Health Net 2002 Annual Report Download - page 40

38 | HEALTH NET, INC.
The Company’s ability to expand its business is
dependent, in part, on competitive premium pricing and its
ability to secure cost-effective contracts with providers.
Achieving these objectives is becoming increasingly diffi-
cult due to the competitive environment. In addition, the
Company’s profitability is dependent, in part, on its ability
to maintain effective 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’s operating
results. Accordingly, past financial performance is not
necessarily a reliable indicator of future performance, and
investors should not use historical records to anticipate
results or future period trends.
The Company’s HMO and insurance subsidiaries are
required to maintain reserves to cover their estimated ulti-
mate liability for expenses with respect to reported and
unreported claims incurred. These reserves are estimates of
future costs based on various assumptions. Establishment
of appropriate reserves is an inherently uncertain process,
and there can be no certainty that currently established
reserves will prove adequate in light of subsequent actual
experience, which in the past has resulted, and in the
future could result, in loss reserves being too high or too
low. The accuracy of these estimates may be affected by
external forces such as changes in the rate of inflation, the
regulatory environment, the judicious administration of
claims, medical costs and other factors. Future loss devel-
opment or governmental regulators could require reserves
for prior periods to be increased, which would adversely
impact earnings in the periods in which such additional
reserves are accrued. In light of present facts and current
legal interpretations, management believes that adequate
provisions have been made for claims and loss reserves.
We contract with physician providers in California and
Connecticut primarily through capitation fee arrangements
for our HMO products. We also use capitation fee arrange-
ments in areas other than California and Connecticut to a
lesser extent. Under a capitation fee arrangement, we pay
the provider a fixed amount per member on a regular basis
and the provider accepts the risk of the frequency and cost
of member utilization of services. The inability of providers
to properly manage costs under capitation arrangements
can result in financial instability of such providers. Any
financial instability of capitated providers could lead to
claims for unpaid health care against us, even if we have
made our regular payments to the capitated providers.
Depending on state law, we may or may not be liable for
such claims. The California agency that until July 1, 1999
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 2002, we adopted SFAS No. 142 which,
among other things, eliminates amortization of goodwill and
other intangibles with indefinite lives. Intangible assets,
including goodwill, that are not subject to amortization
will be tested for impairment annually or more frequently
if events or changes in circumstances indicate that we
might not recover the carrying value of these assets.
We identified the following six reporting units with
goodwill within our businesses: Health Plans, Government
Contracts, Behavioral Health, Dental & Vision, Subacute
and Employer Services Group. In accordance with the
transition requirements of SFAS No. 142, we completed an
evaluation of goodwill at each of our reporting units upon
adoption of this Standard. We used an independent third-
party professional services firm with knowledge and expe-
rience in performing fair value measurements to assist us
in the impairment testing and measurement process. As a
result of these impairment tests, we identified goodwill
impairment at our behavioral health subsidiary and at our
employer services group subsidiary in the amounts of $3.5
million and $5.4 million, respectively. Accordingly, we
recorded an impairment charge of goodwill of $8.9
million, net of tax benefit of $0, which has been reflected
as a cumulative effect of a change in accounting principle
in the consolidated statement of operations for the first
quarter ended March 31, 2002. As part of our annual
goodwill impairment test, we completed an evaluation of
goodwill with the assistance of the same independent
third-party professional services firm at each of our
reporting units as of June 30, 2002. No goodwill impair-
ments were identified in any of our reporting units. We
will perform our annual goodwill impairment test as of
June 30 in future years. Refer to Note 2 of the Notes to
Condensed Consolidated Financial Statements for more
information on our goodwill.
IMPACT OF INFLATION AND OTHER ELEMENTS
The managed health care industry is labor intensive and its
profit margin is low; hence, it is especially sensitive to
inflation. Increases in medical expenses or contracted
medical rates without corresponding increases in premiums
could have a material adverse effect on the Company.
Various federal and state legislative initiatives
regarding the health care industry continue to be proposed
during legislative sessions. If further health care reform or
similar legislation is enacted, such legislation could impact
the Company. Management cannot at this time predict
whether any such initiative will be enacted and, if enacted,
the impact on the financial condition or results of opera-
tions of the Company.