Newswires

February 29, 2012 Newswires

MOLINA HEALTHCARE INC – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Edgar Online, Inc.

 The following discussion of our financial condition and results of operations should be read in conjunction with the "Selected Financial Data" and the accompanying consolidated financial statements and the notes to those statements appearing elsewhere in this report. This discussion contains forward-looking statements that involve known and unknown risks and uncertainties, including those set forth under Item 1A - Risk Factors, above.

Adjustments

We have adjusted all applicable share and per-share amounts to reflect the retroactive effects of the three-for-two stock split in the form of a stock dividend that was effective May 20, 2011.

Overview

Molina Healthcare, Inc. provides quality and cost-effective Medicaid-related solutions to meet the health care needs of low-income families and individuals, and to assist state agencies in their administration of the Medicaid program. Our business comprises our Health Plans segment, consisting of licensed health maintenance organizations serving Medicaid populations in ten states, and our Molina Medicaid Solutions segment, which provides design, development, implementation, and business process outsourcing solutions to Medicaid agencies in an additional five states. We also have a direct delivery business that currently consists of primary care community clinics in California and Washington; additionally, we manage three county-owned primary care clinics under a contract with Fairfax County, Virginia.

We report our financial performance based on the following two reportable segments: Health Plans; and Molina Medicaid Solutions.

Our Health Plans segment comprises health plans in California, Florida, Michigan, Missouri, New Mexico, Ohio, Texas, Utah, Washington, and Wisconsin, and includes our direct delivery business. This segment served approximately 1.7 million members eligible for Medicaid, Medicare, and other government-sponsored health care programs for low-income families and individuals as of December 31, 2011. The health plans are operated by our respective wholly owned subsidiaries in those states, each of which is licensed as a health maintenance organization, or HMO. On February 17, 2012, the Division of Purchasing of the Missouri Office of Administration notified us that our Missouri health plan was not awarded a contract under the Missouri HealthNet Managed Care Request for Proposal; therefore, our Missouri health plan's existing contract with the state will expire without renewal on June 30, 2012. In connection with this notification, we recorded a non-cash impairment charge of approximately $64.6 million, or $1.34 per diluted share. Most of the impairment charge is not tax deductible, resulting in a disproportionate impact to net income. For the year ended December 31, 2011, our Missouri health plan contributed premium revenue of $229.6 million, or 5% of total premium revenue, and comprised 79,000 members, or 4.7% of total Health Plans segment membership. On May 1, 2010, we acquired a health information management business which we operate under the name, Molina Medicaid Solutions. Our Molina Medicaid Solutions segment provides design, development, implementation, and business process outsourcing solutions to state governments for their Medicaid Management Information Systems, or MMIS. MMIS is a core tool used to support the administration of state Medicaid and other health care entitlement programs. Molina Medicaid Solutions currently holds MMIS contracts with the states of Idaho, Louisiana, Maine, New Jersey, and West Virginia, as well as a contract to provide drug rebate administration services for the Florida Medicaid program. On June 9, 2011, Molina Medicaid Solutions received notice from the state of Louisiana that the state intends to award the contract for a replacement Medicaid Management Information System, or MMIS, to another firm. Our revenue under the Louisiana MMIS contract from May 1, 2010, the date we acquired Molina Medicaid Solutions, through December 31, 2010, was approximately $32 million. For the year ended December 31, 2011, our revenue under the Louisiana MMIS contract was approximately $57 million. We expect that we will continue to perform under this contract through implementation and acceptance of the successor MMIS. Based upon our past experience and our knowledge of the Louisiana MMIS bid process, we believe that implementation and acceptance of the successor MMIS will not occur until 2014 at the earliest. Through implementation and acceptance of the successor MMIS we expect to recognize between $45 million and $50 million in revenue annually under our Louisiana MMIS contract. 37

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Composition of Revenue and Membership

Health Plans Segment

  Our Health Plans segment derives its revenue, in the form of premiums, chiefly from Medicaid contracts with the states in which our health plans operate. Premium revenue is fixed in advance of the periods covered and, except as described in "Critical Accounting Policies" below, is not generally subject to significant accounting estimates. For the year ended December 31, 2011, we received approximately 94% of our premium revenue as a fixed amount per member per month, or PMPM, pursuant to our Medicaid contracts with state agencies, our Medicare contracts with the Centers for Medicare and Medicaid Services, or CMS, and our contracts with other managed care organizations for which we operate as a subcontractor. These premium revenues are recognized in the month that members are entitled to receive health care services. The state Medicaid programs and the federal Medicare program periodically adjust premium rates.

For the year ended December 31, 2011, we received approximately 6% of our premium revenue in the form of "birth income" - a one-time payment for the delivery of a child - from the Medicaid programs in all of our state health plans except New Mexico. Such payments are recognized as revenue in the month the birth occurs.

  The amount of the premiums paid to us may vary substantially between states and among various government programs. Premiums PMPM for the Children's Health Insurance Program, or CHIP, members are generally among our lowest, with rates as low as approximately $70 PMPM in California. Premium revenues for Medicaid members are generally higher. Among the Temporary Assistance for Needy Families, or TANF, Medicaid population - the Medicaid group that includes mostly mothers and children - PMPM premiums range between approximately $110 in California to $250 in Missouri. Among our Medicaid Aged, Blind or Disabled, or ABD, membership, PMPM premiums range from approximately $330 in Utah to $1,400 in Ohio. Contributing to the variability in Medicaid rates among the states is the practice of some states to exclude certain benefits from the managed care contract (most often pharmacy, inpatient, behavioral health and catastrophic case benefits) and retain responsibility for those benefits at the state level. Medicare membership generates the highest average PMPM premiums, at approximately $1,200 PMPM.

The following table sets forth the approximate total number of members by state health plan as of the dates indicated:

                                                         September 30,        September 30,        September 30,                                                                        As of December 31,                                                          2011                 2010                 2009 Total Ending Membership by Health Plan: California                                                  355,000              344,000              351,000 Florida                                                      69,000               61,000               50,000 Michigan                                                    222,000              227,000              223,000 Missouri                                                     79,000               81,000               78,000 New Mexico                                                   88,000               91,000               94,000 Ohio                                                        248,000              245,000              216,000 Texas                                                       155,000               94,000               40,000 Utah                                                         84,000               79,000               69,000 Washington                                                  355,000              355,000              334,000 Wisconsin (1)                                                42,000               36,000                   -  Total                                                     1,697,000            1,613,000            1,455,000  Total Ending Membership by State for our Medicare Advantage Plans(1): California                                                    6,900                4,900                2,100 Florida                                                         800                  500                   - Michigan                                                      8,200                6,300                3,300 New Mexico                                                      800                  600                  400 Ohio                                                            200                   -                    - Texas                                                           700                  700                  500 Utah                                                          8,400                8,900                4,000 Washington                                                    5,000                2,600                1,300  Total                                                        31,000               24,500               11,600                                             38

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  Table of Contents                                                       September 30,        September 30,        September 30,                                                                        As of December 31,                                                          2011                 2010                 2009 Total Ending Membership by State for our Aged, Blind or Disabled Population: California                                                   31,500               13,900               13,900 Florida                                                      10,400               10,000                8,800 Michigan                                                     37,500               31,700               32,200 New Mexico                                                    5,600                5,700                5,700 Ohio                                                         29,100               28,200               22,600 Texas                                                        63,700               19,000               17,600 Utah                                                          8,500                8,000                7,500 Washington                                                    4,800                4,000                3,200 Wisconsin (1)                                                 1,700                1,700                   -  Total                                                       192,800              122,200              111,500

(1) We acquired the Wisconsin health plan on September 1, 2010. As of

December 31, 2011, the Wisconsin health plan had approximately 2,000 Medicare

Advantage members covered under a reinsurance contract with a third party;

these members are not included in the membership tables herein.

Molina Medicaid Solutions Segment

  The payments received by our Molina Medicaid Solutions segment under its state contracts are based on the performance of multiple services. The first of these is the design, development and implementation, or DDI, of a Medicaid Management Information System, or MMIS. An additional service, following completion of DDI, is the operation of the MMIS under a business process outsourcing, or BPO arrangement. While providing BPO services (which include claims payment and eligibility processing) we also provide the state with other services including both hosting and support and maintenance. Because we have determined the services provided under our Molina Medicaid Solutions contracts represent a single unit of accounting, we recognize revenue associated with such contracts on a straight-line basis over the period during which BPO, hosting, and support and maintenance services are delivered.

Composition of Expenses

Health Plans Segment

  Operating expenses for the Health Plans segment include expenses related to the provision of medical care services, G&A expenses, and premium tax expenses. Our results of operations are impacted by our ability to effectively manage expenses related to medical care services and to accurately estimate medical costs incurred. Expenses related to medical care services are captured in the following four categories:

• Fee-for-service: Physician providers paid on a fee-for-service basis are

paid according to a fee schedule set by the state or by our contracts with

these providers. Most hospitals are paid on a fee-for-service basis in a

variety of ways, including per diem amounts, diagnostic-related groups or

DRGs, percent of billed charges, and case rates. As discussed below, we

also pay a small portion of hospitals on a capitated basis. We also have

stop-loss agreements with the hospitals with which we contract. Under all

fee-for-service arrangements, we retain the financial responsibility for

medical care provided. Expenses related to fee-for-service contracts are

recorded in the period in which the related services are dispensed. The

costs of drugs administered in a physician or hospital setting that are

         not billed through our pharmacy benefit managers are included in          fee-for-service costs.

• Capitation: Many of our primary care physicians and a small portion of our

specialists and hospitals are paid on a capitated basis. Under capitation

         contracts, we typically pay a fixed per-member per-month, or PMPM, payment          to the provider without regard to the frequency, extent, or nature of the          medical services actually furnished. Under capitated contracts, we remain          liable for the provision of certain health care services. Certain of our          capitated contracts also contain incentive programs based on service

delivery, quality of care, utilization management, and other criteria.

         Capitation payments are fixed in advance of the periods covered and are          not subject to significant accounting estimates. These payments are

expensed in the period the providers are obligated to provide services.

         The financial risk for pharmacy services for a small portion of our          membership is delegated to capitated providers.

