Health Net 10-Q 2012
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
For the quarterly period ended March 31, 2012
For the transition period from to
Commission File Number: 1-12718
HEALTH NET, INC.
(Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:
The number of shares outstanding of the registrant’s Common Stock as of May 3, 2012 was 83,287,000 (excluding 65,337,236 shares held as treasury stock).
HEALTH NET, INC.
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION
HEALTH NET, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
See accompanying condensed notes to consolidated financial statements.
HEALTH NET, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
See accompanying condensed notes to consolidated financial statements.
HEALTH NET, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except per share data)
See accompanying condensed notes to consolidated financial statements.
HEALTH NET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Amounts in thousands)
See accompanying condensed notes to consolidated financial statements.
HEALTH NET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
See accompanying condensed notes to consolidated financial statements.
HEALTH NET, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Health Net, Inc. prepared the accompanying unaudited consolidated financial statements following the rules and regulations of the Securities and Exchange Commission (SEC) for interim reporting. In this Quarterly Report on Form 10-Q, unless the context otherwise requires, the terms “Company,” “Health Net,” “we,” “us,” and “our” refer to Health Net, Inc. and its subsidiaries. As permitted under those rules and regulations, certain notes or other financial information that are normally required by accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted if they substantially duplicate the disclosures contained in the annual audited financial statements. The accompanying unaudited consolidated financial statements should be read together with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2011 (Form 10-K).
We are responsible for the accompanying unaudited consolidated financial statements. These consolidated financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results in accordance with GAAP. In accordance with GAAP, we make certain estimates and assumptions that affect the reported amounts. Actual results could differ from those estimates and assumptions. In addition, revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be indicative of those for the full year.
On April 1, 2011, we began delivering administrative services under the new T-3 contract for the TRICARE North Region (T-3 contract). See Note 2 for additional information on our T-3 contract. Under the terms of the T-3 contract, we pay health care costs for our TRICARE members and are later fully reimbursed by the United States Department of Defense for such payments. Cash flows for such health care cost payments and reimbursements are presented as Customer funds administered as a separate line item within cash flows from financing activities in the consolidated statements of cash flows for the three months ended March 31, 2012. Similarly, cash flows related to the catastrophic reinsurance subsidy, the low-income member cost sharing subsidy and the coverage gap discount under the Medicare prescription drug program, known as Part D, which are also accounted for under deposit accounting, are presented as Customer funds administered for the three months ended March 31, 2012 and 2011, respectively. Prior to the quarterly reporting period ended September 30, 2011, such cash flows related to the Medicare Part D program had been presented as other current assets and other liabilities line items within cash flows from operating activities in the consolidated statements of cash flows. This reclassification had no impact on our net earnings or balance sheets as previously reported.
In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (ASU 2011-04). This update provides guidance on how fair value measurement should be applied where existing GAAP already requires or permits fair value measurements. In addition, ASU 2011-04 requires expanded disclosures regarding fair value measurements. We adopted the provisions of ASU 2011-04 as of January 1, 2012, which did not have a material impact on our consolidated financial statements. The new disclosures have been included with our fair value disclosures in Note 8.
In June 2011, the FASB issued ASU No. 2011-05, "Comprehensive Income (Topic 220), Presentation of Comprehensive Income" (ASU 2011-05). Under ASU 2011-05, entities are no longer allowed to present other comprehensive income solely in the statement of stockholders' equity. Entities are required to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. We adopted the provisions of ASU 2011-05 as of January 1, 2012 and accordingly, present two separate but consecutive statements, which include statements of operations and statements of comprehensive income.
During the first quarter of 2012, we committed to a plan to sell the business operations of our Medicare stand-alone Prescription Drug Plan (Medicare PDP) business to Pennsylvania Life Insurance Company, a subsidiary of CVS Caremark Corporation (CVS Caremark). As a result of the sale, the operating results of our Medicare PDP business, previously reported within our Western Region Operations reportable segment, have been reclassified as discontinued operations in our consolidated statement of operations for the three months ended March 31, 2012 and 2011, respectively. In addition, as of March 31, 2012, we have classified $145.2 million in assets and $41.8 million in liabilities related to our Medicare PDP business as assets and liabilities of discontinued operation held for sale, respectively. See Note 3 for more information regarding the sale of our Medicare PDP business.
2. SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
Cash equivalents include all highly liquid investments with maturity of three months or less when purchased. We had no checks outstanding, net of deposits as of March 31, 2012 and December 31, 2011, respectively. Checks outstanding, net of deposits are classified as accounts payable and other liabilities in the consolidated balance sheets and the changes are reflected in the line item net increase (decrease) in checks outstanding, net of deposits within the cash flows from financing activities in the consolidated statements of cash flows.
