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, 1996
-----------------
Commission file number 0-23430
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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. [X]
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, 1997
----- -----------------------------
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.
<PAGE> 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 and receive 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 % 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 value and
makes adjustments when considered necessary. The effect of this reimbursement
mechanism is to establish a maxmium 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.
<PAGE> 2
The Company's agreements also 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. The contingency reserve
withholding is also designed to encourage efficient medical practice by the
physicians. Less expensive medical outcomes enhance net income and
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 the contingency
reserve 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 liabilities for contingency reserve payouts at December 31, 1996
and 1995, were $2,105,294 and $1,954,669 respectively.
The Company withheld from payment to the participating physicians $1,120,049
and $950,376 for the years ended December 31, 1996 and 1995, respectively.
The liability recorded was equal to the actual amounts withheld for 1996 and
1995. The recorded liability for prior years was the estimate of the
projected payouts for the prior amounts withheld. As of January 1,1994, the
percentage withheld was reduced from 20% to 15%. See Note 6 of Notes to
Consolidated Financial Statements.
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 it 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 tradename 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.
<PAGE> 3
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, 1997,
DAKOTACARE and its subsidiaries provided health care services to
approximately 89,000 individuals. Approximately 10.4% of the state's
population and approximately 17% 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 24,000 in 1996. Commencing in
1993, the Company began its Administrative Services Only (ASO) business and
by January 1, 1997, had enrolled approximately 61,000 ASO enrollees, bringing
the total individuals served by the Company to approximately 85,000. The
Company's HMO client disenrollment rate is significantly 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 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 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. 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. Such growth and expansion opportunities may include
acquisitions or dispositions of segments of its operations, and 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.
<PAGE> 4
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, large 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 persons 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, maintenance of restricted deposits
in the minimum amount of fifty percent of the Company's unearned premium
liability, approval of the Company's benefits contract 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 reserve payments.
<PAGE> 5
The following table sets forth, by type of investment, the percentage of the
total investment portfolio, excluding the cash surrender value of life
insurance, represented by each type of investment as of December 31:
<TABLE>
<S> <C> <C>
1996 1995
Certificates of deposit 24.0% 21.2%
Obligations of state and political
subdivisions 35.7 39.5
Obligations of U.S. government
corporations 32.4 30.3
U.S. government agency collateralized
mortgage obligations 7.9 9.0
------ ------
100.0% 100.0%
====== ======
</TABLE>
The Company's investment portfolio, excluding cash surrender value of life
insurance, totaled $6,382,097 and $5,206,199 as of December 31, 1996 and
1995, respectively. In addition, substantially all of the cash and cash
equivalents are in interest bearing accounts. Cash and cash equivalents
totaled $3,422,692 and $3,586,196 at December 31, 1996 and 1995, respectively.
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 nor 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.
<PAGE> 6
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 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, 1996, 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
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As of December 31, 1996, the Company leases approximately 14,900 square feet
of space in Sioux Falls, South Dakota, from the South Dakota State Medical
Association (an affiliated company). The lease expired December 31, 1996,
and was renewed for one year. The Company has leased space from the South
Dakota State Medical Association on one year lease terms from inception, and
plans to do so in the future. The Company anticipates being able to rent
additional space from the South Dakota State Medical Association when
necessary. On 1/1/97, the Company acquired a 5,520 square foot office
building in Webster, South Dakota, (which was leased through 12/31/96), and
also leases smaller offices in Rapid City, South Dakota, and Pierre, South
Dakota.
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, 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.
<PAGE> 7
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
(A) There were no matters submitted to shareholders vote in the 4th quarter of
1996.
<PAGE> 8
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, (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.
<PAGE> 9
Holders
- -------
As of March 15, 1997, there were 1,038 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 South Dakota Division of Insurance, it is not
restricted by the Division of Insurance in the amount of dividends it may pay.
At December 31, 1996, the Company exceeded this requirement by approximately
$6,513,000. During 1996 and 1995, the Company paid out dividends of
$271,037 and $310,563, respectively, on Class C shares. On January 28,
1997, the Board of Directors approved payment of dividends of $.08 per share
to be paid on February 14, 1997, for shareholders of record of the Class C
common stock on January 28, 1997.
<PAGE> 10
ITEM 6. SELECTED FINANCIAL DATA
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The following information for the Company is as of and for the years ended
December 31, 1996, 1995, 1994, 1993, and 1992 (dollars in thousands, except
per share data):
Year Ended December 31,
----------------------------------------------
<TABLE>
<S> <C> <C> <C> <C> <C>
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
Income Statement Data:
- ----------------------
Net premiums $28,688 $26,643 $26,790 $24,936 $24,208
Third party administration
fees 3,786 3,023 1,143 462 4
Net investment income 552 489 321 208 223
Total revenues 33,425 30,513 28,497 25,790 24,468
Net claims incurred 23,425 20,305 19,937 19,046 19,100
Other operating expenses 8,393 7,587 5,595 4,549 3,754
Financing cost of debt -- -- 14 91 151
Income before income taxes 1,607 2,621 2,951 2,104 1,463
Net income 1,041 1,790 1,906 1,433 940
======= ======= ======= ======= =======
Earnings per common share(1) $ 0.69 $ 1.19 $ 1.27 $ 1.08 $ *
======= ======= ======= ======= =======
Balance Sheet Data:
- -------------------
Invested assets and cash $ 9,874 $ 8,843 $ 7,804 $ 5,882 $ 5,691
Total assets 12,777 11,425 9,803 7,568 7,511
Reported and unreported
claims payable 3,188 2,710 2,864 2,558 2,449
Contingency reserve payable 2,105 1,955 1,697 1,635 2,517
Long-term debt (including
current maturities) -- -- -- 572 1,034
Total liabilities 7,137 6,545 6,432 5,667 7,701
Stockholders' equity(deficit) 5,640 4,880 3,372 1,901 (190)
</TABLE>
*Information is not available
(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 per common share is calculated by dividing net income
by the weighted average number of Class C common shares outstanding during
each period as follows: 1996 1,505,760 shares; 1995 1,505,760 shares;
1994 1,505,760 shares; and 1993 1,329,373 shares.
