DCP HOLDING CO – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Edgar Online, Inc.

Overview

  Headquartered in Cincinnati, Ohio, Dental Care Plus Group offers to employer groups of all sizes dental HMO, dental PPO, dental indemnity and vision PPO benefit plans and related services. As of December 31, 2012, we had approximately 299,800 members in our dental and vision benefit programs with approximately 2,652 dentists participating in our dental HMO provider network and approximately 2,892 dentists participating in our dental PPO provider network.  We manage our business with four reportable segments: fully-insured dental HMO/IND, fully-insured dental PPO, self-insured dental, and corporate, all other. Corporate, all other consists of revenue associated with our dental PPO and vision products underwritten by third-party insurance carriers and certain corporate activities. Our dental HMO, PPO and indemnity products and our vision product line are marketed to employer groups.  The results of our fully-insured dental HMO/IND, fully-insured dental PPO, and self-insured dental segments are measured by gross profit. We do not measure the results of our corporate, all other segment. We do not allocate investment and other income, insurance expenses, interest expense or other assets or liabilities to our fully-insured and self-insured segments. These items are retained in our corporate, all other segment. Our segments do not share overhead costs and assets.  Many factors have an effect on our results, but most notably our results are influenced by our ability to establish and maintain a competitive and efficient cost structure, and to accurately and consistently establish competitive premiums, ASO fees, and plan benefit levels that are commensurate with our dental and administrative costs. Dental costs are subject to a high rate of inflation due to many forces, including new higher priced technologies and dental procedures, new dental service techniques and therapies, an aging population, the tort liability system, and government regulations.  

Profitability Strategy

  Our strategy focuses on providing solutions for employers to the rising cost of dental care by leveraging our growing networks of participating dentists and deploying a variety of products that give employer groups and members more choices. Additionally, we have increased the diversification of our membership base, not only through our newer products, but also by entering new geographic areas. We expect our dental PPO product to be an important driver of growth in the years ahead.                                           22 

-------------------------------------------------------------------------------- In our markets, there has been limited growth in recent years in the number of individuals enrolled in dental benefit plans. However, there has been a shift of membership out of the more expensive dental indemnity products into the dental PPO products that offer both less expensive in-network benefits and out-of-network benefits. At the same time, members have migrated away from dental HMO products with very limited provider networks. While these dental HMO products are the least expensive, employers and members have focused their attention on the dental PPO products that offer broad provider access with the cost control associated within a contracted provider network for the in-network portion of the dental services rendered.  In our original eight county service area, our non-exclusive dental HMO provider network includes approximately 95% of the dental providers in the market. In that market our dental HMO provides the broad provider access of a dental PPO along with effective utilization and cost control features. Because of the broad provider network and our professional support services to employers, our fully-insured dental HMO is priced higher than other dental HMOs and has premium rates more equivalent to competitor dental PPOs.  

We have experienced steady growth in membership and revenue in our dental products during the last five years. We attribute this growth to our broad provider networks, competitive premium rates for our fully-insured business and ASO fees for our self-insured business, and our commitment to providing outstanding customer service to all of our constituencies (employer groups, members, insurance brokers, and dentists).

  Historically, healthcare services expense has generally increased for both the fully-insured dental segment and the self-insured dental segment. We have and continue to review and adjust our provider fee schedules where appropriate. In 2011, insurance expenses increased by approximately 3.5% compared to 2010. In 2012, insurance expenses increased by approximately 11.4% compared to 2011. Other important factors that have an impact on our profitability are both the competitive pricing environment and market conditions. With respect to pricing, there is a tradeoff between sustaining or increasing underwriting margins versus increasing enrollment. With respect to market conditions, economies of scale have an impact on our administrative overhead. As a result of a decline in preference for more closely managed dental HMO products, dental costs have become increasingly comparable among our larger competitors. Product design and consumer involvement have become more important drivers of dental services consumption, and administrative expense efficiency is becoming a more significant driver of margin sustainability. Consequently, we continually evaluate our administrative expense structure and attempt to realize administrative expense savings principally through technology improvements.  

Highlights

• We had a net income of approximately $1,318,000 for the year ended

December 31, 2012 compared to a net income of approximately $591,000 for

the year ended December 31, 2011. This increase in net income is primarily

the result of an increase in premium revenue of approximately $3,926,000,

to $80,153,000 in 2012 from $76,227,000 in 2011, offset by an increase in

healthcare services expense of approximately $1,385,000, to $63,736,000 in

2012 from $62,351,000 in 2011. This increase in gross margin of

approximately $2,541,000 was offset by an increase in insurance expenses

of $1,492,000, to $14,609,000 in 2012 from $13,117,000 in 2011. Our ratio

of insurance expense to total premium revenue ("insurance expense ratio")

         increased to 18.2% in 2012 from 17.2% in 2011.    

• Our ratio of healthcare services expense to premium revenue ("loss ratio")

decreased by 2.3%, to 79.5% in 2012 from 81.8% in 2011. This loss ratio

decrease is primarily due to an increase in fully-insured premium rates in

2012 compared to 2011, improved underwriting practices and a decrease in

fully-insured healthcare services expense on a per member per month basis

as a result of implementing a provider withhold on the dental PPO product

         effective April 1, 2011. The fully-insured dental HMO/IND and          fully-insured dental PPO segments together represent approximately 69.0%          of our total dental business.    

• Our dental and vision products grew by approximately 9,100 members, or

         3.1%, from 290,700 members at December 31, 2011 to 299,800 members at          December 31, 2012. This membership increase from December 31, 2011 is due          to an increase in fully-insured dental HMO/IND membership of                                            23 

--------------------------------------------------------------------------------

approximately 1,900 members, an increase in fully-insured dental PPO

membership of approximately 5,000 members, an increase in self-insured

dental membership of approximately 1,500 members and an increase in

corporate, all other membership of approximately 700 members.

   We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our consolidated financial statements and related changes in certain key items in those consolidated financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain critical accounting policies and estimates have an impact on our consolidated financial statements.  

Comparison of Results of Operations for 2012 and 2011

  The following table shows membership totals and revenues and expenses for our four business segments for the years ended December 31, 2012 and 2011 (dollars in thousands):                                                  2012          2011        Change         Membership:

Fully-insured dental HMO/IND 148,500 146,600 1.3 %

         Fully-insured dental PPO               43,400        38,400        13.0 %         Self-insured dental                    84,400        82,900         1.8 %         Corporate, all other                   23,500        22,800         3.1 %          Total membership                      299,800       290,700         3.1 %          Premium revenue:

Fully-insured dental HMO /IND $ 43,844$ 42,527 3.1 %

         Fully-insured dental PPO               11,429         9,557        19.6 %         Self-insured dental                    24,380        23,650         3.1 %         Corporate, all other                      500           493         1.4 %          Total premium revenue                  80,153        76,227         5.2 %          Investment income:         Corporate, All Other                      128           111        15.3 %          Other income:         Corporate, All Other                      102            78        30.8 %          Total revenue                          80,383        76,416         5.2 % 

Healthcare services expense:

         Fully-insured dental HMO/IND           33,399        33,463        

(0.2 %)

         Fully-insured dental PPO                9,363         8,543         

9.6 %

         Self-insured dental                    20,974        20,345         

3.1 %

          Total healthcare services expense      63,736        62,351         2.2 %          Insurance expense         Corporate, All Other                   14,609        13,117        11.4 %          Income tax expense         Corporate, All Other                      720           356           *      * Not meaningful                                            24 

--------------------------------------------------------------------------------

Summary

  Net income was approximately $1,318,000 and $591,000 for 2012 and 2011, respectively. The increase in net income primarily resulted from an increase in premium revenue of approximately $3,926,000, to $80,153,000 in 2012 from $76,227,000 in 2011, offset by an increase in healthcare services expense of $1,385,000, to $63,736,000 in 2012 from $62,351,000 in 2011. The resulting increase in gross margin of approximately $2,541,000 was offset by an increase in insurance expenses of $1,492,000, to $14,609,000 in 2012 from $13,117,000 in 2011. Our ratio of insurance expense to total premium revenue ("insurance expense ratio") increased to 18.2% in 2012 from 17.2% in 2011.  

