ITEM 1. BUSINESS
South Dakota State Medical Holding Company, Incorporated, 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.
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 2000 through 2002 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 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 $2,974,808 and $2,215,750 for the years ended December 31, 2002 and 2001, 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, 2002 and 2001, was $5,190,558 and $3,846,711, respectively. The recorded liability is equal to actual amounts withheld plus or minus claims adjustments for each of the two years in the period ended December 31, 2002.
2. 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). During December of 1998, DHP ceased business operations and the Company was formally dissolved in 2001. 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. In August 2000, the Company organized and purchased a 54.35% interest in Carewest, Inc. (Carewest) The Company increased its ownership percentage in Carewest to 81.30% at December 31, 2001 and to 84.03% at December 31, 2002. The Articles of Incorporation of DAS and Carewest permit them to engage in the development of Third Party Administration services for health and welfare plans. Carewest has subcontracted with DAS to perform a substantial part of the Third Party Administration activities.
PRODUCTS AND MARKETING The Company markets its products under the trade name of DAKOTACARE. The Company has three reportable segments as defined by Financial Accounting Standards Board (FASB) Statement No. 131. The segments' products include 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 12,550 employees. As of January 1, 2003, DAKOTACARE and its subsidiaries provided health care services to approximately 120,000 individuals, which also includes medical coverage enrollment and ancillary product enrollment for both the HMO and TPA segments.
Approximately 17% of the state's population and approximately 26% of DAKOTACARE's target market of approximately 460,000 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 for medical coverage, which was approximately 35,000 at the end of 2001, increased to approximately 40,000 by the end of 2002. Net enrollment declined by approximately 1,000 members for January 1, 2003. Commencing in 1993, the Company began its TPA business and by January 1, 2003, had enrolled for medical coverage approximately 59,000 enrollees, bringing the total individuals served by the Company and its' subsidiaries to medical coverage to approximately 98,000. The Company's HMO client disenrollment rate is lower than the industry rate as a whole. The ancillary product enrollment for the HMO and TPA segments increased to a total of approximately 22,000 for January 1, 2003, bringing the total health care services enrollment to approximately 120,000. All 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.
The Company's policy is to reinsure that portion of risk in excess of $125,000 in 2002 and 2001 of covered hospital inpatient expenses of any enrollee per contract year. The covered expenses are subject to a coinsurance provision which ranged from 50% to 90% in 2002 and 2001 based on average daily amounts specified in the plan. They are also subject to a $2,000,000 lifetime maximum benefit per enrollee in 2002 and 2001. 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.
3. 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 Carewest 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 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. The Company exceeded Regulatory Action Level RBC at December 31, 2002, but did not exceed the Company Action Level RBC. As required by the Division, the Company intends to formulate a plan to achieve and exceed this requirement and submit it to the Division for approval.
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 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.
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.
4.
The following table sets forth, by type of investment, the percentage of the total investment portfolio, excluding cash and cash equivalents and contracts with life insurance companies, represented by each type of investment as of December 31:
2002 2001 ---- ---- Certificates of deposit 23.5% 21.5% Obligations of state and political subdivisions 54.1 51.3 Obligations of U.S. Treasury, government agencies and corporations 9.3 14.6 Corporate bonds 10.8 10.6 Bond mutual funds 2.3 2.0 ----- -----
100.0% 100.0% ===== =====
The Company's investment portfolio, excluding cash and cash equivalents and contracts with life insurance companies, totaled $6,372,146 and $6,507,366 as of December 31, 2002 and 2001, respectively. Cash and cash equivalents totaling $10,543,214 and $8,673,787 at December 31, 2002 and 2001, respectively, are invested substantially in interest bearing accounts.
The anti-kickback provisions of the Medicare law prohibit the payment or receipt of any remuneration in return for the referral of a patient, the charges to whom are subject to reimbursement by Medicare. The Company 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. 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.
5.
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 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, 2002, the Company employed 127 persons on a full-time basis. None of these employees are covered by a collective bargaining agreement, and the Company believes its employee relations are good.
ITEM 2.
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. The Company owns an office building in Webster, SD. The Company leases office space in Rapid City, SD starting January 1, 2001 that terminates December 31, 2003.
ITEM 3.
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 Circuit Court of South Dakota by Sioux Agency, Inc., D. Greg Heineman and Roger D. Larsen, who are stockholders of the Company, and by Williams Insurance Agency, Inc., a non-stockholder of the Company. The claim alleged wrongful non-renewal of a sales agency contract and sought both compensatory and punitive damages. This lawsuit was settled in July, 2001, under a confidentiality provision between the parties. The amount of settlement is included in the third quarter 2001 results of operations and related cash flows. The settlement expense is also included and allocated between the HMO and TPA segments in determining segment income or loss for each.
ITEM 4.
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 2002.
6. PART II
ITEM 5.
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, but a limited number of exchanges of Class C shares have occurred directly between interested buyers and sellers. 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 95,400 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.
HOLDERS As of March 12, 2003, there were 1,360 holders of record of Class A preferred stock, 1 holder of Class B preferred stock, and 694 holders of record of Class C common stock. There are no options or warrants outstanding.
