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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Commission file number 0-23430
South Dakota State Medical Holding Company, Incorporated
(Exact name of registrant as specified in its charter)
South Dakota 46-0401087
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1323 South Minnesota Avenue
Sioux Falls, South Dakota 57105
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (605) 334-4000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class A Preferred Stock, No Par Value, Stated Value $10 Per Share
(Title of class)
Class C Common Stock, Par Value $.01 Per Share
(Title of class)
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
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 checkmark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at March 20, 1998
Class C Common Stock 1,505,760
The aggregate market value of the voting stock held by non-affiliates
is not determinable as there is no market or exchange where these
shares are traded.
1
PART I
ITEM 1. BUSINESS
South Dakota State Medical Holding Company, Incorporated (the
Company, Corporation or DAKOTACARE), was incorporated in the State of
South Dakota on May 5, 1988. Its corporate offices are located at
1323 South Minnesota Avenue, Sioux Falls, South Dakota, 57105. The
Articles of Incorporation permit the Company to engage in the
development of quality comprehensive health care delivery systems; to
conduct, promote, or operate alternative health care delivery systems
and other contractual health service arrangements, including but not
limited to, traditional third party reimbursement systems, preferred
provider organizations, and health maintenance organizations (HMO).
The Company contracts with over 98% of the physicians in the State of
South Dakota, 100% of the hospitals in the State of South Dakota, and
many other health care providers to provide medical services to its
enrollees. Physicians who are members of the South Dakota State
Medical Association and who complete the Company's credentialing
process may participate with the Company by purchasing one share of
Class A voting preferred stock of the Company for $10. The fee for
non-members is $1,000. The South Dakota State Medical Association
owns 100% of the Class B voting preferred stock of the Company, and
through this ownership, maintains voting control of the Company.
The Company's agreements with participating physicians stipulate
compensation on a fee-for-service basis utilizing a relative value
schedule developed by the Company. This schedule assigns a value
(measured in number of units) for each individual service for which a
physician may perform and submit a bill. These values are then
multiplied by an overall value per unit assigned by the Company, and
the product is the maximum amount allowed for payment to the
physician. Actual reimbursement is at the lower of this product or
the actual billed amount. The Company, at least annually, reviews
the unit values and makes adjustments when considered necessary. The
effect of this reimbursement mechanism is to establish a maximum
allowable reimbursement, which is not dependent upon actual billed
charges. Regardless of the physician bill, reimbursement will never
exceed the maximum amount established by the relative value schedule.
Physicians also may not bill patients for any excess of the billed
charge over the amount allowed by the Company, but instead have
contractually agreed to hold the patient harmless for any such
amounts.
The Company's agreements with participating physicians provide that
up to 20% of fees for services provided, as submitted to and allowed
by the Company, may be withheld to provide a contingency reserve that
may be used to fund operations or meet other financial requirements
of the Company. Currently, the Company is withholding 15% of fees as
set by the Board of Directors. The contingency reserve withholding
is also designed to encourage efficient medical practice by the
physicians. Less expensive medical outcomes enhance net income and
2
consequently, an increased likelihood of contingency reserve payouts
to the physicians. The amounts withheld may be paid to the
participating physicians at the discretion of the Board of Directors
of the Company, although the Company is not contractually obligated
to pay out amounts withheld. The recorded liability was an estimate
of the projected payouts for prior amounts withheld. Management
estimates the expected amount of contingency reserves and records a
liability based upon factors such as cash flow needs, net income, and
accumulations of amounts withheld. Payments to physicians are made
at such times as the Board of Directors approves. The recorded
liability for contingency reserves at December 31, 1997 and 1996, was
$2,963,846 and $2,105,294, respectively. The Company withheld from
payment to the participating physicians $1,336,156 and $1,120,049 for
the years ended December 31, 1997 and 1996, respectively. The
liability recorded was equal to the actual amounts withheld for 1997
and 1996. The recorded liability for prior years was the estimate of
the projected payouts for the prior amounts withheld.
In 1992, the Company incorporated DAKOTACARE Administrative Services,
Incorporated (DAS), a wholly owned subsidiary of the Company. In
1994, the Company organized and then purchased a 50.11% interest in
Dakota Health Plans, Incorporated (DHP). The Articles of
Incorporation of DAS and DHP permit them to engage in the development
of third party administration (TPA) services for health and welfare
plans. DHP has subcontracted with DAS to perform substantially all
TPA activities. In January 1996, the Company incorporated DAKOTACARE
Insurance, Ltd. (DIL), a wholly owned subsidiary of the Company. DIL
was formed to accept reinsurance risk on stop-loss policies of DAS
and DHP customers, and other insurance risks.
Products and Marketing
The Company markets its products under the trade name of DAKOTACARE.
Its products include group managed health care products such as HMO
products, in addition to managed care and claims administration
services for self-insured employer groups. Also, cafeteria plan
administration and workers compensation managed care services are
offered. The Company markets its products through an exclusive
network of independent insurance agents throughout South Dakota.
The Company markets its products to employer groups with a minimum of
two covered employees and its' customers range in size from employers
of this size to its largest customer with over 2,500 employees. As
of January 1, 1998, DAKOTACARE and its subsidiaries provided health
care services to approximately 75,000 individuals.
Approximately 10.6% of the state's population and approximately 18%
of DAKOTACARE's target market of approximately 425,000 is served by
DAKOTACARE and its subsidiaries, which does not include Medicare and
Medicaid populations, federal employee groups, the individual policy
market, and other potential populations. The Company's HMO
enrollment, which had remained relatively stable from 1990 to 1995 at
approximately 20,000 enrollees, grew to nearly 25,000 in 1996 and
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26,000 in 1997. Commencing in 1993, the Company began its
Administrative Services Only (ASO) business and by January 1, 1998,
had enrolled approximately 50,000 ASO enrollees, bringing the total
individuals served by the Company and its' subsidiaries to
approximately 75,000. The Company's HMO client disenrollment rate is
lower than the industry rate as a whole. All underwriting and
pricing decisions are made by the DAKOTACARE underwriting department
and reviewed by senior management. DAKOTACARE's underwriters
evaluate the prior loss history, the inherent risk characteristics,
and the demographic makeup of the applicants where appropriate.
Through a specific excess liability reinsurance agreement with
Lincoln National Health and Casualty Insurance Company, the Company
reinsures that portion of its risk in excess of $85,000 of covered
hospital inpatient expenses of any enrollee per contract year. The
policy is subject to a coinsurance provision which ranges from 50% to
90% based on average daily amounts specified in the subscriber plan,
and a $2,000,000 lifetime maximum benefit per enrollee. The Company
would be liable for any obligations that the reinsuring company is
unable to meet under the reinsurance agreement. The reinsurance
agreement also provides for enrollee benefits to be paid in the event
the Company should cease operations or become insolvent, and a
conversion privilege for all enrollees in the event of plan
insolvency and for any enrollee that moves out of the service area of
the Company.
The Company operates under a license issued by the South Dakota
Department of Commerce and Regulation, Division of Insurance, for the
operation of the health maintenance organization. DAS and DHP are
also registered as third party administrators in South Dakota and
several other states. The Company has also received certification
from the South Dakota Department of Labor as a workers' compensation
managed care plan.
The Company continually seeks out and evaluates opportunities for
future growth and expansion. These opportunities may include
acquisitions or dispositions of segments of its operations, marketing
of insurance products underwritten by other companies, the internal
development of new products and techniques for the containment of
health care costs, and the measurement of the outcomes and efficiency
of health care delivered.
Competition
The managed health care industry evolved primarily as a result of
health care buyers' concerns over rising health care costs. The
industry's goal is to infuse greater cost effectiveness and
accountability into the health care system through the development of
different managed care products, while increasing the accessibility
and quality of health care services. The managed health care
industry has become increasingly competitive in many markets. As
managed care (HMO, Preferred Provider Organization, etc.) penetration
of the health care market increases, the Company expects that
marketing to large employer groups will become more difficult and
competition for smaller employer groups will intensify. In addition,
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more employers may choose to self-insure their health care risk and
seek benefit administration and managed care services from third
parties to assist them in controlling and reporting health care
costs. In such an environment, the Company believes that having a
broad line of health care programs and products available will be
important in being selected by employers to manage their health care
programs. The Company's health care products compete for group
membership with traditional health insurance plans, Blue Cross/Blue
Shield plans, and third party administrators who provide services to
self-insured employers. The ability to increase the number of
individuals covered by the Company's services or to increase premiums
can be affected by the level of competition in any particular area.
The Company believes that the principal competitive factors affecting
the Company include price, the level and quality of service provided,
provider network capabilities, and marketplace reputation.
Regulations
The Company is regulated by the South Dakota Department of Commerce
and Regulation, Division of Insurance (Division). South Dakota
statutes require the filing of periodic financial reports and
maintenance of restricted deposits in an amount of not less than
fifty percent of unearned premiums of the Company on its outstanding
policies or $200,000. The Company requires approval from the
Division for the Company's benefits contracts and premium rates,
licensing of its agents, and other items. The Company is also
subject to periodic examination of its financial affairs and market
conduct. The Division completed an examination of DAKOTACARE for
years through December 31, 1991, which was released in March 1993.
DAKOTACARE must comply with applicable insurance statutes and
regulations which prescribe the nature, form, quality, and relative
amounts of investments which may be made by insurance companies and
HMOs. Generally, these statutes and regulations permit companies to
invest within varying limitations in state, municipal, and federal
government obligations, corporate obligations, preferred and common
stocks, bank certificates of deposit, and certain types of real
estate and first mortgage loans. The Company's management believes
that its investment strategy is conservative, with preservation of
capital being the foremost objective. Its investment strategy is
also influenced by the terms of its coverage written and by its
expectations as to the timing of claims and contingency reserves
payments.
The following table sets forth, by type of investment, the percentage
of the total investment portfolio, excluding cash and cash
equivalents and cash surrender value of life insurance, represented
by each type of investment as of December 31:
5
1997 1996
Certificates of deposit 21.7% 24.0%
Obligations of state and political
subdivisions 42.9 32.7
Obligations of U.S. Treasury, government
agencies and corporations 25.3 30.9
U.S. government agency collateralized
mortgage obligations 5.4 7.9
Bond mutual funds 4.7 4.5
100.0% 100.0%
The Company's investment portfolio, excluding cash and cash
equivalents and cash surrender value of life insurance, totaled
$6,432,239 and $6,382,097 as of December 31, 1997 and 1996,
respectively. Cash and cash equivalents totaling $4,467,754 and
$3,422,692 at December 31, 1997 and 1996, respectively, are invested
substantially in interest bearing accounts.
