10-K 1 k10_0112.txt DECEMBER 31, 2001 10K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 Commission file number 0-23430 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED (Exact name of registrant as specified in its charter) SOUTH DAKOTA 46-0401087 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1323 SOUTH MINNESOTA AVENUE SIOUX FALLS, SOUTH DAKOTA 57105 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (605) 334-4000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: CLASS A PREFERRED STOCK, NO PAR VALUE, STATED VALUE $10 PER SHARE (Title of class) CLASS C COMMON STOCK, PAR VALUE $.01 PER SHARE (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at March 21, 2002 ----- ----------------------------- Class C Common Stock 1,365,604 The aggregate market value of the voting stock held by non-affiliates is not determinable as there is no market or exchange where these shares are traded. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the document listed below have been incorporated by Reference into the indicated part of this Form 10-K DOCUMENT INCORPORATED PART OF FORM 10-K Proxy Statement for 2002 Annual Meeting Item 11 of Part III PART I ITEM 1. BUSINESS South Dakota State Medical Holding Company, Incorporated (the Company, Corporation or DAKOTACARE), was incorporated in the State of South Dakota on May 5, 1988. Its corporate offices are located at 1323 South Minnesota Avenue, Sioux Falls, South Dakota, 57105. The Articles of Incorporation permit the Company to engage in the development of quality comprehensive health care delivery systems; to conduct, promote, or operate alternative health care delivery systems and other contractual health service arrangements, including but not limited to, traditional third party reimbursement systems, preferred provider organizations, and health maintenance organizations (HMO). The Company contracts with over 98% of the physicians in the State of South Dakota, 100% of the hospitals in the State of South Dakota, and many other health care providers to provide medical services to its enrollees. Physicians who are members of the South Dakota State Medical Association and who complete the Company's credentialing process may participate with the Company by purchasing one share of Class A voting preferred stock of the Company for $10. The fee for non-members is $1,000. The South Dakota State Medical Association owns 100% of the Class B voting preferred stock of the Company, and through this ownership, maintains voting control of the Company. The Company's agreements with participating physicians stipulate compensation on a fee-for-service basis utilizing a relative value schedule developed by the Company. This schedule assigns a value (measured in number of units) for each individual service for which a physician may perform and submit a bill. These values are then multiplied by an overall value per unit assigned by the Company, and the product is the maximum amount allowed for payment to the physician. Actual reimbursement is at the lower of this product or the actual billed amount. The Company, at least annually, reviews the unit values and makes adjustments when considered necessary. The effect of this reimbursement mechanism is to establish a maximum allowable reimbursement, which is not dependent upon actual billed charges. Regardless of the physician bill, reimbursement will never exceed the maximum amount established by the relative value schedule. Physicians also may not bill patients for any excess of the billed charge over the amount allowed by the Company, but instead have contractually agreed to hold the patient harmless for any such amounts. The Company's agreements with participating physicians provide that up to 20% of fees for services provided, as submitted to and allowed by the Company, may be withheld to provide a contingency reserve that may be used to fund operations or meet other financial requirements of the Company. The percentage withheld for years 1999 through 2001 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 $2,276,742 and $1,497,780 for the years ended December 31, 2001 and 2000, 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, 2001 and 2000, was $3,846,711 and $2,875,472, respectively. The recorded liability is equal to actual amounts withheld plus or minus claims adjustments for each of the three years in the period ended December 31, 2001. 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) and increased its ownership percentage in Carewest to 81.30% at December 31, 2001. The Articles of Incorporation of DAS, DHP and Carewest permit them to engage in the development of Third Party Administration(TPA) services for health and welfare plans. Carewest has subcontracted with DAS to perform a substantial part of the TPA 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 group managed health care products (HMO), managed care and claims administration services for self-insured employer groups (TPA) and the reinsurance segment, which provides excess medical stop loss coverage to the self insured employer groups. A detailed analysis of the various segments is contained in the Notes to the Consolidated Financial Statements-Note 12. The Company markets its products through an exclusive network of independent insurance agents throughout South Dakota. The Company markets its products to employer groups with a minimum of two covered employees and its' customers range in size from employers of this size to its largest customer with over 12,850 employees. As of January 1, 2002, DAKOTACARE and its subsidiaries provided health care services to approximately 113,000 individuals, which also includes enrollment in ancillary product services for both the HMO and TPA products. Approximately 15% of the state's population and approximately 23% of DAKOTACARE's target market of approximately 450,000 is served by DAKOTACARE and its subsidiaries, which does not include Medicare and Medicaid populations, federal employee groups, the individual policy market, and other potential populations. The Company's HMO enrollment, which was approximately 30,000 at the end of 2000, increased to approximately 35,000 by the end of 2001. Net enrollment added effective January 1, 2002 was approximately 3,000 members. Commencing in 1993, the Company began its TPA business and by January 1, 2002, had enrolled approximately 65,000 enrollees, bringing the total individuals served by the Company and its' subsidiaries to approximately 103,000. The Company's HMO client disenrollment rate is lower than the industry rate as a whole. All underwriting and pricing decisions are made by the DAKOTACARE underwriting department 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 2001 and 2000 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 2001 and 2000 based on average daily amounts specified in the plan. They are also subject to a $2,000,000 lifetime maximum benefit per enrollee in 2001 and 2000. 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 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: 2001 2000 ---- ---- Certificates of deposit 21.5% 20.7% Obligations of state and political subdivisions 51.3 44.0 Obligations of U.S. Treasury, government agencies and corporations 14.6 21.8 Obligations of Industry 10.6 11.4 Bond mutual funds 2.0 2.1 ----- ----- 100.0% 100.0% ===== ===== The Company's investment portfolio, excluding cash and cash equivalents and contracts with life insurance companies, totaled $6,507,366 and $6,035,638 as of December 31, 2001 and 2000, respectively. Cash and cash equivalents totaling $8,673,787 and $7,439,514 at December 31, 2001 and 2000, 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, 2001, the Company employed 120 persons on a full-time basis. None of these employees are covered by a collective bargaining agreement, and the Company believes its employee relations are good. ITEM 2. PROPERTIES The Company leases office space in Sioux Falls, South Dakota, from the South Dakota State Medical Association (Association). See ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS for additional details on this lease with the Association, which is an affiliated company. In January 1997, the Company purchased an office building in Webster, South Dakota, which was previously leased. The Company leased an office in Rapid City starting January 1, 2001 and terminates December 31, 2003. 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 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. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (A) There were no matters submitted to shareholder vote in the fourth quarter of 2001. 6. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS STOCK PRICES There is no active trading for shares of stock of the Company and the stock is not listed on any exchange or over-the-counter market, 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 21, 2002, there were 1,260 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, 2001 and 2000 was $200,000 on a statutory basis of accounting, which the Company significantly exceeded. During 2001 and 2000, the Company paid dividends of $69,930 and $69,930, respectively, 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. During 2001 and 2000, 33,003 and 34,341 shares, respectively, 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 2001, the Company issued a net increase of 81 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. SELECTED FINANCIAL DATA The following information for the Company is as of and for the years ended December 31, 2001, 2000, 1999, 1998, and 1997(dollars in thousands, except per share data): Years Ended December 31, ------------------------------------------- 2001 2000 1999 1998 1997 ------- ------- ------- ------ ------- Income Statement Data: Net premiums $57,993 $43,574 $34,249 $35,718 $34,754 Third party administration fees 4,075 3,372 3,061 3,081 3,628 Investment income 688 767 514 607 615 Total revenues 63,898 48,424 38,428 40,053 39,581 Net claims incurred 51,615 35,151 30,095 30,615 30,976 Other operating expenses 13,620 10,395 9,147 8,835 8,727 Income (loss) before income taxes and minority interest (1,337) 2,878 (814) 603 (122) Net income (loss) (718) 1,954 (622) 483 (110) ======= ======= ======= ======= ======= Earnings (loss) per common share $ (0.52) $ 1.38 $ (0.43) $ 0.33 $ (0.07) ======= ======= ======= ======= ======= Balance Sheet Data: Invested assets and cash $15,273 $13,576 $10,425 $10,876 $10,981 Total assets 19,358 17,704 13,654 14,277 14,011 Reported and unreported claims payable 8,238 5,831 4,667 4,410 4,164 Contingency reserves payable 3,847 2,875 2,723 2,691 2,964 Total liabilities 14,736 11,796 9,414 9,017 8,807 Stockholders' equity 4,622 5,908 4,240 5,260 5,204