DIVIDENDS The Class A and B preferred stockholders 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, 2002 and 2001 was $200,000 on a statutory basis of accounting, which the Company significantly exceeded. No dividends were paid in 2002 and none are accrued at December 31, 2002. During 2001, the Company paid dividends of $69,930 on Class C stock.
7. 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. No shares were acquired in 2002 for the treasury under the Program. During 2001, 33,003 shares were acquired for the treasury under the Program. The value per share was computed using guidelines established in 1995 by an investment organization, and updated using audited consolidated 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. During 2002, the Company issued a net increase 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.
8.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following information for the Company is as of and for the years ended December 31, 2002, 2001, 2000, 1999, and 1998(dollars in thousands, except per share data):
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 as follows: 2002 1,365,604; 2001 1,379,258; 2000 1,412,869; 1999 1,448,600; 1998 1,482,635 shares.
9.
ITEM 7.
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, 2002, 2001, 2000, and 1999. 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.
Years Ended December 31, ----------------------------- 2002 2001 2000 1999 ---- ---- ---- ---- Loss ratio 94.3% 89.4% 81.4% 87.5% Expense ratio 10.7 15.0 15.1 15.8 ----- ----- ---- ---- Combined ratio 105.0% 104.4% 96.5% 103.3% ===== ====== ====== ======
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 increase in the loss ratio was due to increased claims and cost per claim on a per member basis, which was greater than the increased revenues on a per member basis. The expense ratio decreased due to the large increase in premiums and the ability to maintain the actual costs of the administrative expenses at a relatively constant amount. See Comparison of Years December 31, 2002 and December 31, 2001 and Comparison of Years December 31, 2001 and December 31, 2000.
10. Activity in the liability for reported and unreported claims payable is summarized as follows:
The difference between the reserves reported in the accompanying tables, which are presented in accordance with accounting principles generally accepted in the United States of America (GAAP), and the statutory reserves reported to state regulatory authorities was insignificant for all periods presented.
11.
The following table presents the development of DAKOTACARE's consolidated balance sheet reserves for reported and unreported claims payable from 1993 through 2002. 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.
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, 2002, are adequate.
Application of Critical Accounting Policies
Generally Accepted Accounting Principles (GAAP) requires management to utilize estimates when reporting financial results. The Company has identified the policies discussed below as Critical Accounting Policies because the accounting estimates require management to make certain assumptions about matters that may be uncertain at the time the estimate was made and a different method of estimating could have been reasonably made that could have a material impact on the presentation of our financial condition, changes in financial condition or results of operations.
Management used all the relevant facts available to them at the time to make the best judgments about accounting estimates. Estimates significant to the financial statements include the amount recorded for contingency reserves, the liabilities for reported and unreported claims payable, and the valuation allowance recorded on deferred taxes.
Following is management's description of the process utilized in forming particularly sensitive accounting estimates. 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 that the corresponding amounts are paid to the participating physicians. The recorded liability at December 31, 2002 is equal to actual amounts withheld for the years ended December 31, 2002 and 2001. During 2002, the Company's Board of Directors, with approval from the Division of Insurance, voted to write off $1,575,224 of contingency reserves withheld in 2000, which reduced claims expense in 2002 and was accounted for as a change in accounting estimate. This change had the effect of decreasing the net loss for 2002 by $1,039,648, or $.75 per common share, net of income taxes.
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.
Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. 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. During the year ended December 31, 2002, the Company recorded an additional valuation allowance of $1,273,300 on the deferred tax assets recorded on the consolidated financial statements to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient future taxable income during the period that deductible temporary differences and carry forwards are expected to be available to reduce taxable income.
Although management believes that it uses the best information available to determine the above estimates, unforeseen market or other conditions could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in making the final estimate determinations.
12.
RESULTS OF OPERATIONS
GENERAL The following results of operations include the operations of DAKOTACARE and its subsidiaries for the years ended December 31, 2002, 2001, and 2000.
COMPARISON OF YEARS DECEMBER 31, 2002 AND DECEMBER 31, 2001
GENERAL The Company's net loss increased $1,951,297 to a loss of $2,668,907 for the year ended December 31, 2002, as compared to a loss of $717,610 for the year ended December 31, 2001. This increase was primarily due to an increase in net claims expense of $20,509,219, an increase in income taxes of $1,021,968, an increase in administrative expenses of $67,560, and a decrease in minority interest in loss of subsidiaries of $65,828. These were offset by an increase in net premium revenues of $18,554,004 and an increase in other revenues of $1,159,274.
REVENUES Total revenues increased $19,713,278, or 30.9%, for the year ended December 31, 2002, as compared to December 31, 2001. Revenues from net premiums generated by the health maintenance organization increased $18,460,931. This increase is attributable to a 19.9% increase in the number of enrollee months and a 10.1% increase in the net premium earned per enrollee for the year ended December 31, 2002, as compared to December 31, 2001. Revenues from the third party administration fees increased by $958,527 due to increased fees per enrollee totalling 7.2% and increased enrollee months of 10.5%. Investment income decreased $237,665 due primarily to decreased average rates earned on invested assets, but was somewhat offset by the increase in the amount of invested assets during the year.
