We lease office space for our principal executive offices in Woodland Hills, California. Our executive offices, comprising approximately 164,370 square feet, are occupied under two separate leases that expire on January 31, 2008 (with respect to 48,922 square feet of space) and December 31, 2014 (with respect to 115,448 square feet of space). A significant portion of our California HMO operations are also housed in Woodland Hills, in a separate 333,954 square foot leased facility. The lease for this two-building facility expires December 31, 2011. Combined rent and rent-related obligations for our Woodland Hills facilities were approximately $14.4 million in 2006.
We also lease an aggregate of approximately 463,150 square feet of office space in Rancho Cordova, California for certain Health Plan Services and Government Contract operations. Our aggregate rent and rent-related obligations under these leases were approximately $8.2 million in 2006. These leases expire at various dates ranging from 2007 to 2013. We also lease a total of approximately 109,285 square feet of office space in San Rafael and Pointe Richmond, California for certain specialty services operations. In addition to the office space referenced above, we lease approximately 91 sites in 26 states, totaling approximately 1,076,572 square feet of space.
We also own facilities comprising, in the aggregate, approximately 523,195 square feet of space. These facilities include operations or headquarters for our health plan subsidiaries in Arizona and Connecticut, respectively, as well as a data center facility in Rancho Cordova, California. On February 23, 2007, we announced that we entered into a sale/leaseback transaction for our Shelton, Connecticut facility. The Shelton Property comprises 327,327 square feet of space. For additional information on the Shelton Property sale/leaseback see “Item 1. Business - Recent and Other Developments and Other Company Information.”
We are an integrated managed care organization that delivers managed health care services through health plans and government sponsored managed care plans. We are among the nation’s largest publicly traded managed health care companies. Our mission is to help people be healthy, secure and comfortable. We provide health benefits to approximately 6.6 million individuals in 27 states and the District of Columbia through group, individual, Medicare (including Part D), Medicaid, TRICARE and Veterans Affairs programs. Our behavioral health services subsidiary, MHN, provides behavioral health, substance abuse and employee assistance programs (EAPs) to approximately 7.3 million individuals, including our own health plan members. Our subsidiaries also offer managed health care products related to prescription drugs, and offer managed health care product coordination for multi-region employers and administrative services for medical groups and self-funded benefits programs.
Government contracts revenue is made up of two major components: health care and administrative services. The health care component includes revenue recorded for health care costs for the provision of services to our members, including paid claims and estimated incurred but not reported claims (IBNR) expenses for which we are at risk, and underwriting fees earned for providing the health care and assuming underwriting risk in the delivery of care. The administrative services component encompasses fees received for all other services provided to both the government customer and to beneficiaries, including services such as medical management, claims processing, enrollment, customer services and other services unique to the managed care support contract with the government.
Health plan enrollment (excluding Medicare Part D members) increased by 15,000 members in 2006 versus 2005 following three years of year-over-year declines; and
We provide ASO products to large employer groups in California, Connecticut, New Jersey and New York. Under these arrangements, we provide claims processing, customer services, medical management, provider network access and other administrative services. Effective in 2006, we reported revenues from our ASO business in a separate line item titled “administrative services fees and other income” in our consolidated statements of operations. Historically, ASO revenue amounts were reported as part of health plan services premiums. In recent periods, these revenues have increased to a level at which we believe that reporting them in a separate line item provides useful insight on our operations. All affected prior period financial information reflects this reclassification.
(c) The administrative ratio is computed as the sum of G&A and depreciation expenses divided by the sum of health plan services premiums and administrative services fees and other income.
Net income improved to $329.3 million in 2006, or $2.78 per diluted share, from $229.8 million in 2005, or $1.99 per diluted share. Results in 2006 reflect the impact of a $37.1 million litigation charge related to estimated legal defense costs for the McCoy/Wachtel litigation and $70.1 million of expenses related to the refinancing of our senior notes. Results in 2005 reflect the impact of $83.3 million in litigation, asset impairment and restructuring charges. See “Item 3. Legal Proceedings” for additional information on these litigation matters. See “Liquidity and Capital Resources-Capital Structure” for additional information on the refinancing of our senior notes. See “-Year Ended December 31, 2005 compared to Year Ended December 31, 2004” for additional information on the 2005 litigation, asset impairment and restructuring charges.
