We also lease an aggregate of approximately 548,807 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 $11.0 million in 2007. These leases expire at various dates ranging from 2009 to 2013. We also lease a total of approximately 121,542 square feet of office space in San Rafael and Point Richmond, California for certain specialty services operations.
On March 29, 2007 we sold our 68-acre commercial campus in Shelton, Connecticut (the Shelton Property) to The Dacourt Group, Inc. (Dacourt) and leased it back from Dacourt under an operating lease agreement for an initial term of ten years with an option to extend for two additional terms of ten years each. We received net cash proceeds of $83.9 million and recorded a deferred gain of $60.9 million, which is amortized into income as contra-G&A expense over the lease term. Under the Shelton Property lease agreement and other lease agreements, we lease an aggregate of approximately 459,595 square feet of office space in Shelton, Connecticut for certain Health Plan Services for our Northeast Division. Our aggregate rent and rent-related obligations under these leases were approximately $7.6 million in 2007. These leases expire at various dates ranging from 2016 to 2017.
Our Government Contracts segment includes our government-sponsored managed care federal contract with the U.S. Department of Defense (the Department of Defense) under the TRICARE program in the North Region and other health care related government contracts that we administer for the Department of Defense. Under the TRICARE contract for the North Region, we provide health care services to approximately 2.9 million Military Health System (MHS) eligible beneficiaries (active duty personnel and TRICARE/Medicare dual eligible beneficiaries), including 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 ASO.
We measure our Health Plan Services segment profitability based on medical care ratio (MCR) and pretax income. The MCR is calculated as health plan services expense divided by health plan services premiums. The pretax income is calculated as health plan services premiums and administrative services fees and other income less health plan services expense and G&A and other net expenses. See “-Results of Operations-Table of Summary Financial Information” for a calculation of our MCR and “-Results of Operations-Health Plan Services Segment Results” for a calculation of our pretax income.
General and administrative expenses include those costs related to employees and benefits, consulting and professional fees, marketing, premium taxes and assessments, occupancy costs and litigation and regulatory-related costs. Such costs are driven by membership levels, introduction of new products, system consolidations and compliance requirements for changing regulations. These expenses also include expenses associated with corporate shared services and other costs to reflect the fact that such expenses are incurred primarily to support the Health Plan Services segment. Selling expenses consist of external broker commission expenses and generally vary with premium volume.
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.
Total revenues for the year ended December 31, 2007 increased by approximately 9% to $14.1 billion from the same period in 2006;
On May 31, 2007, we completed the acquisition of, in substance, The Guardian Life Insurance Company of America’s 50% interest in managed care and indemnity products called HealthCare Solutions (Guardian Transaction). On March 31, 2006, we completed the acquisition of certain health plan businesses of Universal Care, Inc. (Universal Care), a California-based health care company, and paid $74.0 million, including transaction-related costs. With this acquisition, we added 83,000 members as of December 31, 2006. As a result, our health plan services premium revenue, health plan services costs and G&A expenses, and related metrics for the year ended December 31, 2007 include the impact from the Guardian Transaction and the acquisition of Universal Care.
(c) The G&A expense ratio is computed as G&A expenses divided by the sum of health plan services premiums and administrative services fees and other income.
In 2007, we recorded $306.8 million pre-tax, or $222.4 million after-tax, charges incurred as a result of us reaching an agreement in principle to settle three class action lawsuits known as the McCoy, Wachtel and Scharfman lawsuits; the proposed resolution of regulatory issues with the New Jersey Department of Banking and Insurance; arbitration settlement; and other immaterial litigation matters. See “Item 3. Legal Proceedings” for additional information regarding these matters. The charge amount is comprised of the following:
$201.5 million recorded as part of health plan services expenses during the year ended December 31, 2007 for claim-related matters, class disbursements and remediations; and
$105.3 million recorded as part of G&A expenses during the year ended December 31, 2007 for attorney’s fees, regulatory fines, arbitration settlement and estimated liability for litigation unrelated to the class action lawsuits.