<PAGE> 11
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, 1996, 1995, 1994, and
1993. 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,
-----------------------------------
<TABLE>
<S> <C> <C> <C> <C>
1996 1995 1994 1993
---- ---- ---- ----
Loss ratio 81.7% 76.2% 74.4% 76.4%
Expense ratio 16.3 18.4 17.2 17.1
---- ---- ---- ----
Combined ratio 98.0% 94.6% 91.6% 93.5%
==== ==== ==== ====
</TABLE>
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 and the financing cost of debt divided by net premium revenue.
The increase in the loss ratio was due primarily to an unusually high number
of high dollar claims in late 1996, and lower premium increases due to
competitive market forces. The decrease in expense ratio is due primarily to
increased premium volume and decreased expenses in many areas due to
concentrated cost-cutting efforts. See - Comparison of Years Ended
December 31, 1996 and 1995 and Comparison of Years Ended December 31, 1995
and December 31, 1994.
<PAGE> 12
The following table is a reconciliation of beginning and ending reserves for
claims losses and loss adjustment expenses (LAE) balances:
Year Ended
----------------------------------
<TABLE>
<S> <C> <C> <C> <C>
1996 1995 1994 1993
---- ---- ---- ----
(dollars in thousands)
Reserves at beginning of year $2,710 $2,864 $2,558 $2,449
------ ------ ------ ------
Provision for losses and LAE
for claims occurring in the
current year 23,350 20,310 19,920 18,975
Increase (decrease) in reserves
for claims occurring in
prior years 75 (5) 17 71
______ ______ ______ ______
Net losses and LAE incurred 23,425 20,305 19,937 19,046
Losses and LAE payments for
claims occurring during:
Current year 20,248 17,425 17,142 16,400
Prior years 2,777 2,981 2,541 2,518
------ ------ ------ ------
23,025 20,406 19,683 18,918
Reinsurance Recoverable:
Beginning of year (15) (68) (16) (35)
End of year 93 15 68 16
------ ------ ------ ------
78 (53) 52 (19)
------ ------ ------ ------
Reserves at end of year $3,188 $2,710 $2,864 $2,558
====== ====== ====== ======
</TABLE>
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.
<PAGE> 13
The following table presents the development of DAKOTACARE's balance sheet
reserves for 1988 through 1996. 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,
-------------------------------------------------------------
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1996 1995 1994 1993 1992 1991 1990 1989 1988
---- ---- ---- ---- ---- ---- ---- ---- ----
(dollars in thousands)
Reserves for
unpaid losses 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 2,793 2,985 2,524 2,375 2,482 2,561 3,553 3,856
Two Years Later -- 2,977 2,519 2,392 2,553 2,511 3,561 3,856
Three Years Later -- -- 2,519 2,392 2,553 2,583 3,561 3,856
Four Years Later -- -- -- 2,392 2,553 2,583 3,561 3,856
Five Years Later -- -- -- -- 2,553 2,583 3,561 3,856
Six Years Later -- -- -- -- -- 2,583 3,561 3,856
Seven Years Later -- -- -- -- -- -- 3,561 3,856
Liability Reestimated
as of:
End of Year 3,188 2,710 2,864 2,558 2,449 2,456 2,532 3,382 3,788
One Year Later 2,793 2,985 2,524 2,375 2,482 2,561 3,553 3,856
Two Years Later -- 2,977 2,519 2,392 2,553 2,511 3,561 3,856
Three Years Later -- -- 2,519 2,392 2,553 2,583 3,561 3,856
Four Years Later -- -- -- 2,392 2,553 2,583 3,561 3,856
Five Years Later -- -- -- -- 2,553 2,583 3,561 3,856
Six Years Later -- -- -- -- -- 2,583 3,561 3,856
Seven Years Later -- -- -- -- -- -- 3,561 3,856
_____ _____ _____ _____ _____ _____ _____ _____ _____
Redundancy
(Deficiency) -- (83) (113) 39 57 (97) (51) (179) (68)
===== ===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
The Company has been 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. In addition,
with the exception of 1996 where enrollment increased by over 20%, the level
of enrollees has remained fairly constant over the past several years leading
to more stable reserve requirements. The Company believes its reserves at
December 31, 1996, are adequate.
<PAGE> 14
RESULTS OF OPERATIONS
General
- -------
The following results of operations includes the operations of DAKOTACARE and
its subsidiaries for the years ended December 31, 1996, 1995, and 1994.
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.
<PAGE> 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.
COMPARISON OF YEARS DECEMBER 31, 1995 AND DECEMBER 31, 1994
General
- -------
The Company's net income decreased $115,813 to $1,790,165 for the year ended
December 31, 1995, as compared to $1,905,978 for the year ended December 31,
1994, representing a 6.08% decrease. This decrease was primarily due to an
increase in operating expenses of $2,359,437 which was offset by an increase
of $2,015,648 in total revenues and a $225,000 decrease in income taxes.
Revenues
- --------
Total revenues increased $2,015,648, or 7.07%, for the year ended
December 31, 1995, as compared to December 31, 1994. The revenues from the
net premiums generated by the health maintenance organization decreased
$147,147. This decrease is attributable to a 4.11% decrease in the number of
enrollees for the year ended December 31, 1995, as compared to December 31,
1994, but was offset by a 3.72% increase in the premiums earned per enrollee.