Our key objectives for 2006 were to position our membership for profitable growth; respond to the changing legal and political environment; improve pretax margin; and improve cash generation to resume our stock repurchase program. We believe we have met these key objectives as discussed below.
Our total health plan enrollment increased by 315,000 members in 2006 compared to 2005. Medicare Part D business and the March 31, 2006 acquisition of certain health plan businesses of Universal Care, Inc. (Universal Care Acquisition) were the primary drivers of the membership increase. We achieved our enrollment target for Medicare Part D and membership reached over 300,000 members. We have successfully integrated the members acquired in the Universal Care Acquisition with better than expected operating results and, as a result of the Universal Care Acquisition, have added a total of approximately 83,000 members as of December 31, 2006. Our commercial enrollment stabilized in 2006 and new commercial sales in 2006 were nearly double the amount of new commercial sales in 2005. These increases were partially offset by decreases due to pricing competition.
Our pretax profit margins improved to 3.7% for 2006, compared to 3.2% for 2005. This is attributable to our Health Plan Services MCR improving to 83.0% for 2006, compared to 84.3% for 2005. This improvement is primarily due to a focused Medicare re-contracting effort in late 2005 in California and Arizona. Our continued focus on pricing discipline and moderating health care cost trends also contributed to the improvement. The increase in commercial premium PMPM was 8% for the year ended December 31, 2006 compared to the same period in 2005. Our Government Contracts cost ratio also improved to 94.0% for 2006, compared to 95.8% for 2005, reflecting lower medical expenses as a result of our working effectively with TRICARE beneficiaries and managing to moderate health care cost trends. Partially offsetting the improvements in the Health Plan Services MCR and the Government Contracts ratio are increases in general, administrative and selling expenses from our continued investment in new products and marketing support for the new sales effort.
Our cash flow from operations increased by $86.5 million in 2006 to $277.9 million from $191.4 million in 2005. During the fourth quarter of 2006, we resumed repurchases of our common stock under our stock repurchase program and repurchased approximately 5.5 million shares for $250 million. We have $200 million remaining in repurchase authorization as of December 31, 2006.
Before the start of 2005, our objectives were to remain focused on disciplined pricing; contain the growth in health care costs; eliminate prior period reserve restatements (e.g., actual liability is different than previously estimated); stabilize or reverse the decline in commercial membership; improve pretax profit margins; increase statutory capital and strengthen the balance sheet; complete the transition to our TRICARE contract for the North Region; and to successfully prepare for the Medicare Part D drug benefit opportunity. The results of our efforts to meet these objectives are discussed below.
Commercial health plan membership declined 10% at December 31, 2005 when compared to December 31, 2004, however, the rate of membership decline had begun to slow.
The Health Plan Services MCR declined to 84.3% for the year ended December 31, 2005 compared to 88.4% for the year ended December 31, 2004, primarily driven by the $169 million charge recorded in the fourth quarter ended December 31, 2004 (of which $158 million was recorded in Health Plan Services costs). Favorable commercial health care cost trends also contributed to the improvement.
As of December 31, 2005, we had settled approximately 87% of the provider disputes related to the $169 million charge recorded in the fourth quarter ended December 31, 2004.
We participate in state Medicaid programs in California, Connecticut and New Jersey. California membership, where the program is known as Medi-Cal, comprised 85% and 84% of our Medicaid membership at December 31, 2006 and 2005, respectively. Membership in our Medicaid programs increased by 10,000 members at December 31, 2006 compared to December 31, 2005, primarily due to enrollment increases in Healthy Families and Healthy Kids programs in California.
Total health plan membership decreased 6% to approximately 3.4 million members at December 31, 2005 from approximately 3.6 million members at December 31, 2004. Overall, small group and individual enrollment declined 18% and large group enrollment declined 7% from December 31, 2004 to December 31, 2005.