OPERATING EXPENSES Total operating expenses increased $20,576,779, or 31.5%, for the year ended December 31, 2002, as compared to December 31, 2001. The change was due primarily to an increase in claims incurred, state insurance taxes, personnel expenses, office expenses, advertising expenses, and other general and administrative expenses. These increases were somewhat offset by a decrease in commissions expenses.
Net claims expense increased by $20,509,219, or 39.7%, for the year ended December 31, 2002, as compared to December 31, 2001. The average claims paid per enrollee increased by 16.2% while the number of enrollee months increased by 19.9%. The Company contracts with an actuary annually to review the cost of claims related to each coverage type and accordingly determine the prices to charge for each coverage type for the next year. In the Fall of 2002, the Company received approval from the Division to implement updated rates. These new rates went into effect beginning January 2003 for new groups and groups renewing their coverage. As groups renew their coverage throughout the year, the new rates will be implemented at that time for those groups. The effect of these rate increases is anticipated to increase premiums by approximately 20% on a per member basis. The trends for each quarter of 2002, indicated that the costs of claims on a per member basis increased faster than the premiums earned on a per member basis. Claims expense per member increased approximately 15% from the prior year, while premiums earned per member increased approximately 11% from the prior year. Since a large number of renewals occur with a January 1 date, the biggest increase in per member premiums are generally seen in the first quarter. Claims expense will generally increase throughout the year and thus the latter quarters will reflect larger claims loss percentages than the earlier quarters. With an increase in premiums anticipated at approximately 20% on a per member basis and claims expenses increases anticipated at approximately 15%, the Company anticipates that it should see a reversal of this trend for 2003. Additional changes in benefit coverages have also been implemented to help maintain the costs of the care provided. State insurance taxes increased by $310,876 in 2002 as compared to 2001 due primarily to increased premium revenues. These increased premium revenues and the increased third party administration fees increased the commissions paid to agents in 2002 as compared to 2001. The settlement of a lawsuit aforementioned in Part 1, Item 3 settled in 2001 and paid as commissions, caused the overall commission expense to decrease in total in 2002 as compared to 2001. Personnel expenses increased $592,287, or 11.4%, in 2002 as compared to 2001. This was due primarily to annual compensation adjustments and an increase in staffing needs due to the increased volume. Office expense increased $235,692, or 31.6%, largely due to increased postage and supplies costs resulting from additional clientele and membership. Advertising increased $125,229, or 30.6%, due to the strategic decision to increase spending as set forth in the business plan. Other general and administrative expenses increased $67,560, or 0.5%, in 2002 as compared to 2001. This was primarily due to a donation given to a local medical school facility.
13. INCOME TAXES Income tax expense should represent approximately 35% of income before income taxes and minority interest, but due to permanent tax differences and the change in the valuation allowance recorded against deferred income tax assets in 2002, the Company recorded income tax expense of $494,201. The valuation allowance recorded against deferred income taxes stems from limiting recorded deferred tax assets to recoverable income taxes paid in prior years. See Note 8 of the Notes to Consolidated Financial Statements.
COMPARISON OF YEARS DECEMBER 31, 2001 AND DECEMBER 31, 2000
GENERAL The Company's net income decreased $2,671,587 to a loss of $717,610 for the year ended December 31, 2001, as compared to income of $1,953,977 for the year ended December 31, 2000. This decrease was primarily due to an increase in net claims expense of $16,464,873, an increase in administrative expenses of $3,224,493, and a decrease in minority interest in loss of subsidiaries of $19,348. These were offset by an increase in net premium revenues of $14,718,973, an increase in other revenues of $1,055,470, and an decrease in income taxes of $1,562,684.
REVENUES Total revenues increased $15,474,443, or 32.0%, for the year ended December 31, 2001, as compared to December 31, 2000. Revenues from net premiums generated by the health maintenance organization increased $14,660,319. This increase is attributable to a 23.7% increase in the number of enrollee months and a 8.4% increase in the net premium earned per enrollee for the year ended December 31, 2001, as compared to December 31, 2000. Revenues from the third party administration fees increased by $703,397 due to increased fees per enrollee totalling 4.1% and increased enrollee months of 7.9%. Investment income decreased $79,397 due primarily to decreased average rates earned on invested assets, but was somewhat offset by the increase in the amount of invested assets during the year.
OPERATING EXPENSES Total operating expenses increased $19,689,366, or 43.2%, for the year ended December 31, 2001, as compared to December 31, 2000. The change was due primarily to an increase in claims incurred, commissions, state insurance taxes, personnel expenses, office expenses, and other general and administrative expenses. These increases were offset by a decrease in professional fees expenses.