The increase in revenue per enrollee was lower than the national average due
to a shift by clients in their choice of benefit plans. The decrease in
enrollees was primarily due to more restrictive underwriting standards and
transfer of some groups to self-funded plans. Revenues from the third party
administration fees increased by $1,880,189 as the Company's subsidiaries
increased the number of enrollees participating in these plans. Net
investment income increased $168,041 due primarily to the increase in the
amount of assets invested.
<PAGE> 16
Operating Expenses
- ------------------
Total operating expenses increased $2,359,437, or 9.24%, for the year ended
December 31, 1995, as compared to December 31, 1994. This was due to an
increase in claims incurred, personnel expense, professional fees expense,
office expense, and advertising expense.
Net claims expense increased by $368,223, or 1.85%. Average claims per
enrollee increased by 6.22% in 1995 as compared to 1994 while the number of
enrollees decreased by 4.11%. During 1995, the Company paid out $154,569 in
contingency reserve payments in excess of the amount originally estimated.
This amount was expensed in 1995. During 1995, the Company also had two
unusually large claims incurred which totaled approximately $290,000, net of
reinsurance. Personnel expense increased by $1,036,904, or 47.41%, in 1995
as compared to 1994 due to the increase 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
the ASO contracts from approximately 48,000 at January 1, 1995, to
approximately 60,000 at January 1, 1996. The Company increased the number
of enrollees from approximately 20,000 at January 1, 1996 to approximately
25,000 at January 1, 1997. Professional fees expense increased
$262,328, or 41.07%, in 1995 as compared to 1994. 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 $238,322, or 58.36%, primarily due to increases for printing,
postage, and telephone expenses as a result of the increase in enrollment in
DAS and DHP. Advertising expense increased $191,609, or 44.50%, in 1995 as
compared to 1994. This was primarily due to more television and radio
advertising by all companies for the purpose of increasing enrollment in all
lines of business.
Income Taxes
- ------------
Income tax expense represents 31.24% and 35.38% of income before income taxes
and minority interest for the years ended December 31, 1995 and 1994,
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.
<PAGE> 17
Net cash provided by operating activities decreased by $420,079 to $1,424,123
for the year ended December 31, 1996, as compared to 1995. Changes in
working capital components, primarily changes in payables and unearned
premiums and fees, comprise a majority of the decrease in cash provided by
operating activities, as well as a decrease in net income.
Other uses of cash and cash equivalents were for the payment of dividends,
purchases of leasehold improvements and equipment, and the increase in
purchases of investment securities. 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,
1996, the Company has certificates of deposit of $500,000 on deposit with the
South Dakota Division of Insurance to meet the deposit requirement of state
insurance laws.
The Company is not contractually obligated to pay out the contingency reserve
withheld but has historically elected to pay out a majority of amounts
withheld. Historically, there has been a two year lag between the period in
which the contingency reserve is withheld and the period in which the
corresponding amount withheld is paid out.
The Company believes that cash flow generated by operations, withholding of
contingency reserves, cash on hand, and short-term investment balances will
be sufficient to fund operations, pay out the projected contingency reserve
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.
<PAGE> 18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS
<TABLE>
<S> <C>
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
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- -----------------------------------------------------------------------
FINANCIAL DISCLOSURES
- ---------------------
None.
<PAGE> 19
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
<TABLE>
<S> <C> <C>
Name Age Positions
- ---- --- ---------
Robert L. Ferrell, M.D. 57 President and Director
Guy E. Tam, M.D. 58 Secretary/Treasurer and Director
James Jackson, M.D. 54 Director
Patrick Beckman 53 Director
Frank D. Messner, M.D. 53 Director
K. Gene Koob, M.D. 54 Director
Ben J. Henderson, D.O. 55 Director
Douglas M. Holum, M.D. 38 Director
Jeffrey J. Rodman 41 Director
Robert D. Johnson 53 Chief Executive Officer
Kirk J. Zimmer 36 Senior Vice President
William O. Rossing, M.D. 62 Vice President, Medical Director
Sharon K. Duncan 49 Vice President, System Operations
Dean M. Krogman 47 Vice President, External Operations
Elizabeth D. Mendelson 43 Vice President, Underwriting
Barbara A. Smith 35 Vice President, Operations
Thomas N. Nicholson 37 Vice President, Sales and Marketing
Bruce E. Hanson 33 Chief Financial Officer
</TABLE>
<PAGE> 20
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. 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. Jackson became a director of the Company in June 1988. He is a member of
the South Dakota State Medical Association and has been engaged in the
practice of cardiology in Rapid City, South Dakota, since 1979.
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. 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.
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.
Dr. Holum became a director of the Company in June 1995. He is a member of
the South Dakota State Medical Association and has been engaged as a family
practitioner in Mitchell, South Dakota, since 1992.
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.
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.
<PAGE> 21
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 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 as its Chief Financial
Officer. 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.
<PAGE> 22
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 due to
the resignation of Gerald E. Tracy, M.D., in January 1997. The terms of
Dr. James Jackson, Dr. K. Gene Koob, and Dr. Frank Messner expire at the 1997
Annual Meeting of Shareholders; the terms of Dr. Robert Ferrel, Dr. Douglas
Holum, and Dr. Ben Henderson expire at the 1998 Annual Meeting of
Shareholders; and the terms of Dr. Guy Tam, Mr. Patrick Beckman, and Mr.
Jeffrey Rodman expire at the 1999 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.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
SUMMARY COMPENSATION TABLE
--------------------------
<TABLE>
<S> <C> <C> <C>
(a) (b) (c) (i)
Name and Principal All Other
Position Year Salary $ Compensation(1)
- ------------------ ---- -------- ---------------
Robert D. Johnson 1996 $58,632 $12,373
Chief Executive Officer 1995 $41,330 $13,968
1994 $31,625 $6,440
Russell H. Harris, M.D. 1996(2) $48,937 $9,469
Vice President, 1995 $101,029 $11,431
Medical Affairs 1994 $95,662 $10,935
</TABLE>
(1) Consists of retirement plan contribution and premiums paid on the
deferred compensation plan.
