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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission file number: 001-31719
 
 
 
 
https://cdn.kscope.io/427ab8c5cdacc1921fcad76564352300-molinalogo2016a13.jpg
MOLINA HEALTHCARE, INC.
(Exact name of registrant as specified in its charter)
 
 
 
 
Delaware
 
13-4204626
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
200 Oceangate, Suite 100
Long Beach, California
 
90802
(Address of principal executive offices)
 
(Zip Code)
(562) 435-3666
(Registrant’s telephone number, including area code)
 
 
 
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.    Yes  ý    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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


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Large accelerated filer
ý
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 
Yes  ¨ No  ý
The number of shares of the issuer’s Common Stock, $0.001 par value, outstanding as of April 28, 2017, was approximately 57,004,000.


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MOLINA HEALTHCARE, INC. FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED March 31, 2017

TABLE OF CONTENTS
 
Page

CROSS-REFERENCE INDEX
ITEM NUMBER
Page

 
 
 
PART I - Financial Information
 
 
 
 
1.

 
 
 
2.

 
 
 
3.
Quantitative and Qualitative Disclosures About Market Risk
41

 
 
 
4.

 
 
 
Part II - Other Information
 
 
 
 
1.

 
 
 
1A.

 
 
 
2.

 
 
 
3.
Defaults Upon Senior Securities
Not Applicable.

 
 
 
4.
Mine Safety Disclosures
Not Applicable.

 
 
 
5.
Other Information
Not Applicable.

 
 
 
6.

 
 
 
 

 
 
 
 
 
 



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FINANCIAL STATEMENTS
MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF INCOME
 
Three Months Ended March 31,
 
2017
 
2016
 
(In millions, except per-share data)
(Unaudited)
Revenue:
 
 
 
Premium revenue
$
4,648

 
$
3,995

Service revenue
131

 
140

Premium tax revenue
111

 
109

Health insurer fee revenue

 
90

Investment income and other revenue
14

 
9

Total revenue
4,904

 
4,343

Operating expenses:
 
 
 
Medical care costs
4,111

 
3,588

Cost of service revenue
122

 
127

General and administrative expenses
439

 
340

Premium tax expenses
111

 
109

Health insurer fee expenses

 
58

Depreciation and amortization
39

 
32

Total operating expenses
4,822

 
4,254

Operating income
82

 
89

Other (income) expenses, net:
 
 
 
Interest expense
26

 
25

Other income, net
(75
)
 

Total other (income) expenses, net
(49
)
 
25

Income before income tax expense
131

 
64

Income tax expense
54

 
40

Net income
$
77

 
$
24

 
 
 
 
Net income per share:
 
 
 
Basic
$
1.38

 
$
0.44

Diluted
$
1.37

 
$
0.43

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Three Months Ended March 31,
 
2017
 
2016
 
(Amounts in millions)
(Unaudited)
Net income
$
77

 
$
24

Other comprehensive income:
 
 
 
Unrealized investment gain
1

 
9

Less: effect of income taxes

 
3

Other comprehensive income, net of tax
1

 
6

Comprehensive income
$
78

 
$
30

See accompanying notes.

Molina Healthcare, Inc. 2017 Form 10-Q | 4

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MOLINA HEALTHCARE, INC.
CONSOLIDATED BALANCE SHEETS
 
March 31,
2017
 
December 31,
2016
 
(Amounts in millions,
except per-share data)
 
(Unaudited)
 
 
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
3,198

 
$
2,819

Investments
2,056

 
1,758

Receivables
1,006

 
974

Income taxes refundable

 
39

Prepaid expenses and other current assets
142

 
131

Derivative asset

 
267

Total current assets
6,402

 
5,988

Property, equipment, and capitalized software, net
447

 
454

Deferred contract costs
89

 
86

Intangible assets, net
131

 
140

Goodwill
620

 
620

Restricted investments
115

 
110

Deferred income taxes
10

 
10

Derivative asset
181

 

Other assets
43

 
41

 
$
8,038

 
$
7,449

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
Medical claims and benefits payable
$
1,926

 
$
1,929

Amounts due government agencies
1,575

 
1,202

Accounts payable and accrued liabilities
438

 
385

Deferred revenue
461

 
315

Income taxes payable
21

 

Current portion of long-term debt
1

 
472

Derivative liability

 
267

Total current liabilities
4,422

 
4,570

Senior notes
1,455

 
975

Lease financing obligations
198

 
198

Deferred income taxes
11

 
15

Derivative liability
181

 

Other long-term liabilities
44

 
42

Total liabilities
6,311

 
5,800

 
 
 
 
Stockholders’ equity:
 
 
 
Common stock, $0.001 par value; 150 shares authorized; outstanding: 57 shares at March 31, 2017 and December 31, 2016

 

Preferred stock, $0.001 par value; 20 shares authorized, no shares issued and outstanding

 

Additional paid-in capital
841

 
841

Accumulated other comprehensive loss
(1
)
 
(2
)
Retained earnings
887

 
810

Total stockholders’ equity
1,727

 
1,649

 
$
8,038

 
$
7,449

See accompanying notes.

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MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Three Months Ended March 31,
 
2017
 
2016
 
(Amounts in millions)
(Unaudited)
Operating activities:
 
 
 
Net income
$
77

 
$
24

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
49

 
44

Deferred income taxes
(5
)
 
30

Share-based compensation
6

 
7

Amortization of convertible senior notes and lease financing obligations
8

 
8

Other, net
3

 
6

Changes in operating assets and liabilities:
 
 
 
Receivables
(32
)
 
(266
)
Prepaid expenses and other assets
(12
)
 
(202
)
Medical claims and benefits payable
(3
)
 
255

Amounts due government agencies
373

 
181

Accounts payable and accrued liabilities
50

 
205

Deferred revenue
146

 
(129
)
Income taxes
59

 
(24
)
Net cash provided by operating activities
719

 
139

Investing activities:
 
 
 
Purchases of investments
(733
)
 
(611
)
Proceeds from sales and maturities of investments
433

 
348

Purchases of property, equipment and capitalized software
(26
)
 
(46
)
Increase in restricted investments
(7
)
 
(4
)
Net cash paid in business combinations

 
(2
)
Other, net
(6
)
 
1

Net cash used in investing activities
(339
)
 
(314
)
Financing activities:
 
 
 
Proceeds from employee stock plans
1

 

Other, net
(2
)
 
2

Net cash (used in) provided by financing activities
(1
)
 
2

Net increase (decrease) in cash and cash equivalents
379

 
(173
)
Cash and cash equivalents at beginning of period
2,819

 
2,329

Cash and cash equivalents at end of period
$
3,198

 
$
2,156


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MOLINA HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
 
Three Months Ended March 31,
 
2017
 
2016
 
(Amounts in millions)
(Unaudited)
Supplemental cash flow information:
 
 
 
 
 
 
 
Schedule of non-cash investing and financing activities:
 
 
 
Common stock used for share-based compensation
$
(6
)
 
$
(7
)
 
 
 
 
Details of change in fair value of derivatives, net:
 
 
 
 (Loss) gain on 1.125% Call Option
$
(86
)
 
$
3

Gain (loss) on 1.125% Conversion Option
86

 
(3
)
Change in fair value of derivatives, net
$

 
$

 
 
 
 
Details of business combinations:
 
 
 
Fair value of assets acquired
$

 
$
(134
)
Purchase price amounts accrued/received

 
30

Reversal of amounts advanced to sellers in prior year

 
102

Net cash paid in business combinations
$

 
$
(2
)
See accompanying notes.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2017

