We currently maintain our principal place of business at 100 Crowne Point Place, Sharonville, Ohio 45241, which we own. 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.
Headquartered in Cincinnati, Ohio, Dental Care Plus Group offers to employer groups of all sizes dental HMO, dental PPO, dental indemnity and vision PPO benefit plans and related services. As of December 31, 2010, we had approximately 287,900 members in our dental and vision benefit programs with 2,858 dentists participating in our provider networks.
We have experienced steady growth in membership and revenue in our dental products during the last five years. We attribute this growth to our broad provider networks, competitive premium rates for our fully-insured business and ASO fees for our self-insured business, and our commitment to providing outstanding customer service to all of our constituencies (employer groups, members, insurance brokers, and dentists). The introduction of the DentaPremier dental indemnity product in 2003 created new business opportunities for us with employer groups in our original eight county service area. The introduction of the DentaSelect dental PPO product has been instrumental to our new sales in the Dayton, Ohio and Central Kentucky markets.
We had a net income of $12,000 for the year ended December 31, 2010 compared to net loss of $(289,000) for the year ended December 31, 2009. This increase in net income is primarily the result of a decrease in total insurance expenses of $217,000, to $12,518,000 in 2010 from $12,735,000 in 2009. Our ratio of insurance expense to total premium revenue (“insurance expense ratio”) decreased by 1.5%, to 16.6% in 2010 from 18.1% in 2009.
We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our consolidated financial statements and related changes in certain key items in those consolidated financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain critical accounting policies and estimates have an impact on our consolidated financial statements.
Basic loss per redeemable common share was $(3.74) and $(37.27) at December 31, 2010 and 2009, respectively. The increase in net income on redeemable common shares primarily resulted from a decrease in total insurance expense as a percentage of total premium revenue to 16.6% in 2010 from 18.1% in 2009 that was offset in part by an increase in healthcare service expense as a percentage of total premium revenue to 83.6% in 2010 from 82.7% in 2009.
Our fully-insured membership increased approximately 18,200 in 2010. This membership increase is primarily attributable to an increase of approximately 9,600 fully-insured dental HMO members, an increase of approximately 8,700 fully-insured dental PPO members, and a decrease of approximately 100 fully-insured dental indemnity members underwritten by Dental Care Plus, Inc. (“DCP”). The increase in fully-insured dental HMO membership of 9,600 members is due to new sales in the Cincinnati and Northern Kentucky markets of approximately 9,900 members and the conversion of one large employer group with approximately 7,500 members from the self-insured DHMO to the fully insured DHMO effective January 1, 2010. These membership increases were offset by the loss of approximately 7,800 members due to employer groups that did not renew with the Company or reduced employee counts of retained employer groups. The increase in fully-insured dental PPO membership is primarily due to new sales in the new geographic areas in Ohio and Kentucky.
Corporate, all other premium revenue is primarily derived from the non-DCP dental indemnity product, dental PPO product and vision product underwritten by third party insurance carriers. In aggregate, Corporate, all other premium revenue increased by $46,000, or 11.0%, to $463,000 in 2010 from $417,000 in 2009.
Investment income increased $16,000, or 16.2%, to $115,000 from $99,000 in 2009. This increase is attributable to the higher yields earned from our investment grade corporate bond investments that we purchased in 2010. This increase in investment income was offset by a decrease in the prevailing interest rates on our certificates of deposit and a money market fund in 2010 compared to 2009. In 2009, we invested in Federal Deposit Insurance Corporation (“FDIC”) insured certificates of deposit and money market funds. In 2010, we invested in investment grade corporate bonds, FDIC insured certificates of deposit and money market funds.
Professional consulting expense decreased by $81,000, or 28.1%, as a result of the delay of discretionary projects. These expense reductions were offset by some expense increases. Salaries and benefits increased by $166,000, or 4.5%, due to staff pay increases implemented in 2010 and the addition of new employees in staff positions. Commissions expense increased $261,000, or 8.9%, due to the higher level of new membership sales in 2010.
from an increase in total healthcare services expense as a percentage of total premium revenue to 82.7% in 2009 from 80.9% in 2008. In addition, insurance expense as a percentage of total premium revenue increased to 18.1% in 2009 from 18.0% in 2008.
