<PAGE>
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, 1998
Commission file number 0-23430
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
(Exact name of registrant as specified in its charter)
SOUTH DAKOTA 46-0401087
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1323 SOUTH MINNESOTA AVENUE
SIOUX FALLS, SOUTH DAKOTA 57105
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (605) 334-4000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
CLASS A PREFERRED STOCK, NO PAR VALUE, STATED VALUE $10 PER SHARE
(Title of class)
CLASS C COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
Class Outstanding at March 22, 1999
----- -----------------------------
<S> <C>
Class C Common Stock 1,465,345
</TABLE>
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>
PART I
ITEM 1. BUSINESS
South Dakota State Medical Holding Company, Incorporated (the Company,
Corporation or DAKOTACARE), was incorporated in the State of South Dakota on May
5, 1988. Its corporate offices are located at 1323 South Minnesota Avenue, Sioux
Falls, South Dakota, 57105. The Articles of Incorporation permit the Company to
engage in the development of quality comprehensive health care delivery systems;
to conduct, promote, or operate alternative health care delivery systems and
other contractual health service arrangements, including but not limited to,
traditional third party reimbursement systems, preferred provider organizations,
and health maintenance organizations (HMO).
The Company contracts with over 98% of the physicians in the State of South
Dakota, 100% of the hospitals in the State of South Dakota, and many other
health care providers to provide medical services to its enrollees. Physicians
who are members of the South Dakota State Medical Association and who complete
the Company's credentialing process may participate with the Company by
purchasing one share of Class A voting preferred stock of the Company for $10.
The fee for non-members is $1,000. The South Dakota State Medical Association
owns 100% of the Class B voting preferred stock of the Company, and through this
ownership, maintains voting control of the Company.
The Company's agreements with participating physicians stipulate compensation on
a fee-for-service basis utilizing a relative value schedule developed by the
Company. This schedule assigns a value (measured in number of units) for each
individual service for which a physician may perform and submit a bill. These
values are then multiplied by an overall value per unit assigned by the Company,
and the product is the maximum amount allowed for payment to the physician.
Actual reimbursement is at the lower of this product or the actual billed
amount. The Company, at least annually, reviews the unit values and makes
adjustments when considered necessary. The effect of this reimbursement
mechanism is to establish a maximum allowable reimbursement, which is not
dependent upon actual billed charges. Regardless of the physician bill,
reimbursement will never exceed the maximum amount established by the relative
value schedule. Physicians also may not bill patients for any excess of the
billed charge over the amount allowed by the Company, but instead have
contractually agreed to hold the patient harmless for any such amounts.
The Company's agreements with participating physicians provide that up to 20% of
fees for services provided, as submitted to and allowed by the Company, may be
withheld to provide a contingency reserve that may be used to fund operations or
meet other financial requirements of the Company. The percentage withheld for
years 1996 through 1998 was 15%. 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
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Company, although the Company is not contractually obligated to pay out
amounts withheld. Management estimates the expected amount of contingency
reserves and records a liability based upon factors such as cash flow needs,
net income, and accumulations of amounts withheld. The Company withheld from
payment to the participating physicians $1,321,668 and $1,336,156 for the
years ended December 31, 1998 and 1997, respectively. Payments to physicians
are made at such times as the Board of Directors approves payouts. The
recorded liability for contingency reserves at December 31, 1998 and 1997,
was $2,690,568 and $2,963,846, respectively. The recorded liability is equal
to actual amounts withheld for the years ended December 31, 1998, 1997 and
1996.
In 1992, the Company incorporated DAKOTACARE Administrative Services,
Incorporated (DAS), a wholly owned subsidiary of the Company. In 1994, the
Company organized and then purchased a 50.11% interest in Dakota Health Plans,
Incorporated (DHP). The Articles of Incorporation of DAS and DHP permit them to
engage in the development of third party administration (TPA) services for
health and welfare plans. DHP has subcontracted with DAS to perform
substantially all TPA activities. In January 1996, the Company incorporated
DAKOTACARE Insurance, Ltd. (DIL), a wholly owned subsidiary of the Company. DIL
was formed to accept reinsurance risk on stop-loss policies of DAS and DHP
customers, reinsurance risk on group term life insurance coverage of DAKOTACARE
and DAS customers and other insurance risks.
PRODUCTS AND MARKETING
The Company markets its products under the trade name of DAKOTACARE. The Company
has three reportable segments as defined by FASB Statement No. 131. The
segments' products include group managed health care products (HMO), managed
care and claims administration services for self-insured employer groups (TPA)
and the reinsurance segment, which provides excess medical stop loss coverage to
the self insured employer groups. A detailed analysis of the various segments is
contained in the Notes to the Consolidated Financial Statements-Note 12. The
Company markets its products through an exclusive network of independent
insurance agents throughout South Dakota.
The Company markets its products to employer groups with a minimum of two
covered employees and its' customers range in size from employers of this size
to its largest customer with over 550 employees. As of January 1, 1999,
DAKOTACARE and its subsidiaries provided health care services to approximately
78,000 individuals.
Approximately 11.0% of the state's population and approximately 17% of
DAKOTACARE's target market of approximately 450,000 is served by DAKOTACARE and
its subsidiaries, which does not include Medicare and Medicaid populations,
federal employee groups, the individual policy market, and other potential
populations. The Company's HMO enrollment, which had remained relatively stable
from 1990 to 1995 at approximately 20,000 enrollees, grew to nearly 25,000 in
1996 and 26,000 in 1997, but has since declined to approximately 24,000 by the
end of 1998. Commencing in 1993, the Company began its TPA business and by
January 1, 1999, had enrolled approximately 56,000 ASO enrollees, bringing the
total individuals served by the Company and its' subsidiaries to approximately
78,000. The Company's HMO client disenrollment rate is lower than the industry
rate as a whole. All
3
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underwriting and pricing decisions are made by the DAKOTACARE underwriting
department based on underwriting policy and guidelines established by senior
management. DAKOTACARE's underwriters evaluate the prior loss history, the
inherent risk characteristics, and the demographic makeup of the applicants
where appropriate.
Through a specific excess liability reinsurance agreement with Lincoln National
Health and Casualty Insurance Company, the Company reinsures that portion of its
risk in excess of $85,000 of covered hospital inpatient expenses of any enrollee
per contract year. The policy is subject to a coinsurance provision which ranges
from 50% to 90% based on average daily amounts specified in the plan, and a
$2,000,000 lifetime maximum benefit per enrollee. The Company would be liable
for any obligations that the reinsuring company is unable to meet under the
reinsurance agreement. The reinsurance agreement also provides for enrollee
benefits to be paid in the event the Company should cease operations or become
insolvent, and a conversion privilege for all enrollees in the event of plan
insolvency and for any enrollee that moves out of the service area of the
Company.
The Company operates under a license issued by the South Dakota Department of
Commerce and Regulation, Division of Insurance, for the operation of the health
maintenance organization. DAS and DHP are also registered as third party
administrators in South Dakota and several other states. The Company has also
received certification from the South Dakota Department of Labor as a workers'
compensation managed care plan.
The Company continually seeks out and evaluates opportunities for future growth
and expansion. These opportunities may include acquisitions or dispositions of
segments of its operations, marketing of insurance products underwritten by
other companies, the internal development of new products and techniques for the
containment of health care costs, and the measurement of the outcomes and
efficiency of health care delivered.
COMPETITION
The managed health care industry evolved primarily as a result of health care
buyers' concerns over rising health care costs. The industry's goal is to infuse
greater cost effectiveness and accountability into the health care system
through the development of different managed care products, while increasing the
accessibility and quality of health care services. The managed health care
industry has become increasingly competitive in many markets. As managed care
(HMO, Preferred Provider Organization, etc.) penetration of the health care
market increases, the Company expects that marketing to large employer groups
will become more difficult and competition for smaller employer groups will
intensify. In addition, more employers may choose to self-insure their health
care risk and seek benefit administration and managed care services from third
parties to assist them in controlling and reporting health care costs. In such
an environment, the Company believes that having a broad line of health care
programs and products available will be important in being selected by employers
to manage their health care programs. The Company's health care products compete
for group membership with traditional health insurance plans, Blue Cross/Blue
Shield plans, other HMO's, and third party administrators who provide
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services to self-insured employers. The ability to increase the number of
individuals covered by the Company's services or to increase premiums can be
affected by the level of competition in any particular area. The Company
believes that the principal competitive factors affecting the Company include
price, the level and quality of service provided, provider network
capabilities, and marketplace reputation.
REGULATIONS
The Company is regulated by the South Dakota Department of Commerce and
Regulation, Division of Insurance (Division). South Dakota statutes require the
filing of periodic financial reports and maintenance of restricted deposits in
an amount of not less than the greater of fifty percent of unearned premiums of
the Company on its outstanding policies or $200,000. The Company requires
approval from the Division for the Company's benefits contracts and premium
rates, licensing of its agents, and other items. The Company is also subject to
periodic examination of its financial affairs and market conduct. The Division
completed an examination of DAKOTACARE for years through December 31, 1991,
which was released in March 1993. The Division is in process of the required 5
year exam for DAKOTACARE for the years ended December 31, 1996.
DAKOTACARE must comply with applicable insurance statutes and regulations which
prescribe the nature, form, quality, and relative amounts of investments which
may be made by insurance companies and HMOs. Generally, these statutes and
regulations permit companies to invest within varying limitations in state,
municipal, and federal government obligations, corporate obligations, preferred
and common stocks, bank certificates of deposit, and certain types of real
estate and first mortgage loans. The Company's management believes that its
investment strategy is conservative, with preservation of capital being the
foremost objective. Its investment strategy is also influenced by the terms of
its coverage written and by its expectations as to the timing of claims and
contingency reserves payments.
The following table sets forth, by type of investment, the percentage of the
total investment portfolio, excluding cash and cash equivalents and cash
surrender value of life insurance, represented by each type of investment as of
December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Certificates of deposit 20.8% 21.7%
Obligations of state and political
subdivisions 54.7 42.9
Obligations of U.S. Treasury, government
agencies and corporations 17.6 25.3
U.S. government agency collateralized
mortgage obligations 1.2 5.4
Bond mutual funds 5.7 4.7
----- -----
100.0% 100.0%
===== =====
</TABLE>
The Company's investment portfolio, excluding cash and cash equivalents and cash
surrender value of life insurance, totaled $5,403,216 and $6,432,239 as of
December 31, 1998 and 1997, respectively. Cash and cash equivalents totaling
$5,372,457 and $4,467,754 at December 31, 1998 and 1997, respectively, are
invested substantially in interest bearing accounts.
