2. Summary of Significant Accounting Policies

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”), which is a new comprehensive revenue recognition standard that will supersede virtually all existing revenue guidance under GAAP. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” (“ASU 2016-08”), which clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” (“ASU 2016-10”), which clarifies the performance obligations and licensing implementation guidance of ASU 2014-09. In July 2015, the FASB approved to defer the effective date of ASU 2014-09. In December 2016, the FASB issued ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers” (“ASU 2016-20”), which amends various aspects of ASU 2014-09. The amendments in these ASUs are effective for annual and interim reporting periods of public entities beginning after December 15, 2017. The Company has identified its major revenue streams and is in the process of completing formal contract reviews. While the Company continues to assess all of the potential impacts of these ASUs, the Company does not expect implementation of these ASUs will have a significant impact on the Company’s consolidated results of operations, financial position and cash flows. The Company intends to adopt the new standard on a modified retrospective basis.

In June 2014, the FASB issued ASU No. 2014‑12, “Compensation—Stock Compensation (Topic 718): Accounting for Share‑Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period” (“ASU 2014‑12”), which revises the accounting treatment for stock compensation tied to performance targets. The amendments in this ASU are effective for annual and interim reporting periods beginning after December 15, 2015 and were adopted by the Company during the quarter ended March 31, 2016. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.

In August 2014, the FASB issued ASU No. 2014‑15, “Presentation of Financial Statements—Going Concern (Subtopic 205‑40)” (“ASU 2014‑ 15”), which provides guidance in GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. This amendment should reduce diversity in the timing and content of footnote disclosures. This ASU is effective for the annual period ending after December 15, 2016, was adopted by the Company during the quarter ended December 31, 2016. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.

In February 2015, the FASB issued ASU No. 2015‑02, “Amendments to the Consolidation Analysis” (“ASU 2015‑02”), which amends certain requirements for determining whether a variable interest entity must be consolidated. The amendments in this ASU are effective for annual and interim reporting periods of public entities beginning after December 15, 2015 and were adopted by the Company during the quarter ended March 31, 2016. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.

In April 2015, the FASB issued ASU No. 2015-05, “Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement” (“ASU 2015-05”), which provides guidance to clarify the customer’s accounting for fees paid in a cloud computing arrangement. The amendments in this ASU are effective for annual and interim reporting periods of public entities beginning after December 15, 2015 and were adopted by the Company on a prospective basis during the quarter ended March 31, 2016. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.

In July 2015, the FASB issued ASU No. 2015‑11, “Inventory (Topic 330): Simplifying the Measurement of Inventory” (“ASU 2015‑11”). The amendment under this ASU requires that an entity measure inventory at the lower of cost or net realizable value. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2016. The guidance is not expected to materially impact the Company’s consolidated results of operations, financial position or cash flows.

In September 2015, the FASB issued ASU No. 2015‑16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement Period Adjustments” (“ASU 2015‑16”). The amendment under this ASU requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this ASU are effective for annual and interim reporting periods of public entities beginning after December 15, 2015 and were adopted by the Company during the quarter ended March 31, 2016. The effect of this guidance is immaterial to the Company’s consolidated results of operations, financial position and cash flows.

In February 2016, the FASB issued ASU No. 2016‑02, “Leases” (“ASU 2016‑02”). This ASU amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets. This guidance is effective for annual and interim reporting periods of public entities beginning after December 15, 2018, with early adoption permitted. The Company is currently assessing the impact of adoption, but believes the effect of this ASU will have a material effect on the Company’s consolidated balance sheets. The Company is currently assessing the potential impact this ASU will have on the Company’s consolidated results of operations, financial position and cash flows.

In March 2016, the FASB issued ASU No. 2016-09, “Compensation-Stock Compensation (Topic 718)” (“ASU 2016-09”). This ASU amends the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This guidance is effective for annual and interim reporting period of public entities beginning after December 15, 2016, with early adoption permitted. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. During the quarter ended December 31, 2016, the Company elected to early adopt this standard as of January 1, 2016. The effect of this guidance was immaterial to the Company’s consolidated results of operations, financial position and cash flows.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). This ASU amends the accounting on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2019, with early adoption permitted for fiscal years beginning after December 31, 2018. The Company is currently assessing the potential impact this ASU will have on the Company’s consolidated results of operations, financial positions and cash flows.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). This ASU makes eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2017, with early adoption permitted. The ASU is required to be applied using a retrospective transition method to each period presented unless impractical. The Company is currently assessing the potential impact this ASU will have on the Company’s consolidated results of operations, financial positions and cash flows.

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash” (“ASU 2016-18”). This ASU requires that the statement of cash flows explain the change during the period in total cash, cash equivalents, restricted cash and restricted equivalents. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2017, with early adoption permitted. The ASU is required to be applied using a retrospective transition method to each period presented. During the quarter ended December 31, 2016, the Company elected to early adopt this standard. Adoption of this standard resulted in a reduction to the Company’s operating cash flows of $21.4 million, $81.7 million and $51.8 million for the years ended December 31, 2014, 2015 and 2016, respectively.

In December 2016, the FASB issued ASU 2016-19, “Technical Corrections and Improvements” (“ASU 2016-19”). The amendments in this ASU cover a wide range of Topics in the Accounting Standard Codification, including internal use software covered under Subtopic 350-40. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2017, with early adoption permitted. The Company is currently assessing the potential impact this ASU will have on the Company’s consolidated results of operations, financial positions and cash flows.

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business” (“ASU 2017-01”). The amendments in this ASU clarify whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2017, with early adoption permitted. The Company is currently assessing the potential impact this ASU will have on the Company’s consolidated results of operations, financial positions and cash flows.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). The amendments in this ASU eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. This guidance is effective for annual and interim periods of public entities beginning after December 15, 2019, with early adoption permitted for interim periods after January 1, 2017. The Company is currently assessing the potential impact this ASU will have on the Company’s consolidated results of operations, financial positions and cash flows.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates of the Company include, among other things, accounts receivable realization, valuation allowances for deferred tax assets, valuation of goodwill and intangible assets, medical claims payable, other medical liabilities, contingent consideration, stock compensation assumptions, tax contingencies and legal liabilities. Actual results could differ from those estimates.