Total Health Plan Services premiums increased by $857.8 million, or 9%, for the year ended December 31, 2006 as compared to the same period in 2005, and decreased by $10.6 million, or 0.1%, for the year ended December 31, 2005 as compared to the same period in 2004 as shown in the following table:
Commercial premium revenues increased by $106.2 million, or 2%, for the year ended December 31, 2006 as compared to the same period in 2005 primarily due to our ongoing pricing discipline and the Universal Care Acquisition. The commercial premium PMPM increased by an average of 8% in the year ended December 31, 2006 compared to the same period in 2005. The Universal Care Acquisition added approximately $122 million of premium revenues for the year ended December 31, 2006.
Commercial premium revenues decreased by $144.7 million, or 2%, for the year ended December 31, 2005 as compared to the same period in 2004 due to membership losses in large and small groups. The decline in commercial premium revenues related to membership decline was partially offset by an increase in premium rates attributable to our implementation of higher rates in our large and small group markets in all of our health plans to account for higher health care costs. The increase in the commercial premium PMPM was 11% for the year ended December 31, 2005 over the same period in 2004.
Medicaid premiums increased by $43.2 million, or 4%, for the year ended December 31, 2005 as compared to the same period in 2004. The increase in the Medicaid premium PMPM was 3% for the year ended December 31, 2005 over the same period in 2004, primarily due to rate increases for the Healthy Families and Access for Infants and Mothers (AIM) programs. These programs accounted for approximately 12% of total Medicaid membership.
Our Health Plan Services MCRs by line of business are as follows:
Medicaid health care costs increased by $1.8 million, or 0.2%, for the year ended December 31, 2006 as compared to the same period in 2005 due primarily to an increase in enrollment. The decrease in the Medicaid health care cost PMPM was 1% for the year ended December 31, 2006 over the same period in 2005. The Medicaid MCR decreased for the year ended December 31, 2006 when compared to the same period in 2005, primarily driven by lower physician costs.
Medicare Risk health care costs increased by $48.0 million, or 4%, for the year ended December 31, 2005 as compared to the same period in 2004. The increase in the Medicare Risk health care cost PMPM was 3% for the year ended December 31, 2005 compared to the same period in 2004. Medicare Risk health care costs increased primarily as a result of higher physician and inpatient claim costs and increased capitation expense related to Medicare rate adjustments for 2003 and 2004 totaling $9.7 million, which were recognized in 2005 (See “-Health Plan Services Premiums” for detail regarding the increase in premium revenue related to the 2003 and 2004 Medicare rate adjustment). These increases were partially offset by provider settlements of $14.6 million recorded in the fourth quarter of 2004.
Net investment income increased by $14.6 million, or 25%, for the year ended December 31, 2005 as compared to the same period in 2004, primarily due to an increase in interest rates and an increase in the average balance of investments, partially offset by lower net realized gains. Included in net investment income was $(0.6) million and $4.2 million of net realized (loss) gain on sale of investments for 2005 and 2004, respectively.
G&A costs increased by $208.5 million, or 22%, for the year ended December 31, 2006 as compared to the same period in 2005. Our administrative ratio (G&A and depreciation expenses as a percentage of Health Plan Services premiums and administrative services fees and other income) also increased to 11.4% for the year ended December 31, 2006 from 10.3% for the same period in 2005. The increase was primarily due to our increased spending for our Medicare expansion plans, an increase in marketing activities for new product development, the addition of the members from the Universal Care Acquisition, new business bid costs and recognition of stock option expense as a result of adopting SFAS No. 123(R). See Note 2 to our consolidated financial statements for further information on the impact of SFAS No. 123(R).
Interest expense increased by $6.6 million, or 15%, for the year ended December 31, 2006 as compared to the same period in 2005. The increase was primarily due to interest on the term and bridge loans we entered into in June 2006 and an increase in the variable rate interest we paid on the swap contracts that hedged against interest rate risk associated with our senior notes, offset in part by a decrease in interest on the senior notes, which were redeemed on August 14, 2006. See “-Debt Refinancing” below.