The anti-kickback provisions of the Medicare law prohibit the payment
or receipt of any remuneration in return for the referral of a
patient the charges to whom are subject to reimbursement by Medicare.
The Company, which provides HMO coverage on a group basis does not
provide coverage for the cost of medical and hospital expenses to
Medicare beneficiaries. If otherwise eligible for coverage through
the Company, the Medicare eligible beneficiary may choose to have the
Company provide their health care benefits in lieu of coverage by
Medicare. The Company does not believe that it offers incentives to
Medicare beneficiaries or that any discounts the HMO receives from
health care providers would violate the anti-kickback provisions of
the Medicare law.
Government regulation of employee benefit plans, including health
care coverage, health plans and the Company's specialty managed care
products is a changing area of law that varies from jurisdiction to
jurisdiction and generally gives responsible administrative agencies
broad discretion. The Company believes that it is in compliance in
all material respects with the various federal and state regulations
applicable to its current operations. To maintain such compliance,
it may be necessary for the Company or its subsidiaries to make
changes from time to time in its services, products, structure, or
marketing methods. Additional governmental regulation or future
interpretation of existing regulation could increase the cost of the
Company's compliance or otherwise affect the Company's operations,
products, profitability, or business prospects. Numerous proposals
have been introduced in the United States Congress relating to health
care reform. As a provider of cost effective managed care plans for
medium and small employers, the Company believes it is delivering
products and services that address current health care reform issues.
The Company will continue to evaluate its business strategy as
necessary to maximize its ability to adapt to the changing health
care marketplace.
ERISA
The provision of services to or through certain types of employee
health benefit plans is subject to the Employee Retirement Income
Security Act of 1974 (ERISA). ERISA is a complex set of laws and
6
regulations that are subject to periodic interpretation by the United
States Department of Labor. ERISA places certain controls on how
DAKOTACARE may do business with employers covered by ERISA,
particularly employers who maintain self-funded plans. The
Department of Labor is engaged in an ongoing ERISA enforcement
program, which may result in additional constraints on how ERISA
governed benefit plans conduct their activities. There have recently
been legislative attempts to limit ERISA's preemptive effect on state
laws. If such limitations were to be enacted, they might increase
DAKOTACARE's administrative costs and its liability exposure under
state law-based suits relating to employee health benefits offered by
DAKOTACARE's health plans.
Employees
As of December 31, 1997, the Company employed 110 persons on a full-
time basis. None of these employees are covered by a collective
bargaining agreement, and the Company believes its employee relations
are good.
ITEM 2. PROPERTIES
The Company leases office space in Sioux Falls, South Dakota, from
the South Dakota State Medical Association (Association). See ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS for additional
details on this lease with the Association, which is an affiliated
company. In January 1997, the Company purchased an office building
in Webster, South Dakota, which was previously leased. The Company
also leases a small office in Pierre, South Dakota. Another office
was leased in Rapid City until June 1997, at which time an agent of
the Company assumed the lease for his insurance agency operations.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in legal actions in the ordinary course of
its business. Although the outcome of any such legal actions cannot
be predicted, management believes there is no legal proceeding
pending against or involving the Company for which the outcome is
likely to have a material adverse effect upon the consolidated
financial position or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(A) There were no matters submitted to shareholder vote in the
fourth quarter of 1997.
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
Stock Prices
There is no active trading for shares of stock of the Company and the
stock is not listed on any exchange or over-the-counter market.
However, limited infrequent exchanges of Class C shares have occurred
directly between interested buyers and sellers and in across the desk
stock transactions with a brokerage firm. The Company does not
regularly receive price information on these transactions. The
amended and restated Articles of Incorporation of the Company
currently restrict the ownership of shares as follows: (i) the
ownership of the Company's Class A voting preferred stock is
restricted to medical or osteopathic physicians who have executed
participating agreements with the Company and may not be issued to or
held by any hospital, (ii) the ownership of the Company's Class B
voting preferred stock is restricted to the South Dakota State
Medical Association, and (iii) the ownership of the Company's Class C
non-voting common stock is restricted to (a) medical or osteopathic
physicians who have executed participating physician agreements with
the Company, (b) a trust or self-directed individual retirement
account controlled by such physicians, (c) professional corporations,
partnerships, or other entities domiciled in the state of South
Dakota, and in which a participating physician is a shareholder,
partner, or employee in the practice of medicine, (d) management
employees or agents of the Company, the South Dakota State Medical
Association, the South Dakota Foundation for Medical Care, or (e) a
spouse or child of a shareholder of the Company, if such shares were
first held by one of the persons or entities entitled to own Class C
common stock. In addition, the Class C non-voting common stock may
not be issued or transferred to any hospital or to any natural person
or entity who is not a resident or domiciliary of the state of South
Dakota.
Shares Eligible for Future Sale
The Company's Class A voting preferred stock is nontransferable and
ownership of the Company's Class B voting preferred stock is
restricted to the South Dakota State Medical Association.
Approximately 92,410 shares of the Company's Class C non-voting stock
are currently owned by the officers and directors of the Company.
All of the remaining Class C shares are eligible for resale under
Rule 144(k) of the Securities Act of 1933, as amended, subject to the
ownership restrictions contained in the Company's Amended and
Restated Articles of Incorporation. The Company intends to register
under the Act the officers' and directors' outstanding Class C non-
voting common stock to enable the public resale of such shares by the
holders thereof, subject to the ownership restrictions contained in
the Company's Amended and Restated Articles of Incorporation.
8
Holders
As of March 20, 1998, there were 1,069 holders of record of Class A
preferred stock, 1 holder of Class B preferred stock, and 673 holders
of record of Class C common stock. There are no options or warrants
outstanding.
Dividends
The Class A and B preferred stock are not entitled to dividends. As
approved by the stockholders at a special meeting held on December
28, 1995, the Company is not required to pay annual cumulative
dividends to its Class C common stock. The Board of Directors, at
its discretion, can elect to pay dividends in any amount subject to
availability of funds and regulatory requirements on reserves. As
long as the Company exceeds required regulatory capital as required
by the Division, there are no dividend restrictions. At December 31,
1997, the Company exceeded this requirement by approximately
$6,654,000. During 1997 and 1996, the Company paid dividends of
$331,267 and $271,037, respectively, on Class C shares.
Stock Repurchase Plan
As a service to the Company's shareholders to facilitate liquidity
for Class C common stock (Common Stock) in the event of death,
disability, or retirement of a shareholder, the Company's Board of
Directors adopted a Stock Repurchase Program (Program) which was
implemented in February 1998. Participation in the Program is
voluntary. No shareholder is required to sell his or her shares of
Common Stock under the Program nor is the Company required to
purchase any Common Stock under the Program. The purchase and sale
of Common Stock under the Program is subject to repurchase conditions
as described in the Program.
Unregistered Sales of Securities
Ownership of the Company's Class A Voting Preferred Stock is
restricted to medical or osteopathic physicians who have executed
participating physician agreements with the Company. Class A
Preferred Stock is nontransferable and holders of these shares do not
receive dividends. Each such physician is issued one share of Class
A Voting Preferred Stock upon execution of his or her participation
agreement and the payment of $10 per share. Upon the termination of
a physician's participation agreement, his or her share of Class A
Preferred Stock is canceled without compensation. During 1997, the
Company issued a total of 194 shares of Class A Preferred Stock to
physicians who entered into participation agreements with the
Company. To the extent that the registration provisions of the
Securities Act of 1933, as amended, were applicable to these
transactions, the Company relied on the exemption from registration
contained in Section 4(2) of that act.
9
ITEM 6. SELECTED FINANCIAL DATA
The following information for the Company is as of and for the years
ended December 31, 1997, 1996, 1995, 1994, and 1993 (dollars in
thousands, except per share data):
Year Ended December 31,
1997 1996 1995 1994 1993
Income Statement Data:
Net premiums $34,754 $28,688 $26,643 $26,790 $24,936
Third party administration fees 3,628 3,786 3,023 1,143 462
Investment income 615 552 489 321 208
Total revenues 39,581 33,425 30,513 28,497 25,790
Net claims incurred 30,976 23,425 20,305 19,937 19,046
Other operating expenses 8,727 8,393 7,587 5,609 4,640
Income (loss) before
income taxes (122) 1,607 2,621 2,951 2,103
Net income (loss) (110) 1,041 1,790 1,906 1,433
Earnings (loss) per common share(1) $ (.07) $ 0.69 $ 1.19 $ 1.27 $ 1.08
Balance Sheet Data:
Invested assets and cash $10,981 $ 9,874 $ 8,843 $ 7,804 $ 5,882
Total assets 14,011 12,777 11,425 9,803 7,568
Reported and unreported
claims payable 4,164 3,188 2,710 2,864 2,558
Contingency reserves payable 2,964 2,105 1,955 1,697 1,635
Long-term debt (including
current maturities) -- -- -- -- 572
Total liabilities 8,807 7,137 6,545 6,432 5,667
Stockholders' equity 5,204 5,640 4,880 3,372 1,901
(1) Earnings per common share for 1995 and prior years have been restated
from amounts previously reported to give retroactive effect to the
recapitalization discussed in Note 9 of the Notes to Consolidated Financial
Statements. Earnings(loss) per common share is calculated in accordance
with the provisions of Financial Accounting Standards Board Statement No. 128,
"Earnings Per Share", which was effective for 1997. This Statement
establishes standards for computing and presenting earnings(loss) per
share (EPS). It replaces the presentation of primary EPS with a presentation
of basic EPS. It also requires dual presentation of basic and diluted EPS on
the face of an income statement for all entities with complex capital
structures. This Statement requires restatement of all prior-period EPS data
presented. All references to earnings (loss) per share are to basic earnings
(loss) per share. No restatement of EPS was necessary as a result of the
application of Statement No. 128. Earnings (loss) per common share was
calculated by dividing net income by the weighted average number of Class C
common shares outstanding during each period as follows: 1997 1,505,760
shares; 1996 1,505,760 shares; 1995 1,505,760 shares; 1994 1,505,760 shares;
and 1993 1,329,373 shares.
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ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
The following operating statistics are presented for DAKOTACARE's
operation as a health maintenance organization only and do not
include the operations of its subsidiaries for the years ended
December 31, 1997, 1996, 1995, and 1994. The results indicated in
the following tables are not indicative of future operating results.