Net claims expense increased by $16,464,873, or 46.8%, for the year ended December 31, 2001, as compared to December 31, 2000. The average claims paid per enrollee increased by 19.0% while the number of enrollee months increased by 23.7%. The Company contracts with an actuary annually to review the cost of claims related to each coverage type and accordingly determine the prices to charge for each coverage type for the next year. Our new rates will be in effect during the second quarter of 2002, at which time management expects that revenues will increase per member to cover the increased claims costs. Commissions and state insurance taxes increased by $2,443,667 and $144,870, respectively, in 2001 as compared to 2000 due primarily to increased premium revenues and third party administration fees earned by the Company. The settlement of a lawsuit aforementioned in Part 1, Item III also increased commissions when compared to the prior year. Personnel expenses increased $726,047, or 16.2%, in 2001 as compared to 2000. This was due primarily to annual compensation adjustments and an increase in staffing needs due to the increased volume. Office expense increased $59,389, or 8.6%, largely due to increased postage costs resulting from additional clientele and membership. Other general and administrative expenses increased $86,238, or 13.4%, in 2001 as compared to 2000. This was primarily due to the increased insurance costs related to liability and other insurance coverages.
13. INCOME TAXES Income tax (benefit) expense represents 39.5% and 35.9% of (loss) income before income taxes and minority interest for the years ended December 31, 2001 and 2000, respectively. Permanent tax differences and the change in the valuation allowance recorded against deferred income tax assets increased the provision percentage above the expected 35% in 2001 and 2000. The valuation allowance recorded against deferred income taxes stems from reducing those assets to amounts which are expected to be realized. 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 costs 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 $692,772 to $1,816,062 for the year ended December 31, 2002, as compared to 2001. Net cash provided by operating activities decreased from the prior year primarily due to increases in net losses and increases in receivables since December 31, 2001. Reported and unreported claims payable increased since December 31, 2001, but to a lesser amount than the prior year resulting in less cash provided by operating activities when compared to the prior year's amount. The decrease in cash provided was offset by a decrease in prepaids and other assets, a decrease in deferred income taxes, an increase in unearned premiums and administration fees, and an increase in contingency reserves payable since December 31, 2001.
Other uses of cash and cash equivalents were for the purchases of property and equipment and the purchase of securities held to maturity. The Company has invested cash not currently needed in operations into intermediate-term bonds, consisting primarily of municipal bonds, U.S. government securities and corporate bonds.
At December 31, 2002, the Company has certificates of deposit of $900,000 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. In 2002, the Company did not pay any previously withheld amounts and wrote off a portion of the contingency reserve liability. The amount approved by the Division that was written off was $1,575,224, which was withheld for claims incurred in 2000. This amount was expensed as claims at the time they were incurred and was treated as a reduction in claims expense in 2002 when they were written off. 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. Currently, the reserves withheld from claims with a date of service in 2002 and 2001 are the amounts remaining within the contingent reserve payable.
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 future 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.
15.
INDUSTRY TRENDS
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.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued certain Statements of Financial Accounting Standards, which have required effective dates occurring after the Company's December 31, 2002 year end. The Company's financial statements are not expected to be materially affected by those accounting pronouncements.
ITEM 7A.
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.
16.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS
Page ----
Independent Auditor's Report
Consolidated Financial Statements
Balance Sheets Statements of Operations Statements of Stockholders' Equity Statements of Cash Flows Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
17.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Positions - - ---- --- ---------
K. Gene Koob, M.D. 60 President and Director
James A. Engelbrecht, M.D. 55 Secretary/Treasurer and Director
Ben J. Henderson, D.O. 60 Vice President and Director
Thomas L. Krafka, M.D. 57 Director
Stephan D. Schroeder, M.D. 52 Director
John E. Rittmann, M.D. 65 Director
John Sternquist, M.D. 54 Director
James R. Reynolds, M.D. 59 Director
Bob L. Sutton 34 Director
R. Van Johnson 58 Director
L. Paul Jensen 54 Chief Executive Officer
Kirk J. Zimmer 42 Senior Vice President
William O. Rossing, M.D. 68 Vice President, Medical Director
Sharon K. Duncan 55 Vice President, System Operations
Dean M. Krogman 53 Vice President, External Operations
Barbara A. Smith 41 Vice President, Medical Services
Thomas N. Nicholson 43 Vice President, Sales and Marketing
Bruce E. Hanson 39 Vice President, Finance
Brian E. Meyer 40 Vice President, Information Systems
Scott L. Jamison 45 Vice President, Provider Relations
Dr. Koob became a director of the Company in June 1994 and an officer since October 2000. 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. Engelbrecht became a director of the Company in June 1997 and an officer since October 2000. 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.
Dr. Henderson became a director of the Company in June 1995 and an officer since October 2000. 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. Krafka 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 the practice of radiology in Rapid City, South Dakota, since 1976.
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 as a family practitioner in Watertown, South Dakota, since 1973.
Dr. Sternquist became a director of the Company in October 2000. He is a member of the South Dakota State Medical Association and has been engaged in the practice as a general surgeon in Yankton, South Dakota, since 1980.
Dr. Reynolds became a director of the Company in September 1999. He is a member of the South Dakota State Medical Association and has been engaged in the practice of cardiac surgery, thoracic surgery, and vascular surgery in Sioux Falls since 1975.
Mr. Sutton became a director of the Company in September 1999. He is the Executive Vice President of the South Dakota Bankers Association and previously, Mr. Sutton was the Executive Director of the South Dakota Petroleum Council, from 1995 to 1998. 18.