Our fully-insured membership increased approximately 16,100 in 2009. Our fully-insured dental HMO membership increased approximately 4,200 members, or 3.2%, to 135,400 at December 31, 2009 from 131,200 at December 31, 2008. This membership increase is attributable to new fully-insured dental HMO sales in the Cincinnati and Northern Kentucky market of approximately 16,900 members, offset by a decrease in fully-insured dental HMO membership of 12,700 members that did not renew their contracts with Dental Care Plus in the last 12 months. Our fully-insured indemnity membership increased by approximately 600 members, or 13.3%, to approximately 5,100 members at December 31, 2009 from approximately 4,500 members at December 31, 2008. In addition, our fully-insured dental PPO membership increased by approximately 11,300 members, to approximately 30,600 members at December 31, 2009 from approximately 19,300 members at December 31, 2008.
Our self-insured dental membership decreased approximately 10,500 members, or 10.7%, to approximately 87,600 members at December 31, 2009 from approximately 98,100 members at December 31, 2008. This membership decrease was primarily due to the loss of one large self-insured employer group with approximately 15,700 members, offset by new self-insured sales of approximately of 5,200 members.
Our corporate, all other membership increased by approximately 3,800 members. This membership was primarily due to the increase in our vision membership underwritten by a third-party insurance carrier.
Fully-insured dental HMO premium revenue increased $1,693,000 in 2009, to $37,842,000 in 2009 from $36,149,000 in 2008. This increase is primarily due to the 2009 new sales of the fully-insured dental HMO product discussed above, offset by the fully-insured dental HMO membership decrease due to employer groups that did not renew their contracts in 2009. Fully-insured dental indemnity premium revenue increased by $149,000, or 12.5%, to $1,341,000 in 2009 from $1,192,000 in 2008. Fully-insured dental PPO premium revenue increased by $3,192,000, or 107.1%, to $6,172,000 in 2009 from $2,980,000 in 2008 primarily due to the increase in fully-insured dental PPO membership discussed above.
Corporate, all other premium revenue is primarily derived from the non-DCP dental indemnity product, dental PPO product and vision product underwritten by third party insurance carriers. In aggregate, Corporate, all other premium revenue decreased by $18,000, or 4.1%, to $417,000 in 2009 from $435,000 in 2008.
Fully-insured dental HMO healthcare services expense increased by $1,979,000, or 7.1%, to $29,932,000 in 2009 from $27,953,000 in 2008. This increase is attributable to the 2.6% increase in fully-insured dental HMO member months in 2009 compared to 2008 and an increase in fully-insured dental HMO healthcare services expense on a per member per month basis of approximately 4.3% in 2009 for both our new and existing fully-insured membership.
Fully-insured dental indemnity healthcare services expense increased by $178,000, or 16.4%, to $1,262,000 in 2009 from $1,084,000 in 2008. Approximately $94,000 of this increase is attributable to the 8.7% increase in fully-insured dental indemnity member months in 2009 compared to 2008. Approximately $84,000 of this increase is attributable to an increase in fully-insured dental indemnity healthcare services expense on a per member per month basis of approximately 7.2% in 2009.
Consolidated insurance expenses increased $789,000 in 2009. Total insurance expenses as a percentage of total premium revenue, or the insurance expense ratio, was 18.1% for 2009, increasing 0.1% from the 2008 ratio of 18.0%. Salaries and benefits increased by $160,000, or 4.5%, due to staff pay increases implemented in 2009 and the addition of new employees in staff positions. Commissions expense increased $426,000, or 16.9%, due to the higher level of new membership sales. Accounting and auditing expense increased by $47,000, or 20.4%, in 2009 due to additional costs related to our anticipated Sarbanes Oxley Act of 2002 Section 404 (“SOX”) attestation and a new audit of our administrative system based on Statement on Auditing Standards No. 70. Legal fees increased by $81,000, or 39.5%, in 2009 as a result of required state insurance department filings and new product development.
Our effective tax rate for 2009 of 26.8% decreased 10.0% compared to the 36.8% effective tax rate in 2008. Our 2009 effective tax rate was lower than the federal statutory rate primarily due to permanent tax differences and applicable state and local taxes. See Note 5 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.