(2) Dr. Harris passed away in June 1996.
<PAGE> 23
No other officer received total annual salary and bonus in excess of $100,000
during 1996, 1995, or 1994. The Board of Directors receives $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 one other executive officer, provision has been made
for the future compensation which is payable upon the completion of the
earlier of 25 years or any earlier retirement age specified by the Board
of Directors by resolution. At December 31, 1996, $40,851 has been accrued
under these contracts.
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 15, 1997, 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.
<PAGE> 24
<TABLE>
<S> <C> <C> <C>
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 Gerald E. Tracy, M.D. 1 .10%
Class C Common 28,960 1.92%
Class A Preferred Guy E. Tam, M.D. 1 .10%
Class C Common 4,360 .29%
Class C Common Bernard Christenson 960 .06%
Class A Preferred James Jackson, M.D. 1 .10%
Class C Common 3,570 .24%
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 A Preferred Douglas M. Holum, M.D. 1 .10%
Class C Common Jeffrey J. Rodman -- --
Class C Common Robert D. Johnson(2) 14,560 .97%
1323 South Minnesota Avenue
Sioux Falls, SD 57105
Class A Preferred Russell H. Harris, M.D. 1 .10%
Class C Common 12,000 .80%
Class A Preferred All Directors and Executive 8 .77%
Officers as a Group
Class C Common (18 people) 92,410 6.14%
</TABLE>
____________________________
(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.
<PAGE> 25
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------
The Company leases office space from the Association. In January 1996 the
Company signed a one year lease, which expired December 31, 1996, which
required minimum annual rental payments of $158,400. A one year lease was
entered into with the Association in January 1997 which requires minimum
annual rental payments of $168,120. Total rental payments for office space
to the Association were $158,400, $144,650, and $119,000, for the years ended
December 31, 1996, 1995, and 1994, respectively. Commencing in 1995,
employees of the Foundation provided management services for the Company.
Total management fees paid to the Foundation for the years ended December 31,
1996 and 1995, were $138,000 and $46,000, respectively. The Company provides
group health insurance coverage for employees of the Association and the
Foundation. Total premium income from the affiliates was $85,186, $128,191,
$129,535, in the years ended December 31, 1996, 1995, and 1994, respectively.
Robert D. Johnson received salaries and retirement contributions totaling
$110,934, $110,628, and $107,253, from the South Dakota State Medical
Association for the years ended 1996, 1995, and 1994, respectively.
<PAGE> 26
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- -------------------------------------------------------------------------
The following documents are filed as part of this report:
<TABLE>
<S> <C>
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
</TABLE>
<TABLE>
<S> <C>
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 4.1 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
21 Subsidiaries of the Registrant
</TABLE>
REPORTS ON FORM 8-K
None.
<PAGE> 27
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 __03/28/97______________
Robert D. Johnson
Chief Executive Officer
(Principal Executive Officer)
By _/s/ Kirk J. Zimmer___________ Dated __03/28/97________________
Kirk J. Zimmer
Senior Vice President
(Principal Financial Officer)
By __/s/ Bruce E. Hanson_________ Dated ___03/28/97_______________
Bruce E. Hanson
Chief Financial Officer
(Principal Accounting Officer)
By __/s/ Robert L. Ferrell, MD___ Dated ____03/28/97______________
Robert L. Ferrell, M.D.
Director
By __/s/ Guy E. Tam, MD__________ Dated ____03/28/97______________
Guy E. Tam, M.D.
Director
By __/s/ James Jackson, MD_______ Dated ____03/28/97_______________
James Jackson, M.D.
Director
By __/s/ Patrick Beckman_________ Dated ____03/28/97_______________
Patrick Beckman
Director
<PAGE> 28
By __/s/ Frank Messner, MD________ Dated ____03/28/97_______________
Frank Messner, M.D.
Director
By __/s/ K. Gene Koob, MD_________ Dated ____03/28/97_______________
K. Gene Koob, M.D.
Director
By __/s/ Ben J. Henderson, DO_____ Dated ____03/28/97_______________
Ben J. Henderson, D.O.
Director
By __/s/ Douglas M. Holum, MD_____ Dated ___03/28/97________________
Douglas M. Holum, M.D.
Director
By __/s/ Jeffrey J. Rodman________ Dated ___03/28/97_________________
Jeffrey J. Rodman
Director
<PAGE> 29
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 as of
December 31, 1996 and 1995, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1996. 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 audit.
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 as of
December 31, 1996 and 1995, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1996,
in conformity with generally accepted accounting principles.
As described in Note 1 to the consolidated financial statements, on
January 1, 1994, the Company changed its method of accounting for investments
in marketable debt and equity securities to adopt FASB Statement No. 115.
McGladrey & Pullen, LLP.
Sioux Falls, South Dakota
March 17, 1997
F-1
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
D/B/A DAKOTACARE
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
<TABLE>
<S> <C> <C>
ASSETS 1996 1995
- -----------------------------------------------------------------------------
Current Assets
Cash and cash equivalents $ 3,422,692 $ 3,586,196
Investment in securities held to
maturity (Note 5) 524,511 1,195,129
Certificates of deposit 875,000 604,900
Receivables (Note 3) 836,364 534,570
Prepaids and other assets 138,487 71,957
Deferred income taxes (Note 8) 518,000 462,000
-----------------------------
Total current assets 6,315,054 6,454,752
-----------------------------
Long-Term Investments
Investment in securities held to
maturity (Note 5) 4,034,271 2,613,470
Investment in securities available
for sale (Note 5) 288,550 292,700
Pledged certificates of deposit (Note 5) 500,000 500,000
Certificates of deposit 159,765 -
Cash surrender value of life insurance 69,000 51,000
----------------------------
5,051,586 3,457,170
----------------------------
Leasehold Improvements and Equipment, at cost,
net of accumulated depreciation 1,070,650 1,173,891
Deferred Income Taxes (Note 8) 340,000 339,000
----------------------------
$12,777,290 $11,424,813
============================
</TABLE>
See Notes to Consolidated Financial Statements.
