We currently maintain our principal place of business at 100 Crowne Point Place, Sharonville, Ohio 45241, which is owned by our wholly-owned subsidiary, Dental Care Plus. We occupy approximately 60% of this property. The remaining amount, approximately 40%, is leased to third party tenants. We believe that our existing facility is adequate to support our business.
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 that have a broad provider network.
Insurance expenses increased significantly in 2006, 2007 and 2008 in connection with our expansion into Dayton, Ohio and Central Kentucky with new dental indemnity and dental PPO products. Other important factors that have an impact on our profitability are both the competitive pricing environment and market conditions. With respect to pricing, there is a tradeoff between sustaining or increasing underwriting margins versus increasing or decreasing enrollment. With respect to market conditions, economies of scale have an impact on our administrative overhead. As a result of a decline in preference for tightly-managed dental HMO products, dental costs have become increasingly comparable among our larger competitors. Product design and consumer involvement have become more important drivers of dental services consumption, and administrative expense
We generated net income of approximately $615,000 for the year ended December 31, 2008 compared to net income of approximately $604,000 for the year ended December 31, 2007. The net income increase is primarily the result of increased membership, lower fully-insured healthcare service utilization and the shift of a large fully-insured employer group with high utilization to the self-insured arrangement.
Our dental and vision products grew by approximately 22,800 members, or 9.3%, from 245,000 members at December 31, 2007 to 267,800 members at December 31, 2008. Our membership at December 31, 2008 includes approximately 21,700 members in our DentaSelect dental PPO offering.
We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our financial statements and related changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain critical accounting principles and estimates have an impact on our financial statements.
The following chart shows membership totals and revenues and expenses for our three business segments for the years ended December 31, 2008 and 2007 (in thousands, except for membership data and percentage change):
Net income available for redeemable common shares was approximately $615,000 and $604,000 for the years ended December 31, 2008 and 2007, respectively. Basic earnings per redeemable common share was $72.71 and $72.88 at December 31, 2008 and 2007, respectively. The increase in net income available for redeemable common shares primarily resulted from increased premium revenue and decreased insurance expense as a percentage of total premium revenue from 18.8% in 2007 to 18.0% in 2008, offset by an increase in total healthcare services expense as a percentage of total premium revenue from 80.3% in 2007 to 80.9% in 2008.
Our self-insured dental HMO membership increased approximately 13,800 members primarily due to the conversion of 9,000 members of one employer group from our fully-insured dental HMO product to our self-insured dental HMO product effective January 1, 2008. The remaining 4,800 member increase was the result of our adding a number of large new self-insured groups in Southwestern Ohio and Northern Kentucky. As of January 1, 2009, one self-insured employer group that represented approximately 6% of the Company’s total revenue in 2008 elected not to renew its contract with the Company. However, the Company has replaced the majority of this membership loss with new fully-insured membership effective January 1, 2009.
Fully-insured dental premium increased approximately $639,000 in 2008. Approximately $612,000 of this premium revenue increase is attributable to net membership volume increases in the fully-insured dental product lines. New fully-insured sales resulted in an increase in fully-insured premium revenue of approximately $5.1
Fully-insured healthcare services expense increased approximately $340,000 in 2008. Approximately $481,000 of this healthcare service expense is attributable to net membership volume increases in the fully-insured dental product lines. New fully-insured sales resulted in an increase in fully-insured healthcare services expense of approximately $4.0 million in 2008 that was offset by a decrease in fully-insured revenue of approximately $3.5 million due to the conversion of employer groups to the self-insured product line in 2007 and 2008. This increase was offset by a decrease in healthcare services expense of approximately $141,000 due to a decrease in healthcare services expense on a per member per month basis. Fully-insured healthcare services expense increased by approximately $345,000 as a result of higher healthcare services expense for existing and new business. This increase was offset by a decrease in healthcare services expense of approximately $486,000 due to the shift of employer groups with higher than average healthcare services expense per member per month to the self-insured product.
