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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 000-51954

 

 

DCP Holding Company

(Exact name of Registrant as specified in its Charter)

 

Ohio   20-1291244

(State or Other Jurisdiction of

Incorporation or Organization)

 

(IRS Employer

Identification No.)

100 Crowne Point Place

Sharonville, Ohio

  45241
(Address of Principal Executive Office)   (Zip Code)

Registrant’s telephone number, including area code: (513) 554-1100

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if smaller reporting company)    Smaller reporting Company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of September 30, 2013, there were 551 and 7,801 of the Registrant’s Class A and Class B Redeemable Common Shares outstanding, respectively.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

  PART I – FINANCIAL INFORMATION   
         PAGE  

Item 1.

  Financial Statements (unaudited)      1   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      14   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      25   

Item 4.

  Controls and Procedures      25   
  PART II – OTHER INFORMATION   

Item 1.

  Legal Proceedings      26   

Item 1A.

  Risk Factors      26   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      26   

Item 3.

  Defaults Upon Senior Securities      26   

Item 4.

  Mine Safety Disclosures      26   

Item 5.

  Other Information      26   

Item 6.

  Exhibits      27   
  Signatures      28   

 

i


Table of Contents

Item 1. Financial Statements

DCP HOLDING COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

 

     September 30,      December 31,  
     2013      2012  

ASSETS

     

INVESTMENTS:

     

Fixed maturities, available for sale at fair value, amortized cost of $6,393,000 and $3,771,000 at September 30, 2013 and December 31, 2012, respectively

   $ 6,449,862       $ 4,022,368   

Short-term investments, available for sale at fair value, amortized cost of $255,000 and $393,000 at September 30, 2013 and December 31, 2012, respectively

     256,596         394,342   
  

 

 

    

 

 

 

Total investments

     6,706,458         4,416,710   

CASH AND CASH EQUIVALENTS

     6,926,228         8,530,758   

ACCRUED INVESTMENT INCOME

     36,787         32,918   

ACCOUNTS RECEIVABLE, net of allowance of $21,737 and $55,163 at September 30, 2013 and December 31, 2012, respectively

     824,900         485,443   

UNBILLED ACCOUNTS RECEIVABLE

     40,766,353         18,596,063   

DEFERRED ACQUISITION COSTS

     2,613,465         1,184,413   

PROPERTY AND EQUIPMENT, net of depreciation and amortization of $2,782,724 and $2,590,246 at September 30, 2013 and December 31, 2012, respectively

     2,387,647         2,189,212   

OTHER ASSETS

     2,117,346         1,902,272   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 62,379,184       $ 37,337,789   
  

 

 

    

 

 

 

LIABILITIES, REDEEMABLE SHARES AND SHAREHOLDERS’ EQUITY

     

CLAIMS PAYABLE

   $ 2,292,985       $ 2,136,010   

UNEARNED PREMIUM REVENUE

     42,375,077         19,792,176   

OTHER PAYABLES AND ACCRUALS

     4,960,487         4,097,473   

MORTGAGE LOAN PAYABLE

     1,305,800         1,340,000   

CAPITAL LEASE OBLIGATION

     103,255         111,186   

DEFERRED COMPENSATION

     1,974,121         1,613,111   
  

 

 

    

 

 

 

TOTAL LIABILITIES

     53,011,725         29,089,956   
  

 

 

    

 

 

 

COMMITMENTS AND CONTINGENCIES

     
  

 

 

    

 

 

 

REDEEMABLE PREFERRED AND COMMON SHARES:

     

Provider Preferred-2009 Series Redeemable Preferred Shares, no par value, cumulative 5% dividend—authorized, 5,000 shares; issued none

     

Institutional Preferred Shares-2010 Series, no par value, cumulative 5% dividend—authorized, 300 shares; issued and outstanding, 300 shares at September 30, 2013 and December 31, 2012, respectively

     376,595         373,743   

Institutional Preferred Shares-2012 Series, no par value, cumulative 5% dividend—authorized, 1,000 shares; issued and outstanding, 1,000 shares at September 30, 2013 and December 31, 2012, respectively

     1,087,017         1,078,785   

Institutional Preferred Shares-2013 Series, no par value, cumulative 5% dividend—authorized, 1,000 shares; issued and outstanding, 1,000 shares at September 30, 2013 and zero at December 31, 2012

     999,836      

Class A, Redeemable Common Shares, no par value—authorized, 7,500 shares; issued and outstanding, 551 and 565 shares at September 30, 2013 and December 31, 2012, respectively

     455,473         460,630   

Class B Redeemable Common Shares, no par value—authorized, 100,000 shares; issued and outstanding, 7,801 and 7,770 shares at September 30, 2013 and December 31, 2012, respectively

     6,448,538         6,334,675   
  

 

 

    

 

 

 

Total redeemable preferred and common shares

     9,367,459         8,247,833   
  

 

 

    

 

 

 

SHAREHOLDERS’ EQUITY—Preferred Shares; no par value—authorized, 92,700 shares; issued, none

     
  

 

 

    

 

 

 

TOTAL LIABILITIES, REDEEMABLE SHARES AND SHAREHOLDERS’ EQUITY

   $ 62,379,184       $ 37,337,789   
  

 

 

    

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

1


Table of Contents

DCP HOLDING COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

 

     For the Three Months Ended      For the Nine Months Ended  
     September 30,      September 30,  
     2013     2012      2013     2012  

REVENUES

         

Premium revenue

   $ 22,613,692      $ 20,355,918       $ 64,878,290      $ 59,777,226   

Investment income

     42,947        34,232         115,881        97,916   

Realized gains on investments, net

       39,502           39,545   

Other income

     13,237        18,309         45,906        50,813   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total revenues

     22,669,876        20,447,961         65,040,077        59,965,500   
  

 

 

   

 

 

    

 

 

   

 

 

 

EXPENSES

         

Healthcare services expense

     18,238,159        16,091,750         51,933,947        48,252,095   
  

 

 

   

 

 

    

 

 

   

 

 

 

Insurance expense:

         

Salaries and benefits expense

     1,493,450        1,302,389         4,367,545        3,973,354   

Commission expenses and other acquisition costs

     1,062,492        952,644         2,950,084        2,847,863   

Other insurance expense

     1,688,256        1,113,629         4,879,451        3,613,075   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total insurance expense

     4,244,198        3,368,662         12,197,080        10,434,292   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total expenses

     22,482,357        19,460,412         64,131,027        58,686,387   
  

 

 

   

 

 

    

 

 

   

 

 

 

INCOME BEFORE INCOME TAX

     187,519        987,549         909,050        1,279,113   
  

 

 

   

 

 

    

 

 

   

 

 

 

INCOME TAX EXPENSE

     66,135        366,182         320,003        467,672   
  

 

 

   

 

 

    

 

 

   

 

 

 

NET INCOME ON REDEEMABLE SHARES

     121,384        621,367         589,047        811,441   
  

 

 

   

 

 

    

 

 

   

 

 

 

OTHER COMPREHENSIVE (LOSS) INCOME

         

Change in the fair value of interest rate swap, net of income tax of ($284), $947, $2,365, $2,870, respectively

     (553     1,840         4,583        5,572   

Change in the fair value of investments, net of income tax of ($4,754), $18,182, ($63,677), $57,438, respectively

     6,898        35,237         (125,840     111,498   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total other comprehensive (loss) income

     6,345        37,077         (121,257     117,070   
  

 

 

   

 

 

    

 

 

   

 

 

 

TOTAL COMPREHENSIVE INCOME

   $ 127,729      $ 658,444       $ 467,790      $ 928,511   
  

 

 

   

 

 

    

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

DCP HOLDING COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF REDEEMABLE SHARES AND SHAREHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012 (UNAUDITED)

 

 

     Redeemable Common Shares     Redeemable Preferred Shares     Shareholders’ Equity        
                             Institutional Preferred      Institutional Preferred      Institutional Preferred                    
     Class A     Class B     2010-Series      2012-Series      2013-Series           Other Accumulated        
     Number of           Number of           Number of             Number of             Number of            Retained     Comprehensive        
     Shares     Amount     Shares     Amount     Shares      Amount      Shares      Amount      Shares      Amount     Earnings     Income (Loss)     Total  

Balance at December 31, 2012

     565      $ 460,630        7,770      $ 6,334,675        300       $ 373,743         1,000       $ 1,078,785               

Net income

                            $ 589,047        $ 589,047   

Other comprehensive loss, net

                              $ (121,257     (121,257

Dividends declared

                              (361,539       (361,539

Redeemable Shares issued

         134        108,079                    1,000       $ 1,000,000         

Class A Common Shares exchanged for Class B Common Shares

     (7     (5,672     7        5,672                          

Redeemable Shares repurchased

     (7     (5,654     (110     (89,050                       

Accretion (dilution) of shares to redemption value

       6,169          89,162           2,852            8,232            (164     (227,508     121,257        (106,251
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2013

     551      $ 455,473        7,801      $ 6,448,538        300       $ 376,595         1,000       $ 1,087,017         1,000       $ 999,836      $        $        $     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 
     Redeemable Common Shares     Redeemable Preferred Shares     Shareholders’ Equity        
                             Institutional Preferred      Institutional Preferred      Institutional Preferred                    
     Class A     Class B     2010-Series      2012-Series      2013-Series           Other Accumulated        
     Number of           Number of           Number of             Number of             Number of            Retained     Comprehensive        
     Shares     Amount     Shares     Amount     Shares      Amount      Shares      Amount      Shares      Amount     Earnings     Income (Loss)     Total  

Balance at December 31, 2011

     596      $ 409,211        7,827      $ 5,378,383        300       $ 342,464                     

Net income

                            $ 811,441        $ 811,441   

Other comprehensive income, net

                              $ 117,070        117,070   

Dividends declared

                              (227,298       (227,298

Redeemable Shares issued

         32        22,575              1,000       $ 1,000,000               

Class A Common Shares exchanged for Class B Common Shares

     (14     (9,819     14        9,819                          

Redeemable Shares repurchased

     (7     (4,898     (139     (96,383                       

Accretion (dilution) of shares to redemption value

       44,720          593,229           19,237            44,027              (584,143     (117,070     (701,213
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

