13 Accounting for Leases and other accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS No. 13. However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination that are required to be measured at fair value under FASB Statement No. 141, Business Combinations or FASB No. 141R, Business Combinations. This FSP is effective upon initial adoption of SFAS No. 157. The Company is currently evaluating the impact of adopting SFAS No. 157 on its consolidated financial position, results of operations and cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115”. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with few exceptions. SFAS No. 159 also establishes presentation and disclosure requirements to facilitate comparisons between companies that choose different measurement attributes
for similar assets and liabilities. The requirements of SFAS No. 159 will be effective for the Company beginning January 1, 2008. The Company does not expect SFAS No. 159 to have a material effect on our results of operations or financial position.
After completing the required net asset valuation analysis in May of 2006, the Company and the representatives of the former Adenta shareholders negotiated an agreement whereby the former Adenta shareholders were paid the $50,000 held in escrow plus additional cash consideration of $25,000. Under the terms of the negotiated agreement, the Company is no longer obligated to pay the former Adenta shareholders any portion of its tax savings resulting from the use of certain tax loss carry forwards. With the completion of the final purchase price allocation in June of 2006, the goodwill was determined to be $136,355. The following table summarizes the preliminary and final purchase price allocation.
With the acquisition of Adenta, the Company obtained a network lease agreement with Humana Dental, approximately 10,000 dental members and a provider network consisting of approximately 500 dentists in Kentucky. Of the $450,000 allocated to intangible assets, $210,000 was allocated to the Humana Dental network lease contract with a 3-year useful life, $130,000 was allocated to Adenta memberships with a 12-year useful life, and $110,000 was allocated to the Adenta provider network with a 20-year useful life. The results of operations of Adenta are included in the Company’s consolidated financial statements since June 2, 2005.
On July 25, 2006, Humana Dental provided the Company with written notice of termination of the network lease agreement effective October 23, 2006. Accordingly the Company recorded an impairment charge of approximately $128,000 (included in amortization expense) to eliminate the remaining balance associated with the Humana Dental network lease agreement intangible asset in July of 2006. For the year ended December 31, 2006, the Company recorded amortization expense of approximately $196,000 related to these identifiable intangible assets. The results of operations of Adenta are included in the Company’s consolidated financial statements since June 2, 2005. The Company estimates amortization expense on remaining identifiable intangible assets will be approximately $15,000 in each of the fiscal years 2007-2011.
The Company owned FDIC insured certificates of deposit with a cost of $1,967,000 and $1,900,000 as of December 31, 2007 and 2006, respectively. Each certificate of deposit is invested with a separate FDIC-insured financial institution. As of December 31, 2007, twelve certificates of deposit with a cost of $1,109,000 and a fair value of $1,109,139 have maturities of between 12 and 24 months. As of December 31, 2006, eight certificates of deposit with a cost of $800,000 and a fair value of $796,189 had maturities of between 12 and 15 months. These short-term and long-term investments are classified as available-for-sale and are carried at fair value, which is based on quoted market prices. The unrealized losses on investment activity are due to a decrease in the quoted market prices for these certificates of deposit caused by an increase in prevailing interest rates since they were purchased.
Investments classified at December 31, 2007 and 2006, as short term and long term assets were as follows:
The components of the provision for income taxes are summarized as follows as of December 31, 2007, 2006 and 2005, respectively:
The Company had $242,579, $291,000 and $316,881 of net operating loss carry forwards to utilize in future years at December 31, 2007, 2006 and 2005, respectively. These losses will expire between 2010 and 2024.
In connection with the adoption of FIN 48, the Company recorded a cumulative effect adjustment of a change in accounting principle as prescribed by FIN 48 which reduced retained earnings approximately $6,000. The amount of unrecognized tax benefits from uncertain tax positions at January 1, 2007 was $4,300. The Company has accrued approximately $1,700 in interest and penalties as of January 1, 2007. The total amount of FIN 48 liability recorded at January 1, 2007 of $6,000 is included as a current liability in accounts payable and other accrued liabilities in the accompanying balance sheet. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
remeasured at the end of each reporting period through the remaining vesting period with the change in fair value of the liability recognized currently.
Detail supporting the computation of basic and diluted earnings per redeemable common share was as follows for the years ended December 31, 2007, 2006, and 2005:
The weighted average outstanding redeemable common shares used to compute basic earnings per redeemable common share have been adjusted for the stock split that occurred effective August 31, 2005. As of December 31, 2007, there were 44 restricted share awards granted that have a dilutive effect on the Company’s earnings per share. As of December 31, 2006 and 2005, no restricted share awards had been granted that would have a dilutive effect on the Company’s basic earnings per share.
The Company has authorized 100,000 preferred shares, without par value. As of December 31, 2007 and 2006, no 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.
On August 10, 2005, the Company’s Board of Directors approved and declared a stock dividend of five Class B Redeemable Common Shares for each Class A Redeemable Common Shares and five Class B Redeemable Common Shares for each Class B Redeemable Common Share outstanding as of August 31, 2005. There were 653 and 681 Class A Redeemable Common Shares, 7,815 and 7,438 Class B Redeemable Common Shares issued and outstanding as of December 31, 2007 and 2006, respectively.
Dividends restrictions vary among the subsidiaries. Dental Care Plus is restricted by regulatory requirements of the 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 Department, 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 positive retained earnings. Under these restrictions, the total dividends that may be paid by Dental Care Plus in 2008 without prior regulatory approval are approximately $467,000. There were no dividends declared or paid by any subsidiaries during 2007 or 2006. Dental Care Plus paid a dividend of $250,000 in 2005.
At December 31, 2007, the fair value of the mortgage note is approximately $1,226,000.
In 2004, the Company entered into a Master Equipment Lease Agreement with a leasing company related to the computer hardware and software for its dental insurance administration system. The Master Equipment Lease Agreement includes a four year capital lease for computer software and implementation costs which totaled approximately $823,000. The net book value of the equipment under the capital lease is approximately $494,000 and $658,000 at December 31, 2007 and 2006, respectively.
The fair value of the capital lease obligation approximates the present value of minimum lease payments at December 31, 2007.
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 predictable with assurance. 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 likely have a materially adverse effect on the financial condition or results of operations of the Company.
In 2004, the Company began to lease space in its building to unrelated parties under noncancellable leases. Income recorded by the Company under noncancellable leases amounted to approximately $58,000, $92,000 and $74,000 for the years ended December 31, 2007, 2006 and 2005, respectively. Such amounts are recorded as other income in the accompanying financial statements. As of December 31, 2007, future minimum annual lease income under noncancellable leases are as follows:
On January 3, 2006, DCP Holding Company entered into an agreement with a commercial bank for a $500,000 working capital line of credit. Interest is payable based on the prime borrowing rate and was 7.25% and 7.75% at December 31, 2007 and 2006, respectively. The Company did not have any interest expense for the line of credit in 2007 and paid $158 in 2006.
A summary of our unaudited quarterly results of operations for the years ended December 31, 2007 and 2006 is as follows (amounts in thousands, except for per share results):