Fully-insured dental HMO healthcare services expense decreased by approximately $2,283,000, or 7.6%, from approximately $30,236,000 in 2007 to approximately $27,953,000 in 2008. This decrease is primarily attributable to the 6.6% decrease in fully-insured dental HMO member months in 2008 compared to 2007 and a slight decrease in utilization on a per member per month basis and a less expensive mix of services provided in 2008 compared to 2007 primarily due to the shift of 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 Dental Care Plus dental indemnity product was introduced in the fourth quarter of 2007. The fully-insured Dental Care Plus dental indemnity healthcare services expense increased by approximately $841,000, or 346.1%, from $243,000 in 2007 to approximately $1,084,000 in 2008. The fully-insured Dental Care Plus dental PPO healthcare services expense for the portion of the risk retained by DCP increased by approximately $1,781,000, or 235.0%, from approximately $758,000 in 2007 to approximately $2,539,000 in 2008.
Net income available for redeemable common shares was approximately $604,000 and $103,000 for the years ended December 31, 2007 and 2006, respectively. Basic earnings per redeemable common shares was $72.88 and $12.59 at December 31, 2007 and 2006, respectively. The increase in net income available for redeemable common shares primarily resulted from a decrease in total healthcare services expense as a percentage of total premium revenue from 81.5% in 2006 to 80.3% in 2007 and offset by increased insurance expenses.
conversion of dental indemnity membership to be underwritten by Dental Care Plus during 2007, we had approximately 4,000 fully-insured indemnity members at December 31, 2007. In addition, our fully-insured dental PPO membership increased by approximately 5,100 members, from approximately 1,000 members at December 31, 2006 to approximately 6,100 members at December 31, 2007.
Corporate, All Other membership increased by approximately 700 members, or 4.3%, from approximately 16,100 members at December 31, 2006 to approximately 16,800 members at December 31, 2007. Dental indemnity membership underwritten by a third party insurance carrier decreased by approximately 2,900 members, or 78.4%, from approximately 3,700 members at December 31, 2006 to approximately 800 members as of December 31, 2007. This decrease is attributable to the shift of these dental indemnity members to a fully-insured product underwritten by Dental Care Plus. Dental PPO membership underwritten by a third party insurance carrier increased by approximately 1,300 members, or 16.5%, from approximately 7,900 members at December 31, 2006 to approximately 9,200 members at December 31, 2007. 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.
Fully-insured dental premium increased approximately $1,972,000 in 2007. Approximately $1.9 million of this premium revenue increase is attributable to net membership volume increases in the fully-insured dental product lines. New fully-insured sales resulted in an increase in fully-insured premium revenue of approximately $4.8 million in 2007 that was offset by a decrease in fully-insured revenue of approximately $2.5 million due to the conversion of employer groups to the self-insured product line in 2007 and 2008 and a decrease of approximately $368,000 in the Adenta fully-insured premium revenue. Approximately $61,000 of this premium revenue increase is associated with fully-insured dental premium rates during 2008.
Total self-insured revenue increased approximately $6,283,000 in 2007. This increase is attributable to the 34.9% increase in self-insured HMO membership, an increase in self-insured ASO fee rates and a provider fee schedule increase implemented at the beginning of 2007 that contributed to the 6.0% increase in self-insured claim revenue on a per member per month basis. The self-insured segment revenue has two components:
Corporate, All Other premium revenue is 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 approximately $108,000 in 2007. During the first nine months of 2007, the dental indemnity product was underwritten by a third party insurance carrier and we were paid a portion of its premium in the form of administrative fees that cover our related costs and broker commissions. These dental indemnity administrative fees were approximately $124,000 for the years ended December 31, 2006 and 2007. Our other dental PPO product is underwritten by third party insurance carriers and we are paid a portion of its premium in the form of administrative fees that cover our related costs and broker commissions. These dental PPO administrative fees increased by approximately $18,000, or 11.0%, from approximately $164,000 in 2006 to approximately $182,000 in 2007. In addition, our fully-insured vision product is underwritten by a third party insurance carrier and we are paid a portion of its premium in the form of administrative fees that cover our related costs and broker commissions. These vision product administrative fees increased by approximately $65,000, or 66.3%, from approximately $98,000 in 2006 to approximately $163,000 in 2007.
