Headquartered in Cincinnati, Ohio, the Dental Care Plus Group offers to Ohio, Kentucky and Indiana employer groups of all sizes dental HMO, dental PPO, dental indemnity and vision PPO benefit plans and related services. The Company also offers dental PPO plans to individuals and small groups on the Ohio, Indiana, Pennsylvania, Georgia and Tennessee exchanges and individual dental HMO and PPO plans in Ohio and Kentucky. As of December 31, 2016, we had approximately 382,100 members in our dental and vision benefit programs with approximately 2,900 providers participating in our dental HMO network, approximately 3,100 providers participating in our DentaSelect dental PPO network and approximately 2,200 in our Balanced Value dental PPO network. The Company has a network access agreement with a national dental network management company that has one of the largest PPO networks of providers under contract in the United States. With this network access agreement, our dental PPO members have access to approximately 2,700 additional providers in Ohio and Indiana and approximately 45,300 additional providers throughout the United States. The Company also has other network access arrangements for the dental PPO plans that it offers on the Ohio, Indiana, Pennsylvania, Georgia and Tennessee exchanges. With this network access arrangement, FFM exchange members have access to the following approximate number of providers in 2016 in these five states: Ohio - 2,900 providers; Indiana - 1,100 providers; Pennsylvania - 1,400 providers; Georgia - 1,700 providers; Tennessee - 700 providers.
We manage our business with four reportable segments: fully-insured dental HMO and indemnity (“dental HMO/IND”), fully-insured dental PPO, self-insured dental, and corporate, all other. Self-insured dental consists of the self-insured dental HMO, self-insured dental PPO and self-insured dental indemnity products. Corporate, all other primarily consists of revenue associated with our dental and vision products underwritten by third-party insurance carriers and certain other corporate activities.
Our strategy focuses on providing solutions to employers and individuals to manage the rising cost of dental care by leveraging our products that give employer groups and members options that meet their needs. We strive to provide excellent customer service to our employer groups, members, brokers and providers. Additionally, we have increased the diversification of our membership base, not only through our newer products, but also by entering new geographic territories.
We had net income of approximately $1,989,000 for the year ended December 31, 2016 compared to net income of approximately $958,000 for the year ended December 31, 2015. The increase in net income is primarily the result of higher gross margin of approximately $3,517,000 offset by an increase in insurance expense of approximately $2,067,000. Our ratio of insurance expense to total premium revenue (“insurance expense ratio”) increased to 21.0% in 2016 from 20.4% in 2015.
Our dental and vision products grew by approximately 19,900 members, or 5.5%, from 362,200 members at December 31, 2015 to 382,100 members at December 31, 2016. This membership increase from December 31, 2015 is due to an increase in fully-insured dental HMO/IND membership of approximately 8,800 members, an increase in fully-insured dental PPO membership of approximately 9,700 members and an increase in corporate, all other membership of approximately 3,900 members. This was offset by a slight decrease in self-insured dental membership of approximately 2,500 members.
During 2016, we sold an aggregate of 433 Class B and 1,766 Class C Redeemable Common Shares for approximately $2,280,000. The net proceeds, with available cash, was used to repurchase all outstanding shares of the Company’s Redeemable Institutional Preferred Shares.
Fully-insured dental HMO/IND premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $1,387,000 in fully-insured dental HMO/IND premium revenue. An increase in fully-insured dental HMO/IND membership in 2016 resulted in an increase in fully-insured dental HMO/IND premiums of approximately $2,548,000. The membership increase is the result of new fully-insured employer group business as well as an increase in the fully-insured individual product membership. The fully-insured dental HMO/IND segment represented approximately 50.6% of our total dental business in 2016.
Self-Insured Claim Revenue - Self-insured claim revenue slightly increased approximately $171,000, or 0.6%. Self-insured claim revenue increased by approximately $115,000 due to new self-insured sales. Also, self-insured claim revenue increased by approximately $56,000 primarily due to an increase in the self-insured claim revenue on a per member per month basis as a result of fee schedule increases effective January 1, 2016.