Mr. Johnson became a director of the Company in September 1999. He is a Lobbyist and former Executive Vice President of the South Dakota Automobile Dealers Association and the former Executive Director of the South Dakota Trucking Association.
Mr. Jensen became the Company's Chief Executive Officer in August 1999. He has also served as the Chief Executive Officer of the South Dakota State Medical Association since 1999, and as Chief Executive Officer of the South Dakota Foundation for Medical Care from 1996 to 1999.
Mr. Zimmer joined the Company in May 1988 and became the Company's Senior Vice President in January 1990. Mr. Zimmer had been a Vice President since November 1988. Mr. Zimmer had been previously employed, since 1982, with McGladrey & Pullen, LLP, a national certified public accountant firm and was a general services manager from 1986 to 1988.
Dr. Rossing became the Company's Vice President and Medical Director upon joining the Company in August 1996. Prior to his retirement from active practice in July 1996, Dr. Rossing had been in the practice of internal medicine in Sioux Falls, South Dakota, since 1966, following his tenure with the U.S. Army Medical Service.
Ms. Duncan became the Company's Vice President of System Operations in February 1990. Prior to joining DAKOTACARE, Ms. Duncan had served as Vice President with Blue Shield of South Dakota since 1986.
Mr. Krogman joined the Company in May 1993 and became the Company's Vice President of External Operations in July 1994. Mr. Krogman is also employed by the South Dakota State Medical Association. Mr. Krogman has been a contract lobbyist since 1989 and was a broker/owner of Borchardt/Krogman and Associates, a real estate company, until 1993.
Ms. Smith joined the Company in June 1996 and became the Company's Vice President of Operations in September 1996. 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. 19. 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.
Mr. Jamison joined the Company in May 2000 as the Vice President of Provider Relations. Mr. Jamison had been employed by a clinic in Sioux Falls, SD.
19.
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. No positions are currently vacant. The terms of Dr K. Gene Koob, Dr. James Engelbrecht and Dr. John Sternquist expire at the 2003 Annual Meeting of the Shareholders; the terms of Dr. John Rittman, Dr. Ben Henderson, Dr. Thomas Krafka and Dr. Stephan Schroeder expire at the 2004 Annual Meeting of the Shareholders; the terms of Dr James Reynolds, Mr. Bob Sutton, and Mr. Van Johnson expire at the 2005 Annual Meeting of Shareholders. The Officers of the Board of Directors are elected for one-year terms and expire at the conclusion of the annual meeting of shareholders.
The Bylaws currently require that eight of the directors be holders of Class A voting preferred stock of the Company and two of the directors be consumers. The Articles of Incorporation restrict ownership of Class A voting preferred stock to medical or osteopathic physicians who have executed Participating Physician Agreements with the Company. To assure equal eligibility and opportunity throughout the state of South Dakota and avoid domination of the Board of Directors by any geographic area or areas, the number of physician directors from any one District Medical Society of the South Dakota State Medical Association cannot exceed two. The consumer directors may be from any geographic location which is served by South Dakota State Medical Holding Company and their residence does not affect the geographic restriction for physician directors. The consumer directors are currently Mr. Bob Sutton and Mr. Van Johnson. 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, 2002, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were timely complied with.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in June, 2003.
20.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information, as of March 12, 2003, 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. Amount & Nature Title Name and Address of of Beneficial Percent of Class Beneficial Owner Ownership of Class - ---------------------------------------------------------------------------- Class B Preferred South Dakota State 1,300 100% Medical Association(1) 1323 South Minnesota Avenue Sioux Falls, SD 57105
Class A Preferred Lloyd Solberg, M.D. 1 .07% Class C Common P. O. Box 5054 135,330 9.91% Sioux Falls, SD 57117-5054
Class A Preferred Thomas L. Krafka, M.D. 1 .07% Class C Common 16,640 1.22%
Class A Preferred John C. Sternquist, M.D. 1 .07% Class C Common 560 .04%
Class A Preferred K. Gene Koob, M.D. 1 .07%
Class A Preferred Ben J. Henderson, D.O. 1 .07% Class C Common 1,060 .08%
Class A Common Stephan D. Schroeder 1 .07% Class C Common 1,920 .14%
Class A Preferred James Engelbrecht, M.D. 1 .07% Class C Common 1,160 .08%
Class A Preferred John Rittmann, M.D. 1 .07% Class C Common 8,340 .61%
Class A Preferred James Reynolds, M.D. 1 .07% Class C Common 50,440 3.69%
Class C Common Bob Sutton -- --
Class C Common Van Johnson -- --
21.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (cont.)
Amount & Nature Title Name and Address of of Beneficial Percent of Class Beneficial Owner Ownership of Class - ---------------------------------------------------------------------------- Class C Common L. Paul Jensen(2) 5,760 .42% 1323 South Minnesota Avenue Sioux Falls, SD 57105
Class C Common William Rossing, M.D. 8,720 .64%
Class C Common Kirk J. Zimmer 800 .06%
Class C Common Thomas Nicholson -- --
Class A Preferred All Directors and Executive 8 .59% Officers as a Group Class C Common (14 people) 95,400 6.99%
- - -------------- (1) The South Dakota State Medical Association is an affiliated company. (2) L. Paul Jensen is the Chief Executive Officer of the Company and the South Dakota State Medical Association.