5
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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 provides HMO coverage on a
group basis and does not provide coverage for the cost of medical and hospital
expenses to Medicare beneficiaries. If otherwise eligible for coverage through
the Company, the Medicare eligible beneficiary may choose to have the Company
provide their health care benefits in lieu of coverage by Medicare. The Company
does not believe that it offers incentives to Medicare beneficiaries or that any
discounts the HMO receives from health care providers would violate the
anti-kickback provisions of the Medicare law.
Government regulation of employee benefit plans, including health care coverage,
health plans and the Company's specialty managed care products is a changing
area of law that varies from jurisdiction to jurisdiction and generally gives
responsible administrative agencies broad discretion. The Company believes that
it is in compliance in all material respects with the various federal and state
regulations applicable to its current operations. To maintain such compliance,
it may be necessary for the Company or its subsidiaries to make changes from
time to time in its services, products, structure, or marketing methods.
Additional governmental regulation or future interpretation of existing
regulation could increase the cost of the Company's compliance or otherwise
affect the Company's operations, products, profitability, or business prospects.
Numerous proposals have been introduced in the United States Congress relating
to health care reform. As a provider of cost effective managed care plans for
medium and small employers, the Company believes it is delivering products and
services that address current health care reform issues. The Company will
continue to evaluate its business strategy as necessary to maximize its ability
to adapt to the changing health care marketplace.
ERISA
The provision of services to or through certain types of employee health benefit
plans is subject to the Employee Retirement Income Security Act of 1974 (ERISA).
ERISA is a complex set of laws and 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, 1998, the Company employed 103 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.
6
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ITEM 2. PROPERTIES
The Company leases office space in Sioux Falls, South Dakota, from the South
Dakota State Medical Association (Association). See ITEM 13. CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS for additional details on this lease with
the Association, which is an affiliated company. In January 1997, the Company
purchased an office building in Webster, South Dakota, which was previously
leased. The Company also leases a small office in Pierre, South Dakota. Another
office was leased in Rapid City until June 1997, at which time an agent of the
Company assumed the lease for his insurance agency operations.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in legal actions in the ordinary course of its business.
Although the outcome of any such legal actions cannot be predicted, management
believes there is no legal proceeding pending against or involving the Company
for which the outcome is likely to have a material adverse effect upon the
consolidated financial position or results of operations of the Company.
On September 9, 1998, a claim against the Company was filed in the 2nd
Judicial Circuit Court of South Dakota by Sioux Agency, Inc., D. Greg Heineman
and Roger D. Larsen, who are all stockholders of the Company, and by Williams
Insurance Agency, Inc., a non-stockholder of the Company. The claim alleges
wrongful non-renewal of a sales agency contract. The suit is seeking
compensatory damages of $3.3 million and punitive damages of $10.0 million.
Currently, the lawsuit is in the discovery stages. Management believes the
lawsuit is without merit and the Company will vigorously defend itself in
this matter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(A) There were no matters submitted to shareholder vote in the fourth quarter of
1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
STOCK PRICES
There is no active trading for shares of stock of the Company and the stock is
not listed on any exchange or over-the-counter market. However, limited
infrequent exchanges of Class C shares have occurred directly between interested
buyers and sellers and in across the desk stock transactions with a brokerage
firm. The Company does not regularly receive price information on these
transactions. The amended and restated Articles of Incorporation of the Company
currently restrict the ownership of shares as follows: (i) the ownership of the
Company's Class A voting preferred stock is restricted to medical or osteopathic
physicians who have executed participating agreements with the Company and may
not be issued to or held by any hospital, (ii) the ownership of the Company's
Class B voting preferred stock is restricted to the South Dakota State Medical
Association, and (iii) the ownership of the Company's Class C non-voting common
stock is restricted to (a) medical or osteopathic physicians who have executed
participating physician agreements with the Company, (b) a trust or
self-directed individual retirement account controlled by such physicians, (c)
professional corporations, partnerships, or other entities domiciled in the
state of South Dakota, and in which a participating physician is a shareholder,
partner, or employee in the practice of medicine, (d) management employees or
agents of the Company, the South Dakota State Medical Association, the South
Dakota Foundation for Medical Care, or (e) a spouse or child of a shareholder of
the Company, if such shares were first held by one of the persons or entities
entitled to own Class C common stock. In addition, the Class C non-voting common
stock may not be issued or transferred to any hospital or to any natural person
or entity who is not a resident or domiciliary of the state of South Dakota.
SHARES ELIGIBLE FOR FUTURE SALE
The Company's Class A voting preferred stock is nontransferable and ownership of
the Company's Class B voting preferred stock is restricted to the South Dakota
State Medical Association. Approximately 63,900 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.
HOLDERS
As of March 22, 1999, there were 1,090 holders of record of Class A preferred
stock, 1 holder of Class B preferred stock, and 684 holders of record of Class C
common stock. There are no options or warrants outstanding.
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DIVIDENDS
The Class A and B preferred stock are not entitled to dividends. 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. As long as the
Company exceeds required regulatory capital as required by the Division, there
are no dividend restrictions. Regulatory capital as required by the Division at
December 31, 1998 and 1997 was $200,000 on a statutory basis of accounting,
which the Company significantly exceeded. During 1998 and 1997, the Company paid
dividends of $146,754 and $331,267, respectively, on Class C stock.
STOCK REPURCHASE PLAN
As a service to the Company's shareholders to facilitate liquidity for Class C
common stock (Common Stock) in the event of death, disability, or retirement of
a shareholder, the Company's Board of Directors adopted a Stock Repurchase
Program (Program) which was implemented in February 1998. Participation in the
Program is voluntary. No shareholder is required to sell his or her shares of
Common Stock under the Program nor is the Company required to purchase any
Common Stock under the Program. In 1998, The Board of Directors approved the
purchase of 40,415 shares, or $280,480. The value per share was computed using
guidelines established in 1995 by an investment organization, and updated using
the December 31, 1998 audited financial statements. These calculations are
tested for accuracy and consistency by an independent accounting firm. The
purchase and sale of Common Stock under the Program is subject to repurchase
conditions as described in the Program.
UNREGISTERED SALES OF SECURITIES
Ownership of the Company's Class A Voting Preferred Stock is restricted to
medical or osteopathic physicians who have executed participating physician
agreements with the Company. Class A Preferred Stock is nontransferable and
holders of these shares do not receive dividends. Each such physician is issued
one share of Class A Voting Preferred Stock upon execution of his or her
participation agreement and the payment of $10 per share. Upon the termination
of a physician's participation agreement, his or her share of Class A Preferred
Stock is canceled without compensation. During 1998, the Company issued a total
of 90 shares of Class A Preferred Stock to physicians who entered into
participation agreements with the Company. To the extent that the registration
provisions of the Securities Act of 1933, as amended, were applicable to these
transactions, the Company relied on the exemption from registration contained in
Section 4(2) of that act.
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ITEM 6. SELECTED FINANCIAL DATA
The following information for the Company is as of and for the years ended
December 31, 1998, 1997, 1996, 1995 and 1994 (dollars in thousands, except per
share data):
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------ -------
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Net premiums $35,718 $34,754 $28,688 $26,643 $26,790
Third party administration fees 3,081 3,628 3,786 3,023 1,143
Investment income 607 615 552 489 321
Total revenues 40,053 39,581 33,425 30,513 28,497
Net claims incurred 30,615 30,976 23,425 20,305 19,937
Other operating expenses 8,835 8,727 8,393 7,587 5,609
Income (loss) before income taxes
and minority interest 603 (122) 1,607 2,621 2,951
Net income (loss) 483 (110) 1,041 1,790 1,906
======= ======= ======= ======= =======
Earnings (loss) per common share(1) $ 0.33 $ (0.07) $ 0.69 $ 1.19 $ 1.27
======= ======= ======= ======= =======
Balance Sheet Data:
Invested assets and cash $10,876 $10,981 $ 9,874 $ 8,843 $ 7,804
Total assets 14,277 14,011 12,777 11,425 9,803
Reported and unreported
claims payable 4,410 4,164 3,188 2,710 2,864
Contingency reserves payable 2,691 2,964 2,105 1,955 1,697
Total liabilities 9,017 8,807 7,137 6,545 6,432
Stockholders' equity 5,260 5,204 5,640 4,880 3,372
</TABLE>
(1) Earnings per common share for 1995 and prior years have been restated from
amounts previously reported to give retroactive effect to the recapitalization.
Earnings (loss) per common share is calculated in accordance with the provisions
of Financial Accounting Standards Board Statement No. 128, "Earnings Per Share",
which was adopted in 1997. This Statement establishes standards for computing
and presenting earnings (loss) per share (EPS). It replaces the presentation of
primary EPS with a presentation of basic EPS. It also requires dual presentation
of basic and diluted EPS on the face of an income statement for all entities
with complex capital structures. This Statement requires restatement of all
prior-period EPS data presented. All references to earnings (loss) per share are
to basic earnings (loss) per share. No restatement of EPS was necessary as a
result of the application of Statement No. 128. Earnings (loss) per common share
was calculated by dividing net income by the weighted average number of Class C
common shares outstanding during each period as follows: 1998 1,482,635 shares;
1997 1,505,760 shares; 1996 1,505,760 shares; 1995 1,505,760 shares; and 1994
1,505,760 shares.
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ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
GENERAL
The following operating statistics are presented for DAKOTACARE's operation as a
health maintenance organization only and do not include the operations of its
subsidiaries for the years ended December 31, 1998, 1997, 1996, and 1995. 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.
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Loss ratio 85.9% 88.7% 81.7% 76.2%
Expense ratio 15.0 14.5 16.3 18.4
----- ----- ---- ----
Combined ratio 100.9% 103.2% 98.0% 94.6%
----- ----- ---- ----
----- ----- ---- ----
</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
divided by net premium revenue.
The net decrease in the loss ratio was due to decreased utilization and higher
premium increases, but was offset by increased costs for physicians and
hospitals in 1998. The increase in the expense ratio is due to additional costs
incurred to upgrade existing systems and obtain data sources to help maximize
efficiencies. See Comparison of Years December 31, 1998 and December 31, 1997
and Comparison of Years December 31, 1997 and December 31, 1996.
Activity in the liability for reported and unreported claims payable is
summarized as follows:
<TABLE>
<CAPTION>
Years Ended
-----------------------------------
1998 1997 1996 1995
------ ------ ------ ------
(dollars in thousands)
<S> <C> <C> <C> <C>
Balance at January 1 $4,164 $3,188 $2,710 $2,864
------ ------ ------ ------
Incurred related to:
Current year 30,198 30,237 23,350 20,310
Prior years 417 739 75 (5)
------ ------ ------ ------
Total incurred 30,615 30,976 23,425 20,305
------ ------ ------ ------
Paid related to:
Current year 25,705 26,217 20,248 17,425
Prior years 4,710 3,921 2,777 2,981
------ ----- ------ ------
Total paid 30,415 30,138 23,025 20,406
------ ------ ------ ------
Less reinsurance recoverables at January 1 (230) (92) (14) (67)
Plus reinsurance recoverables at December 31 276 230 92 14
------ ------ ------ ------
Balance at December 31 $4,410 $4,164 $3,188 $2,710
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
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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.