G&A costs increased by $68.3 million, or 8%, for the year ended December 31, 2005 as compared to the same period in 2004. Our administrative ratio (G&A and depreciation expenses as a percentage of Health Plan Services premiums and other income) also increased to 10.3% for the year ended December 31, 2005 from 9.7% for the same period in 2004. The increase was primarily due to our increased spending in preparation for our Medicare Advantage and Part D expansion plans and an increase in health plan marketing activities, partially offset by $10.6 million in legal costs associated with the provider settlements that was recognized in 2004.
Amortization and depreciation expense decreased by $10.6 million for the year ended December 31, 2005 as compared to the same period in 2004 primarily due to the sale of assets in the sale-leaseback transaction we completed in June 2005.
Interest expense increased by $11.5 million, or 35%, for the year ended December 31, 2005 as compared to the same period in 2004. A $4.5 million increase in interest expense resulted primarily from a 150 basis point increase in the interest rate on our senior notes due to the downgrade of our senior unsecured debt rating effective September 2004, and a $6.8 million increase in interest expense resulted from higher variable interest rate we paid on the swap contract settlements.
Under our TRICARE contract for the North Region, we provide health care services to approximately 2.9 million, 3.0 million and 2.9 million eligible beneficiaries in MHS as of December 31, 2006, 2005 and 2004, respectively. Included in the 2.9 million MHS-eligible beneficiaries as of December 31, 2006 were 1.8 million TRICARE eligibles for whom we provide health care and administrative services and 1.1 million other MHS-eligible beneficiaries for whom we provide administrative services only. As of December 31, 2006 and 2005, there were approximately 1.4 million TRICARE eligibles enrolled in TRICARE Prime under our North Region contract.
Government contracts costs increased by $23.3 million or 1% for the year ended December 31, 2006 as compared to the same period in 2005, primarily due to higher costs from providing services under our Option 3 TRICARE contract.
The Government contracts ratio decreased by 180 basis points for the year ended December 31, 2006 as compared to the same period in 2005 primarily due to improved health care performance in each successive option period of the TRICARE contract for the North Region, particularly the Option 3 period which began on April 1, 2006 and moderating health care cost trends.
On June 23, 2006, we began a series of transactions for the purpose of refinancing our 8.375% Senior Notes due 2011 (Senior Notes). In connection with the refinancing, we incurred $70.1 million in costs, including a $51.0 million redemption premium with respect to our Senior Notes and $11.1 million for the settlement of four interest rate swap contracts (Swap Contracts). We also paid $3.0 million for professional fees and incurred $5.0 million of other non-cash expenses related to such refinancing. The Senior Notes were redeemed on August 14, 2006. See “-Liquidity and Capital Resources” and Note 6 to our consolidated financial statements for additional information on our refinancing activities.
In order to enhance efficiency and reduce administrative costs, we commenced, in 2004, an involuntary workforce reduction of approximately 500 positions, which included reductions resulting from an intensified performance review process, throughout many of our functional groups and divisions, most notably in the Northeast. The workforce reduction was substantially completed by June 30, 2005 and all of the $25.3 million of severance and related benefit costs recorded in 2004 had been paid out by December 31, 2005. We used available cash to fund these payments. See Note 14 to the consolidated financial statements for additional information regarding severance and related benefit costs.
We recognized a net pretax gain of $1.2 million related to the sales of our Florida health plan, our two subacute subsidiaries and our dental and vision subsidiaries. See Note 3 to our consolidated financial statements for further information on these sales.
Our income tax expense and the effective income tax rate for the years ended December 31, 2006, 2005 and 2004 are as follows:
The effective income tax rate differs from the statutory federal tax rate of 35.0% in each year due primarily to state income taxes, tax-exempt investment income and business divestitures. The effective income tax rate decreased from 2005 to 2006 primarily due to tax benefits associated with the sale of the subsidiary that formerly held our Pennsylvania health plan and certain of its affiliates. We recognized an approximate $32 million tax benefit related to this sale in the year ended December 31, 2006. Our state tax rate decreased primarily as a result of beneficial tax elections and an increased proportion of income earned by subsidiaries that are assessed premium rather than income tax. The effective income tax rate increased from 2004 to 2005 primarily due to the reduction in the impact of the tax benefits associated with tax return examination settlements and an increase in state taxes due to change in the business mix.