Managed Care and Other Revenue

Managed Care Revenue. Managed care revenue, inclusive of revenue from the Company’s risk, EAP and ASO contracts, is recognized over the applicable coverage period on a per member basis for covered members. The Company is paid a per member fee for all enrolled members, and this fee is recorded as revenue in the month in which members are entitled to service. The Company adjusts its revenue for retroactive membership terminations, additions and other changes, when such adjustments are identified, with the exception of retroactivity that can be reasonably estimated. The impact of retroactive rate amendments is generally recorded in the accounting period in which terms to the amendment are finalized, and that the amendment is executed. Any fees paid prior to the month of service are recorded as deferred revenue. Managed care revenues approximated $2.6 billion, $2.7 billion and $2.3 billion for the years ended December 31, 2014, 2015 and 2016, respectively.

Fee‑For‑Service, Fixed Fee and Cost‑Plus Contracts. The Company has certain contracts with customers under which the Company recognizes revenue as services are performed and as costs are incurred. This includes revenues recorded in relation to the Patient Protection and Affordable Care Act health insurer fee (“HIF fee”) billed on a cost reimbursement basis. Revenues from these contracts approximated $290.9 million, $342.0 million and $503.2 million for the years ended December 31, 2014, 2015 and 2016, respectively.

Rebate Revenue. The Company administers a rebate program for certain clients through which the Company coordinates the achievement, calculation and collection of rebates and administrative fees from pharmaceutical manufacturers on behalf of clients. Each period, the Company estimates the total rebates earned based on actual volumes of pharmaceutical purchases by the Company’s clients, as well as historical and/or anticipated sharing percentages. The Company earns fees based upon the volume of rebates generated for its clients. The Company does not record as rebate revenue any rebates that are passed through to its clients. Total rebate revenues for the years ended December 31, 2014, 2015 and 2016 approximated $43.6 million, $88.7 million and $85.4 million, respectively.

In relation to the Company’s PBM business, the Company administers rebate programs through which it receives rebates from pharmaceutical manufacturers that are shared with its customers. The Company recognizes rebates when the Company is entitled to them and when the amounts of the rebates are determinable. The amount recorded for rebates earned by the Company from the pharmaceutical manufacturers is recorded as a reduction of cost of goods sold.

PBM and Dispensing Revenue

Pharmacy Benefit Management Revenue. The Company recognizes PBM revenue, which consists of a negotiated prescription price (ingredient cost plus dispensing fee), co‑payments collected by the pharmacy and any associated administrative fees, when claims are adjudicated. The Company recognizes PBM revenue on a gross basis (i.e. including drug costs and co‑payments) as it is acting as the principal in the arrangement and is contractually obligated to its clients and network pharmacies, which is a primary indicator of gross reporting. In addition, the Company is solely responsible for the claims adjudication process, negotiating the prescription price for the pharmacy, collection of payments from the client for drugs dispensed by the pharmacy, and managing the total prescription drug relationship with the client’s members. If the Company enters into a contract where it is only an administrator, and does not assume any of the risks previously noted, revenue will be recognized on a net basis. PBM revenues approximated $575.7 million, $1.2 billion and $1.5 billion for the years ended December 31, 2014, 2015 and 2016, respectively.

Dispensing Revenue. The Company recognizes dispensing revenue, which includes the co‑payments received from members of the health plans the Company serves, when the specialty pharmaceutical drugs are shipped. At the time of shipment, the earnings process is complete, the obligation of the Company’s customer to pay for the specialty pharmaceutical drugs is fixed, and, due to the nature of the product, the member may neither return the specialty pharmaceutical drugs nor receive a refund. Revenues from the dispensing of specialty pharmaceutical drugs on behalf of health plans approximated $216.0 million, $211.6 million and $221.8 million for the years ended December 31, 2014, 2015 and 2016, respectively.

Medicare Part D. The Company is contracted with the Centers for Medicare and Medicaid (“CMS”) as a Prescription Drug Plan (“PDP”) to provide prescription drug benefits to Medicare beneficiaries. Net revenues include premiums earned by the PDP, which includes a direct premium paid by CMS and a beneficiary premium paid by the PDP member. In cases of low-income members, the beneficiary premium may be subsidized by CMS. The Company recognizes insurance premium revenues on a monthly basis on a per member basis for covered members. In addition to these premiums, net revenue includes certain payments from the members based on the members’ actual prescription claims, including co-payments, coverage gap benefits, deductibles and co-insurance (collectively, “Member Responsibilities”). The Company receives a prospective subsidy payment from CMS each month to subsidize a portion of the Member Responsibilities for low-income members. If the prospective subsidy differs from actual prescription claims, the difference is recorded as either a receivable or payable on the consolidated balance sheets. The Company assumes no risk for the Member Responsibilities, including the portion subsidized by CMS. The Company recognizes revenues for Member Responsibilities, including the portion subsidized by CMS, on a gross basis as claims are adjudicated. The CMS also provides an annual risk corridor adjustment which compares the Company’s actual drug costs incurred to the premiums received. Based on the risk corridor adjustment, the Company may receive additional premiums from CMS or may be required to refund CMS a portion of previously received premiums. The Company calculates the risk corridor adjustment on a quarterly basis and the amount is included in net revenues with a corresponding receivable or payable on the consolidated balance sheets. Medicare Part D revenues approximated $272.8 million for the year ended December 31, 2016, including co-payments, which are included in PBM revenues above, of $31.0 million. As of December 31, 2016, the Company had $117.5 million in net receivables associated with Medicare Part D from CMS and other parties related to this business.