Investments classified as available-for-sale, which consist primarily of debt securities, are stated at fair value. Unrealized gains and losses are excluded from earnings and reported as other comprehensive income, net of income tax effects. The cost of investments sold is determined in accordance with the specific identification method and realized gains and losses are included in net investment income. We analyze all debt investments that have unrealized losses for impairment consideration and assess the intent to sell such securities. If such intent exists, impaired securities are considered other-than-temporarily impaired. Management also assesses if we may be required to sell the debt investments prior to the recovery of amortized cost, which may also trigger an impairment charge. If securities are considered other-than-temporarily impaired based on intent or ability, we assess whether the amortized costs of the securities can be recovered. If management anticipates recovering an amount less than the amortized cost of the securities, an impairment charge is calculated based on the expected discounted cash flows of the securities. Any deficit between the amortized cost and the expected cash flows is recorded through earnings as a charge. All other temporary impairment changes are recorded through other comprehensive income. During the three months ended March 31, 2012 and 2011, respectively, no losses were recognized from other-than-temporary impairments.
Fair Value of Financial Instruments
The estimated fair value amounts of cash equivalents, investments available-for-sale, premiums and other receivables, notes receivable and notes payable have been determined by using available market information and appropriate valuation methodologies. The carrying amounts of cash equivalents approximate fair value due to the short maturity of those instruments. Fair values for debt and equity securities are generally based upon quoted market prices. Where quoted market prices were not readily available, fair values were estimated using valuation methodologies based on available and observable market information. Such valuation methodologies include reviewing the value ascribed to the most recent financing, comparing the security with securities of publicly traded companies in a similar line of business, and reviewing the underlying financial performance including estimating discounted cash flows. The carrying value of premiums and other receivables, long-term notes receivable and nonmarketable securities approximates the fair value of such financial instruments. The fair value of notes payable is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to us for debt with the same remaining maturities. The fair value of our fixed-rate borrowings was $428.0 million and $423.1 million as of March 31, 2012 and December 31, 2011, respectively. For the periods ending March 31, 2012 and December 31, 2011, respectively, the fair value of our variable-rate borrowings under our revolving credit facility was $112.5 million. The fair value of our fixed-rate borrowings was determined using the quoted market price, which is a Level 1 input in the fair value hierarchy. The fair value of our variable-rate borrowings was estimated to equal the carrying value because the interest rates paid on these borrowings were based on prevailing market rates. Since the pricing inputs are other than quoted prices and fair value is determined using an income approach, our variable-rate borrowings are classified as a Level 2 in the fair value hierarchy. See Notes 7 and 8 for additional information regarding our financing arrangements and fair value measurements, respectively.
Health Plan Services Health Care Cost
The cost of health care services is recognized in the period in which services are provided and includes an estimate of the cost of services that have been incurred but not yet reported. Such costs include payments to primary care physicians, specialists, hospitals and outpatient care facilities, and the costs associated with managing the extent of such care. Our health care cost can also include from time to time remediation of certain claims as a result of periodic reviews by various regulatory agencies. We estimate the amount of the provision for health care service costs incurred but not yet reported (IBNR) using GAAP and standard actuarial methodologies based upon historical data including the period between the date services are rendered and the date claims are received and paid, denied claim activity, expected medical cost inflation, seasonality patterns and changes in membership, among other things. The estimates for health care service costs incurred but not yet reported are made on an accrual basis and adjusted in future periods as required. Any adjustments to the prior period estimates are included in the current period.
The majority of the reserve balance held at each quarter-end is associated with the most recent months' incurred services because these are the services for which the fewest claims have been paid. The degree of uncertainty in the estimates of incurred claims is greater for the most recent months' incurred services. Revised estimates for prior periods are determined in each quarter based on the most recent updates of paid claims for prior periods. Estimates for service costs incurred but not yet
reported are subject to the impact of changes in the regulatory environment, economic conditions, changes in claims trends, and numerous other factors. Given the inherent variability of such estimates, the actual liability could differ significantly from the amounts estimated. During the quarter ended March 31, 2012, we recorded $25 million of adverse development related to prior periods. This adverse development consisted of $67 million of incurred claims related to prior periods, net of a $42 million provision for adverse deviation originally accrued to provide for such development. The $67 million is attributable to the revision of the previous estimate of incurred claims for prior years as a result of adverse prior period development. We believe this adverse development was due to significant delays in claims submissions for the fourth quarter of 2011 arising from issues related to a new billing format required by the Health Insurance Portability and Accountability Act of 1996 (HIPAA) coupled with an unanticipated flattening of commercial medical claims trends. In developing the revised estimate, there were no changes in the approach used to determine the key actuarial assumptions, which are the completion factor and medical cost trend. While the ultimate amount of claims and losses paid are dependent on future developments, management currently believes that our recorded reserves are adequate to cover such costs.