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: 2001 1,379,258; 2000 1,412,869; 1999 1,448,600; 1998 1,482,635 shares; 1997 1,505,760 shares. 9. 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, 2001, 2000, 1999, and 1998. 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, ----------------------------- 2001 2000 1999 1998 ---- ---- ---- ---- Loss ratio 89.4% 81.4% 87.5% 85.9% Expense ratio 15.0 15.1 15.8 15.0 ----- ----- ---- ---- Combined ratio 104.4% 96.5% 103.3% 100.9% ===== ====== ====== ====== 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 remained fairly constant as a percentage of revenues which indicate that the expenses paid increased proportionately with the increase in revenues. See Comparison of Years December 31, 2001 and December 31, 2000 and Comparison of Years December 31, 2000 and December 31, 1999. 10. Activity in the liability for reported and unreported claims payable is summarized as follows: Years Ended December 31, ----------------------------------- 2001 2000 1999 1998 ------ ------ ------ ------ (dollars in thousands) Balance at January 1 $5,831 $4,667 $4,410 $4,164 ------ ------ ------ ------ Incurred related to: Current year 51,684 36,026 30,227 30,198 Prior years (69) (875) 911 417 Contingency reserve written off -- -- (1,043) -- ------ ------ ------ ------ Total incurred 51,615 35,151 30,095 30,615 ------ ------ ------ ------ Paid related to: Current year 43,493 29,843 24,241 25,705 Prior years 5,748 4,195 5,321 4,710 ------ ----- ------ ------ Total paid 49,241 34,038 29,562 30,415 ------ ------ ------ ------ Less reinsurance recoverables at January 1 (51) 0 (276) (230) Plus reinsurance recoverables at December 31 84 51 0 276 ------ ------ ------ ------ Balance at December 31 $8,238 $5,831 $4,667 $4,410 ====== ====== ====== ======

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 1992 through 2001. 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. As of December 31, ------------------------------------------------------------------- 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- (dollars in thousands) Reported and unreported claims payable $8,238 $5,831 $4,667 $4,410 $4,164 $3,188 $2,710 $2,864 $2,558 $2,449 Paid (cumulative) as of: End of Year -- -- -- -- -- -- -- -- -- One Year Later 5,782 4,222 5,321 4,581 3,927 2,793 2,985 2,524 2,375 Two Years Later -- 4,191 4,891 4,581 3,927 2,793 2,977 2,519 2,392 Three Years Later -- -- 4,880 4,581 3,927 2,793 2,977 2,519 2,392 Four Years Later -- -- -- 4,603 3,927 2,793 2,977 2,519 2,392 Five Years Later -- -- -- -- 3,927 2,793 2,977 2,519 2,392 Six Years Later -- -- -- -- -- 2,793 2,977 2,519 2,392 Seven Years Later -- -- -- -- -- -- 2,977 2,519 2,392 Eight Years Later -- -- -- -- -- -- -- 2,519 2,392 Nine Years Later -- -- -- -- -- -- -- -- 2,392 Liability reestimated as of: End of Year 8,238 5,831 4,667 4,410 4,164 3,188 2,710 2,864 2,558 2,449 One Year Later 5,782 4,222 5,321 4,581 3,927 2,793 2,985 2,524 2,375 Two Years Later -- 4,191 4,891 4,581 3,927 2,793 2,977 2,519 2,392 Three Years Later -- -- 4,880 4,581 3,927 2,793 2,977 2,519 2,392 Four Years Later -- -- -- 4,603 3,927 2,793 2,977 2,519 2,392 Five Years Later -- -- -- -- 3,927 2,793 2,977 2,519 2,392 Six Years Later -- -- -- -- -- 2,793 2,977 2,519 2,392 Seven Years Later -- -- -- -- -- -- 2,977 2,519 2,392 Eight Years Later -- -- -- -- -- -- -- 2,519 2,392 Nine Years Later -- -- -- -- -- -- -- -- 2,392 ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- Redundancy (Deficiency) $ -- $ 49 $ 476 $(470) $(439) $(739) $ (83) $(113) $ 39 $ 57 ===== ===== ===== ===== ===== ===== ===== ===== ===== =====