Membership

  Our fully-insured dental HMO/IND membership increased approximately 1,900 in 2012. This membership increase is primarily attributable to an increase of approximately 2,400 fully-insured dental HMO members, offset by a decrease of approximately 500 fully-insured dental indemnity members underwritten by Dental Care Plus, Inc. ("DCP"). The increase in fully-insured dental HMO membership of 2,400 members is due to new sales in the Cincinnati and Northern Kentucky markets of approximately 12,100 members during 2012, offset by the loss of approximately 9,700 members with employer groups that did not renew with the Company or reduced employee counts of retained employer groups. A significant portion of the fully-insured dental HMO membership losses were the result of not renewing certain employer groups that did not accept the premium rate increases we proposed to move them to profitability. In addition, some of these membership losses were due to corporate acquisitions where our employer group customers moved to the new parent company benefit plans.  Our fully-insured dental PPO membership increased by approximately 5,000 members in 2012. This membership increase is due to new sales in the Dayton and Columbus, Ohio markets and the Southern Kentucky market of approximately 9,200 members during 2012, offset by the loss of approximately 4,200 members with employer groups that did not renew with the Company or reduced employee counts of retained employer groups in these markets.  Our self-insured dental membership increased by approximately 1,500 members in 2012. This increase is primarily due to the addition of new self-insured dental HMO and dental PPO employer groups in the Southwest Ohio and Northern Kentucky markets, as well as an increase in membership of existing employer groups in the last twelve months.  Our corporate, all other membership increased by approximately 700 members in 2012. The increase is primarily due to an increase of approximately 800 members in our vision plan, offset by a decrease of approximately 100 dental indemnity members that shifted into the fully-insured dental HMO/IND segment at renewal.  Revenue                                                                    (Amounts in thousands)                                                                  Total Dollar         Member Volume          Rate                                      2012           2011            Change               Change             Change Total Fully-Insured Dental HMO/IND Premium                    $ 43,844       $ 42,527       $       1,317       $           541       $    776   Fully-insured dental HMO/IND premium increased approximately $1,317,000 in 2012 compared to 2011. Fully-insured dental HMO/IND premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $776,000 in fully-insured dental HMO/IND premium revenue. An increase in fully-insured dental HMO/IND membership in 2012 resulted in an increase in fully-insured dental HMO/IND premiums of approximately $541,000. The fully-insured dental HMO/IND segment represented approximately 54.7% of our total dental business in 2012.                                           25  --------------------------------------------------------------------------------

                                                                 (Amounts in thousands)                                                                                          Member                                                                      Total Dollar        Volume         Rate                                             2012         2011           Change           Change        Change

Total Fully-Insured Dental PPO Premium $ 11,429$ 9,557 $

1,872 $ 970$ 902

   Fully-insured dental PPO premium increased approximately $1,872,000 in 2012 compared to 2011. Fully-insured dental PPO premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $902,000 in fully-insured dental PPO premium revenue. An increase in fully-insured dental PPO membership in 2012 resulted in an increase in fully-insured dental PPO premiums of approximately $970,000. The fully-insured dental PPO segment represented approximately 14.3% of our total dental business in 2012.                                                        (Amounts in thousands)                                                                             Member                                                          Total Dollar       Volume        Rate                                  2012         2011          Change          Change       Change   Self-Insured Claim Revenue   $ 23,131     $ 22,442     $         689     $    516     $    173   Self-Insured ASO Fees           1,249        1,208                41           28           13    Total Self-Insured Revenue   $ 24,380     $ 23,650     $         730     $    544     $    186   Total self-insured revenue increased approximately $730,000 in 2012 compared to 2011. Self-insured dental revenue increased by approximately $544,000 due to new self-insured sales. In addition, self-insured revenue increased by approximately $186,000 due to an increase in the self-insured claims revenue on a per member per month basis as a result of slightly higher dental service utilization and a slight increase in self-insured administrative fee rates on per member per month basis. The self-insured dental segment represented approximately 30.4% of our total dental business in 2012. The self-insured segment revenue has two components:  Self-Insured Claim Revenue-Self-insured claim revenue increased approximately $689,000, or 3.1%, to $23,131,000 in 2012 from $22,442,000 in 2011. Self-insured claim revenue increased by approximately $516,000 due to new self-insured sales. Also self-insured claims revenue increased by approximately $173,000 primarily due to an increase in the self-insured claims revenue on a per member per month basis as a result of slightly higher dental service utilization.  Self-Insured ASO Fees-Self-insured ASO fees increased approximately $41,000, or 3.4%, to $1,249,000 in 2012 from $1,208,000 in 2011. Approximately $28,000 of this increase is attributable to the self-insured product sales. Approximately $13,000 of this increase was due to a small increase in average self-insured ASO fee rates.  Corporate, all other premium revenue is primarily derived from the non-DCP dental indemnity product, dental PPO product and vision product underwritten by third party insurance carriers. In aggregate, corporate, all other premium revenue increased by approximately $7,000, or 1.4%, to $500,000 in 2012 from $493,000 in 2011.  Investment Income  Investment income increased approximately $17,000, or 15.3%, to $128,000 in 2012 from $111,000 in 2011. This increase is the result of funds that were invested in medium duration investment grade corporate bonds with higher yields during all of 2012. We invested in short duration investment grade corporate bonds for the first seven months of 2011 before transitioning to medium duration investment grade corporate bond investments during the last five months of 2011 and into 2012.                                           26 

--------------------------------------------------------------------------------

Other Income

Other income increased approximately $24,000 or 30.8% to $102,000 in 2012 from $78,000 in 2011. This increase is primarily the result of an increase of realized gains due to the sale of investments in 2012 as compared to 2011.