Significant Customers

Customers exceeding ten percent of the consolidated Company’s net revenues

The Company provides behavioral healthcare management and other related services to members in the state of Florida pursuant to contracts with the State of Florida (the “Florida Contracts”). The Company had behavioral healthcare contracts with various areas in the State of Florida (the “Florida Areas”) which were part of the Florida Medicaid program. The State of Florida implemented a new system of mandated managed care through which Medicaid enrollees receive integrated healthcare services, and in 2014 phased out the behavioral healthcare programs under which the Florida Areas’ contracts operated. The Company has a contract with the State of Florida to provide integrated healthcare services under the new program (“the Florida Medicaid Contract”). The Florida Medicaid Contract began on February 4, 2014 and extends through December 31, 2018, unless sooner terminated by the parties. The State of Florida has the right to terminate the Florida Medicaid Contract with cause, as defined, upon 24 hour notice and upon 30 days notice for any reason or no reason at all. The Florida Contracts generated net revenues of $253.7 million, $439.5 million and $548.7 million for the years ended December 31, 2014, 2015 and 2016, respectively.

Through December 31, 2015, the Company provided behavioral healthcare management and other related services to members in the state of Iowa pursuant to contracts with the State of Iowa (the “Iowa Contracts”). The Iowa Contracts terminated on December 31, 2015. The Iowa Contracts generated net revenues of $465.0 million, $530.3 million and $13.5 million for the years ended December 31, 2014, 2015 and 2016, respectively.

Customers exceeding ten percent of segment net revenues

In addition to the Florida Contracts and Iowa Contracts previously discussed, the following customers generated in excess of ten percent of net revenues for the respective segment for the years ended December 31, 2014, 2015 and 2016 (in thousands):


Segment	Term Date	2014		2015			2016

Healthcare
None

Pharmacy Management
Customer A	December 31, 2016 (1)	$	171,936	$	324,809		$	264,152
Customer B	December 31, 2018		123,812		130,200	*		139,273	*

* Revenue amount did not exceed 10 percent of net revenues for the respective segment for the year presented. Amount is shown for comparative purposes only.

(1)

A vast majority of this customer’s revenues were generated from drug acquisition costs related to PBM services which terminated on September 1, 2016. The Company continues to provide specialty drug formulary management services to the customer and is in negotiations with the customer to extend this contract.

Concentration of Business

The Company also has a significant concentration of business with various counties in the State of Pennsylvania (the “Pennsylvania Counties”) which are part of the Pennsylvania Medicaid program, with members under its contract with CMS and with various agencies and departments of the United States federal government. Net revenues from the Pennsylvania Counties in the aggregate totaled $369.9 million, $395.7 million and $461.6 million for the years ended December 31, 2014, 2015 and 2016, respectively. Net revenues from members in relation to its contract with CMS in aggregate totaled $272.8 million for the year ended December 31, 2016. Net revenues from contracts with various agencies and departments of the United States federal government in aggregate totaled $139.5 million, $164.3 million, and $252.5 million for the years ended December 31, 2014, 2015 and 2016, respectively.

The Company’s contracts with customers typically have terms of one to three years, and in certain cases contain renewal provisions (at the customer’s option) for successive terms of between one and two years (unless terminated earlier). Substantially all of these contracts may be immediately terminated with cause and many of the Company’s contracts are terminable without cause by the customer or the Company either upon the giving of requisite notice and the passage of a specified period of time (typically between 60 and 180 days) or upon the occurrence of other specified events. In addition, the Company’s contracts with federal, state and local governmental agencies generally are conditioned on legislative appropriations. These contracts generally can be terminated or modified by the customer if such appropriations are not made.

Income Taxes

The Company files a consolidated federal income tax return with most of its eighty-percent or more controlled subsidiaries. The Company files a separate consolidated federal income tax return for AlphaCare of New York, Inc. (“AlphaCare”) and its parent, AlphaCare Holdings, Inc. (“AlphaCare Holdings”). The Company and its subsidiaries also file income tax returns in various state and local jurisdictions.

The Company estimates income taxes for each of the jurisdictions in which it operates. This process involves determining both permanent and temporary differences resulting from differing treatment for tax and book purposes. Deferred tax assets and/or liabilities are determined by multiplying the temporary differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. The Company then assesses the likelihood that the deferred tax assets will be recovered from the reversal of temporary differences, the implementation of feasible and prudent tax planning strategies, and future taxable income. To the extent the Company cannot conclude that recovery is more likely than not, it establishes a valuation allowance. The effect of a change in tax rates on deferred taxes is recognized in income in the period that includes the enactment date.

Reversals of both valuation allowances and unrecognized tax benefits are recorded in the period they occur, typically as reductions to income tax expense. However, reversals of unrecognized tax benefits related to deductions for stock compensation in excess of the related book expense are recorded as reductions to deferred tax assets, although prior to the adoption of ASU 2016-09 in 2016 were recorded as increases in additional paid‑in capital.

The Company recognizes interim period income taxes by estimating an annual effective tax rate and applying it to year‑to‑date results. The estimated annual effective tax rate is periodically updated throughout the year based on actual results to date and an updated projection of full year income. Although the effective tax rate approach is generally used for interim periods, taxes on significant, unusual and infrequent items are recognized at the statutory tax rate entirely in the period the amounts are realized.