Our primary sources of cash are premiums, ASO fees, investment and other income, as well as the proceeds from the maturity of our investment securities, from the sale of redeemable common and preferred shares, and from borrowings. Our primary uses of cash include disbursements for claims payments, insurance expense, interest expense, taxes, purchases of investment securities, capital expenditures, redeemable common shares redemptions, and payments on borrowings. Because premiums are collected in advance of claims payments, our business should normally produce positive operating cash flows during a period of increasing enrollment. Conversely, cash flows would be negatively impacted during a period of shrinking enrollment. Cash decreased $708,000, or 10.5%, for the year ended December 31, 2010 to approximately $6.0 million at December 31, 2010 from approximately $6.7 million at December 31, 2009. This cash decrease is primarily due to an increase in our investments in investment grade corporate bonds. Cash increased approximately $4.2 million or 168.0%, to approximately $6.7 million at December 31, 2009 from approximately $2.5 million at December 31, 2008. This increase was primarily due to approximately $4.5 million increase in cash flows from investing activities that was the result of our decision in 2008 to move funds out of money market mutual funds yielding less than 0.1% interest to our checking account where the earnings credit of approximately 0.4% was used to offset bank fees. The change in cash for the years ended December 31, 2010, 2009 and 2008 is summarized as follows (in thousands):
In 2009, we generated $37,000 of cash in operating activities. This level of cash flow from operating activities is lower than the cash flow generated from operating activities in 2008. We had a net loss of $(289,000) in 2009, primarily due to a 2.5% increase in fully-insured healthcare service utilization. In addition to our 2009
net loss, other uses of cash include: a decrease in claims payable of $315,000, and a decrease in unearned premium of $647,000 that was offset by a decrease in unbilled accounts receivable of $860,000. The decrease in our claims payable is primarily due to the fact that there was a provider withhold return liability of $464,000 at December 31, 2008 and no provider withhold return liability at December 31, 2009. The decrease in unbilled accounts receivable and a corresponding decrease in unearned premium revenue of $860,000 are the result of some large two-year fully insured dental contracts that expired December 31, 2009. The unearned premium decrease was offset by an increase in unearned premiums received in advance of $213,000. Additional uses of cash included an increase in deferred acquisition costs and an increase in other assets totaling $180,000. Also, we had a non-cash tax benefit related to deferred income taxes of $292,000. These uses of operating cash were offset by non-cash depreciation and amortization expense of $468,000, an increase in deferred compensation liabilities of $275,000, along with a decrease in accrued investment income, a decrease in accounts receivable and an increase in other payables and accruals totaling $156,000.
In 2009, we invested $245,000 in building improvements, office equipment and computer equipment and software. Also in 2009, approximately $19.2 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 $14.6 million in additional FDIC insured certificates of deposit and money market funds. Collectively, this resulted in an increase in cash from investment activities of approximately $4.3 million. Approximately $4.5 million of the increase in cash flows from investing activities was the result of our decision in the fourth quarter to move funds out of money market mutual funds yielding less than 0.1% interest to our checking account where the earnings credit of approximately 0.4% was used to offset bank fees.
In 2009, we paid $120,000 of our outstanding mortgage balance and $19,000 in capital lease payments for our dental administration software. During 2009, we repurchased redeemable common shares of $172,000, which was offset by the issuance of redeemable common shares and provider preferred shares related to our current share offerings of $222,000.
In 2008, we executed a revolving note with a commercial bank in the amount of $650,000 collateralized by a second mortgage on our office building. 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 $224,000 in capital lease payments for our dental administration software. During 2008, we repurchased redeemable common shares of $68,000, which was offset by the issuance of redeemable commons shares of $28,000.
In most cases, our reimbursement to our participating providers for covered dental services under the dental HMO are subject to a 10% withhold by us. The amounts withheld are not retained in a separate fund and we have no obligation to pay any portion of the amounts withheld to the providers. The dental providers have no vested rights in the amounts withheld unless our Board of Directors authorizes any amounts withheld to be paid to the providers, and then vesting is only to the extent of such amounts authorized to be paid. Once authorized for payment by the Board, such amounts are recorded as claims payable liabilities until paid.
The Board may authorize aggregate provider withhold payments in amounts between 0% and 45% of the total provider withhold returns for future years in relation to the total provider withhold amount for those years. However, the Board will not authorize an aggregate provider withhold payment for any year that would result in
an operating loss for the year in review. These forecasted amounts are based on projections of future claims revenues and certain planning assumptions and estimates currently being made with respect to future application of the factors historically considered by the Board in making its determination to authorize the payment of withhold amounts. These planning assumptions reflect management’s current expectations and views about future events and are subject to risks, uncertainties and other factors that could cause actual withhold payment amounts to differ materially from these stated assumptions. Important factors that could cause actual results to differ materially from those being planned for, include, among others: claims exceeding or not meeting our estimates, a threatened or actual downgrade in our financial strength rating, the loss of a significant customer or broker, the loss of a large employer group and an unexpected change in dental service utilization by our dental members.
