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MISSION •VISION •FUTURE
2002 ANNUAL REPORT

Table of contents

  • Page 1
    MISSION • VISION • FUTURE 2002 ANNUAL REPORT

  • Page 2
    Table of Contents Financial Highlights ...1 Mission ...2 Vision ...4 Future ...6 Letter to Stockholders ...8 Health Net's Seven Goals ...10 Key Financial Metrics ...24 2002 Financial Review ...25

  • Page 3
    ... impacting the comparability of information. In addition, we sold our non-affiliate pharmacy benefits management operations, our health plans in Utah, Washington, New Mexico, Louisiana, Texas and Oklahoma, our two hospitals, a thirdparty administrator subsidiary and a PPO network subsidiary in 1999...

  • Page 4
    MIS 2 | H E A L T H N E T, I N C .

  • Page 5
    ... help people be healthy, secure and comfortable One Mission - shared by each of us. This Mission, embraced by more than 9,000 associates every day, helps 5.4 million members get the health care services they need. This, above all else, is what defines Health Net. It is the larger purpose that fuels...

  • Page 6
    V I S 4 | H E A L T H N E T, I N C .

  • Page 7
    I O N Health Net will be the recognized leader in adding value to the lives of the people we serve by delivering: â†' Access to quality health care that helps people achieve improved health outcomes; â†' Understandable, reliable and affordable products; and â†' Service that exceeds expectations. ...

  • Page 8
    FUT 6 | H E A L T H N E T, I N C .

  • Page 9
    URE Making it a reality. One Future - where our Mission and Vision are at the cornerstone of all we do at Health Net. One Company, with common goals, with a commitment to put our customers first, with an aspiration to be the best that we can be. In the following pages, we'll look at our seven new...

  • Page 10
    ...health plans in California and Oregon. These experienced executives have brought a renewed focus and drive to our company. We confronted the challenge of rapidly rising health care costs with new benefits and innovative product designs. In sum, 2002 was an eventful and successful year for Health Net...

  • Page 11
    ..., health plan membership declined by 2 percent in 2002. However, we added members in small group and middle market accounts to counter the departures from many large group accounts where it is increasingly difficult to deploy cost-effective benefit designs. As affirmation of our strategy, company...

  • Page 12
    ... with employee cost-sharing options, making it possible for many employers to continue to offer comprehensive benefits. Beyond these commercial markets, we applied the same focus to state and federal programs Small Group Enrollment (in thousands) that serve seniors, low-income individuals and...

  • Page 13
    OVER THE YEARS, WE HAVE BUILT A DIVERSE BASE OF PROFITABLE BUSINESS BY IDENTIFYING KEY MARKETS - AND PROVIDING THE RIGHT SOLUTIONS.

  • Page 14
    ... a greater voice in their health care decisions. One such consumer-centric option is Health Net's Variable Hospital Copay plan. Introduced in California in late 2002, these tiered hospital products allow members to review hospitals based on quality and cost. Higher priced hospitals are in a higher...

  • Page 15
    THESE HEALTH CARE PRODUCTS WILL BE MOST SUCCESSFUL IF WE ALSO PROVIDE OUR MEMBERS WITH TOOLS TO MAKE THE RIGHT DECISIONS. Health Net's Web-based Hospital Comparison Report measures: â†' Volume of patients per procedure/condition â†' Unfavorable outcomes â†' Mortality rates â†' Length of stay â†' ...

  • Page 16
    ...Net as a place to work Ability to compete Proud to work for Health Net +8 +16 +11 Since 1999, Health Net has made steady improvement in its Annual Associate Survey results. THESE TRAINING AND DEVELOPMENT PROGRAMS ARE KEY TO OUR ONE COMPANY INITIATIVES THAT ENABLE US TO BETTER SERVE OUR CUSTOMERS...

  • Page 17
    ... the company's top managers. Through practical information on associate motivation and 360-degree feedback from customers, supervisors and peers, the course is designed to help make Health Net a better, more productive - and more effective - place to work. We are also introducing new competencies...

  • Page 18
    ... monthly premiums online. Among our California-based individual and small group sales representatives and brokers, the use of real-time quotes and online enrollment has become commonplace. Finally, we are expanding Internet-based systems so more doctors and hospitals can submit claims electronically...

  • Page 19
    TECHNOLOGY ALSO PLAYS A POWERFUL ROLE IN OUR ABILITY TO PROVIDE BETTER CUSTOMER SERVICE.