Our cash flow from operating activities is impacted by, among other things, the timing of collections on our amounts receivable from our TRICARE contract for the North Region. Health care receivables related to TRICARE are best estimates of payments that are ultimately collectible or payable. The timing of collection of such receivables is impacted by government audit and negotiation and can extend for periods beyond a year. Amounts receivable under government contracts were $199.6 million and $122.8 million as of December 31, 2006 and 2005, respectively. Our cash flow from operating activities is also impacted by the timing of collections on our amounts receivable from CMS. Our receivable from CMS increased by $165 million from 2005 to 2006, including $125 million related to Medicare Part D. Our payable related to Medicare Part D was approximately $72 million as of December 31, 2006.
During the fourth quarter of 2004, we recorded a pretax charge of $169 million for expenses associated with provider settlements that had been or were in the process of being resolved, principally involving the alleged underpayment of stop-loss claims. These provider settlements were substantially resolved and the related payments were substantially completed as of December 31, 2006. The cash payments for provider dispute settlements were funded by cash flows from operations.
Our total cash and cash equivalents as of December 31, 2006 and 2005 were $704.8 million and $742.5 million, respectively. The changes in cash and cash equivalents are summarized as follows:
Net cash from operating activities increased by $86.5 million for the year ended December 31, 2006 compared to the same period in 2005. This increase was primarily due to the following:
Net increase in net income plus amortization and depreciation of $91 million,
Decrease in provider dispute payments of $78 million, primarily related to the provider dispute charge reserve provided for in the fourth quarter of 2004, partially offset by
Net increase of $53 million in amounts receivable, net of $72 million in payables, related to Medicare Part D business that began on January 1, 2006.
Net cash from operating activities increased by $246.3 million for the year ended December 31, 2005 compared to the same period in 2004 primarily due to the following:
Net increase in net income plus amortization, depreciation and other net non-cash charges of $180.4 million,
Net increase in cash flows from amounts receivable/payable under government contracts of $146 million, primarily due to the transition to the TRICARE contract for the North Region, partially offset by
Increase in provider dispute payments of $109 million, primarily related to the provider dispute charge reserve provided for in the fourth quarter of 2004.
Net cash used in investing activities decreased by $59.2 million compared to the year ended December 31, 2005 primarily due to the following:
In September 2004, we placed our stock repurchase program on hold, primarily as a result of Moody’s and S&P having downgraded our non-credit-enhanced, senior unsecured long-term debt rating to below investment grade. Our Board of Directors had previously authorized us to repurchase up to $450 million of our common stock under the stock repurchase program.
On October 14, 2006, the Board of Directors authorized the resumption of repurchases of our common stock under the stock repurchase program. At that time, the outstanding amount under the stock repurchase program was $215 million (which amount includes exercise proceeds and tax benefits the Company had received to date from the exercise of employee stock options). The Board of Directors also increased the size of the stock repurchase program by $235 million. As a result, the Company was then authorized under the stock repurchase program to acquire shares of its common stock in an aggregate amount of up to $450 million. Although we are currently limited to repurchases of our common stock in amounts not to exceed the $450 million, additional amounts may be added to the program based on exercise proceeds and tax benefits the Company receives from the exercise of employee stock options. However, these additional amounts may not be used to purchase additional shares of our common stock without further approval of the Board of Directors.
On November 9, 2006, we resumed repurchases of our common stock under our stock repurchase program and repurchased approximately 5.5 million shares for $250 million during the fourth quarter of 2006. Included in the total repurchases are 2,689,538 shares repurchased at an initial purchase price of $47.22 per share, or $127 million, under an accelerated share repurchase (ASR) agreement with JP Morgan executed on December 14, 2006. Under the ASR agreement, JP Morgan is expected to purchase an equivalent number of shares in the open market over a period of several months. The repurchased shares are subject to a future price adjustment based on JP Morgan’s volume-weighted average purchase price for the shares. If JP Morgan’s volume-weighted average purchase price for the shares is greater than $47.22 per share, we will be required to pay JP Morgan an amount equal to the difference between the volume-weighted average purchase price and $47.22 (True-Up). Under the ASR agreement, we may elect to settle the True-Up in shares of Health Net common stock or cash.