Our Government contracts revenues increased 5% in 2007 to $2.5 billion from $2.4 billion in 2006. The Government contracts cost ratio improved to 92.2% in 2007 compared to 94.0% in 2006.
Our G&A expense ratio improved by 10 basis points to 11.1% in 2007 compared to 11.2% in 2006. The G&A expense ratio for 2007 included the impact of $105.3 million, or 90 basis points, of G&A expenses related to the litigation and regulatory-related charge. Our selling costs ratio increased by 50 basis points to 2.9% in 2007 compared to 2.4% in 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 were increases in general, administrative and selling expenses from our continued investment in new products and marketing support for the new sales effort.
The following table summarizes the operating results of our reportable segments for the last three fiscal years:
Our total health plan membership increased by 55,000 members, or 2%, to 3.8 million members at December 31, 2007 when compared to December 31, 2006. The increase was primarily driven by the addition of 79,000 stand-alone PDP members and 37,000 Medicare Advantage members, partially offset by a decrease of 67,000 commercial and ASO members.
Membership in our commercial health plans decreased by 67,000 members, or 3%, at December 31, 2007 compared to December 31, 2006. This decrease was primarily attributable to the mix shift from large group to small group/individual enrollment resulting in net loss of 26,000 commercial risk members and a 41,000 ASO member loss. This mix shift was predominantly seen in our California plan, which experienced a decline of 73,000 large group members primarily from a loss of two large accounts, partially offset by a net gain of 58,000 small group and individual members. Our Northeast plans experienced a decline of 37,000 members in the large group market, which was partially offset by a net gain of 16,000 members in our New York small group market. As a result of our targeted mix shift, our small group and individual enrollment comprised approximately 35% of our commercial risk enrollment, excluding ASO, at December 31, 2007, up from 31% at December 31, 2006.
Membership in our Medicare Advantage program increased by 37,000 members at December 31, 2007 compared to December 31, 2006, due to membership growth primarily in Arizona and Connecticut. Our stand-alone Medicare PDP membership increased by 79,000 members at December 31, 2007 compared to December 31, 2006.
Total health plan membership increased by 9% to 3.7 million members at December 31, 2006 from 3.4 million members at December 31, 2005. The increase was driven by the addition of 300,000 Medicare Part D members and 83,000 members from the Universal Care acquisition. Consistent with our strategy of growing our small group and mid-market segments, our small group and individual enrollment increased by 33,000 members in 2006, or 5%, as compared to 2005. Membership in our large group declined by 45,000 members, or 3%, from 2005 to 2006. At December 31, 2006, approximately 30% of our commercial enrollment, including ASO, was in the small group and individual segments, up from 28% for the same period in 2005.
Total Health Plan Services premiums increased by $1,070.6 million, or 10%, for the year ended December 31, 2007 as compared to the same period in 2006, and increased by $857.8 million, or 9%, for the year ended December 31, 2006 as compared to the same period in 2005. On a PMPM basis, premiums increased by 8% for the year ended December 31, 2007 as compared to the same period in 2006, and increased by 3% for the year ended December 31, 2006 as compared to the same period in 2005.
Health Plan Services costs increased by $1,162.5 million, or 14%, for the year ended December 31, 2007 as compared to the same period in 2006, and increased by $587.4 million, or 7%, for the year ended December 31, 2006 as compared to the same period in 2005. Health plan MCR was 85.4% at December 31, 2007 compared to 83.0% at December 31, 2006 and 84.3% at December 31, 2005.
Commercial health care costs increased by $657.6 million, or 11%, for the year ended December 31, 2007 as compared to the same period in 2006. The increase in the commercial health care cost trend on a PMPM basis was 12.5% for the year ended December 31, 2007 over the same period in 2006. Commercial MCR increased to 85.7% for the year ended December 31, 2007 from 83.2% for the year ended December 31, 2006. These increases were primarily due to a $201.5 million charge recorded the third quarter of 2007 in health care costs for proposed remediation claim settlements related to litigation and regulatory-related matters (see “Item 3. Legal Proceedings” for additional information on these litigation matters). The charge recorded in 2007 impacted the commercial MCR by 270 basis points and commercial health care cost trend on a PMPM basis by 360 basis points. Physician and hospital costs rose about 9% and 10% from higher paid claims, respectively. Commercial bed days rose by less than 1% in 2007 over 2006. Pharmacy costs rose about 6% due to higher utilization on a PMPM basis for the year ended December 31, 2007 over the same period in 2006.