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 the aggregate, corporate, all other premium revenue increased by approximately $88,000, or 12.9%, to $771,000 in 2016 from $683,000 in 2015.
Our effective tax rate for 2016 was 40.7% compared to the 45.5% effective tax rate in 2015. The decrease in the effective tax rate in 2016 compared to 2015 is primarily the result of the lower impact of non-deductible expenses as compared to overall income before income taxes. Also, our 2016 and 2015 effective tax rates were higher than the federal statutory rate primarily due to the impact of permanent tax differences related to nondeductible federal premium tax, legal fees and meal and entertainment expenses. See Note 10 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.
Net income was approximately $958,000 and $1,341,000 for 2015 and 2014, respectively. This decrease in net income is primarily the result of an increase in insurance expense of approximately $1,751,000. Our ratio of insurance expense to total premium revenue (“insurance expense ratio”) increased to 20.4% in 2015 from 19.9% in 2014.
Fully-insured dental HMO/IND premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $499,000 in fully-insured dental HMO/IND premium revenue. An increase in fully-insured dental HMO/IND membership in 2015 resulted in an increase in fully-insured dental HMO/IND premiums of approximately $1,011,000. The membership increase is the result of new fully-insured employer group business as well as an increase in the fully-insured individual product membership. The fully-insured dental HMO/IND segment represented approximately 50.3% of our total dental business in 2015.
Fully-insured dental PPO premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $386,000 in fully-insured dental PPO premium revenue. An increase in fully-insured PPO group membership in the 2015 period resulted in an increase in fully-insured dental PPO premiums of approximately $2,353,000. The increase in membership is the result of an increase in fully-insured dental PPO group membership as well as an increase in fully-insured on-exchange dental PPO membership. The fully-insured dental PPO segment represents approximately 19.5% of our total dental business.
Other income and realized (losses) gains on investments decreased approximately $89,000 or 96.7% to $3,000 in 2015 from $92,000 in 2014. This decrease is primarily the result of realized losses due to the impairment of six corporate bonds in 2015. We concluded that the decrease in the market values of these assets had resulted in other-than temporary impairments.
During 2016, we made purchases totaling approximately $5,336,000 of investment grade and non-investment grade corporate bonds, money markets and certificates of deposit in order to improve investment income. Also during 2016, we sold investment grade and non-investment grade corporate bonds, and certificates of deposit and maturities that together totaled approximately $3,676,000. The remaining net cash used in investing activities during 2016 was primarily due to purchases of computer equipment and internally developed software development costs.
During 2015, we made purchases totaling approximately $4,955,000 of investment grade and non-investment grade corporate bonds, money markets and certificates of deposit in order to improve investment income. Also during 2015, we sold investment grade and non-investment grade corporate bonds, and certificates of deposit and maturities that together totaled approximately $3,738,000. In addition, in December 2015, we sold certain office equipment and computer equipment with a value of approximately $347,000 to a leasing company and entered into a capital lease agreement to lease back these same assets over a four year period. The remaining net cash used in investing activities during 2015 was primarily due to purchases in building improvements, internally developed software development cost and computer equipment.
As of December 31, 2016, we believe our most significant other commitments are:
Deferred Compensation - We expect to pay our deferred compensation liability of approximately $4,051,000 to the Company directors and employees as they retire or otherwise terminate their association with the Company in future years.
We have an annually renewable agreement with a commercial bank for a $500,000 working capital line of credit. Interest is payable at a variable rate of LIBOR plus 2.50%. The Company did not have any interest expense for the line of credit in 2016, 2015 or 2014. As of December 31, 2016 and 2015, there was no amount outstanding on this line of credit.
Dental Care Plus, an Ohio-domiciled insurance company dually licensed as a life and health insurer and a specialty health insuring corporation, is able to underwrite dental indemnity, dental PPO, dental HMO, and vision benefit products as well as other life and health insurance products in Ohio. The minimum required capital and surplus for Dental Care Plus licensed as a life and health insurance company in Ohio was $2.5 million at December 31, 2016.
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 the 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, 2016 filed with the Ohio Department of Insurance reflected total adjusted capital in excess of Company Action Level RBC.