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, 2001, are adequate. 12. RESULTS OF OPERATIONS GENERAL The following results of operations include the operations of DAKOTACARE and Its subsidiaries for the years ended December 31, 2001, 2000, and 1999. 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 34% in 2001 and 2000. The valuation allowance was originally added in 2000. See Note 8 of the Notes to Consolidated Financial Statements. COMPARISON OF YEARS DECEMBER 31, 2000 AND DECEMBER 31, 1999 GENERAL The Company's net income increased $2,575,791 to income of $1,953,977 for the year ended December 31, 2000, as compared to a loss of $621,814 for the year ended December 31, 1999. This increase was primarily due to an increase in net premium income of $9,325,028, an increase in other revenues of $670,836, and an increase in minority interest in loss of subsidiaries of $115,065. These were offset by an increase in net claims expense of $5,055,492, an increase in administrative expenses of $1,247,786, and an increase in income taxes of $1,231,860. REVENUES Total revenues increased $9,995,864, or 26.0%, for the year ended December 31, 2000, as compared to December 31, 1999. Revenues from net premiums generated by the health maintenance organization increased $9,315,180. This increase is attributable to a 16.2% increase in the number of enrollee months and a 9.9% increase in the net premium earned per enrollee for the year ended December 31, 2000, as compared to December 31, 1999. Revenues from the third party administration fees increased by $311,163 due to increased fees per enrollee totalling 7.5%. Enrollee months also increased by 2.6%. Investment income increased $253,586 due primarily to an increase in the amount of average invested assets during the year and higher interest rates earned. OPERATING EXPENSES Total operating expenses increased $6,303,278, or 16.1%, for the year ended December 31, 2000, as compared to December 31, 1999. The change was due primarily to an increase in claims incurred, personnel expenses, commissions, occupancy expenses, state insurance taxes, and other general and administrative expenses. During 1999, the Company's Board of Directors, with approval from the Division of Insurance, voted to write off $1,043,131 of contingency reserves withheld in 1997, which reduced claims expense in 1999. Net claims expense increased by $5,055,492, or 16.8%, for the year ended December 31, 2000, as compared to December 31, 1999. The average claims paid per enrollee increased by 1.5% while the number of enrollee months increased by 16.2%. Commissions and state insurance taxes increased by $371,383 and $122,541, respectively, in 2000 as compared to 1999 due to the increased premium income of the HMO. Personnel expenses increased $401,268, or 9.8%, in 2000 as compared to 1999. This was due primarily to annual compensation adjustments and an increase in staffing needs due to the increased volume. Occupancy expense increased $94,501, or 13.6%, due to increased depreciation expense resulting from the additional equipment purchased in 1999. Other general and administrative expenses increased $184,435, or 40.3%, in 2000 as compared to 1999. This was primarily due to the continued addition of licenses and service fees in using computer databanks for information. Insurance expenses also increased due to rising costs and coverage increases elected. A fee settlement of a subsidiary is also included in the increase. 14. INCOME TAXES Income tax expense (benefit) represents 35.9% and 24.2% of income (loss) before income taxes and minority interest for the years ended December 31, 2000 and 1999, respectively. Permanent tax differences and the change in the valuation allowance recorded against deferred income taxes increased the provision percentage above the expected 34% in 2000. The valuation allowance was originally added in 1999, which reduced the amount of income tax benefit below the expected tax rate of 34%. 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 $861,806 to $2,508,834 for the year ended December 31, 2001, as compared to 2000. Net cash provided by operating activities decreased primarily due to decreases in net income to a net loss and decreases in accounts payable and accrued expenses since December 31, 2000. The decrease in cash provided was offset by a decrease in receivables, an increase in reported and unreported claims payable and an increase in contingency reserves payable since December 31, 2000. Other uses of cash and cash equivalents were for the payment of dividends, the purchases of property and equipment, the purchase of treasury stock, 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, 2001, 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 2001, the Company paid $1,305,503 which was the total withheld for claims incurred in 1999. 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 2001 and 2000 are the only 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 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. TRENDS, EVENTS, OR UNCERTAINTIES In recent years, there has been a trend by clients to switch to plans with higher employee cost-sharing levels in order to maintain lower premiums. As a provider of cost effective managed care plans for medium and small employers, the Company believes it is delivering products and services that address current health care reform issues. The Company will continue to evaluate its business strategy as necessary to maximize its ability to adapt to the changing health care marketplace. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets. Statement 141 eliminates the pooling method for accounting for business combinations, requires that intangible assets that meet certain criteria be reported separately from goodwill, and requires negative goodwill arising from a business combination to be recorded as an extraordinary gain. Statement 142 eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life, requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life, requires the carrying value of goodwill which exceeds its implied fair value to be recognized as an impairment loss. The provisions of FASB Statement 141 apply to all business combinations initiated after June 30, 2001 and all business combinations accounted for by the purchase method for which the date of acquisition is July 1, 2001, or later. The provisions of FASB Statement 142 are required to be implemented by the Company in the first quarter of 2002. The adoption of these new standards should have no significant impact on the Company's financial position or results of operations. The FASB also recently issued Statement 143, Accounting for Asset Retirement Obligations. Statement 143, which is effective for fiscal years beginning after June 15, 2002, covers the accounting for closure or removal-type costs that are incurred with respect to long-lived assets. The nature of the Company's business and long-lived assets is such that adoption of this new standard should have no significant impact on the Company's financial position or results of operations. In August 2001, the FASB issued Statement 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes FASB No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. Statement 144 also supersedes certain aspects of APB 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, with regard to reporting the effects of a disposal of a segment of a business and will require expected future operating losses from discontinued operations to be reported in discontinued operations in the period incurred rather than as of the measurement date as presently required by APB 30. Additionally, certain dispositions may now qualify for discontinued operations treatment. The provisions of Statement 144 are required to be applied for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of this new standard should have no significant impact on the Company's financial position or results of operations. 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. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS Page ---- Independent Auditor's Report F-1 Consolidated Financial Statements Balance Sheets F-2 Statements of Operations F-4 Statements of Stockholders' Equity F-5 Statements of Cash Flows F-7 Notes to Consolidated Financial Statements F-9 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. 17. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Name Age Positions - ---- --- --------- K. Gene Koob, M.D. 59 President and Director James A. Engelbrecht, M.D. 54 Secretary/Treasurer and Director Ben J. Henderson, D.O. 59 Vice President and Director Thomas L. Krafka, M.D. 56 Director Stephan D. Schroeder, M.D. 51 Director John E. Rittmann, M.D. 64 Director John Sternquist 53 Director James R. Reynolds, M.D. 58 Director Bob L. Sutton 33 Director R. Van Johnson 57 Director L. Paul Jensen 53 Chief Executive Officer Kirk J. Zimmer 41 Senior Vice President William O. Rossing, M.D. 67 Vice President, Medical Director Sharon K. Duncan 54 Vice President, System Operations Dean M. Krogman 52 Vice President, External Operations Barbara A. Smith 40 Vice President, Medical Services Thomas N. Nicholson 42 Vice President, Sales and Marketing Bruce E. Hanson 38 Vice President, Finance Brian E. Meyer 39 Vice President, Information Systems Scott L. Jamison 44 Vice President, Provider Relations Dr. Koob became a director of the Company in June 1994. He is a member of the South Dakota State Medical Association and has been engaged as a neurologist in Sioux Falls, South Dakota, since 1974. Dr. Engelbrecht became a director of the Company in June 1997. He is a member of the South Dakota State Medical Association and has been engaged in the practice of internal medicine and rheumatology in Rapid City, South Dakota, since 1980. Dr. Henderson became a director of the Company in June 1995. He is a member of the South Dakota State Medical Association and has been engaged in the practice of internal medicine in Mobridge, South Dakota, since 1972. Dr. 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. Frank Messner, and Dr. James Engelbrecht expired at the 2000 Annual Meeting of Shareholders, but the terms of Dr. K. Gene Koob, and Dr. James Engelbrecht were renewed at that time. The term of Dr. John Sternquist commenced in October 2000. The terms of Dr. James Reynolds, Mr. Bob Sutton and Mr. Van Johnson expire at the 2002 Annual Meeting of the Shareholders; 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 Shareholders. The Bylaws currently require that eight of the directors be holders of Class A voting preferred stock of the Company and two of the directors be consumers. The Articles of Incorporation restrict ownership of Class A voting preferred stock to medical or osteopathic physicians who have executed Participating Physician Agreements with the Company. To assure equal eligibility and opportunity throughout the state of South Dakota and avoid domination of the Board of Directors by any geographic area or areas, the number of physician directors from any one District Medical Society of the South Dakota State Medical Association can not exceed two. The consumer directors may be from any geographic location which is served by South Dakota State Medical Holding Company and their residence does not affect the geographic restriction for physician directors. The 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, 2001, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten-percent beneficial owners were timely complied with. 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, 2002. 20. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information, as of March 21, 2002, 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 .08% 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 .08% Class C Common 16,640 1.22% Class A Preferred John C. Sternquist, M.D. 1 .08% Class C Common 560 .04% Class A Preferred K. Gene Koob, M.D. 1 .08% Class A Preferred Ben J. Henderson, D.O. 1 .08% Class C Common 1,060 .08% Class A Common Stephan D. Schroeder 1 .08% Class C Common 1,920 .14% Class A Preferred James Engelbrecht, M.D. 1 .08% Class C Common 1,160 .08% Class A Preferred John Rittmann, M.D. 1 .08% Class C Common 8,340 .61% Class A Preferred James Reynolds, M.D. 1 .08% 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 .68% 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. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company leases office space from the South Dakota State Medical Association (Association). The Company has a one year lease which automatically renews for one year terms each January 1, unless terminated with at least 30 days notice prior to the end of the lease term. The 2001 lease required minimum rental payments of $211,016 and was terminated on December 31, 2001. On January 1, 2002, the Company entered into a three year lease with the 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 Company also has entered into other short-term lease agreements for which the total rental commitment at December 31, 2001 was not significant. Total rental payments for the years ended December 31, 2001, 2000 and 1999 were $239,216, $217,162 and $204,870, 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, 2001, 2000 and 1999 was $66,086, $55,689 and $48,330, respectively. L. Paul Jensen received salaries and retirement contributions totaling $97,087, $94,273 and $30,312 from the South Dakota Medical Association for the years ended 2001, 2000 and 1999, respectively. Robert D. Johnson retired CEO of the Company, received salaries and retirement contributions totaling $332,400 from the South Dakota State Medical Association for the year ended 1999. He received no compensation for the years ended 2001 and 2000. 22. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K The following documents are filed as part of this report: FINANCIAL STATEMENTS Page ---- Independent Auditor's Report F-1 Consolidated Financial Statements Balance Sheets F-2 Statements of Operations F-4 Statements of Stockholders' Equity F-5 Statements of Cash Flows F-7 Notes to Financial Statements F-9 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 21 Subsidiaries of the Registrant 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 03/29/2002 ---------------------------------- -------------------- L. Paul Jensen Chief Executive Officer (Principal Executive Officer) By /s/Kirk J. Zimmer Dated 03/29/2002 ---------------------------------- -------------------- Kirk J. Zimmer Senior Vice President (Principal Financial Officer) By /s/Bruce E. Hanson Dated 03/29/2002 ---------------------------------- -------------------- Bruce E. Hanson Vice President Finance By /s/ K. Gene Koob Dated 03/29/2002 ---------------------------------- -------------------- K. Gene Koob, M.D. President and Director By /s/James Engelbrecht Dated 03/29/2002 ---------------------------------- -------------------- James Engelbrecht, M.D. Secretary/Treasurer and Director By /s/Ben J. Henderson Dated 03/29/2002 ---------------------------------- -------------------- Ben J. Henderson, D.O. Vice President and Director By /s/Thomas L. Krafka Dated 03/29/2002 ---------------------------------- -------------------- Thomas L. Krafka, M.D. Director By /s/James R. Reynolds Dated 03/29/2002 ---------------------------------- -------------------- James R. Reynolds, M.D. Director 24. By /s/ John Sternquist Dated 03/29/2002 ---------------------------------- -------------------- John Sternquist, M.D. Director By /s/John Rittmann Dated 03/29/2002 ---------------------------------- -------------------- John Rittmann, M.D. Director By /s/ Stephan D. Schroeder Dated 03/29/2002 ---------------------------------- -------------------- Stephan D. Schroeder, M.D. Director By /s/ Bob Sutton Dated 03/29/2002 ---------------------------------- -------------------- Bob Sutton Director By /s/Van Johnson Dated 03/29/2002 ---------------------------------- -------------------- Van Johnson Director 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, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. 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, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. /s/ McGLADREY & PULLEN, LLP Sioux Falls, South Dakota March 15, 2002 F-1 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2001 AND 2000 ASSETS 2001 2000 ------------------------------------------------------------------------------- Current Assets Cash and cash equivalents $ 8,673,787 $ 7,439,514 Investment in securities held to maturity (Note 5) 890,714 455,018 Certificates of deposit 1,300,000 500,000 Receivables (Note 3) 1,544,987 1,869,688 Prepaids and other assets 135,541 101,430 Deferred income taxes (Note 8) 916,000 811,000 ---------------------------- TOTAL CURRENT ASSETS 13,461,029 11,176,650 ---------------------------- Long-Term Investments Investment in securities held to maturity (Note 5) 4,083,452 4,205,220 Investment in securities available for sale (Note 5) 133,200 125,400 Certificates of deposit 100,000 750,000 Contracts with life insurance companies 92,337 101,119 ---------------------------- 4,408,989 5,181,739 ---------------------------- Property and Equipment, at cost, net of accumulated depreciation 756,872 903,191 Deferred Income Taxes (Note 8) 731,000 442,000 ---------------------------- $19,357,890 $17,703,580 ============================