Medicare health care costs increased by $453.5 million, or 24%, for the year ended December 31, 2007 as compared to the same period in 2006. Medicare health care costs increased as a result of higher hospital costs and higher pharmacy costs mainly in Arizona and the Northeast and increased capitation expense from Medicare risk factor adjustments totaling $27.2 million, which was recognized in the year ended December 31, 2007. Of this
amount, $22.5 million, $3.9 million and $0.8 million were for the 2007, 2006, and 2003 payment years, respectively (see “-Health Plan Services Premiums” for detail regarding the increase in premium revenue related to the Medicare rate adjustment). Medicare MCR, including Medicare Advantage and Part D, increased by 210 basis points for the year ended December 31, 2007.
Commercial health care costs increased by $72.4 million, or 1%, for the year ended December 31, 2006 as compared to the same period in 2005, partially due to the addition of 49,000 commercial members from the Universal Care Acquisition. The increase in the commercial health care cost trend on a PMPM basis was 7% for the year ended December 31, 2006 over the same period in 2005. Physician and hospital costs rose about 6% and 9% from higher paid claims, respectively, and pharmacy costs rose about 4% due to higher utilization on a PMPM basis for the year ended December 31, 2006 over the same period in 2005. Commercial bed days remained unchanged from 2005. Commercial MCR declined slightly for the year ended December 31, 2006 as compared to the same period in 2005 due to continued pricing discipline and moderating health care cost trends.
Medicare Risk health care costs increased by $513.2 million, or 36%, for the year ended December 31, 2006 as compared to the same period in 2005. Medicare Risk health care costs increased as a result of an increase in pharmacy costs due to Medicare Part D coverage, an increase in membership and increased capitation expense from Medicare risk factor adjustments totaling $29.1 million, which was recognized in the year ended December 31, 2006. Of this amount, $14.9 million, $13.2 million and $1.0 million were for the 2006, 2005, and 2004 payment years, respectively (see “-Health Plan Services Premiums” for detail regarding the increase in premium revenue related to the Medicare rate adjustment). Medicare Risk MCR decreased in the year ended December 31, 2006 due to an increase in revenue driven by Medicare Part D business and net revenue from Medicare risk factor adjustments, as well as a focused contracting effort late in 2005 in California and Arizona.
Administrative services fees and other income increased by $3.2 million, or 6%, for the year ended December 31, 2006 as compared to the same period in 2005. The increase was primarily due to incentive payments for certain medical cost discounts and administrative fees received in arrears.
Net investment income increased by $38.2 million, or 52%, for the year ended December 31, 2006 as compared to the same period in 2005. The increase was primarily due to an increase in book yields as a result of generally higher interest rates across the yield curve. We also recognized an investment gain and investment interest income of approximately $6 million and $3 million, respectively, from the liquidation of the U.S. Treasury securities portfolio that we established to fund the redemption of our senior notes in the year ended December 31, 2006. Included in net investment income for 2005 was $(0.6) million of net realized (loss) on sale of investments.
G&A costs increased by $110.2 million, or 9%, for the year ended December 31, 2007 as compared to the same period in 2006. The increase in costs was primarily driven by a $105.3 million charge for attorney’s fees and regulatory fines related to the litigation and regulatory-related matters and arbitration settlement (see “Item 3. Legal Proceedings” for additional information on these litigation matters). Our G&A expense ratio decreased to 11.1% for the year ended December 31, 2007 from 11.2% for the same period in 2006. The charge recorded in 2007 impacted the ratio by 90 basis points.