The following table presents the development of DAKOTACARE's consolidated
balance sheet reserves for reported and unreported claims payable from 1989
through 1998. The top line of the table shows the reserves at the balance sheet
date for each of the indicated periods. This represents the original estimate of
reported and unreported claims payable established in the respective year. 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 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.
<TABLE>
<CAPTION>
As of December 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994 1993 1992 1991 1990 1989
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reported and unreported
claims payable 4,410 4,164 3,188 2,710 2,864 2,558 2,449 2,456 2,532 3,382
Paid (cumulative) as of:
End of Year -- -- -- -- -- -- -- -- --
One Year Later 4,581 3,927 2,793 2,985 2,524 2,375 2,482 2,561 3,553
Two Years Later -- 3,927 2,793 2,977 2,519 2,392 2,553 2,511 3,561
Three Years Later -- -- 2,793 2,977 2,519 2,392 2,553 2,583 3,561
Four Years Later -- -- -- 2,977 2,519 2,392 2,553 2,583 3,561
Five Years Later -- -- -- -- 2,519 2,392 2,553 2,583 3,561
Six Years Later -- -- -- -- -- 2,392 2,553 2,583 3,561
Seven Years Later -- -- -- -- -- -- 2,553 2,583 3,561
Eight Years Later -- -- -- -- -- -- -- 2,583 3,561
Nine Years Later -- -- -- -- -- -- -- -- 3,561
Liability reestimated as of:
End of Year 4,410 4,164 3,188 2,710 2,864 2,558 2,449 2,456 2,532 3,382
One Year Later 4,581 3,927 2,793 2,985 2,524 2,375 2,482 2,561 3,553
Two Years Later -- 3,927 2,793 2,977 2,519 2,392 2,553 2,511 3,561
Three Years Later -- -- 2,793 2,977 2,519 2,392 2,553 2,583 3,561
Four Years Later -- -- -- 2,977 2,519 2,392 2,553 2,583 3,561
Five Years Later -- -- -- -- 2,519 2,392 2,553 2,583 3,561
Six Years Later -- -- -- -- -- 2,392 2,553 2,583 3,561
Seven Years Later -- -- -- -- -- -- 2,553 2,583 3,561
Eight Years Later -- -- -- -- -- -- -- 2,583 3,561
Nine Years Later -- -- -- -- -- -- -- -- 3,561
----- ----- ----- ----- ----- ----- ----- ----- ----- ------
Redundancy (Deficiency) -- (417) (739) (83) (113) 39 57 (97) (51) (179)
----- ----- ----- ----- ----- ----- ----- ----- ----- ------
----- ----- ----- ----- ----- ----- ----- ----- ----- ------
</TABLE>
The Company is continually taking steps to improve its estimation of reserves
for reported and unreported claims payable. This includes, among other things,
improved underwriting standards, which stabilize the Company's assumptions of
risks, leading to a more predictable estimate of reported and unreported claims
payable. Additional approaches have also been developed to estimate claims
payable. The Company believes its reserves at December 31, 1998, are adequate.
12
<PAGE>
RESULTS OF OPERATIONS
GENERAL
The following results of operations include the operations of DAKOTACARE and its
subsidiaries for the years ended December 31, 1998, 1997, and 1996.
COMPARISON OF YEARS DECEMBER 31, 1998 AND DECEMBER 31, 1997
GENERAL
The Company's net income increased $593,146 to income of $483,038 for the year
ended December 31, 1998, as compared to a loss of $110,108 for the year ended
December 31, 1997, representing a 538.7% increase. This increase was primarily
due to an increase in net premium income of $963,404 which was offset by a
decrease of $547,184 in third party administration fee revenues and a $180,625
increase in income taxes.
REVENUES
Total revenues increased $471,903, or 1.2%, for the year ended December 31,
1998, as compared to December 31, 1997. Revenues from net premiums generated by
the health maintenance organization increased $987,293. This increase is
attributable to an 8.6% increase in the premiums earned per enrollee for the
year ended December 31, 1998, as compared to December 31, 1997, but a 5.1%
decrease in the number of enrollees limited the net premium growth. The increase
in revenue per enrollee was needed to keep pace with rising claim costs. The
decrease in enrollees was due to the competitive business climate in the local
marketplace. Revenues from the third party administration fees decreased by
$547,184 as enrollees participating in the Company's subsidiaries' TPA plans
decreased. Investment income decreased $8,519 due primarily to a decrease in the
average yield earned on invested assets, but was offset by an increase in
average invested assets.
OPERATING EXPENSES
Total operating expenses decreased $253,297, or 0.6%, for the year ended
December 31, 1998, as compared to December 31, 1997. The change was due
primarily to a decrease in claims incurred and commission expenses, but was
offset by an increase in personnel, professional fees and other general and
administrative expenses.
Net claims expense decreased by $361,780, or 1.2%. Average claims per enrollee
increased by 5.3% in 1998 as compared to 1997 while the number of enrollees
decreased by 5.1%. An unusually high dollar claim that was incurred and paid in
late 1998, caused the average claims per enrollee and claims expense to remain
higher than expected, but claims expense as a whole declined due primarily to
the decreased enrollment. Commissions expense decreased by $87,246, or 5.8%, in
1998 as compared to 1997 due to the decreased enrollees of the HMO. The
Company's subsidiaries increased the number of enrollees covered under various
contracts from approximately 50,000 at January 1, 1998, to approximately 56,000
at January 1, 1999. Membership decreased initially on the January 1, 1998
renewals, but membership increased on July 1, 1998 due to one large group. As a
result, overall HMO membership decreased in 1998 as compared to 1997, even
though the membership numbers were higher in 1998 compared to 1997.
13
<PAGE>
Personnel expenses increased $87,058, or 2.3% in 1998 as compared to 1997.
This was due primarily to the employment of additional technical staff.
Professional fees expense increased $49,976, or 5.2%, in 1998 as compared to
1997. This was primarily due to increased legal costs incurred during the
year. Other general and administrative expenses increased $68,714, or 22.2%
in 1998 as compared to 1997. This was primarily due to the addition of
licenses and service fees in using computer databanks for information.
INCOME TAXES
Income tax expense (credits) represent 20.5% and 46.7% of income (loss) before
income taxes and minority interest for the years ended December 31, 1998 and
1997, respectively. In 1998, permanent tax differences and the effect on the tax
rate brackets decreased the estimated provision, thus decreasing the related
percentage. As a result of previous levels of pretax earnings and the
availability of recoverable income taxes paid in recent years, no valuation
allowance is required for recorded deferred tax assets. See Note 8 of the Notes
to Consolidated Financial Statements.
COMPARISON OF YEARS DECEMBER 31, 1997 AND DECEMBER 31, 1996
GENERAL
The Company's net income decreased $1,150,749 to a loss of $110,108 for the year
ended December 31, 1997, as compared to income of $1,040,641 for the year ended
December 31, 1996, representing a 110.6% decrease. This decrease was primarily
due to an increase in claims expenses of $7,550,999 which was offset by an
increase of $6,155,859 in total revenues and a $592,000 decrease in income
taxes.
REVENUES
Total revenues increased $6,155,859, or 18.4%, for the year ended December 31,
1997, as compared to December 31, 1996. Revenues from net premiums generated by
the health maintenance organization increased $5,858,240. This increase is
attributable to a 19.4% increase in the number of enrollees for the year ended
December 31, 1997, as compared to December 31, 1996, and a 1.1% increase in the
premiums earned per enrollee. The increase in revenue per enrollee was in line
with national averages. The increase in enrollees was due to the continued
emphasis on small group (2 to 50 employees) business and competitive rates in
relation to the local marketplace. Revenues from the third party administration
fees decreased by $158,296 as enrollees participating in the Company's
subsidiaries' TPA plans decreased. Investment income increased $63,400 due
primarily to an increase in the amount of assets invested.
OPERATING EXPENSES
Total operating expenses increased $7,884,842, or 24.8%, for the year ended
December 31, 1997, as compared to December 31, 1996. The change was due
primarily to an increase in claims incurred and commission expenses, but was
offset by a reduction of professional fees.
Net claims expense increased by $7,550,999, or 32.2%. Average claims per
enrollee increased by 10.4% in 1997 as compared to 1996 while the number of
enrollees increased by 19.4%. Unusually high dollar claims
14
<PAGE>
incurred in late 1996 were paid in 1997, which caused the average claims per
enrollee, claims expense and unreported claims payable to increase more than
expected. Commissions expense increased by $287,783, or 23.5%, in 1997 as
compared to 1996 due to the increased activity of the HMO. The Company's
subsidiaries decreased the number of enrollees covered under various
contracts from approximately 64,000 at January 1, 1997, to approximately
50,000 at January 1, 1998. Substantially all of the decrease occurred on
renewals for January 1, 1998, which kept the 1997 overall member months
similar to the member months for 1996. Professional fees expense decreased
$112,579, or 10.4%, in 1997 as compared to 1996. This was primarily due to
state legislation passed in 1997, which spread the cost of each five-year
exam for domiciled companies to all insurance companies registered in the
State. This caused a reduction in the amount of accrued exam fees needed and
thus reduced the overall expense. Also, professional fees decreased by using
consultants less and by performing more duties in house.
INCOME TAXES
Income tax expense (credits) represents 46.7% and 33.3% of income (loss) before
income taxes and minority interest for the years ended December 31, 1997 and
1996, respectively. In 1997, permanent tax differences and the effect on the tax
rate brackets increased the estimated credits, thus increasing the related
percentage. As a result of previous levels of pretax earnings and the
availability of recoverable income taxes paid in recent years, no valuation
allowance is required for recorded deferred tax assets. See Note 8 of the Notes
to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of cash have been premium and fee revenue,
collection of premiums in advance of the claims cost associated with them, and
an agreement with participating physicians in which a percentage of fees for
services is withheld for cash flows of the Company. The Company in the past has
had borrowings from banks and affiliated companies, but currently does not need
to borrow for liquidity purposes.
Net cash provided by operating activities decreased by $1,065,539 to $440,323
for the year ended December 31, 1998, as compared to 1997. Net cash provided by
operating activities increased primarily due to net income, an increase in
reported and unreported claims payable, a decrease in deferred taxes and an
increase in unearned premiums and administration fees. The cash provided from
these items were offset by an increase in receivables and a decrease in
contingency reserves payable since December 31, 1997.
Other uses of cash and cash equivalents were for the payment of dividends and
purchases of property and equipment. The Company has invested cash not currently
needed in operations into intermediate-term bonds, consisting primarily of
municipal bonds and U.S. government securities.