Fully-insured healthcare services expense increased approximately $1,019,000 in 2007. Approximately $1.5 million of this healthcare service expense is attributable to net membership volume increases in the fully-insured dental product lines. New fully-insured sales resulted in an increase in fully-insured healthcare services expense of approximately $3.8 million in 2007 that was offset by a decrease in fully-insured revenue of approximately $2.0 million due to the conversion of employer groups to the self-insured product line in 2007. 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. The increase in healthcare services expense due to net volume increases was offset by a decrease in healthcare services expense of approximately $513,000 due to the shift of employer groups with higher than average healthcare services expense per member per month to the self-insured product.
Self-insured healthcare services expense increased approximately $5,108,000 in 2007. This increase is attributable to both the 34.9% increase in self-insured dental HMO membership, the provider fee schedule increase implemented at the beginning of 2007, and the shift of the two employer groups with higher than average healthcare services expense on a per-member-per-month basis into the self-insured product line.
Corporate, All Other healthcare services expense is not recognized by the Company due to the fact that our other dental indemnity, dental PPO and vision PPO products are underwritten by third party insurance carriers.
In the normal course of business, the Company ceded portions of its written premium revenue. As such, the Company limits its loss exposure to that portion of the insurable risk that it retains. Dental insurance premium ceded was approximately $228,000 in 2007. The healthcare services expense ceded was approximately $189,000 in 2007. 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.
In 2008, we generated approximately $1,660,000 of cash in operating activities. This level of cash flow from operating activities is consistent with the cash flow generated from operating activities in 2006. We realized net income of approximately $615,000. In addition to our 2008 net income, we recognized depreciation and amortization of approximately $446,000. With the conversion of our fully-insured employer group contracts to be non-cancelable by the Company, there was an increase in unearned premium of approximately $20.9 million that was offset by an increase in accounts receivable of approximately $20.8 million. Other sources of cash include: an increase in deferred income taxes, a decrease in accounts receivable, an increase in claims payable, an increase in accounts payable and other accrued expenses, an increase in deferred compensation and other minor changes to operating assets and liabilities totaling approximately $1,701,000. These sources of operating cash were offset by an increase in deferred policy acquisition costs of approximately $1,196,000.
In 2007, we used approximately $398,000 of cash in operating activities mainly due to the reduction of our claims payable liability that resulted from the payment of the majority of our dental claims inventory at the end of 2007. We realized net income of approximately $604,000. In addition to our 2007 net income, we recognized depreciation and amortization of approximately $405,000. Other sources of cash include: increases in our unearned premium, other payables and deferred compensation totaling approximately $598,000. These sources of operating cash were offset by a decrease in our claims payable liability of approximately $1.5 million due to the payments to dental providers on December 31, 2007 that reduced our inventory of reported claims in process, increases in accounts receivable, accrued investment income and other assets totaling approximately $339,000, and deferred income taxes of approximately $144,000.
In 2008, we invested approximately $321,000 in building improvements, office equipment and computer equipment and software. Our investment in a new telephone system represented approximately $133,000 of this amount. Also in 2008, approximately $18.9 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 $20.2 million in additional FDIC insured certificates of deposit and money market funds.
In 2006, we invested approximately $160,000 in building improvements, office equipment and computer equipment. During 2006, we completed the required net asset valuation analysis for the Adenta acquisition in 2005, and the Company and the representatives of the former Adenta shareholders negotiated an agreement whereby the former Adenta shareholders were paid an additional cash consideration of $25,000. Also in 2006, approximately $3.1 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 $4.0 million in addition FDIC insured certificates of deposit and money market funds.