  • Page 20
    ... health care cost increases, making us better stewards of our customers' dollars. We devote significant resources every year to programs that help members with specific chronic conditions such as asthma and diabetes. Through intense member education, telephonic counseling and medication compliance...

  • Page 21
    WE STRIVE TO IMPROVE CLINICAL OUTCOMES THAT CAN ENHANCE THE HEALTH OF OUR MEMBERS. Health Net's Disease Management programs are designed to: â†' Improve clinical outcomes â†' Enhance member satisfaction â†' Decrease hospital admission rates â†' Decrease emergency room usage â†' Produce cost savings

  • Page 22
    GOAL 6: EFFICIENCY Administrative Ratio 2000 13.1% 2001 10.8% 2002 10.6% From 2000 to year-end 2002, we've reduced the administrative ratio by 250 basis points. SUPERIOR SERVICE AND EFFICIENT OPERATIONS WILL DRIVE OUR PERFORMANCE. 20 | H E A L T H N E T, I N C .

  • Page 23
    ... and expense. This carefully planned initiative will touch each of our associates - and every aspect of Health Net's business - from e-mail systems and membership databases to medical management systems and Web sites. As each milestone is completed, our company becomes more customer focused. This...

  • Page 24
    ... operate as one company that builds excellent business systems and processes and demonstrates integrity in all aspects of the operation of our business. One Company. At the end of the day, this is the ultimate goal for Health Net. It's the inspiration behind Health Net's Mission and Vision. It's the...

  • Page 25
    ...SIGHTS ON THE VISION OF HEALTH NET AS A TOP-TIER COMPANY. Health Net's 2003 key initiatives include: â†' Improvement in customer and client service levels â†' "One System" and operations consolidation â†' Improvement in Associate Survey results â†' Integrated approach to Disease Management programs...

  • Page 26
    ...10.8% 2002 10.6% Adjusted earnings per share and ROE exclude asset impairments, restructuring charges and other one-time items. The administrative ratio is the sum of general and administrative expenses plus depreciation expense divided by the sum of health plan services revenue plus other income...

  • Page 27
    2002 Financial Review Market for Registrant's Common Equity and Related Stockholder Matters Management's Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures about Market Risk Report of Management Report of Independent Auditors ...

  • Page 28
    ... net worth requirements and additional state regulations which may restrict the declaration of dividends by HMOs, insurance companies and licensed managed health care plans. The payment of any dividend is at the discretion of our Board of Directors and depends upon our earnings, financial position...

  • Page 29
    ... Government Contracts/Specialty Services reportable segment included government-sponsored managed care plans through the TRICARE programs, behavioral health, dental and vision, and managed care products related to bill review, administration and cost containment for hospitals, health plans and other...

  • Page 30
    ...loss of $76.1 million for the sales of our Florida health plan and related corporate facility building and costs of $79.7 million related to our 2001 restructuring plan. See "Asset Impairment and Restructuring Charges" and "Net Loss on Assets Held for Sale and Sale of Businesses and Properties." 28...

  • Page 31
    ... ASO member months. ENROLLMENT INFORMATION The table below summarizes the Company's at-risk insured and ASO enrollment information for the last three fiscal years. (Amounts in thousands) 2002 Percent Change 2001 Percent Change 2000 Health Plan Services: Commercial Federal Program State Programs...

  • Page 32
    ... declines in California Public Employees' Retirement System (CalPERS) accounted for 55,000 members of the decline in the large group market. This decline is partially offset by a 100,000 membership increase in our PPO/POS products in the small group and individual markets, â- Decrease in Arizona of...

  • Page 33
    ... months. The premium increases on a PMPM basis were in large, small and individual groups across all states averaging 11%, 13% and 7%, respectively. The majority of the decrease in member months were from non-renewal of members in our large group HMO product in California and Arizona, offset by...

  • Page 34
    ... in 2000. This decrease is primarily due to a decline in business volume from certain customers that decided to perform their claims processing and bill review functions in-house. HEALTH PLAN SERVICES COSTS Government Contracts revenues increased $73.9 million or 5.8% for the year ended December 31...

  • Page 35
    ...certain TRICARE contracts where the copay requirement for dependents of a service person is eliminated resulting in additional health care costs that must be paid by us to the provider. GENERAL AND ADMINISTRATIVE COSTS 2002 Compared to 2001 2001 Compared to 2000 Health Plan Services MCR increased...

  • Page 36
    ... revised useful lives as a result of our operations and systems consolidation. Effective December 31, 2002, MedUnite, Inc., a health care information technology company, in which we had invested $13.4 million, was sold. As a result of the sale, our original investments were exchanged for $1 million...