     575      $ 439,214        7,734      $ 5,907,623        300       $ 361,701         1,000       $ 1,044,027          $        $        $        $     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

3


Table of Contents

DCP HOLDING COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

     For the Nine Months Ended
September 30,
 
     2013     2012  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income on redeemable shares

   $ 589,047      $ 811,441   

Adjustments to reconcile net income to cash provided by operating activities:

    

Depreciation and amortization

     282,247        212,322   

Loss on disposal of property

     56,495     

Realized gain on investments, net

       (39,545

Deferred compensation

     372,130        214,613   

Effects of changes in operating assets and liabilities:

    

Accrued investment income

     (3,869     18,658   

Accounts receivable

     (339,457     (87,006

Unbilled accounts receivable

     (22,170,290     (5,303,361

Deferred acquisition costs

     (1,429,052     (286,090

Other assets

     (157,351     (17,009

Claims payable

     156,975        41,242   

Unearned premium revenue

     22,582,901        5,633,358   

Other payables and accruals

     862,751        (105,021
  

 

 

   

 

 

 

Net cash provided by operating activities

     802,527        1,093,602   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Purchases of investments

     (3,570,750     (883,734

Sales and maturities of investments

     1,084,496        1,066,833   

Investment, other

     (5,000     (40,000

Acquisition of property and equipment

     (441,418     (61,333
  

 

 

   

 

 

 

Net cash (provided by) used in investing activities

     (2,932,672     81,766   
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Mortgage loan repayments

     (34,200     (90,000

Payments on capital lease

     (101,104     (80,497

Repurchase of redeemable shares

     (74,501     (100,981

Redeemable shares issued

     1,096,959        1,022,575   

Dividends paid

     (361,539     (243,621
  

 

 

   

 

 

 

Net cash provided by financing activities

     525,615        507,476   
  

 

 

   

 

 

 

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

     (1,604,530     1,682,844   

CASH AND CASH EQUIVALENTS—Beginning of period

     8,530,758        6,976,358   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS—End of period

   $ 6,926,228      $ 8,659,202   
  

 

 

   

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION

    

Cash paid for interest

   $ 42,200      $ 34,400   

Cash paid for income taxes

     490,000        635,000   

NON-CASH INVESTING AND FINANCING ACTIVITIES:

    

Redeemed common shares (in other payables and accruals)

   $ 180,228      $ 71,609   

Class A redeemable common shares exchanged for Class B redeemable common shares

     5,672        9,819   

Capital lease obligation

     93,173     

Redeemable common shares issued in lieu of cash payment of deferred compensation

     11,120     

Purchased property and equipment (included in other payables and accruals)

     13,352     

See notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

DCP HOLDING COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF September 30, 2013 (UNAUDITED)

 

 

1. BASIS OF PRESENTATION

The condensed consolidated interim financial statements included in this report have been prepared by DCP Holding Company and Subsidiaries (the “Company”) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation are reflected in the interim financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the audited 2012 financial statements and notes thereto as included in the DCP Holding Company annual report on Form 10-K for the year ended December 31, 2012 filed with the Commission on March 20, 2013. These unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial statements. Certain financial information that is required in the annual financial statements may not be required for interim financial reporting purposes and has been condensed or omitted. Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The interim condensed consolidated financial statements have been prepared in accordance with the accounting policies described in the notes to the Company’s consolidated financial statements for the year ended December 31, 2012. While management believes that the procedures followed in preparation of interim financial information are reasonable, the accompanying condensed consolidated financial statements include estimates for items such as changes in claims payable, deferred tax accounts, deferred acquisition costs, deferred share-based compensation and accrued expenses, among others. Any adjustments related to such estimates during the reporting period were of a normal recurring nature.

Use of Estimates—The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Premium Revenue—

Fully-Insured—Membership contracts are written on an annual basis and are subject to cancellation by the employer group upon thirty days written notice. The Company’s unearned premium revenue was approximately $42,375,000 and $19,792,000 at September 30, 2013 and December 31, 2012, respectively, and primarily relates to the estimated premium revenue associated with the remaining contract periods. Related amounts recorded in unbilled accounts receivable were approximately $40,766,000 and $18,596,000 at September 30, 2013 and December 31, 2012, respectively. Premiums are due monthly in advance and are recognized evenly as revenue during the period in which the Company is obligated to provide services to members. Any amounts not received by the end of a reporting period are recorded as accounts receivable by the Company. Any premiums received prior to the beginning of a reporting period are recognized as premiums received in advance and are included in unearned premium revenue in the accompanying condensed consolidated balance sheets. Premiums received in advance were approximately $1,609,000 and $1,196,000 at September 30, 2013 and December 31, 2012, respectively. Management has determined that as of September 30, 2013 and December 31, 2012, respectively, no premium deficiency reserve is required. The Company’s premium deficiency reserve analysis includes an allocation of investment income.

 

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Table of Contents

Self-Insured—The Company provides administrative and claims processing services, benefit plan design, and access to its provider networks for an administrative fee to self-insured groups. The Company has no underwriting risk arising from the provision or cost of any services provided to the self-insured groups. The Company recognizes and records self-insured premiums on a gross basis because: (i) the Company is the primary obligor in its contractual relationships with self-insured employers and dental service providers, (ii) the Company establishes the pricing for the services provided, (iii) the Company controls the selection of and the relationships with the dental service providers, and (iv) the Company is involved in the determination of dental service specifications. Self-insured premium revenue is recognized upon the payment of claims for self-insured members in accordance with agreements with self-insured employers and is included in premium revenue in the accompanying condensed consolidated statements of comprehensive income.

Third-party administration fee revenue (“ASO fees”) is recognized monthly when earned and is normally based on annual contracts with the self-insured groups. ASO fees are charged to self-insured employer groups monthly on a per subscriber per month basis. ASO fees also include the administrative fees the Company earns relative to the dental PPO, dental indemnity and vision products that are underwritten by third-party insurance carriers.

Healthcare Services Expense— Healthcare services expense is recognized on a monthly basis. In the case of the fully-insured dental HMO and indemnity (“dental HMO/IND”) and dental PPO segments, 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 actuarial estimates. For the self-insured dental segment, the healthcare services expense is based solely on the paid claims for the self-insured membership. In most cases, reimbursement to the Company’s participating providers for covered dental services under the dental HMO and in-network PPO are subject to a 10% withhold. The amounts withheld are not retained in a separate fund, and the Company has no obligation to pay any portion of the amounts withheld to the providers. At the end of each year, the Board of Directors determines, in its sole discretion, how much, if any, of the provider withhold is to be paid out to participating providers. Provider withhold payments authorized by the Board during the fiscal year are recorded as an increase to healthcare services expense.

Investments—The Company invests in certificates of deposit, investment grade corporate bonds and money market funds. The Company classifies all investments as available-for-sale. The Company engages a fixed income portfolio manager to manage the Company’s investment grade corporate bonds, under the Company’s direction, in order to maximize investment returns. Such investments are recorded at fair value, with unrealized gains and losses recorded as a component of other comprehensive income. The Company recognizes gains and losses when these securities have other than temporary impairment, 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 record an other-than-temporary impairment for a security incorporates both quantitative criteria and qualitative information. The Company considers the severity of the loss on a security, duration of loss, duration of the investment, credit rating of the security, as well as payment performance and the Company’s intent or requirement to sell the investment before recovery when determining whether any impairment is other than temporary. The Company’s impairment policy for fixed-maturity securities states that other-than-temporary impairment is considered to have occurred if (1) the Company intends to sell the impaired fixed maturity security; (2) it is more likely than not that 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 $280,000 at September 30, 2013 and December 31, 2012. These funds are restricted and not available to the Company for normal operations and are included in other assets in the accompanying condensed consolidated balance sheets.

Deferred Acquisition Costs—Deferred acquisition costs are those incremental direct costs related to the successful acquisition of new and renewal business. These incremental direct costs are those that are essential to the contract transaction and would not have been incurred had the contract transaction not occurred. Such incremental direct costs include commissions, costs of contract issuance and underwriting, premium taxes and other costs the Company incurs to successfully acquire new business or renew existing business. The Company defers policy acquisition costs and amortizes them over the estimated life of the contracts, which are short-duration in nature, in proportion to premiums earned. The Company capitalized deferred acquisition costs of approximately $744,000 and $853,000 and amortized approximately $969,000 and $883,000 of these capitalized costs for the three months ended September 30, 2013 and 2012, respectively. The Company capitalized deferred acquisition costs of approximately $4,307,000 and $2,977,000 and amortized approximately $2,878,000 and $2,691,000 of these capitalized costs for the nine months ended September 30, 2013 and 2012, respectively. The amortization of these costs are recorded in commission expense and other acquisition costs included in the condensed consolidated statements of comprehensive income.

 

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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 $5,000 and $35,000 for the three months ended September 30, 2013 and 2012, respectively. Dental insurance premium assumed was approximately $35,000 and $162,000 for the nine months ended September 30, 2013 and 2012, respectively. The healthcare services expense assumed was approximately $10,000 and $41,000 for the three months ended September 30, 2013 and 2012, respectively. The healthcare services expense assumed was approximately $25,000 and $154,000 for the nine months ended September 30, 2013 and 2012, respectively. The Company had approximately $14,000 of reinsurance premium receivable at September 30, 2013 and December 31, 2012 and approximately $3,000 and $9,000 of reinsurance claims payable at September 30, 2013 and December 31, 2012, respectively.

New Accounting Standards— In February 2013, the FASB issued new guidance regarding comprehensive income for amounts reclassified out of other comprehensive income (loss) effective prospectively for fiscal years beginning after December 15, 2012. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income (“AOCI”) by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. There were no material reclassifications out of AOCI for the three and nine months ended September 30, 2013. The Company had net realized gains of approximately $40,000 with a tax expense of approximately $14,000 that were reclassified out of AOCI to earnings for the three and nine months ended September 30, 2012.