The Senior Notes were redeemable, at our option, at a price equal to the greater of:
The interest rate payable on our Senior Notes was dependent on whether the Moody’s or S&P credit rating applicable to the Senior Notes was below investment grade (as defined in the Senior Notes Indenture). In late 2004 and throughout the first half of 2005, Moody’s and S&P downgraded our senior unsecured debt rating to below investment grade. As a result of the downgrades, the interest rate on the Senior Notes increased from the original rate of 8.375% per annum to an adjusted rate of 9.875% per annum, resulting in an increase in our interest expense of $6 million on an annual basis. The adjusted interest rate of 9.875% per annum remained in effect for so long as the Moody’s rating on our Senior Notes remained below Baa3 (or the equivalent) or the S&P rating on our Senior Notes remained below BBB- (or the equivalent).
On June 23, 2006, we borrowed $200 million under a Bridge Loan Agreement and $300 million under a Term Loan Agreement in connection with the Senior Notes redemption. See “-Bridge Loan Agreement” and “-Term Loan Agreement,” below. We used the net proceeds from these borrowings to purchase approximately $500 million in U.S. Treasury securities that we pledged (the Pledged Securities) as collateral to secure the Senior Notes. The Pledged Securities, originally purchased for $497 million, together with approximately $9 million in investment gains and interest income earned thereon, represented funds in the aggregate amount of approximately $506 million at August 14, 2006, the date of redemption of the Senior Notes. These funds were sufficient to redeem the Senior Notes for approximately $451 million, including a redemption premium of approximately $51 million, and to pay the accrued interest on the Senior Notes to the redemption date in the aggregate amount of $12 million. A portion of the remaining $43 million provided by the sale of the Pledged Securities was used to cover $11.1 million in costs for the termination and settlement of our Swap Contracts and to pay approximately $3 million of professional fees and other expenses related to the refinancing of the Senior Notes. The remaining $29 million of the proceeds from the sale of the Pledged Securities was returned to the Company’s general operating fund to be used for general working capital purposes.
As a result of our pledge of the Pledged Securities to secure the Senior Notes, Moody’s and S&P upgraded their ratings on the Senior Notes to investment grade (Baa1 and BBB, respectively) effective June 28, 2006 because the Senior Notes were effectively secured. The increase in the ratings on the Senior Notes caused the interest rate on the Senior Notes to decrease from 9.875% to 8.375% pursuant to the terms of the Senior Notes Indenture. On June 30, 2006, we issued a notice to redeem all of the outstanding Senior Notes, and we completed the redemption on August 14, 2006. Semi-annual interest was payable on the Senior Notes on April 15 and
On September 26, 2006, we terminated the Swap Contracts that we had maintained as a part of our hedging strategy to manage certain exposures related to the effect of changes in interest rates on our Senior Notes. See “Quantitative and Qualitative Disclosures About Market Risk” and Note 6 to our consolidated financial statements for additional information regarding the Swap Contracts.
We can obtain letters of credit in an aggregate amount of $300 million under our revolving credit facility. The maximum amount available for borrowing under our revolving credit facility is reduced by the dollar amount
As a result of our non-credit-enhanced, senior unsecured long-term debt rating not being at or above BBB- by S&P, we are currently subject to a minimum borrower cash flow fixed charge coverage ratio rather than the minimum consolidated fixed charge coverage ratio and are subject to additional reporting requirements to the lenders under the revolving credit facility. The minimum borrower cash flow fixed charge coverage ratio calculates fixed charges on a parent-company-only basis. In the event our non-credit-enhanced, senior unsecured long-term debt rating is upgraded to at least BBB- by S&P, our coverage ratio covenant will revert to the consolidated fixed charge coverage ratio. In addition, as a result of our non-credit-enhanced, senior unsecured long-term debt rating not being at or above BBB- by S&P, the revolving credit facility prohibits us from making dividends, distributions or redemptions in respect of our capital stock in excess of $75 million (plus proceeds received by us from the exercise of stock options held by employees, management or directors of the company and any tax benefit to us related to such exercise) in any consecutive four-quarter period, less other restricted payments made in such period, except that we may repurchase up to $500 million of our capital stock, subject to specified conditions contained in the revolving credit facility (including a maximum leverage ratio), without limitation as to the source of funds used to make the repurchases. On November 6, 2006, we amended the revolving credit facility to, among other things, allow for the repurchase of up to $500 million of our capital stock, subject to specified conditions contained in such agreements (including a maximum leverage ratio), without limitation as to the source of funds used to make the repurchases. See “-Recent Amendments,” below.