• Pharmacy: Pharmacy costs include all drug, injectibles, and immunization

costs paid through our pharmacy benefit managers. As noted above, drugs

and injectibles not paid through our pharmacy benefit managers are

included in fee-for-service costs, except in those limited instances where

         we capitate drug and injectible costs.                                            39

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• Other: Other medical care costs include medically related administrative

costs, certain provider incentive costs, reinsurance cost, and other

health care expense. Medically related administrative costs include, for

example, expenses relating to health education, quality assurance, case

management, disease management, 24-hour on-call nurses, and a portion of

our information technology costs. Salary and benefit costs are a

substantial portion of these expenses. For the years ended December 31,

         2011, 2010, and 2009, medically related administrative costs were          approximately $102.3 million, $85.5 million, and $74.6 million,          respectively.   Our medical care costs include amounts that have been paid by us through the reporting date as well as estimated liabilities for medical care costs incurred but not paid by us as of the reporting date. See "Critical Accounting Policies" below for a comprehensive discussion of how we estimate such liabilities.

Molina Medicaid Solutions Segment

  Cost of service revenue consists primarily of the costs incurred to provide business process outsourcing and technology outsourcing services under our contracts in Idaho, Louisiana, Maine, New Jersey, West Virginia, and Florida. General and administrative costs consist primarily of indirect administrative costs and business development costs.  In some circumstances we may defer recognition of incremental direct costs (such as direct labor, hardware, and software) associated with a contract if revenue recognition is also deferred. Such deferred contract costs are amortized on a straight-line basis over the remaining original contract term, consistent with the revenue recognition period. We began to recognize deferred contract costs for our Maine contract in September 2010, at the same time we began to recognize revenue associated with that contract. In Idaho, we expect to begin recognition of deferred contract costs in 2012, in a manner consistent with our anticipated recognition of revenue.

2011 Financial Performance Summary

  The following table and narrative briefly summarizes our financial and operating performance for the years ended December 31, 2011, 2010, and 2009. All ratios, with the exception of the medical care ratio and the premium tax ratio, are shown as a percentage of total revenue. The medical care ratio and the premium tax ratio are computed as a percentage of premium revenue because there are direct relationships between premium revenue earned, and the cost of health care and premium taxes.                                                        September 30,           September 30,        September 30,                                                                     Year Ended December 31,                                                         2011                   2010                 2009                                                      (Dollar amounts in thousands, except per-share data) Earnings per diluted share                       $             0.45       $          1.32      $          0.79 Premium revenue                                  $        4,603,407       $     3,989,909      $     3,660,207 Service revenue                                  $          160,447       $        89,809      $            - Operating income                                 $           80,173       $       105,001      $        51,934 Net income                                       $           20,818       $        54,970      $        30,868 Total ending membership                                   1,697,000             1,613,000            1,455,000  Premium revenue                                                96.5 %                97.6 %               99.8 % Service revenue                                                 3.4 %                 2.2 %                 - Investment income                                               0.1 %                 0.2 %                0.2 %  Total revenue                                                 100.0 %               100.0 %              100.0 %   Medical care ratio                                             83.9 %                84.5 %               86.8 % General and administrative expense ratio                        8.7 %                 8.5 %                7.5 % Premium tax ratio                                               3.4 %                 3.5 %                3.5 % Operating income                                                1.7 %                 2.6 %                1.4 % Net income                                                      0.4 %                 1.3 %                0.8 % Effective tax rate                                             67.8 %                38.6 %               19.1 %                                            40

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Year Ended December 31, 2011 Compared with the Year Ended December 31, 2010

Fiscal Year 2011 Overview and Highlights

For the year, our net income was $20.8 million, or $0.45 per diluted share, a decrease of 66% over 2010. As described above, we recorded a non-cash impairment charge of approximately $64.6 million, or $1.34 per diluted share, in connection with the expiration of our Missouri health plan's contract with the state of Missouri effective June 30, 2012. Absent this impairment charge, improved performance of the Health Plans segment drove our improved performance overall for the year ended December 31, 2011. We earned premium revenues of $4.6 billion, up 15.4% over the previous year. Meanwhile, we achieved a medical care ratio of 83.9%, compared with a medical care ratio of 84.5% for fiscal year 2010. We have continued to lay the foundation for further growth, achieving certification of our Medicaid management information system in Maine, winning large contract awards in Texas, serving more of the ABD population in California, and preparing to serve dual-eligible members in many of our states. During 2011, we continued to pursue the expansion of our Health Plans segment; membership grew 8.4% on a member-month basis over 2010. We have expanded our growing presence in Texas, where new contracts in 2010 and 2011 have led to the addition of approximately 61,000 members in 2011, which includes nearly 45,000 new ABD members. This membership growth not only provides increased scale for leveraging our resources in Texas, it makes us an increasingly important player in a state where the potential revenue opportunity will grow as new Medicaid beneficiaries qualify for coverage under health care reform.

Our Texas and Wisconsin health plans continue to face challenges. We have undertaken a number of measures-focused on both utilization and unit cost reductions-to improve the profitability of these health plans.

  We remain concerned about state budget deficits, which are not expected to improve in 2012. Accordingly, the rate environment for our health plans remains uncertain, and we have received several rate reductions in 2011, including a 2.5% reduction in New Mexico effective July 1, 2011, a 2% reduction in Utah effective July 1, 2011, a 2% rate reduction in Texas effective September 1, 2011, and a 1% reduction in California effective October 1, 2011. Additionally, we have received a proposed rate reduction in California that we believe will translate into a premium reduction of approximately 3.5% retroactive to July 1, 2011. However, we have also received rate increases, including a 5% rate increase at our Missouri health plan effective July 1, 2011, a 7.5% rate increase at our Florida plan effective September 1, 2011, and a 1% rate increase at our Michigan plan effective October 1, 2011.  With respect to our Molina Medicaid Solutions business, our MMIS in Maine received full certification from CMS in December 2011. The state of Idaho has sent their formal request for system certification to CMS, and we anticipate certification review in early 2012, with formal certification in the second half of 2012.  Health Plans Segment  Premium Revenue

In the year ended December 31, 2011, compared with the year ended December 31, 2010, premium revenue increased 15.4% due to a membership increase of approximately 8.4% (on a member-month basis), and PMPM revenue increase of approximately 6.4%. Premium revenues were impacted by the following in 2011:

• In the fourth quarter of 2011, our New Mexico health plan entered into a

contract amendment that more closely aligns the calculation of revenue

with the methodology adopted under the Affordable Care Act. The contract

amendment changed the calculation of the amount of revenue that may be

recognized relative to medical costs, and resulted in the recognition of

approximately $5.6 million of premium revenue which all related to periods

         prior to 2011.

• Also in the fourth quarter of 2011, the addition of pharmacy benefits at

our Ohio health plan effective October 1, 2011, increased premium revenue.

   Absent the adjustment to New Mexico premium revenue and the addition of the pharmacy benefit in Ohio, premium revenue PMPM increased approximately 4.4%, from $218 in 2010 to $227 in 2011. Increased enrollment among the ABD and Medicare populations contributed to the higher premium revenue PMPM. Medicare premium revenue was $388.2 million for the year ended December 31, 2011, compared with $265.2 million for the year ended December 31, 2010.                                           41

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Medical Care Costs

The following table provides the details of consolidated medical care costs for the periods indicated (dollars in thousands except PMPM amounts):

                                                                September 30,        September 30,        September 30,        September 30,        September 30,        September 30,                                                                                                           Year Ended December 31,                                                                                     2011                                                           2010                                                                                                          % of                                                           % of                                                               Amount                PMPM                 Total               Amount                PMPM                 Total Fee for service                                           $     2,764,309      $        139.02                71.6  %    $     2,360,858      $        128.73                70.0  % Capitation                                                        518,835                26.09                 13.4              555,487                30.29                 16.5 Pharmacy                                                          418,007                21.02                 10.8              325,935                17.77                  9.7 Other                                                             158,843                 8.00                  4.2              128,577                 7.01                  3.8  Total                                                     $     3,859,994      $        194.13               100.0  %    $     3,370,857      $        183.80               100.0  %    The medical care ratio decreased to 83.9% for the year ended December 31, 2011, compared with 84.5% for the year ended December 31, 2010. Absent that portion of the adjustment to New Mexico premium revenue that related to 2010, the medical care ratio was 84.0% for the year ended December 31, 2011. Total medical care costs increased less than 6% PMPM.

• Pharmacy costs (excluding the addition of pharmacy benefits at our Ohio

health plan effective October 1, 2011) increased approximately 7% PMPM.

Approximately two-thirds of the increase in pharmacy costs was

attributable to higher unit costs, with the remainder due to increased

          utilization.          •   Capitation costs decreased approximately 14% PMPM, primarily due to the

transition of members in Michigan and Washington into fee-for-service

          networks.          •   Fee-for-service costs increased approximately 8% PMPM, partially due to          the transition of members from capitated provider networks into          fee-for-service networks.

• Fee-for-service and capitation costs combined increased approximately 4%

PMPM. Excluding the Texas health plan, fee-for-service and capitation

costs combined increased approximately 2% PMPM. • Hospital utilization decreased approximately 5%. The medical care ratio of the California health plan increased to 85.8% for the year ended December 31, 2011, from 83.5% for the year ended December 31, 2010. The California health plan received premium reductions of approximately 3% and 1% effective July 1, 2011, and October 1, 2011, respectively. In the second half of 2011, the California health plan added approximately 14,500 new ABD members with average premium revenue of approximately $385 PMPM. The medical care ratio of the Florida health plan decreased to 91.9% for the year ended December 31, 2011, from 95.4% for the year ended December 31, 2010, primarily due to initiatives that have reduced pharmacy and behavioural health costs, and a premium rate increase of approximately 7.5% effective September 1, 2011. The medical care ratio of the Michigan health plan decreased to 81.2% for the year ended December 31, 2011, from 83.7% for the year ended December 31, 2010, primarily due to improved Medicare performance and lower inpatient facility costs. The Michigan health plan received a premium rate increase of approximately 1% effective October 1, 2011. The medical care ratio of the Missouri health plan decreased to 85.3% for the year ended December 31, 2011, from 85.5% for the year ended December 31, 2010. The health plan received a premium rate increase of approximately 5% effective July 1, 2011. 42