Interest expense decreased by $18.7 million, or 37%, for the year ended December 31, 2007 as compared to the same period in 2006. The decreases were primarily due to lower interest rates on our Senior Notes in 2007 compared with the senior notes we redeemed in the third quarter of 2006, and lower interest on our term and bridge loans and revolver borrowings as a result of lower outstanding balances and early termination of the debt. See “-Debt Refinancing” and “Liquidity and Capital Resources-Senior notes” below.
Amortization and depreciation expense decreased by $8.1 million for the year ended December 31, 2006 as compared to the same period in 2005 primarily due to the sale of assets in the sale-leaseback transaction completed in June 2005. See Note 12 to our consolidated financial statements for further information on this sale-leaseback transaction.
Under our TRICARE contract for the North Region, we provide health care services to approximately 2.9 million eligible beneficiaries in MHS as of December 31, 2007. Included in the 2.9 million MHS-eligible beneficiaries as of December 31, 2007 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, 2007 and 2006, there were approximately 1.4 million TRICARE eligibles enrolled in TRICARE Prime under our North Region contract.
Our TRICARE contract for the North Region includes a target cost and price for reimbursed health care costs, which is negotiated annually during the term of the contract with underruns and overruns of our target cost borne 80% by the government and 20% by us. In the normal course of contracting with the federal government, we recognize changes in our estimate for the target cost underruns and overruns when the amounts become determinable, supportable, and the collectibility is reasonably assured. During the year ended December 31, 2007 and 2006, we recognized a decrease in the revenue estimate of $58 million and $104 million, respectively, and a decrease in the cost estimate of $75 million and $128 million, respectively.
Government contracts revenues increased by $68.5 million, or 3%, for the year ended December 31, 2006 as compared to the same period in 2005. The increase was primarily due to an increase in health care services provided under a new option year in the TRICARE contract, Option 3, which began April 1, 2006 and a new behavioral health contract with the Department of Defense for counseling services to active military personnel on an ASO basis.
In 2007, we recorded $306.8 million pre-tax, or $222.4 million after-tax, charges incurred as a result of us reaching an agreement in principle to settle three class action lawsuits known as the McCoy, Wachtel and Scharfman lawsuits; the proposed resolution of regulatory issues with the New Jersey Department of Banking
and Insurance; arbitration settlement; and other immaterial litigation matters. See “Item 3. Legal Proceedings” for additional information regarding these matters. The charge amount is comprised of the following:
Included in the $105.3 million charge amount is $10 million related to an arbitration settlement. In recent years, there has been growing public attention in California to the practices of health plans and health insurers involving the rescission of members’ policies for misrepresenting their health status on applications for coverage. We are party to arbitrations and litigation in which rescinded members allege that we unlawfully rescinded their coverage. The lawsuits generally seek not only the cost of medical services that were not paid for as a result of the rescission, but in some cases they also seek damages for emotional distress, attorney fees and punitive damages. On February 21, 2008, we received an arbitration decision in a case involving the rescission of an individual insurance policy. The arbitration decision ordered us to pay approximately $9.4 million in medical service costs, emotional distress and punitive damages. To provide for this judgment, we have accrued $10.0 million, including estimated attorney fees, in our financial statements for the year ended December 31, 2007. The payment of this judgment will be funded by operating cash flow. This disclosure updates the earnings release that we issued on February 5, 2008.
AmCareco litigation. On August 2, 2005 and November 4, 2005, a total of three separate judgments were entered against us in connection with a lawsuit arising from the 1999 sale of three of our health plan subsidiaries to AmCareco, Inc. The aggregate amount of the judgments was $108.7 million. During the three months ended June 30, 2005, we recorded a pretax charge of $15.9 million representing total estimated legal defense costs related to this litigation. As of December 31, 2007, no modifications have been made to the original estimated cost. We did not accrue any amount for the compensatory or punitive damages awards as of December 31, 2005,
and we intend to vigorously appeal this judgment. See Notes 12 and 14 to the consolidated financial statements for additional information on this litigation.