1. Basis of Presentation
Organization and Operations
Molina Healthcare, Inc. provides quality managed health care to people receiving government assistance. We offer cost-effective Medicaid-related solutions to meet the health care needs of low-income families and individuals, and to assist government agencies in their administration of the Medicaid program. We have three reportable segments. These segments consist of our Health Plans segment, which comprises the vast majority of our operations; our Molina Medicaid Solutions segment; and our Other segment.
The Health Plans segment consists of health plans in 12 states and the Commonwealth of Puerto Rico, and includes our direct delivery business. As of March 31, 2017, these health plans served approximately 4.8 million members eligible for Medicaid, Medicare, and other government-sponsored health care programs for low-income families and individuals. This membership includes Affordable Care Act Marketplace (Marketplace) members, most of whom receive government premium subsidies. The health plans are operated by our respective wholly owned subsidiaries in those states, each of which is licensed as a health maintenance organization (HMO). Our direct delivery business consists primarily of the operation of primary care clinics in several states in which we operate.
Our health plans’ state Medicaid contracts generally have terms of three to four years. These contracts typically contain renewal options exercisable by the state Medicaid agency, and allow either the state or the health plan to terminate the contract with or without cause. Our health plan subsidiaries have generally been successful in retaining their contracts, but such contracts are subject to risk of loss when a state issues a new request for proposal (RFP) open to competitive bidding by other health plans. If one of our health plans is not a successful responsive bidder to a state RFP, its contract may be subject to non-renewal.
In addition to contract renewal, our state Medicaid contracts may be periodically amended to include or exclude certain health benefits (such as pharmacy services, behavioral health services, or long-term care services); populations such as the aged, blind or disabled (ABD); and regions or service areas.
The Molina Medicaid Solutions segment provides support to state government agencies in the administration of their Medicaid programs, including business processing, information technology development and administrative services.
The Other segment includes primarily our Pathways behavioral health and social services provider, and corporate amounts not allocated to other reportable segments.
Health Plans Segment Recent Developments
Proposed Medicare Acquisition. In August 2016, we entered into agreements with each of Aetna Inc. and Humana Inc. to acquire certain membership and assets related to their Medicare Advantage business (the Proposed Medicare Acquisition). The Proposed Medicare Acquisition was subject to closing conditions including the completion of the proposed acquisition of Humana by Aetna (the Aetna-Humana Merger). In January 2017, the U.S. District Court for the District of Columbia granted the request made by the U.S. Department of Justice in its civil antitrust lawsuit against Aetna and Humana, to prohibit the Aetna-Humana Merger. In February 2017, the Proposed Medicare Acquisition was terminated by the parties pursuant to the terms of the transaction. Under the termination agreement, we received an aggregate termination fee of $75 million from Aetna and Humana in the first quarter of 2017, which was recorded as other income. 
New York Health Plan. On August 1, 2016, we closed on our acquisition of the outstanding equity interests of Today’s Options of New York, Inc., which now operates as Molina Healthcare of New York, Inc. The purchase price allocation was completed, and the final purchase price adjustments were recorded in the first quarter of 2017. Such adjustments were insignificant, and the final purchase price was $38 million.

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Consolidation and Interim Financial Information
The consolidated financial statements include the accounts of Molina Healthcare, Inc., its subsidiaries, and variable interest entities (VIEs) in which Molina Healthcare, Inc. is considered to be the primary beneficiary. Such VIEs are insignificant to our consolidated financial position and results of operations. In the opinion of management, all adjustments considered necessary for a fair presentation of the results as of the date and for the interim periods presented have been included; such adjustments consist of normal recurring adjustments. All significant intercompany balances and transactions have been eliminated. The consolidated results of operations for the current interim period are not necessarily indicative of the results for the entire year ending December 31, 2017.
The unaudited consolidated interim financial statements have been prepared under the assumption that users of the interim financial data have either read or have access to our audited consolidated financial statements for the fiscal year ended December 31, 2016. Accordingly, certain disclosures that would substantially duplicate the disclosures contained in the December 31, 2016 audited consolidated financial statements have been omitted. These unaudited consolidated interim financial statements should be read in conjunction with our December 31, 2016 audited consolidated financial statements.

2. Significant Accounting Policies
Revenue Recognition – Health Plans Segment
Premium revenue is fixed in advance of the periods covered and, except as described below, is not generally subject to significant accounting estimates. Premium revenues are recognized in the month that members are entitled to receive health care services, and premiums collected in advance are deferred. Certain components of premium revenue are subject to accounting estimates and fall into two broad categories discussed in further detail below: 1) “Contractual Provisions That May Adjust or Limit Revenue or Profit;” and 2) “Quality Incentives.”
Contractual Provisions That May Adjust or Limit Revenue or Profit
Medicaid
Medical Cost Floors (Minimums), and Medical Cost Corridors: A portion of our premium revenue may be returned if certain minimum amounts are not spent on defined medical care costs. In the aggregate, we recorded a liability under the terms of such contract provisions of $262 million and $272 million at March 31, 2017 and December 31, 2016, respectively, to amounts due government agencies. Approximately $245 million and $244 million of the liability accrued at March 31, 2017 and December 31, 2016, respectively, relates to our participation in Medicaid Expansion programs.
In certain circumstances, our health plans may receive additional premiums if amounts spent on medical care costs exceed a defined maximum threshold. Receivables relating to such provisions were insignificant at March 31, 2017 and December 31, 2016.
Profit Sharing and Profit Ceiling: Our contracts with certain states contain profit-sharing or profit ceiling provisions under which we refund amounts to the states if our health plans generate profit above a certain specified percentage. In some cases, we are limited in the amount of administrative costs that we may deduct in calculating the refund, if any. Liabilities for profits in excess of the amount we are allowed to retain under these provisions were insignificant at March 31, 2017 and December 31, 2016.
Retroactive Premium Adjustments: State Medicaid programs periodically adjust premium rates on a retroactive basis. In these cases, we must adjust our premium revenue in the period in which we learn of the adjustment, rather than in the months of service to which the retroactive adjustment applies. In the first quarter of 2016, we recorded a retroactive increase to Medicaid premium revenue of approximately $18 million relating to dates of service prior to 2016.
Medicare
Risk Adjustment: Our Medicare premiums are subject to retroactive increase or decrease based on the health status of our Medicare members (measured as a member risk score). We estimate our members’ risk scores and the related amount of Medicare revenue that will ultimately be realized for the periods presented based on our knowledge of our members’ health status, risk scores and Centers for Medicare & Medicaid Services (CMS) practices. Consolidated balance sheet amounts related to anticipated Medicare risk adjustment premiums and Medicare Part D settlements were insignificant at March 31, 2017 and December 31, 2016.

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Minimum MLR: Additionally, federal regulations have established a minimum annual medical loss ratio (Minimum MLR) of 85% for Medicare. The medical loss ratio represents medical costs as a percentage of premium revenue. Federal regulations define what constitutes medical costs and premium revenue. If the Minimum MLR is not met, we may be required to pay rebates to the federal government. We recognize estimated rebates under the Minimum MLR as an adjustment to premium revenue in our consolidated statements of income.
Marketplace
Premium Stabilization Programs: The Affordable Care Act (ACA) established Marketplace premium stabilization programs effective January 1, 2014. These programs, commonly referred to as the “3R’s,” include a permanent risk adjustment program, a transitional reinsurance program, and a temporary risk corridor program. We record receivables or payables related to the 3R programs and the Minimum MLR when the amounts are reasonably estimable as described below, and, for receivables, when collection is reasonably assured. Our receivables (payables) for each of these programs, as of the dates indicated, were as follows:
 
March 31, 2017
 
December 31,
2016
 
Current Benefit Year
 
Prior Benefit Years
 
Total
 
 
 
 
 
 
 
 
 
 
(In millions)
Risk adjustment
$
(247
)
 
$
(522
)
 
$
(769
)
 
$
(522
)
Reinsurance

 
58

 
58

 
55

Risk corridor

 
(5
)
 
(5
)
 
(1
)
Minimum MLR
(37
)
 
(3
)
 
(40
)
 
(1
)
Risk adjustment: Under this permanent program, our health plans’ composite risk scores are compared with the overall average risk score for the relevant state and market pool. Generally, our health plans will make a risk transfer payment into the pool if their composite risk scores are below the average risk score, and will receive a risk transfer payment from the pool if their composite risk scores are above the average risk score. We estimate our ultimate premium based on insurance policy year-to-date experience, and recognize estimated premiums relating to the risk adjustment program as an adjustment to premium revenue in our consolidated statements of income.
Reinsurance: This program was designed to provide reimbursement to insurers for high cost members and ended December 31, 2016; we expect to settle the outstanding receivable balance in 2017.
Risk corridor: This program was intended to limit gains and losses of insurers by comparing allowable costs to a target amount as defined by CMS, and ended December 31, 2016; we expect to settle the outstanding payable balance in 2017.
Additionally, the ACA established a Minimum MLR of 80% for the Marketplace. The medical loss ratio represents medical costs as a percentage of premium revenue. Federal regulations define what constitutes medical costs and premium revenue. If the Minimum MLR is not met, we may be required to pay rebates to our Marketplace policyholders. Each of the 3R programs is taken into consideration when computing the Minimum MLR. We recognize estimated rebates under the Minimum MLR as an adjustment to premium revenue in our consolidated statements of income.
Quality Incentives
At several of our health plans, revenue ranging from approximately 1% to 3% of certain health plan premiums is earned only if certain performance measures are met.
The following table quantifies the quality incentive premium revenue recognized for the periods presented, including the amounts earned in the periods presented and prior periods. Although the reasonably possible effects of a change in estimate related to quality incentive premium revenue as of March 31, 2017 are not known, we have no reason to believe that the adjustments to prior years noted below are not indicative of the potential future changes in our estimates as of March 31, 2017.