 

3. INVESTMENTS

The Company owned certificates of deposit insured by the Federal Deposit Insurance Corporation (“FDIC”) with an amortized cost of $1,250,000 and $1,200,000 as of September 30, 2013 and December 31, 2012, 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. The Company also invests in money market funds included in short-term investments and are classified as available-for-sale, with a cost and fair value of approximately $55,000 and $93,000 as of September 30, 2013 and December 31, 2012, respectively. The Company invests in investment grade corporate bonds with an amortized cost of approximately $5,343,000 and $2,871,000 as of September 30, 2013 and December 31, 2012, respectively. The investment grade corporate bonds included in fixed maturities investments are classified as available-for-sale and are carried at fair value.

At September 30, 2013, the Company has ninety-nine investment grade corporate bonds, which consist of eighty-one different securities each with a credit rating of A- or better and eighteen securities that had a credit rating of between BBB+ and BBB-. The weighted average yield-to-cost of the Company’s investment grade corporate bonds was approximately 3.06% at September 30, 2013. The weighted average maturity of the Company’s investment grade corporate bonds was 6.04 years at September 30, 2013. The unrealized gains and losses on available-for-sale investment activity are due to a change in fair value for these investments caused primarily by changes in prevailing interest rates since they were purchased. There were no material realized gains or losses for the three and nine months ended September 30, 2013. There were approximately $40,000 of realized gains for the three and nine months ended September 30, 2012.

 

 

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At September 30, 2013 and December 31, 2012, maturity dates for fixed maturities and short-term investments (excluding the money market funds) were:

 

     Available-for-Sale  
September 30, 2013    Amortized
Cost
     Fair Value      % of
Total Value
 

Maturity dates occurring:

        

Less than 1 year (Two certificates of deposit)

   $ 200,000       $ 201,902         3.0

Greater than 1 year (Six certificates of deposit and ninety-nine corporate bonds)

     6,393,305         6,449,862         97.0
  

 

 

    

 

 

    

 

 

 

Total

   $ 6,593,305       $ 6,651,764         100.0
  

 

 

    

 

 

    

 

 

 
     Available-for-Sale  
December 31, 2012    Amortized
Cost
     Fair Value      % of
Total Value
 

Maturity dates occurring:

        

Less than 1 year (Two certificates of deposit)

   $ 300,000       $ 300,986         7.0

Greater than 1 year (Six certificates of deposit and forty-four corporate bonds)

     3,771,437         4,022,368         93.0
  

 

 

    

 

 

    

 

 

 

Total

   $ 4,071,437       $ 4,323,354         100.0
  

 

 

    

 

 

    

 

 

 

Investments classified at September 30, 2013 and December 31, 2012 as fixed maturities and short-term investments were as follows:

 

     Available-for-Sale  
September 30, 2013    Amortized
Cost
     Gross
Unrealized
Gain
     Gross
Unrealized
Loss
    Fair Value  

Money market fund

   $ 54,694            $ 54,694   

Certificates of deposit, short term

     200,000       $ 1,902           201,902   

Certificates of deposit, fixed maturities

     1,050,000         9,711       $ (2,702     1,057,009   

Corporate bonds, fixed maturities

     5,343,305         104,416         (54,868     5,392,853   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments

   $ 6,647,999       $ 116,029       $ (57,570   $ 6,706,458   
  

 

 

    

 

 

    

 

 

   

 

 

 
     Available-for-Sale  
December 31, 2012    Amortized
Cost
     Gross
Unrealized
Gain
     Gross
Unrealized
Loss
    Fair Value  

Money market fund

   $ 93,356            $ 93,356   

Certificates of deposit, short term

     300,000       $ 986           300,986   

Certificates of deposit, fixed maturities

     900,000         13,987           913,987   

Corporate bonds, fixed maturities

     2,871,437         238,351       $ (1,407     3,108,381   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments

   $ 4,164,793       $ 253,324       $ (1,407   $ 4,416,710   
  

 

 

    

 

 

    

 

 

   

 

 

 

Unrealized losses on investments at September 30, 2013 and December 31, 2012 were generally due to higher current market yields relative to the yields of the investments at their amortized cost. Unrealized losses due to credit risk associated with the underlying collateral of the investments, if any, are not material. All investments with unrealized losses are reviewed quarterly to determine if any impairment is other than temporary, requiring a charge to earnings. The Company considers the severity of the loss on a security, duration of loss, duration of the investment, credit rating of the security, as well as payment performance and the Company’s intent or requirement to sell the investment before recovery when determining whether any impairment is other than temporary. The Company had no other than temporary impairment charges for the three and nine months ended September 30, 2013 and 2012. The Company had no investments in a continuous unrealized loss position for greater than one year as of September 30, 2013 or December 31, 2012.

 

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4. DEFERRED COMPENSATION PLAN

Share-based compensation cost is measured at the grant date based on the fair value of the liability awards and is recognized as expense ratably over the vesting periods and is included in other insurance expense in the condensed consolidated statements of comprehensive income. The fair value of the liability awards is remeasured at the end of each reporting period through the remaining vesting period with the change in fair value recognized in earnings currently.

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 $13,000 and $20,000 related to deferred director fees and deferred employee compensation for the three months ended September 30, 2013 and 2012, respectively. The Company recorded expense of approximately $51,000 and $67,000 related to deferred director fees and deferred employee compensation for the nine months ended September 30, 2013 and 2012, 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. A director will receive Class B Redeemable Common Shares upon vesting. A key employee may elect to defer receiving such amounts until termination of employment and vesting requirements are met. If a 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. In 2012, the Company established a long-term incentive compensation program for named executive officers pursuant to which an officer may receive an award of up to 45% of such officer’s base salary in the form of share awards which will vest if established Company performance criteria are achieved over a three year period.

The deferred compensation expense related to these awards is recorded ratably during the applicable vesting period. The Company recorded deferred compensation expense of approximately $74,000 and $50,000 related to deferred share awards and the change in the value of phantom shares for the three months ended September 30, 2013 and 2012, respectively. The Company recorded deferred compensation expense of approximately $359,000 and $152,000 related to deferred share awards and the change in the value of phantom shares for the nine months ended September 30, 2013 and 2012, respectively. As of September 30, 2013, there is approximately $493,000 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 2.2 years.

In February 2013 and March 2012, the Board declared a per share cash dividend for all Class A and Class B redeemable common shares in the amounts of $32.60 and $21.00, respectively. With the dividend, the holders of restricted share units and phantom shares received an equivalent share based dividend that resulted in an increase in the deferred compensation liability of approximately $52,000 and $28,000 in February 2013 and March 2012, respectively.

The expected fair value of the awards is calculated by applying the three year historical average trend 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 nine months ended September 30, 2013 and 2012 were $957 and $741, respectively. At September 30, 2013 and December 31, 2012, the deferred compensation liability was approximately $1,974,000 and $1,613,000, respectively.

 

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The following is a summary of activity of non-vested awards for the nine months ended September 30, 2013 and 2012:

 

     Individual
Director’s
Share Awards
    Weighted
Average Grant
Date Fair
Value
     Key Employee
Share Awards
    Weighted
Average Grant
Date Fair
Value
 

Non-vested awards at January 1, 2013

          535.8      $ 746   

Granted

     252.0      $ 885         203.0        1,046   

Converted to Shares

     (14.0     885        

Forfeited

          (21.0     871   
  

 

 

      

 

 

   

Non-vested awards at September 30, 2013

     238.0      $ 885         717.8      $ 827   
  

 

 

      

 

 

   
     Individual
Director’s
Share Awards
    Weighted
Average Grant
Date Fair
Value
     Key Employee
Share Awards
    Weighted
Average Grant
Date Fair
Value
 

Non-vested awards at January 1, 2012

          148.4      $ 788   

Granted

     165.0      $ 723         220.0        753   

Forfeited

     (13.0     723        
  

 

 

      

 

 

   

Non-vested awards at September 30, 2012

     152.0      $ 723         368.4      $ 767   
  

 

 

      

 

 

   

The following is a summary of activity of vested awards for the nine months ended September 30, 2013 and 2012:

 

     Individual
Director’s
Awards
    Weighted
Average Vested
price
     Key Employee
Awards
     Weighted
Average Vested
price
 

Vested awards at January 1, 2013

     876.0      $ 815         339.7       $ 840   

Share based dividend

     34.5        828         13.4         828   

Vested during the year

     14.0        794         

Redeemed vested awards

     (103.8     794         

Converted to Redeemable Common Shares

     (14.0     794         
  

 

 

      

 

 

    

Vested awards at September 30, 2013

     806.7      $ 787         353.1       $ 816   
  

 

 

      

 

 

    
     Individual
Director’s
Awards
    Weighted
Average Vested
price
     Key Employee
Awards
     Weighted
Average Vested
price
 

Vested awards at January 1, 2012

     908.0      $ 702         256.6       $ 710   

Share based dividend

     26.7        715         7.5         715   

Vested during the year

          

Redeemed vested awards

     (58.7     682         
  

 

 

      

 

 

    

Vested awards at September 30, 2012

     876.0      $ 692         264.1       $ 703   
  

 

 

      

 

 

    

 

5. SEGMENT INFORMATION

The Company manages its business with four segments: fully-insured dental HMO/IND, fully-insured dental PPO, self-insured dental and corporate, all other. Self-insured dental consists of the self-insured dental HMO, self-insured dental PPO and self-insured dental indemnity products. Corporate, all other 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.

 

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The results of the fully-insured dental HMO/IND, fully-insured dental PPO and self-insured dental segments are measured by gross profit. The Company does not allocate insurance expense, investment and other income, assets or liabilities to these segments because the Company does not use these measures to analyze the 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, which is defined as premium revenue less healthcare services expense, was approximately $4,376,000 and $4,265,000 for the three months ended September 30, 2013 and 2012, respectively. The Company’s gross profit was approximately $12,944,000 and $11,525,000 for the nine months ended September 30, 2013 and 2012, respectively.