  • Page 37
    ... and corporate offices within the Company. As of September 30, 2002, the termination of positions in connection with the 2001 Plan had been completed and we recorded a modification of $1.5 million to reflect an increase in the severance and related benefits in connection with the 2001 Plan from...

  • Page 38
    ... sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for $15 million, payable by a secured five-year note bearing eight percent interest per annum. We estimated and recorded a $76.1 million pretax loss on the sales of our Florida health plan and the related...

  • Page 39
    ... of certain baseline medical loss ratios. Final settlement is not scheduled to occur until the latter part of 2003. The development of claims and claims related metrics and information provided by Florida Health Plan Holdings II, L.L.C. have not resulted in any revisions to the maximum $28 million...

  • Page 40
    ...control over health care costs while providing members with quality care. Factors such as health care reform, regulatory changes, increased cost of medical services, utilization, new technologies and drugs, hospital costs, major epidemics and numerous other external influences may affect the Company...

  • Page 41
    ... FLOWS 2002 Compared to 2001 The Company believes that cash from operations, existing working capital, lines of credit, and funds from any potential divestitures of business are adequate to fund existing obligations, introduce new products and services, and continue to develop health care-related...

  • Page 42
    ... expenses for all business units within the Company (the 2001 Plan). In connection with the 2001 Plan, we decided on enterprise-wide staff reductions and consolidations of certain administrative, financial and technology functions. As of December 31, 2002, we had completed the 2001 Plan and recorded...

  • Page 43
    ...health care companies. MedUnite, Inc. provides online internet provider connectivity services including eligibility information, referrals, authorizations, claims submission and payment. The funded amounts were included in other noncurrent assets. Effective December 31, 2002, MedUnite, Inc. was sold...

  • Page 44
    ... the final order; our non-compliance with any material terms of HMO or insurance regulations pertaining to fiscal soundness and not cured or waived within 30 days, solvency or financial condition; the occurrence of specified adverse events in connection with any employee pension benefit plan of ours...

  • Page 45
    ... for the year ended December 31, 2002. REVENUE RECOGNITION Health plan services premiums include HMO, POS and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage, for which premiums are based on a predetermined prepaid fee...

  • Page 46
    ... patterns and changes in membership. The estimates for service costs 0.2 % (0.5)% 0.1 % (0.1)% (1.4)% (0.3)% (0.4)% (0.5)% (0.4)% Our HMOs in California and Connecticut generally contract with various medical groups to provide professional care to certain of its members on a capitated, or fixed...

  • Page 47
    ... Shared-risk arrangements provide for our providers and us to share in the variance between actual costs and predetermined goals. Our health plans in Connecticut, New Jersey and New York market to small employer groups through a marketing agreement with The Guardian Life Insurance Company of America...

  • Page 48
    ...profiles of the Company in comparison to the guideline companies. Methodologies for selecting guideline companies include the exchange methodology and the acquisition methodology. The exchange methodology is based upon transactions of minority-interests in publicly traded companies engaged in a line...

  • Page 49
    ...insurance for employees in the small group market, (iii) prevent the exclusion of individuals from coverage under group plans based on health status, and (iv) establish national standards for the electronic exchange of health information. In December 2000, the Department of Health and Human Services...

  • Page 50
    ... market risk associated with its investments, the Company has some interest rate market risk due to its floating rate borrowings. Notes payable totaled $398.8 million as of December 31, 2002 with a related interest rate of 8.375%. The interest rate on borrowings under the revolving credit facility...

  • Page 51
    ... in this Annual Report. The consolidated financial statements and related information were prepared in accordance with accounting principles generally accepted in the United States of America and include certain amounts that are based on management's best estimates and judgments. The Company's Chief...

  • Page 52
    ... Health Net, Inc. December 31, (Amounts in thousands) 2002 2001 ASSETS Current Assets: Cash and cash equivalents Investments - available for sale Premiums receivable, net of allowance for doubtful accounts (2002 - $13,964; 2001 - $14,595) Amounts receivable under government contracts Reinsurance...

  • Page 53
    ..., Inc. Year Ended December 31, (Amounts in thousands, except per share data) 2002 2001 2000 REVENUES Health plan services premiums Government contracts Net investment income Other income Total revenues EXPENSES $ 8,584,418 1,498,689 65,561 52,875 10,201,543 $ 8,576,202 1,339,066 78,910 70,...

  • Page 54
    ...net of tax of $5,741 Total comprehensive income Exercise of stock options including related tax benefit Repurchases of common stock Issuance of restricted stock Amortization of restricted stock Employee stock purchase plan Balance at December 31, 2002 See accompanying notes to consolidated financial...