In 2008, we executed a revolving note with a commercial bank in the amount of $650,000 collateralized by a second mortgage on the office building owned by Dental Care Plus, Inc. As of December 31, 2008, there was a principal balance outstanding of $630,000 related to this revolving note. In 2008, we paid $120,000 of our outstanding mortgage balance and approximately $224,000 in capital lease payments for our dental administration software. During 2008, we repurchased redeemable common shares with a value of approximately $68,000, which was offset by the issuance of redeemable commons shares with a value of approximately $28,000.
On January 3, 2006 we entered into an agreement with a commercial bank for a $500,000 working capital line of credit. Interest was payable based on the prime borrowing rate of 3.25% at December 31, 2008. The Company did not have any interest expense for the line of credit in 2008 or 2007. As of December 31, 2008 and 2007 there was no amount outstanding on the line of credit.
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 94% 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.
Our largest subsidiary, Dental Care Plus operates in states that regulate its payment of dividends and debt service on inter-company loans, as well as other inter-company cash transfers and require minimum levels of equity as well as limit investments to approved securities. The amount of dividends that may be paid by Dental Care Plus, without prior approval by state regulatory authorities, is limited based on statutory income and statutory capital and surplus. Prior notification must be provided to state agencies in Ohio, Kentucky and Indiana before paying a dividend even if approval is not required.
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.
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, 2008, 2007 and 2006, respectively, such changes increased or (decreased), net of related income tax effects, by the following amounts:
We have classified all of our investments as “available-for-sale.” Accordingly, investments are carried at fair value, based on quoted market prices, and unrealized gains and losses, net of applicable income taxes, are reported in a separate caption of stockholders’ equity. We invest our excess cash in FDIC insured bank certificates of deposit and U.S. government security money market funds. Each certificate of deposit with an original cost of $100,000 is invested with a separate FDIC-insured financial institution. The quoted market prices of these certificates of deposit are the amounts we would receive if we liquidated them prior to maturity. We follow a consistent and systematic process for recognizing impairments on securities that sustain other-than-temporary declines in value. The decision to impair a security incorporates both quantitative criteria and qualitative information. The impairment review process considers a number of factors including, but not limited to the length of time and the extent to which the fair value has been less than cost, our intent and ability to retain impaired investments for a period of time sufficient to allow for any anticipated recovery in value, and general market conditions. As of December 31, 2008, there were no other-than-temporary impairments. In the event there was an unrealized loss on an investment that we believed to be other-than-temporary, the loss would be reported in the consolidated statement of operations, instead of in a separate caption of stockholders’ equity. The Company maintains its cash in bank deposit accounts, which at times exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant risks with respect to its cash.
Between December 31, 2007 and December 31, 2008, our IBNR estimate increased by approximately $207,000 or 17.5%, primarily due to a fully-insured membership increase of 7.7%, an increase in healthcare services expense in 2008 on a per member per month basis and an increase in the portion of fully-insured membership represented by fully-insured dental indemnity membership in 2008. Reported claims in process increased by approximately $108,000, or 17.7%, from December 31, 2007 to December 31, 2008 due to an increase in the number of days of reported claims in process from 4 days at December 31, 2007 to 5 days at December 31, 2008. The number of days of reported claims in process at year end varies with the timing of our weekly provider claim payment cycle. Other healthcare services expense payable decreased by approximately $175,000, primarily due to the fact that the unpaid provider withhold payment of $464,000 at December 31, 2008 that was authorized by our Board of Directors in December of 2008 was $186,000 less than the comparable unpaid provider withhold amount of $650,000 at December 31, 2007.
We have not changed the key actuarial methodologies and assumptions used by management to estimate the IBNR and reported claims in process components of our claims payable liability during the periods presented, and management has not adjusted any of the key methodologies and assumptions used in calculating the most recent estimate of the IBNR and reported claims in process components of our claims payable liability.
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, 2008 within variance ranges historically experienced.