Healthcare Services Expenses

                                                                   (Amounts in thousands)                                                               Total Dollar          Member Volume         Utilization                                   2012           2011            Change                Change               Change Total Fully-Insured Dental HMO/IND Healthcare Service Expense                         $ 33,399       $ 33,463       $         (64 )      $           425       $        (489 )   Fully-insured dental HMO/IND healthcare services expense decreased by $64,000, or 0.2%, to $33,399,000 in 2012 from $33,463,000 in 2011. This decrease is attributable to a decrease in fully-insured dental HMO/IND healthcare services expense on a per member per month basis of approximately $489,000, or 1.5%, in 2012 for both existing and new fully-insured dental HMO/IND membership. This decrease was offset by an increase in fully-insured dental HMO/IND healthcare services expense of approximately $425,000 due to an increase in fully-insured dental HMO/IND member months of 1.3% in 2012 compared to 2011.                                                                    (Amounts in thousands)                                                               Total Dollar         Member Volume         Utilization                                    2012          2011            Change               Change               Change Total Fully-Insured Dental PPO Healthcare Service Expense                           $ 9,363       $ 8,543       $         820       $           867       $         (47 )   Fully-insured dental PPO healthcare services expense increased by $820,000, or 9.6%, to $9,363,000 in 2012 from $8,543,000 in 2011. This increase is attributable to an increase in fully-insured dental PPO healthcare services expense of approximately $867,000 due to an increase in fully-insured dental PPO member months of 10.1% in 2012 compared to 2011. This increase was offset by a decrease in fully-insured dental PPO healthcare services expense of approximately $47,000 due to a decrease in fully-insured dental PPO healthcare services expense on a per member per month basis of approximately 0.5% in 2012 for both existing and new fully-insured dental PPO membership.                                                                   (Amounts in thousands)                                                               Total Dollar         Member Volume         Utilization                                   2012           2011            Change               Change               Change Self-Insured Healthcare Services Expense                $ 20,974       $ 20,345       $         629       $           468       $         161   Self-insured healthcare services expense increased by approximately $629,000, or 3.1%, in 2012. An increase of 2.3% in self-insured member month volume in 2012 compared to 2011 resulted in an increase in self-insured healthcare services expense of approximately $468,000. Self-insured dental healthcare services expense increased by approximately $161,000 due to an increase in dental service utilization level by our self-insured members in 2012 compared to 2011.  

Corporate, all other healthcare services expense is not recognized by the Company due to the fact that our other dental indemnity, dental PPO and vision PPO products are underwritten by third party insurance carriers.

                                       27

--------------------------------------------------------------------------------

Insurance Expenses

  Consolidated insurance expenses increased approximately $1,492,000 in 2012. Total insurance expenses as a percentage of total premium revenue, or the insurance expense ratio, was 18.2% for 2012, increasing 1.0% from the 2011 ratio of 17.2%. Salaries and wages increased by approximately $488,000 as a result of salary and wage increases in 2012, the addition of some incremental full-time positions and management bonuses in 2012 due to our improved profitability. Commissions expense increased approximately $157,000, or 4.8%, due to the increase in total premium revenue in 2012 compared to 2011. Advertising expense in 2012 increased by approximately $144,000, or 86.3%, as advertising programs were initiated in the Columbus, Ohio market in addition to the ongoing advertising programs in our other established markets. Professional consulting expense increased by approximately $61,000, or 16.9%, as a result of proceeding with discretionary projects in 2012 that were delayed in 2011. Board of Directors expense increased by approximately $199,000, or 33.1%, primarily due to a 16.2% increase in the book value of directors deferred compensation restricted share awards. In addition, bad debt expense increased by approximately $42,000 as the result of certain employer group receivable balances that were determined to be uncollectable. Also, miscellaneous expenses increased by approximately $32,000 due to the one-time costs incurred relative to the refinancing of our office building.  

Income Taxes

  Our effective tax rate for 2012 was 35.3% compared to the 37.6% effective tax rate in 2011. Our 2012 and 2011 effective tax rates were higher than the federal statutory rate primarily due to the impact of permanent tax differences related to meal and entertainment and legal fees. See Note 5 to the consolidated financial statements included in Item 8-Financial Statements and Supplementary Data for a complete reconciliation of the federal statutory rate to the effective tax rate.                                           28 

--------------------------------------------------------------------------------

Comparison of Results of Operations for 2011 and 2010

  The following table shows membership totals and revenues and expenses for our four business segments for the years ended December 31, 2011 and 2010 (dollars in thousands):                                                  2011          2010         Change         Membership:

Fully-insured dental HMO/IND 146,600 150,000 (2.3 %)

         Fully-insured dental PPO               38,400        39,300         (2.3 %)         Self-insured dental                    82,900        78,700          5.3 %         Corporate, all other                   22,800        19,900         14.6 %          Total membership                      290,700       287,900          1.0 %          Premium revenue:

Fully-insured dental HMO /IND $ 42,527$ 42,646 (0.3 %)

         Fully-insured dental PPO                9,557         9,384          1.8 %         Self-insured dental                    23,650        23,022          2.7 %         Corporate, all other                      493           463          6.5 %          Total premium revenue                  76,227        75,515          0.9 %          Investment income:         Corporate, All Other                      111           115         (3.5 %)          Other income:         Corporate, All Other                       78            64         21.9 %          Total revenue                          76,416        75,694          1.0 % 

Healthcare services expense:

         Fully-insured dental HMO/IND           33,463        34,038         

(1.7 %)

         Fully-insured dental PPO                8,543         9,278         

(7.9 %)

         Self-insured dental                    20,345        19,826         

2.6 %

          Total healthcare services expense      62,351        63,142         (1.3 %)          Insurance expense         Corporate, All Other                   13,117        12,672          3.5 % 

Income tax expense (benefit)

        Corporate, All Other                      356           (30 )          *      * Not meaningful   Summary  Net income (loss) was approximately $591,000 and $(89,000) for 2011 and 2010, respectively. The increase in net income primarily resulted from an increase in premium revenue of approximately $712,000, to $76,227,000 in 2011 from $75,515,000 in 2010 and a decrease in healthcare services expense of $791,000, to $62,351,000 in 2011 from $63,142,000 in 2010. The resulting increase in gross margin of approximately $1,503,000 was offset by an increase in insurance expenses of $445,000, to $13,117,000 in 2011 from $12,672,000 in 2010. Our ratio of insurance expense to total premium revenue ("insurance expense ratio") increased to 17.2% in 2011 from 16.8% in 2010.  

Membership

  Our fully-insured dental HMO/IND membership decreased approximately 3,400 in 2011. This membership decrease is primarily attributable to a decrease of approximately 2,900 fully-insured dental HMO members and a decrease of approximately 500 fully-insured dental indemnity members underwritten by Dental Care Plus, Inc.                                           29 

-------------------------------------------------------------------------------- ("DCP"). The decrease in fully-insured dental HMO membership of 2,900 members is due to the loss of approximately 12,400 members with employer groups that did not renew with the Company or reduced employee counts of retained employer groups, offset by new sales in the Cincinnati and Northern Kentucky markets of approximately 9,500 members during 2011. A significant portion of the fully-insured dental HMO membership losses were the result of corporate acquisitions where our employer group customers moved to the new parent company benefit plans.  Our fully-insured dental PPO membership decreased by approximately 900 members in 2011. This membership decrease is due to the loss of approximately 5,100 members with employer groups that did not renew with the Company or reduced employee counts of retained employer groups in these markets, offset by new sales in the Dayton and Columbus, Ohio markets and the Southern Kentucky market of approximately 4,200 members during 2011.  Our self-insured dental membership increased by approximately 4,200 members in 2011. This increase is primarily due to the addition of new self-insured dental HMO and dental PPO employer groups in the Southwest Ohio and Northern Kentucky markets, as well as an increase in membership of existing employer groups in the last twelve months.  Our corporate, all other membership increased by approximately 2,900 members in 2011. The increase is primarily due to an increase of approximately 3,400 members in our vision plan, offset by a decrease of approximately 500 dental indemnity members that shifted into the fully-insured segment at renewal.  Revenue                                                                    (Amounts in thousands)                                                                  Total  Dollar         Member  Volume          Rate                                     2011           2010             Change                 Change             Change Total Fully-Insured Dental HMO/IND Premium                   $ 42,527       $ 42,646       $          