When developing our estimate for claims payable liability as of December 31, 2016, we considered actual paid claim data from January 2017. As a result, we are able to use the completion factors approach for all historical months in 2016, including December 2016. 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, 2016 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.
We have audited the accompanying consolidated balance sheets of DCP Holding Company and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of comprehensive income, redeemable shares and shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. 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.
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. Providers who participate in one or more of the Dental Care Plus networks own a majority of the Company’s Redeemable Common Shares. The Company’s Redeemable Common Shares are also owned by retired providers, Company board members, non-provider individuals and employees. The Company primarily offers to employer groups of all sizes dental health maintenance organization (“HMO”), participating provider organization (“PPO”) and indemnity plans for dental care services and vision benefit plans. As of December 31, 2016, we had approximately 342,000 members in our dental benefits plans and approximately 40,100 members in our vision benefit plans with approximately 2,900 providers participating in our dental HMO network, approximately 3,100 providers participating in our DentaSelect dental PPO network and approximately 2,200 in our Balanced Value dental PPO network. The Company has a network access agreement with a national dental network management company that has one of the largest PPO networks of providers under contract in the United States. With this network access agreement, our dental PPO members have access to approximately 45,300 additional providers throughout the United States. The Company also has other network access arrangements for the dental PPO plans that it offers on the Ohio, Indiana, Pennsylvania, Georgia and Tennessee exchanges. With this network access arrangement, FFM exchange members have access to the following approximate number of providers in 2016 in these five states: Ohio - 2,900 providers; Indiana - 1,100 providers; Pennsylvania - 1,400 providers; Georgia - 1,700 providers; Tennessee - 700 providers.
The Company reviews property and equipment for impairment whenever events or changes in circumstances, such as significant decreases in market values of assets, changes in legal factors or in the business climate, and accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset, or other such factors indicate that the carrying amount may not be recoverable.
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 $1,850,000 and $326,000 at December 31, 2016 and 2015, respectively. These funds are restricted and not available to the Company for normal operations and are included in other assets in the accompanying consolidated balance sheets.
Goodwill and Intangible Assets- Goodwill arises in business combinations when the purchase price exceeds the fair value of identifiable assets acquired less liabilities assumed. As with tangible and other intangible assets, periodic impairment reviews are required, at least annually, as well as when events or circumstances change. Management uses judgment in assessing goodwill for impairment. Management reviews the recorded value of our goodwill annually, or sooner if events or changes in circumstances indicate that the carrying amount may exceed fair value. Professional judgment is exercised in determining future cash flows, timing and business valuation comparables or selecting discount rates to be used in any valuation assessments.
Redeemable Institutional Preferred Shares- In 2010, the Company entered into a Preferred Stock Purchase Agreement (the “2010 Stock Purchase Agreement”) with an investor. Pursuant to the 2010 Stock Purchase Agreement, the investor agreed to purchase 300 Redeemable Institutional Preferred 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.
Fully-Insured-Membership contracts are written on an annual or multi-year basis and are subject to cancellation by the employer group upon thirty days written notice. The Company’s unearned premium revenue was approximately $46,955,000 and $32,631,000 at December 31, 2016 and 2015, respectively, and primarily relates to the estimated premium revenue associated with the remaining contract periods. Related unbilled amounts recorded in accounts receivable were approximately $45,687,000 and $30,955,000 at December 31, 2016 and 2015, 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 $1,268,000 and $1,676,000 at December 31, 2016 and 2015, respectively. Management has determined that as of December 31, 2016 and 2015, respectively, no premium deficiency reserve is required. The Company’s premium deficiency reserve analysis includes an allocation of investment income.
Self-Insured-The Company provides administrative and claims processing services, benefit plan design, and access to its provider networks for an administrative fee to self-insured groups. The Company has no underwriting risk arising from the provision or cost of any services provided to the self-insured groups. The Company recognizes and records self-insured premiums on a gross basis because: (i) the Company is the primary obligor in its contractual relationships with self-insured employers and dental service providers, (ii) the Company establishes the pricing for the services provided, (iii) the Company controls the selection of and the relationships with the dental service providers, and (iv) the Company is involved in the determination of dental service specifications. Self-insured premium revenue is recognized upon the payment of claims for self-insured members in accordance with agreements with self-insured employers and is included in premium revenue in the accompanying consolidated statements of comprehensive income.