The combined ratio, which reflects underwriting results but not
investment and ancillary income, is a traditional measure of the
underwriting performance of a health maintenance organization. A
combined ratio of less than 100% indicates underwriting profitability
while a combined ratio in excess of 100% indicates an underwriting
loss.
Year Ended December 31,
1997 1996 1995 1994
Loss ratio 88.7% 81.7% 76.2% 74.4%
Expense ratio 14.5 16.3 18.4 17.1
Combined ratio 103.2% 98.0% 94.6% 91.6%
The loss ratio is computed by dividing the net claims expense into
net premium revenue. The Company's results of operations will be
affected by the changes in the loss ratio. The loss ratio may vary
from period to period depending principally on claims experience.
The expense ratio is computed by taking the sum of the remaining
operating expenses of the health maintenance organization divided by
net premium revenue.
The increase in the loss ratio was due to increased utilization,
increased costs for physicians and hospitals in 1997, and lower
premium increases due to competitive market forces. The decrease in
expense ratio is due to increased premium volume and decreased
expenses in many areas due to concentrated cost-cutting efforts. See
- - Comparison of Years Ended December 31, 1997 and December 31, 1996
and Comparison of Years Ended December 31, 1996 and December 31,
1995.
11
The following table is a reconciliation of beginning and ending
reserves for claims losses and loss adjustment expenses (LAE)
balances:
Year Ended
1997 1996 1995 1994
(dollars in thousands)
Balance at January 1 $3,188 $2,710 $2,864 $2,558
Incurred related to:
Current year 30,237 23,350 20,310 19,920
Prior years 739 75 (5) 17
Total incurred 30,976 23,425 20,305 19,937
Paid related to:
Current year 26,217 20,248 17,425 17,142
Prior years 3,921 2,777 2,981 2,541
Total paid 30,138 23,025 20,406 19,683
Less reinsurance recoverables
at January 1 (92) (15) (68) (16)
Plus reinsurance recoverables
at December 31 230 93 15 68
Balance at December 31 $4,164 $3,188 $2,710 $2,864
The difference between the reserves reported in the accompanying
tables, which are presented in accordance with generally accepted
accounting principles (GAAP), and the statutory reserves reported to
state regulatory authorities was insignificant for all periods
presented.
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The following table presents the development of DAKOTACARE's
consolidated balance sheet reserves for reported and unreported
claims payable from 1989 through 1997. The top line of the table
shows the reserves at the balance sheet date for each of the
indicated periods. This represents the estimated amount of losses
and LAE arising in all prior years that are unpaid at the balance
sheet date, including estimates of claims incurred but not reported
(IBNR). The Company is not required to pay claims if they are
submitted over one year past the date of service. The Company also
has paid over 99% of the covered claims received and expected to be
received within one year after service. Since there would be minimal
impact on discounting claims reserves, the Company does not follow
the practice of discounting claims reserves.
As of December 31,
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
(dollars in thousands)
Reserves for unpaid losses 4,164 3,188 2,710 2,864 2,558 2,449 2,456 2,532 3,382 3,788
and LAE
Paid (cumulative) as of:
End of Year -- -- -- -- -- -- -- -- --
One Year Later 3,927 2,793 2,985 2,524 2,375 2,482 2,561 3,553 3,856
Two Years Later -- 2,793 2,977 2,519 2,392 2,553 2,511 3,561 3,856
Three Years Later -- -- 2,977 2,519 2,392 2,553 2,583 3,561 3,856
Four Years Later -- -- -- 2,519 2,392 2,553 2,583 3,561 3,856
Five Years Later -- -- -- -- 2,392 2,553 2,583 3,561 3,856
Six Years Later -- -- -- -- -- 2,553 2,583 3,561 3,856
Seven Years Later -- -- -- -- -- -- 2,583 3,561 3,856
Eight Years Later -- -- -- -- -- -- -- 3,561 3,856
Nine Years Later -- -- -- -- -- -- -- -- 3,856
Liability Reestimated as of:
End of Year 4,164 3,188 2,710 2,864 2,558 2,449 2,456 2,532 3,382 3,788
One Year Later 3,927 2,793 2,985 2,524 2,375 2,482 2,561 3,553 3,856
Two Years Later -- 2,793 2,977 2,519 2,392 2,553 2,511 3,561 3,856
Three Years Later -- -- 2,977 2,519 2,392 2,553 2,583 3,561 3,856
Four Years Later -- -- -- 2,519 2,392 2,553 2,583 3,561 3,856
Five Years Later -- -- -- -- 2,392 2,553 2,583 3,561 3,856
Six Years Later -- -- -- -- -- 2,553 2,583 3,561 3,856
Seven Years Later -- -- -- -- -- -- 2,583 3,561 3,856
Eight Years Later -- -- -- -- -- -- -- 3,561 3,856
Nine Years Later -- -- -- -- -- -- -- -- 3,856
Redundancy (Deficiency) -- (739) (83) (113) 39 57 (97) (51) (179) (68)
The Company is continually taking steps to improve its estimation of
reserves for unpaid losses and LAE. This includes, among other
things, improved underwriting standards, which stabilize the
Company's assumptions of risks, leading to more predictable estimate
of losses and loss reserves. Additional approaches have also been
developed to estimate the reserves. The Company believes its
reserves at December 31, 1997, are adequate.
13
RESULTS OF OPERATIONS
General
The following results of operations include the operations of
DAKOTACARE and its subsidiaries for the years ended December 31,
1997, 1996, and 1995.
COMPARISON OF YEARS DECEMBER 31, 1997 AND DECEMBER 31, 1996
General
The Company's net income decreased $1,150,749 to a loss of $110,108
for the year ended December 31, 1997, as compared to income of
$1,040,641 for the year ended December 31, 1996, representing a
110.6% decrease. This decrease was primarily due to an increase in
claims expenses of $7,550,999 which was offset by an increase of
$6,155,859 in total revenues and a $592,000 decrease in income taxes.
Revenues
Total revenues increased $6,155,859, or 18.4%, for the year ended
December 31, 1997, as compared to December 31, 1996. Revenues from
net premiums generated by the health maintenance organization
increased $5,858,240. This increase is attributable to a 19.4%
increase in the number of enrollees for the year ended December 31,
1997, as compared to December 31, 1996, and a 1.1% increase in the
premiums earned per enrollee. The increase in revenue per enrollee
was in line with national averages. The increase in enrollees was
due to the continued emphasis on small group (2 to 50 employees)
business and competitive rates in relation to the local marketplace.
Revenues from the third party administration fees decreased by
$158,296 as enrollees participating in the Company's subsidiaries'
TPA plans decreased. Investment income increased $63,400 due
primarily to an increase in the amount of assets invested.
Operating Expenses
Total operating expenses increased $7,884,842, or 24.8%, for the year
ended December 31, 1997, as compared to December 31, 1996. The
change was due primarily to an increase in claims incurred and
commission expenses, but was offset by a reduction of professional
fees.
Net claims expense increased by $7,550,999, or 32.2%. Average claims
per enrollee increased by 10.4% in 1997 as compared to 1996 while the
number of enrollees increased by 19.4%. Unusually high dollar claims
incurred in late 1996 were paid in 1997, which caused the average
claims per enrollee, claims expense and unreported claims payable to
increase more than expected. Commissions expense increased by
$287,783, or 23.5%, in 1997 as compared to 1996 due to the increased
activity of the HMO. The Company's subsidiaries decreased the number
of enrollees covered under various contracts from approximately
64,000 at January 1, 1997, to approximately 50,000 at January 1,
1998. Substantially all of the decrease occurred on renewals for
January 1, 1998, which kept the 1997 overall member months similar to
the member months for 1996. Professional fees expense decreased
$112,579, or 10.4%, in 1997 as compared to 1996. This was primarily
due to state legislation passed in 1997, which spread the cost of
each five-year exam for domiciled companies to all insurance
companies registered in the State. This caused a reduction in the
amount of accrued exam fees needed and thus reduced the overall
expense. Also, professional fees decreased by using consultants less
and by performing more duties in house.
Income Taxes
Income tax expense (credits) represents 46.7% and 33.3% of income
(loss) before income taxes and minority interest for the years ended
December 31, 1997 and 1996, respectively. In 1997, permanent tax
differences and the effect on the tax rate brackets increased the
estimated credits, thus increasing the related percentage. As a
result of previous levels of pretax earnings and the availability of
recoverable income taxes paid in recent years, no valuation allowance
is required for recorded deferred tax assets. See Note 8 of the
Notes to Consolidated Financial Statements.
COMPARISON OF YEARS DECEMBER 31, 1996 AND DECEMBER 31, 1995
General
The Company's net income decreased $749,524 to $1,040,641 for the
year ended December 31, 1996, as compared to $1,790,165 for the year
ended December 31, 1995, representing a 41.9% decrease. This
decrease was primarily due to an increase in claims expenses of
$3,120,623 which was offset by an increase of $2,912,418 in total
revenues and a $284,000 decrease in income taxes.
Revenues
Total revenues increased $2,912,418, or 9.5%, for the year ended
December 31, 1996, as compared to December 31, 1995. Revenues from
net premiums generated by the health maintenance organization
increased $2,044,586. This increase is attributable to a 23.1%
increase in the number of enrollees for the year ended December 31,
1996, as compared to December 31, 1995, and a 2.1% increase in the
premiums earned per enrollee. The increase in revenue per enrollee
was in line with national averages. The increase in enrollees was
primarily due to an emphasis on small group (2 to 50 employees)
business and competitive rates in relation to the local marketplace.
Revenues from the third party administration fees increased by
$763,043 as the Company's subsidiaries increased the number of
enrollees participating in these plans. Net investment income
increased $62,481 due primarily to an increase in the amount of
assets invested.
Operating Expenses
Total operating expenses increased $3,926,989, or 14.1%, for the year
ended December 31, 1996, as compared to December 31, 1995. This was
due to an increase in claims incurred, personnel expense,
professional fees expense, and office expense.
15
Net claims expense increased by $3,120,623, or 15.4%. Average claims
per enrollee increased by 9.6% in 1996 as compared to 1995 while the
number of enrollees increased by 23.1%. During 1996, the Company
paid out $71,253 in contingency reserve payments in excess of the
amount originally estimated. This amount was expensed in 1996.
Personnel expense increased by $478,980, or 14.9%, in 1996 as
compared to 1995 due to the increased activity of its subsidiaries
and additional employees for the Company as it expands its business.