EQUITY COMPENSATION PLAN INFORMATION The Company does not currently have any equity compensation plans for its directors, officers or other employees. As such, the Company has omitted the table required under 201(d) of Regulation S-K.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company leases office space from the South Dakota State Medical Association (Association). On January 1, 2002, the Company entered into a three year lease which will automatically renew for one year terms each January 1, unless terminated with at least 30 days notice prior to the end of the lease term. The 2002 lease required minimum annual rental payments of $227,784. On January 1, 2001, Carewest entered into a three year lease for office space with an unrelated third party which requires minimum monthly rentals of $1,500. The Company also has entered into other short-term lease agreements with other unrelated third parties for which the total rental commitment at December 31, 2002 was not significant. Total rental payments for the years ended December 31, 2002, 2001and 2000 were $252,087, $239,216, and $217,162, 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, 2002, 2001 and 2000 were $85,005, $66,086 and $55,689, respectively.
L. Paul Jensen received salaries and retirement contributions totaling $99,280, $97,087 and $94,273 from the South Dakota Medical Association for the years ended 2002, 2001 and 2000, respectively.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. The term "disclosure controls and procedures" is defined in Rules 13a-14(c) and 15d-14(c) of the Securities and Exchange Act of 1934 ("Exchange Act"). These rules refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. The CEO and the CFO, together with management has evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days before the filing of this yearly report (the "Evaluation Date"), and they have concluded that, as of the Evaluation Date, such controls and procedures were effective at ensuring that required information will be disclosed on a timely basis in our reports filed under the Exchange Act.
(b) Changes in internal controls. We maintain a system of internal accounting controls that are designed to provide reasonable assurance that our books and records accurately reflect our transactions and that our established policies and procedures are carefully followed. For the year ended December 31, 2002, there were no significant changes to our internal controls or in other factors that could significantly affect our internal controls, and we have not identified any significant deficiencies or material weaknesses in our internal controls.
22.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this report:
FINANCIAL STATEMENTS Page ----
Independent Auditor's Report Consolidated Financial Statements Balance Sheets Statements of Operations Statements of Stockholders' Equity Statements of Cash Flows Notes to Financial Statements
EXHIBITS Exhibit No. Description - ----------- -----------
3.1 The Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Form 8-A, as filed with the Securities and Exchange Commission on January 19, 1996)
3.2 The Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Form 8-A, as filed with the Securities and Exchange Commission on January 19, 1996)
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 (incorporated by reference to Exhibit 10 to the Company's Form 10-K, as filed with the Securities and Exchange Commission on March 29, 2002)
21 Subsidiaries of the Registrant
99.1 CEO Certification 99.2 CFO Certification
REPORTS ON FORM 8-K None.
23.
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/L. Paul Jensen Dated 03/28/2003 ---------------------------------- -------------------- L. Paul Jensen Chief Executive Officer (Principal Executive Officer)
By /s/Kirk J. Zimmer Dated 03/28/2003 ---------------------------------- -------------------- Kirk J. Zimmer Senior Vice President (Principal Financial Officer)
By /s/Bruce E. Hanson Dated 03/28/2003 ---------------------------------- -------------------- Bruce E. Hanson Vice President Finance
By /s/ K. Gene Koob Dated 03/28/2003 ---------------------------------- -------------------- K. Gene Koob, M.D. President and Director
By /s/James Engelbrecht Dated 03/28/2003 ---------------------------------- -------------------- James Engelbrecht, M.D. Secretary/Treasurer and Director
By /s/Ben J. Henderson Dated 03/28/2003 ---------------------------------- -------------------- Ben J. Henderson, D.O. Vice President and Director
By /s/Thomas L. Krafka Dated 03/28/2003 ---------------------------------- -------------------- Thomas L. Krafka, M.D. Director
By /s/James R. Reynolds Dated 03/28/2003 ---------------------------------- -------------------- James R. Reynolds, M.D. Director
24.
By /s/ John Sternquist Dated 03/28/2003 ---------------------------------- -------------------- John Sternquist, M.D. Director
By /s/John Rittmann Dated 03/28/2003 ---------------------------------- -------------------- John Rittmann, M.D. Director
By /s/ Stephan D. Schroeder Dated 03/28/2003 ---------------------------------- -------------------- Stephan D. Schroeder, M.D. Director
By /s/ Bob Sutton Dated 03/28/2003 ---------------------------------- -------------------- Bob Sutton Director
By /s/Van Johnson Dated 03/28/2003 ---------------------------------- -------------------- Van Johnson Director
Certifications
I, L. Paul Jensen, certify that:
1. I have reviewed this annual report on Form 10-K of South Dakota State Medical Holding Company, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
_/s/ L. Paul Jensen___ L. Paul Jensen Chief Executive Officer
March 28, 2003
I, Bruce E. Hanson, certify that:
1. I have reviewed this annual report on Form 10-K of South Dakota State Medical Holding Company, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
_/s/ Bruce E. Hanson______ Bruce E. Hanson Chief Finance Officer
March 28, 2003
25.