On June 23, 2006, we borrowed $200 million under a bridge loan agreement with The Bank of Nova Scotia, as administrative agent and lender (Bridge Loan Agreement). As of December 31, 2006, $200 million was outstanding under the Bridge Loan Agreement. We may voluntarily prepay amounts outstanding under the Bridge Loan Agreement, in whole or in part, at any time without penalty or premium (subject to certain customary breakage costs). The bridge loan is mandatorily prepayable only to the extent that loans made under the Bridge Loan Agreement exceed unutilized commitments under our revolving credit facility. At our option, borrowings under the Bridge Loan Agreement generally may be designated and maintained as either base rate loans or eurodollar rate loans. Base rate loans generally bear interest at a rate per annum equal to the sum of (i) the higher of (a) the applicable prime commercial rate and (b) the Federal Funds Rate plus 0.5% and (ii) 0.5%. Eurodollar rate loans generally bear interest at a rate per annum equal to the sum of (i) the applicable eurodollar interest rate (LIBOR) and (ii) 1.5%. The interest rate on the bridge loan at December 31, 2006 was 6.95%. Borrowings under the Bridge Loan Agreement initially had a final maturity date of September 22, 2006. On September 21, 2006, we amended the Bridge Loan Agreement to, among other things, extend the final maturity date of borrowings under the Bridge Loan Agreement to March 22, 2007. On November 6, 2006, we amended the Bridge Loan Agreement to, among other things, allow for the repurchase of up to $500 million of our capital stock, subject to specified conditions contained in such agreements (including a maximum leverage ratio), without limitation as to the source of funds used to make the repurchases. See “-Recent Amendments” below. We currently expect to repay the outstanding borrowings under our Bridge Loan Agreement with a draw on the revolving credit facility.
Certain of our subsidiaries must comply with minimum capital and surplus requirements under applicable state laws and regulations, and must have adequate reserves for claims. Management believes that as of December 31, 2006, all of our health plans and insurance subsidiaries met their respective regulatory requirements.
risk and other factors, generates the authorized control level (ACL), which represents the minimum amount of net worth believed to be required to support the regulated entity’s business. For states in which the RBC requirements have been adopted, the regulated entity typically must maintain the greater of the Company Action Level RBC, calculated as 200% of the ACL, or the minimum statutory net worth requirement calculated pursuant to pre-RBC guidelines. Because our regulated subsidiaries are also subject to their state regulators’ overall oversight authority, some of our subsidiaries are required to maintain minimum capital and surplus in excess of the RBC requirement, even though RBC has been adopted in their states of domicile. We generally manage our aggregate regulated subsidiary capital above 300% of ACL, although RBC standards are not yet applicable to all of our regulated subsidiaries. At December 31, 2006, we had sufficient capital to exceed this level. In addition to the foregoing requirements, our regulated subsidiaries are subject to restrictions on their ability to make dividend payments, loans and other transfers of cash or other assets to the parent company.
As necessary, we make contributions to and issue standby letters of credit on behalf of our subsidiaries to meet RBC or other statutory capital requirements under state laws and regulations. Health Net, Inc. did not make any capital contributions to its subsidiaries to meet RBC or other statutory capital requirements under state laws and regulations during the year ended December 31, 2006 or thereafter through February 28, 2007.