The Company's subsidiaries have increased the number of enrollees
covered under various contracts from approximately 60,000 at January
1, 1996, to approximately 64,000 at January 1, 1997. Professional
fees expense increased $181,790, or 20.2%, in 1996 as compared to
1995. This was primarily due to increased consulting work being
performed and an increase in utilization review by outside companies
with increased enrollment. Office expense increased $33,735, or 5.0%,
primarily due to increases for printing, postage, and telephone
expenses as a result of the increase in enrollment in DAS and DHP.
Income Taxes
Income tax expense represents 33.3% and 31.24% of income before
income taxes and minority interest for the years ended December 31,
1996 and 1995, respectively. As a result of existing levels of
pretax earnings and the availability of recoverable income taxes paid
in recent years, no valuation allowance is required for recorded
deferred tax assets. See Note 8 of the Notes to Consolidated
Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of cash have been premium and fee
revenue, collection of premiums in advance of the claims cost
associated with them, and an agreement with participating physicians
in which a percentage of fees for services is withheld for cash flows
of the Company. The Company in the past has had borrowings from
banks and affiliated companies, but currently does not need to borrow
for liquidity purposes.
Net cash provided by operating activities increased by $81,739 to
$1,505,862 for the year ended December 31, 1997, as compared to 1996.
Net cash provided by operating activities increased primarily due to
an increase in reported and unreported claims payable and an increase
in contingency reserves payable since December 31, 1996. The net
cash provided by operating activities was offset by a net loss, an
increase in deferred income taxes receivable, and a decrease in
unearned premiums and administration fees since December 31, 1996.
Other uses of cash and cash equivalents were for the payment of
dividends and purchases of leasehold improvements and equipment. The
Company has invested cash not currently needed in operations into
intermediate-term bonds, consisting primarily of municipal bonds and
U.S. government securities. At December 31, 1997, the Company has
16
certificates of deposit of $500,000 on deposit with the Division to
meet the deposit requirements of state insurance laws.
The Company is not contractually obligated to pay out contingency
reserves withheld but has historically elected to pay out a majority
of amounts withheld. Typically, two years lapse from the date the
contingency reserves are withheld to the date which the corresponding
amounts are paid to the participating physicians.
The Company believes that cash flows generated by operations,
withholding of contingency reserves, cash on hand, and short-term
investment balances will be sufficient to fund operations, pay out
projected contingency reserves payable, and pay dividends on the
Class C common stock.
INFLATION
A substantial portion of the Company's operating expenses consist of
health care costs, which, in the general economy, have been rising at
a rate greater than that of the overall Consumer Price Index. The
Company believes that its cost control measures and risk sharing
arrangements reduce the effect of inflation on such costs.
Historically, market conditions and the regulatory environment in
which the Company operates have permitted the Company to offset a
portion or all of the impact of inflation on the cost of health care
benefits through premium increases. If the Company was not able to
continue to increase premiums, a material adverse impact on the
Company's operations could result. Inflation does not have a material
effect on the remainder of the Company's operating expenses.
TRENDS, EVENTS, OR UNCERTAINTIES
In recent years, there has been a trend by clients to switch to plans
with higher employee cost-sharing levels in order to maintain lower
premiums. As a provider of cost effective managed care plans for
medium and small employers, the Company believes it is delivering
products and services that address current health care reform issues.
The Company will continue to evaluate its business strategy as
necessary to maximize its ability to adapt to the changing health
care marketplace.
The Year 2000 issue is whether computer systems will properly
recognize date-sensitive information when the year changes to 2000.
Systems that do not properly recognize such information could
generate erroneous data or cause a system to fail. The Company is
heavily dependent on computer processing in its business activities
and the Year 2000 issue creates risk for the Company from unforeseen
problems in the Company's computer system and from third parties with
whom the Company processes financial information. Such failures of
the Company's computer system and/or third parties' computer systems
could have a material impact on the Company's ability to conduct its
17
business. In accordance with its remediation plan to resolve the
Year 2000 issue, the Company has substantially completed a
preliminary review of its computer systems to identify the systems
that could be affected by the Year 2000 issue. Based on the
Company's review of its computer systems, management believes the
cost of the remediation effort to make the systems year 2000
compliant is approximately $45,000. Management expects $30,000 and
$15,000 to be incurred in 1998 and 1999, respectively. Such costs
will be charged against income as they are incurred.
18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS
Page
Independent Auditor's Report F-1
Consolidated Financial Statements
Balance Sheets F-2
Statements of Income F-4
Statements of Stockholders' Equity F-5
Statements of Cash Flows F-6
Notes to Financial Statements F-8
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES
None.
19
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Positions
Frank D. Messner, M.D. 54 President and Director
Patrick Beckman 54 Vice President and Director
Guy E. Tam, M.D. 59 Secretary/Treasurer and Director
Robert L. Ferrell, M.D. 58 Director
K. Gene Koob, M.D. 55 Director
Ben J. Henderson, D.O. 56 Director
Jeffrey J. Rodman 42 Director
John E. Rittmann, M.D. 60 Director
James A. Engelbrecht, M.D. 50 Director
Robert D. Johnson 54 Chief Executive Officer
Kirk J. Zimmer 37 Senior Vice President
William O. Rossing, M.D. 63 Vice President, Medical Director
Sharon K. Duncan 50 Vice President, System Operations
Dean M. Krogman 48 Vice President, External Operations
Elizabeth D. Mendelson 44 Vice President, Underwriting
Barbara A. Smith 36 Vice President, Medical Services
Thomas N. Nicholson 38 Vice President, Sales and Marketing
Bruce E. Hanson 34 Vice President, Finance
Brian E. Meyer 35 Vice President, Information Systems
20
Dr. Messner became a director of the Company in June 1994. He is a
member of the South Dakota State Medical Association and has been
engaged as a radiologist in Yankton, South Dakota, since 1974.
Mr. Beckman became a director of the Company in June 1991. Mr.
Beckman has been engaged in the real estate business in Sioux Falls,
South Dakota, since 1969. Mr. Beckman was a principal in Beckman-Zea
Realty, Inc., from 1979 to 1992. Since then he is the sole owner of
Beckman Realty and Development Corporation.
Dr. Tam became a director of the Company in May 1990, and became
Secretary in September 1990. Dr. Tam is a member of the South Dakota
State Medical Association and has been engaged in practice as a
family practitioner in Sioux Falls, South Dakota, since 1968.
Dr. Ferrell has been a director since inception and became President
in May 1990. Dr. Ferrell is a past President of the South Dakota
State Medical Association and has been in practice as an otology,
laryngology, rhinology specialist in Rapid City, South Dakota, since
1973.
Dr. Koob became a director of the Company in June 1994. He is a
member of the South Dakota State Medical Association and has been
engaged as a neurologist in Sioux Falls, South Dakota, since 1974.
Dr. Henderson became a director of the Company in June 1995. He is a
member of the South Dakota State Medical Association and has been
engaged in the practice of internal medicine in Mobridge, South
Dakota, since 1972.
Mr. Rodman became a director of the Company in June 1996. Mr. Rodman
has been Executive Vice President of the South Dakota Banker's
Association since 1989. He has also served as Chairman of the South
Dakota Banker's Insurance Services, Inc., since 1993.
Dr. Rittmann became a director of the Company in June 1997. He is a
member of the South Dakota State Medical Association and has been
engaged in the practice as a family practitioner in Watertown, South
Dakota, since 1973.
Dr. Engelbrecht became a director of the Company in June 1997. He is
a member of the South Dakota State Medical Association and has been
engaged in the practice of internal medicine and rheumatology in
Rapid City, South Dakota, since 1980
Mr. Johnson became the Company's Chief Executive Officer upon its
inception. He has also served as the Chief Executive Officer of the
South Dakota State Medical Association since 1972, and as Chief
Executive Officer of the South Dakota Foundation for Medical Care
from 1973 to 1996.
Mr. Zimmer joined the Company in May 1988 and became the Company's
Senior Vice President in January 1990. Mr. Zimmer had been a Vice
President since November 1988. Mr. Zimmer had been previously
employed, since 1982, with McGladrey & Pullen, LLP, a national
21
certified public accountant firm and was a general services manager
from 1986 to 1988.
Dr. Rossing became the Company's Vice President and Medical Director
upon joining the Company in August 1996. Prior to his retirement
from active practice in July 1996, Dr. Rossing had been in the
practice of internal medicine in Sioux Falls, South Dakota, since
1966, following his tenure with the U.S. Army Medical Service.
Ms. Duncan became the Company's Vice President of System Operations
in February 1990. Prior to joining DAKOTACARE, Ms. Duncan had served
as Vice President with Blue Shield of South Dakota since 1986.
Mr. Krogman joined the Company in May 1993 and became the Company's
Vice President of External Operations in July 1994. Mr. Krogman is
also employed by the South Dakota State Medical Association. Mr.
Krogman has been a contract lobbyist since 1989 and was a
broker/owner of Borchardt/Krogman and Associates, a real estate
company, until 1993.
Ms. Mendelson joined the Company in November 1991 and became the
Company's Vice President of Underwriting in July 1995. Prior to
joining DAKOTACARE, Ms. Mendelson had served for nine years at Blue
Shield of California, most recently as Senior Manager, Individual
Products.
Ms. Smith joined the Company in June 1996 and became the Company's
Vice President of Operations in September 1996. Prior to joining the
Company, Ms. Smith had served for four years as the Secretary of the
South Dakota Department of Health and for the prior two years as
Special Advisor to the Governor of the State of South Dakota.
Mr. Nicholson joined the Company in July 1996 as the Vice President
of Sales and Marketing. Mr. Nicholson had been previously employed,
since 1981, by the Williams Insurance Agency and was an Executive
Vice President since 1994.
Mr. Hanson joined the Company in December 1996 and became the Vice
President of Finance in March 1997. Mr. Hanson had been in private
practice as a certified public accountant since 1991, and previously
had been employed, since 1985, with Charles Bailly & Co., a regional
certified public accountant firm.
Mr. Meyer joined the Company in July 1997 as the Vice President of
Information Systems. Mr. Meyer had been previously employed since
1985 with Berkly Information Services and was Vice President of
Systems Development since 1990.
