Health Net 2002 Annual Report Download - page 61

HEALTH NET, INC. | 59
Goodwill and Other Intangible Assets
Goodwill and other intangible assets arise primarily as a
result of various business acquisitions and consist of iden-
tifiable 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 non-compete agreements.
In July 2001, the Financial Accounting Standards
Board (FASB) issued two new pronouncements: Statement
of Financial Accounting Standards (SFAS) No. 141,
“Business Combinations,” and SFAS No. 142, “Goodwill
and Other Intangible Assets.” SFAS No. 141 is effective as
follows: (a) use of the pooling-of-interest method is
prohibited for business combinations initiated after June
30, 2001; and (b) the provisions of SFAS No. 141 also
apply to all business combinations accounted for by the
purchase method that are completed after June 30, 2001
(that is, the date of the acquisition is July 2001 or later).
Transition provisions that applied to business combina-
tions completed before July 1, 2001 that were accounted
for by the purchase method had no impact on us.
Effective January 1, 2002, we adopted SFAS No. 142
which, among other things, eliminates amortization of
goodwill and other intangibles with indefinite lives.
Intangible assets, including goodwill, that are not subject
to amortization will be tested for impairment annually or
more frequently if events or changes in circumstances indi-
cate that we might not recover the carrying value of these
assets. The impairment test follows a two-step approach.
The first step determines if the goodwill is potentially
impaired; the second step measures the amount of the
impairment loss, if necessary. Under the first step, goodwill
is considered potentially impaired if the value of the
reporting unit is less than the reporting unit’s carrying
amount, including goodwill. Under the second step, the
impairment loss is then measured as the excess of recorded
goodwill over the fair value of goodwill, as calculated. The
fair value of goodwill is calculated by allocating the fair
value of the reporting unit to all the assets and liabilities of
the reporting unit as if the reporting unit was purchased in
a business combination and the purchase price was the fair
value of the reporting unit.
We identified the following six reporting units with
goodwill within our businesses: Health Plans, Government
Contracts, Behavioral Health, Dental & Vision, Subacute
and Employer Services Group. In accordance with the
transition requirements of SFAS No. 142, we completed an
evaluation of goodwill at each of our reporting units upon
adoption of this Standard. We also re-assessed the useful
lives of our other intangible assets and determined that
they properly reflect the estimated useful lives of these
assets. As a result of these impairment tests, we identified
goodwill impairment at our behavioral health subsidiary
and at our employer services group subsidiary in the
amounts of $3.5 million and $5.4 million, respectively.
Accordingly, we recorded an impairment charge to good-
will of $8.9 million, net of tax benefit of $0, which was
reflected as a cumulative effect of a change in accounting
principle in the consolidated statement of operations
during the first quarter ended March 31, 2002. As part of
our annual goodwill impairment test, we completed an
evaluation of goodwill with the assistance of the same
independent third-party professional services firm at each
of our reporting units as of June 30, 2002. No further
goodwill impairments were identified in any of our
reporting units. We will perform our annual goodwill
impairment test as of June 30 in future years.
Our measurement of fair value was based on utiliza-
tion of both the income and market approaches to fair
value determination. We used an independent third-party
professional services firm with knowledge and experience in
performing fair value measurements to assist us in the
impairment testing and measurement process. The income
approach was based on a discounted cash flow method-
ology. The discounted cash flow methodology is based
upon converting expected cash flows to present value.
Annual cash flows were estimated for each year of a
defined multi-year period until the growth pattern becomes
stable. The interim cash flows expected after the growth
pattern becomes stable were calculated using an appro-
priate capitalization technique and then discounted. The
market approach used a market valuation methodology
which included the selection of companies engaged in a line
(or lines) of business similar to the Company to be valued
and an analysis of the comparative operating results and
future prospects of the Company in relation to the guide-
line companies selected. The market price multiples are
selected and applied to the Company based on the relative
performance, future prospects and risk profiles of the
Company in comparison to the guideline companies.
Methodologies for selecting guideline companies include
the exchange methodology and the acquisition method-
ology. The exchange methodology is based upon transac-
tions of minority interests in publicly traded companies
engaged in a line (or lines) of business similar to the
Company. The public companies selected are defined as
guideline companies. The acquisition methodology involved
analyzing the transaction involving similar companies that
have been bought and sold in the public marketplace.