15
<PAGE>
At December 31, 1998, the Company has certificates of deposit of $500,000 on
deposit with the Division to meet the deposit requirements of state insurance
laws.
The Company is not contractually obligated to pay out contingency reserves
withheld but has historically elected to pay out a majority of amounts withheld.
Typically, two years lapse from the date the contingency reserves are withheld
to the date which the corresponding amounts are paid to the participating
physicians.
The Company believes that cash flows generated by operations, withholding of
contingency reserves, cash on hand, and short-term investment balances will be
sufficient to fund operations, pay out projected contingency reserves payable,
and pay dividends on the Class C common stock.
INFLATION
A substantial portion of the Company's operating expenses consist of health care
costs, which, in the general economy, have been rising at a rate greater than
that of the overall Consumer Price Index. The Company believes that its cost
control measures and risk sharing arrangements reduce the effect of inflation on
such costs. Historically, market conditions and the regulatory environment in
which the Company operates have permitted the Company to offset a portion or all
of the impact of inflation on the cost of health care benefits through premium
increases. If the Company was not able to continue to increase premiums, a
material adverse impact on the Company's operations could result. Inflation does
not have a material effect on the remainder of the Company's operating expenses.
TRENDS, EVENTS, OR UNCERTAINTIES
In recent years, there has been a trend by clients to switch to plans with
higher employee cost-sharing levels in order to maintain lower premiums. As a
provider of cost effective managed care plans for medium and small employers,
the Company believes it is delivering products and services that address current
health care reform issues. The Company will continue to evaluate its business
strategy as necessary to maximize its ability to adapt to the changing health
care marketplace.
The Year 2000 issue is whether computer systems will properly recognize
date-sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Company is heavily dependent on computer processing in its
business activities and the Year 2000 issue creates risk for the Company from
unforeseen problems in the Company's computer system and from third parties with
whom the Company processes financial information. Such failures of the Company's
computer system and/or third parties' computer systems could have a material
impact on the Company's ability to conduct its business.
16
<PAGE>
In accordance with its remediation plan to resolve the Year 2000 issue, the
Company completed a review of its computer systems to identify the systems that
could be affected by the Year 2000 issue. In 1999, the Company installed new
operations systems software which the vendor has represented to be Year 2000
compliant. Final Year 2000 compliance testing is expected to be completed April
1999 for mission critical systems and by September 1999 for non-mission critical
systems.
Based on the Company's review of its computer systems, management believes the
cost of the remediation effort to make the systems Year 2000 compliant is
approximately $225,000, which includes approximately 2,400 to 2,700 hours
expected to be incurred by Company personnel related to Year 2000 issues with a
projected cost of approximately $136,000. Such costs will be charged against
income as they are incurred. Total Year 2000 costs incurred through December 31,
1998 were approximately $86,000.
Currently, no contingency plan has been finalized, but planning is in process. A
finalized plan is estimated to be in place by July, 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have any material market risk as defined by Item 305 of
Regulation S-K. The Company has market risk with its cash and investments, but
due to the conservative nature of the invested assets, management feels that
market risk is limited.
17
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
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-7
Notes to Financial Statements F-9
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
18
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
Name Age Positions
- ---- --- ---------
<S> <C> <C>
Frank D. Messner, M.D. 55 President and Director
Patrick Beckman 55 Vice President and Director
Guy E. Tam, M.D. 60 Secretary/Treasurer and Director
Thomas L. Krafka, M.D. 53 Director
K. Gene Koob, M.D. 56 Director
Ben J. Henderson, D.O. 57 Director
Stephan D. Schroeder, M.D. 48 Director
John E. Rittmann, M.D. 61 Director
James A. Engelbrecht, M.D. 51 Director
Robert D. Johnson 55 Chief Executive Officer
Kirk J. Zimmer 38 Senior Vice President
William O. Rossing, M.D. 64 Vice President, Medical Director
Sharon K. Duncan 51 Vice President, System Operations
Dean M. Krogman 49 Vice President, External Operations
Elizabeth D. Mendelson 45 Vice President, Underwriting
Barbara A. Smith 37 Vice President, Medical Services
Thomas N. Nicholson 39 Vice President, Sales and Marketing
Bruce E. Hanson 35 Vice President, Finance
Brian E. Meyer 36 Vice President, Information Systems
</TABLE>
19
<PAGE>
Dr. Messner became a director of the Company in June 1994. He is a member of the
South Dakota State Medical Association and has been engaged as a radiologist in
Yankton, South Dakota, since 1974.
Mr. Beckman became a director of the Company in June 1991. Mr. Beckman has been
engaged in the real estate business in Sioux Falls, South Dakota, since 1969.
Mr. Beckman was a principal in Beckman-Zea Realty, Inc., from 1979 to 1992.
Since then he is the sole owner of Beckman Realty and Development Corporation.
Dr. Tam became a director of the Company in May 1990, and became Secretary in
September 1990. Dr. Tam is a member of the South Dakota State Medical
Association and has been engaged in practice as a family practitioner in Sioux
Falls, South Dakota, since 1968.
Dr. Krafka became a director of the Company in October 1998. He is a member of
the South Dakota Medical Association and has been engaged in the practice of
radiology in Rapid City, South Dakota, since 1976.
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. Schroeder became a director of the Company in October 1998. He is a member
of the South Dakota State Medical Association and has been engaged in practice
as a family practitioner in Miller, South Dakota, since 1980
Dr. Rittmann became a director of the Company in June 1997. He is a member of
the South Dakota State Medical Association and has been engaged in the practice
as a family practitioner in Watertown, South Dakota, since 1973.
Dr. Engelbrecht became a director of the Company in June 1997. He is a member of
the South Dakota State Medical Association and has been engaged in the practice
of internal medicine and rheumatology in Rapid City, South Dakota, since 1980
Mr. Johnson became the Company's Chief Executive Officer upon its inception. He
has also served as the Chief Executive Officer of the South Dakota State Medical
Association since 1972, and as Chief Executive Officer of the South Dakota
Foundation for Medical Care from 1973 to 1996.
Mr. Zimmer joined the Company in May 1988 and became the Company's Senior Vice
President in January 1990. Mr. Zimmer had been a Vice President since November
1988. Mr. Zimmer had been previously employed, since 1982, with McGladrey &
Pullen, LLP, a national 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
20
<PAGE>
upon joining the Company in August 1996. Prior to his retirement from active
practice in July 1996, Dr. Rossing had been in the practice of internal
medicine in Sioux Falls, South Dakota, since 1966, following his tenure with
the U.S. Army Medical Service.
Ms. Duncan became the Company's Vice President of System Operations in February
1990. Prior to joining DAKOTACARE, Ms. Duncan had served as Vice President with
Blue Shield of South Dakota since 1986.
Mr. Krogman joined the Company in May 1993 and became the Company's Vice
President of External Operations in July 1994. Mr. Krogman is also employed by
the South Dakota State Medical Association. Mr. Krogman has been a contract
lobbyist since 1989 and was a broker/owner of Borchardt/Krogman and Associates,
a real estate company, until 1993.
Ms. Mendelson joined the Company in November 1991 and became the Company's Vice
President of Underwriting in July 1995. Prior to joining DAKOTACARE, Ms.
Mendelson had served for nine years at Blue Shield of California, most recently
as Senior Manager, Individual Products.
Ms. Smith joined the Company in June 1996 and became the Company's Vice
President of Operations in September 1996. Prior to joining the Company, Ms.
Smith had served for four years as the Secretary of the South Dakota Department
of Health and for the prior two years as Special Advisor to the Governor of the
State of South Dakota.
Mr. Nicholson joined the Company in July 1996 as the Vice President of Sales and
Marketing. Mr. Nicholson had been previously employed, since 1981, by the
Williams Insurance Agency and was an Executive Vice President since 1994.
Mr. Hanson joined the Company in December 1996 and became the Vice President of
Finance in March 1997. Mr. Hanson had been in private practice as a certified
public accountant since 1991, and previously had been employed, since 1985, with
Charles Bailly & Co., a regional certified public accountant firm.
Mr. Meyer joined the Company in July 1997 as the Vice President of Information
Systems. Mr. Meyer had been previously employed since 1985 with Berkley
Information Services and was Vice President of Systems Development since 1990.
Pursuant to the Company's Bylaws, the Board of Directors consists of ten
directors who are elected for three-year terms expiring at each successive
annual meeting of shareholders. Currently, no director may serve more than three
consecutive terms. One director position is currently vacant. Dr. Robert
Ferrell's term expired after the 1998 Annual Meeting of the Shareholders and Mr.
Jeffrey Rodman resigned in June 1998, while the terms of Dr. Thomas Krafka and
Dr. Stephan Schroeder commenced in October 1998. The terms of Dr. Guy Tam and
Mr. Patrick Beckman expire at the 1999 Annual Meeting of Shareholders; and the
terms of Dr. K. Gene Koob, Dr. Frank Messner, and Dr. James Engelbrecht expire
at the 2000 Annual Meeting of Shareholders; and the terms of Dr. John Rittman,
Dr. Ben Henderson, Dr. Thomas Krafka and Dr. Stephan Schroeder expire at the
2001 Annual
21
<PAGE>
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. One consumer
director is currently Mr. Patrick Beckman, while the other position is
vacant. The officers of the Company are appointed by the Board of Directors
and hold office until their successors are chosen and qualified.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file with the Securities
and Exchange Commission initial reports of ownership and reports of changes in
ownership of Common Stock and other equity securities of the Company. Officers,
directors and greater than ten-percent stockholders are also required by SEC
regulation to furnish the Company with copies of all Section 16(a) forms they
file.
To the Company's knowledge, based solely on review of the copies of such reports
furnished to the Company and written representations that no other reports were
required, during the fiscal year ended December 31, 1998, all Section 16(a)
filing requirements applicable to its officers, directors and greater than
ten-percent beneficial owners were timely complied with.
22
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
(a) (b) (c) (i)
Name and Principal All Other
Position Year Salary $ Compensation(1)
- ------------------ ---- -------- ---------------
<S> <C> <C> <C>
Robert D. Johnson 1998 $77,642 $15,138
Chief Executive Officer 1997 $76,367 $14,380
1996 $58,632 $12,373
William Rossing, M.D. 1998 $106,603 $12,519
Vice President, 1997 $107,195 --
Medical Director 1996 $39,230 --
Kirk J. Zimmer 1998 $116,095 $15,289
Senior Vice President 1997 $106,738 $14,000
1996 $95,025 $12,176
Thomas N. Nicholson 1998 $124,130 $14,473
Vice President, Marketing 1997 $120,101 --
1996 $57,558 --
</TABLE>
- --------------
(1) Consists of retirement plan contribution and premiums paid on the deferred
compensation plan.