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Three Months Ended March 31,
 
2017
 
2016
 
(In millions)
Maximum available quality incentive premium - current period
$
38

 
$
40

Amount of quality incentive premium revenue recognized in current period:
 
 
 
Earned current period
$
19

 
$
18

Earned prior periods
5

 
5

Total
$
24

 
$
23

 
 
 
 
Quality incentive premium revenue recognized as a percentage of total premium revenue
0.5
%
 
0.6
%
Income Taxes
The provision for income taxes is determined using an estimated annual effective tax rate, which is generally greater than the U.S. federal statutory rate primarily because of state taxes, nondeductible expenses such as the Health Insurer Fee (HIF), certain compensation, and other general and administrative expenses. The effective tax rate in the first quarter of 2017 decreased significantly, compared with prior year levels, due primarily to the 2017 HIF moratorium.
The effective tax rate may be subject to fluctuations during the year, particularly as a result of the level of pretax earnings, and also as new information is obtained. Such information may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of pretax earnings in the various tax jurisdictions in which we operate, valuation allowances against deferred tax assets, the recognition or the reversal of the recognition of tax benefits related to uncertain tax positions, and changes in or the interpretation of tax laws in jurisdictions where we conduct business. We recognize deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities, along with net operating loss and tax credit carryovers.
Premium Deficiency Reserves on Loss Contracts
We assess the profitability of our medical care policies to identify groups of contracts where current operating results or forecasts indicate probable future losses. If anticipated future variable costs exceed anticipated future premiums and investment income, a premium deficiency reserve is recognized. We recorded a premium deficiency reserve of $30 million as of December 31, 2016 relating to our Marketplace program, which decreased to $22 million as of March 31, 2017.
Recent Accounting Pronouncements
Goodwill Impairment. In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-04, Simplifying the Test for Goodwill Impairment, which eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, an impairment charge will be the excess of the carrying amount of the reporting unit, including goodwill, over the fair value of the reporting unit. ASU 2017-04 is effective beginning January 1, 2020; early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. We intend to early adopt ASU 2017-04 and will apply the provisions of this standard in our interim or annual goodwill impairment tests subsequent to January 1, 2017. We are unable to quantify the impact of adoption to future quarters because the impact of this standard is dependent on the fair value of our reporting units at the time an impairment assessment is performed.
Stock Compensation. In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation – Stock Compensation. ASU 2016-09 simplifies several aspects of accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, statutory tax and classification in the statement of cash flows. We adopted ASU 2016-09 in the first quarter of 2017; such adoption did not significantly impact our consolidated financial statements in the first quarter of 2017. In addition, the prior period presentation in the statement of cash flows was not adjusted because such adjustments were insignificant. We are unable to quantify the impact of adoption to future quarters, however, because such impact is dependent on future stock prices which we cannot predict.
Leases. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), as modified by ASU 2017-03, Transition and Open Effective Date Information. Under ASU 2016-02, an entity will be required to recognize assets and liabilities for the rights and obligations created by leases on the entity’s balance sheet for both finance and operating leases. For leases with a term of 12 months or less, an entity can elect to not recognize lease assets and lease liabilities and expense the lease over a straight-line basis for the term of the lease. ASU 2016-02 will require

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new disclosures that depict the amount, timing, and uncertainty of cash flows pertaining to an entity’s leases. ASU 2016-02 is effective for us beginning January 1, 2019 and must be adopted using a modified retrospective approach for annual and interim periods beginning after December 15, 2018. Early adoption is permitted. Under this guidance, we will record assets and liabilities relating primarily to our long-term office leases, and are currently evaluating the effect to our consolidated financial statements.
Revenue Recognition. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). We intend to adopt this standard and the related modifications on January 1, 2018, using the modified retrospective approach. Under this approach, the cumulative effect of initially applying the guidance will be reflected as an adjustment to beginning retained earnings.
We have determined that the insurance contracts of our Health Plans segment, which comprises the vast majority of our operations, are excluded from the scope of ASU 2014-09 because the recognition of revenue under these contracts is dictated by other accounting standards governing insurance contracts. 
For our Molina Medicaid Solutions segment, we have determined that certain service revenue and cost of service revenue will no longer be deferred and recognized over the service delivery period. Rather, service revenue will be recognized based on the expected cost plus gross margin method, and cost of service revenue will be recognized as incurred. As of March 31, 2017, we expect the cumulative adjustment for historical periods through March 31, 2017, to increase retained earnings by no more than $50 million. This estimate will be updated in each quarterly and annual report until adoption. We are currently quantifying the effect of adoption in connection with our Other segment.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the Securities and Exchange Commission (SEC) did not have, or are not believed by management to have, a significant impact on our present or future consolidated financial statements.

3. Net Income per Share
The following table sets forth the calculation of basic and diluted net income per share:
 
Three Months Ended March 31,
 
2017
 
2016
 
(In millions, except net income per share)
Numerator:
 
 
 
Net income
$
77

 
$
24

Denominator:
 
 
 
Denominator for basic net income per share
56

 
55

Effect of dilutive securities:
 
 
 
Share-based compensation

 
1

1.125% Warrants (1)

 
1

Denominator for diluted net income per share
56

 
57

 
 
 
 
Net income per share: (2)
 
 
 
Basic
$
1.38

 
$
0.44

Diluted
$
1.37

 
$
0.43

______________________________
(1)
For more information regarding the 1.125% Warrants, refer to Note 9, “Stockholders' Equity.”
(2)
Source data for calculations in thousands.


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4. Fair Value Measurements
We consider the carrying amounts of cash and cash equivalents and other current assets and current liabilities (not including derivatives and the current portion of long-term debt) to approximate their fair values because of the relatively short period of time between the origination of these instruments and their expected realization or payment. For our financial instruments measured at fair value on a recurring basis, we prioritize the inputs used in measuring fair value according to a three-tier fair value hierarchy as follows:
Level 1 — Observable Inputs. Level 1 financial instruments are actively traded and therefore the fair value for these securities is based on quoted market prices on one or more securities exchanges.
Level 2 — Directly or Indirectly Observable Inputs. Level 2 financial instruments are traded frequently though not necessarily daily. Fair value for these investments is determined using a market approach based on quoted prices for similar securities in active markets or quoted prices for identical securities in inactive markets.
Level 3 — Unobservable Inputs. Level 3 financial instruments are valued using unobservable inputs that represent management’s best estimate of what market participants would use in pricing the financial instrument at the measurement date. Our Level 3 financial instruments include derivative financial instruments.
Derivative financial instruments include the 1.125% Call Option derivative asset and the 1.125% Conversion Option derivative liability. These derivatives are not actively traded and are valued based on an option pricing model that uses observable and unobservable market data for inputs. Significant market data inputs used to determine fair value as of March 31, 2017 included the price of our common stock, the time to maturity of the derivative instruments, the risk-free interest rate, and the implied volatility of our common stock. As described further in Note 8, “Derivatives,” the 1.125% Call Option asset and the 1.125% Conversion Option liability were designed such that changes in their fair values would offset, with minimal impact to the consolidated statements of income. Therefore, the sensitivity of changes in the unobservable inputs to the option pricing model for such instruments is mitigated.
The net changes in fair value of Level 3 financial instruments were insignificant to our results of operations for the three months ended March 31, 2017.
Our financial instruments measured at fair value on a recurring basis at March 31, 2017, were as follows:
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(In millions)
Corporate debt securities
$
1,353

 
$

 
$
1,353

 
$

Government-sponsored enterprise securities (GSEs)
209

 
209

 

 

