Health Net 2005 Annual Report Download - page 70

claims), and other liabilities including capitation payable, shared risk settlements, provider disputes, provider
incentives and other reserves for our two reporting segments, Health Plan Services and Government Contracts.
As of December 31, 2005, Health Plan Services reserves for claims comprised approximately 74% of reserves for
claims and other settlements. See Note 16 to our accompanying consolidated financial statements for a
reconciliation of changes in the reserve for claims.
We estimate the amount of our reserves for claims primarily by using standard actuarial developmental
methodologies. This method is also known as the chain-ladder or completion factor method. The developmental
method estimates reserves for claims based upon the historical lag between the month when services are rendered
and the month claims are paid while taking into consideration, among other things, expected medical cost
inflation, seasonality patterns, product mix, benefit plan changes and changes in membership. A key component
of the developmental method is the completion factor which is a measure of how complete the claims paid to
date are relative to the estimate of the claims for services rendered for a given period. While the completion
factors are reliable and robust for older service periods, they are more volatile and less reliable for more recent
periods since a large portion of health care claims are not submitted to us until several months after services have
been rendered. Accordingly, for the most recent months, the incurred claims are estimated from a trend analysis
based on per member per month claims trends developed from the experience in preceding months. This method
is applied consistently year over year while assumptions may be adjusted to reflect changes in medical cost
inflation, seasonality patterns, product mix, benefit plan changes and changes in membership.
An extensive degree of actuarial judgment is used in this estimation process, considerable variability is
inherent in such estimates, and the estimates are highly sensitive to changes in medical claims submission and
payment patterns and medical cost trends. As such, the completion factors and the claims per member per month
trend factor are the most significant factors used in estimating our reserves for claims. Since a large portion of the
reserves for claims is attributed in the most recent months, the estimated reserves for claims is highly sensitive to
these factors. The following table illustrates the sensitivity of these factors and the estimated potential impact on
our operating results caused by these factors:
Completion Factor (a)
Increase (Decrease)
in Factor
Health Plan Services
Increase (Decrease) in
Reserves for Claims
2% $ (46.4) million
1% $ (23.7) million
(1)% $ 24.6 million
(2)% $ 50.1 million
Medical Cost Trend (b)
Increase (Decrease)
in Factor
Health Plan Services
Increase (Decrease) in
Reserves for Claims
2% $ 22.7 million
1% $ 11.4 million
(1)% $ (11.4) million
(2)% $ (22.7) million
(a) Impact due to change in completion factor for the most recent three months. Completion factors indicate
how complete claims paid to date are in relation to the estimate of total claims for a given period. Therefore,
an increase in completion factor percent results in a decrease in the remaining estimated reserves for claims.
(b) Impact due to change in annualized medical cost trend used to estimate the per member per month cost for
the most recent three months.
Other relevant factors include exceptional situations that might require judgmental adjustments in setting the
reserves for claims, such as system conversions, processing interruptions or changes, environmental changes or
other factors. In California, there were significant improvements in the claims processing that had a material
impact upon the reserve levels as of December 31, 2005. None of the other factors had a material impact on the
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