No other officer received total annual salary and bonus in excess of $100,000
during 1998, 1997, or 1996. The Board of Directors receive $250 per Board
meeting attended and are reimbursed for costs associated with the attendance of
such meetings. The Company currently has no stock options or other equity-based
compensation for its directors, officers, or employees.
The Company intends to enter into indemnification agreements with each executive
officer and director. The Company has employment agreements with its executive
officers and maintains key person insurance of $250,000 on Robert D. Johnson and
$188,700 on Kirk J. Zimmer.
In connection with employment contracts between the Company, the Chief Executive
Officer, and the Senior Vice President, provision has been made for the future
compensation which is payable upon the completion of the earlier of 25 years of
service or any earlier retirement age specified by the Board of Directors by
resolution. The contracts only provide compensation incentives for the
executives At December 31, 1997, $58,274 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 non-employee directors has been
an officer, employee, or insider of the Company or its subsidiaries.
23
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information, as of March 22, 1999, 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.
24
<PAGE>
<TABLE>
<CAPTION>
Amount & Nature
Title Name and Address of of Beneficial Percent
of Class Beneficial Owner Ownership of Class
- -------- ------------------- --------------- --------
<S> <C> <C> <C>
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 9.10%
P. O. Box 5054
Sioux Falls, SD 57117-5054
Class A Preferred Thomas L. Krafka, M.D. 1 .09%
Class C Common 16,640 1.14%
Class A Preferred Guy E. Tam, M.D. 1 .09%
Class C Common 4,360 .30%
Class C Common Patrick Beckman -- --
Class A Preferred Frank D. Messner, M.D. 1 .09%
Class C Common 8,800 .60%
Class A Preferred K. Gene Koob, M.D. 1 .09%
Class A Preferred Ben J. Henderson, D.O. 1 .09%
Class C Common 560 .04%
Class A Common Stephan D. Schroeder 1 .09%
Class C Common 1,120 .08%
Class A Preferred James Engelbrecht, M.D. 1 .09%
Class A Preferred John Rittmann, M.D. 1 .09%
Class C Common 8,340 .57%
Class C Common Robert D. Johnson(2) 14,560 .99%
1323 South Minnesota Avenue
Sioux Falls, SD 57105
Class C Common William Rossing, M.D. 8,720 .60%
Class C Common Kirk J. Zimmer 800 .05%
Class C Common Thomas Nicholson -- --
Class A Preferred All Directors and Executive 8 .72%
Officers as a Group
Class C Common (18 people) 63,900 4.36%
</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.
25
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company leases office space from the Association. During 1999, the Company
signed a one year lease, which expires December 31, 1999. Under the terms of the
lease, the lease automatically renews for a successive one year term and will
renew for successive one year terms thereafter unless terminated with at least
30 days notice prior to the end of the lease term. The 1999 lease requires
minimum rental payments of $211,016. Total rental payments for office space for
the years December 31, 1998, 1997 and 1996 were $204,870, $186,500 and $158,400,
respectively.
The Company provides group health insurance coverage for employees of the
Association. Total premium income from the affiliate for the years ended
December 31, 1998, 1997 and 1996 was $47,721, $42,517, and $45,535,
respectively.
Robert D. Johnson received salaries and retirement contributions totaling
$110,860, $104,210 and $110,934, from the South Dakota State Medical Association
for the years ended 1998, 1997, and 1996, respectively.
26
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this report:
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS Page
----
<S> <C>
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-7
Notes to Financial Statements F-9
</TABLE>
EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
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)
3.3 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
(incorporated by reference to Exhibit 4.2 to the Company's
Form 10-K, as filed with the Securities and Exchange
Commission on March 29, 1996)
10 Office Lease with the South Dakota State Medical Association
21 Subsidiaries of the Registrant
27 Financial Data Schedule
</TABLE>
REPORTS ON FORM 8-K
None.
27
<PAGE>
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 3/29/99
---------------------------------- --------------------
Robert D. Johnson
Chief Executive Officer
(Principal Executive Officer)
By /s/KIRK J. ZIMMER Dated 3/29/99
---------------------------------- --------------------
Kirk J. Zimmer
Senior Vice President
(Principal Financial Officer)
By /s/Bruce E. Hanson Dated 3/29/99
---------------------------------- --------------------
Bruce E. Hanson
Vice President Finance
(Principal Accounting Officer)
By /s/Thomas L. Krafka, MD Dated 3/29/99
---------------------------------- --------------------
Thomas L. Krafka, M.D.
Director
By /s/Guy E. Tam, MD Dated 3/29/99
---------------------------------- --------------------
Guy E. Tam, M.D.
Director
By /s/James Engelbrecht, MD Dated 3/29/99
---------------------------------- --------------------
James Engelbrecht, M.D.
Director
By /s/Patrick Beckman Dated 3/29/99
---------------------------------- --------------------
Patrick Beckman
Director
By /s/Frank Messner, MD Dated 3/29/99
---------------------------------- --------------------
Frank Messner, M.D.
Director
28
<PAGE>
By /s/K. Gene Koob, MD Dated 3/29/99
---------------------------------- --------------------
K. Gene Koob, M.D.
Director
By /s/Ben J. Henderson, DO Dated 3/29/99
---------------------------------- --------------------
Ben J. Henderson, D.O.
Director
By /s/Stephan D. Schroeder, MD Dated 3/29/99
---------------------------------- --------------------
Stephan D. Schroeder, M.D.
Director
By /s/John Rittmann, MD Dated 3/29/99
---------------------------------- --------------------
John Rittmann, M.D.
Director
29
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
South Dakota State Medical Holding Company, Incorporated
d/b/a DAKOTACARE
Sioux Falls, South Dakota
We have audited the accompanying consolidated balance sheets of South Dakota
State Medical Holding Company, Incorporated d/b/a DAKOTACARE and subsidiaries
as of December 31, 1998 and 1997, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of South
Dakota State Medical Holding Company, Incorporated d/b/a DAKOTACARE and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ McGLADREY & PULLEN, LLP
Sioux Falls, South Dakota
March 22, 1999
F-1
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 5,372,457 $ 4,467,754
Investment in securities held to maturity
(Note 5) 405,094 901,599
Certificates of deposit 575,000 843,559
Receivables (Note 3) 1,252,780 799,395
Prepaids and other assets 153,930 124,729
Deferred income taxes (Note 8) 647,000 720,000
----------------------------
TOTAL CURRENT ASSETS 8,406,261 7,857,036
----------------------------
Long-Term Investments
Investment in securities held to maturity
(Note 5) 3,567,422 3,837,081
Investment in securities available for sale
(Note 5) 305,700 300,000
Pledged certificates of deposit (Note 5) 500,000 500,000
Certificate of deposit 50,000 50,000
Cash surrender value of life insurance 100,000 81,000
----------------------------
4,523,122 4,768,081
----------------------------
Property and Equipment, at cost,
net of accumulated depreciation 913,006 963,684
Deferred Income Taxes (Note 8) 435,000 422,000
----------------------------
$14,277,389 $14,010,801
----------------------------
----------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-2
<PAGE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C>
Current Liabilities
Reported and unreported claims payable (Note 7) $ 4,409,622 $ 4,163,804
Unearned premiums and administration fees 839,043 629,783
Accounts payable and accrued expenses 727,925 695,050
Contingency reserves payable (Note 6) 1,300,000 1,627,000
----------------------------
TOTAL CURRENT LIABILITIES 7,276,590 7,115,637
----------------------------
Contingency Reserves Payable (Note 6) 1,390,568 1,336,846
----------------------------
Minority Interest in Subsidiary 350,606 354,160
----------------------------
Commitments and Contingencies (Notes 4, 13 and 14)
Stockholders' Equity (Note 9)
Class A preferred, voting, no par value, $10
stated value, 2,500 shares authorized; 1,105
and 1,069 shares issued at December 31, 1998
and 1997 11,050 10,690
Class B preferred, voting, no par value,
$1 stated value, 2,500 shares authorized;
issued and outstanding 1,300 shares 1,300 1,300
Class C common, nonvoting, $.01 par value,
10,000,000 shares authorized; issued
1,505,760 shares 15,058 15,058
Additional paid-in capital 3,749,342 3,749,342
Retained earnings 1,771,993 1,435,709
Accumulated other comprehensive income (8,638) (7,941)
Less cost of Class C common treasury stock,
40,415 shares (280,480) -
----------------------------
5,259,625 5,204,158
----------------------------
$14,277,389 $14,010,801
----------------------------
----------------------------
</TABLE>
F-3
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
D/B/A DAKOTACARE
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Premiums $ 36,157,947 $ 35,124,035 $ 29,071,245
Less premiums ceded for reinsurance (440,396) (369,888) (383,408)
------------ ------------ ------------
35,717,551 34,754,147 28,687,837
Third party administration fees 3,080,947 3,628,131 3,786,427
Investment income 606,615 615,134 551,734
Other income 647,850 583,648 399,203
------------ ------------ ------------
TOTAL REVENUES 40,052,963 39,581,060 33,425,201
------------ ------------ ------------
Operating expenses:
Claims incurred 31,318,143 31,593,161 23,528,141
Less reinsurance recoveries (703,563) (616,801) (102,780)
------------ ------------ ------------
30,614,580 30,976,360 23,425,361
Personnel expenses 3,891,275 3,804,217 3,703,067
Commissions 1,425,808 1,513,054 1,225,271
Professional fees expenses 1,020,213 970,237 1,082,816
Office expenses 625,614 673,114 713,964
Occupancy expenses 657,207 656,951 625,541
State insurance taxes 458,519 421,622 330,574
Advertising expenses 378,638 378,310 386,174
Other general and administrative expenses 378,000 309,286 325,541
------------ ------------ ------------
TOTAL OPERATING EXPENSES 39,449,854 39,703,151 31,818,309
------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME
TAXES AND MINORITY INTEREST 603,109 (122,091) 1,606,892
Income taxes (credits) (Note 8) 123,625 (57,000) 535,000
------------ ------------ ------------
INCOME (LOSS) BEFORE MINORITY INTEREST 479,484 (65,091) 1,071,892
Minority interest in income (loss) of subsidiary (3,554) 45,017 31,251
------------ ------------ ------------
NET INCOME (LOSS) $ 483,038 $ (110,108) $ 1,040,641
------------ ------------ ------------
------------ ------------ ------------
Earnings (loss) per common share $ 0.33 $ (0.07) $ 0.69
------------ ------------ ------------
------------ ------------ ------------
</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, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
Additional
Capital Paid-In
Stock Capital
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance, December 31, 1995 $ 25,818 $ 3,749,342
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 - -
Comprehensive income:
Net income - -
Net change in unrealized loss on securities available for sale - -
Comprehensive income - -
----------------------------
Balance, December 31, 1996 26,778 3,749,342
Issuance of Class A preferred stock 1,940 -
Redemption of Class A preferred stock (1,670) -
Dividends paid on Class C common stock - -
Comprehensive income:
Net (loss) - -
Net change in unrealized loss on securities available for sale - -
Comprehensive income - -
----------------------------
Balance, December 31, 1997 27,048 3,749,342
Issuance of Class A preferred stock 900 -
Redemption of Class A preferred stock (540) -
Dividends paid on Class C common stock - -
Purchase of treasury stock (Note 9) - -
Comprehensive income:
Net income - -
Net change in unrealized loss on securities available for sale - -
Comprehensive income - -
----------------------------
Balance, December 31, 1998 $ 27,408 $ 3,749,342
----------------------------
----------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
Accumulated
Other
Retained Comprehensive Treasury
Earnings Income Stock Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance, December 31, 1995 $ 1,107,480 $ (3,049) - $ 4,879,591
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) - - (271,037)