U.S. treasury notes
193

 
193

 

 

Municipal securities
152

 

 
152

 

Asset-backed securities
110

 

 
110

 

Certificates of deposit
39

 

 
39

 

Subtotal - current investments
2,056

 
402

 
1,654

 

1.125% Call Option derivative asset
181

 

 

 
181

Total assets measured at fair value on a recurring basis
$
2,237

 
$
402

 
$
1,654

 
$
181

 
 
 
 
 
 
 
 
1.125% Conversion Option derivative liability
$
181

 
$

 
$

 
$
181

Total liabilities measured at fair value on a recurring basis
$
181

 
$

 
$

 
$
181


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Our financial instruments measured at fair value on a recurring basis at December 31, 2016, were as follows:
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(In millions)
Corporate debt securities
$
1,179

 
$

 
$
1,179

 
$

GSEs
231

 
231

 

 

U.S. treasury notes
84

 
84

 

 

Municipal securities
142

 

 
142

 

Asset-backed securities
69

 

 
69

 

Certificates of deposit
53

 

 
53

 

Subtotal - current investments
1,758

 
315

 
1,443

 

1.125% Call Option derivative asset
267

 

 

 
267

Total assets measured at fair value on a recurring basis
$
2,025

 
$
315

 
$
1,443

 
$
267

 
 
 
 
 
 
 
 
1.125% Conversion Option derivative liability
$
267

 
$

 
$

 
$
267

Total liabilities measured at fair value on a recurring basis
$
267

 
$

 
$

 
$
267

Fair Value Measurements – Disclosure Only
The carrying amounts and estimated fair values of our senior notes, which are classified as Level 2 financial instruments, are indicated in the following table.
 
March 31, 2017
 
December 31, 2016
 
Carrying
Value
 

Fair Value
 
Carrying
Value
 

Fair Value
 
(In millions)
5.375% Notes
$
691

 
$
726

 
$
691

 
$
714

1.125% Convertible Notes
477

 
705

 
471

 
792

1.625% Convertible Notes
287

 
321

 
284

 
344

 
$
1,455

 
$
1,752

 
$
1,446

 
$
1,850


5. Investments
Available-for-Sale Investments
The following tables summarize our investments as of the dates indicated:
 
March 31, 2017
 
Amortized
 
Gross
Unrealized
 
Estimated
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
(In millions)
Corporate debt securities
$
1,354

 
$
1

 
$
2

 
$
1,353

GSEs
210

 

 
1

 
209

U.S. treasury notes
193

 

 

 
193

Municipal securities
153

 

 
1

 
152

Asset-backed securities
110

 

 

 
110

Certificates of deposit
39

 

 

 
39

 
$
2,059

 
$
1

 
$
4

 
$
2,056


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December 31, 2016
 
Amortized
 
Gross
Unrealized
 
Estimated
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
(In millions)
Corporate debt securities
$
1,180

 
$
1

 
$
2

 
$
1,179

GSEs
232

 

 
1

 
231

U.S. treasury notes
84

 

 

 
84

Municipal securities
143

 

 
1

 
142

Asset-backed securities
69

 

 

 
69

Certificates of deposit
53

 

 

 
53

 
$
1,761

 
$
1

 
$
4

 
$
1,758

The contractual maturities of our investments as of March 31, 2017 are summarized below:
 
Amortized Cost
 
Estimated
Fair Value
 
(In millions)
Due in one year or less
$
1,151

 
$
1,151

Due after one year through five years
872

 
870

Due after five years through ten years
36

 
35

 
$
2,059

 
$
2,056

Gross realized gains and losses from sales of available-for-sale securities are calculated under the specific identification method and are included in investment income. Gross realized investment gains and losses for the three months ended March 31, 2017 and 2016 were insignificant.
We have determined that unrealized losses at March 31, 2017 and December 31, 2016, are temporary in nature, because the change in market value for these securities has resulted from fluctuating interest rates, rather than a deterioration of the credit worthiness of the issuers. So long as we maintain the intent and ability to hold these securities to maturity, we are unlikely to experience losses. In the event that we dispose of these securities before maturity, we expect that realized losses, if any, will be insignificant. 
The following table segregates those available-for-sale investments that have been in a continuous loss position for less than 12 months, and those that have been in a loss position for 12 months or more as of March 31, 2017:
 
In a Continuous Loss Position
for Less than 12 Months
 
In a Continuous Loss Position
for 12 Months or More
 
Estimated
Fair
Value
 
Unrealized
Losses
 
Total
Number of
Positions
 
Estimated
Fair
Value
 
Unrealized
Losses
 
Total
Number of
Positions
 
(Dollars in millions)
Corporate debt securities
$
570

 
$
2

 
341

 
$

 
$

 

GSEs
200

 
1

 
83

 

 

 

Municipal securities
84

 
1

 
101

 

 

 

 
$
854

 
$
4

 
525

 
$

 
$

 

The following table segregates those available-for-sale investments that have been in a continuous loss position for less than 12 months, and those that have been in a loss position for 12 months or more as of December 31, 2016:
 
In a Continuous Loss Position
for Less than 12 Months
 
In a Continuous Loss Position
for 12 Months or More
 
Estimated
Fair
Value
 
Unrealized
Losses
 
Total
Number of
Positions
 
Estimated
Fair
Value
 
Unrealized
Losses
 
Total
Number of
Positions
 
(Dollars in millions)
Corporate debt securities
$
542

 
$
2

 
378

 
$

 
$

 

GSEs
198

 
1

 
73

 

 

 

Municipal securities
101

 
1

 
129

 

 

 

 
$
841

 
$
4

 
580

 
$

 
$

 


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Held-to-Maturity Investments
Pursuant to the regulations governing our Health Plans segment subsidiaries, we maintain statutory deposits and deposits required by government authorities primarily in certificates of deposit and U.S. treasury securities. We also maintain restricted investments as protection against the insolvency of certain capitated providers. The use of these funds is limited as required by regulation in the various states in which we operate, or as needed in the event of insolvency of capitated providers. We have the ability to hold our restricted investments until maturity, and as a result, we would not expect the value of these investments to decline significantly due to a sudden change in market interest rates.
The contractual maturities of our restricted investments, which are designated as held-to-maturity and are carried at amortized cost, which approximates fair value, as of March 31, 2017 are summarized below:
 
Amortized
Cost
 
Estimated
Fair Value
 
(In millions)
Due in one year or less
$
97

 
$
97

Due after one year through five years
18

 
18

 
$
115

 
$
115


6. Medical Claims and Benefits Payable
The following table provides the details of our medical claims and benefits payable (including amounts payable for the provision of long-term services and supports, or LTSS) as of the dates indicated.
 
March 31,
2017
 
December 31,
2016
 
(In millions)
Fee-for-service claims incurred but not paid (IBNP)
$
1,425

 
$
1,352

Pharmacy payable
133

 
112

Capitation payable
36

 
37

Other
332

 
428

 
$
1,926

 
$
1,929

“Other” medical claims and benefits payable include amounts payable to certain providers for which we act as an intermediary on behalf of various government agencies without assuming financial risk. Such receipts and payments do not impact our consolidated statements of income. Non-risk provider payables amounted to $131 million and $225 million as of March 31, 2017 and December 31, 2016, respectively.
The following table presents the components of the change in our medical claims and benefits payable for the periods indicated. The amounts presented for “Components of medical care costs related to: Prior periods” represent the amount by which our original estimate of medical claims and benefits payable at the beginning of the period were more than the actual amount of the liability based on information (principally the payment of claims) developed since that liability was first reported.