  • Page 55
    ... Compensation Total Balance at January 1, 2000 Comprehensive income: Net income Change in unrealized depreciation on investments, net of tax of $343 Total comprehensive income Exercise of stock options including related tax benefit Conversion of Class B to Class A Employee stock purchase plan...

  • Page 56
    ... in assets and liabilities, net of effects of dispositions: Premiums receivable and unearned premiums Other assets Amounts receivable/payable under government contracts Reserves for claims and other settlements Accounts payable and other liabilities Net cash provided by operating activities CASH...

  • Page 57
    ... 15 states through group, individual, Medicare, Medicaid and TRICARE (formerly known as the Civilian Health and Medical Program of the Uniformed Services (CHAMPUS)) programs. Our subsidiaries also offer managed health care products related to behavioral health, dental, vision and prescription drugs...

  • Page 58
    ...-sponsored managed care plans through the TRICARE programs, behavioral health, dental and vision, and managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities. NOTE 2-Summary of Significant Accounting Policies Consolidation...

  • Page 59
    ... care to enrolled members on a capitation basis. Our HMOs also contract with hospitals, physicians and other providers of health care, pursuant to discounted fee-for-service arrangements, hospital per diems, and case rates under which providers bill the HMOs for each individual service provided...

  • Page 60
    ... million and $224.0 million for health care services already provided under these contracts as of December 31, 2002 and 2001, respectively. Property and Equipment Investments classified as available for sale are reported at fair value based on quoted market prices, with unrealized gains and losses...

  • Page 61
    ... assets consist of the value of employer group contracts, provider networks and non-compete agreements. In July 2001, the Financial Accounting Standards Board (FASB) issued two new pronouncements: Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and SFAS No...

  • Page 62
    ... Health Plans Health Dental/Vision Subacute Services Group Total Balance at January 1, 2001 Amortization Other adjustments Balance at December 31, 2001 Impairment losses Reclassification from other intangible assets Goodwill written off related to sale of business unit Balance at December 31, 2002...

  • Page 63
    ... are managed within established guidelines which limit the amounts which may be invested with one issuer. Concentrations of credit risk with respect to premiums receivable are limited due to the large number of payers comprising our customer base. Our 10 largest employer groups accounted for...

  • Page 64
    ... summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While SFAS No. 148 does not amend SFAS No. 123 to require companies...

  • Page 65
    ..., except per share data): 2002 2001 2000 Net income, as reported Add: Stock-based employee compensation expense included in reported net income, net of related tax effects Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards subject to SFAS...

  • Page 66
    ... litigation related to the sale of our Florida health plan completed on August 1, 2001. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146 addresses financial accounting and reporting for costs associated with...

  • Page 67
    ...operations. During 2000, we secured an exclusive e-business connectivity services contract from the Connecticut State Medical Society IPA, Inc. (CSMS-IPA) for $15.0 million. CSMS-IPA is an association of medical doctors providing health care primarily in Connecticut. The amounts paid to CSMS-IPA for...

  • Page 68
    ...health care companies. MedUnite, Inc. provides online internet provider connectivity services including eligibility information, referrals, authorizations, claims submission and payment. The funded amounts were included in other noncurrent assets. Effective December 31, 2002, MedUnite, Inc. was sold...

  • Page 69
    ...as follows: 2002 (Amounts in thousands) Amortized Cost Gross Unrealized Holding Gains Gross Unrealized Holding Losses Carrying Value Mortgage-backed securities Asset-backed securities U.S. government and agencies Obligations of states and other political subdivisions Corporate debt securities Other...

  • Page 70
    ..., 2001, we entered into credit agreements for two new revolving syndicated credit facilities with Bank of America, N.A. as administrative agent, that replaced our previous credit facility. The new facilities, provide for an Scheduled principal repayment on the senior notes payable for the next five...

  • Page 71
    ... credit rating at the time of the borrowing. The maximum amount outstanding under the previous credit facility during 2001 was $766 million. NOTE 7-Stock Option and Employee Stock Purchase Plans We have various stock option plans which cover certain employees, officers and non-employee directors...

  • Page 72
    ...of a Right, other than any Acquiring Person or Adverse Person, to purchase, upon exercise at the then-current exercise price of such Right, that number of shares of Class A Common Stock having a market value of two times such exercise price. In addition and subject to certain exceptions contained in...