Comprehensive income:
Net income 1,040,641 - -
Net change in unrealized loss on securities available for sale - (10,083) -
Comprehensive income - - - 1,030,558
-----------------------------------------------------------
Balance, December 31, 1996 1,877,084 (13,132) - 5,640,072
Issuance of Class A preferred stock - - - 1,940
Redemption of Class A preferred stock - - - (1,670)
Dividends paid on Class C common stock (331,267) - - (331,267)
Comprehensive income:
Net (loss) (110,108) - -
Net change in unrealized loss on securities available for sale - 5,191 -
Comprehensive income - - - (104,917)
-----------------------------------------------------------
Balance, December 31, 1997 1,435,709 (7,941) - 5,204,158
Issuance of Class A preferred stock - - - 900
Redemption of Class A preferred stock - - - (540)
Dividends paid on Class C common stock (146,754) - - (146,754)
Purchase of treasury stock (Note 9) - - (280,480) (280,480)
Comprehensive income:
Net income 483,038 - -
Net change in unrealized loss on securities available for sale - (697) -
Comprehensive income - - - 482,341
-----------------------------------------------------------
Balance, December 31, 1998 $ 1,771,993 $ (8,638) $ (280,480) $ 5,259,625
-----------------------------------------------------------
-----------------------------------------------------------
</TABLE>
F-6
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows From Operating Activities
Net income (loss) $483,038 $ (110,108) $ 1,040,641
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation 307,211 319,493 318,297
Loss on disposal of property and equipment - - 1,664
Minority interest in income (loss) of subsidiary (3,554) 45,017 31,251
Amortization of discounts and premiums on
investments and certificates of deposit, net (138,461) (139,675) (103,151)
(Increase) decrease in receivables (453,385) 36,969 (301,794)
(Increase) decrease in prepaids and other assets (29,201) 13,758 (66,530)
(Increase) decrease in deferred income taxes 60,000 (284,000) (57,000)
Increase in reported and unreported
claims payable 245,818 975,349 478,455
Increase (decrease) in accounts payable
and accrued expenses 32,875 15,629 (107,587)
Increase (decrease) in unearned premiums
and administration fees 209,260 (225,122) 39,252
Increase (decrease) in contingency
reserves payable (273,278) 858,552 150,625
------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 440,323 1,505,862 1,424,123
------------------------------------------
Cash Flows From Investing Activities
Purchase of securities available for sale (6,397) (6,259) (5,933)
Held to maturity securities:
Matured 985,000 525,000 1,200,000
Purchased (367,364) (726,030) (1,983,309)
Repayments on collateralized mortgage obligations 283,548 157,013 133,471
Proceeds from maturities of certificates of deposit 1,447,000 1,470,000 1,104,900
Purchase of certificates of deposit (1,175,000) (1,325,000) (1,531,959)
(Increase) in cash surrender value of life insurance (19,000) (12,000) (18,000)
Purchase of property and equipment (256,533) (231,238) (216,720)
Proceeds from sale of property and equipment - 18,711 -
------------------------------------------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES 891,254 (129,803) (1,317,550)
------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
F-7
<PAGE>
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------------------
<S> <C> <C> <C>
Cash Flows From Financing Activities
Proceeds from issuance of capital stock $ 900 $ 1,940 $ 1,290
Redemption of capital stock (540) (1,670) (330)
Payment of dividends (146,754) (331,267) (271,037)
Purchase of treasury stock (280,480) - -
------------------------------------------
NET CASH (USED IN) FINANCING ACTIVITIES (426,874) (330,997) (270,077)
------------------------------------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 904,703 1,045,062 (163,504)
Cash and Cash Equivalents
Beginning 4,467,754 3,422,692 3,586,196
------------------------------------------
Ending $ 5,372,457 $ 4,467,754 $ 3,422,692
------------------------------------------
------------------------------------------
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Income taxes, net of refunds $ 315,275 $ 2,000 $ 790,000
Supplemental Disclosures of Noncash Investing
and Financing Activities
(Increase) decrease in unrealized loss on
securities available for sale (697) 5,191 (10,083)
</TABLE>
F-8
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
D/B/A DAKOTACARE
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), and its 50.11% owned subsidiary, Dakota
Health Plans, Incorporated (DHP). DAS and DHP are third party administrators
of health care plans for independent employer companies. DIL's primary
activity is in providing reinsurance quota share excess medical stop loss
coverage to DAS and DHP's self funded customers. During December of 1998, DHP
ceased business operations. Management expects to formally dissolve DHP
during 1999 with no material effect on the consolidated financial statements.
All intercompany balances and transactions have been eliminated in
consolidation.
BASIS OF FINANCIAL STATEMENT PRESENTATION: The consolidated financial
statements have been prepared in conformity with generally accepted
accounting principles. In preparing the financial statements, management is
required to make estimates and assumptions that affect the reported amounts
of assets and liabilities as of the date of the balance sheet. Actual
results could differ significantly from those estimates. Material estimates
that are particularly susceptible to significant change in the near-term
relate to the liabilities for reported and unreported claims payable.
CASH AND CASH EQUIVALENTS: For purposes of reporting the statements of cash
flows, the Company includes as cash equivalents all cash accounts and highly
liquid debt instruments which are not subject to withdrawal restrictions or
penalties. Certificates of deposit are considered investments as all have
been purchased with maturities in excess of ninety days. Cash and cash
equivalents as of December 31, 1998 and 1997 includes approximately $631,000
and $572,000, respectively, in money market funds which are not federally
insured. The Company believes it is not exposed to any significant credit
risk on cash and cash equivalents.
F-9
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
D/B/A DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVESTMENT SECURITIES: Investment securities classified as held to maturity
are those debt securities that the Company has both the intent and ability to
hold to maturity regardless of changes in market condition, liquidity needs,
or changes in general economic conditions. These securities are stated at
amortized cost.
Investment securities classified as available for sale are marketable equity
securities and those debt securities that the Company intends to hold for an
indefinite period of time, but not necessarily to maturity. Any decision to
sell a security classified as available for sale would be based on various
factors, including significant movements in interest rates, changes in the
maturity mix of the Company's assets and liabilities, liquidity needs,
regulatory capital considerations, and other similar factors. Investment
securities available for sale are carried at fair value. Unrealized gains or
losses are reported as increases or decreases in comprehensive income, net of
the related deferred tax effect.
Premiums and discounts on investments in debt securities are amortized over
their contractual lives, except for collateralized mortgage obligations, for
which prepayments are probable and predictable, which are amortized over the
estimated expected repayment terms of the underlying mortgages. The method
of amortization results in a constant effective yield on those securities
(the interest method). Interest on debt securities is recognized in income
as accrued. Realized gains and losses on the sale of investment securities
are determined using the specific identification method.
DEPRECIATION: Building and building improvements are depreciated using
straight-line methods over the estimated useful lives of the assets, which
are twenty to thirty-nine years. Depreciation on furniture, equipment and
automobiles is computed using straight-line methods based upon the estimated
useful lives of the respective assets, which is principally five to seven
years. A summary of property and equipment is as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------------
<S> <C> <C>
Furniture, equipment and automobiles $ 2,485,278 $ 2,253,358
Building and building improvements 53,370 62,609
Other 134,818 131,967
----------------------------------
2,673,466 2,447,934
Less accumulated depreciation 1,760,460 1,484,250
----------------------------------
$ 913,006 $ 963,684
----------------------------------
----------------------------------
</TABLE>
F-10
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
D/B/A DAKOTACARE
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 received prior to the end
of the coverage period is recorded as unearned premiums. Revenue is reduced
by reinsurance premiums ceded to reinsurance companies. Third party
administration fees are recorded as earned in the period in which the related
services are performed. The unearned portion of fees received but not earned
prior to the end of the contract is recorded as unearned administration fees.
REPORTED AND UNREPORTED CLAIMS PAYABLE: The coverage offered by the Company
is on an occurrence basis which provides for payment of claims which occur
during the period of coverage regardless of when the claims are reported.
Reported and unreported claims payable consist of actual claims reported to
be paid and estimates of health care services rendered but not reported and
to be paid. The liabilities for reported and unreported claims payable have
been estimated by utilizing statistical information developed from historical
data, current enrollment, health service utilization statistics and other
related information. In addition, the Company uses the services of an
independent actuary in the determination of its year end liabilities. The
accruals are continually monitored and reviewed and as adjustments to the
estimated liabilities become necessary, such adjustments are reflected in
current operations.
INCOME TAXES: Deferred taxes are provided on a liability method whereby
deferred tax assets are recognized for deductible temporary differences and
operating loss and tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their
tax bases. Deferred tax assets are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some portion or
all of the deferred tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on
the date of enactment.
EARNINGS (LOSS) PER COMMON SHARE: Earnings (loss) per common share is
calculated in accordance with the provisions of Financial Accounting
Standards Board (FASB) Statement No. 128, "Earnings Per Share", which was
adopted in 1997. This Statement establishes standards for computing and
presenting earnings (loss) per share (EPS). It replaces the presentation of
primary EPS with a presentation of basic EPS. It also requires dual
presentation of basic and diluted EPS on the face of an income statement for
all entities with complex capital structures. This Statement requires
restatement of all prior-period EPS data presented. All references to
earnings (loss) per share in the consolidated financial statements are to
basic earnings (loss) per share. No restatement of EPS was necessary as a
result of the application of Statement No. 128. Earnings (loss) per common
share was calculated by dividing net income (loss) by the weighted average
number of Class C common shares outstanding during each period. The weighted
average number of Class C common shares outstanding was 1,482,635 in 1998 and
1,505,760 in both and 1997 and 1996.
F-11
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (continued)
NEW ACCOUNTING STANDARDS: Effective January 1, 1998, the Company adopted FASB
Statement No. 130, which establishes new rules for the reporting and display of
comprehensive income and its components, but has no effect on the Company's net
income (loss) or total stockholders' equity. Statement No. 130 requires
unrealized gains and losses on the Company's securities available for sale,
which prior to adoption were reported separately in stockholders' equity, to be
included in comprehensive income. Prior year financial statements have been
reclassified to conform to the requirements of Statement No. 130.
