Health Net 2010 Annual Report Download - page 61

How We Measure Our Profitability
Our profitability depends in large part on our ability to, among other things, effectively price our health care
products; manage health care costs, and pharmacy costs; contract with health care providers; attract and retain
members; and manage our general and administrative (“G&A”) and selling expenses. In addition, factors such as
state and federal health care reform legislation and regulation, competition and general economic conditions
affect our operations and profitability. The effect of escalating health care costs, as well as any changes in our
ability to negotiate competitive rates with our providers, may impose further risks to our ability to profitably
underwrite our business, and may have a material impact on our business, financial condition or results of
operations.
We measure our Western Region Operations reportable segment profitability based on medical care ratio
(“MCR”) and pretax income. The MCR is calculated as health plan services expense divided by health plan
services premiums. The pretax income is calculated as health plan services premiums and administrative services
fees and other income less health plan services expense and G&A and other net expenses. See “—Results of
Operations—Western Region Operations Reportable Segment—Western Region Operations Segment Results”
for a calculation of the MCR and pretax income.
Health plan services premiums include health maintenance organization (“HMO”), point of service (“POS”)
and preferred provider organization (“PPO”) premiums from employer groups and individuals and from
Medicare recipients who have purchased supplemental benefit coverage (which premiums are based on a
predetermined prepaid fee), Medicaid revenues based on multi-year contracts to provide care to Medicaid
recipients, and revenue under Medicare risk contracts, including Medicare Part D, to provide care to enrolled
Medicare recipients. Medicare revenue can also include amounts for risk factor adjustments and additional
premiums that we charge in some places to members who purchase our Medicare risk plans. The amount of
premiums we earn in a given period is driven by the rates we charge and enrollment levels. Administrative
services fees and other income primarily include revenue for administrative services such as claims processing,
customer service, medical management, provider network access and other administrative services. Health plan
services expense includes medical and related costs for health services provided to our members, including
physician services, hospital and related professional services, outpatient care, and pharmacy benefit costs. These
expenses are impacted by unit costs and utilization rates. Unit costs represent the health care cost per visit, and
the utilization rates represent the volume of health care consumption by our members.
G&A expenses include those costs related to employees and benefits, consulting and professional fees,
marketing, premium taxes and assessments, occupancy costs and litigation and regulatory-related costs. Such
costs are driven by membership levels, introduction of new products, system consolidations, outsourcing
activities and compliance requirements for changing regulations. These expenses also include expenses
associated with corporate shared services and other costs to reflect the fact that such expenses are incurred
primarily to support health plan services. Selling expenses consist of external broker commission expenses and
generally vary with premium volume.
We measure our Government Contracts segment profitability based on government contracts cost ratio and
pretax income. The government contracts cost ratio is calculated as government contracts cost divided by
government contracts revenue. The pretax income is calculated as government contracts revenue less government
contracts cost. See “—Results of Operations—Government Contracts Reportable Segment—Government
Contract Segment Results” for a calculation of the government contracts ratio and pretax income.
Government Contracts revenue is made up of two major components: health care and administrative
services. The health care component includes revenue recorded for health care costs for the provision of services
to our members, including paid claims and estimated incurred but not reported claims (“IBNR”) expenses for
which we are at risk, and underwriting fees earned for providing the health care and assuming underwriting risk
in the delivery of care. The administrative services component encompasses fees received for all other services
provided to both the government customer and to beneficiaries, including services such as medical management,
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