Concentrations of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash equivalents, investments and premiums receivable. All cash equivalents and investments are managed within established guidelines, which provide us diversity among issuers. Concentrations of credit risk with respect to premiums receivable are limited due to the large number of payers comprising our customer base. The federal government is the primary customer of our Government Contracts reportable segment with fees and premiums associated with this customer accounting for 99% of our Government Contracts revenue. In addition, the federal government is a significant customer of our Western Region Operations reportable segment as a result of our contract with Centers for Medicare & Medicaid Services (CMS) for coverage of Medicare-eligible individuals. Furthermore, all of our Medicaid/Medi-Cal revenue is derived in California through our relationship with the State of California Department of Health Care Services (DHCS). As a result, DHCS is a significant customer of our Western Region Operations reportable segment.
Comprehensive income includes all changes in stockholders’ equity (except those arising from transactions with stockholders) and includes net income (loss), net unrealized appreciation (depreciation) after tax on investments available-for-sale and prior service cost and net loss related to our defined benefit pension plan.
Our accumulated other comprehensive income (loss) is as follows:
Earnings Per Share
Basic earnings per share excludes dilution and reflects net income divided by the weighted average shares of common stock outstanding during the periods presented. Diluted earnings per share is based upon the weighted average shares of common stock and dilutive common stock equivalents (this reflects the potential dilution that could occur if stock options were exercised and restricted stock units (RSUs) and performance share units (PSUs) were vested) outstanding during the periods presented.
Common stock equivalents arising from dilutive stock options, RSUs and PSUs are computed using the treasury stock method. For the three months ended March 31, 2012 and March 31, 2011, 1,774,000 and 1,553,000 shares, respectively, of common stock equivalents were excluded from the computation of loss per share due to their anti-dilutive effect. Stock options
expire at various times through April 2019.
In March 2010, our Board of Directors authorized a $300 million stock repurchase program (2010 stock repurchase program). We completed our 2010 stock repurchase program in April 2011. In May 2011, our Board of Directors authorized a new stock repurchase program for the repurchase of up to $300 million of our outstanding common stock (2011 stock repurchase program). As of December 31, 2011, the remaining authorization under our 2011 stock repurchase program was $76.3 million. On March 8, 2012 our Board of Directors approved a $323.7 million increase to our 2011 stock repurchase program. The remaining authorization under our 2011 stock repurchase program as of March 31, 2012 was $400.0 million. See Note 6 for more information regarding our 2010 and 2011 stock repurchase programs.
Goodwill and Other Intangible Assets
The carrying amount of goodwill by reporting unit is as follows:
On April 1, 2012, we completed the sale of our Medicare PDP business. See Note 3 for additional information regarding the sale of our Medicare PDP business. Our Medicare PDP business was previously reported as part of our Western Region Operations reporting unit. As of March 31, 2012, we re-allocated the Western Region Operations reporting unit goodwill to the Medicare PDP business based on relative fair values of the reporting unit with and without the Medicare PDP business. Our measurement of fair value is based on a combination of the income approach based on a discounted cash flow methodology and the discounted total consideration received in connection with the sale of our Medicare PDP business. After the reallocation of goodwill, we performed a two-step impairment test to determine the existence of any impairment and the amount of the impairment. In the first step, we compared the fair value to the related carrying value and concluded that no impairment to either the carrying value of our Medicare PDP business or our Western Region Operations reporting unit had occurred. Based on the result of the first step test, we did not need to complete the second step test. See Note 8 for goodwill fair value measurement information.
The intangible assets that continue to be subject to amortization using the straight-line method over their estimated lives are as follows:
We performed our annual impairment test on our goodwill and other intangible assets as of June 30, 2011 for our Western Region Operations reporting unit and also re-evaluated the useful lives of our other intangible assets. No goodwill impairment was identified. We also determined that the estimated useful lives of our other intangible assets properly reflected the current estimated useful lives.