Our income tax expense and the effective income tax rate for the years ended December 31, 2007, 2006 and 2005 are as follows:
Our total cash and cash equivalents as of December 31, 2007 and 2006 were $1,007.0 million and $704.8 million, respectively. The changes in cash and cash equivalents are summarized as follows:
and preservation of principal by investing in high-quality, investment grade securities while maintaining liquidity in each portfolio sufficient to meet our cash flow requirements and attaining the highest total return on invested funds.
Net increase in purchases of investments available for sale portfolio of $140 million, and
Increase of $6.3 million in cash paid for acquisitions, of which $80.3 million was paid for the Guardian Transaction during 2007 as compared to $74 million paid to acquire certain health plan assets of Universal Care, Inc. during 2006, partially offset by
On October 26, 2007, our Board of Directors increased the size of our stock repurchase program by $250 million, bringing the total amount of the program to $700 million. Subject to Board approval, additional amounts are added to the repurchase program from time to time based on exercise proceeds and tax benefits the Company receives from the employee stock options. We repurchased 4,322,959 shares during the year ended December 31, 2007, for aggregate consideration of approximately $230 million.
We used net free cash available to fund the share repurchases. The remaining authorization under our stock repurchase program as of December 31, 2007 was $346 million. As of December 31, 2007, we had repurchased
an aggregate of 29,771,752 shares of our common stock under our stock repurchase program at an average price of $34.16 for aggregate consideration of approximately $1,017.0 million (which amount includes exercise proceeds and tax benefits the Company had received from the exercise of employee stock options).
The financing facility provides that it may be terminated through a series of put and call transactions (1) at the option of one of our wholly-owned subsidiaries at any time after December 20, 2009, or (2) upon the occurrence of certain defined acceleration events. These acceleration events, include, but are not limited to:
a change of control (as defined in the financing facility documentation);
cross-acceleration to other indebtedness of our Company in excess of $50 million;
noncompliance by Health Net with any material term or provision of the HMO Regulations or Insurance Regulations (as each such term is defined in the financing facility documentation);
The indenture governing the Senior Notes limits our ability to incur certain liens, or consolidate, merge or sell all or substantially all of our assets. In the event of the occurrence of both (1) a change of control of Health Net, Inc. and (2) a below investment grade rating by any two of Fitch, Inc., Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services, within a specified period, we will be required to make an offer to purchase the Senior Notes at a price equal to 101% of the principal amount of the Senior Notes plus accrued and unpaid interest to the date of repurchase. As of December 31, 2007, we were in compliance with all of the covenants under the indenture governing the Senior Notes.
plus, in each case, accrued and unpaid interest on the principal amount being redeemed to the redemption date.
On June 25, 2007, we entered into a $900 million five-year revolving credit facility with Bank of America, N.A. as Administrative Agent, Swingline Lender, and L/C Issuer, and the other lenders party thereto. This revolving credit facility replaced our $700 million revolving credit facility which had a maturity date of June 30, 2009. Our revolving credit facility provides for aggregate borrowings in the amount of $900 million, which includes a $400 million sub-limit for the issuance of standby letters of credit and a $50 million sub-limit for swing line loans. In addition, we have the ability from time to time to increase the facility by up to an additional $250 million in the aggregate, subject to the receipt of additional commitments. The revolving credit facility matures on June 25, 2012.
Our revolving credit facility includes, among other customary terms and conditions, limitations (subject to specified exclusions) on our and our subsidiaries’ ability to incur debt; create liens; engage in certain mergers, consolidations and acquisitions; sell or transfer assets; enter into agreements which restrict the ability to pay dividends or make or repay loans or advances; make investments, loans, and advances; engage in transactions with affiliates; and make dividends.
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). We repaid all of our outstanding borrowings under
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, 2007, all of our health plans and insurance subsidiaries met their respective regulatory requirements, in all material respects.
By law, regulation and governmental policy, our health plan and insurance subsidiaries, which we refer to as our regulated subsidiaries, are required to maintain minimum levels of statutory net worth. The minimum statutory net worth requirements differ by state and are generally based on balances established by statute, a percentage of annualized premium revenue, a percentage of annualized health care costs, or risk-based capital (RBC) requirements. The RBC requirements are based on guidelines established by the National Association of Insurance Commissioners. The RBC formula, which calculates asset risk, underwriting risk, credit risk, business 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, 2007, 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.