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Three Months Ended March 31,
 
2017
 
2016
 
(Dollars in millions)
Medical claims and benefits payable, beginning balance
$
1,929

 
$
1,685

Components of medical care costs related to:
 
 
 
Current period
4,253

 
3,755

Prior periods
(142
)
 
(167
)
Total medical care costs
4,111

 
3,588

 
 
 
 
Change in non-risk provider payables
(96
)
 
24

 
 
 
 
Payments for medical care costs related to:
 
 
 
Current period
2,683

 
2,241

Prior periods
1,335

 
1,116

Total paid
4,018

 
3,357

Medical claims and benefits payable, ending balance
$
1,926

 
$
1,940

Benefit from prior period as a percentage of:
 
 
 
Balance at beginning of period
7.4
%
 
10.0
%
Premium revenue, trailing twelve months
0.8
%
 
1.2
%
Medical care costs, trailing twelve months
0.9
%
 
1.3
%
Reinsurance recoverables of $67 million and $61 million as of March 31, 2017 and December 31, 2016, respectively, are included in receivables.
As indicated above, the amounts ultimately paid out on our medical claims and benefits payable liabilities in fiscal years 2017 and 2016 were less than what we had expected when we had established those liabilities. The differences between our original estimates and the amounts ultimately paid out (or now expected to be ultimately paid out) for the most part related to IBNP. While many related factors working in conjunction with one another serve to determine the accuracy of our estimates, we are seldom able to quantify the impact that any single factor has on a change in estimate. In addition, given the variability inherent in the reserving process, we will only be able to identify specific factors if they represent a significant departure from expectations. As a result, we do not expect to be able to fully quantify the impact of individual factors on changes in estimates.
We believe that the most significant uncertainties surrounding our IBNP estimates at March 31, 2017 are as follows:
In the first quarter of 2017, our Marketplace enrollment across all health plans increased over 500,000 members. Due to limited insight into the cost patterns associated with this large number of new Marketplace members, our liability estimates for these members are subject to more than the usual amount of uncertainty.
At our Florida health plan, claims receipts increased significantly over the last few months due to an increase in the receipt of secondary claims, many of which are not our liability. These claims, known as COBA (coordination of benefits agreement) claims, will either be denied or will have very small paid amounts. For this reason, claims denial rates, amounts paid per claim and other claims indicators will be impacted, making our liability estimates subject to more than the usual amount of uncertainty.
At our Illinois health plan, we paid a large number of claims in the first quarter of 2017 that had previously been denied and disputed by providers. This has created some distortion in the payment patterns, making our liability estimates subject to more than the usual amount of uncertainty.
We recognized favorable prior period claims development in the amount of $142 million for the three months ended March 31, 2017. This amount represents our estimate as of March 31, 2017, of the extent to which our initial estimate of medical claims and benefits payable at December 31, 2016 was more than the amount that will ultimately be paid out in satisfaction of that liability. We believe the overestimation was due primarily to the following factors:
At our Puerto Rico health plan, we increased the outpatient claims liability at December 31, 2016 due to a significant increase in pharmacy utilization, which typically indicates that outpatient costs will also be increasing. However, our actual outpatient costs were ultimately lower than our estimates.

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At our California health plan, we increased our claims liability at December 31, 2016 to reflect delays in the processing of paper claims. Subsequent adjudication of those claims has demonstrated that our actual additional claim costs were less than the additional amount we added to the December 31, 2016 liability estimate.
At our Texas health plan, higher than expected claims recoveries caused our actual costs to be less than expected.

7. Debt
Substantially all of our debt is held at the parent, which is reported in the Other segment. The following table summarizes our outstanding debt obligations and their classification in the accompanying consolidated balance sheets (in millions):
 
March 31,
2017
 
December 31,
2016
Current portion of long-term debt:
 
 
 
1.125% Convertible Notes, net of unamortized discount
$

 
$
477

Lease financing obligations
1

 
1

Debt issuance costs

 
(6
)
 
1

 
472

Senior notes:
 
 
 
5.375% Notes
700

 
700

1.125% Convertible Notes, net of unamortized discount
482

 

1.625% Convertible Notes, net of unamortized premium and discount
289

 
286

Debt issuance costs
(16
)
 
(11
)
 
1,455

 
975

Lease financing obligations
198

 
198

 
$
1,654

 
$
1,645

5.375% Notes due 2022
We have outstanding $700 million aggregate principal amount of senior notes (5.375% Notes) due November 15, 2022, unless earlier redeemed. According to their terms, the guarantees under the 5.375% Notes mirror those of the Credit Facility, defined and described below. See Note 14, “Supplemental Condensed Consolidating Financial Information,” for more information on the guarantors.
Credit Facility
In January 2017, we entered into an amended unsecured $500 million revolving credit facility (Credit Facility), referred to as the First Amendment. As of March 31, 2017, outstanding letters of credit amounting to $6 million reduced our borrowing capacity under the Credit Facility to $494 million. The Credit Facility has a term of five years and all amounts outstanding will be due and payable on January 31, 2022. Subject to obtaining commitments from existing or new lenders and satisfaction of other specified conditions, we may increase the Credit Facility to up to $650 million. As of March 31, 2017, no amounts were outstanding under the Credit Facility.
In addition to increasing amounts available to borrow under the Credit Facility and extending its term, the First Amendment provided that all guarantors immediately prior to January 3, 2017, other than Molina Information Systems, LLC, d/b/a Molina Medicaid Solutions, Molina Pathways, LLC, and Pathways Health and Community Support LLC, were automatically and unconditionally released from their obligations as guarantors of the Credit Facility and the 5.375% Notes.
The Credit Facility contains customary non-financial and financial covenants, including a net leverage ratio and an interest coverage ratio. In February 2017, we entered into a second amendment to the Credit Facility (the Second Amendment) which modified the Credit Facility’s definition of the earnings measure used in the financial covenant computations to a) allow us to receive credit for risk corridor payments owed to, but not received or accrued by us during 2016; and b) account for the difference between the amount of actual risk transfer payments made or accrued by us during 2016, and the amount of risk transfer payments that would have been due under the federal

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government’s proposed 2018 risk adjustment payment transfer formula. At March 31, 2017, we were in compliance with all financial and non-financial covenants under the Credit Facility.
Convertible Senior Notes
We have outstanding $550 million aggregate principal amount of 1.125% cash convertible senior notes due January 15, 2020, unless earlier repurchased or converted. We refer to these notes as our 1.125% Convertible Notes. We also have outstanding $302 million aggregate principal amount of 1.625% convertible senior notes due August 14, 2044, unless earlier repurchased, redeemed, or converted. We refer to these notes as our 1.625% Convertible Notes. The 1.125% Convertible Notes are convertible entirely to cash, and the 1.625% Convertible Notes are convertible partially to cash, each prior to their respective maturity dates under certain circumstances, one of which relates to the closing price of our common stock over a specified period. We refer to this conversion trigger as the stock price trigger.
The stock price trigger for the 1.125% Convertible Notes is $53.00 per share. The stock price trigger for the 1.625% Convertible Notes is $75.51 per share. The 1.125% Convertible Notes and the 1.625% Convertible Notes did not meet their respective stock price triggers in the quarter ended March 31, 2017; therefore, they were not convertible and were reported as non-current as of March 31, 2017.
The 1.625% Convertible Notes have a contractual maturity date in 2044; however, on contractually specified dates beginning in August 2018, holders may require us to repurchase some or all of the 1.625% Convertible Notes, or we may redeem any or all of the 1.625% Convertible Notes.
Cross Default Provisions
The terms of our 5.375% Notes and each of the 1.125% and 1.625% Convertible Notes contain cross default provisions with the Credit Facility that are triggered upon an event of default under the Credit Facility, and when borrowings under the Credit Facility equal or exceed certain amounts as defined in the related indentures.
Debt Commitment Letter
In connection with the Proposed Medicare Acquisition, we entered into a debt commitment letter with Barclays Bank PLC (Barclays) in August 2016. Under this debt commitment letter, Barclays agreed to lend us up to $400 million, subject to satisfaction of certain conditions, including consummation of the Proposed Medicare Acquisition. The debt commitment letter automatically terminated in February 2017 as a result of the termination of the Proposed Medicare Acquisition. The costs associated with the debt commitment letter and its termination were reimbursed as described in Note 1, “Basis of PresentationHealth Plans Segment Recent Developments.”