F-2
<PAGE>
<TABLE>
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
- -----------------------------------------------------------------------------
Current Liabilities
Reported and unreported claims
payable (Note 7) $ 3,188,455 $ 2,710,000
Unearned premiums and administration fees 854,905 815,653
Accounts payable and accrued expenses 679,421 787,008
Contingency reserve payable (Note 6) 950,000 973,000
-----------------------------
Total current liabilities 5,672,781 5,285,661
-----------------------------
Contingency Reserve Payable (Note 6) 1,155,294 981,669
-----------------------------
Minority Interest in Subsidiary 309,143 277,892
-----------------------------
Commitments and Contingencies (Notes 4, 10 and 12)
Stockholders' Equity (Note 9)
Class A preferred, voting, no par value,
$10 stated value, 2,500 shares authorized;
issued and outstanding 1,042 and 976 shares
at December 31, 1996 and 1995 10,420 9,760
Class B preferred, voting, no par value,
$1 stated value, 2,500 shares authorized;
issued and outstanding 1,300 and 1,000
shares at December 31, 1996 and 1995 1,300 1,000
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 1,877,084 1,107,480
Unrealized loss on securities available
for sale (13,132) (3,049)
-------------------------------
5,640,072 4,879,591
-------------------------------
$ 12,777,290 $ 11,424,813
===============================
</TABLE>
F-3
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
D/B/A DAKOTACARE
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1996, 1995 and 1994
<TABLE>
<S> <C> <C> <C>
1996 1995 1994
- -----------------------------------------------------------------------------
Revenues:
Premiums $ 29,071,245 $ 27,056,671 $ 27,187,727
Less premiums ceded for
reinsurance (383,408) (413,420) (397,329)
------------------------------------------
28,687,837 26,643,251 26,790,398
Third party administration fees 3,786,427 3,023,384 1,143,195
Investment income 551,734 489,253 321,212
Other income 399,203 356,895 242,330
------------------------------------------
Total revenues 33,425,201 30,512,783 28,497,135
------------------------------------------
Operating expenses:
Claims incurred 23,528,141 20,667,382 20,242,387
Less reinsurance recoveries (102,780) (362,644) (305,872)
------------------------------------------
23,425,361 20,304,738 19,936,515
Personnel expenses 3,703,067 3,224,087 2,187,183
Commissions 1,225,271 1,109,817 1,053,688
Professional fees expenses 1,082,816 901,026 638,698
Office expenses 713,964 680,229 441,907
Occupancy expenses 625,541 518,527 430,578
Advertising expenses 386,174 519,907 328,298
State insurance taxes 330,574 319,837 318,750
Other general and administrative
expenses 325,541 313,152 196,266
------------------------------------------
Total operating expenses 31,818,309 27,891,320 25,531,883
------------------------------------------
Income from operations 1,606,892 2,621,463 2,965,252
Financing cost of debt - - 14,080
------------------------------------------
Income before income taxes
and minority interest 1,606,892 2,621,463 2,951,172
Income taxes (Note 8) 535,000 819,000 1,044,000
------------------------------------------
Income before minority interest 1,071,892 1,802,463 1,907,172
Minority interest in income
of subsidiary 31,251 12,298 1,194
------------------------------------------
Net income $ 1,040,641 $ 1,790,165 $ 1,905,978
==========================================
Earnings per common share $ 0.69 $ 1.19 $ 1.27
==========================================
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
D/B/A DAKOTACARE
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1996, 1995 and 1994
<TABLE>
<S> <C> <C> <C> <C>
Unrealized
Loss on
Additional Retained Securities
Capital Paid-In Earnings Available
Stock Capital (Deficit) for Sale
---------------------------------------------------------------------------
Balance, December 31, 1993 $ 47,184 $ 3,726,756 $ (1,873,149) $ -
Issuance of Class A
common stock 850 - - -
Redemption of Class A
common stock (190) - - -
Dividends paid on Class C
preferred stock - - (404,951) -
Increase in unrealized
loss on securities
available for sale - - - (30,589)
Net income - - 1,905,978 -
------------------------------------------------
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)
================================================
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
D/B/A DAKOTACARE
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1996, 1995 and 1994
<TABLE>
<S> <C> <C> <C>
1996 1995 1994
- -----------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 1,040,641 $ 1,790,165 $ 1,905,978
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation 318,297 251,222 196,221
Loss on disposal of equipment 1,664 - 2,065
Minority interest in income of
subsidiary 31,251 12,298 1,194
Amortization of discounts and premiums
on investments and certificates
of deposit, net (103,151) (100,888) (85,160)
(Increase) in receivables (301,794) (68,892) (84,828)
(Increase) in prepaids and other assets (66,530) (6,111) (29,377)
(Increase) in deferred income taxes (57,000) (120,000) (67,000)
Increase (decrease) in reported and
unreported claims payable 478,455 (154,000) 305,512
Increase (decrease) in accounts payable
and accrued expenses (107,587) (21,028) 402,349
Increase in unearned premiums and
administration fees 39,252 3,692 316,074
Increase in contingency reserve payable 150,625 257,744 61,798
-----------------------------------
Net cash provided by operating
activities 1,424,123 1,844,202 2,924,826
-----------------------------------
Cash Flows From Investing Activities
Purchases of securities available
for sale (5,933) (5,660) (207,710)
Held to maturity securities:
Matured 1,200,000 1,147,884 752,000
Purchases (1,983,309) (1,386,995) (2,711,231)
Repayments on collateralized
mortgage obligations 133,471 45,409 45,348
Proceeds from maturities of
certificates of deposit 1,104,900 1,200,000 2,050,000
Purchase of certificates of deposit (1,531,959) (1,604,900) (1,200,000)
Receipt of principal payments on
mortgage loan on real estate - - 132,156
(Increase) in cash surrender value
of life insurance (18,000) (11,000) (10,410)
Purchase of leasehold improvements
and equipment (216,720) (637,994) (345,216)
Proceeds from sale of equipment - - 7,200
--------------------------------------
Net cash (used in) investing
activities (1,317,550) (1,253,256) (1,487,863)
--------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE>
<TABLE>
<S> <C> <C> <C>
1996 1995 1994
----------------------------------------------------------------------------