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The medical care ratio of the New Mexico health plan decreased to 80.2% for the year ended December 31, 2011, from 80.6 % for the year ended December 31, 2010. The New Mexico health plan received a premium rate reduction of approximately 2.5% effective July 1, 2011. As discussed above, the New Mexico health plan entered into a contract amendment changed the calculation of the amount of revenue that may be recognized relative to medical costs in the fourth quarter of 2011. Consequently, premium revenue recognized in the year ended December 31, 2011, includes $5.6 million related to periods prior to 2011. The medical care ratio of the Ohio health plan decreased to 77.6% for the year ended December 31, 2011, from 79.1% for the year ended December 31, 2010, due to an increase in Medicaid premium PMPM of approximately 4.5% effective January 1, 2011, and relatively flat fee-for-service costs. The pharmacy benefit was restored to all managed care plans in Ohio effective October 1, 2011. The medical care ratio of the Texas health plan increased to 93.4% for the year ended December 31, 2011, from 86.2% for the year ended December 31, 2010. Effective February 1, 2011, we added approximately 30,000 ABD members in the Dallas-Fort Worth area and effective September 1, 2011, we added approximately 8,000 ABD members and 3,000 TANF members in the Jefferson Service area. Medical costs in the Dallas-Fort Worth area were well in excess of premium revenue. Excluding the ABD population in the Dallas-Fort Worth region, the medical care ratio of the Texas health plan was 85.7% for the year ended December 31, 2011. The medical care ratio of the Utah health plan decreased to 78.1% for the year ended December 31, 2011, from 91.3% for the year ended December 31, 2010, primarily due to reduced fee-for-service inpatient and physician costs and an increase in Medicaid premiums PMPM. Effective July 1, 2010, the Utah health plan received a premium rate increase of approximately 7%. Lower fee-for-service costs were the result of both lower unit costs and lower utilization. During the second quarter of 2011 we settled certain claims with the state regarding the savings share provision of our contract in effect from 2003 through June of 2009. We settled for the contract years 2006 through 2009 and recognized $6.9 million in premium revenue without any corresponding charge to expense. The Utah health plan received a premium rate reduction of approximately 2% effective July 1, 2011. The medical care ratio of the Washington health plan remained flat at 83.9% for the year ended December 31, 2011 compared with the year ended December 31, 2010. Higher fee-for-service and pharmacy costs were offset by lower capitation costs. The medical care ratio of the Wisconsin health plan (acquired September 1, 2010) was 92.5% for the year ended December 31, 2011. The state of Wisconsin reduced capitation rates by 11% on January 1, 2011. We have undertaken a number of measures - focused on both utilization and unit cost reductions - to improve the profitability of the Wisconsin health plan. Significant improvements in inpatient utilization were realized in the second half of 2011.

Health Plans Segment Operating Data

The following table summarizes member months, premium revenue, medical care costs, medical care ratio, and premium taxes by health plan for the periods indicated (PMPM amounts are in whole dollars; member months and other dollar amounts are in thousands):

                      September 30,        September 30,        September 30,

September 30, September 30, September 30, September 30,

Year Ended December 31, 2011

                                                Premium Revenue                          Medical Care Costs                   Medical                     Member                                                                                                    Care                Premium                    Months(1)              Total                PMPM                 Total                PMPM                 Ratio             Tax Expense California                4,190      $       575,176      $        137.27      $       493,419      $        117.75                85.8  %    $         7,499 Florida                     788              203,945               258.70              187,358               237.66                 91.9                   41 Michigan                  2,660              662,127               248.91              537,779               202.16                 81.2               38,733 Missouri                    959              229,584               239.38              195,832               204.19                 85.3                   - New Mexico                1,074              345,732               321.94              277,338               258.25                 80.2                9,285 Ohio                      2,966              988,896               333.40              766,949               258.57                 77.6               76,677 Texas                     1,616              409,295               253.40              382,390               236.74                 93.4                7,117 Utah                        972              287,290               295.51              224,513               230.94                 78.1                   - Washington                4,171              823,323               197.42              690,513               165.57                 83.9               14,865 Wisconsin(2)                488               69,596               142.56               64,346               131.81                 92.5                   44 Other(3)                     -                 8,443                   -                39,557                   -                    -                   328                           19,884      $     4,603,407      $        231.51      $     3,859,994      $        194.13                83.9  %    $       154,589                                             43

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September 30, September 30, September 30, September 30,

Year Ended December 31, 2010

                                                Premium Revenue                          Medical Care Costs                   Medical                     Member                                                                                                    Care                Premium                    Months(1)              Total                PMPM                 Total                PMPM                 Ratio             Tax Expense California                4,197      $       506,871      $        120.77      $       423,021      $        100.79                83.5  %    $         6,912 Florida                     664              170,683               256.87              162,839               245.07                 95.4                    1 Michigan                  2,708              630,134               232.66              527,596               194.80                 83.7               39,187 Missouri                    946              210,852               222.98              180,291               190.66                 85.5                   - New Mexico                1,104              366,784               332.02              295,633               267.61                 80.6                9,300 Ohio                      2,817              860,324               305.42              680,802               241.69                 79.1               67,358 Texas                       708              188,716               266.72              162,714               229.97                 86.2                3,251 Utah                        921              258,076               280.27              235,576               255.84                 91.3                   - Washington                4,141              758,849               183.27              636,617               153.75                 83.9               13,513 Wisconsin(2)                134               30,033               224.75               27,574               206.35                 91.8                   - Other(3)                     -                 8,587                   -                38,194                   -                    -                   253                           18,340      $     3,989,909      $        217.56      $     3,370,857      $        183.80                84.5  %    $       139,775

(1) A member month is defined as the aggregate of each month's ending membership

    for the period presented.

(2) We acquired the Wisconsin health plan on September 1, 2010.

(3) "Other" medical care costs also include medically related administrative

costs of the parent company.

Days in Medical Claims and Benefits Payable

The days in medical claims and benefits payable were as follows:

                                                         September 30,        September 30,        September 30,                                                                           December 31,                                                          2011                 2010                 2009 Days in claims payable: fee-for-service only                40 days              42 days              44 days Number of claims in inventory at end of period              111,100              143,600               93,100 Billed charges of claims in inventory at end of period (in thousands)                               $       207,600      $

218,900 $ 131,400

Molina Medicaid Solutions Segment

  We acquired Molina Medicaid Solutions on May 1, 2010; therefore, the year ended December 31, 2010 includes only eight months of operating results for this segment. Performance of the Molina Medicaid Solutions segment was as follows:                                                            September 30,              September 30,                                                       Twelve Months Ended        Eight Months Ended                                                        December 31, 2011         December 31, 2010                                                                      (In thousands) Service revenue before amortization                  $             167,269      $             98,125 Amortization recorded as reduction of service revenue                                                             (6,822 )                  (8,316 )  Service revenue                                                    160,447                    89,809 Cost of service revenue                                            143,987                    78,647 General and administrative costs                                     9,270                     5,135 Amortization of customer relationship intangibles recorded as amortization                                             5,127                     3,418  Operating income                                     $               2,063      $              2,609    We are currently deferring recognition of all revenue as well as all direct costs (to the extent that such costs are estimated to be recoverable) in Idaho until the MMIS in that state receives certification from CMS. For the year ended December 31, 2011, cost of service revenue includes $11.5 million of direct costs associated with the Idaho contract that would otherwise have been recorded as deferred contract costs. In assessing the recoverability of the deferred contract costs associated with the Idaho contract during 2011, we determined that these costs should be expensed as a period cost. In December 2011, our MMIS in Maine received full certification from CMS.                                           44

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Consolidated Expenses and Other

General and Administrative Expenses

General and administrative expenses were $415.9 million, or 8.7% of total revenue, for the year ended December 31, 2011, compared with $346.0 million, or 8.5% of total revenue, for the year ended December 31, 2010.

Premium Tax Expense

Premium tax expense decreased to 3.4% of premium revenue, for the year ended December 31, 2011, from 3.5% for the year ended <chron>December 31, 2010.

Depreciation and Amortization

Depreciation and amortization related to our Health Plans segment is all recorded in "Depreciation and Amortization" in the consolidated statements of income. Amortization related to our Molina Medicaid Solutions segment is recorded within three different headings in the consolidated statements of income as follows:

• Amortization of purchased intangibles relating to customer relationships

         is reported as amortization within the heading "Depreciation and          Amortization;"

• Amortization of purchased intangibles relating to contract backlog is

         recorded as a reduction of "Service Revenue;" and

• Amortization of capitalized software is recorded within the heading "Cost

of Service Revenue."

   The following table presents all depreciation and amortization recorded in our consolidated statements of income, regardless of whether the item appears as depreciation and amortization, a reduction of service revenue, or as cost of service revenue.                                                     September 30,        September 30,        September 30,        September 30,                                                                           Year Ended December 31,                                                                2011                                      2010                                                                       % of Total                                % of Total                                                    Amount               Revenue              Amount               Revenue                                                                        (Dollar amounts in thousands) Depreciation, and amortization of capitalized software                           $        30,864                  0.7 %    $        27,230                  0.7 % Amortization of intangible assets                       19,826                  0.4               18,474                  0.4  Depreciation and amortization reported as such in the consolidated statements of income                                                  50,690                  1.1               45,704                  1.1 Amortization recorded as reduction of service revenue                                          6,822                  0.1                8,316                  0.2 Amortization of capitalized software recorded as cost of service revenue                     16,871                  0.4                6,745                  0.2  Total                                          $        74,383                  1.6 %    $        60,765                  1.5 %

Impairment of Goodwill and Intangible Assets

We recorded a non-cash impairment charge of approximately $64.6 million, or $1.34 per diluted share, in connection with the expiration of our Missouri health plan's contract with the state of Missouri effective June 30, 2012. Of the total charge, $58.5 million is not tax deductible, resulting in a disproportionate impact to net income.

Interest Expense

  Interest expense was $15.5 million for the years ended December 31, 2011 and 2010. Interest expense includes non-cash interest expense relating to our convertible senior notes, which amounted to $5.5 million and $5.1 million for the years ended December 31, 2011 and 2010, respectively.                                           45

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Income Taxes

  Income tax expense is recorded at an effective rate of 67.8% for the year ended December 31, 2011, compared with 38.6% for the year ended December 31, 2010. The effective rate for the year ended December 31, 2011 reflects the non-deductible nature of the majority of the Missouri impairment charge, discrete tax benefits of $1.7 million recognized for statute closures, prior year tax return to provision reconciliations, and certain non-recurring income that is not subject to income tax. Excluding the impact from the Missouri impairment charge and discrete tax benefits, the effective tax rate for the year ended December 31, 2011 was 37.9%.

Year Ended December 31, 2010 Compared with the Year Ended December 31, 2009

Health Plans Segment

Premium Revenue

  In the year ended December 31, 2010, compared with the year ended December 31, 2009, premium revenue increased 9.0% due to a membership increase of approximately 10.9% (on a member-month basis). On a PMPM basis, however, consolidated premium revenue decreased 2.1% because of declines in premium rates. The decrease in PMPM revenue was due to the transfer of the pharmacy benefit to the state fee-for-service programs in Ohio (effective February 1, 2010) and Missouri (effective October 1, 2009). Exclusive of the transfer of the pharmacy benefit in Ohio and Missouri, Medicaid premium revenue PMPM increased approximately 1.5% over the year ended December 31, 2009. Medicare enrollment exceeded 24,000 members at December 31, 2010, and Medicare premium revenue was $265.2 million for the year ended December 31, 2010, compared with $135.9 million for the year ended December 31, 2009.