Estimated annual pretax amortization expense for other intangible assets for each of the next five years ending December 31 is as follows (dollars in millions):
We and our consolidated subsidiaries are required to set aside certain funds that may only be used for certain purposes pursuant to state regulatory requirements. We have discretion as to whether we invest such funds in cash and cash equivalents or other investments. As of March 31, 2012 and December 31, 2011, the restricted cash and cash equivalents balances totaled $0.2 million and $5.3 million, respectively, and are included in other noncurrent assets. Investment securities held by trustees or agencies were $25.7 million and $20.7 million as of March 31, 2012 and December 31, 2011, respectively, and are included in investments available-for-sale.
Divested Operations and Services
Divested operations and services revenues and expenses include items related to the run-out of our Northeast business that was sold on December 11, 2009. Prior to the first quarter of 2012, these line items had been called Northeast administrative services fees and other revenues and expenses. Due to the sale of our Medicare PDP business on April 1, 2012, starting with the first quarter of 2012, divested operations and services revenues and expenses also include transition-related revenues and expenses related to the sale of our Medicare PDP business. We currently expect to provide Medicare PDP transition-related services to CVS Caremark through December 31, 2012, although certain transition-related services may continue through March 31, 2014. See Note 3 for additional information regarding the sale of our Medicare PDP business and the sale of our Northeast business, and see Note 4 for information regarding the change to our reportable segments as a result of the sale of our Medicare PDP business.
T-3 TRICARE Contract
On April 1, 2011, we began delivering administrative services under the T-3 contract for the TRICARE North Region. The T-3 contract was awarded to us on May 13, 2010. We were the managed care contractor for the United States Department of Defense's (DoD) previous TRICARE contract in the North Region, which ended on March 31, 2011.
The T-3 contract has five one-year option periods; however, on March 15, 2011, the DoD exercised option period 2 (without exercising option period 1), due to a delay of approximately one year in the government's initial award of the T-3 contract. Accordingly, option period 2 commenced on April 1, 2011. On March 22, 2012, the DoD exercised option period 3, which commenced on April 1, 2012. If all remaining option periods are exercised, the T-3 contract would conclude on March 31, 2015.
We provide various types of administrative services under the contract, including: provider network management, referral management, medical management, disease management, enrollment, customer service, clinical support service, and claims processing. We also provided assistance in the transition into the T-3 contract, and will provide assistance in any transition out of the T-3 contract. These services are structured as cost reimbursement arrangements for health care costs plus administrative fees earned in the form of fixed prices, fixed unit prices, and contingent fees and payments based on various incentives and penalties.
In accordance with GAAP, we evaluate, at the inception of the contract and as services are delivered, all deliverables in the service arrangement to determine whether they represent separate units of accounting. The delivered items are considered separate units of accounting if the delivered items have value to the customer on a standalone basis (i.e., they are sold separately by any vendor) and no general right of return exists relative to the delivered item. While we identified two separate units of accounting within the T-3 contract, no determination of estimated selling price was performed because both units of accounting are performed ratably over the option periods and, accordingly, the same methodology of revenue recognition applies to both units of accounting.
Therefore, we recognize revenue related to administrative services on a straight-line basis over the option period, when the fees become fixed and determinable.
The T-3 contract includes various performance-based incentives and penalties. For each of the incentives or penalties, we
adjust revenue accordingly based on the amount that we have earned or incurred at each interim date and are legally entitled to in the event of a contract termination.
The transition-in process for the T-3 contract began in the second quarter of 2010. We had deferred transition-in costs of $43.8 million, which began amortizing on April 1, 2011 on a straight-line basis, and we had related deferred revenues of $52.5 million, which are being amortized over the customer relationship period. Fulfillment costs associated with the T-3 contract are expensed as incurred.
Revenues and expenses associated with the T-3 contract are reported as part of Government Contracts revenues and Government Contracts expenses, respectively, in the consolidated statements of operations and included in our Government Contracts reportable segment.
The TRICARE members are served by our network and out-of-network providers in accordance with the T-3 contract. We pay health care costs related to these services to the providers and are later reimbursed by the DoD for such payments. Under the terms of the T-3 contract, we are not the primary obligor for health care services and accordingly, we do not include health care costs and related reimbursements in our consolidated statement of operations. Health care costs for the T-3 contract that are paid and reimbursable amounted to $620.9 million for the three months ended March 31, 2012.
CMS Risk Adjustment Data Validation Audit Methodology
On February 24, 2012, CMS published its final payment error calculation methodology for Medicare Advantage risk adjustment data validation contract-level audits (RADV audits). CMS will begin applying the final methodology for RADV audits of the 2011 payment year. The final methodology provides for payment recovery based on extrapolated estimates of payment error rates. However, the final methodology also includes, among other things, a fee-for-service adjuster, which would limit our payment liability to an error rate in excess of CMS' own fee-for-service error rate. CMS' final methodology is complex and we continue to evaluate its potential impact on us, but potential payment adjustments could have a material adverse effect on our results of operations and financial condition.