A summary of our future commitments as of December 31, 2010 is as follows:
A mortgage note, secured by the land and the office building, bears interest based on the 30-day LIBOR rate plus 1.75% and was 2.01% and 1.98% at December 31, 2010 and 2009, respectively. At the maturity date of the mortgage note in 2013, the expected outstanding balance of the note of $600,000 must be repaid or refinanced.
We also entered into an interest rate swap agreement that effectively changed the interest rate related to $1,500,000 of the $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. Our effective interest expense on the mortgage note was 3.97%, 4.08% and 4.49% at December 31, 2010, 2009 and 2008, respectively. At December 31, 2010, the carrying value of the mortgage note approximates fair value.
Deferred Compensation-We expect to pay our deferred compensation liability to the Company directors and employees as they retire or terminate in future years.
This decrease in cash and short term investments from December 31, 2009 to December 31, 2010 is primarily due to the net cash used in by financing activities of $1,730,000, offset by the cash provided by investing activities of $146,000 and the cash generated by operating activities of $876,000. In addition to this decrease in cash and short term investments there was a shift of $255,000 from short term investments to long term investments during this period.
We believe our cash, short term investments and working capital lines of credit together are sufficient to meet our short term and long term liquidity needs. In the short term, we are obligated to make payments related to our contractual obligations such as our building mortgage and our operating leases and other commitments (see contractual obligations and other commitments). In the long term, we will continue to be obligated to make payments related to our contractual obligations delineated above. We will also be obligated in certain circumstances to repurchase the redeemable shares of our provider shareholders who die, are permanently
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 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, 2010.
We maintained aggregate statutory capital and surplus of approximately $5.5 million as of December 31, 2010 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 2010 resulting from the expansion of our networks and membership, capital requirements will increase. We expect to fund these increased requirements through the retention of earnings and capital raised in future redeemable common and preferred share offerings.
Unbilled accounts receivable represents the accounts receivable for all remaining future months related to our non-cancelable fully-insured dental contracts with a corresponding unearned premium revenue liability. With monthly premium billing, the billed amount is recorded as accounts receivable, and the unbilled accounts receivable is adjusted for the billing of new or renewed contracts.
Goodwill arises in business combinations when the purchase price of assets acquired net of liabilities assumed exceeds the fair value. As with tangible and other intangible assets, periodic impairment reviews are required, at least annually, as well as when events or circumstances change. Management uses judgment in assessing goodwill for impairment. 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. Considerable judgment must be exercised in determining future cash flows and their timing and choosing business value comparables or selecting discount rates to be used in any value computations. There has not been any impairment to our goodwill.
No provider withhold liability was recognized in either 2010 or 2009 due to the fact no provider withhold return was authorized by our Board of Directors in either year.
Between December 31, 2009 and December 31, 2010, our IBNR estimate increased by $398,000 or 29.9%, primarily due to a 10.6% increase in the number of fully-insured members at December 31, 2010 compared to December 31, 2009 and an increase in fully-insured claims on a per member per month basis of approximately 2.1%. Also our IBNR estimate at December 31, 2010 has increased due to an increase in fully-insured dental PPO business as a percentage of total fully-insured dental business. Fully-insured dental PPO business typically has lower completion factors than fully-insured dental HMO business.
In 2009, the Board of Directors authorized and approved for issuance the redeemable Provider Preferred Shares-2009 (“Provider Preferred Shares”) Series that includes 5,000 preferred shares of the 100,000 preferred shares authorized. These Provider Preferred Shares may only be purchased by participating dentists in the Company’s dental plans or retired participating dentists that own at least 12 Redeemable Common Shares (Class A and/or B). The Provider Preferred Shares are considered to be redeemable preferred shares due to the fact that the shareholders have the option to require the Company to repurchase these shares upon their death, permanent disability or retirement. The Company records the Provider Preferred Shares as redeemable Provider Preferred Shares in the consolidated balance sheets outside of shareholders’ equity at the redemption value of the preferred shares. Accordingly, Provider Preferred Shares are participating securities that share in the net income (loss) or other comprehensive income (loss) as a change to the redemption value of the redeemable Provider Preferred Shares to accrete (dilute) the carrying value to the redemption value at the end of each reporting period. Under this method, the end of the reporting period is treated as if it were also the redemption date for the security. Redeemable Provider Preferred Shares are entitled to a cumulative cash dividend equal to 5% of the year end book value of the redeemable Provider Preferred Shares.