Our significant contractual obligations as of December 31, 2007 are summarized below for the years ending December 31:
On March 29, 2007, we sold our 68-acre commercial campus in Shelton, Connecticut (the “Shelton Property”) to The Dacourt Group, Inc. (“Dacourt”) and leased it back from Dacourt under an operating lease agreement for an initial term of ten years with an option to extend for two additional terms of ten years each.
On June 30, 2005, we entered into the Lease Agreement in connection with a sale-leaseback transaction involving certain of our assets. See Note 12 to the consolidated financial statements for additional information regarding these sale-leaseback transactions.
We have excluded from such table amounts already recorded in our current liabilities on our consolidated balance sheet as of December 31, 2007. 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.
In order to secure judgment pending our appeal in the AmCareco litigation, we obtained surety bonds totaling $114.7 million, which are further secured by letters of credit issued in December 2005 in the amounts of $90.1 million. See Notes 6 and 12 to the consolidated financial statements for additional information.
As of December 31, 2007, we had no off-balance sheet arrangements as defined under Regulation S-K 303(a)(4) and the instructions thereto.
On a monthly basis, we estimate the amount of uncollectible receivables to reflect allowances for doubtful accounts. The allowances for doubtful accounts are estimated based on the creditworthiness of our customers, our historical collection rates and the age of our unpaid balances. During this process, we also assess the
recoverability of the receivables, and an allowance is recorded based upon their net realizable value. Those receivables that are deemed to be uncollectible, such as receivables from bankrupt employer groups, are fully written off against their corresponding asset account, with a debit to the allowance to the extent such an allowance was previously recorded.
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, 2007.
seek treatment, and revisions to the provisions of the contract in the form of change orders. Each of these factors is subject to significant judgment, and we have incorporated our best estimate of these factors in estimating the reserve for IBNR claims.
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. 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, 2007. These amounts are the same since all of the estimated health care IBNR expenses incurred are offset by an equal amount of revenues earned.
Goodwill and other intangible assets arise primarily as a result of various business acquisitions and consist of identifiable intangible assets acquired and the excess of the cost of the acquisitions over the tangible and intangible assets acquired and liabilities assumed (goodwill). Identifiable intangible assets consist of the value of employer group contracts, provider networks and customer relationships.
We record deferred tax assets and liabilities based on differences between the book and tax bases of assets and liabilities (see Note 10 to the consolidated financial statements). The deferred tax assets and liabilities are calculated by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse. We establish a valuation allowance in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, “Accounting for Income Taxes.” We continually review the adequacy of the valuation allowance and recognize the benefits from our deferred tax assets only when an analysis of both positive and negative factors indicate that it is more likely than not that the benefits will be realized.
We file tax returns in many tax jurisdictions. Often, application of tax rules within the various jurisdictions is subject to differing interpretation. Despite our belief that our tax return positions are fully supportable, we believe that it is probable certain positions will be challenged by taxing authorities, and we may not prevail on the positions as filed. Accordingly, we maintain a liability for the estimated amount of contingent tax challenges by taxing authorities upon examination, in accordance with Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), which we adopted as of January 1, 2007. Prior to 2007, we maintained a liability pursuant to SFAS No. 5, “Accounting for Contingencies.” FIN 48 clarifies the accounting for uncertain taxes recognized in a company’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” The interpretation requires us to analyze the amount at which each tax position meets a “more likely than not” standard for sustainability upon examination by taxing authorities. Only tax benefit amounts meeting or exceeding this standard will be reflected in tax provision expense and deferred tax asset balances. The interpretation also requires that any differences between the amounts of tax benefits reported on tax returns and tax benefits reported in the financial statements be recorded in a liability for unrecognized tax benefits. The liability for unrecognized tax benefits is reported separately from deferred tax assets and liabilities and classified as current or noncurrent based upon the expected period of payment. See Note 10 to the consolidated financial statements for additional disclosures related to FIN 48 policies and the impact of adoption.