8. Derivatives
The following table summarizes the fair values and the presentation of our derivative financial instruments (defined and discussed individually below) in the consolidated balance sheets:
 
Balance Sheet Location
 
March 31,
2017
 
December 31,
2016
 
 
 
(In millions)
Derivative asset:
 
 
 
 
 
1.125% Call Option
Current assets: Derivative asset
 
$

 
$
267

 
Non-current assets: Derivative asset
 
$
181

 
$

Derivative liability:
 
 
 
 
 
1.125% Conversion Option
Current liabilities: Derivative liability
 
$

 
$
267

 
Non-current liabilities: Derivative liability
 
$
181

 
$

Our derivative financial instruments do not qualify for hedge treatment; therefore the change in fair value of these instruments is recognized immediately in our consolidated statements of income, and reported in other income, net. Gains and losses for our derivative financial instruments are presented individually in the consolidated statements of cash flows, supplemental cash flow information.
1.125% Notes Call Spread Overlay. Concurrent with the issuance of the 1.125% Convertible Notes in 2013, we entered into privately negotiated hedge transactions (collectively, the 1.125% Call Option) and warrant transactions

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(collectively, the 1.125% Warrants), with certain of the initial purchasers of the 1.125% Convertible Notes (the Counterparties). We refer to these transactions collectively as the Call Spread Overlay. Under the Call Spread Overlay, the cost of the 1.125% Call Option we purchased to cover the cash outlay upon conversion of the 1.125% Convertible Notes was reduced by proceeds from the sale of the 1.125% Warrants. Assuming full performance by the Counterparties (and 1.125% Warrants strike prices in excess of the conversion price of the 1.125% Convertible Notes), these transactions are intended to offset cash payments in excess of the principal amount of the 1.125% Convertible Notes due upon any conversion of such Notes.
1.125% Call Option. The 1.125% Call Option, which is indexed to our common stock, is a derivative asset that requires mark-to-market accounting treatment due to cash settlement features until the 1.125% Call Option settles or expires. For further discussion of the inputs used to determine the fair value of the 1.125% Call Option, refer to Note 4, “Fair Value Measurements.”
1.125% Conversion Option. The embedded cash conversion option within the 1.125% Convertible Notes is accounted for separately as a derivative liability, with changes in fair value reported in our consolidated statements of income until the cash conversion option settles or expires. For further discussion of the inputs used to determine the fair value of the 1.125% Conversion Option, refer to Note 4, “Fair Value Measurements.”
As of March 31, 2017, the 1.125% Call Option and the 1.125% Conversion Option were classified as a non-current asset and non-current liability, respectively, because the 1.125% Convertible Notes were not convertible as of March 31, 2017, as described in Note 7, “Debt.”

9. Stockholders' Equity
Stockholders’ equity increased $78 million during the three months ended March 31, 2017 compared with stockholders’ equity at December 31, 2016. The increase was due to net income of $77 million and $1 million of other comprehensive income.
1.125% Warrants
In connection with the Call Spread Overlay transaction described in Note 8, “Derivatives,” in 2013, we issued 13,490,236 warrants with a strike price of $53.8475 per share. Under certain circumstances, beginning in April 2020, when the price of our common stock exceeds the strike price of the 1.125% Warrants, we will be obligated to issue shares of our common stock subject to a share delivery cap. The 1.125% Warrants could separately have a dilutive effect to the extent that the market value per share of our common stock exceeds the applicable strike price of the 1.125% Warrants. Refer to Note 3, “Net Income per Share,” for dilution information for the periods presented. We will not receive any additional proceeds if the 1.125% Warrants are exercised.
Stock Incentive Plans
In connection with our equity incentive plans and employee stock purchase plan, approximately 246,000 shares of common stock were purchased or vested, net of shares used to settle employees’ income tax obligations, during the three months ended March 31, 2017.
As of March 31, 2017, there was $39 million of total unrecognized compensation expense related to unvested restricted share awards, including those with performance conditions, which we expect to recognize over a remaining weighted-average period of 2.4 years. This unrecognized compensation cost assumes an estimated forfeiture rate of 3.8% for non-executive employees as of March 31, 2017.
Restricted and performance stock activity for the three months ended March 31, 2017 is summarized below:
 
Restricted Shares
 
Performance Shares
 
Total
 
Weighted
Average
Grant Date
Fair Value
Unvested balance as of December 31, 2016
577,244

 
345,656

 
922,900

 
$
58.15

Granted
351,214

 

 
351,214

 
49.51

Vested
(208,425
)
 
(107,320
)
 
(315,745
)
 
51.88

Forfeited
(5,061
)
 

 
(5,061
)
 
63.71

Unvested balance as of March 31, 2017
714,972

 
238,336

 
953,308

 
57.02

The total fair value of restricted awards, including those with performance or market conditions, granted during the three months ended March 31, 2017 and 2016 was $17 million and $18 million, respectively. The total fair value of

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restricted awards, including those with performance and market conditions, which vested during the three months ended March 31, 2017 and 2016 was $16 million and $32 million, respectively.

10. Segment Information
We have three reportable segments. These segments consist of our Health Plans segment, which comprises the vast majority of our operations; our Molina Medicaid Solutions segment; and our Other segment. Our reportable segments are consistent with how we currently manage the business and view the markets we serve.
Gross margin is the appropriate earnings measure for our reportable segments, based on how our chief operating decision maker currently reviews results, assesses performance, and allocates resources.
Gross margin for our Health Plans segment is referred to as “Medical margin,” and for our Molina Medicaid Solutions and Other segments, as “Service margin.” Medical margin represents the amount earned by the Health Plans segment after medical costs are deducted from premium revenue. The medical care ratio represents medical care costs as a percentage of premium revenue, and is one of the key metrics used to assess the performance of the Health Plans segment. Therefore, the underlying medical margin is the most important measure of earnings reviewed by the chief operating decision maker. The service margin is equal to service revenue minus cost of service revenue.
 
 
Health Plans
 
Molina Medicaid Solutions
 
Other
 
Consolidated
 
 
 
 
 
 
 
(In millions)
Three Months Ended March 31, 2017
 
 
 
 
 
 
 
 
Total revenue (1)
 
$
4,771

 
$
46

 
$
87

 
$
4,904

Gross margin
 
537

 
4

 
5

 
546

 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2016
 
 
 
 
 
 
 
 
Total revenue (1)
 
4,201

 
52

 
90

 
4,343

Gross margin
 
407

 
6

 
7

 
420

 
 
 
 
 
 
 
 
 
Total Assets
 
 
 
 
 
 
 
 
March 31, 2017
 
6,586

 
279

 
1,173

 
8,038

December 31, 2016
 
5,897

 
267

 
1,285

 
7,449

______________________
(1)
Total revenue consists primarily of premium revenue, premium tax revenue and health insurer fee revenue for the Health Plans segment, and service revenue for the Molina Medicaid Solutions and Other segments. Inter-segment revenue is insignificant.
The following table reconciles gross margin by segment to consolidated income before income tax expense:
 
Three Months Ended March 31,
 
2017
 
2016
 
(In millions)
Gross margin:
 
 
 
Health Plans
$
537

 
$
407

Molina Medicaid Solutions
4

 
6

Other
5

 
7

Total gross margin
546

 
420

Add: other operating revenues (1)
125

 
208

Less: other operating expenses (2)
(589
)
 
(539
)
Operating income
82

 
89

Other (income) expenses, net
(49
)
 
25

Income before income tax expense
$
131

 
$
64


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______________________
(1)
Other operating revenues include premium tax revenue, health insurer fee revenue, investment income and other revenue.
(2)
Other operating expenses include general and administrative expenses, premium tax expenses, health insurer fee expenses and depreciation and amortization.

