Health Net 2006 Annual Report Download - page 105

HEALTH NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
adjustment calculation is performed in the subsequent year based on the full year of experience of the prior year
or, in the event of program termination, based on the experience up to the date of such termination. Estimated
CMS risk share amounts are recorded on a quarterly basis as part of health plan services premium revenue based
on cumulative experience up to the date of the financial statements.
Health care costs and general and administrative expenses associated with Part D are recognized as the costs
and expenses are incurred.
CMS Risk Factor Adjustments
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 recognized $92.0 million of favorable Medicare risk factor estimates in our health plan services
premium revenues in the year ended December 31, 2006. Of this amount, $51.9 million, $37.0 million and $3.1
million were for the 2006, 2005 and 2004 payments years, respectively. We also recognized $29.1 million of
capitation expense related to the Medicare risk factor estimates in our health plan services costs 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.
We recognized $17.2 million and $0 for the years ended December 31, 2005 and 2004, respectively, for
favorable Medicare risk factor estimates from 2003 and 2004 in our health plan services premium revenues. We
also recognized $9.7 million and $0 for the years ended December 31, 2005 and 2004, respectively, of capitation
expense related to the Medicare risk factor estimates from 2003 and 2004 in our health plan services costs.
Share-Based Compensation Expense
As of December 31, 2006, we had various stock option and long-term incentive plans which permit the grant
of stock options and other equity awards to certain employees, officers and non-employee directors, which are
described more fully in Note 7. Prior to January 1, 2006, we accounted for stock-based compensation under the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued
to Employees” (APB Opinion No. 25), and related Interpretations, as permitted under Statement of Financial
Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123). No
stock-based employee compensation cost for stock options was recognized in our Consolidated Statement of
Operations for years ended December 31, 2005 or prior, as all options granted under those plans had an exercise
price equal to the market value of the underlying common stock on the date of grant.
Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), “Share-
Based Payment,” (SFAS No. 123(R)) using the modified—prospective transition method. Under such transition
method, compensation cost recognized in the year ended December 31, 2006 includes: (a) compensation cost for
all stock options granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-
based payments granted on or after January 1, 2006, based on the grant-date fair value estimated in accordance
with the provisions of SFAS No. 123(R). Results for prior periods have not been restated. The compensation cost
that has been charged against income under our various stock option and long-term incentive plans was $20.1
million, $2.5 million and $1.9 million during the years ended December 31, 2006, 2005 and 2004, respectively.
The total income tax benefit recognized in the income statement for share-based compensation arrangements was
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