Medical Care Costs

The following table provides the details of consolidated medical care costs for the periods indicated (dollars in thousands except PMPM amounts):

                                                                September 30,        September 30,        September 30,        September 30,        September 30,        September 30,                                                                                                           Year Ended December 31,                                                                                     2010                                                           2009                                                                                                          % of                                                           % of                                                               Amount                PMPM                 Total               Amount                PMPM                 Total Fee for service                                           $     2,360,858      $        128.73                70.0  %    $     2,077,489      $        126.14                65.4  % Capitation                                                        555,487                30.29                 16.5              558,538                33.91                 17.6 Pharmacy                                                          325,935                17.77                  9.7              414,785                25.18                 13.1 Other                                                             128,577                 7.01                  3.8              125,424                 7.62                  3.9  Total                                                     $     3,370,857      $        183.80               100.0  %    $     3,176,236      $        192.85               100.0  %

The medical care ratio decreased to 84.5% for the year ended December 31, 2010, compared with 86.8% for the year ended December 31, 2009.

  The medical care ratio of the California health plan decreased to 83.5% for the year ended December 31, 2010, from 92.2% for the year ended December 31, 2009, primarily due to lower inpatient facility fee-for-service costs resulting from provider network restructuring and improved medical management.  The medical care ratio of the Florida health plan increased to 95.4% for the year ended December 31, 2010, from 93.8% for the year ended December 31, 2009, primarily due to higher capitation costs and higher fee-for-service costs in the outpatient and physician categories.  The medical care ratio of the Michigan health plan increased to 83.7% for the year ended December 31, 2010, from 81.5% for the year ended December 31, 2009, primarily due to higher inpatient facility fee-for-service costs.  The medical care ratio of the New Mexico health plan decreased to 80.6% for the year ended December 31, 2010, from 85.7% for the year ended December 31, 2009, primarily due to reduced fee-for-service costs which more than offset decreased premium revenue PMPM.                                           46

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The medical care ratio of the Ohio health plan decreased to 79.1% for the year ended December 31, 2010, from 86.1% for the year ended December 31, 2009, primarily due to an increase in Medicaid premium PMPM of approximately 6% effective January 1, 2010 (exclusive of the reduction related to pharmacy benefits), partially offset by higher inpatient facility fee-for-service costs.

  The medical care ratio of the Utah health plan decreased to 91.3% for the year ended December 31, 2010, from 91.8% for the year ended December 31, 2009, due to improved financial performance in the second half of 2010. That improved financial performance was the result of reduced fee-for-service costs in the second half of 2010 and an increase in Medicaid premium PMPM of approximately 7% effective July 1, 2010.  The medical care ratio of the Washington health plan decreased to 83.9% for the year ended December 31, 2010, from 84.5% for the year ended December 31, 2009, primarily due to reduced fee-for-service costs which more than offset decreased premium revenue PMPM. Premium revenue PMPM decreased for all of 2010 compared with 2009 because the rate increase of approximately 2.5% effective July 1, 2010 was not enough to offset decreases received during the second half of 2009.

Health Plans Segment Operating Data

                      September 30,        September 30,        September 30,

September 30, September 30, September 30, September 30,

Year Ended December 31, 2010

                                                Premium Revenue                          Medical Care Costs                   Medical                     Member                                                                                                    Care                Premium                    Months(1)              Total                PMPM                 Total                PMPM                 Ratio             Tax Expense California                4,197      $       506,871      $        120.77      $       423,021      $        100.79                83.5  %    $         6,912 Florida                     664              170,683               256.87              162,839               245.07                 95.4                    1 Michigan                  2,708              630,134               232.66              527,596               194.80                 83.7               39,187 Missouri                    946              210,852               222.98              180,291               190.66                 85.5                   - New Mexico                1,104              366,784               332.02              295,633               267.61                 80.6                9,300 Ohio                      2,817              860,324               305.42              680,802               241.69                 79.1               67,358 Texas                       708              188,716               266.72              162,714               229.97                 86.2                3,251 Utah                        921              258,076               280.27              235,576               255.84                 91.3                   - Washington                4,141              758,849               183.27              636,617               153.75                 83.9               13,513 Wisconsin(2)                134               30,033               224.75               27,574               206.35                 91.8                   - Other(3)                     -                 8,587                   -                38,194                   -                    -                   253                           18,340      $     3,989,909      $        217.56      $     3,370,857      $        183.80                84.5  %    $       139,775                        September 30,        September 30,        September 30,

September 30, September 30, September 30, September 30,

Year Ended December 31, 2009

                                                Premium Revenue                          Medical Care Costs                   Medical                     Member                                                                                                    Care                Premium                    Months(1)              Total                PMPM                 Total                PMPM                 Ratio             Tax Expense California                4,135      $       481,717      $        116.49      $       443,892      $        107.34                92.2  %    $        16,446 Florida                     386              102,232               264.94               95,936               248.62                 93.8                   16 Michigan                  2,523              557,421               220.94              454,431               180.12                 81.5               36,482 Missouri                    927              230,222               248.25              191,585               206.59                 83.2                   - New Mexico                1,042              404,026               387.67              346,044               332.03                 85.7               11,043 Ohio                      2,411              803,521               333.33              691,402               286.82                 86.1               47,849 Texas                       402              134,860               335.69              110,794               275.78                 82.2                2,513 Utah                        793              207,297               261.43              190,319               240.02                 91.8                   - Washington                3,847              726,137               188.77              613,876               159.58                 84.5               14,175 Wisconsin(2)                 -                    -                    -                    -                    -                    -                    - Other(3)(4)                  -                12,774                   -                37,957                   -                    -                    57                           16,466      $     3,660,207      $        222.24      $     3,176,236      $        192.85                86.8  %    $       128,581

(1) A member month is defined as the aggregate of each month's ending membership

    for the period presented.

(2) We acquired the Wisconsin health plan on September 1, 2010.

(3) "Other" medical care costs also include medically related administrative

    costs at the parent company.

(4) As of December 31, 2009, our Nevada health plan no longer served members.

     Premium revenue and medical care costs for the Nevada health plan have been     included in "Other."                                              47

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Molina Medicaid Solutions Segment

  Molina Medicaid Solutions contributed $2.6 million to operating income for the year ended December 31, 2010, but reported an operating loss of $3.6 million for the quarter ended December 31, 2010. The operating loss for the fourth quarter of 2010 was primarily the result of system stabilization costs incurred for two of Molina Medicaid Solutions' contracts.

Performance of the Molina Medicaid Solutions segment for the year ended December 31, 2010 was as follows:

September 30,                                                                      (In thousands) Service revenue before amortization                                  $

98,125

 Amortization recorded as reduction of service revenue                         (8,316 )  Service revenue                                                               89,809 Cost of service revenue                                                       78,647 General and administrative costs

5,135

 Amortization of customer relationship intangibles recorded as amortization                                                                   3,418  Operating income                                                     $         2,609

Consolidated Expenses and Other

General and Administrative Expenses

  General and administrative expenses were $346.0 million, or 8.5% of total revenue, for the year ended December 31, 2010, compared with 276.0 million, or 7.5% of total revenue, for the year ended December 31, 2009. The increase in the G&A ratio was the result of higher administrative expenses for the Health Plans segment, driven in part by the cost of our Medicare expansion, higher variable compensation expense as a result of substantially improved financial performance in 2010, employee severance and settlement costs, and costs relating to the acquisitions of Molina Medicaid Solutions and the Wisconsin health plan.

Premium Tax Expense

Premium tax expense relating to Health Plans segment premium revenue was 3.5% of revenue for both years ended December 31, 2010, and 2009.

Depreciation and Amortization

  The following table presents all depreciation and amortization recorded in our consolidated statements of income, regardless of whether the item appears as depreciation and amortization, a reduction of service revenue, or as cost of service revenue.                                                     September 30,        September 30,        September 30,        September 30,                                                                           Year Ended December 31,                                                                2010                                      2009                                                                       % of Total                                % of Total                                                    Amount               Revenue              Amount               Revenue                                                                        (Dollar amounts in thousands) Depreciation, and amortization of capitalized software                           $        27,230                 0.7  %    $        25,172                 0.7  % Amortization of intangible assets                       18,474                  0.4               12,938                  0.3  Depreciation and amortization reported as such in the consolidated statements of income                                                  45,704                  1.1               38,110                  1.0 Amortization recorded as reduction of service revenue                                          8,316                  0.2                   -                    - Amortization of capitalized software recorded as cost of service revenue                      6,745                  0.2                   -                    -  Total                                          $        60,765                 1.5  %    $        38,110                 1.0  %                                             48

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Interest Expense

Interest expense increased to $15.5 million for the year ended December 31, 2010, from $13.8 million for the year ended December 31, 2009. We incurred higher interest expense relating to the $105 million draw on our credit facility (beginning May 1, 2010) to fund the acquisition of Molina Medicaid Solutions. Amounts borrowed to fund this acquisition were repaid in the third quarter using proceeds from our equity offering in the third quarter of 2010. Interest expense includes non-cash interest expense relating to our convertible senior notes, which amounted to $5.1 million and $4.8 million for the years ended December 31, 2010 and 2009, respectively. Income Taxes Income tax expense was recorded at an effective rate of 38.6% for the year ended December 31, 2010, compared with 19.1% for the year ended December 31, 2009. The lower rate in 2009 was primarily due to discrete tax benefits recorded in 2009 as a result of settling tax examinations, and higher than previously estimated tax credits. Acquisitions Molina Center. On December 7, 2011, our wholly owned subsidiary Molina Center LLC closed on its acquisition of the 460,000 square foot office building located in Long Beach, California. The building, or Molina Center, consists of two conjoined fourteen-story office towers on approximately five acres of land. For the last several years we have leased approximately 155,000 square feet of the Molina Center for use as our corporate headquarters and also for use by our California health plan subsidiary. The final purchase price was $81 million, which amount was paid with a combination of cash on hand and bank financing under a term loan agreement. We acquired this business primarily to facilitate space needs for the projected future growth of the Company.

Molina Medicaid Solutions. On May 1, 2010, we acquired a health information management business which we operate under the name, Molina Medicaid SolutionsSM as described in Overview, above.