We have excluded from such table amounts already recorded in our current liabilities on our consolidated balance sheet as of December 31, 2006. We have also excluded from such table various contracts we have entered into with our health care providers, health care facilities, the federal government and other contracts that we have entered into for the purpose of providing health care services. We have excluded those contracts that allow for cancellation without significant penalty, obligations that are contingent upon achieving certain goals and contracts for goods and services that are fulfilled by vendors within a short time horizon and within the normal course of business.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principal areas requiring the use of estimates include revenue recognition, health care costs, reserves for contingent liabilities, amounts receivable or payable under government contracts, goodwill and recoverability of long-lived assets and investments. Accordingly, we consider accounting policies on these areas to be critical in preparing our consolidated financial statements. A significant change in any one of these amounts may have a significant impact on our consolidated results of operations and financial condition. A more detailed description of the significant accounting policies that we use
in preparing our financial statements is included in the notes to our consolidated financial statements which are included elsewhere in this Annual Report on Form 10-K.
We have an arrangement with CMS for certain of our Medicare products whereby periodic changes in our risk factor adjustment scores for certain diagnostic codes result in changes to our health plan services premium revenues. We recognize such changes when the amounts become determinable, supportable and the collectibility is reasonably assured. We also have risk sharing arrangements under our Medicare contracts where variances in our actual claim experience from the targeted medical claim amount negotiated in our contracts are shared.
Other relevant factors include exceptional situations that might require judgmental adjustments in setting the reserves for claims, such as system conversions, processing interruptions or changes, environmental changes or other factors. All of these factors are used in estimating reserves for claims and are important to our reserve methodology in trending the claims per member per month for purposes of estimating the reserves for the most recent months. In developing its best estimate of reserves for claims, we consistently apply the principles and methodology described above from year to year, while also giving due consideration to the potential variability of these factors. Because reserves for claims includes various actuarially developed estimates, our actual health care services expense may be more or less than our previously developed estimates. Claims processing expenses are also accrued based on an estimate of expenses necessary to process such claims. Such reserves are continually monitored and reviewed, with any adjustments reflected in current operations.
We assess the profitability of contracts for providing health care services when operating results or forecasts indicate probable future losses. Significant factors that can lead to a change in our profitability estimates include premium yield and health care cost trend assumptions, risk share terms and non-performance of a provider under a capitated agreement resulting in membership reverting to fee-for-service arrangements with other providers. Contracts are grouped in a manner consistent with the method of determining premium rates. Losses are determined by comparing anticipated premiums to estimates for the total of health care related costs less reinsurance recoveries, if any, and the cost of maintaining the contracts. Losses, if any, are recognized in the period the losses are determined and are classified as Health Plan Services. We held no premium deficiency reserves as of December 31, 2006.
Other government contracts revenues are recognized in the month in which the eligible beneficiaries are entitled to health care services or in the month in which the administrative services are performed or the period that coverage for services is provided. Revenue under the expired former Region 11, Region 6 and Regions 9, 10 and 12 contracts was subject to price adjustments attributable to inflation and other factors. The effects of these adjustments were recognized on a monthly basis, with the final determination of these amounts occurring in 2005.
Under our TRICARE contract for the North Region we recognize amounts receivable and payable under the government contracts related to estimated health care IBNR expenses which are reported separately on the accompanying consolidated balance sheet as of December 31, 2006. These amounts are the same since all of the estimated health care IBNR expenses incurred are offset by an equal amount of revenues earned.
Some of the amounts receivable under government contracts are comprised primarily of price adjustments and change orders for services not originally specified in the contracts. Change orders arise because the government often directs us to implement changes to our contracts before the scope and/or value is defined or negotiated. We start to incur costs immediately, before we have proposed a price to the government. In these situations, we make no attempt to estimate and record revenue. Our policy is to defer the costs as incurred until we have submitted a cost proposal to the government, at which time we will record the costs and the appropriate value for revenue, using our best estimate of what will ultimately be negotiated. In the normal course of contracting with the federal government, we may make claims for contract and price adjustments arising from cost over-runs against the government. We recognize such claims when the amounts become determinable, supportable and the collectibility is reasonably assured.