The amount of the annual provider withhold payment authorized by our Board varies from year to year depending on, among other factors deemed relevant from time to time, the amount of pre-tax income projected for the year then ending, our estimated income tax liability for the year, the amount of retained earnings needed to satisfy the risk-based capital requirements of the Ohio Department of Insurance, factors impacting our financial strength rating with A.M. Best, such as the ratio of our projected fully-insured premium revenue to our projected capital and surplus level, and the amount of capital needed for anticipated future capital expenditures.
The annual provider withhold payment authorized by the Board is recorded in December of the applicable year, resulting in a corresponding increase of claims expense and claims payable liability. Depending on the amount of the provider withhold payment authorized, there may be a material increase in the claims payable liability at year end. At December 31, 2008, our claims payable liability increased by approximately 21% after
Deferred acquisition costs are those costs that vary with and are primarily related to the acquisition of new and renewal business. Such costs include commissions, costs of contract issuance and underwriting, premium taxes and other costs the Company incurs to acquire new business or renew existing business. Effective May 1, 2008, the Company defers acquisition costs and amortizes them over the estimated life of the contracts in proportion to premiums earned. The Company capitalized deferred acquisition costs of approximately $2,632,000 and amortized approximately $1,436,000 of these capitalized costs for the year ended December 31, 2008. These amounts are recorded in commission expense and other acquisition costs included in the consolidated statements of operations. Prior to the dates of the amendment of our contracts to be non-cancelable, all costs were expensed as incurred.
The Company’s Class A and Class B redeemable common shares are owned by participating providers and Company directors. Only participating providers in our service area that includes all counties located in Ohio and Kentucky are eligible to own Class A voting redeemable common shares (See Note 9). All participating providers, Company directors and Company employees are eligible to own the Class B non-voting redeemable common shares. To comply with the requirements of EITF D-98, the Company’s Class A and Class B common shares are 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 records Class A and Class B common shares as Redeemable Common Shares in the consolidated balance sheet outside of permanent 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 Shareholders’ Equity 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.
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. The Company’s unearned premium revenue was approximately $20,845,000 at December 31, 2008 for the estimated premium revenue associated with the remaining contract periods and related amounts recorded in unbilled accounts receivable.
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. Based on our 2008 operating results, a 1% increase in dental services utilization above the anticipated level would translate into an increase in our claims payable liability of approximately $313,000.
Our accounting for income taxes is in accordance with Statements of Financial Accounting Standard (“SFAS”) No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that are recognized in our financial statements in different periods than those in which the events are recognized in our tax returns. The measurement of deferred tax liabilities and assets is based on current tax laws as of the balance sheet date. We record a valuation allowance related to deferred tax assets in the event that available evidence indicates that the future tax benefits related to deferred tax assets may not be realized. A valuation allowance is required when it is more likely than not that the deferred tax assets will not be realized. Our determination of whether a valuation allowance is required is subject to change based on future estimates of the recoverability of our net deferred tax assets.
not apply to assets acquired and liabilities assumed in a business combination that are required to be measured at fair value under SFAS No. 141, “Business Combinations” or SFAS No. 141(R), “Business Combinations.” As disclosed in Note 19, the Company adopted SFAS No. 157 effective January 1, 2008. Currently, the adoption of SFAS No. 157-2 does not have an impact on the Company’s consolidated financial statements.
In April, 2008, the FASB issued FSP 142-3, “Determination of the Useful Lives of Intangible Assets.” This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset. This FSP is effective for consolidated financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. The adoption of SFAS No. 142-3 will not have a material impact on the Company’s useful lives of intangible assets.
We have audited the accompanying consolidated balance sheets of DCP Holding Company and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity and redeemable common shares, and cash flows for each of the three years in the period ended December 31, 2008. 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, 2008
As an Ohio-domiciled insurance company dually licensed as a life and health insurer and a specialty health insuring corporation, Dental Care Plus is able to underwrite dental indemnity, dental PPO, dental HMO, and vision benefit products as well as other life and health oriented products. 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. As of June 1, 2008, the Company transitioned the majority of its employer groups with dental PPO products underwritten by a third party insurance carrier to dental PPO products underwritten by Dental Care Plus.