(119 ) $ (1,154 ) $ 1,035

   Fully-insured dental HMO/IND premium decreased approximately $119,000 in 2011 compared to 2010. Fully-insured dental HMO/IND premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $1,035,000 in fully-insured dental HMO/IND premium revenue. A decrease in fully-insured dental HMO/IND membership in 2011 resulted in an decrease in fully-insured dental HMO/IND premiums of approximately $1,154,000. The fully-insured dental HMO/IND segment represented approximately 55.8% of our total dental business in 2011.                                                                      (Amounts in thousands)                                                                  Total  Dollar         Member  Volume           Rate                                      2011          2010             Change                 Change              Change Total Fully-Insured Dental PPO Premium                             $ 9,557       $ 9,384       $           173       $           (242 )      $    415   Fully-insured dental PPO premium increased approximately $173,000 in 2011 compared to 2010. Fully-insured dental PPO premium rates negotiated with employer groups at their renewals resulted in an increase of approximately $415,000 in fully-insured dental PPO premium revenue. A decrease in fully-insured dental PPO membership in 2011 resulted in a decrease in fully-insured dental PPO premiums of approximately $242,000. The fully-insured dental PPO segment represented approximately 12.5% of our total dental business in 2011.                                                                     (Amounts in thousands)                                                                   Total  Dollar         Member  Volume         Rate                                      2011           2010             Change                 Change            Change Self-Insured Claim Revenue         $ 22,443       $ 21,850       $           593       $          1,024       $  (431 ) Self-Insured ASO Fees                 1,207          1,172                    35                     55           (20 )  Total Self-Insured Revenue         $ 23,650       $ 23,022       $           628       $          1,079       $  (451 )                                            30 

-------------------------------------------------------------------------------- Total self-insured revenue increased approximately $628,000 in 2011 compared to 2010. Self-insured dental revenue increased by approximately $1,079,000 due to new self-insured sales. This self-insured revenue increase was offset by a decrease of approximately $451,000 due to a decrease in the self-insured claims revenue on a per member per month basis as a result of lower dental service utilization. Approximately $147,000 of this decrease was the result of run-out claims in 2010 for a larger employer group that was self-insured in 2009 and converted to fully-insured effective January 1, 2010 that did not recur in 2011. The self-insured dental segment represented approximately 31.0% of our total dental business. The self-insured segment revenue has two components:  Self-Insured Claim Revenue-Self-insured claim revenue increased approximately $593,000, or 2.7%, to $22,443,000 in 2011 from $21,850,000 in 2010. Self-insured claim revenue increased by approximately $1,024,000 due to new self-insured sales. This self-insured claims revenue increase was offset by a decrease of approximately $431,000 primarily due to a decrease in the self-insured claims revenue on a per member per month basis as a result of lower dental service utilization.  Self-Insured ASO Fees-Self-insured ASO fees increased approximately $35,000, or 3.0%, to $1,208,000 in 2011 from $1,173,000 in 2010. Approximately $55,000 of this increase is attributable to the self-insured product sales. This increase was offset by a decrease of approximately $20,000 due to a small decrease in average self-insured ASO fee rates.  Corporate, all other premium revenue is primarily derived from the non-DCP dental indemnity product, dental PPO product and vision product underwritten by third party insurance carriers. In aggregate, corporate, all other premium revenue increased by approximately $30,000, or 6.5%, to $493,000 in 2011 from $463,000 in 2010.  Investment Income  Investment income decreased approximately $4,000, or 3.5%, to $111,000 in 2011 from $115,000 in 2010. This decrease is the result of funds that were invested in low yield money market investments during the transition from short duration to medium duration corporate bond investments in 2011. In 2010, we invested in short duration investment grade corporate bonds, Federal Deposit Insurance Corporation ("FDIC") insured certificates of deposit and money market funds. In 2011, we invested in medium duration investment grade corporate bonds, FDIC insured certificates of deposit and money market funds.  

Other Income

  Other income increased approximately $14,000 or 21.6% to $78,000 in 2012 from $64,000 in 2011. This increase is primarily the result of an increase of realized gains due to the sale of investments in 2011. There were no realized gains on the sale of investments in 2010.  

Healthcare Services Expenses

                                                                    (Amounts in thousands)                                                               Total  Dollar          Member  Volume          Utilization                                  2011           2010             Change                  Change                Change Total Fully-Insured Dental HMO/IND Healthcare Service Expense                        $ 33,463       $ 34,038       $          (575 )      $           (923 )      $         348   Fully-insured dental HMO/IND healthcare services expense decreased by $575,000, or 1.7%, to $33,463,000 in 2011 from $34,038,000 in 2010. This decrease is attributable to a decrease in fully-insured dental HMO/IND healthcare services expense of approximately $923,000 due to a decrease in fully-insured dental HMO/IND member months of 2.7% in 2011 compared to 2010. This decrease was offset by an increase in fully-insured dental HMO/IND healthcare services expense of approximately $348,000 resulting from an increase in                                           31

--------------------------------------------------------------------------------

fully-insured dental HMO/IND healthcare services expense on a per member per month basis of approximately 1.0% in 2011 for both existing and new fully-insured dental HMO/IND membership.

                                                                    (Amounts in thousands)                                                              Total  Dollar          Member  Volume          Utilization                                  2011          2010             Change                  Change                Change Total Fully-Insured Dental PPO Healthcare Service Expense                         $ 8,543       $ 9,278       $          (735 )      $           (239 )      $        (496 )   Fully-insured dental PPO healthcare services expense decreased by $735,000, or 7.9%, to $8,543,000 in 2011 from $9,278,000 in 2010. This decrease is attributable to a decrease in fully-insured dental PPO healthcare services expense of approximately $239,000 due to a decrease in fully-insured dental PPO member months of 2.6% in 2011 compared to 2010. This decrease is also the result of a decrease in fully-insured dental PPO healthcare services expense of approximately $496,000 due to a decrease in fully-insured dental PPO healthcare services expense on a per member per month basis of approximately 5.3% in 2011 for both existing and new fully-insured dental PPO membership. The introduction of the 10% provider withhold on the in-network portion of the fully-insured dental PPO effective April 1, 2011 was a primary factor in this decrease in fully-insured dental PPO healthcare services expense on a per member per month basis.                                                                    (Amounts in thousands)                                                               Total  Dollar         Member  Volume         Utilization                                  2011           2010             Change                 Change               Change Self-Insured Healthcare Services Expense               $ 20,345       $ 19,826       $           519       $            929       $        (410 )   Self-insured healthcare services expense increased by approximately $519,000 in 2011. An increase of 4.7% in self-insured member month volume in 2011 compared to 2010 resulted in an increase in self-insured healthcare services expense of approximately $929,000. Self-insured dental healthcare services expense decreased by approximately $410,000 due to a decrease in dental service utilization level by our self-insured members in 2011 compared to 2010.  

Corporate, all other healthcare services expense is not recognized by the Company due to the fact that our other dental indemnity, dental PPO and vision PPO products are underwritten by third party insurance carriers.

Insurance Expenses

  Consolidated insurance expenses increased approximately $445,000 in 2011. Total insurance expenses as a percentage of total premium revenue, or the insurance expense ratio, was 17.2% for 2011, increasing 0.4% from the 2010 ratio of 16.8%. Board of Director expense increased by approximately $300,000, or 100%, primarily due to a 50% increase in total director compensation including cash and deferred share awards compensation as a result of additional share awards and an increase in the book value of redeemable common shares. There was a 50% reduction to director compensation, approved by the Board, in 2010. In addition, advertising expense in 2011 increased by approximately $57,000, or 52.0%, as advertising programs were reinitiated in 2011 after having been forgone in 2010 as part of an initiative to reduce discretionary expenses. Professional consulting expense increased by approximately $156,000, or 75.1%, as a result of proceeding with discretionary projects in 2011 that were delayed in 2010. Salaries and benefits increased by approximately $80,000, primarily as a result of higher management bonuses in 2011 compared to 2010. Commissions expense increased approximately $51,000, or 1.6%, due to the increase in total premium revenue in 2011 compared to 2010.  