Liquidity and Capital Resources

We manage our cash, investments, and capital structure to meet the short- and long-term obligations of our business while maintaining liquidity and financial flexibility. We forecast, analyze, and monitor our cash flows to enable prudent investment management and financing within the confines of our financial strategy. Our regulated subsidiaries generate significant cash flows from premium revenue. Such cash flows are our primary source of liquidity. Thus, any future decline in our profitability may have a negative impact on our liquidity. We generally receive premium revenue in advance of the payment of claims for the related health care services. A majority of the assets held by our regulated subsidiaries are in the form of cash, cash equivalents, and investments. After considering expected cash flows from operating activities, we generally invest cash of regulated subsidiaries that exceeds our expected short-term obligations in longer term, investment-grade, marketable debt securities to improve our overall investment return. These investments are made pursuant to board approved investment policies which conform to applicable state laws and regulations. Our investment policies are designed to provide liquidity, preserve capital, and maximize total return on invested assets, all in a manner consistent with state requirements that prescribe the types of instruments in which our subsidiaries may invest. These investment policies require that our investments have final maturities of five years or less (excluding auction rate securities and variable rate securities, for which interest rates are periodically reset) and that the average maturity be two years or less. Professional portfolio managers operating under documented guidelines manage our investments. As of December 31, 2011, a substantial portion of our cash was invested in a portfolio of highly liquid money market securities, and our investments consisted solely of investment-grade debt securities. All of our investments are classified as current assets, except for our restricted investments, and our investments in auction rate securities, which are classified as non-current assets. Our restricted investments are invested principally in certificates of deposit and U.S. treasury securities.

Investment income decreased to $5.5 million for the year ended December 31, 2011, compared with $6.3 million for the year ended December 31, 2010. Our annualized portfolio yields for the years ended December 31, 2011, 2010, and 2009 were 0.6%, 0.7%, and 1.2%, respectively.

  Investments and restricted investments are subject to interest rate risk and will decrease in value if market rates increase. We have the ability to hold our restricted investments until maturity. Declines in interest rates over time will reduce our investment income.                                           49

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  Cash in excess of the capital needs of our regulated health plans is generally paid to our non-regulated parent company in the form of dividends, when and as permitted by applicable regulations, for general corporate use.

Cash provided by operating activities for the year ended December 31, 2011 was $225.4 million compared with $161.4 million for the year ended December 31, 2010, an increase of $64.0 million. This increase was primarily due to the change in deferred revenue. In 2011, deferred revenue was a use of cash amounting to $8.2 million, compared with $41.9 million in 2010.

  Cash provided by financing activities decreased due to $111.1 million of net proceeds from our common stock offering in the third quarter of 2010, offset by the $48.6 million borrowed under a term loan used to purchase the Molina Center in 2011.

Reconciliation of Non-GAAP (1) to GAAP Financial Measures

 EBITDA (2)                                                                  September 30,        September 30,                                                                          Year Ended                                                                         December 31,                                                                  2011                 2010                                                                        (In thousands) Net income                                                  $        20,818      $        54,970 Add back: Depreciation and amortization reported in the consolidated statements of cash flows                                74,383               60,765 Interest expense                                                     15,519               15,509 Provision for income taxes                                           43,836               34,522  EBITDA                                                      $       154,556      $       165,766

(1) GAAP stands for U.S. generally accepted accounting principles.

(2) EBITDA is not prepared in conformity with GAAP because it excludes

depreciation and amortization, as well as interest expense, and the provision

for income taxes. This non-GAAP financial measure should not be considered as

an alternative to the GAAP measures of net income, operating income,

operating margin, or cash provided by operating activities, nor should EBITDA

be considered in isolation from these GAAP measures of operating performance.

Management uses EBITDA as a supplemental metric in evaluating our financial

performance, in evaluating financing and business development decisions, and

in forecasting and analyzing future periods. For these reasons, management

believes that EBITDA is a useful supplemental measure to investors in

evaluating our performance and the performance of other companies in our

     industry.   Capital Resources  At December 31, 2011, the parent company - Molina Healthcare, Inc. - held cash and investments of approximately $23.6 million, compared with approximately $65.1 million of cash and investments at December 31, 2010. This decline was primarily due to a capital contribution to our Texas health plan in the fourth quarter of 2011 and cash paid to acquire the Molina Center.  On a consolidated basis, at December 31, 2011, we had working capital of $446.2 million compared with $392.4 million at December 31, 2010. At December 31, 2011 we had cash and investments of $893.0 million, compared with $813.8 million of cash and investments at December 31, 2010.

Effective as of October 26, 2011, our board of directors has authorized the repurchase of $75 million in aggregate of either our common stock or our convertible senior notes due 2014 (see discussion of "Convertible Senior Notes" below). The repurchase program will be funded with working capital or draws under our credit facility (see discussion of "Credit Facility" below).

  On July 27, 2011, our board of directors approved a stock repurchase program of up to $7 million to be used to purchase shares of our common stock under a Rule 10b5-1 trading plan. Under this program, we purchased approximately 400,000 shares of our common stock for $7 million (average cost of approximately $17.47 per share) during August 2011. These purchases did not materially impact diluted earnings per share for the year ended December 31, 2011. Subsequently, we retired the $7.0 million of treasury shares purchased, which reduced additional paid-in capital as of December 31, 2011.                                           50

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  We believe that our cash resources, Credit Facility, and internally generated funds will be sufficient to support our operations, regulatory requirements, and capital expenditures for at least the next 12 months.

Credit Facility

On September 9, 2011, we entered into a credit agreement for a $170 million revolving credit facility (the "Credit Facility") with various lenders and U.S. Bank National Association, as LC Issuer, Swing Line Lender, and Administrative Agent. The Credit Facility will be used for general corporate purposes. The Credit Facility has a term of five years under which all amounts outstanding will be due and payable on September 9, 2016. Subject to obtaining commitments from existing or new lenders and satisfaction of other specified conditions, we may increase the Credit Facility to up to $195 million. As of December 31, 2011, there was no outstanding principal balance under the Credit Facility. However, as of December 31, 2011, our lenders had issued two letters of credit in the aggregate principal amount of $10.3 million as required under the Molina Medicaid Solutions contracts with the states of Maine and Idaho, which reduced the amount available under the Credit Facility by $10.3 million. Borrowings under the Credit Facility will bear interest based, at our election, on the base rate plus an applicable margin or the Eurodollar rate. The base rate is, for any day, a rate of interest per annum equal to the highest of (i) the prime rate of interest announced from time to time by U.S. Bank or its parent, (ii) the sum of the federal funds rate for such day plus 0.50% per annum and (iii) the Eurodollar rate (without giving effect to the applicable margin) for a one month interest period on such day (or if such day is not a business day, the immediately preceding business day) plus 1.00%. The Eurodollar rate is a reserve adjusted rate at which Eurodollar deposits are offered in the interbank Eurodollar market plus an applicable margin. In addition to interest payable on the principal amount of indebtedness outstanding from time to time under the Credit Facility, we are required to pay a quarterly commitment fee of 0.25% to 0.50% (based upon our leverage ratio) of the unused amount of the lenders' commitments under the Credit Facility. The initial commitment fee shall be set at 0.35% until our delivery of its financials for the year ended December 31, 2011. The applicable margins range between 0.75% to 1.75% for base rate loans and 1.75% to 2.75% for Eurodollar loans, in each case, based upon our leverage ratio. Our obligations under the Credit Facility are secured by a lien on substantially all of our assets, with the exception of certain of our real estate assets, and by a pledge of the capital stock or membership interests of our operating subsidiaries and health plans (with the exception of the California health plan). The Credit Facility includes usual and customary covenants for credit facilities of this type, including covenants limiting liens, mergers, asset sales, other fundamental changes, debt, acquisitions, dividends and other distributions, capital expenditures, and investments. The Credit Facility also requires us to maintain a ratio of total consolidated debt to total consolidated EBITDA of not more than 2.75 to 1.00 as of the end of each fiscal quarter and a fixed charge coverage ratio of not less than 1.75 to 1.00. At December 31, 2011, we were in compliance with all financial covenants under the Credit Facility. In the event of a default, including cross-defaults relating to specified other debt in excess of $20 million, the lenders may terminate the commitments under the Credit Facility and declare the amounts outstanding, including all accrued interest and unpaid fees, payable immediately. In addition, the lenders may enforce any and all rights and remedies created under the Credit Facility or applicable law. In connection with our entrance into the Credit Facility, on September 9, 2011, we terminated our existing credit agreement with Bank of America, dated March 9, 2005, as amended to date, which had provided us with a $150 million revolving credit facility. Convertible Senior Notes As of December 31, 2011, $187.0 million in aggregate principal amount of our 3.75% Convertible Senior Notes due 2014 (the "Notes") were outstanding. The Notes rank equally in right of payment with our existing and future senior indebtedness. The Notes are convertible into cash and, under certain circumstances, shares of our common stock. The initial conversion rate is 31.9601 shares of our common stock per $1,000 principal amount of the Notes. This represents an initial conversion price of approximately $31.29 per share of our common stock. In addition, if certain corporate transactions that constitute a change of control occur prior to maturity, we will increase the conversion rate in certain circumstances. 51

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Term Loan

  On December 7, 2011, our wholly owned subsidiary, Molina Center LLC, entered into a Term Loan Agreement, dated as of December 1, 2011, with various lenders and East West Bank, as Administrative Agent (the "Administrative Agent"). Pursuant to the terms of the Term Loan Agreement, Molina Center LLC borrowed the aggregate principal amount of $48.6 million to finance a portion of the $81 million purchase price for the acquisition of the approximately 460,000 square foot office building, now named "Molina Center," located in Long Beach, California.  The outstanding principal amount under the Term Loan Agreement bears interest at the rate of 4.25% per annum from the date of the closing of the loan through December 31, 2011, and at the Eurodollar rate for each Interest Period (as defined below) commencing January 1, 2012. The Eurodollar rate is a per annum rate of interest equal to the greater of (a) the rate that is published in the Wall Street Journal as the London interbank offered rate for deposits in United States dollars, for a period of one month, two business days prior to the commencement of an Interest Period, multiplied by a statutory reserve rate established by the Board of Governors of the Federal Reserve System, or (b) 4.25%. The loan matures on November 30, 2018, and is subject to a 25-year amortization schedule that commences on January 1, 2012.  The Term Loan Agreement contains customary representations, warranties, and financial covenants. In the event of a default as described in the Term Loan Agreement, the outstanding principal amount under the Term Loan Agreement will bear interest at a rate 5.00% per annum higher than the otherwise applicable rate. We have agreed to pay to the Administrative Agent a loan fee in the amount of $486,000 and an agency fee of $50,000. All amounts due under the Term Loan Agreement and related loan documents are secured by a security interest in the Molina Center in favor of and for the benefit of the Administrative Agent and the other lenders under the Term Loan Agreement.