Property and Equipment-Property and equipment is carried at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. The building and the building improvements have useful lives of 27 years and 15 years, respectively. Furniture and fixtures have a useful life of 5 years, and computer equipment and software have useful lives of up to 3 years. Maintenance and repair cost are expensed as incurred.
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 $298,000 and $277,000 at December 31, 2008 and 2007, 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.
earned. The Company capitalized deferred acquisition costs of approximately $2,632,000 and amortized approximately $1,436,000 of these capitalized costs for the year ended December 31, 2008. These amounts are recorded in commission expense and other acquisition costs included in the Consolidated Statements of Operations. Prior to the dates of the amendment of our contracts to be non-cancelable, all costs were expensed as incurred.
Investment Income-Investment income of approximately $223,000, $269,000, and $198,000 during 2008, 2007, and 2006, respectively, is comprised of approximately $122,000, $175,000, and $73,000 of interest income earned from money market accounts and cash in operating accounts in 2008, 2007 and 2006, respectively, and approximately $101,000, $94,000, and $125,000 of investment income earned from short-term and long-term in certificates of deposit in 2008, 2007, and 2006, respectively.
The cost of healthcare services provided to members is accrued in the period such services are provided based on the accumulation of estimates of claims reported prior to the end of a reporting period and of estimates of dental services provided but not reported to the Company, net of the amounts withheld in accordance with the provider agreement.
Each year the Board evaluates the performance of the dental HMO plan, capital and surplus requirements prescribed by the Ohio Department of Insurance, factors impacting the Company’s financial strength rating, funding needed to support strategic objectives for the coming years and any other factors deemed relevant by the Board and, based on that evaluation, determines whether or not to authorize the payment to the providers of any portion of the provider withhold. Once authorized by the Board, such amounts are recorded as additional healthcare services expense in the period authorized and shown as additional claims payable liability until paid.
Derivative Instruments-All derivative financial instruments are recorded on the balance sheet at fair value. The changes in fair value of derivatives that are designated as cash flow hedges are recorded in accumulated other comprehensive income, as a component of the consolidated balance sheet, with subsequent reclassification to earnings when the hedged transaction asset or liability impacts earnings. Any ineffectiveness is recognized in earnings immediately.
Federal Income Tax-Deferred federal income tax is provided in the accompanying 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 loss reserve discounting, unrealized gains or losses on invested assets and partial recognition of the unearned premiums.
Earnings Per Share-Basic and diluted earnings per share is computed by dividing net income on redeemable common shares by the weighted average number of common shares outstanding during the period.
During 2008, 2007, and 2006, four fully-insured customers accounted for approximately 9%, 14%, and 20%, respectively, of the Company’s total revenue. Additionally, two self-insured customers accounted for approximately 13%, 16%, and 17% of the Company’s total revenue at December 31, 2008, 2007, and 2006, respectively. As of January 1, 2009, one self-insured employer group that represented approximately 6% of the Company’s total revenue in 2008 elected not to renew its contract with the Company.
New Accounting Standards-In December 2007, the FASB issued SFAS No. 141(R), “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. Currently, the adoption of SFAS No. 141(R) will not have a material impact on the Company’s consolidated financial position or results of operations.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51.” SFAS No. 160 changes the accounting for noncontrolling (minority) interests in consolidated financial statements, including the requirement to classify noncontrolling interests as a component of consolidated stockholders’ equity, and the elimination of “minority interest” accounting in results of operations with earnings attributable to noncontrolling interests reported as part of consolidated earnings. Additionally, SFAS 160 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The adoption of SFAS No. 160 will not have a material impact on the Company’s consolidated financial position or results of operations.