Income Taxes

  Our effective tax rate for 2011 was 37.6% compared to the 25.0% effective tax rate in 2010. Our 2011 effective tax rate was higher than the federal statutory rate primarily due to the impact of permanent tax                                           32  -------------------------------------------------------------------------------- differences related to meal and entertainment and legal fees. Our 2010 effective tax rate was much higher than the federal statutory rate primarily due to the low amount of our pre-tax income (loss) relative to the impact of permanent tax differences. See Note 5 to the consolidated financial statements included in Item 8-Financial Statements and Supplementary Data for a complete reconciliation of the federal statutory rate to the effective tax rate.  

Liquidity and Capital Resources and changes in Financial Condition

  Our primary sources of cash are premiums, ASO fees, investment and other income, as well as the proceeds from the maturity or sale of our investment securities, from the sale of redeemable common and preferred shares, and from borrowings. Our primary uses of cash include disbursements for claims payments, insurance expense, interest expense, taxes, purchases of investment securities, capital expenditures, redeemable common shares redemptions, dividends, and payments on borrowings. Because premiums are collected in advance of claims payments, our business should normally produce positive operating cash flows during a period of increasing enrollment. Conversely, cash flows would be negatively impacted during a period of shrinking enrollment. Cash increased $1,554,000, or 22.3%, for the year ended December 31, 2012 to approximately $8.5 million at December 31, 2012 from approximately $7.0 million at December 31, 2011. This cash increase is primarily the result of improved profitability due to a lower fully-insured loss ratio in 2012. This loss ratio decrease is primarily due to an increase in fully-insured dental HMO/ IND and fully-insured dental PPO premium rates in 2012 compared to 2011, improved underwriting practices, and a decrease in fully-insured dental HMO/IND healthcare services expense on a per member per month basis as a result of a decrease in fully-insured dental HMO/IND dental services utilization. Cash increased approximately $915,000, or 15.1%, for the year ended December 31, 2011 to approximately $7.0 million at December 31, 2011 from approximately $6.1 million at December 31, 2010. This cash increase is primarily the result of a lower fully-insured loss ratio offset by higher insurance expense as a percentage of premium in 2011. This loss ratio decrease is primarily due to an increase in fully-insured premium rates in 2011 compared to 2010, improved underwriting practices, and a decrease in fully-insured healthcare services expense on a per member per month basis as a result of implementing a provider withhold on the dental PPO product effective April 1, 2011. The change in cash for the years ended December 31, 2012, 2011 and 2010 is summarized as follows (in thousands):                                                           2012         2011    

2010

 Net cash provided by operating activities             $ 1,362      $ 1,571      $    876 Net cash used in investing activities                    (256 )       (309 )      (1,730 ) Net cash provided by (used in) financing activities       448         (347 )         146  Increase (decrease) in cash                           $ 1,554      $   915      $   (708 )   

Cash flows from Operating Activities

  In 2012, we generated approximately $1,362,000 of cash from operating activities. This level of cash flow from operating activities is similar to the cash flow generated from operating activities in 2011. We had net income of approximately $1,318,000 in 2012 compared to net income of $591,000 in 2011. During 2012, we paid approximately $1,110,000 in federal tax payments as compared to $95,000 in 2011. In addition to our 2012 net income, we had non-cash depreciation and amortization expense of approximately $288,000 and an increase in deferred compensation liabilities of $542,000. The increase in deferred compensation liabilities is primarily due to the 16% increase in the book value of the common shares during 2012. These sources of cash were offset by cash uses such as a decrease in the claims payable liability of approximately $665,000. A decrease in unbilled accounts receivable of approximately $2,623,000 was offset by a decrease in unearned premium revenue of $2,665,000, resulting in a net cash decrease of $42,000. This cash decrease is attributable to a decrease in unearned premium revenue received in advance. Unbilled accounts receivable and unearned premium revenue are recorded primarily as the result of non-cancelable short-term insurance contracts. Most of our contracts are one year in duration; however, we occasionally enter into multi-year contracts that tend to be for larger groups. As a result, depending on the timing of large group renewals, the unbilled accounts receivable and unearned premium revenue can experience large fluctuations from period to period.                                           33  -------------------------------------------------------------------------------- In 2011, we generated approximately $1,571,000 of cash from operating activities. This level of cash flow from operating activities is higher than the cash flow generated from operating activities in 2010. We had net income of approximately $591,000 in 2011 compared to net loss of $89,000 in 2010. In addition to our 2011 net income, we had non-cash depreciation and amortization expense of approximately $264,000, an increase in deferred compensation liabilities of $226,000, an increase in claims payable of $25,000 and an increase in other payables and accruals of $276,000. The increase in deferred compensation liabilities is primarily due to the 11% increase in the book value of the common shares during 2011, while the increase in other payables and accruals is primarily the result of a higher management bonus liability for 2011. These sources of cash were offset by cash uses such as an increase in accounts receivable of approximately $61,000. A decrease in unbilled accounts receivable of approximately $6,842,000 was offset by a decrease in unearned premium revenue of $7,074,000, resulting in a net cash decrease of $232,000. This cash decrease is attributable to a decrease in unearned premium revenue received in advance. Unbilled accounts receivable and unearned premium revenue are recorded primarily as the result of non-cancelable short-term insurance contracts.  In 2010, we generated approximately $876,000 of cash from operating activities. This level of cash flow from operating activities is higher than the cash flow generated from operating activities in 2009. We had a net loss of approximately $89,000 in 2010 compared to net loss of $289,000 in 2009. Sources of cash include: non-cash depreciation and amortization expense of approximately $505,000, an increase in deferred compensation liabilities of $132,000, an increase in claims payable of $460,000, and an increase in unearned premium of $8,572,000 that was offset by an increase in unbilled accounts receivable of $8,076,000. Both unbilled accounts receivable and unearned premium increased as a result of the conversion of a large employer group from the self-insured segment to the fully-insured segment and the renewal of a large employer group on a multi-year contract, both effective January 1, 2010. The increase in our claims payable is primarily due to the fact that there was a significant increase in fully-insured membership at December 31, 2010 compared to December 31, 2009. These sources of cash were offset by cash uses such as an increase in accounts receivable of approximately $95,000, an increase in deferred policy acquisition costs of $723,000 and an increase in other assets of $99,000.  