Health Care Reform

The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the “Health Reform Law”), imposes a mandatory annual fee on health insurers for each calendar year beginning on or after January 1, 2014. The Company has obtained rate adjustments from customers which the Company expects will cover the direct costs of these fees and the impact from non-deductibility of such fees for federal and state income tax purposes. To the extent the Company has such a customer that does not renew, there may be some impact due to taxes paid where the timing and amount of recoupment of these additional costs is uncertain. In the event the Company is unable to obtain rate adjustments to cover the financial impact of the annual fee, the fee may have a material impact on the Company. For 2014, 2015 and 2016, the HIF fees were $21.4 million, $26.5 million and $26.5 million, respectively, which have been paid and which are included in direct service costs and other operating expenses in the consolidated statements of income. The Company recorded revenues of $36.5 million, $45.4 million and $44.0 million in the years ended December 31, 2014, 2015 and 2016, respectively, associated with the accrual for the reimbursement of the economic impact of the HIF fees from its customers. As of December 31, 2016, the Company has a $13.3 million receivable related to a terminated contract that the customer has expressed their unwillingness to pay, however the Company believes the amount is collectible and has not established a reserve.

Cash and Cash Equivalents

Cash equivalents are short‑term, highly liquid interest‑bearing investments with maturity dates of three months or less when purchased, consisting primarily of money market instruments. At December 31, 2016, the Company’s excess capital and undistributed earnings for the Company’s regulated subsidiaries of $117.7 million are included in cash and cash equivalents.

Restricted Assets

The Company has certain assets which are considered restricted for: (i) the payment of claims under the terms of certain managed care contracts; (ii) regulatory purposes related to the payment of claims in certain jurisdictions; and (iii) the maintenance of minimum required tangible net equity levels for certain of the Company’s subsidiaries. Significant restricted assets of the Company as of December 31, 2015 and 2016 were as follows (in thousands):


	2015		2016
Restricted cash and cash equivalents	$	133,597	$	81,776
Restricted short-term investments		277,556		227,795
Restricted deposits (included in other current assets)		27,752		38,785
Restricted long-term investments		3,826		6,306
Total	$	442,731	$	354,662

Fair Value Measurements

The Company has certain assets and liabilities that are required to be measured at fair value on a recurring basis. These assets and liabilities are to be measured using inputs from the three levels of the fair value hierarchy, which are as follows:

Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2—Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).

Level 3—Unobservable inputs that reflect the Company’s assumptions about the assumptions that market participants would use in pricing the asset or liability. The Company develops these inputs based on the best information available, including the Company’s data.

In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value as of December 31, 2015 and 2016 (in thousands):


	December 31, 2015
	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents (1)	$	—	$	88,817	$	—	$	88,817
Investments:
U.S. Government and agency securities		5,514		—		—		5,514
Obligations of government-sponsored enterprises (2)		—		50,525		—		50,525
Corporate debt securities		—		268,976		—		268,976
Certificates of deposit		—		1,150		—		1,150
Total assets held at fair value	$	5,514	$	409,468	$	—	$	414,982

Liabilities
Contingent consideration	$	—	$	—	$	92,426	$	92,426
Total liabilities held at fair value	$	—	$	—	$	92,426	$	92,426


	December 31, 2016
	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents (3)	$	—	$	177,495	$	—	$	177,495
Investments:
U.S. Government and agency securities		5,817		—		—		5,817
Obligations of government-sponsored enterprises (4)		—		25,767		—		25,767
Corporate debt securities		—		272,219		—		272,219
Certificates of deposit		—		1,450		—		1,450
Total assets held at fair value	$	5,817	$	476,931	$	—	$	482,748

Liabilities
Contingent consideration	$	—	$	—	$	11,153	$	11,153
Total liabilities held at fair value	$	—	$	—	$	11,153	$	11,153

(1)

Excludes $160.2 million of cash held in bank accounts by the Company.

(2)

Includes investments in notes issued by the Federal Home Loan Bank and Federal Farm Credit Banks.

(3)

Excludes $127.0 million of cash held in bank accounts by the Company.

(4)

Includes investments in notes issued by the Federal Home Loan Bank, Federal Farm Credit Banks and Federal National Mortgage Association.

For the years ended December 31, 2015 and 2016, the Company did not transfer any assets between fair value measurement levels.

The carrying values of financial instruments, including accounts receivable and accounts payable, approximate their fair values due to their short-term maturities. The estimated fair value of the Company’s term loans of $418.8 million as of December 31, 2016 was based on current interest rates for similar types of borrowings and is in Level 2 of the fair value hierarchy. The estimated fair values may not represent actual values of the financial instruments that could be realized as of the balance sheet date or that will be realized in the future.

All of the Company’s investments are classified as “available-for-sale” and are carried at fair value.

The contingent consideration liability reflects the fair value of potential future payments related to the Cobalt Therapeutics, LLC (“Cobalt”), 4D Pharmacy Management Systems, Inc. (“4D”), The Management Group, LLC (“TMG”) and Armed Forces Services Corporation (“AFSC”) acquisitions. The CDMI, LLC (“CDMI”) purchase agreement provided for potential contingent payments up to a maximum aggregate amount of $165.0 million. The potential future payments were contingent upon CDMI meeting certain client retention, client conversion and gross profit milestones through December 31, 2016. The CDMI contingent payments were finalized in 2016 and no future potential payments remain outstanding. The 4D purchase agreement provided for potential contingent payments up to a maximum aggregate amount of $30.0 million. The potential future payments were contingent upon the achievement of certain growth targets in the underlying dual eligible membership served by 4D during calendar year 2015 and the retention of certain business. The 4D contingent payments were finalized in 2016 and no future potential payments remain outstanding. The Cobalt, TMG and AFSC purchase agreements also provide for potential contingent payments of up to a maximum of $6.0 million, $15.0 million and $10.0 million, respectively. As of December 31, 2016, there are remaining potential future payments of $5.0 million, $15.0 million and $10.0 million for Cobalt, TMG and AFSC, respectively.