11. Commitments and Contingencies
Regulatory Capital Requirements and Dividend Restrictions
Our health plans, which are operated by our respective wholly owned subsidiaries in those states, are subject to state laws and regulations that, among other things, require the maintenance of minimum levels of statutory capital, as defined by each state. Regulators in some states may also attempt to enforce capital requirements that require the retention of net worth in excess of amounts formally required by statute or regulation. Such statutes, regulations and informal capital requirements also restrict the timing, payment, and amount of dividends and other distributions that may be paid to us as the sole stockholder. To the extent our subsidiaries must comply with these regulations, they may not have the financial flexibility to transfer funds to us. Based on current statutes and regulations, the net assets in these subsidiaries (after intercompany eliminations) which may not be transferable to us in the form of loans, advances, or cash dividends was approximately $1,527 million at March 31, 2017, and $1,492 million at December 31, 2016. Because of the statutory restrictions that inhibit the ability of our health plans to transfer net assets to us, the amount of retained earnings readily available to pay dividends to our stockholders is generally limited to cash, cash equivalents and investments held by the parent company – Molina Healthcare, Inc. Such cash, cash equivalents and investments amounted to $273 million and $264 million as of March 31, 2017 and December 31, 2016, respectively.
The National Association of Insurance Commissioners (NAIC) adopted rules effective December 31, 1998, which, if implemented by the states, set minimum capitalization requirements for insurance companies, HMOs, and other entities bearing risk for health care coverage. The requirements take the form of risk-based capital (RBC) rules which may vary from state to state. All of the states in which our health plans operate, except California, Florida and New York, have adopted these rules. Such requirements, if adopted by California, Florida and New York, may increase the minimum capital required for those states.
As of March 31, 2017, our health plans had aggregate statutory capital and surplus of approximately $1,722 million compared with the required minimum aggregate statutory capital and surplus of approximately $1,100 million. All of our health plans were in compliance with the minimum capital requirements at March 31, 2017. We have the ability, and have committed to provide, additional capital to each of our health plans as necessary to ensure compliance with statutory capital and surplus requirements.
Legal Proceedings
The health care and Medicaid-related business process outsourcing industries are subject to numerous laws and regulations of federal, state, and local governments. Compliance with these laws and regulations can be subject to government review and interpretation, as well as regulatory actions unknown and unasserted at this time. Penalties associated with violations of these laws and regulations include significant fines and penalties, exclusion from participating in publicly funded programs, and the repayment of previously billed and collected revenues.
We are involved in legal actions in the ordinary course of business, some of which seek monetary damages, including claims for punitive damages, which are not covered by insurance. We have accrued liabilities for certain matters for which we deem the loss to be both probable and estimable. Although we believe that our estimates of such losses are reasonable, these estimates could change as a result of further developments of these matters. The outcome of legal actions is inherently uncertain and such pending matters for which accruals have not been established have not progressed sufficiently through discovery and/or development of important factual information and legal issues to enable us to estimate a range of possible loss, if any. While it is not possible to accurately predict or determine the eventual outcomes of these items, an adverse determination in one or more of these pending matters could have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
Marketplace Risk Corridor Program. On January 19, 2017, we filed suit against the United States of America in the United States Court of Federal Claims, Case Number 1:55-cv-01000-UNJ, on behalf of our health plans seeking recovery from the federal government of approximately $52 million in Marketplace risk corridor payments for calendar year 2015. Based upon current estimates, we believe our health plans are also owed approximately $90 million in Marketplace risk corridor payments from the federal government for calendar year 2016, and a further

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nominal amount for calendar year 2014. Our lawsuit seeks recovery of all of these unpaid amounts. We have not recognized revenue, nor have we recorded a receivable, for any amount due from the federal government for unpaid Marketplace risk corridor payments as of March 31, 2017. We have fully recognized all liabilities due to the federal government that we have incurred under the Marketplace risk corridor program, and have paid all amounts due to the federal government as required.
Rodriguez v. Providence Community Corrections. On October 1, 2015, seven individuals, on behalf of themselves and all others similarly situated, filed a complaint in the District Court for the Middle District of Tennessee, Nashville Division, Case No. 3:15-cv-01048 (the Rodriquez Litigation), against Providence Community Corrections, Inc. (now known as Pathways Community Corrections, Inc., or PCC). Rutherford County, Tennessee formerly contracted with PCC for the administration of misdemeanor probation, which involved the collection of court costs and fees from probationers. The complaint alleges, among other things, that PCC illegally assessed fees and surcharges against probationers and made improper threats of arrest and probation revocation if the probationers did not pay such amounts. The plaintiffs in the Rodriguez Litigation seek alleged compensatory, treble, and punitive damages, plus attorneys’ fees, for alleged federal and state constitutional violations, as well as alleged violations of the Racketeer Influenced and Corrupt Organization Act. PCC’s agreement with Rutherford County terminated effective March 31, 2016. On November 1, 2015, one month after the Rodriguez Litigation commenced, we acquired PCC from The Providence Service Corporation (Providence) pursuant to a membership interest purchase agreement. In September 2016, the parties to the Rodriguez Litigation accepted a mediation proposal for settlement pursuant to which PCC would pay the plaintiffs $14 million. The parties are in the process of finalizing the settlement agreement. We expect to recover the full amount of the settlement under the indemnification provisions of the membership interest purchase agreement with Providence.
United States of America, ex rel., Anita Silingo v. Mobile Medical Examination Services, Inc., et al. On or around October 14, 2014, Molina Healthcare of California, Molina Healthcare of California Partner Plan, Inc., Mobile Medical Examination Services, Inc. (MedXM), and other health plan defendants were served with a Complaint previously filed under seal in the Central District Court of California by Relator, Anita Silingo, Case No. SACV13-1348-FMO(SHx). The Complaint alleges that MedXM improperly modified medical records and otherwise took inappropriate steps to increase members’ risk adjustment scores, and that the defendants, including Molina Healthcare of California and Molina Healthcare of California Partner Plan, Inc., purportedly turned a “blind eye” to these unlawful practices. On October 22, 2015, the Relator filed a third amended complaint, seeking general and compensatory damages, treble damages, civil penalties, plus interest and attorneys’ fees. On July 11, 2016, the District Court dismissed with prejudice the third amended complaint, without leave to amend. On September 23, 2016, the plaintiff filed an appeal with the Ninth Circuit Court of Appeals. The plaintiff/appellant’s opening brief was filed March 6, 2017, and the defendant/appellee’s opening brief is due June 5, 2017.
States’ Budgets
From time to time the states in which our health plans operate may experience financial difficulties, which could lead to delays in premium payments. For example, the state of Illinois is operating without a budget for its current fiscal year. As of March 31, 2017, our Illinois health plan served approximately 194,000 members, and recognized premium revenue of approximately $161 million in the first quarter of 2017. As of April 28, 2017, the state of Illinois owed us approximately $80 million for certain January, February and March 2017 premiums.
On May 3, 2017, Puerto Rico’s financial oversight board filed for a form of bankruptcy in the U.S. District Court in Puerto Rico under Title III of PROMESA. The Title III provision allows for a court debt restructuring process similar to U.S. bankruptcy protection. To the extent such bankruptcy results in our failure to receive payment of amounts due under our Medicaid contract with the Commonwealth or the inability of the Commonwealth to extend our Medicaid contract at the end of its current term, such bankruptcy could have a material adverse effect on our business, financial condition, cash flows, or results of operations. As of March 31, 2017, the plan served approximately 326,000 members and recorded premium revenue of approximately $183 million in the first quarter of 2017. As of April 28, 2017, the Commonwealth is current with its premium payments.
Employment Agreements and Severance Payments
We entered into amended and restated employment agreements with our former Chief Executive Officer (CEO) and former Chief Financial Officer (CFO) in 2016. On May 2, 2017, their employment was terminated without cause. Under the amended and restated employment agreements, subject to such former executives signing a general waiver and release agreement, they are each entitled to receive 400% of their base salary, a prorated termination bonus (150% of base salary for the former CEO and 125% of base salary for the former CFO), full vesting of equity compensation, and a cash payment for health and welfare benefits.


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12. Related Party Transactions
Our California health plan has entered into a provider agreement with Pacific Healthcare IPA (Pacific), which is 50% owned by the brother-in-law of Dr. J. Mario Molina and John C. Molina. Under the terms of this provider agreement, the California health plan pays Pacific for medical care Pacific provides to health plan members. For the three months ended March 31, 2017 and 2016, the amounts paid to Pacific were insignificant.
Refer to Note 13, “Variable Interest Entities (VIEs),” for a discussion of the Joseph M. Molina, M.D. Professional Corporations.