Cash flows from Investing Activities

  In 2012, we invested approximately $124,000 in building improvements, office equipment and computer equipment and software. Also in 2012, approximately $1.1 million of our investments in FDIC insured certificates of deposit, investment grade corporate bonds and money market funds either matured or were liquidated. We also invested approximately $1.2 million in additional FDIC insured certificates of deposit, investment grade corporate bonds and money market funds. We also invested $40,000 to develop a dental and vision discount product. Collectively, these investments resulted in a decrease in cash from investment activities of approximately $256,000.  In 2011, we invested approximately $124,000 in building improvements, office equipment and computer equipment and software. Also in 2011, approximately $7.3 million of our investments in FDIC insured certificates of deposit, investment grade corporate bonds and money market funds either matured or were liquidated. We also invested approximately $7.5 million in additional FDIC insured certificates of deposit, investment grade corporate bonds and money market funds. Collectively, this resulted in a decrease in cash from investment activities of approximately $309,000.  In 2010, we invested approximately $151,000 in building improvements, office equipment and computer equipment and software. In December of 2010, we entered into a sale-leaseback transaction with a leasing company where we received approximately $323,000 in cash in exchange for certain fixed assets on our balance sheet and subsequently entered into a capital lease agreement whereby we are obligated to pay lease payments totaling $339,000 related to these assets over a three year period. Also in 2010, approximately $5.4 million of our investments in FDIC insured certificates of deposit and money market funds either matured or were liquidated to fund operations. We also invested approximately $7.3 million in additional FDIC insured certificates of deposit, investment grade corporate bonds and money market funds. Collectively, this resulted in a decrease in cash from investment activities of approximately $1.7 million.                                           34 

--------------------------------------------------------------------------------

Cash flows from Financing Activities

  In 2012, we paid approximately $120,000 of our outstanding mortgage balance and repaid approximately $108,000 related to the capital lease that we executed in December 2010. In December 2012, we entered into a new mortgage loan in the amount of $1,340,000 in order to refinance both the remaining balance on our first mortgage of approximately $660,000 and to repay the balance on our revolving note of approximately $650,000. During 2012, we sold $1 million of institutional preferred shares and approximately $44,000 of Class A and Class B common. Also during 2012, we repurchased redeemable common shares of $138,000 from provider shareholders.  In 2011, we paid approximately $120,000 of our outstanding mortgage balance and repaid approximately $104,000 related to the capital lease that we executed in December 2010. During 2011, we repurchased redeemable common shares of $128,000 from provider shareholders. In the fourth quarter of 2011, we exchanged the 330 outstanding Provider Preferred Shares with a book value of approximately $205,000 for 330 Class B Common Shares with a book value of $227,000 and received $22,000 in cash.  In 2010, we paid approximately $120,000 of our outstanding mortgage balance and borrowed $20,000 on our revolving note collateralized by our office building. During 2010, we repurchased redeemable common shares of $61,000, which was offset by the issuance of redeemable common shares and provider preferred shares related to our 2010 share offerings of $18,000 and the issuance of institutional preferred shares of $300,000.  Our new mortgage note matures in December 2022. The note requires us to make principal payments of $3,800 per month in 2013 and higher principal payments in 2014 through 2022 in accordance with the agreed upon loan amortization schedule. The mortgage note bears interest at a variable rate of 30-day LIBOR plus 1.95%. We also entered into a variable to fixed interest rate swap agreement that converts the variable rate mortgage to a fixed rate mortgage with an effective fixed interest rate of 3.90%. At the maturity date of the mortgage note in December 2022, the expected outstanding balance of the note of approximately $804,000 must be repaid or refinanced.  

Provider Withhold Payments

  In most cases, our reimbursement to our directly contracted participating providers for covered dental services under the dental HMO, and also the dental PPO effective April 1, 2011, are subject to a 10% withhold. The amounts withheld are not retained in a separate fund and we have no obligation to pay any portion of the amounts withheld to the providers. The dental providers have no vested rights in the amounts withheld unless our Board of Directors (the "Board") authorizes any amounts withheld to be paid to the providers, and then vesting is only to the extent of such amounts authorized to be paid. Once authorized for payment by the Board, such amounts are recorded as claims payable liabilities until paid.  In December of each year our Board evaluates the projected pre-tax income of our dental HMO and dental PPO plans, capital and surplus requirements prescribed by the Ohio Department of Insurance and factors impacting our A.M. Best financial strength rating, such as the ratio of our projected fully-insured premium revenue to our projected capital and surplus level. In addition, the Board considers the capital expenditures needed to support strategic objectives for the coming years (such as the improvements to the dental plan administration system, expansion of office space and acquisition of office equipment for new employees) and our estimated federal income tax liability. After considering these and any other factors deemed relevant, the Board determines the amount of the provider withhold that may be paid to participating dental providers, if any. Each participating dental provider's share of the provider withhold payment is based on the proportionate amount of claims paid to such participating dental provider in relation to the total claims paid to all participating dental providers in a given year, expressed as a percentage, and is not related to or dependent upon any such provider's holdings of shares in the Company. Payments authorized by the Board, if any, are accrued in the fourth quarter of the fiscal year. The Board did not authorize any return of withhold for the years ended December 31, 2012, 2011 or 2010.                                           35

--------------------------------------------------------------------------------

Contractual Obligations and Other Commitments

A summary of our future commitments as of December 31, 2012 is as follows:

                                      Less than 1                                        More than Contractual Obligations                year          1-2 years       3-5 years         5 years           Total Long-term debt and interest (1)    $     98,000      $  195,000      $  194,000      $ 1,284,000      $ 1,771,000 Capital lease and interest              113,000              -               -                -           113,000 Operating leases                         88,000          92,000          14,000               -           194,000 Deferred Compensation (2)                81,000         154,000            

 -         1,378,000        1,613,000 Claims payable                        2,136,000              -               -                -         2,136,000  Total                              $  2,516,000      $  441,000      $  208,000      $ 2,662,000      $ 5,827,000      

(1) Includes swap interest payments based on a fixed rate of 3.90%.

(2) Includes deferred compensation liability to Company directors and employees.

We expect to pay two directors approximately $81,000 in 2013 and one director

approximately $154,000 in 2014. The remainder is expected to be paid in more

than five years. Actual payments may occur sooner based on termination dates

of directors or employees.

   A mortgage note, secured by the land and the office building, accrues interest based on the 30-day LIBOR rate plus 1.95% and was 2.02% at December 31, 2012. At the maturity date of the mortgage note in 2022, the expected outstanding balance of the note of approximately $804,000 must be repaid or refinanced. We also entered into an interest rate swap agreement that effectively changed the interest rate related to the $1,340,000 mortgage note with a commercial bank from a variable rate based on the 30-day LIBOR rate plus 1.95% to a fixed rate of approximately 3.90% for the 10-year period through December 2022. At December 31, 2012, the carrying value of the mortgage note approximates fair value. Under this mortgage, the Company is required to have a minimum tangible net worth equal to or greater than $3,500,000 at the end of each fiscal year and a debt service ratio of at least 1:1. The Company was in compliance with these covenants at December 31, 2012.  

As of December 31, 2012, we believe our most significant other commitments are:

Commissions-We expect commission payments to generally correspond to earned premium volume.

  Redeemable Common Shares-Pursuant to the Company's Amended and Restated Code of Regulations, dentist have the right to require the Company to repurchase such dentist's common shares on the term contained in the Code of Regulations. In 2013, we expect to pay approximately $160,000 in redeemed common shares.  

Off-balance sheet Arrangements

None.