Sale of Medicare PDP Business
During the first quarter of 2012, we committed to a plan to sell our Medicare PDP business. On April 1, 2012, our subsidiary Health Net Life Insurance Company (HNL) sold substantially all of the assets, properties and rights of HNL used primarily or exclusively in the Medicare PDP business to CVS Caremark and CVS Caremark assumed certain related liabilities and obligations of HNL as set forth in the related Asset Purchase Agreement. At the closing of the sale, CVS Caremark paid to us $169.9 million (PDP Purchase Price) in cash, representing $400 multiplied by 424,820, the number of individuals enrolled as members of a PDP plan of HNL as of the closing date. We expect to recognize a gain from the sale.
The PDP Purchase Price is subject to adjustments based on pretax cash flow, as defined in the Asset Purchase Agreement, of the PDP business. If pretax cash flow between January 1, 2012 and the closing date reflects a loss of more than $20 million, the PDP Purchase Price will be increased, and if such pretax cash flow reflects a loss of less than $20 million, the PDP Purchase Price will be decreased. Moreover, the PDP Purchase Price will be subject to adjustment to take into account the value as of the closing date of certain net assets related to the PDP business and will also be subject to increase based on the amount of certain prepaid expenses related to the PDP business. We are in the process of finalizing these adjustments with CVS Caremark.
In connection with the transaction, we are not permitted to offer Medicare PDP plans for one year following the closing, subject to certain exceptions. We continue to provide prescription drug benefits as part of our Medicare Advantage plan offerings. In addition, we currently expect to provide Medicare PDP transition-related services to CVS Caremark through December 31, 2012, although certain transition-related services may continue through March 31, 2014. Revenues and expenses from these transition-related services are reported as part of Divested operations and services revenue and expenses (see Notes 2 and 4).
As a result of the sale, the operating results of our Medicare PDP business, previously reported within the Western Region Operations reportable segment, have been reclassified as discontinued operations in our consolidated statement of operations for the three months ended March 31, 2012 and 2011. Our revenues related to the Medicare PDP business were $191.8 million and $163.3 million, for the three months ended March 31, 2012 and 2011, respectively. These revenues were excluded from our continuing operating results and included in loss from discontinued operation. Our Medicare PDP business had a pretax loss of $(28.8) million and $(18.0) million for the three months ended March 31, 2012 and 2011, respectively. As of March 31, 2012 and 2011, we had approximately 424,000 and 401,000 Medicare PDP members, respectively.
As of March 31, 2012, we have classified $145.2 million in assets and $41.8 million in liabilities related to our Medicare PDP business as assets and liabilities of discontinued operation held for sale, respectively. The following table presents the major classes of assets and liabilities included in these amounts (dollars in millions):
In connection with the sale, we assessed the recoverability of goodwill related to our Medicare PDP business and noted no impairment (see Note 2). Our Medicare PDP business had no other long-lived assets. We were also required to measure these assets and liabilities at the lower of carrying value or fair value less cost to sell. We compared the carrying value of the asset group to its estimated fair value less cost to sell. This measurement indicated that the assets held for sale were not impaired.
On December 11, 2009, we completed the sale (the Northeast Sale) of all of the outstanding shares of capital stock of our health plan subsidiaries that were domiciled and had conducted businesses in Connecticut, New Jersey, New York and Bermuda (Acquired Companies) to an affiliate of UnitedHealth Group Incorporated (United). As part of the Northeast Sale, we were required to continue to serve the members of the Acquired Companies and provide certain administrative services to United until July 1, 2011 under administrative services agreements, and we are required to provide run-out support services under claims servicing agreements with United, which will be in effect until the last run out claim under the applicable claims servicing agreement has been adjudicated. All revenues and expenses related to the Northeast Sale, including those relating to the administrative services and/or claims servicing agreements and any revenues and expenses related to the run-out, are reported as part of Divested operations and services revenue and expenses. During the three months ended March 31, 2012 and 2011, we recorded no adjustment to the loss on sale of Northeast health plan subsidiaries and a $34.9 million reduction to the loss on sale of Northeast health plan subsidiaries, respectively.
4. SEGMENT INFORMATION
Following the execution of the Asset Purchase Agreement to sell our Medicare PDP business in the first quarter of 2012, we reviewed our reportable segments. As a result of this review, beginning in the first quarter of 2012, our Divested Operations and Services reportable segment, formerly called the "Northeast Operations" reportable segment also includes the transition-related expenses of our Medicare PDP business that was sold on April 1, 2012. Accordingly, all services provided in connection with divested businesses are now reported as part of our Divested Operations and Services reportable segment.