Listed below is financial information required for each reportable segment for the three and nine months ended September 30, 2013 and 2012 (amounts in thousands):

 

     Three Months Ended      Three Months Ended  
     September 30, 2013      September 30, 2012  
     Revenues-      Healthcare             Revenues-      Healthcare         
     External      Services             External      Services         
     Customers      Expense      Total      Customers      Expense      Total  

Reportable segments:

                 

Fully-insured dental HMO/IND

   $ 11,685       $ 9,128       $ 2,557       $ 10,952       $ 8,204       $ 2,748   

Fully-insured dental PPO

     3,413         2,735         678         2,862         2,350         512   

Self-insured dental

     7,367         6,375         992         6,426         5,537         889   

Corporate, all other

     149            149         116            116   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 22,614       $ 18,238         4,376       $ 20,356       $ 16,091         4,265   
  

 

 

    

 

 

       

 

 

    

 

 

    

Investment income

           43               34   

Realized gains on investments, net

                    40   

Other income

           13               18   

Insurance expense

           4,244               3,369   
        

 

 

          

 

 

 

Income (loss) before income tax

         $ 188             $ 988   
        

 

 

          

 

 

 

Total assets-corporate

         $ 62,379            
        

 

 

          
     Nine Months Ended      Nine Months Ended  
     September 30, 2013      September 30, 2012  
     Revenues-      Healthcare             Revenues-      Healthcare         
     External      Services             External      Services         
     Customers      Expense      Total      Customers      Expense      Total  

Reportable segments:

                 

Fully-insured dental HMO/IND

   $ 34,941       $ 26,943       $ 7,998       $ 32,793       $ 25,485       $ 7,308   

Fully-insured dental PPO

     9,932         8,148         1,784         8,420         7,113         1,307   

Self-insured dental

     19,575         16,843         2,732         18,197         15,654         2,543   

Corporate, all other

     430            430         367            367   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 64,878       $ 51,934         12,944       $ 59,777       $ 48,252         11,525   
  

 

 

    

 

 

       

 

 

    

 

 

    

Investment income

           116               98   

Realized gains on investments, net

                    40   

Other income

           46               51   

Insurance expense

           12,197               10,435   
        

 

 

          

 

 

 

Income before income tax

         $ 909             $ 1,279   
        

 

 

          

 

 

 

Total assets-corporate

         $ 62,379            
        

 

 

          

Inter-segment revenues were not significant for the three and nine months ended September 30, 2013 and 2012.

 

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6. FEDERAL INCOME TAXES

The Company calculates its year to date income tax provision by applying the estimated annual effective tax rate for the year to pretax income. The income tax expense for the three months ended September 30, 2013 was approximately $66,000 with an effective tax rate of 35.3%. The income tax expense for the three months ended September 30, 2012 was approximately $366,000 with an effective tax rate of 37.1%. The income tax expense for the nine months ended September 30, 2013 was approximately $320,000 with an effective tax rate of 35.2%. The income tax expense for the nine months ended September 30, 2012 was approximately $468,000 with an effective tax rate of 36.6%. Tax years subsequent to 2009 remain open to examination by the Internal Revenue Service (“IRS”), and 2008 remains open to state and local tax authorities. The Company has recorded no uncertain tax positions in the tax years that are subject to examination.

 

7. DEBT

In December 2012, the Company refinanced the mortgage of its office building and in connection therewith, the Company executed a mortgage note with a bank, secured by the land and the office building, in the amount of $1,340,000. Interest is payable based on the 30-day LIBOR rate plus 1.95% and was 2.13% and 2.02% at September 30, 2013 and December 31, 2012, respectively. As a result of the mortgage note having a variable interest rate that adjusts monthly with the 30-day LIBOR rate, the carrying value of the mortgage note approximates fair value. The Company also entered into an interest rate swap agreement that effectively changed the interest rate related to the mortgage note with a commercial bank from a variable rate based on the 30-day LIBOR rate plus 1.95% to a fixed rate of 3.90% for the 10-year period through December 22, 2022. The mortgage note fair value disclosure is classified as Level 2 in the fair-value hierarchy.

The Company has an annually renewable agreement with a commercial bank for a $500,000 working capital line of credit. Interest is payable at a variable rate of LIBOR plus 2.50%. The Company did not have any interest expense or significant fees for the line of credit for the three or nine months ended September 30, 2013 and 2012. As of September 30, 2013 and December 31, 2012, there was no amount outstanding on this line of credit. The $500,000 working capital line of credit expires in July 2014.

The Company has an additional annually renewable working capital line of credit for $1,000,000. Interest is payable at a variable rate of LIBOR plus 2.50%. The Company did not have any interest expense for the line of credit in the three or nine months ended September 30, 2013 and 2012. At September 30, 2013 and December 31, 2012, there was no amount outstanding on this line of credit. The $1,000,000 working capital line of credit expires in August 2014. In addition, the Company obtained an irrevocable letter of credit for $40,000, with interest payable on all outstanding amounts at a variable rate of the prime rate of borrowing plus 6.00%. The letter of credit also has an annual fixed rate of 2.10% for access to the letter of credit obligation. The letter of credit expires in December 2013. At September 30, 2013 and December 31, 2012, there was no amount outstanding on the irrevocable letter of credit obligation.

 

8. FAIR VALUE MEASUREMENTS

The Company classifies the assets and liabilities that require measurement of fair value on a recurring basis based on the priority of the observable and market-based sources of data into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are as follows:

 

   

Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.

 

   

Level 2 – Valuations based on significant other observable inputs other than those included in Level 1 such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.

 

   

Level 3 – Valuations based on unobservable inputs such as when observable inputs are not available or inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

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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 September 30, 2013 and December 31, 2012 (amounts in thousands):

 

     September 30, 2013      December 31, 2012  
     Level 1      Level 2      Total
Balance
     Level 1      Level 2      Total
Balance
 

Assets

                 

Fixed maturities

                 

Federally-Insured certificates of deposit

      $ 1,057       $ 1,057          $ 914       $ 914   

Investment grade corporate bonds

        5,393         5,393            3,108         3,108   

Short-term investments

                 

Money market fund

   $ 55            55       $ 93            93   

Federally-Insured certificates of deposit

        202         202            301         301   

Deferred compensation investments (a)

                 

Equity mutual fund investments

     380            380         313            313   

State guarantee fund deposits (b)

                 

Government securities

     230            230         230            230   

Federally-Insured certificates of deposit

        50         50            50         50   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 665       $ 6,702       $ 7,367       $ 636       $ 4,373       $ 5,009   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

                 

Interest rate swap (c)

      $ 34       $ 34          $ 41       $ 41   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $         $ 34       $ 34       $         $ 41       $ 41   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(a) Included as a trading security in other assets
(b) Included in other assets
(c) Included in other payables and accruals

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 deposits; such items are classified as Level 1 of the fair-value hierarchy. Examples include government securities and mutual fund equity securities. The Company primarily bases fair value for investments in fixed-maturity securities (including federally-insured certificates of deposits and investment grade corporate bonds) on quoted market prices or on prices from a pricing vendor, an outside resource that supplies independent securities pricing, dividend, corporate action and descriptive information to support fund pricing, securities operations, research and portfolio management. The Company obtains and reviews the pricing service’s valuation methodologies and validates these prices using various inputs including quotes from other independent regulatory sources. When deemed necessary, the Company validates prices by replicating a sample using a discounted cash flow model. Such items are classified as Level 2 of the fair-value hierarchy. 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.

As of September 30, 2013 and December 31, 2012, there were no assets or liabilities that were required to be measured at fair value on a non-recurring basis. As of September 30, 2013 and December 31, 2012, the Company did not have any assets or liabilities classified as Level 3 of the fair value hierarchy.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking statements

Portions of this report, including this discussion and the information contained in the notes to the condensed consolidated financial statements, contain forward-looking statements under the Private Securities Litigation Reform Act of 1995. You can identify forward-looking statements by words such as “may,” “might,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “intend,” “potential,” “likely will result,” or the negative of such terms or similar expressions. These forward-looking statements reflect our current expectations and views about future events and speak only as of the date of this report. The forward-looking statements are subject to risks, uncertainties and other factors that could cause actual events or results to differ materially from those expressed or implied by the forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements, include, among others: claims costs exceeding our estimates, a downgrade in our financial strength rating, competitive pressures, changes in demand for dental benefits and other economic conditions, the loss of a significant customer or broker, the occurrence or non-occurrence of circumstances beyond our control and those items described in Item 1A – Risk Factors of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012. We do not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date this report is filed.

Overview

Headquartered in Cincinnati, Ohio, we offer dental HMO, dental indemnity, dental PPO and vision PPO benefit plans and related services, primarily to employer groups of two or more employees. As of September 30, 2013, we had approximately 315,700 members in our dental and vision benefit programs with approximately 2,700 dentists participating in our dental HMO network and approximately 3,000 dentists participating in our dental PPO network. The Company has a network leasing agreement with a national dental network management company that has one of the largest PPO networks of dentists under contract in the United States. With this network leasing agreement, Dental Care Plus dental PPO members have access to approximately 2,300 additional dentists in Ohio, Kentucky and Indiana and approximately 39,900 additional dentists throughout the United States.

We manage our business with four reportable segments: fully-insured dental HMO and indemnity (“dental HMO/IND”), fully-insured dental PPO, self-insured dental, and corporate, all other. Self-insured dental consists of the self-insured dental HMO, self-insured dental PPO and self-insured dental indemnity products. Corporate, all other primarily consists of revenue associated with our dental and vision products underwritten by third-party insurance carriers and certain other corporate activities. Our dental HMO/IND and PPO products and our vision product line are primarily marketed to employer groups. The results of our fully-insured dental HMO/IND, fully-insured dental PPO and self-insured dental segments are measured by gross profit. We do not measure the gross profit of our corporate, all other segment. We do not allocate investment and other income, insurance expenses, assets or liabilities to our segments because these measures are not used to analyze the segments. Our segments do not share overhead costs or assets. We do, however, measure the contributions of each of our fully-insured and self-insured segments to costs retained in our corporate, all other segment.