Cash Flows From Financing Activities
Proceeds from issuance of stock $ 1,290 $ 910 $ 850
Redemption of stock (330) (350) (190)
Payments of dividends (271,037) (310,563) (404,951)
Minority investment in subsidiary - 15,000 249,400
Payments on long-term debt - - (572,156)
-------------------------------------
Net cash (used in) financing activities (270,077) (295,003) (727,047)
-------------------------------------
Increase (decrease) in cash and
cash equivalents (163,504) 295,943 709,916
Cash and Cash Equivalents
Beginning 3,586,196 3,290,253 2,580,337
-------------------------------------
Ending $3,422,692 $3,586,196 $3,290,253
=====================================
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest $ - $ - $ 14,080
Income taxes 790,000 881,008 1,141,000
Supplemental Disclosures of Noncash
Investing and Financing Activities
(Increase) decrease in unrealized
loss on securities available for sale (10,083) 27,540 (30,589)
(Decrease) in Class C common stock due
to recapitalization - (22,586) -
Increase in additional paid-in capital
due to recapitalization - 22,586 -
</TABLE>
F-7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
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, which began operations in January 1996), and its 50.11%
owned subsidiary, Dakota Health Plans, Incorporated (DHP), which began
operations in May 1994. DAS & DHP's primary activity is as a third party
administrator 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 remaining maturities in excess of ninety days.
Investment securities: The Financial Accounting Standards Board Statement
- ---------------------
No. 115, "Accounting for Certain Investments in Debt and Equity Securities",
requires that all debt securities and equity securities that have a readily
determinable fair value be classified in three categories and accounted for
as follows:
- - Trading securities
Trading securities are held for resale in anticipation of short-term
(generally 90 days or less) fluctuations in market prices. Trading
securities, consisting primarily of actively traded equity and debt
securities, are stated at fair value. Realized and unrealized gains and
losses are included in income.
- - Held to maturity securities
Held to maturity securities consist solely of debt securities which the
Company has the positive intent and ability to hold to maturity and are
stated at amortized cost.
F-8
<PAGE>
Note 1. Nature of Business and Significant Accounting Policies (continued)
Investment securities (continued):
- ---------------------------------
- - Available for sale securities
Available for sale securities consist of debt securities and marketable
equity securities not classified as trading or held to maturity. Available
for sale securities are stated at fair value and unrealized holding gains and
losses, net of the related deferred tax effect, are reported as a separate
component of stockholders' equity.
Statement No. 115 requires that management determine the appropriate
classification of securities at the date of adoption, and thereafter at the
date individual investment securities are acquired, and that the
appropriateness of such classification be reassessed at each balance sheet
date. Since the Company does not buy investment securities in anticipation
of short-term fluctuations in market prices, investment securities have been
classified as available for sale or held to maturity in accordance with
Statement No. 115.
Prior to the adoption of the accounting change, the Company stated its
investment securities at amortized cost except for mutual funds, which were
stated at lower of cost or market. The effect of adoption on January 1, 1994
was immaterial.
Premiums and discounts on investments in debt securities are amortized over
their contractual lives. 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 are
determined on the basis of the specific securities sold.
Depreciation: Leasehold improvements are depreciated using straight-line
- ------------
methods based upon the estimated useful lives of the assets or the life of
the lease, whichever is shorter. Depreciation on equipment 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 leasehold
improvements and equipment is as follows:
<TABLE>
<S> <C> <C>
1996 1995
---------------------------------
Furniture, equipment and automobiles $ 2,190,608 $ 1,978,052
Leasehold improvements 72,817 72,817
---------------------------------
2,263,425 2,050,869
Less accumulated depreciation 1,192,775 876,978
---------------------------------
$ 1,070,650 $ 1,173,891
=================================
</TABLE>
F-9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies (continued)
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 paid 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.
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 per common share: Earnings per common share for 1995 and 1994 have
- -------------------------
been restated from amounts previously reported to give retroactive effect to
the recapitalization discussed in Note 9. Earnings per common share is
calculated by dividing net income by the weighted average number of Class C
common shares outstanding during each period as follows: 1996 1,505,760
shares, 1995 1,505,760 shares and 1994 1,505,760 shares.
F-10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
Note 2. Fair Value of Financial Instruments
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.
Investments: Fair values for the Company's investment securities are based
on quoted market prices. At December 31, 1996, the carrying amount of the
Company's investment securities was $4,847,332 and the fair value of the
investment securities was $4,872,684.
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:
<TABLE>
<S> <C> <C>
1996 1995
---------------------------------
Commissions $ 31,250 $ 119,580
Drug manufacturer chargebacks 86,547 108,953
Premiums 120,363 82,944
Subrogation, net of recovery expenses 75,000 75,000
Interest 34,689 29,139
Reinsurance (Note 4) 92,579 14,972
Income taxes 223,000 11,000
Funds withheld by ceding insurer 77,455 -
Other 95,481 92,982
---------------------------------
836,364 534,570
Less allowance for doubtful accounts - -
---------------------------------
$ 836,364 $ 534,570
=================================
</TABLE>
F-11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
Note 4. Reinsurance
The Company's policy is to reinsure that portion of the risk in excess of
$85,000 of covered 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.