As of the balance sheet date, the fair value of contingent consideration is determined based on probabilities of payment, projected payment dates, discount rates, projected revenues, gross profits, client base, member engagement and new contract execution. The projected revenues, gross profits, client base, member engagement and new contract execution are derived from the Company’s latest internal operational forecasts. The Company used a probability weighted discounted cash flow method to arrive at the fair value of the contingent consideration. Changes in the operational forecasts, probabilities of payment, discount rates or projected payment dates may result in a change in the fair value measurement. Any changes in the fair value measurement are reflected as income or expense in the consolidated statements of income. As the fair value measurement for the contingent consideration is based on inputs not observed in the market, these measurements are classified as Level 3 measurements as defined by fair value measurement guidance.

For CDMI, the Company estimated undiscounted future contingent payments of $90.1 million as of December 31, 2015, which the Company settled in June 2016. For 4D, the Company estimated net undiscounted future contingent payments of $1.0 million as of December 31, 2015, which the Company settled in February 2016.

For Cobalt, TMG and AFSC the unobservable inputs used in the fair value measurement include the discount rate, probabilities of payment and projected payment dates. For Cobalt, the Company estimated undiscounted future contingent payments of $1.7 million and $0.9 million as of December 31, 2015 and 2016, respectively. As of December 31, 2016, the fair value of the short-term contingent consideration for Cobalt was $0.9 million. For TMG the Company estimated undiscounted future contingent payments of $3.8 million and $2.8 million at the acquisition date and December 31, 2016, respectively. The decrease is mainly a result of changes in operational forecasts and probabilities of payment. As of December 31, 2016, the fair value of the long-term contingent consideration for TMG was $1.8 million. For AFSC the Company estimated undiscounted future contingent payments of $9.0 million at the acquisition date and December 31, 2016. As of December 31, 2016, the fair value of the short-term contingent consideration for AFSC was $8.5 million. As of December 31, 2016, the aggregate amounts and projected dates of future potential contingent consideration payments were $9.9 million in 2017 and $2.8 million in 2020.

As of December 31, 2015, the fair value of the short-term and long-term contingent consideration was $91.6 million and $0.8 million, respectively, and is included in short-term contingent consideration and long-term contingent consideration, respectively, in the consolidated balance sheets. As of December 31, 2016, the fair value of the short-term and long-term contingent consideration was $9.4 million and $1.8 million, respectively, and is included in short-term contingent consideration and long-term contingent consideration, respectively, in the consolidated balance sheets.

The change in the fair value of the contingent consideration was $9.3 million for the year ended December 31, 2014, $6.2 million and $3.1 million of which was recorded in the consolidated statements of income as direct service costs and other operating expenses, and as interest expense, respectively. The change in the fair value of the contingent consideration was $44.3 million for the year ended December 31, 2015, which was recorded as direct service costs and other operating expenses in the consolidated statements of income. The increase was mainly a result of changes in the present value and estimated undiscounted liability. The change in the fair value of the contingent consideration was $(0.1) million for the year ended December 31, 2016, which was recorded as direct service costs and other operating expenses in the consolidated statements of income. The decrease was mainly a result of net changes in present value and estimated undiscounted liability.

The following table summarizes the Company’s liability for contingent consideration (in thousands):


	December 31,		December 31,
	2015		2016
Balance as of beginning of period	$	58,153	$	92,426
Acquisition of 4D		19,290		—
Acquisition of TMG		—		2,244
Acquisition of AFSC		—		8,247
Changes in fair value		44,257		(104)
Payments		(29,274)		(91,660)
Balance as of end of period	$	92,426	$	11,153

Investments

All of the Company’s investments are classified as “available‑for‑sale” and are carried at fair value. Securities which have been classified as Level 1 are measured using quoted market prices in active markets for identical assets or liabilities while those which have been classified as Level 2 are measured using quoted prices for identical assets and liabilities in markets that are not active. The Company’s policy is to classify all investments with contractual maturities within one year as current. Investment income is recognized when earned and reported net of investment expenses. Net unrealized holding gains or losses are excluded from earnings and are reported, net of tax, as “accumulated other comprehensive income (loss)” in the accompanying consolidated balance sheets and consolidated statements of comprehensive income until realized, unless the losses are deemed to be other‑than‑temporary. Realized gains or losses, including any provision for other‑than‑temporary declines in value, are included in the consolidated statements of income.

If a debt security is in an unrealized loss position and the Company has the intent to sell the debt security, or it is more likely than not that the Company will have to sell the debt security before recovery of its amortized cost basis, the decline in value is deemed to be other‑than‑temporary and is recorded to other‑than‑temporary impairment losses recognized in income in the consolidated statements of income. For impaired debt securities that the Company does not intend to sell or it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other‑than‑temporary impairment is recognized in other‑than‑temporary impairment losses recognized in income in the consolidated statements of income and the non‑credit component of the other‑than‑temporary impairment is recognized in other comprehensive income.

The credit component of an other‑than‑temporary impairment is determined by comparing the net present value of projected future cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the best estimate of projected future cash flows at the effective interest rate implicit in the debt security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default. Furthermore, unrealized losses entirely caused by non‑credit related factors related to debt securities for which the Company expects to fully recover the amortized cost basis continue to be recognized in accumulated other comprehensive income.

As of December 31, 2015 and 2016, there were no unrealized losses that the Company believed to be other‑than‑temporary. No realized gains or losses were recorded for the years ended December 31, 2014, 2015, or 2016. The following is a summary of short-term and long-term investments at December 31, 2015 and 2016 (in thousands):


	December 31, 2015
			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
U.S. Government and agency securities	$	5,524	$	—	$	(10)	$	5,514
Obligations of government-sponsored enterprises (1)		50,575		4		(54)		50,525
Corporate debt securities		269,340		—		(364)		268,976
Certificates of deposit		1,150		—		—		1,150
Total investments at December 31, 2015	$	326,589	$	4	$	(428)	$	326,165


	December 31, 2016
			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
U.S. Government and agency securities	$	5,832	$	—	$	(15)	$	5,817
Obligations of government-sponsored enterprises (2)		25,779		2		(14)		25,767
Corporate debt securities		272,479		1		(261)		272,219
Certificates of deposit		1,450		—		—		1,450
Total investments at December 31, 2016	$	305,540	$	3	$	(290)	$	305,253

(1)

Includes investments in notes issued by the Federal Home Loan Bank and Federal Farm Credit Banks.