Regulatory Capital and Dividend Restrictions

Our health plans 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, and restrict the timing, payment, and amount of dividends and other distributions that may be paid to us as the sole stockholder. To the extent the subsidiaries must comply with these regulations, they may not have the financial flexibility to transfer funds to us. 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 $492.4 million at December 31, 2011, and $397.8 million at December 31, 2010. The National Association of Insurance Commissioners, or 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, or RBC, rules. Michigan, Missouri, New Mexico, Ohio, Texas, Utah, Washington, and Wisconsin have adopted these rules, which may vary from state to state. California and Florida have not yet adopted NAIC risk-based capital requirements for HMOs and have not formally given notice of their intention to do so. Such requirements, if adopted by California and Florida, may increase the minimum capital required for those states. As of December 31, 2011, our health plans had aggregate statutory capital and surplus of approximately $509.9 million compared with the required minimum aggregate statutory capital and surplus of approximately $265.7 million. All of our health plans were in compliance with the minimum capital requirements at December 31, 2011. We have the ability and commitment to provide additional capital to each of our health plans when necessary to ensure that statutory capital and surplus continue to meet regulatory requirements.

Critical Accounting Policies

When we prepare our consolidated financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. Actual results could differ from these estimates. Our most significant accounting policies relate to:

• Health plan contractual provisions that may limit revenue based upon the

         costs incurred or the profits realized under a specific contract;

• Health plan quality incentives that allow us to recognize incremental

         revenue if certain quality standards are met;

• The recognition of revenue and costs associated with contracts held by our

         Molina Medicaid Solutions segment; and;       •   The determination of medical claims and benefits payable.                                            52

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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.

Certain components of premium revenue are subject to accounting estimates. The components of premium revenue subject to estimation fall into two categories:

  Contractual provisions that may limit revenue based upon the costs incurred or the profits realized under a specific contract. These are contractual provisions that require the health plan to return premiums to the extent that certain thresholds are not met. In some instances premiums are returned when medical costs fall below a certain percentage of gross premiums; or when administrative costs or profits exceed a certain percentage of gross premiums. In other instances, premiums are partially determined by the acuity of care provided to members (risk adjustment). To the extent that our expenses and profits change from the amounts previously reported (due to changes in estimates) our revenue earned for those periods will also change. In all of these instances our revenue is only subject to estimate due to the fact that the thresholds themselves contain elements (expense or profit) that are subject to estimate. While we have adequate experience and data to make sound estimates of our expenses or profits, changes to those estimates may be necessary, which in turn will lead to changes in our estimates of revenue. In general, a change in estimate relating to expense or profit would offset any related change in estimate to premium, resulting in no or small impact to net income. The following contractual provisions fall into this category:         •   California Health Plan Medical Cost Floors (Minimums): A portion of

certain premiums received by our California health plan may be returned to

the state if certain minimum amounts are not spent on defined medical care

costs. At December 31, 2011, we recorded a liability of $1.0 million under

          the terms of these contract provisions.          •   Florida Health Plan Medical Cost Floor (Minimum) for Behavioral Health: A

portion of premiums received by our Florida health plan may be returned to

the state if certain minimum amounts are not spent on defined behavioral

health care costs. At December 31, 2011, we had not recorded any liability

         under the terms of this contract provision since behavioral health          expenses are not less than the contractual floor.

• New Mexico Health Plan Medical Cost Floors (Minimums) and Administrative

Cost and Profit Ceilings (Maximums): A portion of premiums received by our

New Mexico health plan may be returned to the state if certain minimum

amounts are not spent on defined medical care costs, or if administrative

costs or profit (as defined) exceed certain amounts. Our contract with the

state of New Mexico requires that we spend a minimum percentage of premium

revenue on certain explicitly defined medical care costs (the medical cost

floor). The New Mexico health plan contract also contains certain limits

on the amount our New Mexico health plan can: (a) expend on administrative

costs; and (b) retain as profit. At December 31, 2011, we had not recorded

any liability under the terms of these contract provisions. In the fourth

quarter of 2011, our New Mexico health plan entered into a contract

amendment that more closely aligns the calculation of revenue with the

methodology adopted under the Affordable Care Act. The contract amendment

changed the calculation of the amount of revenue that may be recognized

relative to medical costs, and resulted in the recognition of

approximately $5.6 million of premium revenue which all related to periods

          prior to 2011.          •   Texas Health Plan Profit Sharing: Under our contract with the state of

Texas, there is a profit-sharing agreement under which we pay a rebate to

the state of Texas if our Texas health plan generates pretax income, as

defined in the contract, above a certain specified percentage, as

determined in accordance with a tiered rebate schedule. The rebates, if

         any, are calculated separately for the TANF/CHIP and ABD products. We are          limited in the amount of administrative costs that we may deduct in          calculating the rebate, if any. As a result of profits in excess of the

amount we are allowed to fully retain, we had an aggregate liability of

         approximately $0.7 million accrued pursuant to our profit-sharing          agreement with the state of Texas at December 31, 2011.

• Medicare Revenue Risk Adjustment: Based on member encounter data that we

submit to CMS, our Medicare premiums are subject to retroactive adjustment

for both member risk scores and member pharmacy cost experience for up to

two years after the original year of service. This adjustment takes into

         account the acuity of each member's medical needs relative to what was          anticipated when premiums were originally set for that member. In the

event that a member requires less acute medical care than was anticipated

         by the original premium amount, CMS may recover premium from us. In the          event that a member                                            53

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  requires more acute medical care than was anticipated by the original premium amount, CMS may pay us additional retroactive premium. A similar retroactive reconciliation is undertaken by CMS for our Medicare members' pharmacy utilization. We estimate the amount of Medicare revenue that will ultimately be realized for the periods presented based on our knowledge of our members' heath care utilization patterns and CMS practices. Based on our knowledge of member health care utilization patterns and expenses we have recorded a receivable of approximately $5.0 million for anticipated Medicare risk adjustment premiums at December 31, 2011.  Quality incentives that allow us to recognize incremental revenue if certain quality standards are met. These are contract provisions that allow us to earn additional premium revenue in certain states if we achieve certain quality-of-care or administrative measures. We estimate the amount of revenue that will ultimately be realized for the periods presented based on our experience and expertise in meeting the quality and administrative measures as well as our ongoing and current monitoring of our progress in meeting those measures. The amount of the revenue that we will realize under these contractual provisions is determinable based upon that experience. The following contractual provisions fall into this category:  New Mexico Health Plan Quality Incentive Premiums: Under our contract with the state of New Mexico, incremental revenue of up to 0.75% of our total premium is earned if certain performance measures are met. These performance measures are generally linked to various quality-of-care and administrative measures dictated by the state.  Ohio Health Plan Quality Incentive Premiums: Under our contract with the state of Ohio, incremental revenue of up to 1% of our total premium is earned if certain performance measures are met. Effective February 1, 2010 through June 30, 2011, we were eligible to earn additional incremental revenue of up to 0.25% of our total premium if we met certain pharmacy specific performance measures. These performance measures are generally linked to various quality-of-care measures dictated by the state.  Texas Health Plan Quality Incentive Premiums: Under our contract with the state of Texas, incremental revenue of up to 1% of our total premium may be earned if certain performance measures are met. These performance measures are generally linked to various quality-of-care measures established by the state. The time period for the assessment of these performance measures previously followed the state's fiscal year, but effective January 1, 2011, it follows the calendar year. However, during 2011 the state of Texas notified us that it had discontinued the program for the 2011 calendar year. We anticipate that the program will be reinstituted in 2012.  Wisconsin Health Plan Quality Incentive Premiums: Under our contract with the state of Wisconsin, effective beginning in 2011, up to 3.25% of the premium is withheld by the state. The withheld premiums can be earned by the health plan by meeting certain performance measures. These performance measures are generally linked to various quality-of-care measures dictated by the state.  The following table quantifies the quality incentive premium revenue recognized for the periods presented, including the amounts earned in the period presented and prior periods. Although the reasonably possible effects of a change in estimate related to quality incentive premium revenue as of December 31, 2011 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 December 31, 2011.                                                              September 30,            September 30,            September 30,            September 30,        September 30,                                                                                                  Year Ended December 31, 2011                                                              Maximum                 Amount of                Amount of                                                         Available Quality          Current Year           Quality Incentive        Total Quality                                                             Incentive            Quality Incentive         Premium Revenue           Incentive                                                             Premium -             Premium Revenue          Recognized from        Premium Revenue        Total Revenue                                                           Current Year              Recognized               Prior Year              Recognized           Recognized                                                                                                         (In thousands) New Mexico                                             $             2,271      $             1,558      $               378      $          1,936      $       345,732 Ohio                                                                10,212                    8,363                    3,501                11,864              988,896 Texas                                                                   -                        -                        -                     -               409,295 Wisconsin                                                            1,705                      542                       -                    542               69,596                                                         $            14,188      $            10,463      $             3,879      $         14,342      $     1,813,519                                             54

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   Table of Contents                                                               September 30,            September 30,            September 30,            September 30,        September 30,                                                                                                 Year Ended December 31, 2010                                                             Maximum                 Amount of                Amount of                                                        Available Quality          Current Year           Quality Incentive        Total Quality                                                            Incentive            Quality Incentive         Premium Revenue           Incentive                                                            Premium -             Premium Revenue          Recognized from        Premium Revenue        Total Revenue                                                          Current Year              Recognized               Prior Year              Recognized           Recognized                                                                                                        (In thousands) New Mexico                                            $             2,581      $             1,311      $               579      $          1,890      $       366,784 Ohio                                                                9,881                    3,114                   (1,248 )               1,866              860,324 Texas                                                               1,771                    1,771                       -                  1,771              188,716                                                        $            14,233      $             6,196      $              (669 )    $          5,527      $     1,415,824                                                                September 30,            September 30,            September 30,            September 30,           September 30,                                                                                                   Year Ended December 31, 2009                                                              Maximum                 Amount of                Amount of                                                         Available Quality          Current Year           Quality Incentive          Total Quality                                                             Incentive            Quality Incentive         Premium Revenue         Incentive Premium                                                             Premium -             Premium Revenue          Recognized from              Revenue             Total Revenue                                                           Current Year              Recognized               Prior Year               Recognized             Recognized                                                                                                          (In thousands) New Mexico                                             $             2,378      $             1,097      $              (171 )    $               926      $       404,026 Ohio                                                                 7,040                    5,715                      937                    6,652              803,521 Texas                                                                1,322                    1,322                       -                     1,322              134,860                                                         $            10,740      $             8,134      $               766      $             8,900      $     1,342,407                                             55

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Service Revenue and Cost of Service Revenue - Molina Medicaid Solutions Segment