Many factors have an effect on our results, but most notably our results are influenced by our ability to establish and maintain a competitive and efficient cost structure and to accurately and consistently establish competitive premiums, ASO fees, and plan benefit levels that are commensurate with our dental and administrative costs. Dental costs are subject to a high rate of inflation due to many factors, including new higher priced technologies and dental procedures, new dental service techniques and therapies, an aging population, lifestyle choices, the tort system and government regulations.

Strategy

Our strategy focuses on providing solutions to employers to the rising cost of dental care by leveraging our growing networks of participating dentists and deploying a variety of products that give employer groups and members more choices. We strive to provide excellent customer service to our employers, members and participating dentists. Additionally, we have increased the diversification of our membership base, not only through our newer products, but also by entering new geographic territories.

 

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In our original eight county service area, our non-exclusive dental HMO provider network includes over 95% of the dental providers in the market. In that market, our dental HMO provides the broad provider access of a dental PPO along with effective utilization and cost control features.

Highlights

 

   

We had net income of approximately $589,000 for the nine months ended September 30, 2013 (the “2013 period”) compared to net income of approximately $811,000 for the nine months ended September 30, 2012 (the “2012 period”). The decrease of net income was primarily the result of an increase in insurance expense of $1,762,000 in the 2013 period compared to the 2012 period. This decrease in net income was offset by an increase in gross profit (total premium revenue less healthcare services expense) of approximately $1,419,000 in the 2013 period compared to the 2012 period that was primarily the result of higher fully insured membership and higher premium rates in the 2013 period.

 

   

To date in 2013, our dental and vision product membership increased by approximately 15,900 members to approximately 315,700 members at September 30, 2013. This membership increase from December 31, 2012 is due to an increase in fully-insured dental HMO/IND membership of approximately 3,600 members, an increase in fully-insured dental PPO membership of approximately 5,100 members, an increase in self-insured membership of approximately 4,000 members, and an increase in corporate, all other membership of approximately 3,200 members. The increase in corporate, all other membership is primarily due to an increase in our vision PPO membership.

 

   

Our ratio of healthcare services expense to premium revenue (“loss ratio”) decreased from 80.7% in the nine months ended September 30, 2012 to 80.0% in the nine months ended September 30, 2013. This loss ratio decrease is due primarily to premium rate increases negotiated with fully-insured dental HMO/IND and dental PPO employer groups at renewal.

 

   

In January 2013, we sold 1,000 Redeemable Institutional Preferred Shares at a purchase price of $1,000 per share, for an aggregate purchase price of $1,000,000.

 

   

In March 2013, we paid a dividend of $32.60 per share to all holders of Redeemable Class A and Class B Common Shares. We paid a dividend of $21.00 per share to all holders of Redeemable Class A and Class B Common Shares in March 2012.

Comparison of Results of Operations

The following is a discussion of our results of operations for the quarter ended September 30, 2013 (the “2013 quarter”, the quarter ended September 30, 2012 (the “2012 quarter”), the 2013 period and the 2012 period.

The table below presents membership and financial data for our four reportable segments (dollar amounts in thousands):

 

     As of      As of         
     September 30, 2013      September 30, 2012      Change  

Membership:

        

Fully-insured dental HMO/IND

     152,200         148,300         2.6

Fully-insured dental PPO

     48,500         41,400         17.1

Self-insured dental

     88,300         84,400         4.6

Corporate, all other

     26,700         22,400         19.2
  

 

 

    

 

 

    

Total membership

     315,700         296,500         6.5
  

 

 

    

 

 

    

 

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     Three months ended      Three months ended         
     September 30, 2013      September 30, 2012      Change  

Premium revenue:

        

Fully-insured dental HMO/IND

   $ 11,685       $ 10,952         6.7

Fully-insured dental PPO

     3,413         2,862         19.3

Self-insured dental

     7,367         6,426         14.6

Corporate, all other

     149         116         28.4
  

 

 

    

 

 

    

Total premium revenue

     22,614         20,356         11.1
  

 

 

    

 

 

    

Investment income

     43         34         26.5
  

 

 

    

 

 

    

Realized gains on investments, net

        40         *   
  

 

 

    

 

 

    

Other income

     13         18         (27.8 %) 
  

 

 

    

 

 

    

Total revenue

     22,670         20,448         10.9
  

 

 

    

 

 

    

Healthcare services expense:

        

Fully-insured dental HMO/IND

     9,128         8,204         11.3

Fully-insured dental PPO

     2,735         2,350         16.4

Self-insured dental

     6,375         5,537         15.1

Corporate, all other

           *   
  

 

 

    

 

 

    

Total healthcare service expense

     18,238         16,091         13.3
  

 

 

    

 

 

    

Insurance expense

     4,244         3,369         26.0
  

 

 

    

 

 

    

Income tax expense

     67         367         *   
  

 

 

    

 

 

    

Net Income

   $ 121       $ 621         (80.5 %) 
  

 

 

    

 

 

    

 

* not meaningful

 

     Nine months ended      Nine months ended         
     September 30, 2013      September 30, 2012      Change  

Premium revenue:

        

Fully-insured dental HMO/IND

   $ 34,941       $ 32,793         6.6

Fully-insured dental PPO

     9,932         8,420         18.0

Self-insured dental

     19,575         18,197         7.6

Corporate, all other

     430         367         17.2
  

 

 

    

 

 

    

Total premium revenue

     64,878         59,777         8.5
  

 

 

    

 

 

    

Investment income

     116         98         18.4
  

 

 

    

 

 

    

Realized gains on investments, net

        40         *   
  

 

 

    

 

 

    

Other income

     46         51         (9.8 %) 
  

 

 

    

 

 

    

Total revenue

     65,040         59,966         8.5
  

 

 

    

 

 

    

Healthcare services expense:

        

Fully-insured dental HMO/IND

     26,943         25,485         5.7

Fully-insured dental PPO

     8,148         7,113         14.6

Self-insured dental

     16,843         15,654         7.6

Corporate, all other

           *   
  

 

 

    

 

 

    

Total healthcare service expense

     51,934         48,252         7.6
  

 

 

    

 

 

    

Insurance expense

     12,197         10,435         16.9
  

 

 

    

 

 

    

Income tax expense

     320         468         (31.6 %) 
  

 

 

    

 

 

    

Net Income

   $ 589       $ 811         (27.4 %) 
  

 

 

    

 

 

    

 

* not meaningful

 

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Summary

Fully-insured dental HMO/IND premium revenue increased by $2,148,000 in the 2013 period compared to the 2012 period, and fully-insured dental HMO/IND premium on a per member per month (“PMPM”) basis increased by 3.3%, from $24.64 PMPM in the 2012 period to $25.44 PMPM in the 2013 period due to rate increases obtained on renewal business. Fully-insured dental PPO premium revenue increased by $1,512,000 in the 2013 period compared to the 2012 period, and fully-insured dental PPO premium on a PMPM basis increased by 4.1%, from $22.75 PMPM in the 2012 period to $23.68 PMPM in the 2013 period due to rate increases obtained on renewal business.

Fully-insured dental HMO/IND healthcare services expense increased by $1,458,000 in the 2013 period compared to the 2012 period, and fully-insured dental HMO/IND healthcare services expense on a PMPM basis increased by 2.5% from $19.15 PMPM in the 2012 period to $19.62 in the 2013 period. An increase in fully-insured dental HMO/IND membership resulted in an increase in fully-insured dental HMO/IND healthcare services expense of $813,000. An increase in fully-insured dental HMO/IND healthcare services expense on a PMPM basis resulted in an increase in fully-insured dental HMO/IND healthcare services expense of approximately $645,000. This increase is primarily the result of higher healthcare services utilization in the 2013 period compared to the 2012 period of approximately $250,000 and an increase attributable to a 1.5% dental HMO fee schedule increase of $395,000 that was effective January 1, 2013.

Fully-insured dental PPO healthcare services expense increased by $1,035,000 in the 2013 period compared to the 2012 period, and fully-insured dental PPO healthcare services expense on a PMPM basis increased by 1.1%, from $19.22 PMPM in the 2012 period to $19.43 PMPM in the 2013 period. The higher level of dental PPO healthcare services expense on a PMPM basis due to utilization resulted in an increase in healthcare services expense of $87,000. In addition, an increase in dental PPO healthcare services expense of $948,000 was due to an increase in membership volume in the 2013 period compared to the 2012 period.

Self-insured healthcare services expense increased by $1,189,000 in the 2013 period compared to the 2012 period, and self-insured healthcare services expense on a PMPM based increased by 2.7% from $20.65 PMPM in the 2012 period to $21.21 PMPM in the 2013 period. The higher level of self-insured healthcare services expense on a PMPM basis resulted in an increase in healthcare services expense of $448,000. In addition, an increase in dental PPO healthcare services expense of $741,000 was due to an increase in membership volume in the 2013 period compared to the 2012 period.

Insurance expense increased by $1,762,000 in the 2013 period compared to the 2012 period. This insurance expense increase is primarily attributable to higher professional consulting fees, broker commission expense, and deferred compensation expense in the 2013 period compared to the 2012 period. Higher professional consulting fees are a result of new product development and operational process improvement projects. Insurance expense as a percentage of total revenue, or the insurance expense ratio, was 18.8% for the 2013 period compared to 17.4% for the 2012 period.

Membership

Our fully-insured dental HMO/IND membership increased by approximately 3,900 members as of September 30, 2013 from September 30, 2012. This membership increase is primarily attributable to an increase of approximately 4,000 fully-insured dental HMO members offset by a decrease of approximately 100 fully-insured dental indemnity members. The increase in fully-insured dental HMO/IND membership is primarily the result of new sales of approximately 14,700 members, offset by the loss of approximately 10,700 members due to employer groups that did not renew with the Company or reduced employee counts of retained employer groups. A portion of the fully-insured dental HMO membership losses were the result of corporate acquisitions where our employer group customers moved to the new parent company benefit plans and some of our membership losses were the result of employer groups moving to medical carriers to take advantage of medical/dental package savings.

Our fully insured dental PPO membership increased by approximately 7,100 members as of September 30, 2013 from September 30, 2012. The increase in fully-insured dental PPO membership is primarily the result of new sales of approximately 11,500 members, offset by the loss of approximately 4,400 members due to employer groups that did not renew with the Company or reduced employee counts of retained employer groups.