In 2010, the Board of Directors authorized and approved the issuance of Redeemable Institutional Preferred Shares (“the Shares”) consisting of 300 preferred shares of the 100,000 preferred shares authorized. On July 21, 2010, the Company entered into a Preferred Stock Purchase Agreement (the “Stock Purchase Agreement”) with an investor. Pursuant to the Stock Purchase Agreement, the investor agreed to purchase 300 Shares at a purchase price of $1,000 per share, with an aggregate purchase price of $300,000. The annual dividend payable on each Share is 5% of the book value at the beginning of the dividend period. The proceeds of the sale of the Shares will be used to fund the expansion of current dental insurance products into new markets, to fund corporate infrastructure improvements and to increase the capital and surplus of Dental Care Plus, Inc. (“DCP”) to support the growth of fully-insured dental insurance premium revenue. The sale of the Shares under the Stock Purchase Agreement is pursuant to a private sale exempt from registration under Section 4(2) of the Securities Act of 1933, as amended.
In January 2010, the FASB issued guidance that provides additional disclosures about transfers into and out of Levels 1 and 2 fair value measurements and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 fair value measurements. The guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The guidance is effective for the interim and annual reporting periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for interim and annual reporting periods after December 15, 2010. This guidance did not have a material effect on the Company’s consolidated financial statements or related disclosures.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
AS OF DECEMBER 31, 2010 AND 2009 AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2010
DCP Holding Company (the “Company”) is the parent holding company of three wholly-owned subsidiaries which include Dental Care Plus, Inc., an Ohio corporation, Insurance Associates Plus, Inc., an Ohio corporation, and Adenta, Inc., a Kentucky corporation. The Company is owned and controlled by 608 dentists who participate in our Dental Care Plus products. The Company offers to employer groups of all sizes dental health maintenance organization (“HMO”), participating provider organization (“PPO”) and indemnity plans and vision benefit plans. As of December 31, 2010, the Company had approximately 269,100 members in its dental benefits programs with 2,858 dentists participating in its two provider networks in Southwestern Ohio, Northern Kentucky, Central Kentucky and Southeastern Indiana. In addition, the Company had approximately 18,800 members in its vision benefit programs. The Company markets its products through a network of independent brokers.
The Company’s products consist primarily of dental HMO, PPO and indemnity plans, with dental HMO products constituting 84.6% of its total revenues. Substantially, all of the Company’s products are marketed to employer groups. The Company’s business model allows it to offer dental benefit products including broad networks of participating dentists while at the same time promoting the use of private practice fee-for-service dentistry, a primary interest of the Company’s participating dentists. The dental benefit products the Company offers currently vary depending on geographic market.
Investments-The Company invests in certificates of deposit, investment grade corporate bonds and a money market mutual fund. The Company classifies all certificates of deposit investments and the money market mutual fund as available-for-sale. Such certificates of deposit investments are recorded at fair value, with unrealized gains and losses recorded as a component of other comprehensive income. The Company classifies all investment grade corporate bonds as held-to-maturity based on the Company’s positive intent and ability to hold the securities to maturity. Held-to-maturity investments are recorded at amortized cost. The amortized cost of held-to-maturity investments is adjusted for amortization of premiums and accretion of discounts to maturity using the effective-yield method of amortization. Such amortization is included in investment income. The Company recognizes gains and losses when these securities mature or are sold using the specific identification method.
Management follows 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, the Company’s intent and ability to retain a security for a period adequate to recover its cost, and general market conditions. The Company’s impairment policy for fixed-maturity securities states that other-than-temporary impairment is considered to have occurred (1) if the Company intends to sell the impaired fixed maturity security; (2) if it is more likely than not the Company will be required to sell the fixed maturity security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis.
State Guarantee Fund Deposits-The Company maintains funds on deposit with state insurance departments in those states where the Company is licensed to do business. These funds amounted to approximately $278,000 and $291,000 at December 31, 2010 and 2009, 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.
Redeemable Institutional Preferred Shares-In 2010, the Board of Directors approved the issuance of Redeemable Institutional Preferred Shares (“the Shares”) consisting of 300 preferred shares of the 100,000 authorized. On July 21, 2010, the Company entered into a Preferred Stock Purchase Agreement (the “Stock Purchase Agreement”) with an investor. Pursuant to the Stock Purchase Agreement, the investor agreed to purchase 300 Shares at a purchase price of $1,000 per share, with an aggregate purchase price of $300,000. The annual dividend payable on each Share shall be 5% of the book value at the beginning of the dividend period. Accordingly, Institutional Preferred Shares are participating securities that share in the net income (loss) or other comprehensive income (loss) as a change to the redemption value of the redeemable Institutional Preferred Shares to accrete (dilute) the carrying value to the redemption value at the end of each reporting period. Under this method, the end of the reporting period is treated as if it were also the redemption date for the securities.