See Notes to Consolidated Financial Statements. F-2 LIABILITIES AND STOCKHOLDERS' EQUITY 2001 2000 ------------------------------------------------------------------------------- Current Liabilities Reported and unreported claims payable (Note 7) $ 8,238,361 $ 5,831,471 Unearned premiums and administration fees 1,175,871 1,026,511 Accounts payable and accrued expenses 1,459,263 1,712,748 Contingency reserves payable (Note 6) 1,584,485 1,300,000 ---------------------------- TOTAL CURRENT LIABILITIES 12,457,980 9,870,730 ---------------------------- Contingency Reserves Payable (Note 6) 2,262,226 1,575,472 ---------------------------- Minority Interest in Subsidiaries 15,768 349,331 ---------------------------- Commitments and Contingencies (Notes 4 and 13) Stockholders' Equity (Note 9) Class A preferred, voting, no par value, $10 stated value, 2,500 shares authorized; 1,260 and 1,179 shares issued at December 31, 2001 and 2000 12,600 11,790 Class B preferred, voting, no par value, $1 stated value, 2,500 shares authorized; issued and outstanding 1,300 shares 1,300 1,300 Class C common, nonvoting, $.01 par value, 10,000,000 shares authorized; issued 1,505,760 shares 15,058 15,058 Additional paid-in capital 3,749,342 3,749,342 Retained earnings 2,173,419 2,960,959 Accumulated other comprehensive (loss) (624) (1,223) Less cost of Class C common treasury stock, 2001 140,156 shares, 2000 107,153 shares (1,329,179) (829,179) ---------------------------- 4,621,916 5,908,047 ---------------------------- $19,357,890 $17,703,580 ============================

F-3 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2001, 2000 and 1999 2001 2000 1999 -------------------------------------------------------------------------------------------- Revenues: Premiums $ 58,528,766 $ 44,090,588 $ 34,705,625 Less premiums ceded for reinsurance (536,260) (517,055) (457,120) ------------ ------------ ------------ 57,992,506 43,573,533 34,248,505 Third party administration fees 4,075,143 3,371,746 3,060,583 Investment income 687,788 767,185 513,599 Other income 1,142,958 711,488 605,401 ------------ ------------ ------------ TOTAL REVENUES 63,898,395 48,423,952 38,428,088 ------------ ------------ ------------ Operating expenses: Claims incurred 51,709,053 35,286,842 30,539,355 Less reinsurance recoveries (93,629) (136,291) (444,296) ------------ ------------ ------------ 51,615,424 35,150,551 30,095,059 Personnel expenses 5,212,268 4,486,221 4,084,953 Commissions 4,200,967 1,757,300 1,385,917 Professional fees expenses 867,813 1,075,733 1,040,665 Office expenses 746,715 687,326 680,132 Occupancy expenses 768,696 787,892 693,391 State insurance taxes 686,283 541,413 418,872 Advertising expenses 409,074 417,676 386,280 Other general and administrative expenses 727,854 641,616 457,181 ------------ ------------ ------------ TOTAL OPERATING EXPENSES 65,235,094 45,545,728 39,242,450 ------------ ------------ ------------ INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST (1,336,699) 2,878,224 (814,362) Income taxes (benefit) (Note 8) (527,767) 1,034,917 (196,943) ------------ ------------ ------------ INCOME (LOSS) BEFORE MINORITY INTEREST (808,932) 1,843,307 (617,419) Minority interest in income (loss) of subsidiaries (91,322) (110,670) 4,395 ------------ ------------ ------------ NET INCOME (LOSS) $ (717,610) $ 1,953,977 $ (621,814) ============ ============ ============ Earnings (loss) per common share $ (0.52) $ 1.38 $ (0.43) ============ ============ ============