Effective January 1, 1998, the Company adopted FASB Statement No. 131,
Disclosures About Segments of an Enterprise and Related Information. Statement
No. 131 superseded FASB Statement No. 14, Financial Reporting for Segments of a
Business Enterprise. Statement No. 131 establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports. Statement
No. 131 also establishes standards for related disclosures about products and
services, geographic areas, and major customers. The adoption of Statement No.
131 did not affect results of operations or financial position, but did affect
the disclosure of segment information. See Note 12 for disclosures about the
Company's operating segments.
NOTE 2. FAIR VALUE OF FINANCIAL INSTRUMENTS
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, 1998, the carrying amount and fair value
of the Company's investment securities was $4,278,216 and $4,549,012,
respectively. At December 31, 1997, the carrying amount and fair value of the
Company's investment securities was $5,038,680 and $5,141,045, respectively.
Accrued interest receivable: The carrying amount approximates fair value due to
the nature of the balances recorded.
F-12
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 3. RECEIVABLES
Receivables consist of the following:
<TABLE>
<CAPTION>
1998 1997
-------- ----------
<S> <C> <C>
Commissions $ 3,561 $ 4,300
Drug manufacturer chargebacks 133,111 68,850
Premiums 61,055 151,298
Subrogation, net of recovery expenses 84,011 75,000
Interest 27,068 30,367
Reinsurance 275,651 229,486
Income taxes 273,650 22,000
Funds withheld by ceding insurer 104,485 118,804
Other 290,188 99,290
---------- ----------
1,252,780 799,395
Less allowance for doubtful accounts -- --
---------- ----------
$1,252,780 $ 799,395
---------- ----------
---------- ----------
</TABLE>
NOTE 4. REINSURANCE
The Company's policy is to reinsure that portion of risk in excess of $85,000 of
covered hospital inpatient expenses of any enrollee per contract year, subject
to a coinsurance provision which ranges from 50% to 90% based on average daily
amounts specified in the plan, and a $2,000,000 lifetime maximum benefit per
enrollee. The Company would be liable for any obligations that the reinsuring
company is unable to meet under the reinsurance agreement.
This reinsurance agreement also provides for enrollee benefits to be paid in the
event the Company should cease operations or become insolvent, and a conversion
privilege for all enrollees in the event of plan insolvency and for any enrollee
that moves out of the service area of the Company.
F-13
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 5. INVESTMENT SECURITIES
Investment securities at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
--------------------------------------------------------
<S> <C> <C> <C> <C>
Debt securities held to maturity:
Obligations of U.S. treasury, government
agencies and corporations $ 949,781 $ 58,506 - $1,008,287
Obligations of state and political subdivisions 2,957,539 213,510 (1,833) 3,169,216
U.S. governmental agency collateralized
mortgage obligations 65,196 904 (291) 65,809
--------------------------------------------------------
$3,972,516 $ 272,920 $ (2,124) $4,243,312
--------------------------------------------------------
--------------------------------------------------------
Equity securities available for sale:
Bond mutual funds $ 314,338 $ 1,431 $ (10,069) $ 305,700
--------------------------------------------------------
--------------------------------------------------------
</TABLE>
The amortized cost and estimated fair values of debt securities, by contractual
maturity, are shown below. Expected maturities will differ from contractual
maturities because the borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
December 31, 1998
------------------------------
Amortized Estimated
Cost Fair Value
------------------------------
<S> <C> <C>
Due in one year $ 405,094 $ 408,477
Due after one year through five years 2,018,403 2,089,552
Due after five years through ten years 1,410,538 1,601,087
Due after ten years 73,285 78,387
------------------------------
3,907,320 4,177,503
Collateralized mortgage obligations 65,196 65,809
------------------------------
$ 3,972,516 $ 4,243,312
------------------------------
------------------------------
</TABLE>
F-14
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 5. INVESTMENT SECURITIES (CONTINUED)
Investment securities at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
-----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Debt securities held to maturity:
Obligations of U.S. treasury, government
agencies and corporations $ 1,630,630 $ 36,001 $ - $ 1,666,631
Obligations of state and political
subdivisions 2,760,837 69,718 (483) 2,830,072
U.S. governmental agency collateralized
mortgage obligations 347,213 151 (3,022) 344,342
-----------------------------------------------------------------------
$ 4,738,680 $ 105,870 $ (3,505) $ 4,841,045
-----------------------------------------------------------------------
-----------------------------------------------------------------------
Equity securities available for sale:
Bond mutual funds $ 307,941 $ - $ (7,941) $ 300,000
-----------------------------------------------------------------------
-----------------------------------------------------------------------
</TABLE>
There were no sales of debt or equity securities during the years ended December
31, 1998, 1997 or 1996, and accordingly, no reclassification adjustments on
investment securities for the respective years. At December 31, 1998 and 1997,
no individual investments in obligations of state and political subdivisions
exceeded 10% of the Company's equity.
At December 31, 1998 and 1997, the Company had certificates of deposit of
$500,000 on deposit with the South Dakota Department of Commerce and Regulation,
Division of Insurance (Division of Insurance), to meet the deposit requirement
of state insurance laws.
F-15
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 6. CONTINGENCY RESERVES PAYABLE
The Company's agreements with participating physicians provide that up to 20%
of fees for services provided, as submitted to the Company, may be withheld
to provide a contingency reserve that may be used to fund operations or meet
other financial requirements of the Company. The percentage withheld for the
years 1996 through 1998 was 15%. The amounts withheld may be paid to the
participating physicians at the discretion of the Board of Directors of the
Company, although the Company is not contractually obligated to pay out
amounts withheld. Management estimates the expected amount of contingency
reserves to be paid to participating physicians and records a liability based
upon factors such as cash flow needs, net income, and accumulations of
amounts withheld. Payments to physicians are made at such times as the Board
of Directors approves payouts. The recorded liability is equal to actual
amounts withheld for the years ended December 31, 1998, 1997 and 1996.
Payments to physicians in 1996 exceeded amounts accrued in 1995 by $71,253,
which was accounted for as a change in accounting estimate.
NOTE 7. REPORTED AND UNREPORTED CLAIMS PAYABLE
Activity in the liability for reported and unreported claims payable is
summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------------------
<S> <C> <C> <C>
Balance at January 1 $ 4,163,804 $ 3,188,455 $ 2,710,000
---------------------------------------------------
Incurred related to:
Current year 30,197,890 30,237,417 23,350,462
Prior years 416,690 738,943 74,899
---------------------------------------------------
Total incurred 30,614,580 30,976,360 23,425,361
---------------------------------------------------
Paid related to:
Current year 25,704,590 26,217,052 20,247,806
Prior years 4,710,337 3,920,866 2,776,707
---------------------------------------------------
Total paid 30,414,927 30,137,918 23,024,513
---------------------------------------------------
Less reinsurance recoverables at January 1 (229,486) (92,579) (14,972)
Plus reinsurance recoverables at December 31 275,651 229,486 92,579
---------------------------------------------------
Balance at December 31 $ 4,409,622 $ 4,163,804 $ 3,188,455
---------------------------------------------------
---------------------------------------------------
</TABLE>
F-16
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 8. INCOME TAX MATTERS
The Company is taxable as a property and casualty insurance company under
section 831 of the Internal Revenue Code. The code prescribes certain
adjustments to book income to arrive at taxable income which include
adjustments to unearned premiums, discounting of loss reserves and proration
of tax-exempt income. In addition, increases in contingency reserves, which
are included as claims expenses, are not allowable as tax deductions until
actually paid. The Company files a consolidated income tax return with its
wholly-owned subsidiaries, DAS and DIL.
The components of income tax expense as of December 31 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------
<S> <C> <C> <C>
Current $ 63,625 $ 227,000 $592,000
Deferred (credits) 60,000 (284,000) (57,000)
---------------------------------------
$123,625 $ (57,000) $535,000
---------------------------------------
---------------------------------------
</TABLE>
Total income tax expense differed from the amounts computed by applying the
U.S. federal income tax rate of 35 percent to income before income taxes as a
result of the following:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------
<S> <C> <C> <C>
Computed "expected" tax expense (credits) $ 211,000 $ (42,700) $ 562,400
Tax exempt interest (43,281) (38,861) (30,771)
Lobbying 4,866 9,105 6,825
Reversal of overaccrual of prior year's taxes (26,576) - -
Effect of tax rate brackets and other (22,384) 15,456 (3,454)
---------------------------------------
$ 123,625 $ (57,000) $ 535,000
---------------------------------------
---------------------------------------
</TABLE>
F-17
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 8. INCOME TAX MATTERS (CONTINUED)
The net deferred tax assets consist of the following components at December 31:
<TABLE>
<CAPTION>
1998 1997
----------------------------
<S> <C> <C>
Deferred tax assets:
Contingency reserves payable $ 915,000 $ 1,008,000
Reported and unreported claims payable 44,000 42,000
Unearned premiums 50,000 43,000
Accrued expenses and other 95,000 65,000
Net operating loss carryforward of subsidiary 39,000 47,000
----------------------------
1,143,000 1,205,000
Less valuation allowance - -
----------------------------
1,143,000 1,205,000
----------------------------
Deferred tax liability:
Property and equipment (61,000) (63,000)
----------------------------
$ 1,082,000 $ 1,142,000
----------------------------
----------------------------
Reflected on the accompanying balance sheets as follows:
1998 1997
----------------------------
<S> <C> <C>
Current assets $ 647,000 $ 720,000
Noncurrent assets 435,000 422,000
----------------------------
$ 1,082,000 $ 1,142,000
----------------------------
----------------------------
</TABLE>
F-18
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 9. CAPITAL STOCK
The Class A voting 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 is 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.
The Class B voting preferred stock is restricted to ownership by the South
Dakota State Medical Association, an affiliated company, and is not entitled
to receive dividends.
The Class C nonvoting common stock is not entitled to cumulative dividends
and has no preference in a liquidation. The Class C common stock is
restricted to ownership by the following persons or entities: (1) physicians
entitled to ownership of Class A stock, (2) a trust or self-directed
individual retirement account controlled by a physician entitled to ownership
of Class A stock, (3) a professional corporation, partnership or other entity
domiciled in the State of South Dakota and in which a physician entitled to
ownership of Class A stock is a shareholder, partner, or employee in the
practice of medicine, (4) management, employees or agents of the Company, the
South Dakota State Medical Association, or the South Dakota Foundation for
Medical Care, or (5) the spouse or children of such physician or other person
set forth in (1) or (4) above.