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, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. 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 auditing standards generally accepted in the United States of America. 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, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
/s/ McGLADREY & PULLEN, LLP
Sioux Falls, South Dakota February 28, 2003
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 AND 2001
See Notes to Consolidated Financial Statements.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2002, 2001 and 2000
See Notes to Consolidated Financial Statements.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See Notes to Consolidated Financial Statements.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See Notes to Consolidated Financial Statements.
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 majority owned subsidiary, Carewest, Inc. (Carewest). DAS and Carewest 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' self funded customers. All intercompany balances and transactions have been eliminated in consolidation.
Basis of financial statement presentation: The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. 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 contingency reserves payable and reported and unreported claims payable, and the valuation allowance on deferred tax assets.
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. Although the Company maintains its cash accounts in a limited number of commercial banks, the Company believes it is not exposed to any significant credit risk on cash and cash equivalents.
Receivables: Receivables are recorded based on amounts billed to customers, subscribers, and other third party payors, and amounts estimated to be received or recovered from reinsurers and other third party payors. The Company evaluates the collectibility of such receivables monthly based on the third party payors' financial condition, credit history, and current economic conditions. Receivables are written off when deemed uncollectible. Recoveries of receivables previously written off are recorded when received.
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 conditions, 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, if any.
Note 1. Nature of Business and Significant Accounting Policies (continued) Investment securities (continued): Premiums and discounts on investments in debt securities are amortized over their contractual lives. 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.
2002 2001 ---------------------------------- Furniture, equipment and automobiles $ 2,483,474 $ 2,390,194 Building and building improvements 53,370 53,370 Other 140,236 134,818 ---------------------------------- 2,677,080 2,578,382 Less accumulated depreciation 1,974,459 1,821,510 ---------------------------------- $ 702,621 $ 756,872 ==================================
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.
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)
Income taxes: Deferred taxes are provided on an asset and 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.
Segment reporting: Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company's operations are classified into three business segments.
Earnings (loss) per common share: 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 1,365,604 in 2002, 1,379,258 in 2001 and 1,412,869 in 2000. All references to earnings (loss) per share in the consolidated financial statements are to basic earnings (loss) per share, as the Company has no potentially issuable common stock.
Recent accounting pronouncements: The Financial Accounting Standards Board has issued certain Statements of Financial Accounting Standards, which have required effective dates occurring after the Company's December 31, 2002 year end. The Company's financial statements are not expected to be materially affected by those accounting pronouncements.
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, 2002, the carrying amount and fair value of the Company's investment securities was $4,872,146 and $5,167,060, respectively. At December 31, 2001, the carrying amount and fair value of the Company's investment securities was $5,107,366 and $5,236,548, respectively.
Accrued interest receivable: The carrying amount approximates fair value due to the nature of the balances recorded.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -----------------------------------------------------------------------------
NOTE 3. RECEIVABLES
Receivables consist of the following:
2002 2001 -------- ---------- Income taxes $ 526,600 $ 347,000 Drug manufacturer chargebacks 308,700 286,170 Subrogation, net of recovery expenses 150,000 140,000 Coordination of benefits recoverable 217,400 116,300 Third party administrator receivables 104,878 109,784 Reinsurance 116,370 84,088 Hospital receivables - 75,790 Premiums 64,300 67,962 Funds withheld by ceding insurer 163,041 56,362 Interest 43,460 51,281 Commissions 200,662 49,057 Other 149,680 161,193 ---------- ---------- 2,045,091 1,544,987 Less allowance for doubtful accounts - - ---------- ---------- $2,045,091 $1,544,987 ========== ==========
NOTE 4. REINSURANCE
The Company's policy is to reinsure that portion of risk in excess $125,000 of covered hospital inpatient expenses of any enrollee per contract year, subject to a coinsurance provision which ranged 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.
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, 2002 are as follows:
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.
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, 2001 are as follows:
The components of other comprehensive income (loss) - net change in unrealized gain(loss) on securities available for sale are as follows:
There were no sales of debt or equity securities during the years ended December 31, 2002 and 2001, and accordingly, no reclassification adjustments on investment securities for those years. Proceeds from the sale of securities available for sale in 2000 were $213,564 and resulted in gross losses of $27,437. At December 31, 2002 and 2001, no individual investments in obligations of state and political subdivisions exceeded 10% of the Company's equity. At December 31, 2002 and 2001, the Company had certificates of deposit of $900,000 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.
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 2000 through 2002 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 at December 31, 2002 is equal to actual amounts withheld for the years ended December 31, 2002 and 2001. During 2002, the Company's Board of Directors, with approval from the Division of Insurance, voted to write off $1,575,224 of contingency reserves withheld in 2000, which reduced claims expense in 2002 and was accounted for as a change in accounting estimate. This change had the effect of decreasing the net loss for 2002 by $1,039,648, or $.75 per common share, net of income taxes.
NOTE 7. REPORTED AND UNREPORTED CLAIMS PAYABLE
Activity in the liability for reported and unreported claims payable is summarized as follows:
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 subsidiaries, DAS, DIL and Carewest.