See Notes to Consolidated Financial Statements. F-4 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 Class A Class B Comprehensive Preferred Preferred Income(Loss) Stock Stock - --------------------------------------------------------------------------------------- Balance, December 31, 1998 $ 11,050 $ 1,300 Issuance of Class A preferred stock 850 - Redemption of Class A preferred stock (420) - Dividends paid ($0.05 per share) on Class C common stock - - Purchase of treasury stock (Note 9) - - Comprehensive (loss): Net (loss) $ (621,814) - - Net change in unrealized loss on securities available for sale (26,276) - - ----------- Comprehensive (loss) $ (648,090) ------------------------------------------- Balance, December 31, 1999 11,480 1,300 Issuance of Class A preferred stock 950 - Redemption of Class A preferred stock (640) - Dividends paid ($0.05 per share) on Class C common stock - - Purchase of treasury stock (Note 9) - - Comprehensive income: Net income $1,953,977 - - Net change in unrealized loss on securities available for sale 33,691 - - ----------- Comprehensive income $1,987,668 ------------------------------------------- Balance, December 31, 2000 11,790 1,300 Issuance of Class A preferred stock 1,230 - Redemption of Class A preferred stock (420) - Dividends paid ($0.05 per share) on Class C common stock - - Purchase of treasury stock (Note 9) - - Comprehensive (loss): Net (loss) $ (717,610) - - Net change in unrealized loss on Securities available for sale 599 - - ----------- Comprehensive (loss) $ (717,011) ------------------------------------------- Balance, December 31, 2001 $ 12,600 $ 1,300 ============================

See Notes to Consolidated Financial Statements. F-5 Accumulated Class C Additional Other Common Paid-In Retained Comprehensive Treasury Stock Capital Earnings (Loss) Stock Total ------------------------------------------------------------------------------------------ $ 15,058 $3,749,342 $ 1,771,993 $ (8,638) $ (280,480) $ 5,259,625 - - - - - 850 - - - - - (420) - - (73,267) - - (73,267) - - - - (298,699) (298,699) - - (621,814) - - (621,814) - - - (26,276) - (26,276) - -------------------------------------------------------------------------------------- 15,058 3,749,342 1,076,912 (34,914) (579,179) 4,239,999 - - - - - 950 - - - - - (640) - - (69,930) - - (69,930) - - - - (250,000) (250,000) - - 1,953,977 - - 1,953,977 - - - 33,691 - 33,691 ------------------------------------------------------------------------------------ 15,058 3,749,342 2,960,959 (1,223) (829,179) 5,908,047 - - - - - 1,230 - - - - - (420) - - (69,930) - - (69,930) - - - - (500,000) (500,000) - - (717,610) - - (717,610) - - - 599 - 599 -------------------------------------------------------------------------------------- $ 15,058 $3,749,342 $ 2,173,419 $ (624) $(1,329,179) $ 4,621,916 ======================================================================================

F-6 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 2001 2000 1999 ---------------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income (loss) $ (717,610) $1,953,977 $ (621,814) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 287,969 336,776 329,472 Minority interest in income (loss) of subsidiaries (91,322) (110,670) 4,395 Amortization of discounts and premiums on investments, net (140,797) (134,399) (130,662) Loss on disposal of equipment - 16,076 - Loss on sale of equity securities - 27,437 - (Increase) decrease in receivables 324,701 (940,660) 323,752 (Increase) decrease in prepaids and other assets (34,111) 39,083 13,417 (Increase) decrease in deferred income taxes (394,000) (204,400) 33,400 Increase in reported and unreported claims payable 2,406,890 1,164,218 257,631 Increase (decrease) in accounts payable and accrued expenses (253,485) 894,347 98,632 Increase in unearned premiums and administration fees 149,360 176,734 10,734 Increase in contingency reserves payable 971,239 152,121 32,783 ------------------------------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 2,508,834 3,370,640 351,740 ------------------------------------------ Cash Flows From Investing Activities Available for sale securities: Purchased (7,201) (46,310) (6,976) Sales - 213,564 - Held to maturity securities: Matured or called 890,000 437,248 560,000 Purchased (1,065,221) (1,484,233) - Repayments on collateralized mortgage obligations 2,090 8,485 55,839 Proceeds from maturities of certificates of deposit 1,200,000 1,000,000 1,075,000 Purchase of certificates of deposit (1,350,000) (1,200,000) (1,000,000) (Increase) decrease in contracts with life insurance companies 8,782 5,970 (15,245) Purchase of property and equipment (141,650) (145,566) (526,943) ------------------------------------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (463,200) (1,210,842) 141,675 ------------------------------------------

See Notes to Consolidated Financial Statements. F-7 2001 2000 1999 ------------------------------------------ Cash Flows From Financing Activities Proceeds from issuance of capital stock $ 1,230 $ 950 $ 850 Redemption of capital stock (420) (640) (420) Payment of dividends (69,930) (69,930) (73,267) Purchase of treasury stock (500,000) (250,000) (298,699) Increase (decrease) in minority investment in subsidiary (242,241) 105,000 - ------------------------------------------ NET CASH (USED IN) FINANCING ACTIVITIES (811,361) (214,620) (371,536) ------------------------------------------ INCREASE IN CASH AND CASH EQUIVALENTS 1,234,273 1,945,178 121,879 Cash and Cash Equivalents Beginning 7,439,514 5,494,336 5,372,457 ------------------------------------------ Ending $8,673,787 $7,439,514 $5,494,336 ========================================== Supplemental Disclosures of Cash Flow Information Cash payments for: Income taxes, net of refunds $ 200,000 $1,007,032 $ (250,000) Supplemental Disclosures of Noncash Investing and Financing Activities (Increase) decrease in unrealized loss on securities available for sale $ 599 $ 33,691 $ (26,276)

