Health Net 2006 Annual Report Download - page 78

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.
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 that expose us to potential losses.
We recognize an estimated loss, which may represent damages, settlement costs, future legal expenses or a
combination of the foregoing, as appropriate, from such loss contingencies when 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, consultation with outside counsel and any other
relevant information available.
Goodwill
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 perform our annual impairment test on our recorded goodwill and intangible assets not subject to
amortization as of June 30 or more frequently if events or changes in circumstances indicate that we might not
recover the carrying value of these assets for each of our reporting units. As a result of divestitures that occurred
prior to and including 2004, Health Plans Services is our only reporting unit with goodwill as of December 31,
2006 and 2005. We test goodwill for impairment annually based on the estimated fair value of our Health Plan
Services reporting unit. 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 the income approach to fair value determination. 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 interim cash flows expected after the growth pattern becomes stable are calculated
using an appropriate capitalization technique and then discounted. 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 and membership levels based on current and future plans
and initiatives, long-term strategies and our annual planning and forecasting process as well as the weighted
average cost of capital used in the discounting process. 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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