The net deferred tax assets consist of the following components at December 31:
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ---------------------------------------------------------------------------
NOTE 8. INCOME TAX MATTERS (CONTINUED)
During the year ended December 31, 2002, the Company recorded an additional valuation allowance of $1,273,300 on the deferred tax assets to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient future taxable income during the period that deductible temporary differences and carryforwards are expected to be available to reduce taxable income.
The components of income tax expense as of December 31 are as follows:
2002 2001 2000 --------------------------------------- Current (recoverable) $ (261,399 $ (133,767) $1,239,317 Deferred (benefit) 755,600 (394,000) (204,400) --------------------------------------- $ 494,201 $ (527,767) $1,034,917 =======================================
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:
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. In the event of a liquidation, each share of Class B preferred stock would be given priority over Class C stock and would be entitled to receive a preferential payment after all preferential payments have been made to the holders of Class A preferred stock, in an amount up to (and not to exceed) its par value of $1 per share.
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 has a Stock Repurchase Program (Program). 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 2001 and 2000, 33,003 and 34,341 shares, respectively, were acquired for the treasury under the Program. No shares were acquired during 2002.
Regulatory capital as required by the Division of Insurance at December 31, 2002 and 2001 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. The Company exceeded Regulatory Action Level RBC at December 31, 2002, but did not exceed the Company Action Level RBC. The Company will formulate a plan to achieve and exceed this requirement, then submit it to the Division for approval.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ---------------------------------------------------------------------------
NOTE 10. LEASES AND TRANSACTIONS WITH AFFILIATE
On January 1, 2002, the Company entered into a three year lease of office space with the South Dakota State Medical Association, which requires minimum monthly rentals of $18,982. On January 1, 2001, Carewest entered into a three year lease which requires minimum monthly rentals of $1,500. The total minimum rental commitment at December 31, 2002 under the leases mentioned above is $491,568, in which half of such amount is due in each of the next two years. The Company also has entered into other short-term lease agreements for which the total rental commitment at December 31, 2002 was not significant. Total rental payments for the years ended December 31, 2002, 2001 and 2000 were $252,087, $239,216 and $217,162, respectively.
The Company provides group health insurance coverage for employees of the South Dakota State Medical Association. Total premium income from the affiliate for the years ended December 31, 2002, 2001 and 2000 was $85,005, $66,086 and $55,689, 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, 2002, 2001 and 2000. Retirement plan expense for the years ended December 31, 2002, 2001 and 2000 was $386,588, $374,633 and $275,421, respectively.
In connection with employment contracts between the Company and certain officers, provision has been made for 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, 2002 and 2001, $77,026 and $78,112, respectively, was accrued under these contracts.
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 Carewest, which are TPA's of healthcare 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' self funded customers.
The Company evaluates performance and allocates resources based on net income determined under accounting principles generally accepted in the United States of America. 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 depreciation on the underlying assets.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------
NOTE 12. SEGMENT INFORMATION (CONTINUED)
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.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------
NOTE 12. SEGMENT INFORMATION (CONTINUED)
NOTE 13. LITIGATION
The Company is involved in legal actions in the ordinary course of its business. Although the outcome of any such legal actions cannot be predicted, in the opinion of management, there is no legal proceeding pending against or involving the Company for which the outcome is likely to have a material adverse effect upon the consolidated financial position or results of operations of the Company as of and for the year ended December 31, 2002.
During 1998, a substantial claim was filed against the Company in circuit court which alleged wrongful nonrenewal of a sales agency contract and sought compensatory and punitive damages. The lawsuit was settled in 2001 and all payables and expenses were fully recorded in the accompanying 2001 consolidated financial statements.
SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------
(1) Includes the settlement of a lawsuit (Note 13).
(2) Net of the write off of $1,575,224 of contingency reserves payable(Note 6).
EXHIBIT INDEX -------------
Exhibit No. Description - - ----------- ----------- 21 Subsidiaries of the Registrant
99.1 CEO Certification 99.2 CFO Certification
EXHIBIT 21
EXHIBIT 21. SUBSIDIARIES OF THE REGISTRANT
Name Incorporation % Owned - - ---- ------------- -------
DAKOTACARE Administrative South Dakota 100% Services, Incorporated
DAKOTACARE Insurance, Ltd. Cayman Islands 100%
Carewest, Inc. South Dakota 84.03%
Exhibit 99.1
CERTIFICATION PURSUANT TO 18 U.S.C. Sec. 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of South Dakota State Medical Holding Company, Inc., dba DAKOTACARE(the "Company") on Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, L. Paul Jensen, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
_/s/ L. Paul Jensen_____ Chief Executive Officer
March 28, 2003
Exhibit 99.2
CERTIFICATION PURSUANT TO 18 U.S.C. Sec. 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of South Dakota State Medical Holding Company, Inc., dba DAKOTACARE(the "Company") on Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Bruce Hanson, Chief Finance Officer of the Company, certify, pursuant to 18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
_/s/ Bruce E. Hanson____ Chief Finance Officer
March 28, 2003