We operate within three reportable segments, Western Region Operations, Government Contracts and Divested Operations and Services. Our Western Region Operations reportable segment includes the operations of our commercial, Medicare and Medicaid health plans, our health and life insurance companies, and our behavioral health and pharmaceutical services subsidiaries. These operations are conducted primarily in California, Arizona, Oregon and Washington. As a result of the classification of our Medicare PDP business as discontinued operations, our Western Region Operations reportable segment excludes the operating results of our Medicare PDP business for the three months ended March 31, 2012 and 2011. Our Government Contracts reportable segment includes government-sponsored managed care and administrative services contracts through the TRICARE program, the Department of Defense Military and Family Life Consultant program (MFLC) and other health care-related government contracts. For the three months ended March 31, 2011, our Divested Operations and Services
reportable segment included the operations of our businesses that provided administrative services to United in connection with the Northeast Sale. Beginning in the first quarter of 2012, our Divested Operations and Services reportable segment also includes the transition-related expenses of our Medicare PDP business that was sold on April 1, 2012. Prior period segment information has been conformed to this current presentation in this Quarterly Report on Form 10-Q. See Note 3 for more information regarding the sale of our Medicare PDP business and the Northeast Sale.
The financial results of our reportable segments are reviewed on a monthly basis by our chief operating decision maker (CODM). We continuously monitor our reportable segments to ensure that they reflect how our CODM manages our company.
We evaluate performance and allocate resources based on segment pretax income. Our assets are managed centrally and viewed by our CODM on a consolidated basis; therefore, they are not allocated to our segments and our segments are not evaluated for performance based on assets. The accounting policies of the reportable segments are the same as those described in Note 2 to the consolidated financial statements included in our Form 10-K, except that intersegment transactions are not eliminated.
We also have a Corporate/Other segment that is not a business operating segment. It is added to our reportable segments to provide a reconciliation to our consolidated results. The Corporate/Other segment includes costs that are excluded from the calculation of segment pretax income because they are not managed within the segments and are not directly identified with a particular operating segment. Accordingly, these costs are not included in the performance evaluation of the reportable segments by our CODM. In addition, certain charges, including but not limited to those related to our operations strategy and corporate overhead cost reduction efforts, as well as asset impairments, are reported as part of Corporate/Other.
Our segment information is as follows:
Our health plan services premium revenue by line of business is as follows:
Investments classified as available-for-sale, which consist primarily of debt securities, are stated at fair value. Unrealized
gains and losses are excluded from earnings and reported as other comprehensive income, net of income tax effects. The cost of investments sold is determined in accordance with the specific identification method, and realized gains and losses are included in net investment income. We periodically assess our available-for-sale investments for other-than-temporary impairment. Any such other-than-temporary impairment loss is recognized as a realized loss, which is recorded through earnings, if related to credit losses.
During the three months ended March 31, 2012 and 2011, we recognized no losses from other-than-temporary impairments of our cash equivalents and available-for-sale investments.
We had no noncurrent available-for-sale investments as of March 31, 2012. As of December 31, 2011, we classified $2.1 million as investments available-for-sale-noncurrent because we did not intend to sell and we believed it may take longer than a year for such impaired securities to recover. This classification does not affect the marketability or the valuation of the investments, which are reflected at their market value as of December 31, 2011.
As of March 31, 2012 and December 31, 2011, the amortized cost, gross unrealized holding gains and losses, and fair value of our current investments available-for-sale and our investments available-for-sale-noncurrent, after giving effect to other-than-temporary impairments were as follows:
As of March 31, 2012, the contractual maturities of our current investments available-for-sale were as follows:
Proceeds from sales of investments available-for-sale during the three months ended March 31, 2012 were $650.8 million. Gross realized gains and losses totaled $13.4 million and $0.4 million, respectively, for the three months ended March 31, 2012. Proceeds from sales of investments available-for-sale during the three months ended March 31, 2011 were $398.5 million. Gross realized gains and losses totaled $13.0 million and $0.7 million, respectively, for the three months ended March 31, 2011.
The following tables show our investments’ fair values and gross unrealized losses for individual securities that have been in a continuous loss position through March 31, 2012 and December 31, 2011. These investments are interest-yielding debt securities of varying maturities. We have determined that the unrealized loss position for these securities is primarily due to market volatility. Generally, in a rising interest rate environment, the estimated fair value of fixed income securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of fixed income securities would be expected to increase. These securities may also be negatively impacted by illiquidity in the market.