(2)

Includes investments in notes issued by the Federal Home Loan Bank, Federal National Mortgage Association and Federal Farm Credit Banks.

The maturity dates of the Company’s investments as of December 31, 2016 are summarized below (in thousands):


	Amortized		Estimated
	Cost		Fair Value
2017	$	297,748	$	297,493
2018		7,792		7,760
Total investments at December 31, 2016	$	305,540	$	305,253

Accounts Receivable

The Company’s accounts receivable consists of amounts due from customers throughout the United States. Collateral is generally not required. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. Management believes the allowance for doubtful accounts is adequate to provide for normal credit losses.

Concentration of Credit Risk

Accounts receivable subjects the Company to a concentration of credit risk with third party payors that include health insurance companies, managed healthcare organizations, healthcare providers and governmental entities.

The Company maintains cash and cash equivalents balances at financial institutions which are insured by the Federal Deposit Insurance Corporation (“FDIC”). At times, balances in certain bank accounts may exceed the FDIC insured limits.

Pharmaceutical Inventory

Pharmaceutical inventory consists solely of finished goods (primarily prescription drugs) and is stated at the lower of first‑in first‑out cost or market.

Long‑lived Assets

Long‑lived assets, including property and equipment and intangible assets to be held and used, are currently reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We group and evaluate these long-lived assets for impairment at the lowest level at which individual cash flows can be identified. Impairment is determined by comparing the carrying value of these long‑lived assets to management’s best estimate of the future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. The cash flow projections used to make this assessment are consistent with the cash flow projections that management uses internally in making key decisions. In the event an impairment exists, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the asset, which is generally determined by using quoted market prices or the discounted present value of expected future cash flows.

Property and Equipment

Property and equipment is stated at cost, except for assets that have been impaired, for which the carrying amount has been reduced to estimated fair value. Expenditures for renewals and improvements are capitalized to the property accounts. Replacements and maintenance and repairs that do not improve or extend the life of the respective assets are expensed as incurred. The Company capitalizes costs incurred to develop internal‑use software during the application development stage. Capitalization of software development costs occurs after the preliminary project stage is complete, management authorizes the project, and it is probable that the project will be completed and the software will be used for the function intended. Amortization of capital lease assets is included in depreciation expense and is included in accumulated depreciation as reflected in the table below. Depreciation is provided on a straight‑line basis over the estimated useful lives of the assets, which is generally two to ten years for building improvements (or the lease term, if shorter), three to fifteen years for equipment and three to five years for capitalized internal‑use software. The net capitalized internal use software as of December 31, 2015 and 2016 was $84.8 million and $88.2 million, respectively. Depreciation expense was $68.3 million, $73.4 million and $75.3 million for the years ended December 31, 2014, 2015 and 2016, respectively. Included in depreciation expense for the years ended December 31, 2014, 2015 and 2016 was $40.9 million, $45.6 million and $47.6 million, respectively, related to capitalized internal use software.

Property and equipment, net, consisted of the following at December 31, 2015 and 2016 (in thousands):


	2015		2016
Building improvements	$	13,655	$	16,817
Equipment		207,667		204,743
Capital leases - property		26,945		26,945
Capital leases - equipment		12,335		14,729
Capitalized internal-use software		396,794		446,619
		657,396		709,853
Accumulated depreciation		(482,651)		(537,329)
Property and equipment, net	$	174,745	$	172,524

Goodwill

The Company is required to test its goodwill for impairment on at least an annual basis. The Company has selected October 1 as the date of its annual impairment test. The goodwill impairment test is a two‑step process that requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit with goodwill based on various valuation techniques, with the primary technique being a discounted cash flow analysis, which requires the input of various assumptions with respect to revenues, operating margins, growth rates and discount rates. The estimated fair value for each reporting unit is compared to the carrying value of the reporting unit, which includes goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment by determining an “implied fair value” of goodwill. The determination of a reporting unit’s “implied fair value” of goodwill requires the Company to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying value.

Goodwill is tested for impairment at a level referred to as a reporting unit, which is one level below the operating segment. The Company’s three reporting units are comprised of Commercial, Government and Pharmacy Management.

The fair values of the Commercial (a component of the Healthcare segment) and Pharmacy Management reporting units were determined using a discounted cash flow method. This method involves estimating the present value of estimated future cash flows utilizing a risk adjusted discount rate. Key assumptions for this method include cash flow projections, terminal growth rates and discount rates.

The fair value of the Government (a component of the Healthcare segment) reporting unit was determined using the discounted cash flow and guideline company methods. Key assumptions for the discounted cash flow method are consistent with those described above. For the guideline company method, revenue and earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples for guideline companies were applied to the reporting units pro forma revenue and EBITDA for 2016, which represents actual results for the nine-month period ended September 30, 2016 and projected results for the three-month period ended December 31, 2016, and the reporting unit’s projected revenue and EBITDA for 2017. The weighting applied to the fair values determined using the discounted cash flow and guideline company methods to determine an overall fair value for the Government reporting unit was 75 percent and 25 percent, respectively. The weighting of each of the methods described above was based on the relevance of the approach. A change in the weighting would not change the outcome of the first step of the impairment test.