Pursuant to the Company's Bylaws, the Board of Directors consists of
ten directors who are elected for three-year terms expiring at each
successive annual meeting of shareholders. Currently, no director
may serve more than three consecutive terms. One director position
is currently vacant. Dr. James Jackson and Dr. Douglas Holum
resigned in June 1997, while Dr. John Rittmann and Dr. James
22
Engelbrecht commenced in June 1997. The terms of Dr. Robert Ferrell,
Dr. John Rittmann, and Dr. Ben Henderson expire at the 1998 Annual
Meeting of Shareholders; the terms of Dr. Guy Tam, Mr. Patrick
Beckman, and Mr. Jeffrey Rodman expire at the 1999 Annual Meeting of
Shareholders; and the terms of Dr. K. Gene Koob, Dr. Frank Messner,
and Dr. James Engelbrecht expire at the 2000 Annual Meeting of
Shareholders. The Bylaws currently require that eight of the
directors be holders of Class A voting preferred stock of the Company
and two of the directors be consumers. The Articles of Incorporation
restrict ownership of Class A voting preferred stock to medical or
osteopathic physicians who have executed Participating Physician
Agreements with the Company. To assure equal eligibility and
opportunity throughout the state of South Dakota and avoid domination
of the Board of Directors by any geographic area or areas, the number
of physician directors from any one District Medical Society of the
South Dakota State Medical Association can not exceed two. The
consumer directors may be from any geographic location which is
served by South Dakota State Medical Holding Company and their
residence does not affect the geographic restriction for physician
directors. The two consumer directors are currently Mr. Patrick
Beckman and Mr. Jeffrey Rodman. The officers of the Company are
appointed by the Board of Directors and hold office until their
successors are chosen and qualified.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors and executive officers, and persons who own more
than ten percent of a registered class of the Company's equity
securities, to file with the Securities and Exchange Commission
initial reports of ownership and reports of changes in ownership of
Common Stock and other equity securities of the Company. Officers,
directors and greater than ten-percent stockholders are also required
by SEC regulation to furnish the Company with copies of all Section
16(a) forms they file.
To the Company's knowledge, based solely on review of the copies of
such reports furnished to the Company and written representations
that no other reports were required, during the fiscal year ended
December 31, 1997, all Section 16(a) filing requirements applicable
to its officers, directors and greater than ten-percent beneficial
owners were timely complied with except that Dr. Rittmann, Dr.
Engelbrecht, and Mr. Meyer filed their initial report of beneficial
ownership on Form 3 late.
23
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
(a) (b) (c) (i)
Name and Principal All Other
Position Year Salary $ Compensation(1)
Robert D. Johnson 1997 $76,367 $14,380
Chief Executive Officer 1996 $58,632 $12,373
1995 $41,330 $13,968
William Rossing, M.D. 1997 $107,195 --
Vice President, 1996 $39,230 --
Medical Director 1995 -- --
Kirk J. Zimmer 1997 $106,738 $14,000
Senior Vice President 1996 $95,025 $12,176
1995 $72,492 $8,436
Thomas N. Nicholson 1997 $120,101 --
Vice President, Marketing 1996 $57,558 --
1995 -- --
(1) Consists of retirement plan contribution and premiums paid on the
deferred compensation plan.
No other officer received total annual salary and bonus in excess of
$100,000 during 1997, 1996, or 1995. The Board of Directors receive
$250 per Board meeting attended and are reimbursed for costs
associated with the attendance of such meetings. The Company
currently has no stock options or other equity-based compensation for
its directors, officers, or employees.
The Company intends to enter into indemnification agreements with
each executive officer and director. The Company has employment
agreements with its executive officers and maintains key person
insurance of $250,000 on Robert D. Johnson and $188,700 on Kirk J.
Zimmer.
In connection with employment contracts between the Company, the
Chief Executive Officer, and the Senior Vice President, provision has
been made for the future compensation which is payable upon the
completion of the earlier of 25 years of service or any earlier
retirement age specified by the Board of Directors by resolution.
The contracts only provide compensation incentives for the executives
At December 31, 1997, $49,164 has been accrued under these contracts.
24
Compensation Committee Interlocks and Insider Participation
The Board of Directors currently performs the functions of a
compensation committee. Robert D. Johnson participates in the
deliberation of all officer's compensation except for his salary.
There are no compensation committee interlocks with other companies
and none of the nonemployee directors has been an officer, employee,
or insider of the Company or its subsidiaries.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth information, as of March 20, 1998,
regarding the beneficial ownership of securities of the Company by
(i) each person or group who is known by the Company to be the
beneficial owner of more than 5% of the outstanding voting
securities, (ii) all directors of the Company, (iii) each of the
executive officers of the Company named in the Summary Compensation
Table, and (iv) all directors and executive officers of the Company
as a group. The Company believes that the beneficial owners of the
securities listed below, based on information furnished by such
owners, have sole voting and investment power (or shares such powers
with his or her spouse), subject to the terms of the respective
classes of securities of the Company and the information contained in
the notes to the table.
25
Amount & Nature
Title Name and Address of of Beneficial Percent
of Class Beneficial Owner Ownership of Class
Class B Preferred South Dakota State 1,300 100%
Medical Association(1)
1323 South Minnesota Avenue
Sioux Falls, SD 57105
Class C Common Lloyd Solberg, M.D. 133,360 8.86%
P. O. Box 5054
Sioux Falls, SD 57117-5054
Class A Preferred Robert L. Ferrell, M.D. 1 .10%
Class C Common 31,840 2.11%
Class A Preferred Guy E. Tam, M.D. 1 .10%
Class C Common 4,360 .29%
Class C Common Patrick Beckman -- --
Class A Preferred Frank D. Messner, M.D. 1 .10%
Class C Common 8,800 .58%
Class A Preferred K. Gene Koob, M.D. 1 .10%
Class A Preferred Ben J. Henderson, D.O. 1 .10%
Class C Common 560 .04%
Class C Common Jeffrey J. Rodman -- --
Class A Preferred James Engelbrecht, M.D. 1 .10%
Class A Preferred John Rittmann, M.D. 1 .10%
Class C Common 8,340 .55%
Class C Common Robert D. Johnson(2) 14,560 .97%
1323 South Minnesota Avenue
Sioux Falls, SD 57105
Class C Common William Rossing, M.D. 8,720 .58%
Class C Common Kirk J. Zimmer 800 .05%
Class C Common Thomas Nicholson -- --
Class A Preferred All Directors and Executive 7 .65%
Officers as a Group
Class C Common (18 people) 77,980 5.18%
(1) The South Dakota State Medical Association is an affiliated company.
(2) Robert D. Johnson is the Chief Executive Officer of the South Dakota State
Medical Association.
26
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company leases office space from the Association. During 1997,
the Company signed a one year lease, which expired December 31, 1997.
Under the terms of the lease, the lease automatically renewed for a
successive one year term and will renew for successive one year terms
thereafter unless terminated with at least 30 days notice prior to
the end of the lease term. The 1998 lease requires minimum rental
payments of $204,870. Total rental payments for office space for the
years December 31, 1997, 1996 and 1995 was $186,500, $158,400 and
$144,650, respectively.
The Company provides group health insurance coverage for employees of
the Association. Total premium income from the affiliate for the
years ended December 31, 1997, 1996 and 1995 was $42,517, $45,535,
and $52,125, respectively.
Robert D. Johnson received salaries and retirement contributions
totaling $104,210, $110,934, and $110,628, from the South Dakota
State Medical Association for the years ended 1997, 1996, and 1995,
respectively.
27
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K
The following documents are filed as part of this report:
FINANCIAL STATEMENTS Page
Independent Auditor's Report F-1
Consolidated Financial Statements
Balance Sheets F-2
Statements of Income F-4
Statements of Stockholders' Equity F-5
Statements of Cash Flows F-6
Notes to Financial Statements F-8
EXHIBITS
Exhibit No. Description
3.1 The Amended and Restated Articles of Incorporation of
the Company (incorporated by reference to Exhibit 3.1
to the Company's Form 8-A, as filed with the
Securities and Exchange Commission on January 19, 1996)
3.2 The Amended and Restated Bylaws of the Company
(incorporated by reference to Exhibit 3.2 to the
Company's Form 8-A, as filed with the Securities and
Exchange Commission on January 19, 1996)
4.1 Form of Specimen Certificate for Class A Voting
Preferred Stock (incorporated by reference to Exhibit
to the Company's Form 8-A, as filed with the
Securities and Exchange Commission on January 19, 1996)
4.2 Form of Stock Certificate for Class C Non-Voting Common Stock
10 Office Lease with the South Dakota State Medical
Association (incorporated by reference to Exhibit 10
to the Company's Form 10-K, as filed with the
Securities and Exchange Commission on March 27, 1997)
10.1 Amendment of Office Lease with the South Dakota State
Medical Association
21 Subsidiaries of the Registrant
27 Financial Data Schedule
REPORTS ON FORM 8-K
None.
28
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
By _/s/Robert D. Johnson______Dated __03/20/98
Robert D. Johnson
Chief Executive Officer
(Principal Executive Officer)
By _/s/Kirk J. Zimmer______Dated __03/20/98
Kirk J. Zimmer
Senior Vice President
(Principal Financial Officer)
By _/s/Bruce E. Hanson______Dated __03/20/98
Bruce E. Hanson
Vice President Finance
(Principal Accounting Officer)
By _/s/Robert L. Ferrell, M.D.______Dated __03/20/98
Robert L. Ferrell, M.D.
Director
By _/s/Guy E. Tam, M.D.______Dated __03/20/98
Guy E. Tam, M.D.
Director
By _/s/James Engelbrecht, M.D.______Dated __03/20/98
James Engelbrecht, M.D.
Director
By _/s/Patrick Beckman______Dated __03/20/98
Patrick Beckman
Director
29
By _/s/Frank Messner, M.D.______Dated __03/20/98
Frank Messner, M.D.
Director
By _/s/K. Gene Koob, M.D.______Dated __03/20/98
K. Gene Koob, M.D.
Director
By _/s/Ben J. Henderson, D.O.______Dated __03/20/98
Ben J. Henderson, D.O.
Director
By _/s/Jeffrey J. Rodman______Dated __03/20/98
Jeffrey J. Rodman
Director
By _/s/John Rittmann, M.D.______Dated __03/20/98
John Rittmann, M.D.