  • Page 73
    .... Under these plans, we pay a percentage of the costs of medical, dental and vision benefits during retirement. The plans include certain costsharing features such as deductibles, co-insurance and maximum annual benefit amounts which vary based principally on years of credited service. SFAS No...

  • Page 74
    ... medical benefit plans. The Health Net plan is non-contributory for employees retired prior to December 1, 1995 who have attained the age of 62; employees retiring after December 1, 1995 who have attained age 62 contribute from 25% to 100% of the cost of coverage depending upon years of service...

  • Page 75
    ... compensation increases of between 2.0% to 6.0% for the years ended December 31, 2002 and 2001 were assumed for the pension benefit plans. For measurement purposes, depending upon the type of coverage offered, an 11.0% to 15.0% annual rate of increase in the per capita cost covered health care...

  • Page 76
    ... Superior National Insurance Group, Inc. v. Foundation Health Corporation, Foundation Health Systems, Inc. and Milliman & Robertson, Inc. (M&R), filed on April 28, 2000, in the United States Bankruptcy Court for the Central District of California, case number SV00-14099GM. The lawsuit relates to the...

  • Page 77
    ... or financial condition. STATE OF CONNECTICUT V. PHYSICIANS HEALTH SERVICES , INC . FPA MEDICAL MANAGEMENT, INC . Since May 1998, several complaints have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of...

  • Page 78
    ... above, the United States Court of Appeals for the Second Circuit affirmed dismissal of on March 27, 2002. We filed a motion to dismiss the lead subscriber track case, Romero v. Foundation Health Systems, Inc., and on June 12, 2001, the court entered an order dismissing all claims in that suit...

  • Page 79
    ... Jersey v. Health Net, Inc., et al., (D. N.J.) (filed in New Jersey state court on May 8, 2002). On August 17, 2000, a complaint was filed in the United States District Court for the Southern District of Florida in Shane, the lead provider track action in MDL 1334. The complaint seeks certification...

  • Page 80
    ... class action allegedly brought on behalf of individual physicians in California who provided health care services to members of the defendants' health plans. The complaint alleges violations of RICO, ERISA, certain federal regulations, the California Business and Professions Code and certain state...

  • Page 81
    ... known as CIGNA), United Healthcare of New Jersey, Inc. and United Healthcare Insurance Company and Oxford Health Plans, Inc. The complaint seeks certification of a statewide class of healthcare providers who render or have rendered services to patients who are members of health care plans sponsored...

  • Page 82
    ... mail order, network claims processing and other pharmacy benefit management services. Future minimum commitments are approximately $24 million and are included in the table below. In December 1998, we entered into a long-term services agreement with an external third-party to provide call center...

  • Page 83
    ... revised useful lives as a result of our operations and systems consolidation. Effective December 31, 2002, MedUnite, Inc., a health care information technology company, in which we had invested $13.4 million, was sold. As a result of the sale, our original investments were exchanged for $1 million...

  • Page 84
    ... and corporate offices within the Company. As of September 30, 2002, the termination of positions in connection with the 2001 Plan had been completed and we recorded a modification of $1.5 million to reflect an increase in the severance and related benefits in connection with the 2001 Plan from...

  • Page 85
    .... Our current Health Plan Services reportable segment includes the operations of our health plans in the states of Arizona, California, Connecticut, New Jersey, New York, Oregon and Pennsylvania, the operations of our health and life insurance companies and our behavioral health, dental, vision and...

  • Page 86
    ...reportable segments, Health Plan Services and Government Contracts. Shared service expenses include costs for information technology, finance, operations and certain other administrative functions. Beginning January 1, 2002, we implemented several initiatives to reduce our general and administrative...

  • Page 87
    ...corporate entities and employer services group subsidiary, which are not part of our Health Plan Services and Government Contracts reportable segments, are excluded from our measurement of segment performance. Other corporate entities include our facilities, warehouse, reinsurance and surgery center...

  • Page 88
    ... . EXECUTIVE OFFICERS 21650 Oxnard Street Woodland Hills, California 91367 800.291.6911 818.676.6000 www.health.net INDEPENDENT AUDITORS Richard W. Hanselman 2,6 Chairman of the Board - Health Net, Inc. Corporate Director and Consultant J. Thomas Bouchard 2,3 Former Senior Vice President of Human...

  • Page 89
    Health Net's Executive Committee: Front (L to R): Karin Mayhew, Jay Gellert Back (L to R): Curt Westen, David Olson, Marv Rich, Chris Wing, Jeff Folick, Jim Woys

  • Page 90
    21650 OXNARD STREET WOODLAND HILLS CALIFORNIA 91367 W W W. H E A LT H . N E T