Financial Condition

  Our consolidated cash and short term investments were approximately $8.9 million at December 31, 2012. Our consolidated cash and short term investments increased by approximately $1.6 million from approximately $7.3 million as of December 31, 2011.  This increase in cash and short term investments from December 31, 2011 to December 31, 2012 is primarily due to the net cash provided by operating activities of approximately $1,362,000 and cash provided by financing activities of approximately $448,000, offset by the cash used in investing activities of $256,000.  In July 2012, we renewed an annually renewable agreement with a commercial bank for a $500,000 working capital line of credit. Interest was at a variable rate of LIBOR plus 2.50% and was 2.57% at December 31, 2012. The Company did not have any interest expense for the line of credit in 2012, 2011 or 2010. As of December 31, 2012 and 2011, there was no amount outstanding on this line of credit.                                           36 

-------------------------------------------------------------------------------- In August 2012, we renewed an annually renewable agreement with a commercial bank for a $960,000 working capital line of credit, and the commercial bank also issued an irrevocable letter of credit in the amount of $40,000. Interest was payable at a variable rate of LIBOR plus 2.50% and was 2.57% at December 31, 2012. The Company did not have any interest expense for the line of credit in 2012 or 2011. As of December 31, 2012 and 2011, there was no amount outstanding on this line of credit.  We believe our cash, short term investments and working capital lines of credit together are sufficient to meet our short term and long term liquidity needs. We are obligated to make payments related to our contractual obligations such as our building mortgage and our operating leases and other commitments (see contractual obligations and other commitments). We will also be obligated in certain circumstances to repurchase the redeemable shares of our provider shareholders who die, are permanently disabled, or retire. Our Board considers limitations on the amount of share redemptions each year. While we are not able to estimate future redeemable share redemptions, we repurchased approximately $138,000, $128,000, and $61,000 of redeemable common shares in the years ended December 31, 2012, 2011, and 2010, respectively. We believe our cash balances, available-for-sale investment securities, operating cash flows, and borrowing capacity, taken together, provide adequate resources to fund ongoing operating and regulatory requirements and fund future expansion opportunities and capital expenditures in the foreseeable future.  We operate as a holding company in a highly regulated industry. We are primarily dependent upon management fees that we receive from our subsidiaries. We receive over 99% of our management fees from our subsidiary, Dental Care Plus. We also receive dividends from our subsidiaries from time to time. The dividends from our subsidiary, Dental Care Plus, are subject to regulatory restrictions.  

Regulatory Capital and Surplus Requirements

  Our largest subsidiary, Dental Care Plus, operates in states that regulate its payment of dividends and debt service on inter-company loans, as well as other inter-company cash transfers and require minimum levels of equity as well as limit investments to approved securities. The amount of dividends that may be paid by Dental Care Plus, without prior approval by state regulatory authorities, is limited based on statutory income and statutory capital and surplus. Dividends cannot exceed in any one year the lesser of: (i) 10% of net worth (as of the preceding December 31), or (ii) net income for the prior year, and only if net worth exceeds $250,000 and only out of positive retained earnings. In 2012, Dental Care Plus paid an ordinary dividend in the amount of $360,000 to DCP Holding Company that did not require prior approval by the Ohio Department of Insurance. There were no dividends declared or paid by Dental Care Plus during 2011 or 2010. Even if prior approval is not required, prior notification must be provided to state insurance departments in Ohio, Kentucky and Indiana before paying a dividend.  Dental Care Plus, an Ohio-domiciled insurance company dually licensed as a life and health insurer and a specialty health insuring corporation, is able to underwrite dental indemnity, dental PPO, dental HMO, and vision benefit products as well as other life and health insurance products in Ohio. The minimum required capital and surplus for Dental Care Plus licensed as a life and health insurance company in Ohio was $2.5 million at December 31, 2012.  We maintained aggregate statutory capital and surplus of approximately $7.4 million as of December 31, 2012 and were in compliance with applicable statutory requirements. Although the minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements can vary significantly from state to state. Given our anticipated premium growth in 2013 resulting from the expansion of our networks and membership, capital requirements will increase. We expect to fund these increased requirements through the retention of earnings and capital raised in future redeemable common and preferred share offerings.  

Most states rely on risk-based capital requirements, or RBC, to define the required levels of equity. RBC is a model developed by the NAIC to monitor an entity's solvency. This calculation indicates recommended

                                       37  -------------------------------------------------------------------------------- minimum levels of required capital and surplus and signals regulatory measures should actual surplus fall below these recommended levels. RBC has been adopted by Ohio, Kentucky and Indiana, the three states in which we currently do business. We file our annual statement and RBC reporting with the Ohio Department of Insurance and the NAIC. Dental Care Plus's statutory annual statements for the year ended December 31, 2012 filed with the Ohio Department of Insurance reflected total adjusted capital in excess of Company Action Level RBC.  Other Matters 

The differences between our net income and comprehensive income include the changes in the unrealized gains or losses on marketable securities and changes in the fair value of our interest rate swap agreement. For the years ended December 31, 2012, 2011, and 2010, respectively, such changes increased or (decreased), net of related income tax effects, by the following amounts:

                                                               For Years ended December 31,                                                         2012            2011            2010 Changes in: Change in fair value of investments, net of tax       $ 143,369       $  10,800       $  (9,359 ) Reclassification adjustment for gains included in net income, net of tax                                  (22,708 )       

(11,511 ) Conversion of investments from held-to-maturity to available for sale, net of tax

41,987

 Change in fair value of interest rate swap, net of tax                                                     (20,339 )         7,448          (2,644 )  Total                                                 $ 100,322       $  48,724       $ (12,003 )    The fair market value of the variable-to-fixed interest rate swap contract (net of income tax effects) decreased by $20,339 due to a slight decrease in prevailing interest rates at the end of December 2012. The fair market value of the variable-to-fixed interest rate swap contract (net of income tax effects) increased by $7,448 at December 31, 2011 due to an increase in prevailing interest rates during 2011 as compared to 2010. The fair market value of the variable-to-fixed interest rate swap contract (net of income tax effects) decreased by $2,644 at December 31, 2010 due to a slight decrease in prevailing interest rates during 2010. The fair market value of the variable-to-fixed interest rate swap contract was a liability of $41,275 and $16,354 and is included in other payables and accruals at December 31, 2012 and 2011, respectively.  

Critical Accounting Policies

  Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. Application of those accounting principles includes the use of estimates and assumptions that are made by management, and that we believe are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses in the accompanying consolidated financial statements. We believe the most critical accounting policies used to prepare the accompanying consolidated financial statements are the following:  Liability for Claims Payable  Our estimated liability for claims payable and corresponding healthcare services expense includes claims incurred but not reported ("IBNR"), claims reported but not yet processed and paid and other healthcare services expenses incurred, including estimated costs of processing outstanding claims and actual amounts of accrued but unpaid payments in respect of our Dental Care Plus provider withhold, if any, which is authorized by our Board of Directors. Our estimated liability for claims payable is based primarily on the average historical lag time between the date of service and the date the related claim is paid, taking into account recent trends in payment rates and the average number of incurred claims per covered individual over a rolling 12 month period.                                           38  -------------------------------------------------------------------------------- The following table shows our total claims payable liability as of December 31, and its three components. IBNR represents a substantial portion of our claims payable liability.                                                       2012                          2011 IBNR                                            $ 1,723,219        80.7 %     $ 1,796,298        64.1 % Reported claims in process                          367,430        17.2 %         954,111        34.1 % Other healthcare services expenses payable           45,361         2.1 %   