Director
30
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
South Dakota State Medical Holding Company, Incorporated
d/b/a DAKOTACARE
Sioux Falls, South Dakota
We have audited the accompanying consolidated balance sheets of South
Dakota State Medical Holding Company, Incorporated d/b/a DAKOTACARE
and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial
position of South Dakota State Medical Holding Company, Incorporated
d/b/a DAKOTACARE and subsidiaries as of December 31, 1997 and 1996,
and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
_/s/_McGladrey & Pullen, LLP
Sioux Falls, South Dakota
March 18, 1998
F-1
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a
DAKOTACARE CONSOLIDATED BALANCE SHEETS December 31, 1997 and 1996
ASSETS 1997 1996
Current Assets
Cash and cash equivalents $ 4,467,754 $ 3,422,692
Investment in securities held
to maturity (Note 5) 901,599 524,511
Certificates of deposit 843,559 875,000
Receivables (Note 3) 799,395 836,364
Prepaids and other assets 124,729 138,487
Deferred income taxes (Note 8) 720,000 518,000
Total current assets 7,857,036 6,315,054
Long-Term Investments
Investment in securities held
to maturity (Note 5) 3,837,081 4,034,271
Investment in securities available
for sale (Note 5) 300,000 288,550
Pledged certificates of deposit (Note 5) 500,000 500,000
Certificates of deposit 50,000 159,765
Cash surrender value of life insurance 81,000 69,000
4,768,081 5,051,586
Property and Equipment, at cost,
net of accumulated depreciation 963,684 1,070,650
Deferred Income Taxes (Note 8) 422,000 340,000
$14,010,801 $12,777,290
See Notes to Consolidated Financial Statements.
F-2
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
Current Liabilities
Reported and unreported
claims payable (Note 7) $ 4,163,804 $ 3,188,455
Unearned premiums and administration fees 629,783 854,905
Accounts payable and accrued expenses 695,050 679,421
Contingency reserves payable (Note 6) 1,627,000 950,000
Total current liabilities 7,115,637 5,672,781
Contingency Reserves Payable (Note 6) 1,336,846 1,155,294
Minority Interest in Subsidiary 354,160 309,143
Commitments and Contingencies
(Notes 4, 12 and 14)
Stockholders' Equity (Notes 9 and 15)
Class A preferred, voting, no par value,
$10 stated value, 2,500 shares authorized;
issued and outstanding 1,069 and 1,042
shares at December 31, 1997 and 1996 10,690 10,420
Class B preferred, voting, no par value,
$1 stated value, 2,500 shares authorized;
issued and outstanding 1,300 shares at
December 31, 1997 and 1996 1,300 1,300
Class C common, nonvoting, $.01 par value,
10,000,000 shares authorized; issued and
outstanding 1,505,760 shares 15,058 15,058
Additional paid-in capital 3,749,342 3,749,342
Retained earnings 1,435,709 1,877,084
Unrealized loss on securities available
for sale (7,941) (13,132)
5,204,158 5,640,072
$14,010,801 $12,777,290
F-3
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1997, 1996 and 1995
1997 1996 1995
Revenues:
Premiums $ 35,124,035 $ 29,071,245 $ 27,056,671
Less premiums ceded for reinsurance (369,888) (383,408) (413,420)
34,754,147 28,687,837 26,643,251
Third party administration fees 3,628,131 3,786,427 3,023,384
Investment income 615,134 551,734 489,253
Other income 583,648 399,203 356,895
Total revenues 39,581,060 33,425,201 30,512,783
Operating expenses:
Claims incurred 31,593,161 23,528,141 20,667,382
Less reinsurance recoveries (616,801) (102,780) (362,644)
30,976,360 23,425,361 20,304,738
Personnel expenses 3,804,217 3,703,067 3,224,087
Commissions 1,513,054 1,225,271 1,109,817
Professional fees expenses 970,237 1,082,816 901,026
Office expenses 673,114 713,964 680,229
Occupancy expenses 656,951 625,541 518,527
State insurance taxes 421,622 330,574 319,837
Advertising expenses 378,310 386,174 519,907
Other general and administrative
expenses 309,286 325,541 313,152
Total operating expenses 39,703,151 31,818,309 27,891,320
Income (loss) before income
taxes and minority interest (122,091) 1,606,892 2,621,463
Income taxes (credits) (Note 8) (57,000) 535,000 819,000
Income (loss) before minority
interest (65,091) 1,071,892 1,802,463
Minority interest in income
of subsidiary 45,017 31,251 12,298
Net income (loss) $ (110,108) $ 1,040,641 $ 1,790,165
Earnings (loss) per common share $ (0.07) $ 0.69 $ 1.19
See Notes to Consolidated Financial Statements.
F-4
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1997, 1996 and 1995
Unrealized
Loss on
Additional Retained Securities
Capital Paid-In Earnings Available
Stock Capital (Deficit) for Sale
Balance, December 31, 1994 $ 47,844 $ 3,726,756 $ (372,122) $ (30,589)
Issuance of Class A common stock 910 - - -
Redemption of Class A
common stock (350) - - -
Dividends paid on Class C
preferred stock - - (310,563) -
Adjustment to reflect
recapitalization effective
December 29, 1995 (Note 9) (22,586) 22,586 - -
Decrease in unrealized loss on
securities available for sale - - - 27,540
Net income - - 1,790,165 -
Balance, December 31, 1995 25,818 3,749,342 1,107,480 (3,049)
Issuance of Class A
preferred stock 990 - - -
Redemption of Class A
preferred stock (330) - - -
Issuance of Class B
preferred stock 300 - - -
Dividends paid on Class C common
stock - - (271,037) -
Increase in unrealized loss on
securities available for sale - - - (10,083)
Net income - - 1,040,641 -
Balance, December 31, 1996 26,778 3,749,342 1,877,084 (13,132)
Issuance of Class A preferred
stock 1,940 - - -
Redemption of Class A preferred
stock (1,670) - - -
Dividends paid on Class C
common stock - - (331,267) -
Decrease in unrealized loss on
securities available for sale - - - 5,191
Net (loss) - - (110,108) -
Balance, December 31, 1997 $ 27,048 $ 3,749,342 $ 1,435,709 $ (7,941)
See Notes to Consolidated Financial Statements.
F-5
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997, 1996 and 1995
1997 1996 1995
Cash Flows From Operating Activities
Net income (loss) $ (110,108) $ 1,040,641 $ 1,790,165
Adjustments to reconcile net
income (loss) to net cash provided
by operating activities:
Depreciation 319,493 318,297 251,222
Loss on disposal of property and equipment - 1,664 -
Minority interest in income of subsidiary 45,017 31,251 12,298
Amortization of discounts and premiums
on investments and certificates of
deposit, net (139,675) (103,151) (100,888)
(Increase) decrease in receivables 36,969 (301,794) (68,892)
(Increase) decrease in prepaids
and other assets 13,758 (66,530) (6,111)
(Increase) in deferred income taxes (284,000) (57,000) (120,000)
Increase (decrease) in reported and
unreported claims payable 975,349 478,455 (154,000)
Increase (decrease) in accounts payable
and accrued expenses 15,629 (107,587) (21,028)
Increase (decrease) in unearned premiums
and administration fees (225,122) 39,252 3,692
Increase in contingency reserves payable 858,552 150,625 257,744
Net cash provided by operating activities 1,505,862 1,424,123 1,844,202
Cash Flows From Investing Activities
Purchase of securities available for sale (6,259) (5,933) (5,660)
Held to maturity securities:
Matured 525,000 1,200,000 1,147,884
Purchased (726,030) (1,983,309) (1,386,995)
Repayments on collateralized
mortgage obligations 157,013 133,471 45,409
Proceeds from maturities of certificates
of deposit 1,470,000 1,104,900 1,200,000
Purchase of certificates of deposit (1,325,000) (1,531,959) (1,604,900)
(Increase) in cash surrender value of
life insurance (12,000) (18,000) (11,000)
Purchase of property and equipment (231,238) (216,720) (637,994)
Proceeds from sale of property
and equipment 18,711 - -
Net cash (used in) investing activities (129,803) (1,317,550) (1,253,256)
See Notes to Consolidated Financial Statements.
F-6
1997 1996 1995
Cash Flows From Financing Activities
Proceeds from issuance of capital stock $ 1,940 $ 1,290 $ 910
Redemption of capital stock (1,670) (330) (350)
Payment of dividends (331,267) (271,037) (310,563)
Minority investment in subsidiary - - 15,000
Net cash (used in) financing activities (330,997) (270,077) (295,003)
Increase (decrease) in cash and
cash equivalents 1,045,062 (163,504) 295,943
Cash and Cash Equivalents
Beginning 3,422,692 3,586,196 3,290,253
Ending $ 4,467,754 $ 3,422,692 $ 3,586,196
Supplemental Disclosures of Cash
Flow Information
Cash payments for:
Income taxes, net of refunds $ 2,000 $ 790,000 $ 881,008
Supplemental Disclosures of Noncash
Investing and Financing Activities
(Increase) decrease in unrealized loss
on securities available for sale 5,191 (10,083) 27,540
(Decrease) in Class C common stock due
to recapitalization - - (22,586)
Increase in additional paid-in capital
due to recapitalization - - 22,586
F-7
Note 1. Nature of Business and Significant Accounting Policies
Nature of business: South Dakota State Medical Holding Company,
Incorporated (the Company), is a South Dakota licensed health
maintenance organization (HMO) d/b/a DAKOTACARE. The Company has
contracted with hospitals, physicians and other providers to provide
health care services to policyholders. Policyholders are employee
groups located in South Dakota.
A summary of the Company's significant accounting policies follows:
Principles of consolidation: The accompanying consolidated financial
statements include the accounts of the Company, its wholly-owned
subsidiaries, DAKOTACARE Administrative Services, Incorporated (DAS),
and DAKOTACARE Insurance, LTD. (DIL), and its 50.11% owned
subsidiary, Dakota Health Plans, Incorporated (DHP). DAS & DHP's
primary activity is as third party administrators of health care
plans for independent employer companies. DIL's primary activity is
in providing reinsurance quota share excess medical stop loss
coverage to DAS and DHP's self funded customers. All intercompany
balances and transactions have been eliminated in consolidation.
Basis of financial statement presentation: The consolidated
financial statements have been prepared in conformity with generally
accepted accounting principles. In preparing the financial
statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the
date of the balance sheet. Actual results could differ significantly
from those estimates. Material estimates that are particularly
susceptible to significant change in the near-term relate to the
liabilities for reported and unreported claims payable.
Cash and cash equivalents: For purposes of reporting the statements
of cash flows, the Company includes as cash equivalents all cash
accounts and highly liquid debt instruments which are not subject to
withdrawal restrictions or penalties. Certificates of deposit are
considered investments as all have been purchased with maturities in
excess of ninety days.