13Variable Interest Entities (VIEs)
The Joseph M. Molina, M.D. Professional Corporations (JMMPC) were created to further advance our direct delivery business. JMMPC’s primary shareholder is Dr. J. Mario Molina, who is a member of our board of directors. Dr. Molina is paid no salary and receives no dividends in connection with his work for, or ownership of, JMMPC. JMMPC provides primary care medical services through its employed physicians and other medical professionals. JMMPC also provides certain specialty referral services to our California health plan members through a contracted provider network. Substantially all of the individuals served by JMMPC are members of our California, Florida, New Mexico, Utah and Washington health plans. These health plans have entered into primary care services agreements with JMMPC, under which the health plans paid $31 million to JMMPC for health care services provided in each of the quarters ended March 31, 2017 and 2016. JMMPC does not have agreements to provide professional medical services with any other entities.
Separately, the primary care services agreements direct our health plans to either fund JMMPC’s operating deficits, or receive JMMPC’s operating surpluses, such that JMMPC will derive no profit or loss. Because the MMM services agreements described below mitigate the likelihood of significant operating deficits or surpluses, such payments are generally insignificant.
Our wholly owned subsidiary, Molina Medical Management, Inc. (MMM), has entered into services agreements with JMMPC to provide clinic facilities, clinic administrative support staff, patient scheduling services and medical supplies to JMMPC. The services agreements were designed such that JMMPC will operate at break even, ensuring the availability of quality care and access for our health plan members. The services agreements provide that the administrative fees charged to JMMPC by MMM are reviewed annually to assure the achievement of this goal. For the three months ended March 31, 2017 and 2016, JMMPC paid $13 million and $14 million, respectively, to MMM for clinic administrative services.
We have determined that JMMPC is a VIE, and that we are its primary beneficiary. We have reached this conclusion under the power and benefits criterion model according to GAAP. Specifically, we have the power to direct the activities (excluding clinical decisions) that most significantly affect JMMPC’s economic performance, and the obligation to absorb losses or right to receive benefits that are potentially significant to the VIE, under the agreements described above. Because we are its primary beneficiary, we have consolidated JMMPC. JMMPC’s assets may be used to settle only JMMPC’s obligations, and JMMPC’s creditors have no recourse to the general credit of Molina Healthcare, Inc. As of March 31, 2017, JMMPC had total assets of $17 million, and total liabilities of $17 million. As of December 31, 2016, JMMPC had total assets of $18 million, and total liabilities of $18 million.
Our maximum exposure to loss as a result of our involvement with JMMPC is generally limited to the amounts needed to fund JMMPC’s ongoing payroll, employee benefits and medical care costs associated with JMMPC’s specialty referral activities. We believe that such loss exposures will be insignificant to our consolidated operating results and cash flows for the foreseeable future.

14. Supplemental Condensed Consolidating Financial Information
The 5.375% Notes described in Note 7, “Debt,” are fully and unconditionally guaranteed by certain of our 100% owned subsidiaries on a joint and several basis, with certain exceptions considered customary for such guarantees. The 5.375% Notes and the guarantees are effectively subordinated to all of our and our guarantors’ existing and future secured debt to the extent of the assets securing such debt. In addition, the 5.375% Notes and the guarantees are structurally subordinated to all indebtedness and other liabilities and preferred stock, if any, of our subsidiaries that do not guarantee the 5.375% Notes.

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As discussed in Note 7, “Debt,” the First Amendment to the Credit Facility provided that all guarantors immediately prior to January 3, 2017, other than Molina Information Systems, LLC, d/b/a Molina Medicaid Solutions, Molina Pathways, LLC, and Pathways Health and Community Support LLC, were automatically and unconditionally released from their obligations as guarantors under the Credit Facility and the 5.375% Notes.
The following condensed consolidating financial statements present Molina Healthcare, Inc. (as parent guarantor), the subsidiary guarantors, the subsidiary non-guarantors and eliminations, according to the guarantor structure as assessed at the most recent balance sheet date, March 31, 2017.

CONDENSED CONSOLIDATING STATEMENTS OF INCOME
 
Three Months Ended March 31, 2017
 
Parent Guarantor
 
Other Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
(In millions)
Revenue:
 
 
 
 
 
 
 
 
 
Total revenue
$
341

 
$
48

 
$
4,857

 
$
(342
)
 
$
4,904

Expenses:
 
 
 
 
 
 
 
 
 
Medical care costs
4

 

 
4,107

 

 
4,111

Cost of service revenue

 
42

 
80

 

 
122

General and administrative expenses
297

 
7

 
477

 
(342
)
 
439

Premium tax expenses

 

 
111

 

 
111

Depreciation and amortization
27

 

 
12

 

 
39

Total operating expenses
328

 
49

 
4,787

 
(342
)
 
4,822

Operating income (loss)
13

 
(1
)
 
70

 

 
82

Interest expense
26

 

 

 

 
26

Other income, net
(75
)
 

 

 

 
(75
)
Income (loss) before income taxes
62

 
(1
)
 
70

 

 
131

Income tax expense
31

 

 
23

 

 
54

Net income (loss) before equity in earnings of subsidiaries
31

 
(1
)
 
47

 

 
77

Equity in net earnings of subsidiaries
46

 
(2
)
 

 
(44
)
 

Net income (loss)
$
77

 
$
(3
)
 
$
47

 
$
(44
)
 
$
77


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Three Months Ended March 31, 2016
 
Parent Guarantor
 
Other Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
(In millions)
Revenue:
 
 
 
 
 
 
 
 
 
Total revenue
$
251

 
$
52

 
$
4,290

 
$
(250
)
 
$
4,343

Expenses:
 
 
 
 
 
 
 
 
 
Medical care costs
12

 

 
3,576

 

 
3,588

Cost of service revenue

 
65

 
62

 

 
127

General and administrative expenses
217

 
(15
)
 
388

 
(250
)
 
340

Premium tax expenses

 

 
109

 

 
109

Health insurer fee expenses

 

 
58

 

 
58

Depreciation and amortization
22

 
2

 
8

 

 
32

Total operating expenses
251

 
52

 
4,201

 
(250
)
 
4,254

Operating income

 

 
89

 

 
89

Interest expense
25

 

 

 

 
25

(Loss) income before income taxes
(25
)
 

 
89

 

 
64

Income tax (benefit) expense
(16
)
 

 
56

 

 
40

Net (loss) income before equity in earnings of subsidiaries
(9
)
 

 
33

 

 
24

Equity in net earnings of subsidiaries
33

 
2

 

 
(35
)
 

Net income
$
24

 
$
2

 
$
33

 
$
(35
)
 
$
24


CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
 
Three Months Ended March 31, 2017
 
Parent Guarantor
 
Other Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Net income (loss)
$
77

 
$
(3
)
 
$
47

 
$
(44
)
 
$
77

Other comprehensive income, net of tax
1

 

 
1

 
(1
)
 
1

Comprehensive income (loss)
$
78

 
$
(3
)
 
$
48

 
$
(45
)
 
$
78

 
Three Months Ended March 31, 2016
 
Parent Guarantor
 
Other Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Net income
$
24

 
$
2

 
$
33

 
$
(35
)
 
$
24

Other comprehensive income, net of tax
6

 

 
5

 
(5
)
 
6

Comprehensive income
$
30

 
$
2

 
$
38

 
$
(40
)
 
$
30



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CONDENSED CONSOLIDATING BALANCE SHEETS
 
March 31, 2017
 
Parent Guarantor
 
Other Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
(In millions)
ASSETS
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
187

 
$
19

 
$
2,992

 
$

 
$
3,198

Investments
86

 

 
1,970

 

 
2,056

Receivables
2

 
41

 
963

 

 
1,006

Due from (to) affiliates
155

 
(7
)
 
(148
)
 

 

Prepaid expenses and other current assets
53

 
22

 
67

 

 
142

Total current assets
483

 
75

 
5,844

 

 
6,402

Property, equipment, and capitalized software, net
294

 
47

 
106

 

 
447

Deferred contract costs

 
89

 

 

 
89

Goodwill and intangible assets, net
56

 
72

 
623

 

 
751

Restricted investments

 

 
115

 

 
115

Investment in subsidiaries, net
2,722

 
244

 

 
(2,966
)
 

Deferred income taxes
10

 

 

 

 
10

Derivative asset
181

 

 

 

 
181

Other assets
50

 
3

 
6

 
(16
)
 
43

 
$
3,796

 
$
530

 
$
6,694

 
$
(2,982
)
 
$
8,038

 
 
 
 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
 
 
 
 
 
 
Medical claims and benefits payable
$

 
$

 
$
1,926

 
$

 
$
1,926

Amounts due government agencies

 

 
1,575

 

 
1,575

Accounts payable and accrued liabilities
187

 
39

 
212

 

 
438

Deferred revenue

 
48

 
413

 

 
461

Income taxes payable
17

 
(7
)
 
11

 

 
21

Current portion of long-term debt
1

 

 

 

 
1

Total current liabilities
205

 
80

 
4,137

 

 
4,422

Long-term debt
1,653

 

 
16

 
(16
)
 
1,653

Deferred income taxes
8

 
42

 
(39
)
 

 
11

Derivative liability
181

 

 

 

 
181

Other long-term liabilities
22

 
1

 
21

 

 
44

Total liabilities
2,069