Health Net 2003 Annual Report Download - page 22

networks, we expect that price will continue to be a significant basis of competition. Our premium revenue is set in
advance of the actual delivery of services, and in certain circumstances before contracting with providers, and the related
pricing of the services rendered by these providers. While we attempt to take into account our estimate of expected health
care costs over the premium period in setting the premiums we charge, factors such as competition, regulations and other
circumstances may limit our ability to fully base premiums on estimated costs. In addition, many factors may and often do
cause actual health care costs to exceed those costs estimated and reflected in premiums. These factors may include
increased utilization of services, increased cost of individual services, catastrophes, epidemics, seasonality, new mandated
benefits or other regulatory changes, and insured population characteristics. Our financial condition or results of
operations could be adversely affected by significant premium decreases by our major competitors or by limitations on
our ability to increase or maintain our premium levels.
Our inability to estimate and maintain adequate reserves for claims may adversely affect our business, financial
condition and results of operations.
Our reserves for claims are estimates of future costs based on various assumptions. 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. Included in the reserves for claims are estimates for the costs of
services which have been incurred but not reported. These estimates are continually monitored and reviewed and, as
settlements are made or estimates adjusted, differences are reflected in current operations. Given the uncertainties inherent
in such estimates, the actual liability could differ significantly from the amounts reserved. Moreover, if the assumptions
on which the estimates are based prove to be incorrect and reserves are inadequate to cover our actual claim costs, our
business, financial condition and results of operations could be adversely affected.
We may experience losses as a result of the regional concentration of our business.
Our business operations are concentrated in the Northeast (in the states of Connecticut, New York and New Jersey)
and in the states of California, Arizona and Oregon. Due to this concentration in a small number of states, we are exposed
to a potential deterioration in our financial results resulting from the risk of a significant economic downturn in these
states. If economic conditions in these states significantly deteriorate, we may experience a reduction in existing and new
business, which may have a material adverse effect on our business, financial condition and results of operations. In
addition, if any one of our health plans experiences significant losses, our consolidated results of operations may be
materially and adversely affected. For example, our New Jersey health plan is currently experiencing hospital cost trends
significantly higher than the trends we estimated when we established premiums and potentially higher than those of its
competitors. These higher hospital cost trends have caused a deterioration in margins and we may not be able to offset this
issue with adequate future premium increases. The deterioration in margins in New Jersey has, and may continue to have,
an adverse effect on our business, financial condition and results of operations. A similar deterioration in margins in any
one of the other small number of states we operate in could also have an adverse effect on our financial condition and
results of operations. For additional information regarding the challenges we face in the Northeast and, in particular, New
Jersey, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Executive
Summary — Operating Highlights and Outlook for 2004.”
If we are unable to forecast and manage hospital and pharmaceutical costs, our revenues could decline and our
results of operations could be adversely affected.
One of the fastest increasing categories of our health care costs are the costs of hospital based products and services.
Thus, in addition to the circumstances and factors that may limit our ability to fully base premiums on estimated costs, our
HMOs face an even higher risk with hospital expenses that could have a material adverse effect. Factors underlying the
increase in hospital costs include, but are not limited to, the underfunding of public programs, such as Medicaid and
Medicare, growing rates of uninsured individuals, new technology, state initiated mandates, alleged abuse of hospital
chargemasters, an aging population and, under certain circumstances, relatively low levels of hospital competition.
Significant consolidation of hospital providers in certain markets in which we operate may continue to limit our ability to
negotiate favorable rates for hospital services.
Another significant category of our health care costs are costs of pharmaceutical products and services. Although
pharmaceutical costs have not been increasing at the level of hospital costs, evolving regulation may impact the ability of
our HMOs to continue to receive existing price discounts on pharmaceutical products for our members. Other factors
affecting our pharmaceutical costs include, but are not limited to, the price of drugs, utilization of new and existing drugs
and changes in discounts. The inability to forecast and manage these costs could have an adverse effect on our financial
condition and results of operations.
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