Our self-insured dental membership increased by approximately 3,900 members as of September 30, 2013 from September 30, 2012. This increase is primarily due to the addition of new self-insured dental HMO and dental PPO employer groups in the last twelve months and growth within existing employer groups.

 

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Our corporate, all other membership increased by approximately 4,300 members as of September 30, 2013 from September 30, 2012. Our vision plan membership increased by approximately 4,600 members, and there was a decrease of approximately 300 dental indemnity members underwritten by a third party insurance carrier that shifted into the fully-insured HMO/IND segment at renewal.

Revenue

Fully-insured dental HMO/IND premium revenue for the 2013 quarter increased by approximately $733,000 compared to the 2012 quarter. Fully-insured dental HMO/IND premium rate increases negotiated with employer groups at their renewals resulted in an increase of approximately $365,000 in fully-insured dental HMO/IND premium revenue. An increase in fully-insured HMO/IND membership in the 2013 quarter resulted in an increase in fully-insured dental HMO/IND premiums of approximately $368,000.

Fully-insured dental HMO/IND premium revenue for the 2013 period increased by approximately $2,148,000 compared to the 2012 period. Fully-insured dental HMO/IND premium rate increases negotiated with employer groups at their renewals resulted in an increase of approximately $1,101,000 in fully-insured dental HMO/IND premium revenue. An increase in fully-insured HMO/IND membership in the 2013 period resulted in an increase in fully-insured dental HMO/IND premiums of approximately $1,047,000. The fully-insured dental HMO/IND segment represents approximately 53.9% of our total dental business.

Fully-insured dental PPO premium revenue for the 2013 quarter increased by approximately $551,000 compared to the 2012 quarter. Fully-insured dental PPO premium rate increases negotiated with employer groups at their renewals resulted in an increase of approximately $40,000 in fully-insured dental PPO premium revenue. An increase in fully-insured PPO membership in the 2013 quarter resulted in an increase in fully-insured dental PPO premiums of approximately $511,000.

Fully-insured dental PPO premium revenue for the 2013 period increased by approximately $1,512,000 compared to the 2012 period. Fully-insured dental PPO premium rate increases negotiated with employer groups at their renewals resulted in an increase of approximately $390,000 in fully-insured dental PPO premium revenue. An increase in fully-insured PPO membership in the 2013 period resulted in an increase in fully-insured dental PPO premiums of approximately $1,122,000. The fully-insured dental PPO segment represents approximately 15.3% of our total dental business.

Total self-insured dental revenue for the 2013 quarter increased approximately $941,000 compared to the 2012 quarter. Self-insured dental revenue increased by approximately $648,000 due to an increase in the self-insured claim revenue on a PMPM basis. An increase in self-insured membership in the 2013 quarter resulted in an increase in new self-insured sales of approximately $293,000.

Total self-insured dental revenue for the 2013 period increased approximately $1,378,000 compared to the 2012 period. Self-insured dental revenue increased by approximately $517,000 due to an increase in the self-insured claim revenue on a PMPM basis as a result of higher dental service utilization. An increase in self-insured membership in the 2013 period resulted in an increase in new self-insured sales of approximately $861,000. The self-insured dental segment represents approximately 30.2% of our total dental business.

The self-insured segment revenue has two components:

Self-Insured Claim Revenue - Self-insured claim revenue for the 2013 quarter increased approximately $934,000, or 15.3%, to approximately $7,050,000 in the 2013 quarter from approximately $6,116,000 in the 2012 quarter. Self-insured claim revenue increased by approximately $279,000 due to new self-insured sales. In addition, self-insured claim revenue increased approximately $655,000 as a result of an increase in self-insured claim revenue on a PMPM basis in the 2013 quarter.

Self-insured claim revenue for the 2013 period increased approximately $1,356,000, or 7.9%, to approximately $18,619,000 in the 2013 period from approximately $17,263,000 in the 2012 period. Self-insured claim revenue increased by approximately $816,000 due to new self-insured sales. In addition, self-insured claim revenue increased approximately $540,000 as a result of an increase in self-insured claim revenue on a PMPM basis in the 2013 period.

Self-Insured ASO Fees - Self-insured ASO fees for the 2013 quarter increased approximately $7,000, or 2.4%, to approximately $317,000 in the 2013 quarter from approximately $310,000 in the 2012 quarter. Self-insured ASO fees increased by approximately $14,000 due to the new self-insured product sales offset by a decrease of approximately $7,000 due to a decrease in average self-insured ASO fee rates for the 2013 quarter compared to the 2012 quarter.

 

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Self-insured ASO fees for the 2013 period increased approximately $22,000, or 2.3%, to approximately $956,000 in the 2013 period from approximately $934,000 in the 2012 period. Self-insured ASO fees increased by approximately $44,000 due to the new self-insured product sales offset by a decrease of approximately $22,000 due to a decrease in average self-insured ASO fee rates for the 2013 period compared to the 2012 period.

Corporate, all other premium revenue is primarily derived from the dental indemnity product and the vision product that are underwritten by third-party insurance carriers. In aggregate, corporate, all other premium revenue increased by approximately $33,000 in the 2013 quarter compared to the 2012 quarter, and $63,000 in the 2013 period compared to the 2012 period. The corporate, all other segment represents approximately 0.6% of our total dental business.

Healthcare Services Expense

Fully-insured dental HMO/IND healthcare services expense for the 2013 quarter increased approximately $924,000 compared to the 2012 quarter. An increase in fully-insured dental HMO/IND membership resulted in an increase in fully-insured dental HMO/IND healthcare services expense of $276,000. An increase in fully-insured dental HMO/IND healthcare services expense on a PMPM basis resulted in an increase in fully-insured dental HMO/IND healthcare services expense of approximately $648,000. This increase is primarily the result of higher healthcare services utilization in the 2013 quarter compared to the 2012 quarter of approximately $521,000 and an increase attributable to a 1.5% dental HMO fee schedule increase of $127,000 that was effective January 1, 2013.

Fully-insured dental HMO/IND healthcare services expense for the 2013 period increased approximately $1,458,000 compared to the 2012 period. An increase in fully-insured dental HMO/IND membership resulted in an increase in fully-insured dental HMO/IND healthcare services expense of $813,000. An increase in fully-insured dental HMO/IND healthcare services expense on a PMPM basis resulted in an increase in fully-insured dental HMO/IND healthcare services expense of approximately $645,000. This increase is primarily the result of higher healthcare services utilization in the 2013 period compared to the 2012 period of approximately $250,000 and an increase attributable to a 1.5% dental HMO fee schedule increase of $395,000 that was effective January 1, 2013.

Fully-insured dental PPO healthcare services expense for the 2013 quarter increased approximately $385,000 compared to the 2012 quarter. This increase was primarily the result of an increase in fully-insured dental PPO healthcare services expense of approximately $421,000 related to the increase in fully-insured dental PPO membership discussed above. This was offset by a decrease in fully-insured dental PPO healthcare services expense of approximately $36,000 resulting from a decrease in fully-insured dental PPO healthcare services expense on a PMPM basis from $19.00 in the 2012 quarter to $18.76 in the 2013 quarter. This decrease is due to slightly lower healthcare services utilization in the 2013 quarter compared to the 2012 quarter.

Fully-insured dental PPO healthcare services expense for the 2013 period increased approximately $1,035,000 compared to the 2012 period. This increase was primarily the result of an increase in fully-insured dental PPO healthcare services expense of approximately $948,000 related to the increase in fully-insured dental PPO membership discussed above. An additional increase in fully-insured dental PPO healthcare services expense of approximately $87,000 resulting from an increase in fully-insured dental PPO healthcare services expense on a PMPM basis from $19.22 in the 2012 period to $19.43 in the 2013 period. This increase is due to higher healthcare services utilization in the 2013 period compared to the 2012 period.

Self-insured dental healthcare services expense for the 2013 quarter increased approximately $838,000 compared to the 2012 quarter. The self-insured new sales resulted in an increase in self-insured dental healthcare services expense of approximately $252,000. In addition, an increase of approximately $586,000 of self-insured dental healthcare services expense is the result of an increase in the self-insured healthcare services expense on a PMPM basis from $21.83 in the 2012 quarter to $24.04 in the 2013 quarter.

Self-insured dental healthcare services expense for the 2013 period increased approximately $1,189,000 compared to the 2012 period. The self-insured new sales resulted in an increase in self-insured dental healthcare services expense of approximately $741,000. In addition, an increase of approximately $448,000 of self-insured dental healthcare services expense is the result of an increase in the self-insured healthcare services expense on a PMPM basis from $20.65 in the 2012 period to $21.21 in the 2013 period.

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.

 

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Insurance Expense

Consolidated insurance expense for the 2013 quarter increased approximately $875,000 compared to the 2012 quarter. Consolidated insurance expense for the 2013 period increased approximately $1,762,000 compared to the 2012 period. The higher consolidated insurance expense for the 2013 quarter and the 2013 period was primarily due to higher professional consulting fees, broker commission expense, and deferred compensation expense. Higher professional consulting fees are a result of new product development and operational process improvement projects. Insurance expense as a percentage of total revenue, or the insurance expense ratio, was 18.8% for the 2013 quarter compared to 16.5% for the 2012 quarter and 18.8% for the 2013 period compared to 17.4% for the 2012 period.

Income Taxes

The Company calculates its year to date income tax provision by applying the estimated annual effective tax rate for the year to pretax income. The income tax expense for the three months ended September 30, 2013 was approximately $66,000 with an effective rate of 35.3%. The income tax expense for the three months ended September 30, 2012 was approximately $366,000 with an effective tax rate of 37.1%. The income tax expense for the nine months ended September 30, 2013 was approximately $320,000 with an effective tax rate of 35.2%. The income tax expense for the nine months ended September 30, 2012 was approximately $468,000 with an effective tax rate of 36.6%. Tax years subsequent to 2009 remain open to examination by the Internal Revenue Service (“IRS”), and 2008 remains open to state and local tax authorities. The Company has recorded no uncertain tax positions in the tax years that are subject to examination.