The following table shows our current investments' fair values and gross unrealized losses for individual securities in a continuous loss position as of March 31, 2012:
The following table shows the number of our individual securities-current that have been in a continuous loss position at March 31, 2012:
The following table shows our current investments’ fair values and gross unrealized losses for individual securities that have been in a continuous loss position through December 31, 2011:
The following table shows our noncurrent investments’ fair values and gross unrealized losses for individual securities that have been in a continuous loss position through December 31, 2011:
6. STOCK REPURCHASE PROGRAM
On March 18, 2010, our Board of Directors authorized our 2010 stock repurchase program pursuant to which a total of $300 million of our common stock could be repurchased. We completed our 2010 stock repurchase program in April 2011. During the three months ended March 31, 2011, we repurchased 3.5 million shares of our common stock for aggregate consideration of approximately $104.6 million under our 2010 stock repurchase program. As of December 31, 2011, we had repurchased an aggregate of 10.8 million shares of our common stock under our 2010 stock repurchase program since its inception at an average price of $27.80 per share for aggregate consideration of $300 million.
On May 2, 2011, our Board of Directors authorized our 2011 stock repurchase program pursuant to which a total of $300 million of our outstanding common stock could be repurchased. As of December 31, 2011, the remaining authorization under our 2011 stock repurchase program was $76.3 million. On March 8, 2012 our Board of Directors approved a $323.7 million increase to our 2011 stock repurchase program. Subject to the approval of our Board of Directors, we may repurchase our common stock under our 2011 stock repurchase program from time to time in privately negotiated transactions, through accelerated stock repurchase programs or open market transactions, including pursuant to a trading plan in accordance with Rules 10b5-1 and 10b-18 of the Securities Exchange Act of 1934, as amended. The timing of any repurchases and the actual number of stock repurchases will depend on a variety of factors, including the stock price, corporate and regulatory requirements, restrictions under the Company’s debt obligations, and other market and economic conditions. Our 2011 stock repurchase program may be suspended or discontinued at any time.
During the three months ended March 31, 2012, we did not repurchase any shares of our common stock under our 2011 stock repurchase program. The remaining authorization under our 2011 stock repurchase program as of March 31, 2012 was $400.0 million.
7. FINANCING ARRANGEMENTS
Revolving Credit Facility
In October 2011, we entered into a $600 million unsecured revolving credit facility due in October 2016, which includes a $400 million sublimit for the issuance of standby letters of credit and a $50 million sublimit for swing line loans (which sublimits may be increased in connection with any increase in the credit facility described below). In addition, we have the ability from time to time to increase the credit facility by up to an additional $200 million in the aggregate, subject to the receipt of additional commitments. As of March 31, 2012, $112.5 million was outstanding under our revolving credit facility and the maximum amount available for borrowing under the revolving credit facility was $427.9 million (see "—Letters of Credit" below).
The interest rate payable on our credit facility is based on the consolidated leverage ratio of the Company as defined in the credit facility; however, until the Company delivers a compliance certificate for the fiscal quarter ending March 31, 2012, the Company will pay, at the Company’s option, either (a) the base rate (which is a rate per annum equal to the greatest of
(i) the federal funds rate plus one-half of one percent, (ii) Bank of America, N.A.’s “prime rate” and (iii) the Eurodollar Rate (as such term is defined in the credit facility) for a one-month interest period plus one percent) plus an applicable margin of 87.5 basis points or (b) the Eurodollar Rate plus an applicable margin of 187.5 basis points. Following the Company’s delivery of a compliance certificate for the fiscal quarter ending March 31, 2012, which is due during the second quarter of 2012, the applicable margins are subject to adjustment according to our consolidated leverage ratio, as specified in the credit facility.
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 that 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. In addition, we are required to be in compliance at the end of each fiscal quarter with a specified consolidated leverage ratio and consolidated fixed charge coverage ratio.
Our revolving credit facility contains customary events of default, including nonpayment of principal or other amounts when due; breach of covenants; inaccuracy of representations and warranties; cross-default and/or cross-acceleration to other indebtedness of the Company or our subsidiaries in excess of $50 million; certain ERISA-related events; noncompliance by the Company or any of our subsidiaries with any material term or provision of the HMO Regulations or Insurance Regulations (as each such term is defined in the credit facility) in a manner that could reasonably be expected to result in a material adverse effect; certain voluntary and involuntary bankruptcy events; inability to pay debts; undischarged, uninsured judgments greater than $50 million against us and/or our subsidiaries that are not stayed within 60 days; actual or asserted invalidity of any loan document; and a change of control. If an event of default occurs and is continuing under the revolving credit facility, the lenders thereunder may, among other things, terminate their obligations under the facility and require us to repay all amounts owed thereunder.