51,059 1.8 %

  Total claims payable liability                  $ 2,136,010         100 %   

$ 2,801,468 100 %

    Between December 31, 2011 and December 31, 2012, our IBNR estimate decreased by approximately $73,000 or 4.1%, primarily due to a 1.4% decrease in fully-insured dental HMO/IND claims on a per member per month basis in 2012 compared to 2011. Also, our IBNR estimate at December 31, 2012 has decreased due to a decrease in fully-insured dental HMO/IND utilization in December 2012 compared to December 2011. In addition, the fully-insured dental PPO claims on a per member per month basis decreased by 0.5% in 2012 compared to 2011. Reported claims in process at December 31, 2012 was approximately $367,000, or $587,000 lower than the reported claims in process at December 31, 2011. This decrease was the result of the payment of provider claims that occurred on December 31, 2012 that reduced reported claims in process to its lowest possible level. The final payment of provider claims in 2012 occurred on December 31, 2012, whereas the final payment of provider claims in 2011 occurred on December 26, 2011. Accordingly, there were five days less of reported claims in process at December 31, 2012 as compared to December 31, 2011.  We estimate liabilities for both IBNR and reported claims in process by employing actuarial methods that are commonly used by health insurance actuaries and meet actuarial standards of practice. These actuarial standards of practice require that claim liabilities estimates be adequate under moderately adverse circumstances. The Company's consulting actuary assists us in making these estimates.  Since our liability for claims payable is based on actuarial estimates, the amount of claims eventually paid for services provided prior to the balance sheet date could differ from the estimated liability. Any such differences are recognized in the consolidated statement of comprehensive income (loss) for the period in which the differences are identified.  We develop our estimate for claims payable liability using actuarial methodologies primarily based on historical claim payments and claim receipt patterns, as well as historical dental cost trends. Depending on the period for which incurred claims are estimated, we apply a different method in determining our estimate. Throughout the year, we use both the "completion factors" and the "claims trend factor" to estimate our claims payable liability. On a quarterly basis, for periods prior to the most recent month, we calculate "completion factors" which indicate the percentage of claims payable estimated for a prior period that have been paid as of the end of the current reporting period. We use the completion factors to determine historical patterns over a rolling 12-month period, made consistent period over period with making adjustments for known changes in claim inventory levels and known changes in claim payment processes. Then, for the most recent month, we calculate a "claims trend factor" that estimates incurred claims primarily from a trend analysis based upon per member per month claims trends developed from our historical experience in the preceding months, adjusted for known provider contracting changes, changes in benefit levels and seasonality. We have consistently applied the key actuarial methodologies to estimate the IBNR and reported claims in process components of our claims payable liability.  When developing our estimate for claims payable liability as of December 31, 2012, we considered actual paid claim data from January 2013. As a result, we are able to use the completion factors approach for all historical months in 2012, including December 2012. The table below illustrates how our operating results are impacted when there is a variance between estimated claims expense and actual claims expense. The table shows the sensitivity of the estimated fully-insured incurred claims payable liability to fluctuations in the expected                                           39 

-------------------------------------------------------------------------------- completion factors that were used to estimate the claims payable liability as of December 31, 2012 within variance ranges historically experienced. Based on historical experience, the completion factors we use to estimate outstanding IBNR and reported claims in process are highly reliable for predicting actual claims paid at future times, with a variance range of approximately one-half of one percent, plus or minus.                                   Completion Factors (a)                                                  Estimated claims                   (Decrease)                     payable liability                    Increase                            as of                   In Factor                         12/31/2012                    (0.50%)                           2,294,075                       0%       (estimate used)       2,136,010                     0.50%                            1,995,033    

(a) Reflects estimated potential changes in incurred claims payable liability

caused by changes in completion factors for all months prior to December 31,

2012.

Recognition of Premium Revenue

  Fully-Insured premium revenue is recognized in the period during which dental or vision coverage is provided to the covered individuals. Payments received from customers in advance of the related period of coverage, as well as unbilled accounts receivable, are reflected on the accompanying consolidated balance sheets as unearned premium revenue. The Company's unearned premium revenue was approximately $19,792,000 and $22,457,000 at December 31, 2012 and 2011, respectively, for the estimated premium revenue associated with the remaining contract periods and related amounts recorded in unbilled accounts receivable. Enrollment changes not yet reflected on employer group invoices, also known as retroactive membership adjustments, are estimated based on available data and are reflected in revenue in the current period. These retroactive membership adjustments are generally immaterial to the consolidated financial statements. Self-insured premium revenue is recognized upon the payment of claims for self-insured members in accordance with contracts with self-insured employers. We provide administrative and claims processing services, benefit plan design, and access to provider networks for an administrative fee to self-insured groups. The Company has no underwriting risk arising from the provision or cost of any services provided to the self-insured groups.  

Healthcare Services Expense

  Healthcare services expense is recognized on a monthly basis. In the case of the fully-insured dental segment, healthcare services expense is calculated by taking the paid claims associated with the fully-insured membership and adjusting this amount for the change in the claims payable liability determined using the actuarial estimates discussed above. For the self-insured dental segment, the healthcare services expense is based solely on the paid claims for the self-insured membership. In most cases, our reimbursement to our participating providers for covered dental services under the dental HMO are subject to a 10% withhold. Our reimbursement to our participating providers for in-network covered dental services under the dental PPO also became subject to a 10% withhold effective April 1, 2011. The amounts withheld are not retained in a separate fund and we have no obligation to pay any portion of the amounts withheld to the providers. At the end of each year, our Board of Directors determines, in its sole discretion, how much, if any, of the provider withhold is to be paid out to participating providers. Provider withhold payments authorized by our Board during the fiscal year are recorded as an increase to healthcare services expense.  Income Taxes  Our accounting for income taxes requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that are recognized in our consolidated financial statements in different periods than those in which the events are recognized in our tax returns. The measurement of deferred                                           40 

-------------------------------------------------------------------------------- tax liabilities and assets is based on current tax laws as of the balance sheet date. We record a valuation allowance related to deferred tax assets in the event that available evidence indicates that the future tax benefits related to deferred tax assets may not be realized. A valuation allowance is required when it is more likely than not that the deferred tax assets will not be realized. Our determination of whether a valuation allowance is required is subject to change based on future estimates of the recoverability of our net deferred tax assets.  New Accounting Standards  In December 2011, the FASB issued updated guidance on the presentation of comprehensive income that was issued by the FASB in June 2011 effective prospectively for fiscal years beginning after December 15, 2011. The June 2011 guidance requires entities to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single, continuous statement of comprehensive income or in two separate but consecutive statements. The updated December 2011 guidance defers these changes that relate to the presentation of adjustments between other comprehensive income and net income. The Company has adopted the new guidance and has elected to present one continuous consolidated statement of comprehensive income (loss). This did not have a material impact on the consolidated financial statements.  In February 2013, the FASB issued new guidance regarding comprehensive income for amounts reclassified out of other comprehensive income (loss) effective prospectively for fiscal years beginning after December 15, 2012. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income ("AOCI") by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. The Company is currently evaluating the impact of this guidance on its consolidated financial statements and related disclosures.  In May 2011, the FASB issued guidance related to amendments to certain measurement principles and disclosures regarding fair value measurements. The amendments in this update improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the consolidated financial statements and related disclosures.  In December 2011, the FASB issued guidance regarding balance sheet offsetting disclosures, effective for reporting periods beginning on or after January 1, 2013. The guidance will be applied retrospectively for all comparative periods presented. The guidance requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effects of those arrangements on its financial position. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The objective of the guidance is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards. The FASB issued updated guidance in January 2013 clarifying the scope of the disclosures to include derivatives and hedging instruments that are subject to an enforceable master netting or similar agreement. The guidance will not have a material impact on the Company's consolidated financial statements and related disclosures.  Impact of Inflation 

We do not consider the impact of changes in prices due to inflation to be material in the analysis of our overall operations.

                                       41

--------------------------------------------------------------------------------

Wordcount:

10973