In February 2008, the FASB issued FASB Staff Positions (“FSP”) No. 157-2, which delayed the effective date of Financial Accounting Standard (“SFAS”) No. 157 “Fair Value Measurements” for non-financial assets and non-financial liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a nonrecurring basis. This FSP delayed the effective date to fiscal years beginning after November 15, 2008. 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 SFAS No. 141, “Business Combinations” or SFAS No. 141(R), “Business Combinations.” As disclosed in Note 19, the Company adopted SFAS No. effective January 1, 2008. Currently, the adoption of SFAS No. 157-2 does not have an impact on the Company’s consolidated financial statements.
The components of the provision for income taxes are summarized as follows as of December 31, 2008, 2007 and 2006, respectively:
The Company had $194,580, $242,579 and $291,000 of net operating loss carry forwards to utilize in future years at December 31, 2008, 2007 and 2006, respectively. These losses will expire between 2010 and 2024.
In 2007, 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 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 was included as a other payables and accruals. For the year ended December 31, 2007, the Company reduced its remaining FIN 48 liability by $5,757, as they settled all outstanding state income tax issues associated with the original recorded amount. For the year ended December 31, 2008 the Company did not have any significant FIN 48 liability or expense.
Under the fair value recognition provisions of SFAS No. 123R, “Accounting for Stock-Based Compensation”, 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. 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.
The expected fair value of the awards are calculated by applying the three year historical average growth rate of the book value per redeemable common share over the respective vesting period. The weighted average grant date fair value of the awards granted in the three years ended December 31, 2008, 2007, and 2006 were $680, $556 and $549, respectively. The fair value of the awards converted to Class B Redeemable Commons Shares in May 2008 was approximately $25,000. There were not any awards converted in 2007 or 2006. The fair value of the awards paid in 2007 was approximately $11,000. There were not any award payments in 2008 or 2006. The total fair value of the awards that vested during the three years ended December 31, 2008, 2007 and 2006 were approximately $247,000, $170,000 and $62,000, respectively.
The following is a summary of activity of nonvested awards for the year ended December 31, 2008:
The following is a summary of activity of vested awards for the year ended December 31, 2008:
Detail supporting the computation of basic and diluted earnings per redeemable common share was as follows for the years ended December 31, 2008, 2007, and 2006:
The Company reported diluted earnings per share for the year ended December 31, 2007 as a result of 44 restricted share awards granted that had a dilutive effect on the Company’s earnings per share. The restricted share awards were redeemed and shares were issued in May of 2008. There have been no restricted share awards granted that would have a dilutive effect on the Company’s basic earnings per share for the years ended December 31, 2008 and December 31, 2006.
The Company has authorized 100,000 preferred shares, without par value. As of December 31, 2008 and 2007, 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.
Dividends 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
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 2009 without prior regulatory approval are approximately $517,000. There were no dividends declared or paid by any subsidiaries during 2008, 2007 or 2006.
Generally accepted accounting principles differ in certain respects from the accounting practices prescribed or permitted by state insurance regulatory authorities (“statutory-basis”). The statutory-basis net income of Dental Care Plus was approximately $641,000, $494,000, and $175,000 for the years ended December 31, 2008, 2007, and 2006, respectively. Statutory-basis net worth was approximately $5,174,000 and $4,670,000 at December 31, 2008 and 2007, respectively.
The Company entered into an interest rate swap agreement (Note 12) 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. The notional amount of the interest rate swap reduces concurrently with the reduction of the principal of the mortgage note. The Company’s effective interest expense was 4.49%, 5.22% and 5.41% at December 31, 2008, 2007 and 2006, respectively.
Leases-The Company leases certain equipment and office space under non-cancelable operating leases. Rent expense under all operating leases was approximately $181,000, $211,000, and $210,000 for the years ended December 31, 2008, 2007, and 2006, respectively.
At December 31, 2008, future approximate minimum annual lease payments under non-cancelable operating leases are as follows; 2009-$175,000; 2010-$151,000, and 2011-$34,000.