Goodwill for each of the Company’s reporting units with goodwill at December 31, 2015 and 2016 were as follows (in thousands):



	2015		2016
Commercial	$	242,255	$	242,255
Government		18,363		108,321
Pharmacy Management		360,772		391,478
Total	$	621,390	$	742,054

The changes in the carrying amount of goodwill for the years ended December 31, 2015 and 2016 are reflected in the table below (in thousands):



	2015		2016
Balance as of beginning of period	$	566,106	$	621,390
Acquisition of 4D		49,136		—
Acquisition of AFSC		—		76,736
Acquisition of Veridicus		—		30,705
Other acquisitions and measurement period adjustments		6,148		13,223
Balance as of end of period	$	621,390	$	742,054

Intangible Assets

The Company reviews other intangible assets for impairment when events or changes in circumstances occur which may potentially impact the estimated useful life of the intangible assets. During the second quarter of 2016, the Company recognized $4.8 million in impairment charges, which are reflected in direct service costs and other operating expenses in the consolidated statements of income and reported within the Healthcare segment. The fair value of the impairment was determined using the income method, which resulted in the full impairment of the customer agreement intangible asset recorded in conjunction with the AlphaCare acquisition.

The following is a summary of intangible assets at December 31, 2015 and 2016, and the estimated useful lives for such assets (in thousands):


	December 31, 2015
					Weighted Avg		Gross				Net
	Original				Remaining		Carrying		Accumulated		Carrying
Asset	Useful Life				Useful Life		Amount		Amortization		Amount
Customer agreements and lists	2.5	to	18	years	6.8	years	$	274,790	$	(148,795)	$	125,995
Provider networks and other	1	to	16	years	4.7	years		16,663		(9,284)		7,379
							$	291,453	$	(158,079)	$	133,374


	December 31, 2016
					Weighted Avg		Gross				Net
	Original				Remaining		Carrying		Accumulated		Carrying
Asset	Useful Life				Useful Life		Amount		Amortization		Amount
Customer agreements and lists	2.5	to	18	years	6.4	years	$	357,708	$	(181,588)	$	176,120
Provider networks and other	1	to	16	years	4.3	years		18,240		(12,008)		6,232
AFSC trade name	indefinite				indefinite			3,880		—		3,880
							$	379,828	$	(193,596)	$	186,232

Amortization expense was $22.8 million, $29.4 million and $30.7 million for the years ended December 31, 2014, 2015 and 2016, respectively. The Company estimates amortization expense will be $35.1 million, $30.6 million, $28.5 million, $27.4 million and $26.8 million for the years ending December 31, 2017, 2018, 2019, 2020 and 2021, respectively.

Cost of Care, Medical Claims Payable and Other Medical Liabilities

Cost of care is recognized in the period in which members receive managed healthcare services. In addition to actual benefits paid, cost of care in a period also includes the impact of accruals for estimates of medical claims payable. Medical claims payable represents the liability for healthcare claims reported but not yet paid and claims incurred but not yet reported (“IBNR”) related to the Company’s managed healthcare businesses. Such liabilities are determined by employing actuarial methods that are commonly used by health insurance actuaries and that meet actuarial standards of practice. Cost of care for the Company’s EAP contracts, which are mainly with the United States federal government, pertain to the costs to employ licensed behavioral health counselors to deliver non-medical counseling for these contracts.

The IBNR portion of medical claims payable is estimated based on past claims payment experience for member groups, enrollment data, utilization statistics, authorized healthcare services and other factors. This data is incorporated into contract‑specific actuarial reserve models and is further analyzed to create “completion factors” that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Factors that affect estimated completion factors include benefit changes, enrollment changes, shifts in product mix, seasonality influences, provider reimbursement changes, changes in claims inventory levels, the speed of claims processing and changes in paid claim levels. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the ultimate incurred claims. For the most recent incurred months (generally the most recent two months), the percentage of claims paid for claims incurred in those months is generally low. This makes the completion factor methodology less reliable for such months. Therefore, incurred claims for any month with a completion factor that is less than 70 percent are generally not projected from historical completion and payment patterns; rather they are projected by estimating claims expense based on recent monthly estimated cost incurred per member per month times membership, taking into account seasonality influences, benefit changes and healthcare trend levels, collectively considered to be “trend factors.”

Medical claims payable balances are continually monitored and reviewed. If it is determined that the Company’s assumptions in estimating such liabilities are significantly different than actual results, the Company’s results of operations and financial position could be impacted in future periods. Adjustments of prior period estimates may result in additional cost of care or a reduction of cost of care in the period an adjustment is made. Further, due to the considerable variability of healthcare costs, adjustments to claim liabilities occur each period and are sometimes significant as compared to the net income recorded in that period. Prior period development is recognized immediately upon the actuary’s judgment that a portion of the prior period liability is no longer needed or that additional liability should have been accrued. The following table presents the components of the change in medical claims payable for the years ended December 31, 2014, 2015 and 2016 (in thousands):


	2014		2015		2016
Claims payable and IBNR, beginning of period	$	242,229	$	278,803	$	253,299
Cost of care:
Current year		2,097,395		2,297,255		1,892,914
Prior years(3)		(8,800)		(22,500)		(10,300)
Total cost of care		2,088,595		2,274,755		1,882,614
Claim payments and transfers to other medical liabilities(1):
Current year		1,845,325		2,077,729		1,733,310
Prior years		206,696		222,530		213,985
Total claim payments and transfers to other medical liabilities		2,052,021		2,300,259		1,947,295
Claims payable and IBNR, end of period		278,803		253,299		188,618
Withhold receivables, end of period(2)		(321)		(2,850)		(4,482)
Medical claims payable, end of period	$	278,482	$	250,449	$	184,136

(1)

For any given period, a portion of unpaid medical claims payable could be covered by reinvestment liability (discussed below) and may not impact the Company’s results of operations for such periods.

(2)

Medical claims payable is offset by customer withholds from capitation payments in situations in which the customer has the contractual requirement to pay providers for care incurred.

(3)

Favorable development in 2014, 2015 and 2016 was $8.8 million, $22.5 million and $10.3 million, respectively, and was mainly related to lower medical trends and faster claims completion than originally assumed.