F-8 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), its 50.11% owned subsidiary, Dakota Health Plans, Incorporated (DHP), and its 81.30% owned subsidiary (54.35% at December 31, 2000), 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. In December 1998, DHP ceased business operations and was formally dissolved during 2001 with no material effect on the consolidated financial statements. All intercompany balances and transactions have been eliminated in consolidation. BASIS OF FINANCIAL STATEMENT PRESENTATION: The consolidated financial statements have been prepared in conformity with 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. 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. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents. 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. F-9 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED D/B/A DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------ NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INVESTMENT SECURITIES (continued): Premiums and discounts on investments in debt securities are amortized over their contractual lives, except for collateralized mortgage obligations, for which prepayments are probable and predictable, which are amortized over the estimated expected repayment terms of the underlying mortgages. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Realized gains and losses on the sale of investment securities are determined using the specific identification method. DEPRECIATION: Building and building improvements are depreciated using straight-line methods over the estimated useful lives of the assets, which are twenty to thirty-nine years. Depreciation on furniture, equipment and automobiles is computed using straight-line methods based upon the estimated useful lives of the respective assets, which is principally five to seven years. A summary of property and equipment is as follows: 2001 2000 ---------------------------------- Furniture, equipment and automobiles $ 2,390,194 $ 2,248,544 Building and building improvements 53,370 53,370 Other 134,818 134,818 ---------------------------------- 2,578,382 2,436,732 Less accumulated depreciation 1,821,510 1,533,541 ---------------------------------- $ 756,872 $ 903,191 ================================== REVENUE RECOGNITION: Premiums are billed in advance of their respective coverage periods. Income from such premiums is recorded as earned during the coverage period; the unearned portion of premiums received prior to the end of the coverage period is recorded as unearned premiums. Revenue is reduced by reinsurance premiums ceded to reinsurance companies. Third party administration fees are recorded as earned in the period in which the related services are performed. The unearned portion of fees received but not earned prior to the end of the contract is recorded as unearned administration fees. REPORTED AND UNREPORTED CLAIMS PAYABLE: The coverage offered by the Company is on an occurrence basis which provides for payment of claims which occur during the period of coverage regardless of when the claims are reported. Reported and unreported claims payable consist of actual claims reported to be paid and estimates of health care services rendered but not reported and to be paid. The liabilities for reported and unreported claims payable have been estimated by utilizing statistical information developed from historical data, current enrollment, health service utilization statistics and other related information. In addition, the Company uses the services of an independent actuary in the determination of its year end liabilities. The accruals are continually monitored and reviewed and as adjustments to the estimated liabilities become necessary, such adjustments are reflected in current operations. F-10 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 makers 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 1,379,258 in 2001, 1,412,869 in 2000 and 1,448,600 in 1999. 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. 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, 2001, the carrying amount and fair value of the Company's investment securities was $5,107,366 and $5,236,548, respectively. At December 31, 2000, the carrying amount and fair value of the Company's investment securities was $4,785,638 and $4,866,245, respectively. Accrued interest receivable: The carrying amount approximates fair value due to the nature of the balances recorded. F-11 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------------------------------------------------------------------------- NOTE 3. RECEIVABLES Receivables consist of the following: 2001 2000 -------- ---------- Income taxes $ 347,000 $ 13,600 Drug manufacturer chargebacks 286,170 272,853 Subrogation, net of recovery expenses 140,000 72,730 Coordination of benefits recoverable 116,300 50,300 Third party administrator receivables 109,784 12,178 Reinsurance 84,088 51,158 Hospital receivables 75,790 70,000 Premiums 67,962 79,040 Funds withheld by ceding insurer 56,362 145,470 Interest 51,281 38,238 Lawsuit settlement - 850,000 Other 210,250 214,121 ---------- ---------- 1,544,987 1,869,688 Less allowance for doubtful accounts - - ---------- ---------- $1,544,987 $1,869,688 ========== ========== 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. F-12 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, 2001 are as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value -------------------------------------------------------- Debt securities held to maturity: Obligations of U.S. treasury, government agencies and corporations $ 952,097 $ 57,106 $ - $1,009,203 Obligations of state and political subdivisions 3,335,293 61,293 (29,205) 3,367,381 Corporate bonds 686,776 39,988 - 726,764 -------------------------------------------------------- $4,974,166 $ 158,387 $ (29,205) $5,103,348 ======================================================== Equity securities available for sale: Bond mutual fund $ 133,824 $ - $ (624) $ 133,200 ========================================================

The amortized cost and estimated fair values of debt securities, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. December 31, 2001 ------------------------------ Amortized Estimated Cost Fair Value ------------------------------ Due in one year $ 890,714 $ 901,648 Due after one year through five years 1,543,523 1,625,645 Due after five years through ten years 1,911,168 1,963,949 Due after ten years 628,761 612,106 ------------------------------ $ 4,974,166 $ 5,103,348 ==============================

F-13 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, 2000 are as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value -------------------------------------------------------- Debt securities held to maturity: Obligations of U.S. treasury, government agencies and corporations $1,315,979 $ 37,177 $ (3,261) $1,349,895 Obligations of state and political subdivisions 2,657,348 36,977 (6,516) 2,687,809 Corporate bonds 684,822 16,263 - 701,085 U.S. governmental agency collateralized mortgage obligations 2,089 - (33) 2,056 -------------------------------------------------------- $4,660,238 $ 90,417 $ (9,810) $4,740,845 ======================================================== Equity securities available for sale: Bond mutual fund $ 126,623 $ - $ (1,223) $ 125,400 ========================================================

The components of other comprehensive income (loss) - net change in unrealized (loss) on securities available for sale are as follows: Years Ended December 31, ------------------------------------------ 2001 2000 1999 ------------------------------------------ Unrealized holding gain (loss) arising during the period $ 599 $ 6,254 $ (26,276) Add reclassification adjustment for net losses realized in net income - 27,437 - ------------------------------------------ Net change in unrealized (loss) before income taxes 599 33,691 (26,276) Income taxes - - - ------------------------------------------ Other comprehensive income - net change in unrealized (loss) on securities available for sale $ 599 $ 33,691 $(26,276) ==========================================

There were no sales of debt or equity securities during the years ended December 31, 2001 and 1999, 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, 2001 and 2000, no individual investments in obligations of state and political subdivisions exceeded 10% of the Company's equity. At December 31, 2001 and 2000, the Company had certificates of deposit of $900,000 and $700,000, respectively, on deposit with the South Dakota Department of Commerce and Regulation, Division of Insurance (Division of Insurance), to meet the deposit requirement of state insurance laws. F-14 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 1999 through 2001 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, 2001 is equal to actual amounts withheld for the years ended December 31, 2001 and 2000. During 1999, the Company's Board of Directors, with approval from the Division of Insurance, voted to write off $1,043,131 of contingency reserves withheld in 1997, which reduced claims expense in 1999 and was accounted for as a change in accounting estimate. This change had the effect of decreasing the net loss for 1999 by $688,470, or $.48 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: 2001 2000 1999 --------------------------------------------------- Balance at January 1 $ 5,831,471 $ 4,667,253 $ 4,409,622 --------------------------------------------------- Incurred related to: Current year 51,684,791 36,025,786 30,226,506 Prior years (69,367) (875,235) 911,684 Contingency reserves written off - - (1,043,131) --------------------------------------------------- Total incurred 51,615,424 35,150,551 30,095,059 --------------------------------------------------- Paid related to: Current year 43,493,105 29,842,349 24,240,777 Prior years 5,748,359 4,195,142 5,321,000 --------------------------------------------------- Total paid 49,241,464 34,037,491 29,561,777 --------------------------------------------------- Less reinsurance recoverables at January 1 (51,158) - (275,651) Plus reinsurance recoverables at December 31 84,088 51,158 - --------------------------------------------------- Balance at December 31 $ 8,238,361 $ 5,831,471 $ 4,667,253 --------------------------------------------------- ---------------------------------------------------

F-15 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------------------------------------------------------------------------- NOTE 8. INCOME TAX MATTERS The Company is taxable as a property and casualty insurance company under section 831 of the Internal Revenue Code. The code prescribes certain adjustments to book income to arrive at taxable income which include adjustments to unearned premiums, discounting of loss reserves and proration of tax-exempt income. In addition, increases in contingency reserves, which are included as claims expenses, are not allowable as tax deductions until actually paid. The Company files a consolidated income tax return with its wholly-owned subsidiaries, DAS and DIL. In 2001, the consolidated income tax return also includes Carewest. The components of income tax expense as of December 31 are as follows: 2001 2000 1999 --------------------------------------- Current (recoverable) $ (133,767) $1,239,317 $ (230,343) Deferred (benefit) (394,000) (204,400) 33,400 --------------------------------------- $ (527,767) $1,034,917 $ (196,943) --------------------------------------- --------------------------------------- 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: 2001 2000 1999 --------------------------------------- Computed "expected" tax expense (benefit) $ (468,000) $1,007,000 $(285,000) Tax exempt interest (43,709) (40,487) (42,788) Lobbying 7,188 5,562 2,977 Change in valuation allowance for deferred tax assets 9,000 27,700 108,400 Effect of tax rate brackets and other (32,246) 35,142 19,468 --------------------------------------- $ (527,767) $1,034,917 $(196,943) --------------------------------------- ---------------------------------------