  The payments received by our Molina Medicaid Solutions segment under its state contracts are based on the performance of multiple services. The first of these is the design, development and implementation, or DDI, of a Medicaid Management Information System, or MMIS. An additional service, following completion of DDI, is the operation of the MMIS under a business process outsourcing, or BPO arrangement. While providing BPO services (which include claims payment and eligibility processing) we also provide the state with other services including both hosting and support and maintenance. We have evaluated our Molina Medicaid Solutions contracts to determine if such arrangements include a software element. Based on this evaluation, we have concluded that these arrangements do not include a software element. As such, we have concluded that our Molina Medicaid Solutions contracts are multiple-element service arrangements under the scope of FASB Accounting Standards Codification Subtopic 605-25, Revenue Recognition -- Multiple-Element Arrangements, and SEC Staff Accounting Bulletin Topic 13, Revenue Recognition.  Effective January 1, 2011, we adopted a new accounting standard that amends the guidance on the accounting for multiple-element arrangements. Pursuant to the new standard, each required deliverable is evaluated to determine whether it qualifies as a separate unit of accounting which is generally based on whether the deliverable has standalone value to the customer. In addition to standalone value, previous guidance also required objective and reliable evidence of fair value of a deliverable in order to treat the deliverable as a separate unit of accounting. The arrangement's consideration that is fixed or determinable is then allocated to each separate unit of accounting based on the relative selling price of each deliverable. In general, the consideration allocated to each unit of accounting is recognized as the related goods or services are delivered, limited to the consideration that is not contingent. We have adopted this guidance on a prospective basis for all new or materially modified revenue arrangements with multiple deliverables entered into on or after January 1, 2011. Our adoption of this guidance has not impacted the timing or pattern of our revenue recognition in 2011. Also, there would have been no change in revenue recognized relating to multiple-element arrangements if we had adopted this guidance retrospectively for contracts entered into prior to January 1, 2011.  We have concluded that the various service elements in our Molina Medicaid Solutions contracts represent a single unit of accounting due to the fact that DDI, which is the only service performed in advance of the other services (all other services are performed over an identical period), does not have standalone value because our DDI services are not sold separately by any vendor and the customer could not resell our DDI services. Further, we have no objective and reliable evidence of fair value for any of the individual elements in these contracts, and at no point in the contract will we have objective and reliable evidence of fair value for the undelivered elements in the contracts. For contracts entered into prior to January 1, 2011, objective and reliable evidence of fair value would be required, in addition to DDI standalone value which we do not have, in order to treat DDI as a separate unit of accounting. We lack objective and reliable evidence of the fair value of the individual elements of our Molina Medicaid Solutions contracts for the following reasons:

• Each contract calls for the provision of its own specific set of services.

         While all contracts support the system of record for state MMIS, the          actual services we provide vary significantly between contracts; and

• The nature of the MMIS installed varies significantly between our older

contracts (proprietary mainframe systems) and our new contracts

(commercial off-the-shelf technology solutions).

   Because we have determined the services provided under our Molina Medicaid Solutions contracts represent a single unit of accounting and because we are unable to determine a pattern of performance of services during the contract period, we recognize revenue associated with such contracts on a straight-line basis over the period during which BPO, hosting, and support and maintenance services are delivered.  Provisions specific to each contract may, however, lead us to modify this general principle. In those circumstances, the right of the state to refuse acceptance of services, as well as the related obligation to compensate us, may require us to delay recognition of all or part of our revenue until that contingency (the right of the state to refuse acceptance) has been removed. In those circumstances we defer recognition of any contingent revenue (whether DDI, BPO services, hosting, and support and maintenance services) until the contingency has been removed. These types of contingency features are present in our Maine and Idaho contracts. We began to recognize revenue associated with our Maine contract upon state acceptance in September 2010. In Idaho, we will begin recognition of revenue upon state acceptance.  Costs associated with our Molina Medicaid Solutions contracts include software related costs and other costs. With respect to software related costs, we apply the guidance for internal-use software and capitalize external direct costs of materials and services consumed in developing or obtaining the software, and payroll and payroll-related costs associated with employees who are directly                                           56

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  associated with and who devote time to the computer software project. With respect to all other direct costs, such costs are expensed as incurred, unless corresponding revenue is being deferred. If revenue is being deferred, direct costs relating to delivered service elements are deferred as well and are recognized on a straight-line basis over the period of revenue recognition, in a manner consistent with our recognition of revenue that has been deferred. Such direct costs can include:      •   Transaction processing costs       •   Employee costs incurred in performing transaction services       •   Vendor costs incurred in performing transaction services

• Costs incurred in performing required monitoring of and reporting on

         contract performance

• Costs incurred in maintaining and processing member and provider eligibility

      •   Costs incurred in communicating with members and providers   The recoverability of deferred contract costs associated with a particular contract is analyzed on a periodic basis using the undiscounted estimated cash flows of the whole contract over its remaining contract term. If such undiscounted cash flows are insufficient to recover the long-lived assets and deferred contract costs, the deferred contract costs are written down by the amount of the cash flow deficiency. If a cash flow deficiency remains after reducing the balance of the deferred contract costs to zero, any remaining long-lived assets are evaluated for impairment. Any such impairment recognized would equal the amount by which the carrying value of the long-lived assets exceeds the fair value of those assets.  We are currently deferring recognition of all revenue as well as all direct costs (to the extent that such costs are estimated to be recoverable) in Idaho until the MMIS in that state receives certification from CMS. For the year ended December 31, 2011, cost of service revenue includes $11.5 million of direct costs associated with the Idaho contract that would otherwise have been recorded as deferred contract costs. In assessing the recoverability of the deferred contract costs associated with the Idaho contract during 2011, we determined that these costs should be expensed as a period cost.

Medical Claims and Benefits Payable - Health Plans Segment

The following table provides the details of our medical claims and benefits payable as of the dates indicated:

                                                            September 30,        September 30,        September 30,                                                                              December 31,                                                             2011                 2010                 2009                                                                             (In thousands) Fee-for-service claims incurred but not paid (IBNP)    $       301,020      $       275,259      $       246,508 Capitation payable                                              53,532               49,598               39,995 Pharmacy                                                        26,178               14,649               20,609 Other                                                           21,746               14,850                8,204                                                         $       402,476      $       354,356      $       315,316    The determination of our liability for claims and medical benefits payable is particularly important to the determination of our financial position and results of operations in any given period. Such determination of our liability requires the application of a significant degree of judgment by our management.  As a result, the determination of our liability for claims and medical benefits payable is subject to an inherent degree of uncertainty. Our medical care costs include amounts that have been paid by us through the reporting date, as well as estimated liabilities for medical care costs incurred but not paid by us as of the reporting date. Such medical care cost liabilities include, among other items, unpaid fee-for-service claims, capitation payments owed providers, unpaid pharmacy invoices, and various medically related administrative costs that have been incurred but not paid. We use judgment to determine the appropriate assumptions for determining the required estimates.                                           57

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  The most important element in estimating our medical care costs is our estimate for fee-for-service claims which have been incurred but not paid by us. These fee-for-service costs that have been incurred but have not been paid at the reporting date are collectively referred to as medical costs that are "Incurred But Not Paid," or IBNP. Our IBNP, as reported on our balance sheet, represents our best estimate of the total amount of claims we will ultimately pay with respect to claims that we have incurred as of the balance sheet date. We estimate our IBNP monthly using actuarial methods based on a number of factors. As indicated in the table above, our estimated IBNP liability represented $301.0 million of our total medical claims and benefits payable of $402.5 million as of December 31, 2011. Excluding amounts that we anticipate paying on behalf of a capitated provider in Ohio (which we will subsequently withhold from that provider's monthly capitation payment), our IBNP liability at December 31, 2011, was $294.9 million.  The factors we consider when estimating our IBNP include, without limitation, claims receipt and payment experience (and variations in that experience), changes in membership, provider billing practices, health care service utilization trends, cost trends, product mix, seasonality, prior authorization of medical services, benefit changes, known outbreaks of disease or increased incidence of illness such as influenza, provider contract changes, changes to Medicaid fee schedules, and the incidence of high dollar or catastrophic claims. Our assessment of these factors is then translated into an estimate of our IBNP liability at the relevant measuring point through the calculation of a base estimate of IBNP, a further reserve for adverse claims development, and an estimate of the administrative costs of settling all claims incurred through the reporting date. The base estimate of IBNP is derived through application of claims payment completion factors and trended PMPM cost estimates.  For the fifth month of service prior to the reporting date and earlier, we estimate our outstanding claims liability based on actual claims paid, adjusted for estimated completion factors. Completion factors seek to measure the cumulative percentage of claims expense that will have been paid for a given month of service as of the reporting date, based on historical payment patterns.  The following table reflects the change in our estimate of claims liability as of December 31, 2011 that would have resulted had we changed our completion factors for the fifth through the twelfth months preceding December 31, 2011, by the percentages indicated. A reduction in the completion factor results in an increase in medical claims liabilities. Dollar amounts are in thousands.                                                               September 30,                                                          Increase (Decrease) in                                                            Medical Claims and  (Decrease) Increase in Estimated Completion Factors        Benefits Payable  (6%)                                                   $                119,317  (4%)                                                                     79,598  (2%)                                                                     39,799  2%                                                                      (39,799 )  4%                                                                      (79,598 )  6%                                                                     (119,317 )   For the four months of service immediately prior to the reporting date, actual claims paid are not a reliable measure of our ultimate liability, given the inherent delay between the patient/physician encounter and the actual submission of a claim for payment. For these months of service, we estimate our claims liability based on trended PMPM cost estimates. These estimates are designed to reflect recent trends in payments and expense, utilization patterns, authorized services, and other relevant factors. The following table reflects the change in our estimate of claims liability as of December 31, 2011 that would have resulted had we altered our trend factors by the percentages indicated. An increase in the PMPM costs results in an increase in medical claims liabilities. Dollar amounts are in thousands.                                                                             September 30,                                                                        Increase (Decrease) in                                                                          Medical Claims and (Decrease) Increase in Trended Per member Per Month Cost Estimates        Benefits Payable (6%)                                                                  $                (69,169 ) (4%)                                                                                   (46,113 ) (2%)                                                                                   (23,056 ) 2%                                                                                      23,056 4%                                                                                      46,113 6%                                                                                      69,169                                            58