Note 5. Investment Securities
Investment securities at December 31, 1996 are as follows:
<TABLE>
<S> <C> <C> <C> <C>
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
============================================
</TABLE>
F-12
<PAGE>
NOTES TO CONSOLIDATAED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
Note 5. Investment Securities (continued)
The amortized cost and estimated fair value 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.
<TABLE>
<S> <C> <C>
December 31, 1996
-----------------------------------
Amortized Estimated
Cost Fair Value
-----------------------------------
Due in one year $ 524,511 $ 525,187
Due after one year through five years 2,117,778 2,120,048
Due after five years through ten years 1,341,091 1,370,599
Due after ten years 73,132 75,535
-----------------------------------
4,056,512 4,091,369
Collateralized mortgage obligations 502,270 492,765
-----------------------------------
$ 4,558,782 $ 4,584,134
===================================
</TABLE>
Investment securities at December 31, 1995 are as follows:
<TABLE>
<S> <C> <C> <C> <C>
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 $1,481,673 $ 29,558 $ (21) $1,511,210
Obligations of state and
political subdivisions 1,859,712 46,711 (6,327) 1,900,096
U.S. governmental agency
collateralized mortgage
obligations 467,214 1,176 (9,202) 459,188
------------------------------------------------
$3,808,599 $ 77,445 $ (15,550) $3,870,494
================================================
Equity securities available for sale:
Bond mutual funds $ 295,749 $ - $ (3,049) $ 292,700
================================================
</TABLE>
There were no sales of debt securities during the years ended December 31,
1996, 1995 or 1994. At December 31, 1996 and 1995, no individual investments
in obligations of state and political subdivisions exceeded 10% of the
Company's equity.
At December 31, 1996 and 1995, 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 law.
F-13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
Note 6. Contingency Reserve 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. 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. Effective January 1, 1994, the percentage
withheld from participating physicians was reduced from 20% to 15%. Management
estimates the expected amount of the contingency reserve 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 liability recorded was equal to actual amounts withheld for the
years ended December 31, 1996 and 1995. The recorded liability for prior
years was an estimate of the projected payouts for prior amounts withheld.
Payments to physicians in 1996 and 1995 exceeded amounts accrued by $71,253
and $154,569, respectively, which are 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:
<TABLE>
<S> <C> <C> <C>
1996 1995 1994
----------------------------------------
Balance at January 1 $ 2,710,000 $ 2,864,000 $ 2,558,488
----------------------------------------
Incurred related to:
Current year 23,350,462 20,309,552 19,919,641
Prior years 74,899 (4,814) 16,874
---------------------------------------
Total incurred 23,425,361 20,304,738 19,936,515
---------------------------------------
Paid related to:
Current year 20,247,806 17,425,015 17,141,489
Prior years 2,776,707 2,980,476 2,541,252
---------------------------------------
Total paid 23,024,513 20,405,491 19,682,741
---------------------------------------
Less reinsurance recoverables
at January 1 (14,972) (68,219) (16,481)
Plus reinsurance recoverables
at December 31 92,579 14,972 68,219
---------------------------------------
Balance at December 31 $ 3,188,455 $ 2,710,000 $ 2,864,000
=======================================
</TABLE>
F-14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
Note 8. Income Tax Matters
The Company is taxable as a property and casualty insurance company under
section 832 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:
<TABLE>
<S> <C> <C> <C>
1996 1995 1994
--------------------------------------
Current $592,000 $939,000 $1,111,000
Deferred (credits) (57,000) (120,000) (67,000)
--------------------------------------
$535,000 $819,000 $1,044,000
======================================
</TABLE>
Income taxes recorded in the accompanying financial statements are in
accordance with FASB Statement No. 109, "Accounting for Income Taxes", which
requires an asset and liability approach to financial accounting and
reporting for income taxes. Deferred income tax assets and liabilities are
computed annually for differences between the financial statement and tax
bases of assets and liabilities that will result in taxable or deductible
amounts in the future based on enacted tax laws and rates applicable to the
periods in which the differences are expected to affect taxable income.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized. Income tax expense is the tax
payable or refundable for the period plus or minus the change during the
period in deferred tax assets and liabilities.
Total income tax expense differed from the amounts computed by applying the
U.S. federal income tax rates of 35 percent to income before income taxes as
a result of the following:
<TABLE>
<S> <C> <C> <C>
1996 1995 1994
------------------------------------
Computed "expected" tax expense $ 562,400 $ 917,500 $ 1,032,900
Tax exempt interest (30,771) (28,760) (22,468)
Effect of tax rate brackets and other 3,371 (69,740) 33,568
------------------------------------
$ 535,000 $ 819,000 $ 1,044,000
====================================
</TABLE>
F-15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
Note 8. Income Tax Matters (continued)
The net deferred income taxes in the accompanying balance sheets includes the
following amounts of deferred tax assets and liabilities:
<TABLE>
<S> <C> <C>
1996 1995
----------------------------
Deferred tax asset $ 909,000 $ 821,000
Valuation allowance for deferred tax asset - -
Deferred tax liability (51,000) (20,000)
----------------------------
$ 858,000 $ 801,000
============================
Reflected on the accompanying balance sheets as follows:
1996 1995
---------------------------
Current assets $ 518,000 $ 462,000
Noncurrent assets 340,000 339,000
---------------------------
$ 858,000 $ 801,000
===========================
The tax effects of principal temporary differences are as follows:
1996 1995
--------------------------
Contingency reserve payable $ 716,000 $ 665,000
Claims payable 62,000 57,000
Unearned premiums 53,000 55,000
Equipment (51,000) (20,000)
Accrued expenses 78,000 44,000
---------------------------
$ 858,000 $ 801,000
===========================
</TABLE>
F-16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
Note 9. Capital Stock, Restrictions, Warrants and Recapitalization
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, 1996, 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, affiliated companies, 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 years ended December 31, 1995 and 1994 have been
retroactively adjusted for this split as if it occurred on January 1, 1993.