Redeemable Common Shares-The Company’s Class A and Class B redeemable common shares are owned by participating providers, Company directors and employees. 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 10). All participating providers, Company directors and Company employees are eligible to own the Class B non-voting redeemable common shares. The Company’s Class A and Class B
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 contracts with self-insured employers and is included in premium revenue in the accompanying consolidated statements of operations.
Other Income-Other income is comprised primarily of rental income from the rental of space in the building owned and partially occupied by the Company (See Note 14) as well as revenues earned from the leasing of the Company’s dental provider network to other dental benefit providers.
Healthcare Services Expense-The Company compensates its providers based on contractual reimbursement for various services. With respect to the dental HMO product, the Company generally retains 10% of this reimbursement (including payments on self-insured claims) in accordance with the Company’s provider agreements. Healthcare services expense is recorded net of any amounts withheld in the accompanying consolidated statements of operations. Under the terms of the Company’s provider agreements, the Company is not obligated to return to providers any amounts withheld. Withheld amounts are retained by the Company but not reserved or retained in a separate fund. Participating providers have no interest in the amounts withheld unless the Company’s Board authorizes any amount to be paid to the providers.
The cost of fully-insured healthcare services 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 incurred but not reported to the Company, net of the amounts withheld in accordance with the provider agreements.
Each year the Board evaluates the performance of the Company’s dental plans, capital and surplus requirements prescribed by the Ohio Department of Insurance, factors affecting 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. There was no withhold return authorized for 2010 or 2009.
Reinsurance-In the normal course of business, the Company assumes premium revenue and related healthcare services expense from a third party insurance provider. Dental insurance premium assumed was approximately $148,000 for the year ended December 31, 2010. The healthcare services expense assumed was approximately $135,000 for the year ended December 31, 2010. The Company did not have any assumed dental insurance premium or healthcare services expense for the years ended December 31, 2009 and 2008. As of December 31, 2010, the Company had approximately $9,000 of reinsurance premium receivable and claims payable of approximately $29,000.
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 and qualify as cash flow hedges are recorded in other comprehensive income, with subsequent reclassification to earnings when the hedged transaction asset or liability impacts earnings. Any ineffectiveness is recognized in earnings immediately. The Company’s risk management policy is to not enter into derivatives for speculative purposes.
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 discounting on claims payable, accrued commissions, deferred compensation, unearned premiums, depreciation and deferred acquisition costs.
At December 31, 2010, premiums receivable from one customer totaled approximately 21% of the premiums receivable balance. At December 31, 2009, premium receivables did not have any balance greater than 10% of the total balance from any one customer.
Fair Value of Financial Instruments-Certain financial instruments are required to be recorded at fair value. The estimated fair values of such financial instruments have been determined using market information and valuation methodologies, primarily discounted cash flow analysis and broker-quoted market prices. Changes in assumptions or estimation methods could affect the fair value estimates.
New Accounting Standards-In January 2010, the FASB issued guidance that provides additional disclosures about transfers into and out of Levels 1 and 2 fair value measurements and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 fair value measurements. The guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The guidance is effective for the interim and annual reporting periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for interim and annual reporting periods after December 15, 2010. This guidance did not have a material effect on the Company’s consolidated financial statements or related disclosures.
In October 2010, the FASB issued guidance that amends Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. The new guidance modifies the definitions of the type of costs incurred by insurance entities that can be capitalized in the successful acquisition of new and renewal contracts. The guidance requires incremental direct costs of successful contract acquisition as well as certain costs related to underwriting, policy issuance and processing, medical and inspection and sales force contract selling for successful contract acquisition to be capitalized. These incremental direct costs and other costs are those that are essential to the contract transaction and would not have been incurred had the contract transaction not occurred. The effective date is for reporting periods beginning after December 15, 2011. The Company is evaluating the impact on the Company’s consolidated financial statements and related disclosures.