In May 2015, the FASB issued ASU 2015-09, Financial Services-Insurance: Disclosures About Short-Duration Contracts. ASU 2015-09 requires entities to provide additional disclosures about the liability for unpaid claims and claim adjustment expenses to increase the transparency of significant estimates. The guidance also requires entities to disclose information about significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses, including reasons for the change and the effects on the financial statements. In addition, this guidance also requires entities to disclose a roll forward of the liability of unpaid claims and claim adjustment expense for annual and interim reporting periods. The effective date of this new guidance is for annual reporting periods beginning after December 15, 2015, and interim reporting periods within the annual period beginning after December 15, 2016. The Company adopted the requirements of ASU 2015-09 and has included the new disclosures within Note 6.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 revises the accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. The effective date of ASU 2016-01 is for interim and annual reporting periods beginning after December 15, 2017. The ASU has not yet been adopted by the Company. Management is currently evaluating the impact on the Company’s consolidated financial position, cash flows and results of operations, but it is not expected to have a significant impact.
The Company owned certificates of deposit insured by the Federal Deposit Insurance Corporation (“FDIC”) with an amortized cost of $1,090,000 at December 31, 2016 and 2015. The certificates of deposit included in short-term and fixed maturities investments are classified as available-for-sale and are carried at fair value. The Company also invests in money market funds included in short-term investments and are classified as available-for-sale, with a cost and fair value of approximately $223,000 and $249,000 at December 31, 2016 and 2015, respectively. The Company invested in corporate bonds with an amortized cost of approximately $8,025,000 and $7,855,000 at December 31, 2016 and 2015, respectively. The investment and non-investment grade corporate bonds included in fixed maturity investments are classified as available-for-sale and are carried at fair value.
The deferred compensation expense related to these awards is recorded ratably during the applicable vesting period. The Company recorded deferred compensation expense of approximately $710,000, $597,000, and $872,000, with a deferred tax benefit of approximately $241,000, $203,000, and $296,000, related to deferred share awards and the change in the value of phantom shares for the years ended December 31, 2016, 2015, and 2014, respectively. As of December 31, 2016, there is approximately $145,000 of total unrecognized compensation cost related to non-vested awards under the Plans. That cost is expected to be recognized over a weighted average period of 1.69 years.
The maximum aggregate number of share based awards that may be issued under the Plans are 15,000 Class B Common Shares. In 2016, the non-employee members of the Board were granted a total of 228 share based awards. In 2016, key employees were granted 89 share based awards. In 2016, individuals who elected to defer a portion of their cash compensation purchased approximately 3 phantom shares. The equivalent share based dividend in February 2016 granted approximately 100 share based awards to individuals. As of December 31, 2016, the Company has granted a total of 4,543 share awards, net of share based dividends, forfeitures and rescinded share awards of which 2,863 are outstanding.
The following is a summary of activity of vested awards for the years ended December 31, 2016 and 2015:
Substantially all of the incurred but not reported (“IBNR”) balance for dental HMO and dental PPO as of December 31, 2016 relates to the current year. At December 31, 2016 and 2015, the IBNR balance included in the total claims payable liability was approximately $1,441,000 and $1,874,000, respectively. The following is information about fully insured dental healthcare expense incurred and fully insured healthcare expense paid as of December 31, 2016:
The Company has a mortgage note with a bank, secured by the land and the office building with interest payable based on the 30-day LIBOR rate plus 1.95%. As a result of the mortgage note having a variable interest rate that adjusts monthly with the 30-day LIBOR rate, the carrying value of the mortgage note of $1,148,000 approximates fair value. The Company also entered into an interest rate swap agreement that effectively changed the interest rate related to the mortgage note with a commercial bank from a variable rate based on the 30-day LIBOR rate plus 1.95% to a fixed rate of 3.90% for the 10-year period through December 22, 2022. Under this mortgage, the Company is required to have a minimum tangible net worth equal to or greater than $3,500,000 at the end of each fiscal year and a debt service ratio of at least 1:1. The mortgage note fair value disclosure is classified as Level 2 in the fair-value hierarchy.