Liquidity and Capital Resources and Changes in Financial Condition

Our primary sources of cash include receipts of premiums, ASO fees, investment and other income, proceeds from the sale or maturity of our investment securities, as well as 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, dividends, redeemable common share redemptions and payments on borrowings. Cash decreased approximately $1,605,000, or 18.8%, during the 2013 period to approximately $6,926,000 as of September 30, 2013 from approximately $8,531,000 as of December 31, 2012. The change in cash for the 2013 and 2012 periods is summarized as follows (in thousands):

 

     Nine months ended     Nine months ended  
     September 30, 2013     September 30, 2012  

Net cash provided by operating activities

   $ 802      $ 1,094   

Net cash provided by (used in) investing activities

     (2,933     82   

Net cash provided by financing activities

     526        507   
  

 

 

   

 

 

 

(Decrease) Increase in cash and cash equivalents

   $ (1,605   $ 1,683   
  

 

 

   

 

 

 

Cash Flows from Operating Activities

In the 2013 period, approximately $802,000 was provided by operating activities. We had net income of approximately $589,000. This income is primarily the result of higher gross profit (total revenue less healthcare services expense) in the 2013 period compared to the 2012 period that was offset by higher insurance expense in the 2013 period compared to the 2012 period.

Unearned premium revenue and unbilled accounts receivable increased significantly with the renewal of the large block of fully-insured business as of January 1, 2013, with certain fully-insured groups renewing for two or three years. Due to increased claims activity and the timing of our payments, our claims payable liability increased by approximately $157,000. Other payables and accrued expenses increased by approximately $863,000, primarily due to an increase in accrued broker commissions of $969,000, which is mostly due to the increase of fully-insured business that renewed in January 2013. These cash balance increases were offset by an increase in deferred acquisition costs of approximately $1,429,000, an increase in accounts receivable of approximately $339,000. As disclosed in the condensed consolidated statements of cash flows, we paid $490,000 of federal income taxes in the 2013 period that related to our 2012 extension payment and 2013 estimated tax payments. The remaining effects of changes in operating assets and liabilities that represent fluctuations are not significant and are consistent with the 2012 period.

Cash Flows from Investing Activities

In the 2013 period, we invested approximately $441,000 in building improvements, furniture and fixtures and computer equipment, the majority of which was related to our corporate office expansion. During the 2013 period, we made purchases totaling approximately $3,571,000 of investment grade corporate bonds, certificates of deposit and institutional money market funds in order to improve investment income. Also during the 2013 period, we had certificate of deposit maturities and institutional money market sales that together totaled approximately $1,084,000.

 

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Cash Flows from Financing Activities

In the 2013 period, we made scheduled principal payments of approximately $34,000 related to our office building mortgage and scheduled payments of approximately $101,000 related to our capital leases. During the 2013 period, we repurchased previously redeemed Common Shares with a value of approximately $75,000 and issued Redeemable Common Shares to participating dentists with a value of approximately $97,000. In January 2013, we sold 1,000 Redeemable Institutional Preferred Shares at a purchase price of $1,000 per share, for an aggregate purchase price of $1,000,000, to a large Ohio-based insurance company. We also paid dividends of approximately $270,000 to holders of our Redeemable Common Shares and approximately $92,000 to holders of our Redeemable Institutional Preferred Shares in the 2013 period.

Provider Withhold Funds

In most cases, our reimbursement to our participating providers for covered dental services under the dental HMO and the dental PPO 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 that any amounts withheld shall be paid to the providers, and then vesting is only to the extent of such amounts authorized to be paid by the Board. Once authorized for payment by the Board, such amounts are recorded as claims payable liabilities until paid.

In the 2013 and 2012 periods, no withhold return to participating providers was authorized by the Board of Directors.

Contractual Obligations, Other Commitments and Off-balance Sheet Arrangements

Refer to the Company’s 2012 Annual Report on Form 10-K filed with the SEC for a description of contractual obligations, other commitments and off-balance sheet arrangements. We have had no significant changes in these items in 2013.

Financial Condition

Our consolidated cash and short-term investments were approximately $7.2 million as of September 30, 2013 and approximately $8.9 million as of December 31, 2012. The decrease in cash and short-term investments was primarily due to the cash used in investing activities of approximately $2,933,000. This use of cash was primarily the result of our election to invest an additional $2.8 million in investment grade corporate bonds. This use of cash was offset by cash provided by operating activities of approximately $803,000 and cash provided by financing activities of approximately $526,000. We expect to generate positive cash flow from operations during the balance of 2013. Based on total expenses for the nine months ended September 30, 2013, we estimate that we had approximately 30 days of cash and short-term investments on hand at September 30, 2013. In addition, the Company has access to approximately $6.4 million of fixed maturity investments that are classified as available-for-sale and two working capital lines of credit discussed below.

In December 2012, the Company refinanced the mortgage of its office building and in connection therewith, the Company executed a mortgage note with a bank, secured by the land and the office building, in the amount of $1,340,000. Interest is payable based on the 30-day LIBOR rate plus 1.95% and was 2.13% and 2.02% at September 30, 2013 and December 31, 2012, respectively. The Company also entered into an interest rate swap agreement that effectively changed the interest rate related to the mortgage note with a commercial bank from a variable rate based on the 30-day LIBOR rate plus 1.95% to a fixed rate of 3.90% for the 10-year period through December 22, 2022.

We have an annually renewable agreement with a commercial bank for a $500,000 working capital line of credit. Interest is payable at a variable rate of LIBOR plus 2.50%. We did not have any interest expense or significant fees for the line of credit in the 2013 period or the 2012 period. As of September 30, 2013 and December 31, 2012, there was no amount outstanding on this line of credit. The $500,000 working capital line of credit expires in July 2014.

We have an additional annually renewable working capital line of credit for $1,000,000. Interest is payable at a variable rate of LIBOR plus 2.50%. The Company did not have any interest expense for the line of credit in the 2013 period or the 2012 period. At September 30, 2013 and December 31, 2012, there was no amount outstanding on this line of credit. The $1,000,000 working capital line of credit expires in August 2014. In addition, the Company obtained an irrevocable letter of credit for $40,000, with interest payable on all outstanding amounts at a variable rate of the prime rate of borrowing plus 6.00%. The letter of credit also has an annual fixed rate of 2.10% for access to the letter of credit obligation. The letter of credit expires in December 2013. At September 30, 2013 and December 31, 2012, there was no amount outstanding on the irrevocable letter of credit obligation.

Under the mortgage note and each of the renewable working lines of credit, the Company is required to have a debt service ratio of at least 1:1 at the end of each quarter and a minimum tangible net worth equal to or greater than $3,500,000 at the end of each fiscal year. The Company was in compliance with these covenants at September 30, 2013 and December 31, 2012, respectively.

 

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We believe our premium revenues, cash, investments and working capital lines of credit 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 healthcare services expense, building mortgage, and our capital and operating leases and other commitments, including payment of certain director’s deferred compensation obligations. In the long-term, we will continue to be obligated to make payments related to our other contractual obligations. We will also be obligated in certain circumstances to repurchase the Redeemable Common Shares of our provider shareholders who die, become permanently disabled or retire and make future payments to key employees and directors related to their deferred compensation obligations. We will also be obligated in certain circumstances to repurchase the Redeemable Institutional Preferred Shares upon redemption request. Our Board of Directors establishes limitations on the amount of share redemptions each year. While we are not able to estimate future redemptions of our Redeemable Common Shares and Redeemable Institutional Preferred Shares, we believe our cash balances, investment securities, operating cash flows, and borrowing capacity, taken together, provide adequate resources to fund ongoing operating and regulatory requirements and capital expenditures in the next twelve months.

Our largest subsidiary, Dental Care Plus Inc., (“DCP”), 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 DCP, without prior approval by state regulatory authorities, is limited based on statutory income and statutory capital and surplus. Even if prior approval is not required, prior notification must be provided to state agencies in Ohio, Kentucky and Indiana before paying a dividend. During 2013, the total dividend that the DCP subsidiary may declare without prior regulatory approval is approximately $740,000. There were no dividends declared or paid by DCP in the 2013 or 2012 periods.

A.M. Best Company assigns a rating to companies that have, in their opinion, an ability to meet their ongoing obligations to policyholders, but are financially vulnerable to adverse changes in underwriting and economic conditions. In July 2013, A.M. Best Company affirmed our financial strength rating of B (Fair) with a positive outlook based on DCP’s positive operating performance and improved capitalization. Our A.M. Best rating is a measure of our financial strength relative to other insurance companies and is not a recommendation to buy, sell or hold securities. The rating assigned by A.M. Best Company is based, in part, on the ratio of our fully-insured premium revenue to our statutory capital and surplus.

We attempt to reduce overall risk by maintaining a well-diversified fixed-maturity portfolio. We invest in certificates of deposits, investment grade corporate bonds and money market funds, targeting what we believe to be optimal risk-adjusted after-tax yields. Risk, in this context, includes interest rate, call, reinvestment rate, credit and liquidity risk. We typically do not make a concerted effort to alter duration on a portfolio basis in response to anticipated movements in interest rates. By continually investing in certificates of deposits, money market funds and investment grade corporate bonds, we believe the portfolio mitigates the impact of adverse economic factors. As of September 30, 2013, we had approximately $4,310,000 or 80% of the total fair value of investment grade corporate bonds with a Standard & Poor’s rating of A- or better. The remaining investment grade corporate bonds had a fair value of approximately $1,083,000 with a Standard & Poor’s rating between BBB+ and BBB+. The weighted average yield-to-cost of our investment grade corporate bonds was approximately 3.06% at September 30, 2013. The weighted average maturity of our investment grade corporate bonds was 6.04 years at September 30, 2013.