Investment securities: Investment securities classified as held to
maturity are those debt securities that the Company has both the
intent and ability to hold to maturity regardless of changes in
market condition, liquidity needs, or changes in general economic
conditions. These securities are stated at amortized cost.
Investment securities classified as available for sale are marketable
equity securities and those debt securities that the Company intends
to hold for an indefinite period of time, but not necessarily to
maturity. Any decision to sell a security classified as available
for sale would be based on various factors, including significant
movements in interest rates, changes in the maturity mix of the
Company's assets and liabilities, liquidity needs, regulatory capital
considerations, and other similar factors. Investment securities
available for sale are carried at fair value. Unrealized gains or
losses are reported as increases or decreases in equity, net of the
related deferred tax effect.
F-8
Note 1. Nature of Business and Significant Accounting Policies (continued)
Investment securities (continued): Premiums and discounts on
investments in debt securities are amortized over their contractual
lives, except for collateralized mortgage obligations, for which
prepayments are probable and predictable, which are amortized over
the estimated expected repayment terms of the underlying mortgages.
The method of amortization results in a constant effective yield on
those securities (the interest method). Interest on debt securities
is recognized in income as accrued. Realized gains and losses on the
sale of investment securities are determined using the specific
identification method.
Depreciation: Building and building improvements are depreciated
using straight-line methods over the estimated useful lives of the
assets, which are twenty to thirty-nine years. Depreciation on
furniture, equipment and automobiles is computed using straight-line
methods based upon the estimated useful lives of the respective
assets, which is principally five to seven years. A summary of
property and equipment is as follows:
1997 1996
Furniture, equipment and automobiles $ 2,253,358 $ 2,190,608
Building and building improvements 62,609 -
Other 131,967 72,817
2,447,934 2,263,425
Less accumulated depreciation 1,484,250 1,192,775
$ 963,684 $ 1,070,650
Revenue recognition: Premiums are billed in advance of their
respective coverage periods. Income from such premiums is recorded
as earned during the coverage period; the unearned portion of
premiums received prior to the end of the coverage period is recorded
as unearned premiums. Revenue is reduced by reinsurance premiums
ceded to reinsurance companies. Third party administration fees are
recorded as earned in the period in which the related services are
performed. The unearned portion of fees received but not earned
prior to the end of the contract is recorded as unearned
administration fees.
Reported and unreported claims payable: The coverage offered by the
Company is on an occurrence basis which provides for payment of
claims which occur during the period of coverage regardless of when
the claims are reported. Reported and unreported claims payable
consist of actual claims reported to be paid and estimates of health
care services rendered but not reported and to be paid. The
liabilities for reported and unreported claims payable have been
estimated by utilizing statistical information developed from
historical data, current enrollment, health service utilization
statistics and other related information. In addition, the Company
uses the services of an independent actuary in the determination of
its year end liabilities. The accruals are continually monitored and
reviewed and as adjustments to the estimated liabilities become
necessary, such adjustments are reflected in current operations.
F-9
Note 1. Nature of Business and Significant Accounting Policies (continued)
Income taxes: Deferred taxes are provided on a liability method
whereby deferred tax assets are recognized for deductible temporary
differences and operating loss and tax credit carryforwards and
deferred tax liabilities are recognized for taxable temporary
differences. Temporary differences are the differences between the
reported amounts of assets and liabilities and their tax bases.
Deferred tax assets are reduced by a valuation allowance when, in the
opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized. Deferred tax
assets and liabilities are adjusted for the effects of changes in tax
laws and rates on the date of enactment.
Earnings (loss) per common share: Earnings per common share for 1995
has been restated from the amount previously reported to give
retroactive effect to the recapitalization discussed in Note 9.
Earnings (loss) per common share is calculated in accordance with the
provisions of FASB Statement No. 128, "Earnings Per Share", which was
effective for 1997. This Statement establishes standards for
computing and presenting earnings (loss) per share (EPS). It
replaces the presentation of primary EPS with a presentation of basic
EPS. It also requires dual presentation of basic and diluted EPS on
the face of an income statement for all entities with complex capital
structures. This Statement requires restatement of all prior-period
EPS data presented. All references to earnings (loss) per share in
the consolidated financial statements are to basic earnings (loss)
per share. No restatement of EPS was necessary as a result of the
application of Statement No. 128. Earnings (loss) per common share
was calculated by dividing net income (loss) by the weighted average
number of Class C common shares outstanding during each period. The
weighted average number of Class C common shares outstanding was
1,505,760 in 1997, 1996 and 1995, respectively.
Note 2. Fair Value of Financial Instruments
Financial Accounting Standards Board (FASB) Statement No. 107,
"Disclosures About Fair Value of Financial Instruments", requires
disclosure of fair value information about financial instruments,
whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. Statement No. 107 excludes
certain financial instruments and all nonfinancial instruments from
its disclosure requirements.
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is
practicable to estimate that value:
Cash and cash equivalents and certificates of deposit: The carrying
amount approximates fair value because of the relative short maturity
of those instruments.
F-10
Note 2. Fair Value of Financial Instruments (continued)
Investments: Fair values for the Company's investment securities are
based on quoted market prices. At December 31, 1997, the carrying
amount and fair value of the Company's investment securities was
$5,038,680 and $5,141,045, respectively. At December 31, 1996, the
carrying amount and fair value of the Company's investment securities
was $4,847,332 and $4,872,684, respectively.
Accrued interest receivable: The carrying amount approximates fair
value due to the nature of the balances recorded.
Note 3. Receivables
Receivables are recorded at net estimated collectible amounts and
consist of the following:
1997 1996
Commissions $ 4,300 $ 31,250
Drug manufacturer chargebacks 68,850 86,547
Premiums 151,298 120,363
Subrogation, net of recovery expenses 75,000 75,000
Interest 30,367 34,689
Reinsurance (Note 4) 229,486 92,579
Income taxes 22,000 223,000
Funds withheld by ceding insurer 118,804 77,455
Other 99,290 95,481
799,395 836,364
Less allowance for doubtful accounts - -
$ 799,395 $ 836,364
Note 4. Reinsurance
The Company's policy is to reinsure that portion of risk in excess of
$85,000 of covered hospital inpatient expenses of any enrollee per
contract year, subject to a coinsurance provision which ranges from
50% to 90% based on average daily amounts specified in the plan, and
a $2,000,000 lifetime maximum benefit per enrollee. The Company
would be liable for any obligations that the reinsuring company is
unable to meet under the reinsurance agreement.
This reinsurance agreement also provides for enrollee benefits to be
paid in the event the Company should cease operations or become
insolvent, and a conversion privilege for all enrollees in the event
of plan insolvency and for any enrollee that moves out of the service
area of the Company.
F-11
Note 5. Investment Securities
Investment securities at December 31, 1997 are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
Debt securities held to maturity:
Obligations of U.S. treasury,
government agencies and
corporations $1,630,630 $ 36,001 $ - $1,666,631
Obligations of state and political
subdivisions 2,760,837 69,718 (483) 2,830,072
U.S. governmental agency
collateralized mortgage
obligations 347,213 151 (3,022) 344,342
$4,738,680 $105,870 $(3,505) $4,841,045
Equity securities available
for sale:
Bond mutual funds $ 307,941 $ - $(7,941) $ 300,000
The amortized cost and estimated fair values of debt securities, by
contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because the borrowers may have the
right to call or prepay obligations with or without call or
prepayment penalties.
December 31, 1997
Amortized Estimated
Cost Fair Value
Due in one year $ 901,599 $ 903,074
Due after one year through five years 2,093,776 2,126,987
Due after five years through ten years 1,322,886 1,388,931
Due after ten years 73,206 77,711
4,391,467 4,496,703
Collateralized mortgage obligations 347,213 344,342
$4,738,680 $4,841,045
F-12
Note 5. Investment Securities (continued)
Investment securities at December 31, 1996 are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
Debt securities held to maturity:
Obligations of U.S. treasury,
government agencies and
corporations $1,966,481 $ 17,480 $ (491) $1,983,470
Obligations of state and political
subdivisions 2,090,031 37,004 (19,136) 2,107,899
U.S. governmental agency
collateralized mortgage obligations 502,270 - (9,505) 492,765
$4,558,782 $54,484 $(29,132) $4,584,134
Equity securities available for sale:
Bond mutual funds $ 301,682 $ - $(13,132) $ 288,550
There were no sales of debt or equity securities during the years
ended December 31, 1997, 1996 or 1995. At December 31, 1997 and
1996, no individual investments in obligations of state and political
subdivisions exceeded 10% of the Company's equity.
At December 31, 1997 and 1996, the Company had certificates of
deposit of $500,000 on deposit with the South Dakota Department of
Commerce and Regulation, Division of Insurance (Division of
Insurance), to meet the deposit requirement of state insurance laws.
F-13
Note 6. Contingency Reserves Payable
The Company's agreements with participating physicians provide that
up to 20% of fees for services provided, as submitted to the Company,
may be withheld to provide a contingency reserve that may be used to
fund operations or meet other financial requirements of the Company.
Effective January 1, 1994, the percentage withheld from participating
physicians was reduced from 20% to 15%. The amounts withheld may be
paid to the participating physicians at the discretion of the Board
of Directors of the Company, although the Company is not
contractually obligated to pay out amounts withheld. Management
estimates the expected amount of contingency reserves to be paid to
participating physicians and records a liability based upon factors
such as cash flow needs, net income, and accumulations of amounts
withheld. Payments to physicians are made at such times as the Board
of Directors approves payouts. The recorded liability is equal to
actual amounts withheld for the years ended December 31, 1997 and
1996. The recorded liability for years prior to 1996 was an estimate
of the projected payouts for corresponding amounts withheld.
Payments to physicians in 1996 exceeded amounts accrued by $71,253,
which was accounted for as a change in accounting estimate.
Note 7. Reported and Unreported Claims Payable
Activity in the liability for reported and unreported claims payable
is summarized as follows:
1997 1996 1995
Balance at January 1 $ 3,188,455 $ 2,710,000 $ 2,864,000
Incurred related to:
Current year 30,237,417 23,350,462 20,309,552
Prior years 738,943 74,899 (4,814)
Total incurred 30,976,360 23,425,361 20,304,738
Paid related to:
Current year 26,217,052 20,247,806 17,425,015
Prior years 3,920,866 2,776,707 2,980,476
Total paid 30,137,918 23,024,513 20,405,491
Less reinsurance recoverables at
January 1 (92,579) (14,972) (68,219)
Plus reinsurance recoverables at
December 31 229,486 92,579 14,972
Balance at December 31 $ 4,163,804 $ 3,188,455 $ 2,710,000
F-14
Note 8. Income Tax Matters
The Company is taxable as a property and casualty insurance company
under section 831 of the Internal Revenue Code. The code prescribes
certain adjustments to book income to arrive at taxable income which
include adjustments to unearned premiums, discounting of loss
reserves and proration of tax-exempt income. In addition, increases
in contingency reserves, which are included as claims expenses, are
not allowable as tax deductions until actually paid. The Company
files a consolidated income tax return with its wholly-owned
subsidiaries, DAS and DIL.
