Health Net 2004 Annual Report Download - page 66

Reserves For Contingent Liabilities
In the course of our operations, we are involved on a routine basis in various disputes with members, health care providers, and
other entities, as well as audits by government agencies that relate to our services and/or business practices. We and several of our
competitors were named as defendants in a number of significant class action lawsuits alleging violations of various federal statutes,
including the Employee Retirement Income Security Act of 1974 and the Racketeer Influenced Corrupt Organization Act. See “Item
3.—Legal Proceedings” for additional information regarding these class actions.
We recognize an estimated loss from such loss contingencies when we believe it is both probable that a loss will be incurred and
that the amount of the loss can be reasonably estimated. Our loss estimates are based in part on an analysis of potential results, the
stage of the proceedings, our relevant insurance coverage, consultation with outside counsel and any other relevant information
available. While the final outcome of these proceedings cannot be determined at this time, based on information presently available
we believe that the final outcome of such proceedings will not have a material adverse effect upon our financial condition, results of
operations or liquidity. However, our belief regarding the likely outcome of such proceedings could change in the future and an
unfavorable outcome could have a material adverse effect upon our financial condition, results of operations or liquidity. In addition,
the ultimate outcome of these loss contingencies cannot be predicted with certainty and it is difficult to measure the actual loss, if any,
that might be incurred.
Goodwill
We test goodwill for impairment annually based on the estimated fair value of the reporting units which comprise our Health
Plan Services and Government Contracts reportable segments. We test for impairment on a more frequent basis in cases where events
and changes in circumstances would indicate that we might not recover the carrying value of goodwill. Our measurement of fair value
is based on utilization of both the income and market approaches to fair value determination. As a part of assessing impairments of
goodwill and other intangible assets, we perform fair value measurements and utilize an independent third-party professional services
firm to assist with this assessment. The income approach is based on a discounted cash flow methodology. The discounted cash flow
methodology is based upon converting expected cash flows to present value. Annual cash flows are estimated for each year of a
defined multi-year period until the growth pattern becomes stable. The expected interim cash flows expected after the growth pattern
becomes stable are calculated using an appropriate capitalization technique and then discounted. The market approach uses a market
valuation methodology which includes the selection of companies engaged in a line (or lines) of business similar to ours to be valued
and an analysis of our comparative operating results and future prospects in relation to those of the guideline companies selected. The
market price multiples are selected and applied to us based on our relative performance, future prospects and risk profiles in
comparison to those of the guideline companies. Methodologies for selecting guideline companies include the exchange methodology
and the acquisition methodology. The exchange methodology is based upon transactions of minority-interests in publicly traded
companies engaged in a line (or lines) of business similar to ours. 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. There are numerous assumptions and estimates underlying the determination of the estimated fair value of our
reporting units, including certain assumptions and estimates related to future earnings based on current and future plans and
initiatives. If these planned initiatives do not accomplish their targeted objectives, the assumptions and estimates underlying the
goodwill impairment tests could be adversely affected and have a material effect upon our financial condition, results of operations or
liquidity.
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