To facilitate liquidity for Class C common stock (Common Stock) in the event
of death, disability, or retirement of a shareholder, the Company's Board of
Directors adopted a Stock Repurchase Program (Program) which was implemented
in February 1998. Participation in the Program is voluntary. No shareholder
is required to sell his or her shares of Common Stock under the Program nor
is the Company required to purchase any Common Stock under the Program. The
purchase and sale of Common Stock under the Program is subject to repurchase
conditions as described in the Program. The Board of Directors of the
Company may, at any time, modify or terminate the Program. The Company may
also, at its discretion, offer to repurchase shares of Common Stock outside
of the Program in compliance with applicable laws. During 1998, 40,415
shares were acquired under the Program.
Regulatory capital as required by the South Dakota Department of Commerce and
Regulation, Division of Insurance (Division of Insurance) at December 31,
1998 and 1997 was $200,000 on a statutory basis of accounting, which the
Company significantly exceeded. 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.
The Company is also subject to risk based capital (RBC) requirements
promulgated by the National Association of Insurance Commissioners (NAIC).
The RBC standards establish uniform minimum capital requirements for
insurance companies. The RBC formula applies various weighting factors to
financial balances or various levels of activities based on the perceived
degree of risk. At December 31, 1998, the Company's stockholders' equity
exceeded the minimum levels required by the RBC standards.
F-19
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 10. TRANSACTIONS WITH AFFILIATE
The Company leases office space from the South Dakota State Medical
Association (Association). During 1997, the Company signed a one year lease
which automatically renewed for a one year term through December 31, 1998,
and will renew for successive one year terms thereafter unless terminated
with at least 30 days notice prior to the end of the lease term. The 1999
lease renewal requires minimum rental payments of $211,016. Total rental
payments for this office space for the years ended December 31, 1998, 1997
and 1996 were $204,870, $186,500 and $158,400, respectively.
The Company provides group health insurance coverage for employees of the
Association. Total premium income from the affiliate for the years ended
December 31, 1998, 1997 and 1996 was $47,721, $42,517 and $45,535,
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
required under the plan, were an amount equal to 11.5% of the participants'
compensation for the twelve-month periods ending September 1, 1998, 1997 and
1996. Retirement plan expense for the years ended December 31, 1998, 1997
and 1996 was $233,483, $216,364 and $245,104, 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, 1998 and 1997, $58,274 and $49,164, respectively, was accrued
under these contracts.
F-20
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 12. SEGMENT INFORMATION
The Company has three reportable segments: Health Maintenance Organization
(HMO), Third Party Administration (TPA) and Reinsurance. The HMO segment
consists of the operations of the Company. The Company is a South Dakota
licensed HMO engaged in the development of comprehensive health care delivery
systems. The TPA segment consists of the operations of DAS and DHP. DAS and
DHP are TPA's of health care plans for independent employer companies. The
reinsurance segment consists of the operations of DIL. DIL's primary
activity is in providing reinsurance quota share excess medical stop loss
coverage to DAS and DHP's self funded customers.
The Company evaluates performance and allocates resources based on net income
determined under general accepted accounting principles. The accounting
policies of the reportable segments are the same as those described in the
summary of significant accounting policies. The Company allocates payroll
costs incurred based on the activities of admitting new enrollees and in
adjudicating claims. The HMO segment profit includes the equity in earnings
(loss) of the TPA and reinsurance segments. Intersegment revenues primarily
relate to equipment rental charges which are based on the respective
segment's underlying cost.
The Company's reportable segments are derived from the operations of the
Company and subsidiaries that offer different products. The reportable
segments are managed separately because they provide distinct services.
<TABLE>
<CAPTION>
Year Ended December 31, 1998
- -----------------------------------------------------------------------------------------------------
HMO TPA Reinsurance Totals
----------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external customers $ 35,796,765 $ 3,540,988 $ 673,790 $ 40,011,543
Intersegment revenues - 236,526 - 236,526
Investment income 538,170 55,333 - 593,503
Depreciation expense 85,787 221,424 - 307,211
Segment profit (loss) 483,038 (68,319) 23,345 438,064
Equity in net (loss) of subsidiaries (41,420) - - (41,420)
Income tax expense (credits) 158,350 (34,725) - 123,625
Segment assets 13,607,488 1,953,572 475,006 16,036,066
</TABLE>
F-21
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 12. SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
Year Ended December 31, 1997
- ------------------------------------------------------------------------------------------------------------------
HMO TPA Reinsurance Totals
----------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external customers $ 34,718,343 $ 4,121,995 $ 694,892 $ 39,535,230
Intersegment revenues - 864,735 - 864,735
Investment income 546,562 58,247 10,325 615,134
Depreciation expense 85,284 234,209 - 319,493
Segment profit (loss) (110,108) 111,235 (112,048) (110,921)
Equity in net (loss) of subsidiaries (45,830) - - (45,830)
Income tax expense (credits) (98,142) 41,142 - (57,000)
Segment assets 13,455,364 1,854,251 345,114 15,654,729
Expenditures for long-lived assets -
(land and building) 59,150 - - 59,150
Year Ended December 31, 1996
- ------------------------------------------------------------------------------------------------------------------
HMO TPA Reinsurance Totals
----------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external customers $ 28,829,498 $ 4,248,500 $ 483,471 $ 33,561,469
Intersegment revenues - 802,996 - 802,996
Investment income 500,341 44,419 6,974 551,734
Depreciation expense 84,536 233,761 - 318,297
Segment profit (loss) 1,040,641 196,705 (29,186) 1,208,160
Equity in net income of
subsidiaries 136,268 - - 136,268
Income tax expense 452,000 83,000 - 535,000
Segment assets 12,188,065 1,848,406 269,615 14,306,086
</TABLE>
F-22
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 12. SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------------
<S> <C> <C> <C>
Revenues
Total external revenues for reportable segments $ 40,011,543 $ 39,535,230 $ 33,561,469
Intersegment revenues for reportable segments 236,526 864,735 802,996
Elimination of intersegment revenues (236,526) (864,735) (802,996)
Elimination of net income (loss) of subsidiaries (41,420) (45,830) 136,268
---------------------------------------------
Total consolidated revenues $ 40,052,963 $ 39,581,060 $ 33,425,201
---------------------------------------------
---------------------------------------------
Income or Loss
Total income (loss) for reportable segments $ 438,064 $ (110,921) $ 1,208,160
Elimination of equity in net income (loss)
of subsidiaries (41,420) (45,830) 136,268
Minority interest in income (loss) of subsidiary (3,554) 45,017 31,251
---------------------------------------------
Total consolidated net income (loss) $ 483,038 $ (110,108) $ 1,040,641
---------------------------------------------
---------------------------------------------
Assets
Total assets for reportable segments $ 16,036,066 $ 15,654,729 $ 14,306,086
Elimination of intercompany receivable (100,922) (44,753) (33,791)
Elimination of investment in subsidiaries (1,657,755) (1,599,175) (1,495,005)
---------------------------------------------
Total consolidated assets $ 14,277,389 $ 14,010,801 $ 12,777,290
---------------------------------------------
---------------------------------------------
</TABLE>
NOTE 13. LITIGATION
During 1998, a substantial claim was filed against the Company in circuit
court which alleges wrongful non-renewal of a sales agency contract and seeks
compensatory and punitive damages. As of March 1999, the lawsuit is in the
discovery stage. Management believes the lawsuit is without merit and the
Company will vigorously defend itself in this matter.
In addition, the Company is involved in other 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-23
<PAGE>
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED
d/b/a DAKOTACARE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 14. YEAR 2000 ISSUE AND MANAGEMENT INFORMATION SYSTEM COMMITMENT
The Year 2000 issue is whether computer systems will properly recognize
date-sensitive information when the year changes to 2000. Systems that do
not properly recognize such information could generate erroneous data or
cause a system to fail. The Company is heavily dependent on computer
processing in its business activities and the Year 2000 issue creates risk
for the Company from unforeseen problems in the Company's computer system and
from third parties with whom the Company processes financial information.
Such failures of the Company's computer system and/or third parties' computer
systems could have a material impact on the Company's ability to conduct its
business.
Based on the Company's review of its computer systems, management believes
the remaining cost of the remediation effort to make the systems year 2000
compliant is approximately $225,000. Such costs will be charged against
income as they are incurred.
In addition, in January 1999, the Company entered into a sales licenses and
service agreement (Agreement) to purchase certain computer equipment and
other related items, and to obtain a license for certain software and
programs. Total amounts committed under this Agreement are approximately
$215,000.
F-24
<PAGE>
EXHIBIT INDEX
-------------
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
10 Office Lease with the South Dakota State Medical Association
21 Subsidiaries of the Registrant
</TABLE>
<PAGE>
EXHIBIT 10
LEASE
This LEASE made this 1st day of January, 1999, 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 following structures: "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; as
well as Lots C, D, and E, except the East 25 feet of the South 88 feet
of Lot E of Perry's Subdivision of part of Block 32 of Park Addition to
Sioux Falls, Minnehaha County, South Dakota, according to the recorded
plat thereof. 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, 1999, and end on
the 31st day of December, 1999, 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 Seventeen Thousand Five Hundred Eighty-Four Ten Dollars and
Sixty-Eight Cents ($17,584.68) 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.
3.
31
<PAGE>
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.
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
32
<PAGE>
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
33
<PAGE>
EXHIBIT 21
34
<PAGE>
EXHIBIT 21. SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
Name Incorporation % Owned
- ---- ------------- -------
<S> <C> <C>
DAKOTACARE Administrative South Dakota 100%
Services, Incorporated
Dakota Health Plans, Incorporated South Dakota 50.11%
DAKOTACARE Insurance, Ltd. Cayman Islands 100%
</TABLE>
35
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 5097516
<DEBT-MARKET-VALUE> 5368312
<EQUITIES> 305700
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 5403216
<CASH> 5372457
<RECOVER-REINSURE> 275651
<DEFERRED-ACQUISITION> 0
<TOTAL-ASSETS> 14277389
<POLICY-LOSSES> 4409622
<UNEARNED-PREMIUMS> 839043
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
12350
<COMMON> 15058
<OTHER-SE> 5232217
<TOTAL-LIABILITY-AND-EQUITY> 14277389
35717551
<INVESTMENT-INCOME> 606615
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 3728797
<BENEFITS> 30614580
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 1425808
<INCOME-PRETAX> 603109
<INCOME-TAX> 123625
<INCOME-CONTINUING> 483038
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 483038
<EPS-PRIMARY> .33
<EPS-DILUTED> .33
<RESERVE-OPEN> 4163804
<PROVISION-CURRENT> 30197890
<PROVISION-PRIOR> 416690
<PAYMENTS-CURRENT> 25704590
<PAYMENTS-PRIOR> 4710337
<RESERVE-CLOSE> 4409622
<CUMULATIVE-DEFICIENCY> 416690
</TABLE>