In 2004, the Company began to lease space in its building to unrelated parties under non-cancelable leases. Income recorded by the Company under non-cancelable leases amounted to approximately $47,000, $58,000 and $92,000 for the years ended December 31, 2008, 2007 and 2006, respectively. Such amounts are recorded as other income in the accompanying consolidated financial statements. As of December 31, 2008, approximate future minimum annual lease income under non-cancelable leases are as follows:
Employees of the Company are covered by a defined contribution 401(k) plan sponsored by the Company. Discretionary contributions of a certain percentage of each employee’s contribution, which may not exceed a limit set annually by the Internal Revenue Service, are contributed by the Company each year and vest ratably over a five-year period. Company contributions, including administration fees paid by the Company amounted to approximately $51,000, $50,000, and $30,000 in 2008, 2007, and 2006, respectively.
The Company changed the composition of its reportable segments in the current year, and the amounts in the prior period financial statements relating to reportable segments have been modified to conform to the current composition of reportable segments. The modification of the reportable segments was a result of changes in the structure of the Company’s internal organization that occurred in the current year. 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 three operating segments: fully-insured dental HMO, fully-insured dental PPO and fully-insured dental indemnity products. Self-insured dental consists of two operating segments: the self-insured dental HMO and self-insured indemnity products. Corporate, all other consists primarily of certain corporate activities. After the Company assumed the underwriting risk for its fully-insured dental PPO contracts in Ohio effective June 1, 2008, the Company’s fully-insured dental PPO and fully-insured dental indemnity products were reclassified from the corporate, all other segment and aggregated with the fully-insured dental HMO product to comprise the fully-insured dental segment. The Company identified the segments in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosure about Segments of an Enterprise and Related Information.” These segments are consistent with information used by the Chief Executive Officer (the chief decision maker) in managing the business. The segment information aggregates products with similar economic characteristics. These characteristics include the nature of employer groups and pricing, benefits and underwriting requirements.
The results of the fully-insured and self-insured dental segments are measured by gross profit. The Company does not allocate insurance expense, investment and other income, goodwill, or other assets or liabilities to these segments. These items are assigned to the remainder of the Company’s business, which it identifies as corporate, all other. The Company’s gross profit was approximately $12,617,000, $11,798,000 and $9,561,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
Effective January 1, 2008, the Company adopted SFAS No. 157. Subsequent to the adoption of SFAS No. 157, FSP No. 157-2 delayed the effective date of Financial Accounting Standard (“SFAS”) No. 157 “Fair Value Measurements” for non-financial assets and non-financial liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a nonrecurring basis. This FSP delayed the effective date to fiscal years beginning after November 15, 2008. As amended, SFAS No. 157 provides a 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. The three levels of the fair value hierarchy defined by SFAS No. 157 are as follows:
The following table presents for each of the fair value levels, the Company’s assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2008 (amounts in thousands).
The Company measures fair value using the following valuation methodologies. The Company uses quoted market prices to determine the fair value of the deferred compensation investments and certain state fund guarantee fund deposits; such items are classified as Level 1 of the fair-value hierarchy. Examples include government securities and exchange-traded equity securities. The Company obtains prices from independent vendors to determine the fair value of the majority of its short-term investments and investments portfolio. The remainder of the short-term investments and investments portfolio and the remainder of the state fund guarantee deposits are fair valued using a discounted cash flow method whereby the significant observable inputs include the maturity date and the interest rate yield; such items are classified as Level 2 of the fair-value hierarchy. Examples include brokered and non-brokered certificates of deposit. The Company obtains a price from an independent vendor to determine the fair value of the interest rate swap. The independent vendor uses a discounted cash flow method whereby the significant observable inputs include the replacement interest rates of similar swap instruments in the market and swap curves; such items are classified as Level 2 of the fair value hierarchy.
A summary of our unaudited quarterly results of operations for the years ended December 31, 2008 and 2007 is as follows (amounts in thousands, except for per share results):