Goodwill and intangible assets were recorded as a result of the acquisition of Adenta, Inc. in 2005 related to goodwill, an acquired contract, memberships and a provider network. Goodwill amounted to approximately $136,000 at December 31, 2010 and 2009. There has not been any cumulative impairment on goodwill. Identifiable and amortizable intangible assets amounted to approximately $142,000 net of approximately $98,000 of accumulated amortization at December 31, 2010 and to approximately $158,000 net of approximately $82,000 of accumulated amortization at December 31, 2009. Amortization expense was approximately $15,000 for each of the three years ended December 2010, 2009, and 2008. The provider network intangible asset of approximately $79,000 at December 31, 2010 is being amortized over a period of 20 years, a period during which the Company expects that all of these providers will have retired from the network. Membership intangible assets (net of individual memberships written-off in the year of acquisition) of approximately $63,000 at December 31, 2010 is being amortized over its 11 year useful life in accordance with the Company’s expectation for the membership retention. The remaining weighted-average amortization period for these intangible assets is approximately 11 years. Amortization expense for 2011 through 2016 is expected to be approximately $15,000 each year. Goodwill and intangible assets are included in other assets in the accompanying consolidated balance sheets at December 31, 2010 and 2009.
The Company owned certificates of deposit insured by the Federal Deposit Insurance Corporation (“FDIC”) with a cost of $1,000,000 and $1,800,000 as of December 31, 2010 and 2009, respectively. The certificates of deposit included in short-term and fixed maturities investments are classified as available-for-sale and are carried at fair value, which is based on broker-quoted market prices. The unrealized gains and losses on available-for-sale investment activity are due to a change in the quoted market prices for these investments caused by any changes in prevailing interest rates since they were purchased. The Company also invests in a money market fund with a cost and fair value of $556,341 and $204,111 as of December 31, 2010 and 2009, respectively. In 2010, the Company began to invest in investment grade corporate bonds, which are classified as held-to-maturity and are recorded at amortized cost. The Company owned approximately $2,316,000 of investment grade corporate bonds at amortized cost as of December 31, 2010. The investment grade corporate bonds consisted of three securities with a BBB+ rating at December 31, 2010. The remaining eight investment grade corporate bonds had a credit rating of A- or better at December 31, 2010. There was no change in the credit rating of any investment grade corporate bond during 2010. The weighted average yield-to-book value of our investment grade corporate bonds was approximately 5.55% at December 31, 2010. The weighted average maturity of our investment grade corporate bonds was 2.50 years at December 31, 2010. There were no realized gains or losses for the year ended December 31, 2010 and 2009.
Management believes it is more likely than not that deferred tax assets will reduce future income tax payments. Significant factors considered by management in its determination of the probability of the realization of the deferred tax benefits include the historical operating results and the expectations of future earnings. The Company had $134,565, $146,582, and $194,580 of net operating loss carry forwards to utilize in future years at December 31, 2010, 2009 and 2008, respectively. These losses will expire between 2011 and 2022. Net deferred tax assets are included in other assets in the accompanying consolidated balance sheets at December 31, 2010 and 2009.
The Company’s effective tax rate was different from the U.S statutory rate due to the following:
For the year ended December 31, 2010, 2009 and 2008, the Company did not have any significant uncertain tax position liability or expense. The Company is primarily subject to U.S. federal and various U.S. state and local tax authorities. Tax years subsequent to 2007 remain open to examination by the Internal Revenue Service, and 2006 remains open to other state and local tax authorities. As of December 31, 2010, there are no U.S. federal or state returns under examination.
In accordance with the 2006 Dental Care Plus Management Equity Incentive Plan and the Dental Care Plus, Inc. and DCP Holding Company Deferred Compensation Plan (the “Plans”), Company directors and certain key employees elected to defer portions of their director fees and employee compensation, as applicable. The Company recorded expense of approximately $59,000, $93,000 and $106,000 related to deferred director fees and deferred employee compensation for the years ended December 31, 2010, 2009 and 2008, respectively. Directors and key employees who elect to defer cash compensation may request that the Company invest this compensation in a mutual fund investment or phantom shares of the Company. The Plans also provide for the directors and key employees to receive share awards based on the book value of the Redeemable Common Shares and to elect to defer receiving such amounts until termination of board membership or employment and vesting requirements are met. If a director or key employee does not elect to defer receiving his or her share awards, the individual will receive Class B Redeemable Common Shares upon vesting. If the share awards are deferred, these deferred amounts will be paid in cash at redemption. An individual director’s award vests 100% at the end of each year if the director meets certain attendance requirements. The key employee awards vest 10%, 20%, 30% and 40% at the end of each respective year in a four-year period following the grant date. There are no performance criteria associated with the vesting of the awards for key employees and the only requirement for vesting is that the individual is an employee of the Company at the end of the vesting year in question. The deferred compensation expense related to these awards is recorded ratably during the applicable vesting period. In December 2010, the Board of Directors (the “Board”) elected to rescind the 2010 deferred share awards that were granted to the Board at January 1, 2010 and each director agreed to surrender the deferred share awards. The Company recorded deferred compensation expense of approximately $27,000, $186,000 and $278,000
related to deferred share awards and the change in the value of phantom shares for the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010 there is approximately $113,000 of total unrecognized compensation cost related to non-vested award compensation under the Plans. That cost is expected to be recognized over a weighted average period of 1.8 years.