Actuarial standards of practice require that claim liabilities be adequate under moderately adverse circumstances. Adverse circumstances are situations in which the actual claims experience could be higher than the otherwise estimated value of such claims. In many situations, the claims paid amount experienced will be less than the estimate that satisfies the actuarial standards of practice. Any prior period favorable cost of care development related to a lack of moderately adverse conditions is excluded from “Cost of Care – Prior Years” adjustments, as a similar provision for moderately adverse conditions is established for current year cost of care liabilities and therefore does not generally impact net income.

Due to the existence of risk sharing and reinvestment provisions in certain customer contracts, principally in the Government contracts, a change in the estimate for medical claims payable does not necessarily result in an equivalent impact on cost of care.

The Company believes that the amount of medical claims payable is adequate to cover its ultimate liability for unpaid claims as of December 31, 2016; however, actual claims payments may differ from established estimates.

Other medical liabilities consist primarily of amounts payable to pharmacies for claims that have been adjudicated by the Company but not yet paid. Other medical liabilities also include “reinvestment” payables under certain managed healthcare contracts with Medicaid customers and “profit share” payables under certain risk-based contracts. Under a contract with reinvestment features, if the cost of care is less than certain minimum amounts specified in the contract (usually as a percentage of revenue), the Company is required to “reinvest” such difference in behavioral healthcare programs when and as specified by the customer or to pay the difference to the customer for their use in funding such programs. Under a contract with profit share provisions, if the cost of care is below certain specified levels, the Company will “share” the cost savings with the customer at the percentages set forth in the contract. In addition, certain contracts include provisions to provide the Company additional funding if the cost of care is above the specified levels.

Advertising Costs

Advertising costs consist primarily of printed media services, event sponsorships, and promotional items, which are expensed as incurred. Advertising expense was approximately $2.7 million, $2.5 million, and $2.0 million for the fiscal years ended December 31, 2014, 2015, and 2016, respectively.

Accrued Liabilities

As of December 31, 2015 and 2016, the only individual current liability that exceeded five percent of total current liabilities related to accrued employee compensation liabilities of $37.6 million and $76.1 million, respectively.

Net Income per Common Share attributable to Magellan Health, Inc.

Net income per common share attributable to Magellan Health, Inc. is computed based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period (see Note 6—“Stockholders’ Equity”).

Redeemable Non‑Controlling Interest

As of December 31, 2016 the Company held an 84% equity interest in AlphaCare Holdings. The other shareholders of AlphaCare Holdings have the right to exercise put options, requiring the Company to purchase up to 50% of the remaining shares prior to January 1, 2017 provided certain membership levels are attained. After December 31, 2016 the other shareholders of AlphaCare Holdings have the right to exercise put options requiring the Company to purchase all or any portion of the remaining shares. In addition, after December 31, 2016 the Company has the right to purchase all remaining shares. Non-controlling interests with redemption features, such as put options, that are not solely within the Company’s control are considered redeemable non-controlling interests. Redeemable non-controlling interest is considered to be temporary and is therefore reported in a mezzanine level between liabilities and stockholders’ equity on the Company’s consolidated balance sheet at the greater of the initial carrying amount adjusted for the non-controlling interest’s share of net income or loss or its redemption value. The carrying value of the non-controlling interest as of December 31, 2015 and December 31, 2016 was $5.9 million and $4.8 million, respectively. The $1.1 million decrease in carrying value is a result of operating losses, partially offset by the impact of additional capital provided by the Company. The Company evaluates the redemption value on a quarterly basis. If the redemption value is greater than the carrying value, the Company adjusts the carrying amount of the non-controlling interest to equal the redemption value at the end of each reporting period. Under this method, this is viewed at the end of the reporting period as if it were also the redemption date for the non-controlling interest. The Company will reflect redemption value adjustments in the earnings per share (“EPS”) calculation if redemption value is in excess of the carrying value of the non-controlling interest. As of December 31, 2016, the carrying value of the non-controlling interest exceeded the redemption value and therefore no adjustment to the carrying value was required.

Stock Compensation

At December 31, 2015 and 2016, the Company had equity-based employee incentive plans, which are described more fully in Note 6—“Stockholders’ Equity”. In addition, the Company issued restricted stock awards associated with the Partners Rx Management LLC (“Partners Rx”), CDMI and AFSC acquisitions, which are also described more fully in Note 6—“Stockholders’ Equity”. The Company uses the Black‑Scholes‑Merton formula to estimate the fair value of substantially all stock options granted to employees, and recorded stock compensation expense of $40.6 million, $50.4 million and $37.4 million for the years ended December 31, 2014, 2015 and 2016, respectively. As stock compensation expense recognized in the consolidated statements of income for the years ended December 31, 2014, 2015 and 2016 is based on awards ultimately expected to vest, it has been reduced for annual estimated forfeitures of zero to four percent. If the actual number of forfeitures differs from those estimated, additional adjustments to compensation expense may be required in future periods. If vesting of an award is conditioned upon the achievement of performance goals, compensation expense during the performance period is estimated using the most probable outcome of the performance goals, and adjusted as the expected outcome changes. The Company recognizes compensation costs for awards that do not contain performance conditions on a straight‑line basis over the requisite service period, which is generally the vesting term of three years. For restricted stock units that include performance conditions, stock compensation is recognized using an accelerated method over the vesting period.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current year presentation.

In order to better represent the operations of the Company’s segments, effective January 1, 2016, the Company began allocating operational and corporate support costs to the Healthcare and Pharmacy Management segments. For comparative presentation, the Company applied the allocation methodology retrospectively and reclassified direct service costs and other between segments for the years ended December 31, 2014 and 2015. The impact of these reclassifications are disclosed in Note 10—“Business Segment Information”.

The Company elected to early adopt ASU 2016-18 effective for the fiscal year ended December 31, 2016 and applied it retrospectively. See Note—2 “Summary of Significant Accounting Policies—Recent Accounting Pronouncements” for the impact to the Company’s financial statements.