F-16 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------- NOTE 8. INCOME TAX MATTERS (CONTINUED) The net deferred tax assets consist of the following components at December 31: 2001 2000 ---------------------------- Deferred tax assets: Contingency reserves payable $ 1,308,000 $ 978,000 Reported and unreported claims payable 81,000 57,000 Unearned premiums 72,000 68,000 Accrued expenses and other 233,000 226,000 Net operating loss carryforward of subsidiaries 178,000 148,000 ---------------------------- 1,872,000 1,477,000 Less valuation allowance 157,000 148,000 ---------------------------- 1,715,000 1,329,000 ---------------------------- Deferred tax liability: Property and equipment (68,000) (76,000) ---------------------------- $ 1,647,000 $ 1,253,000 ---------------------------- ---------------------------- Reflected on the accompanying balance sheets as follows: 2001 2000 ---------------------------- Current assets $ 916,000 $ 811,000 Noncurrent assets 731,000 442,000 ---------------------------- $ 1,647,000 $ 1,253,000 ---------------------------- ----------------------------

F-17 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------------------------------------------------------------------------- NOTE 9. CAPITAL STOCK The Class A voting preferred stock is not entitled to receive dividends or other distributions, except for redemption by the Company. In the event of a liquidation, each share of Class A preferred stock would be given priority over Class B and C stock and would be entitled to receive a preferential payment in an amount up to (and not to exceed) its stated value of $10 per share. The Class A preferred stock is restricted to ownership by medical and osteopathic physicians who have executed a participating physician agreement with the Company and may not be issued to or held by a hospital. The Class B voting preferred stock is restricted to ownership by the South Dakota State Medical Association, an affiliated company, and is not entitled to receive dividends. The Class C nonvoting common stock is not entitled to cumulative dividends and has no preference in a liquidation. The Class C common stock is restricted to ownership by the following persons or entities: (1) physicians entitled to ownership of Class A stock, (2) a trust or self-directed individual retirement account controlled by a physician entitled to ownership of Class A stock, (3) a professional corporation, partnership or other entity domiciled in the State of South Dakota and in which a physician entitled to ownership of Class A stock is a shareholder, partner, or employee in the practice of medicine, (4) management, employees or agents of the Company, the South Dakota State Medical Association, or the South Dakota Foundation for Medical Care, or (5) the spouse or children of such physician or other person set forth in (1) or (4) above. To facilitate liquidity for Class C common stock (Common Stock) in the event of death, disability, or retirement of a shareholder, the Company's Board of Directors 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. Regulatory capital as required by the Division of Insurance at December 31, 2001 and 2000 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, 2001. F-18 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------- NOTE 10. TRANSACTIONS WITH AFFILIATE The Company leases office space from the South Dakota State Medical Association (Association). The Company has a one year lease which automatically renews for one year terms each January 1, unless terminated with at least 30 days notice prior to the end of the lease term. The 2001 lease required minimum rental payments of $211,016 and was terminated on December 31, 2001. On January 1, 2002, the Company entered into a three year lease with the 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 Company also has entered into other short-term lease agreements for which the total rental commitment at December 31, 2001 was not significant. Total rental payments for the years ended December 31, 2001, 2000 and 1999 were $239,216, $217,162 and $204,870, 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, 2001, 2000 and 1999 was $66,086, $55,689 and $48,330, 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, 2001, 2000 and 1999. Retirement plan expense for the years ended December 31, 2001, 2000 and 1999 was $374,633, $275,421 and $238,689, 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. The Company is making payments to a retired officer. At December 31, 2001 and 2000, $78,112 and $89,036, 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, DHP and Carewest, which are TPA's of health care plans for independent employer companies. The reinsurance segment consists of the operations of DIL. DIL's primary activity is in providing reinsurance quota share excess medical stop loss coverage to DAS' 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. F-19 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. Year Ended December 31, 2001 HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external customers $ 58,945,048 $ 4,388,962 $ 410,350 $ 63,744,360 Intersegment revenues - 233,662 - 233,662 Investment income 653,296 25,480 9,012 687,788 Depreciation expense 76,212 211,757 - 287,969 Segment profit (loss) (717,610) (421,426) 176,069 (962,967) Equity in net (loss) of subsidiaries (154,035) - - (154,035) Income tax (benefit) (478,400) (49,367) - (527,767) Segment assets 18,915,606 1,286,102 622,372 20,824,080 Year Ended December 31, 2000 HMO TPA Reinsurance Totals ---------------------------------------------------------- Revenues from external customers $ 44,194,355 $ 3,588,674 $ 661,462 $ 48,444,491 Intersegment revenues - 255,824 - 255,824 Investment income 685,367 63,040 18,778 767,185 Depreciation expense 80,549 256,227 - 336,776 Segment profit (loss) 1,953,977 (168,270) 78,139 1,863,846 Equity in net income of subsidiaries 20,539 - - 20,539 Income tax expense 1,004,667 30,250 - 1,034,917 Segment assets 16,838,497 1,839,801 598,647 19,276,945 Year Ended December 31, 1999 HMO TPA Reinsurance Totals -------------------------------------------------------- Revenues from external customers $ 34,048,724 $ 3,259,507 $ 646,836 $ 37,955,067 Intersegment revenues - 241,325 - 241,325 Investment income 455,461 44,138 14,000 513,599 Depreciation expense 88,147 241,325 - 329,472 Segment (loss) (621,814) (267,738) (200,888) (1,090,440) Equity in net (loss) of subsidiaries (473,021) - - (473,021) Income tax (benefit) (55,950) (140,993) - (196,943) Segment assets 12,905,809 1,699,895 457,870 15,063,574

F-20 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ NOTE 12. SEGMENT INFORMATION (CONTINUED) 2001 2000 1999 --------------------------------------------- Revenues Total external revenues for reportable segments $ 63,744,360 $ 48,444,491 $ 37,955,067 Intersegment revenues for reportable segments 233,662 255,824 241,325 Elimination of intersegment revenues (233,662) (255,824) (241,325) Elimination of net income (loss)of subsidiaries (154,035) 20,539 (473,021) --------------------------------------------- Total consolidated revenues $ 63,898,395 $ 48,423,952 $ 38,428,088 --------------------------------------------- --------------------------------------------- Income or Loss Total income (loss) for reportable segments $ (962,967) $ 1,863,846 $ (1,090,440) Elimination of equity in net (loss) of subsidiaries (154,035) 20,539 (473,021) Minority interest in income (loss) of subsidiaries (91,322) (110,670) 4,395 --------------------------------------------- Total consolidated net income (loss) $ (717,610) $ 1,953,977 $ (621,814) --------------------------------------------- --------------------------------------------- Assets Total assets for reportable segments $ 20,824,080 $ 19,276,945 $ 15,063,574 Elimination of intercompany receivable (234,696) (153,092) (135,058) Elimination of investment in subsidiaries (1,231,494) (1,420,273) (1,274,734) --------------------------------------------- Total consolidated assets $ 19,357,890 $ 17,703,580 $ 13,653,782 --------------------------------------------- ---------------------------------------------