Detail supporting the computation of earnings (loss) per redeemable common share was as follows for the years ended December 31, 2010, 2009, and 2008:
The Board authorized and approved for issuance the Provider Preferred Shares-2009 Series that includes 5,000 preferred shares authorized of the 100,000 authorized. These Provider Preferred Shares were purchased by participating dentists in the Company’s dental plans or retired participating dentists that own at least 12 Redeemable Common Shares. Redeemable Provider Preferred Shares are entitled to a cumulative cash dividend equal to 5% of the year end book value of the redeemable Provider Preferred Shares. This dividend payable liability of approximately $10,000 and $11,000 was established in accordance with the Company’s Amended and Restated Articles of Incorporation for shareholders of record as of December 31, 2010 and 2009, respectively, and is included in other accruals in the accompanying consolidated balance sheets. In 2010, the Company paid $11,000 related to the Provider Preferred Shares. There were not any dividends paid in 2009 or 2008.
The Board of Directors authorized and approved the issuance of Redeemable Institutional Preferred Shares (“the Shares”) consisting of 300 preferred shares authorized of the 100,000 authorized. The Company entered into a Preferred Stock Purchase Agreement (the “Stock Purchase Agreement”) with an investor. Pursuant to the Stock Purchase Agreement, the investor agreed to purchase 300 Shares at a purchase price of $1,000 per share, with an aggregate purchase price of $300,000. The annual dividend payable on each Share is 5% of the book
The Company has 94,700 remaining preferred shares, without par value. As of December 31, 2010 and 2009, none of these preferred shares were issued or are outstanding. The preferred shares do not have voting rights except to the extent required by law or designated by the Board of Directors.
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 Company’s effective interest expense on the mortgage note was 3.97%, 4.08% and 4.49% at December 31, 2010, 2009 and 2008, respectively. At December 31, 2010, the carrying value of the mortgage note approximates fair value.
In December 2010, the Company renewed its revolving note with a commercial bank in the amount of $700,000 collateralized by a second mortgage on the office building. Under this revolving note, 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,
and the Company was in compliance with this covenant at December 31, 2010. There was a principal balance outstanding of $650,000 and $630,000 related to this revolving note at December 31, 2010 and 2009, respectively. At December 31, 2010, the carrying value of the revolving note approximates fair value. This revolving note matures in December 2011 and is annually renewable and requires monthly interest payments at a variable rate of 30-day LIBOR plus 1.75%, which was 2.01% and 1.98% at December 31, 2010 and 2009.
On December 29, 2010, the Company entered into a sale-leaseback transaction with a leasing company for the sale of certain fixed assets for approximately $323,000. 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 $339,000 related to these assets over a three 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, and the Company was in compliance with this covenant at December 31, 2010. The net book value of these certain fixed assets is approximately $323,000 at December 31, 2010. The fair value of the capital lease obligation approximates the present value of minimum lease payments at December 31, 2010.
Leases-The Company leases certain equipment and office space under non-cancelable operating leases. Rent expense under all operating leases was approximately $198,000, $176,000 and $181,000 for the years ended December 31, 2010, 2009 and 2008, respectively.
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 $65,000, $56,000, and $51,000 in 2010, 2009, and 2008, respectively.
all outstanding amounts at a variable rate of the prime rate of borrowing plus 6.00%. The $85,000 standby letter of credit will also have an annual fixed rate of 2.10% for access to the standby letter of credit obligation. The $85,000 standby letter of credit expires in December 2011.
The Company manages its business with three reportable segments: fully-insured dental, self-insured dental and corporate, all other. Fully-insured dental consists of the fully-insured dental HMO, fully-insured dental PPO and fully-insured dental indemnity products. Self-insured dental consists of the self-insured dental HMO, self-insured dental PPO and self-insured dental indemnity products. Corporate, all other consists of revenue associated with the Company’s dental indemnity, dental PPO, and vision products underwritten by third-party insurance carriers and certain other corporate activities. These segments are consistent with information used by the Chief Executive Officer (the chief operating decision maker) in managing the business. The segment information aggregates products with similar economic characteristics. These characteristics include the nature of employer groups, pricing, benefits and underwriting requirements.
Listed below is financial information required for each industry segment for the years ended December 31, 2010, 2009 and 2008 (amounts in thousands):