Letters of Credit
Pursuant to the terms of our revolving credit facility, we can obtain letters of credit in an aggregate amount of $400 million and the maximum amount available for borrowing is reduced by the dollar amount of any outstanding letters of credit. As of March 31, 2012 and December 31, 2011, we had outstanding letters of credit of $59.6 million and $59.4 million, respectively, resulting in a maximum amount available for borrowing of $427.9 million and $428.1 million, respectively. As of March 31, 2012 and December 31, 2011, no amounts had been drawn on any of these letters of credit.
In 2007 we issued $400 million in aggregate principal amount of 6.375% Senior Notes due 2017 (Senior Notes). 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 March 31, 2012, no default or event of default had occurred under the indenture governing the Senior Notes.
The Senior Notes may be redeemed in whole at any time or in part from time to time, prior to maturity at our option, at a redemption price equal to the greater of:
plus, in each case, accrued and unpaid interest on the principal amount being redeemed to the redemption date.
Each of the following will be an Event of Default under the indenture governing the Senior Notes:
Our Senior Notes payable balances were $398.9 million as of March 31, 2012 and $398.9 million as of December 31, 2011, respectively.
8. FAIR VALUE MEASUREMENTS
We record certain assets and liabilities at fair value in the consolidated balance sheets and categorize them based upon the level of judgment associated with the inputs used to measure their fair value and the level of market price observability. We also estimate fair value when the volume and level of activity for the asset or liability have significantly decreased or in those circumstances that indicate when a transaction is not orderly.
Investments measured and reported at fair value using Level inputs are classified and disclosed in one of the following categories:
Level 1—Quoted prices are available in active markets for identical investments as of the reporting date. The types of investments included in Level 1 include U.S. Treasury securities and listed equities. We do not adjust the quoted price for these investments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.
Level 2—Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models and/or other valuation methodologies that are based on an income approach. Examples include, but are not limited to, multidimensional relational model, option adjusted spread model, and various matrices. Specific pricing inputs include quoted prices for similar securities in both active and non-active markets, other observable inputs such as interest rates, yield curve volatilities, default rates, and inputs that are derived principally from or corroborated by other observable market data. Investments that are generally included in this category include asset-backed securities, corporate bonds and loans, and state and municipal bonds.
Level 3—Pricing inputs are unobservable for the investment and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require significant management judgment or estimation using assumptions that market participants would use, including assumptions for risk. The investments included in Level 3 are auction rate securities that have experienced failed auctions at one time or are experiencing failed auctions and thus have minimal liquidity. These bonds have frequent reset of coupon rates and have extended to the legal final maturity. The coupons are based on a margin plus a LIBOR rate and continue to pay above market rates. As with most variable or floating rate securities, we believe that based on a market approach, the fair values of these securities are equal to their par values due to the short time periods between coupon resets and based on each issuer’s credit worthiness. Also included in the Level 3 category is an embedded contractual derivative held by the Company estimated at fair value. Significant inputs used in the derivative valuation model include the estimated growth in Health Net health care expenditures and estimated growth in national health care expenditures. The growth in these expenditures was modeled using a Monte Carlo simulation approach.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.
The following tables present information about our assets and liabilities measured at fair value on a recurring basis at March 31, 2012 and December 31, 2011, and indicate the fair value hierarchy of the valuation techniques utilized by us to determine such fair value (dollars in millions):
We had no transfers between Levels 1 and 2 of financial assets or liabilities that are fair valued on a recurring basis during the three months ended March 31, 2012 and 2011. In determining when transfers between levels are recognized, our accounting policy is to recognize the transfers based on the actual date of the event or change in circumstances that caused the transfer.
The changes in the balances of Level 3 financial assets for the three months ended March 31, 2012 and 2011 were as follows (dollars in millions):
As a result of executing the Asset Purchase Agreement relating to the sale of our Medicare PDP business in January 2012 (see Note 3), we reclassified certain assets and liabilities relating to our Medicare PDP business as held for sale. These assets and liabilities held for sale are carried at the lower of carrying value or fair value. As the carrying values for these assets and liabilities approximate fair value, they are recorded at their respective carrying values as of March 31, 2012. The following table presents information about our assets and liabilities classified as held for sale as of March 31, 2012 and the hierarchy of the valuation techniques utilized by us to determine such fair values (dollars in millions):
The following table presents quantitative information about Level 3 Fair Value Measurements (dollars in millions):