Regulatory capital as required by the Division of Insurance at December 31,
1996 and 1995 was $200,000 on a statutory basis of accounting, which the
Company exceeded by approximately $6,513,000 and $5,652,000, 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
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------------------------------
Note 10. Transactions With Affiliates
The Company leases office space from the South Dakota State Medical
Association (Association). In January 1997, the Company signed a one year
lease which expires December 31, 1997 and requires minimum rental payments
of $168,120. Total rental payments for office space for the years ended
December 31, 1996, 1995 and 1994 were $158,400, $144,650 and $119,000,
respectively. Commencing in 1995, employees of the South Dakota Foundation
for Medical Care (Foundation) provided management services for the Company.
Total management fees paid to the Foundation for the years ended December 31,
1996 and 1995 were $138,000 and $46,000, respectively.
The Company provides group health insurance coverage for employees of the
Association and the Foundation. Total premium income from the affiliates for
the years ended December 31, 1996, 1995 and 1994 was $85,186, $128,191 and
$129,535, 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,
1996, 1995 and 1994. Retirement plan expense for the years ended December 31,
1996, 1995 and 1994 was $245,104, $182,175 and $127,059, 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, 1996, $40,851 has been accrued under these contracts.
Note 12. 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.
F-18
<PAGE>
EXHIBIT INDEX
-------------
<TABLE>
<S> <C>
Exhibit No. Description
- ----------- -----------
4.2 Form of Stock Certificate for Class C Non-Voting Common Stock
10 Office Lease with the South Dakota State Medical Association
21 Subsidiaries of the Registrant
</TABLE>
<PAGE>
EXHIBIT 4.2
<PAGE>
EXHIBIT 10
LEASE
This LEASE made this 1st day of January, 1997, between SOUTH DAKOTA STATE
MEDICAL ASSOCIATION of Sioux Falls, South Dakota, Lessor, and South Dakota
State Medical Holding Company, Inc., Sioux Falls, South Dakota, Lessee, is
in agreement with:
1.
That the said lessor leases to the said lessee the property described as:
Office space in the present structure located on "The Southeast Quarter
and the East 11.5 feet of the Southwest quarter of Block 32 in Park
Addition to Sioux Falls, together with the East 25 feet of the South 88
feet of Lot E in Perry's Subdivision of part of Block 32 Park Addition"
surveyed, platted, and recorded in Minnehaha County, South Dakota. The
parking lot space on "The Northwest Quarter of Block 32 in Park Addition
to Sioux Falls" surveyed, platted, and recorded in Minnehaha County,
South Dakota.
The term of this lease shall begin on the 1st day of January, 1997, and end
on the 31st day of December, 1997, and shall automatically renew for
successive one (1) year terms unless terminated with not less than thirty (30)
days notice prior to the end of the lease term. Rent payable pursuant to this
lease shall be:
The sum of Fourteen Thousand Ten Dollars ($14,010) per month, payable on
the first day of each month.
2.
It is further agreed that the lessor shall furnish all and full maintenance
for the property leased hereunder including but not limited to heat, air
conditioning, electricity, gas, water, janitorial service, maintenance of
building fixtures, replacement of building glass breakage, and snow and ice
removal.
<PAGE>
3.
It is provided that the lessor shall cause nothing upon the premises to
become a nuisance.
4.
It is understood that the lessor will be responsible for all real property
taxes, and that each individual party will be responsible for their own
personal property taxes.
5.
The said lessee hereby covenants with the lessor to pay the said rent at the
times and in the manner hereinbefore specified; not at any time to assign this
agreement or to sublet the demised premises, or any portion thereof, without
the written consent of the said lessor or its representatives; to keep the
premises in good order; and to surrender the possession of the premises at the
end of the said term.
6.
It is hereby agreed that, if the building on the premises shall be destroyed
or rendered untenantable by fire or other unavoidable accident, all liability
for rent hereunder shall cease upon payment thereon proportionally to the
day of such fire or unavoidable accident.
<PAGE>
7.
It is also agreed that each said party shall be responsible for insuring its
own property against damage or destruction by fire, wind, or other
unavoidable disaster.
8.
It is further agreed by and between the said parties that any fixtures or
equipment placed in said premises by the lessee herein shall be and remain
the property of said lessee, provided, however, that in the event that the
installation of any such fixtures or equipment shall require a substantial
change or alteration of the premises described herein, then and in such
event prior approval before installation must be obtained from the lessor.
9.
It is further agreed that if the lessee shall violate any of the foregoing
covenants on its part, the lessor shall have the right without formal notice
to re-enter and take possession.
10.
Each party hereto waives all claims for recovery from the other party for any
loss or damage of its property insured under valid and collectible insurance
policies to the extent of any recovery collectible under such insurance
subject to the limitation that this waiver shall apply only when permitted
by the applicable policy of insurance.
11.
This lease may be terminated by either party upon thirty (30) days written
notice to the other party irrespective of any other covenants herein.
The lessees hereby acknowledge the receipt of a true and correct copy of this
lease.
SOUTH DAKOTA STATE MEDICAL ASSOCIATION
Lessor
By: ___/s/ Robert D. Johnson____________
Chief Executive Officer
DAKOTACARE
Lessee
By: ___/s/ Kirk J. Zimmer_______________
Senior Vice-President
<PAGE>
EXHIBIT 21. SUBSIDIARIES OF THE REGISTRANT
------------------------------
<TABLE>
<S> <C> <C>
Name Incorporation % Owned
- ---- ------------- -------
DAKOTACARE Administrative South Dakota 100%
Services, Incorporated
Dakota Health Plans, Incorporated South Dakota 50.11%
DAKOTACARE Insurance, Ltd. Cayman Islands 100%
</TABLE>