In 2015, the Company entered into a sale-leaseback transaction with a leasing company for the sale of certain fixed assets for approximately $347,000. There was no gain or loss on the sale. The Company did not retain the benefits and risk to the property sold and the risk of ownership was transferred to the leasing company. The Company also entered into a capital lease agreement with the leasing company that obligates the Company to pay lease payments totaling approximately $373,000 related to these assets over a four year period. Under this capital lease agreement, the Company is required to have a minimum tangible net worth equal to or greater than $2,500,000 at the end of each fiscal year.
At December 31, 2016, future required payments under all outstanding capital leases are as follows:
The amounts included in other comprehensive income (loss) related to the interest rate swap was $7,471, $(8,687), and $33,504, net of income tax expense (benefit) of $3,848, $(4,475), and $17,260, during 2016, 2015 and 2014, respectively.
Management believes it is more likely than not that deferred tax assets, net of valuation allowance 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 $74,209, $86,226, and $98,247 of net operating loss carry forwards to utilize in future years at December 31, 2016, 2015, and 2014, respectively. These losses will expire between 2018 and 2024. Net deferred tax assets are included in other assets in the accompanying consolidated balance sheets at December 31, 2016 and 2015.
Litigation-In the normal course of business, the Company is subject to various regulatory proceedings, lawsuits, claims and other matters. In the opinion of the Company’s management, we are not aware of any matters which are more than remote in possibility, and the eventual resolution of such matters for amounts above those reflected in the consolidated financial statements would not have a material adverse effect on the financial condition or results of operations of the Company.
Listed below is financial information required for each reportable segment for the years ended December 31, 2016, 2015 and 2014 (amounts in thousands):
The Company’s providers, who are also shareholders, submitted claims of approximately $38,256,000, $38,248,000, and $36,902,000, in 2016, 2015, and 2014, respectively. The Company had claims payable liability to related party providers of approximately $1,779,000 and $1,631,000 at December 31, 2016 and 2015, respectively.
At December 31, 2016 and 2015, there were no assets or liabilities that were required to be measured at fair value on a non-recurring basis. The Company did not have any transfers between fair value hierarchy levels during December 2016 and 2015. As of December 31, 2016 and 2015, the Company did not have any assets or liabilities classified as Level 3 of the fair value hierarchy.
The Company has 100,000 authorized Class D Redeemable Common Shares, without par value. The Class D Redeemable Common Shares are non-voting redeemable common shares that Preferred Shares may be converted to under certain circumstances. As of December 31, 2016 and 2015, none of these Class D Redeemable Common Shares were issued or are outstanding.
The Company is authorized to issue 100,000 preferred shares, without par. In 2010, the Company entered into a Preferred Stock Purchase Agreement with an investor for 300 Redeemable Institutional Preferred Shares at a purchase price of $1,000 per share. In 2012 and 2013, the Company entered into additional Stock Purchase Agreements with an investor for the sale of 1,000 Redeemable Institutional Preferred Shares each year at a purchase price of $1,000 per share. In June 2016, Company exercised its right to redeem all of the Preferred Shares and as of December 31, 2016 there were no issued or outstanding preferred shares. The annual dividend payable on each Redeemable Institutional Preferred Share is 5% of the book value at the beginning of the dividend period. As of December 31, 2016, 2015, and 2014, dividends declared and paid were approximately $69,000, $135,000, and $128,000, respectively.
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 for Dental Care Plus was approximately $1,653,000, $710,000, and $1,156,000 for the years ended December 31, 2016, 2015 and 2014, respectively. Statutory-basis equity was approximately $12,271,000, and $10,454,000 at December 31, 2016 and 2015, respectively.
On February 8, 2017, the Company’s Board of Directors declared a $42.50 per share dividend for all holders of Class A, Class B and Class C redeemable common shares of record on March 1, 2017, payable on March 24, 2017. With the dividend, the holders of restricted share units will receive an equivalent share based dividend.