The components of income tax expense as of December 31 are as
follows:
1997 1996 1995
Current $ 227,000 $ 592,000 $ 939,000
Deferred (credits) (284,000) (57,000) (120,000)
$ (57,000) $ 535,000 $ 819,000
Total income tax expense differed from the amounts computed by
applying the U.S. federal income tax rate of 35 percent to income
before income taxes as a result of the following:
1997 1996 1995
Computed "expected" tax expense (credits) $ (42,700) $ 562,400 $ 917,500
Tax exempt interest (38,861) (30,771) (28,760)
Lobbying 9,105 6,825 5,664
Effect of tax rate brackets and other 15,456 (3,454) (75,404)
$ (57,000) $ 535,000 $ 819,000
F-15
Note 8. Income Tax Matters (continued)
The net deferred tax assets consist of the following components at
December 31:
1997 1996
Deferred tax assets:
Contingency reserves payable $ 1,008,000 $ 716,000
Reported and unreported claims payable 42,000 62,000
Unearned premiums 43,000 53,000
Accrued expenses 65,000 78,000
Net operating loss carryforward of subsidiary 47,000 -
1,205,000 909,000
Less valuation allowance - -
1,205,000 909,000
Deferred tax liability:
Property and equipment (63,000) (51,000)
$ 1,142,000 $ 858,000
Reflected on the accompanying balance sheets as follows:
1997 1996
Current assets $ 720,000 $ 518,000
Noncurrent assets 422,000 340,000
$1,142,000 $ 858,000
F-16
Note 9. Capital Stock
On December 28, 1995, the holders of Class A, B, and C stock approved
a recapitalization plan which became effective December 29, 1995.
Under the recapitalization plan, the former Class A voting common
stock became Class A voting preferred stock. The Class A preferred
stock is not entitled to receive dividends or other distributions,
except for redemption by the Company. In the event of a liquidation,
each share of Class A preferred stock would be given priority over
Class B and C stock and would be entitled to receive a preferential
payment in an amount up to (and not to exceed) its stated value of
$10 per share. The Class A preferred stock continues to be
restricted to ownership by medical and osteopathic physicians who
have executed a participating physician agreement with the Company
and may not be issued to or held by a hospital.
Also under the recapitalization plan, the former Class B voting
common stock became Class B voting preferred stock. The Class B
preferred stock continues to be restricted to ownership by the South
Dakota State Medical Association, an affiliated company, and is not
entitled to receive dividends.
Pursuant to the recapitalization plan, the former Class C nonvoting
preferred stock became Class C nonvoting common stock. The former
Class C preferred stock had been entitled to cumulative dividends of
a minimum of $6.00 each year and had preference in a liquidation. As
of December 31, 1997, there were no cumulative unpaid dividends. As
a result of the recapitalization, the new Class C common stock is not
entitled to cumulative dividends and has no preference in a
liquidation. The Class C common stock is restricted to ownership by
the following persons or entities: (1) physicians entitled to
ownership of Class A stock, (2) a trust or self-directed individual
retirement account controlled by a physician entitled to ownership of
Class A stock, (3) a professional corporation, partnership or other
entity domiciled in the State of South Dakota and in which a
physician entitled to ownership of Class A stock is a shareholder,
partner, or employee in the practice of medicine, (4) management,
employees or agents of the Company, the South Dakota State Medical
Association, or the South Dakota Foundation for Medical Care, or (5)
the spouse or children of such physician or other person set forth in
(1) or (4) above.
On December 29, 1995, the Company reduced the par value of its Class
C common stock from $1 per share to $.01 per share and issued the
1,468,116 additional shares necessary to effect a 40-for-1 common
stock split. The earnings per common share for the year ended
December 31, 1995 has been retroactively adjusted for this split as
if it occurred on January 1, 1995.
Regulatory capital as required by the Division of Insurance at
December 31, 1997 and 1996 was $200,000 on a statutory basis of
accounting, which the Company exceeded by approximately $6,654,000
and $6,513,000, respectively. As long as the Company exceeds
required regulatory capital, it is not restricted by the Division of
Insurance in the amount of dividends it may pay.
F-17
Note 10. Transactions With Affiliate
The Company leases office space from the South Dakota State Medical
Association (Association). During 1997, the Company signed a one
year lease which expired on December 31, 1997. Under the terms of
the lease, the lease automatically renewed for a successive one year
term and will renew for successive one year terms thereafter unless
terminated with at least 30 days notice prior to the end of the lease
term. The 1998 lease requires minimum rental payments of $204,870.
Total rental payments for office space for the years ended December
31, 1997, 1996 and 1995 were $186,500, $158,400 and $144,650,
respectively.
The Company provides group health insurance coverage for employees of
the Association. Total premium income from the affiliate for the
years ended December 31, 1997, 1996 and 1995 was $42,517, $45,535 and
$52,125, respectively.
Note 11. Retirement Plan and Deferred Compensation
The Company is included in a qualified money-purchase pension plan
with the South Dakota State Medical Association and the South Dakota
Foundation for Medical Care. This multiple-employer plan covers
employees who have attained age 21, and have completed one year of
service. Contributions, which are discretionary by the Board of
Directors, were an amount equal to 11.5% of the participants'
compensation for the twelve-month periods ending September 1, 1997,
1996 and 1995. Retirement plan expense for the years ended December
31, 1997, 1996 and 1995 was $216,364, $245,104 and $182,175,
respectively.
In connection with employment contracts between the Company and
certain officers, provision has been made for the future compensation
which is payable upon the completion of the earlier of 25 years of
service to the Company and related organizations or attainment of the
age of 65 or any earlier retirement age specified by the Board of
Directors by resolution. At December 31, 1997 and 1996, $49,164 and
$40,851, respectively, was accrued under these contracts.
F-18
Note 12. Year 2000 Issue
The Year 2000 issue is whether computer systems will properly
recognize date-sensitive information when the year changes to 2000.
Systems that do not properly recognize such information could
generate erroneous data or cause a system to fail. The Company is
heavily dependent on computer processing in its business activities
and the Year 2000 issue creates risk for the Company from unforeseen
problems in the Company's computer system and from third parties with
whom the Company processes financial information. Such failures of
the Company's computer system and/or third parties' computer systems
could have a material impact on the Company's ability to conduct its
business. In accordance with its remediation plan to resolve the
Year 2000 issue, the Company has substantially completed a
preliminary review of its computer systems to identify the systems
that could be affected by the Year 2000 issue. Based on the
Company's review of its computer systems, management believes the
cost of the remediation effort to make the systems year 2000
compliant is approximately $45,000. Management expects $30,000 and
$15,000 to be incurred in 1998 and 1999, respectively. Such costs
will be charged against income as they are incurred.
Note 13. FASB Statements
The FASB issued Statement No. 130, "Reporting Comprehensive Income".
This Statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general-purpose financial statements.
This Statement requires that all items that are required to be
recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This Statement
requires that an enterprise (a) classify items of other comprehensive
income by their nature in a financial statement and (b) display the
accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity
section of a statement of financial position. This Statement is
effective for fiscal years beginning after December 15, 1997, and
will require financial statements of earlier periods that are
presented for comparative purposes to be reclassified.
The FASB issued Statement No. 131, "Disclosures About Segments of an
Enterprise and Related Information". This Statement establishes
standards for the way that public business enterprises report
information about operating segments in annual financial statements
and requires that those enterprises report selected information about
operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers.
This Statement supersedes FASB Statement No. 14, "Financial Reporting
for Segments of a Business Enterprise", but retains the requirement
to report information about major customers. It amends FASB
Statement No. 94, "Consolidation of All Majority-Owned Subsidiaries",
to remove the special disclosure requirements for previous
unconsolidated subsidiaries. This Statement is effective for
financial statements for periods beginning after December 15, 1997.
F-19
Note 14. Litigation
The Company is involved in legal actions in the ordinary course of
its business. Although the outcome of any such legal actions cannot
be predicted, in the opinion of management, there is no legal
proceeding pending against or involving the Company for which the
outcome is likely to have a material adverse effect upon the
consolidated financial position or results of operations of the
Company.
Note 15. Subsequent Event
As a service to the Company's shareholders to facilitate liquidity
for Class C common stock (Common Stock) in the event of death,
disability, or retirement of a shareholder, the Company's Board of
Directors adopted a Stock Repurchase Program (Program) which was
implemented in February 1998. Participation in the Program is
voluntary. No shareholder is required to sell his or her shares of
Common Stock under the Program nor is the Company required to
purchase any Common Stock under the Program. The purchase and sale
of Common Stock under the Program is subject to repurchase conditions
as described in the Program. The Board of Directors of the Company
may, at any time, modify or terminate the Program. The Company may
also, at its discretion, offer to repurchase shares of Common Stock
outside of the Program in compliance with applicable laws.
F-20
EXHIBIT INDEX
Exhibit No. Description
4.2 Form of Stock Certificate for Class C Non-Voting Common Stock
10.1 Amendment of Office Lease with the South Dakota State Medical Association
21 Subsidiaries of the Registrant
27 Financial Data Schedule
EXHIBIT 4.2
EXHIBIT 10.1
Re: Brzica Building
This letter will serve as an Addendum to the lease between South Dakota State
Medical Association and DAKOTACARE for the period ending December 31, 1997.
Beginning July 1, 1997, monthly rent payments will increase from $14,010.00 to
$17,072.50 due to DAKOTACARE's occupancy of the Brzica Building. Please be
agreed also that DAKOTACARE will be responsible for payment of all utilities
and improvements associated with the Brzica Building.
Thank you.
Sincerely,
_/s/Robert D. Johnson
Chief Executive Office
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Name Incorporation % Owned
DAKOTACARE Administrative South Dakota 100%
Services, Incorporated
Dakota Health
Plans, Incorporated South Dakota 50.11%
DAKOTACARE Insurance, Ltd. Cayman Islands 100%