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  The following per-share amounts are based on a combined federal and state statutory tax rate of 37.5%, and 46.4 million diluted shares outstanding for the year ended December 31, 2011. Assuming a hypothetical 1% change in completion factors from those used in our calculation of IBNP at December 31, 2011, net income for the year ended December 31, 2011 would increase or decrease by approximately $12.4 million, or $0.27 per diluted share. Assuming a hypothetical 1% change in PMPM cost estimates from those used in our calculation of IBNP at December 31, 2011, net income for the year ended December 31, 2011 would increase or decrease by approximately $7.2 million, or $0.16 per diluted share. The corresponding figures for a 5% change in completion factors and PMPM cost estimates would be $62.2 million, or $1.34 per diluted share, and $36.0 million, or $0.78 per diluted share, respectively.  It is important to note that any change in the estimate of either completion factors or trended PMPM costs would usually be accompanied by a change in the estimate of the other component, and that a change in one component would almost always compound rather than offset the resulting distortion to net income. When completion factors are overestimated, trended PMPM costs tend to be underestimated. Both circumstances will create an overstatement of net income. Likewise, when completion factors are underestimated, trended PMPM costs tend to be overestimated, creating an understatement of net income. In other words, errors in estimates involving both completion factors and trended PMPM costs will usually act to drive estimates of claims liabilities and medical care costs in the same direction. If completion factors were overestimated by 1%, resulting in an overstatement of net income by approximately $12.4 million, it is likely that trended PMPM costs would be underestimated, resulting in an additional overstatement of net income.  After we have established our base IBNP reserve through the application of completion factors and trended PMPM cost estimates, we then compute an additional liability, once again using actuarial techniques, to account for adverse developments in our claims payments which the base actuarial model is not intended to and does not account for. We refer to this additional liability as the provision for adverse claims development. The provision for adverse claims development is a component of our overall determination of the adequacy of our IBNP. It is intended to capture the potential inadequacy of our IBNP estimate as a result of our inability to adequately assess the impact of factors such as changes in the speed of claims receipt and payment, the relative magnitude or severity of claims, known outbreaks of disease such as influenza, our entry into new geographical markets, our provision of services to new populations such as the aged, blind or disabled (ABD), changes to state-controlled fee schedules upon which a large proportion of our provider payments are based, modifications and upgrades to our claims processing systems and practices, and increasing medical costs. Because of the complexity of our business, the number of states in which we operate, and the need to account for different health care benefit packages among those states, we make an overall assessment of IBNP after considering the base actuarial model reserves and the provision for adverse claims development. We also include in our IBNP liability an estimate of the administrative costs of settling all claims incurred through the reporting date. The development of IBNP is a continuous process that we monitor and refine on a monthly basis as additional claims payment information becomes available. As additional information becomes known to us, we adjust our actuarial model accordingly to establish IBNP.  On a monthly basis, we review and update our estimated IBNP and the methods used to determine that liability. Any adjustments, if appropriate, are reflected in the period known. While we believe our current estimates are adequate, we have in the past been required to increase significantly our claims reserves for periods previously reported, and may be required to do so again in the future. Any significant increases to prior period claims reserves would materially decrease reported earnings for the period in which the adjustment is made.  In our judgment, the estimates for completion factors will likely prove to be more accurate than trended PMPM cost estimates because estimated completion factors are subject to fewer variables in their determination. Specifically, completion factors are developed over long periods of time, and are most likely to be affected by changes in claims receipt and payment experience and by provider billing practices. Trended PMPM cost estimates, while affected by the same factors, will also be influenced by health care service utilization trends, cost trends, product mix, seasonality, prior authorization of medical services, benefit changes, outbreaks of disease or increased incidence of illness, provider contract changes, changes to Medicaid fee schedules, and the incidence of high dollar or catastrophic claims. As discussed above, however, errors in estimates involving trended PMPM costs will almost always be accompanied by errors in estimates involving completion factors, and vice versa. In such circumstances, errors in estimation involving both completion factors and trended PMPM costs will act to drive estimates of claims liabilities (and therefore medical care costs) in the same direction.  Assuming that base reserves have been adequately set, we believe that amounts ultimately paid out should generally be between 8% and 10% less than the liability recorded at the end of the period as a result of the inclusion in that liability of the allowance for adverse claims development and the accrued cost of settling those claims. However, there can be no assurance that amounts ultimately paid out will not be higher or lower than this 8% to 10% range, as shown by our results for the year ended December 31, 2011, when the amounts ultimately paid out were less than the amount of the reserves we had established as of the beginning of that year by 14.6%.                                           59

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  As shown in greater detail in the table below, the amounts ultimately paid out on our liabilities in fiscal years 2010 and 2011 were less than what we had expected when we had established our reserves. While the specific reasons for the overestimation of our liabilities were different in each of the periods presented, in general the overestimations were tied to our assessment of specific circumstances at our individual health plans which were unique to those reporting periods.  We recognized a benefit from prior period claims development in the amount of $51.8 million for the year ended December 31, 2011. This amount represents our estimate as of December 31, 2011 of the extent to which our initial estimate of medical claims and benefits payable at December 31, 2010 exceeded the amount that will ultimately be paid out in satisfaction of that liability. The overestimation of claims liability at December 31, 2010 was due primarily to the following factors:      •   We overestimated the impact of a buildup in claims inventory in Ohio.

• We overestimated the impact of the settlement of disputed provider claims

         in California.

• We underestimated the reduction in outpatient facility claims costs as a

result of a fee schedule reduction in New Mexico effective November 2010,

partially offsetting the impact of the two items above.

   We recognized a benefit from prior period claims development in the amount of $49.4 million for the year ended 2010. This was primarily caused by the overestimation of our liability for claims and medical benefits payable at December 31, 2009. The overestimation of claims liability at December 31, 2009 was the result of the following factors:

• In New Mexico, we underestimated the degree to which cuts to the Medicaid

          fees schedule would reduce our liability as of December 31, 2009.          •   In California, we underestimated the extent to which various network

restructuring, provider contracting, and medical management initiatives

         had reduced our medical care costs during the second half of 2009, thereby          resulting in a lower liability at December 31, 2009.

In estimating our claims liability at December 31, 2011, we adjusted our base calculation to take account of the following factors which we believe are reasonably likely to change our final claims liability amount:

      •   The increasing amount of claims recoveries in Texas.          •   Recent increases in inpatient utilization in Missouri, as well as a          substantial increase in inpatient claims inventory.       •   A significant reduction to our outstanding claims recoveries in Ohio.       •   An increase to our ABD membership in California.

• Late enrollment of newborns, and hence late claims payments, in Michigan

due to issues with the state's administration system, which has disrupted

the normal completion pattern for claims in that state.

   The use of a consistent methodology in estimating our liability for claims and medical benefits payable minimizes the degree to which the under- or overestimation of that liability at the close of one period may affect consolidated results of operations in subsequent periods. Facts and circumstances unique to the estimation process at any single date, however, may still lead to a material impact on consolidated results of operations in subsequent periods. Any absence of adverse claims development (as well as the expensing through general and administrative expense of the costs to settle claims held at the start of the period) will lead to the recognition of a benefit from prior period claims development in the period subsequent to the date of the original estimate. In 2010 and 2011, the absence of adverse development of the liability for claims and medical benefits payable at the close of the previous period resulted in the recognition of substantial favorable prior period development. In both years, however, the recognition of a benefit from prior period claims development did not have a material impact on our consolidated results of operations because the amount of benefit recognized in each year was roughly consistent with that recognized in the previous year.                                           60

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  The following table presents the components of the change in our medical claims and benefits payable for the periods presented. The negative amounts displayed for "Components of medical care costs related to: Prior year" represent the amount by which our original estimate of claims and benefits payable at the beginning of the period exceeded the actual amount of the liability based on information (principally the payment of claims) developed since that liability was first reported.                                                                 September 30,        September 30,                                                                  Year ended December 31,                                                                 2011                 2010                                                               (Dollars in thousands, except                                                                    per-member amounts) Balances at beginning of period                            $       354,356      $       315,316 Balance of acquired subsidiary                                          -                 3,228 Components of medical care costs related to: Current year                                                     3,911,803            3,420,235 Prior year                                                         (51,809 )            (49,378 )  Total medical care costs                                         3,859,994            3,370,857  Payments for medical care costs related to: Current year                                                     3,516,994            3,085,388 Prior year                                                         294,880              249,657  Total paid                                                       3,811,874            3,335,045  Balances at end of year                                    $       402,476

$ 354,356

  Benefit from prior years as a percentage of: Balance at beginning of year                                          14.6 %               15.7 % Premium revenue                                                        1.1 %                1.2 % Total medical care costs                                               1.3 %                1.5 % Claims Data (1): Days in claims payable, fee for service                                 40                   42 Number of members at end of period                               1,697,000

1,613,000

 Number of claims in inventory at end of period                     111,100              143,600

Billed charges of claims in inventory at end of period $ 207,600

     $       218,900 Claims in inventory per member at end of period                       0.07                 0.09

Billed charges of claims in inventory per member end of period

                                                     $        122.33      $        135.71 Number of claims received during the period                     17,207,500

14,554,800

Billed charges of claims received during the period $ 14,306,500

$    11,686,100

(1) "Claims Data" for the year ended December 31, 2010 does not include our

Wisconsin health plan acquired September 1, 2010.

Commitments and Contingencies

  We are not an obligor to or guarantor of any indebtedness of any other party. We are not a party to off-balance sheet financing arrangements except for operating leases which are disclosed in Note 18 to the accompanying audited consolidated financial statements for the year ended December 31, 2011.                                           61

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Contractual Obligations

  In the table below, we present our contractual obligations as of December 31, 2011. Some of the amounts we have included in this table are based on management's estimates and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties, and other factors. Because these estimates and assumptions are necessarily subjective, the contractual obligations we will actually pay in future periods may vary from those reflected in the table. Amounts are in thousands.                                                          September 30,        September 30,        September 30,        September 30,         September 30,                                                          Total                2012               2013-2014            2015-2016         2017 and Beyond Medical claims and benefits payable                 $       402,476      $       402,476      $            -       $            -       $             - Principal amount of long-term debt(1)                       235,600                1,197              189,361                2,568                42,474 Operating leases                                            101,424               25,553               40,936               22,338                12,597 Interest on long-term debt                                   32,527                9,061               16,267                3,788                 3,411 Purchase commitments                                         33,595               19,845               12,142                1,608                    -  Total contractual obligations                       $       805,622      $       458,132      $       258,706      $        30,302      $         58,482

(1) Represents the principal amount due on our 3.75% Convertible Senior Notes due

2014, and our term loan due 2018.

   As of December 31, 2011, we have recorded approximately $10.7 million of unrecognized tax benefits. The above table does not contain this amount because we cannot reasonably estimate when or if such amount may be settled. See Note 13 to the accompanying audited consolidated financial statements for the year ended December 31, 2011 for further information.

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