NOTE 13. LITIGATION During 1998, a substantial claim was filed against the Company in circuit court which alleged wrongful nonrenewable of a sales agency contract and sought compensatory and punitive damages. The lawsuit was settled in 2001 and all payables and expenses are fully recorded in the accompanying 2001 consolidated financial statements. In addition, the Company is involved in other legal actions in the ordinary course of its business. Although the outcome of any such legal actions cannot be predicted, in the opinion of management, there is no legal proceeding pending against or involving the Company for which the outcome is likely to have a material adverse effect upon the consolidated financial position or results of operations of the Company. F-21 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ NOTE 14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Year ended December 31, 2001 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------------------------------------------------------------------------------------------- Total revenues $14,609,754 $15,381,707 $16,534,612 $17,372,322 Claims incurred, net 11,658,449 11,680,324 12,592,451 15,684,200 Total operating expenses 14,595,560 14,465,608 17,406,493 (1)18,767,433 Net income (loss) 106,907 556,573 (603,289) (777,801) Earnings (loss) per share $ 0.08 $ 0.40 $ (0.44) $ (0.57) Year ended December 31, 2000 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------------------------------------------------------------------------------------------- Total revenues $10,812,637 $11,612,390 $12,350,361 $13,648,564 Claims incurred, net 7,380,452 7,774,623 8,992,386 11,003,090 (2) Total operating expenses 9,775,972 10,322,148 11,418,495 14,029,113 Net income (loss) 679,234 788,872 647,474 (161,603) Earnings (loss) per share $ 0.47 $ 0.55 $ 0.46 $ (0.11)

(1) Includes the settlement of a lawsuit (Note 13). (2) Includes an $850,000 receivable (reduction of incurred amount) and $420,000 payable (increase in incurred amount) relating to the settlement of two separate lawsuits relating to claims paid in prior years. F-22 SOUTH DAKOTA STATE MEDICAL HOLDING COMPANY, INCORPORATED d/b/a DAKOTACARE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- NOTE 15. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets. Statement 141 eliminates the pooling method for accounting for business combinations, requires that intangible assets that meet certain criteria be reported separately from goodwill, and requires negative goodwill arising from a business combination to be recorded as an extraordinary gain. Statement 142 eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life, requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life, requires the carrying value of goodwill which exceeds its implied fair value to be recognized as an impairment loss. The provisions of FASB Statement 141 apply to all business combinations initiated after June 30, 2001 and all business combinations accounted for by the purchase method for which the date of acquisition is July 1, 2001, or later. The provisions of FASB Statement 142 are required to be implemented by the Company in the first quarter of 2002. The adoption of these new standards should have no significant impact on the Company's financial position or results of operations. The FASB also recently issued Statement 143, Accounting for Asset Retirement Obligations. Statement 143, which is effective for fiscal years beginning after June 15, 2002, covers the accounting for closure or removal-type costs that are incurred with respect to long-lived assets. The nature of the Company's business and long-lived assets is such that adoption of this new standard should have no significant impact on the Company's financial position or results of operations. In August 2001, the FASB issued Statement 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes FASB No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. Statement 144 also supersedes certain aspects of APB 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, with regard to reporting the effects of a disposal of a segment of a business and will require expected future operating losses from discontinued operations to be reported in discontinued operations in the period incurred rather than as of the measurement date as presently required by APB 30. Additionally, certain dispositions may now qualify for discontinued operations treatment. The provisions of Statement 144 are required to be applied for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of this new standard should have no significant impact on the Company's financial position or results of operations. F-23 EXHIBIT INDEX ------------- Exhibit No. Description - ----------- ----------- 10 Office Lease with the South Dakota State Medical Association 21 Subsidiaries of the Registrant EXHIBIT 10 LEASE This LEASE made this 1st day of January, 2002, between SOUTH DAKOTA STATE MEDICAL ASSOCIATION of Sioux Falls, South Dakota, Lessor, and South Dakota State Medical Holding Company, Inc., Sioux Falls, South Dakota, Lessee, is in agreement with: 1. That the said lessor leases to the said lessee the property described as: Office space in the following structures: "The Southeast Quarter and the East 11.5 feet of the Southwest quarter of Block 32 in Park Addition to Sioux Falls, together with the East 25 feet of the South 88 feet of Lot E in Perry's Subdivision of part of Block 32 Park Addition" surveyed, platted, and recorded in Minnehaha County, South Dakota; as well as Lots C, D, and E, except the East 25 feet of the South 88 feet of Lot E of Perry's Subdivision of part of Block 32 of Park Addition to Sioux Falls, Minnehaha County, South Dakota, according to the recorded plat thereof. The parking lot space on "The Northwest Quarter of Block 32 in Park Addition to Sioux Falls" surveyed, platted, and recorded in Minnehaha County, South Dakota. The term of this lease shall begin on the 1st day of January, 2002, and end on the 31st day of December, 2004, and shall automatically renew for successive two (2) year terms unless terminated with not less than thirty (30) days notice prior to the end of the lease term. Rent payable pursuant to this lease shall be: The sum of Eighteen Thousand Nine Hundred Eighty-Two Dollars and Twenty-Five Cents ($18,982.25) per month, payable on the first day of each month. 2. It is further agreed that the lessor shall furnish all and full maintenance for the property leased hereunder including but not limited to heat, air conditioning, electricity, gas, water, janitorial service, maintenance of building fixtures, replacement of building glass breakage, and snow and ice removal. 3. It is provided that the lessor shall cause nothing upon the premises to become a nuisance. 4. It is understood that the lessor will be responsible for all real property taxes, and that each individual party will be responsible for their own personal property taxes. 5. The said lessee hereby covenants with the lessor to pay the said rent at the times and in the manner hereinbefore specified; not at any time to assign this agreement or to sublet the demised premises, or any portion thereof, without the written consent of the said lessor or its representatives; to keep the premises in good order; and to surrender the possession of the premises at the end of the said term. 6. It is hereby agreed that, if the building on the premises shall be destroyed or rendered untenantable by fire or other unavoidable accident, all liability for rent hereunder shall cease upon payment thereon proportionally to the day of such fire or unavoidable accident. 7. It is also agreed that each said party shall be responsible for insuring its Own property against damage or destruction by fire, wind, or other unavoidable disaster. 8. It is further agreed by and between the said parties that any fixtures or equipment placed in said premises by the lessee herein shall be and remain the property of said lessee, provided, however, that in the event that the installation of any such fixtures or equipment shall require a substantial change or alteration of the premises described herein, then and in such event prior approval before installation must be obtained from the lessor. 9. It is further agreed that if the lessee shall violate any of the foregoing covenants on its part, the lessor shall have the right without formal notice to re-enter and take possession. 10. Each party hereto waives all claims for recovery from the other party for any loss or damage of its property insured under valid and collectible insurance policies to the extent of any recovery collectible under such insurance subject to the limitation that this waiver shall apply only when permitted by the applicable policy of insurance. 11. This lease may be terminated by either party upon thirty (30) days written notice to the other party irrespective of any other covenants herein. The lessees hereby acknowledge the receipt of a true and correct copy of this lease. SOUTH DAKOTA STATE MEDICAL ASSOCIATION Lessor By: _/s/L. Paul Jensen_________________ Chief Executive Officer DAKOTACARE Lessee By: _/s/Kirk Zimmer____________________ Senior Vice-President 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 81.30%

SD STATE MEDICAL HOLDING CO INC 10-K