Our regulated subsidiary’s state of domicile has statutory risk-based capital, or RBC, requirements for health and other insurance companies largely based on the NAIC’s RBC Model Act. These RBC requirements are intended to measure capital adequacy, taking into account the risk characteristics of an insurer’s investments and products. The NAIC sets forth the formula for calculating the RBC requirements, which are designed to take into account asset risks, insurance risks, interest rate risks and other relevant risks with respect to an individual insurance company’s business. In general, an insurance company must submit a report of its RBC level to the state insurance department or insurance commissioner, as appropriate, at the end of each calendar year. Our subsidiary’s risk-based capital as of December 31, 2012, which was the most recent date for which reporting was required, was in excess of all mandatory RBC thresholds.

Critical Accounting Policies

Deferred Acquisition Costs

Deferred acquisition costs are those incremental direct costs related to the successful acquisition of new and renewal business. 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. Such incremental direct costs include commissions, costs of contract issuance and underwriting, premium taxes and other costs the Company incurs to successfully acquire new business or renew existing business. The Company defers policy acquisition costs and amortizes them over the estimated life of the contracts, which are short-duration in nature, in proportion to premiums earned.

 

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Claims Payable Liability

We estimate liabilities for both incurred but not reported (“IBNR”) and reported claims in process by employing actuarial methods that are commonly used by health insurance actuaries and meet actuarial standards of practice. These actuarial standards of practice require that claim liability estimates be adequate under moderately adverse circumstances. The Company’s consulting actuary assists us in making these estimates. Since our liability for claims payable is based on actuarial estimates, the amount of claims eventually paid for services provided prior to the balance sheet date could differ from the estimated liability. Any such differences are recognized in the condensed consolidated statements of comprehensive income for the period in which the differences are identified. Historically, such differences have not been material.

We develop our estimate for claims payable liability using actuarial methodologies and assumptions, primarily based on historical claim payments and claim receipt patterns, as well as historical dental cost trends. Depending on the period for which incurred claims are estimated, we apply a different method in determining our estimate. For periods prior to the most recent month, we calculate a “completion factor” which indicates the percentage of claims payable estimated for a prior period that have been paid as of the end of the current reporting period. We use the completion factor to determine historical patterns over a rolling 12-month period, made consistent by making adjustments for known changes in claims in process levels and known changes in claim payment processes. For the most recent month, we calculate a “claims trend factor” that estimates incurred claims primarily from a trend analysis based upon PMPM claims trends developed from our historical experience in the preceding months, adjusted for known provider contracting changes, changes in benefit levels, seasonality and consideration of any subsequent actual claims data available. When developing our estimate for claims payable liability as of December 31, 2012, we considered actual paid claim data from January 2013. As a result, we were able to use the completion factors approach for all historical months at December 31, 2012.

We have not changed the key actuarial methodologies 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 used in calculating the most recent estimate of the IBNR and reported claims in process components of our claims payable liability. Our assumptions in the 2013 period for the claims trend factor used to estimate incurred claims for September 30, 2013 are generally consistent with the dental services utilization levels we experienced in the prior year and our expectation that this level of utilization will continue in the future.

The table below illustrates how our operating results are affected 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 September 30, 2013 within variance ranges historically experienced.

 

Completion Factor (a)      Claims Trend Factor (b)  
          Estimated
claims
              Estimated claims  
(Decrease)         payable liability      (Decrease)        payable liability  
Increase         as of      Increase        as of  

In Factor

        9/30/2013      In Factor        9/30/2013  
(0.5)%         2,481,010       (5)%        2,116,425   
0%    (estimate used)      2,292,985       0%   (estimate used)      2,292,985   
0.5%         2,146,234       5%        2,469,545   

 

(a) Reflects estimated potential changes in incurred claims payable liability caused by changes in completion factors for months prior to the most recent month.
(b) Reflects estimated potential changes in incurred claims payable liability caused by annualized claims trend used for the estimation of the PMPM incurred claims for the most recent month.

 

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Based on historical experience, we believe the completion factors we use to estimate outstanding IBNR and reported claims in process are reliable for predicting actual claims paid at future times, with a variance range of approximately one-half of one percent, plus or minus. The claims trend factors we use to estimate outstanding IBNR and reported claims in process for the most recent month are somewhat less reliable based on historical experience, with a variance range of approximately five percent, plus or minus. We have found that the estimated claims trend factor can be higher or lower than what the paid claims data indicates with the passage of time primarily because of factors beyond our control, such as the level of utilization of services by dental members and the expected and actual mix of the types of services received by dental members.

In 2013, our first quarter healthcare services expense on a PMPM basis was lower than the first quarter of 2012. This decrease was primarily due to a lower level of self-insured healthcare services expense on a PMPM basis, offset by a slight increase in fully-insured dental HMO/IND and fully-insured dental PPO healthcare services expense on a PMPM basis. In the second quarter of 2013, our healthcare services expense on a PMPM basis was slightly higher than the second quarter of 2012. This increase in healthcare services expense on a PMPM basis was the result of higher dental services utilization in the 2013 quarter. In the third quarter of 2013, our healthcare services expense on a PMPM basis was higher than that in the third quarter of 2012 as a result of higher dental services utilization in the third quarter of 2013.

Based on our healthcare services expense on a PMPM basis that adjusts the quarterly healthcare services expense for membership volume changes, we have observed that the utilization of our dental plan members is somewhat variable. In general, claims on a PMPM basis are generally lower in the second and fourth quarter than in the first quarter and the third quarter. The higher third quarter claim level on a PMPM basis is primarily due to the high level of dental services used in July and August by student members prior to returning to school. Use of dental services is lowest in the fourth quarter due to the holiday season and the fact that a portion of our members have already reached their maximum annual benefit level for the year. The following shows these trends in tabular form:

 

     Healthcare Service Expense  
     2013      2012  
     $000’s      $PMPM      $000’s      $PMPM  

First Quarter

   $ 16,954       $ 19.78       $ 16,240       $ 19.83   

Second Quarter

     16,742         19.46         15,920         19.43   

Third Quarter

     18,238         20.98         16,092         19.61   

Fourth Quarter

           15,484         18.72   

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Market risk is the risk that we will incur investment losses or increased interest expense due to adverse changes in market rates and prices. Our market risk exposures are substantially related to our investment portfolio and the impact of interest rate changes on these securities. In addition, interest rate changes can affect future interest expense for debt obligations that have a variable rate of interest associated with them.

At September 30, 2013 and December 31, 2012, respectively, our investment portfolio consisted of approximately $55,000 and $93,000 of institutional money market funds. Our portfolio also included approximately $5,393,000 and $3,108,000 of investment grade corporate bonds and approximately $1,259,000 and $1,215,000 of investments in FDIC-insured bank certificates of deposits at September 30, 2013 and December 31, 2012, respectively. In 2013, we instructed our investment manager to invest additional funds in shorter duration investment grade corporate bonds with maturities up to five years. At September 30, 2013, our portfolio included approximately $2,875,000 of these shorter duration investment grade corporate bonds.

There is increased interest rate risk associated with our investment in longer duration investment grade corporate bonds. We have evaluated the impact on the invested portfolio’s fair value considering an immediate 100 basis point change in interest rates. A 100 basis point increase in interest rates would result in an approximate $255,000 decrease in fair value, whereas a 100 basis point decrease in interest rates would result in an approximate $242,000 increase in fair value. The investment grade corporate bonds and certificates of deposits are all classified as available-for-sale.

At September 30, 2013 and December 31, 2012, we had a mortgage note with a bank with an outstanding principal balance of $1,306,000 and $1,340,000, respectively, with a variable rate based on LIBOR plus 1.95%. However, in December 2012, we entered into a variable to fixed interest rate swap contract that effectively eliminated the interest rate risk exposure on the entire outstanding loan principal. Management estimates that a 100 basis point increase in interest rates would not materially impact our annual pre-tax earnings.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), of the design and effectiveness of the Company’s disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2013. Based on the evaluation, the Principal Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2013.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Securities Exchange Act Rules 13a-15(f) and 15(d)-15(f)) during the three and nine months ended September 30, 2013 that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not a party to any pending legal proceedings that we believe would, individually or in the aggregate, have a material adverse effect on our financial condition, results of operations or cash flows.

ITEM 1A. RISK FACTORS

Certain factors may have a material adverse effect on our business, financial condition and results of operations and you should carefully consider them. It is not possible to predict or identify all such factors. For discussion of our potential risks or uncertainties, refer to Part I, Item 1A, Risk Factors, included in our 2012 Annual Report on Form 10-K. There have been no material changes to the risk factors disclosed in our 2012 Annual Report on Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

We repurchased and retired 2 Class A Redeemable Common Shares and 34 Class B Redeemable Common Shares during the three months ended September 30, 2013 as follows:

 

Period

  Total Class A
shares
purchased
    Total Class B
shares
purchased
    Average price
paid per share
    Total Number of Shares
Purchased as Part of a
Publicly Announced
Plans or Programs
    Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs
 

July 1 – July 31, 2013

    0        12 (a)    $ 811.19        0        N/A   

August 1 – August 31, 2013

    1 (a)      11 (a)    $ 814.20        0        N/A   

September 1 – September 30, 2013

    1 (a)      11 (a)    $ 787.13        0        N/A   

 

(a) 

Repurchased from shareholder in accordance with the Company’s obligations under its Amended and Restated Code of Regulations.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

 

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ITEM 6. EXHIBITS

 

Exhibits

     
31.1    CEO certifications pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
31.2    CFO certifications pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32    CEO and CFO certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101    Financial information and Notes to Financial Statements for the three and nine months ended September 30, 2013, formatted in XBRL (Extensible Business Reporting Language).

 

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    DCP HOLDING COMPANY

November 14, 2013

    By:  

/s/ Anthony A. Cook

      Anthony A. Cook.
      President, Chief Executive Officer and Director
      Principal Executive Officer

November 14, 2013

    By:  

/s/ Robert C. Hodgkins, Jr.

      Robert C. Hodgkins, Jr.
      Vice President and Chief Financial Officer
      Principal Executive Officer

 

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INDEX TO EXHIBITS

 

Exhibit
No.

  

Item

31.1    Certifications pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2    Certifications pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32    Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101    Financial information and Notes to Financial Statements for the three and nine months ended September 30, 2013, formatted in XBRL (Extensible Business Reporting Language).