Health Net 2003 Annual Report Download - page 39

Our product line in our health plan operations has begun to change over the past few years. We have been selling
PPO products at a faster growth rate than HMOs, which historically has been our largest enrollment. At the end of 2003,
approximately 50% of our commercial enrollment was in HMO products, down from 65% as of December 31, 2001. In
response to growing demand from employers for more flexible product lines, we are developing and plan to introduce
Consumer Directed Health Plan products in the next several years. In 2003, we test marketed one such product in our
Oregon health plan.
We expect commercial premium yields to increase at a slower rate in 2004 compared to the 11.8% yield achieved in
2003. This is consistent with expected declines in overall health care cost trends and in line with our philosophy of
maintaining premium prices slightly higher than our health care cost trends. We believe this slowing of rate increases is
consistent with industry trends for 2004. In Medicare, we expect that premium revenues will rise at a faster pace due to
increased funding from the Medicare reform legislation. We expect that Medicaid premiums will again rise at a slower
rate than health care costs and expect that they will decline slightly in California, due to the state’s budget pressures. This
expectation is consistent with our ongoing overall strategic approach to participate selectively in the Medicaid market.
Since much of our Medi-Cal membership is serviced by medical groups to whom we make capitation payments, our
revenues and profit margin are not significantly impacted by these declining premiums.
With respect to our G&A expenses, we expect that growth in overall spending will continue in the first half of 2004
with the continued funding of the Health Net One systems consolidation project described below. As a result, we expect to
see a decline in the administrative ratio in the second half of 2004 as we eliminate expenses associated with the project,
eliminate the need to maintain two separate technology platforms and begin to realize savings.
We believe that managing health care costs is an essential function for a managed care company. In 2003, hospital
costs rose at a faster pace than other costs. We have implemented a number of projects to curtail the rate of growth in
hospital costs and expect the rate of growth to slow in 2004 from the 12.8% recorded in 2003. These projects include new
contracting strategies, including an increase in the use of reimbursement methodologies that are not based on hospital
billed charges, and other techniques. Among the medical management techniques we utilize to contain the growth of
health care costs are pre-authorization or certification for outpatient and inpatient hospitalizations and a concurrent review
of active inpatient hospital stays and discharge planning. We also contract with third parties to manage certain conditions
such as neonatal intensive care unit admissions and stays, as well as chronic conditions such as asthma, diabetes and
congestive heart failure. These techniques are widely used in the managed care industry and are accepted practice in the
medical profession.
In 2003, our physician cost increases were 3.9%, consistent with expectations. Pharmaceutical costs for all lines
declined slightly in 2003 as compared with the industry trend of an approximate 12% increase and prior year trends in the
low double and high single digit percentages. Increased use of multi-tier benefits, increased use of generic drugs and the
conversion of two popular medications to over-the-counter status were key factors in the slowing of the pharmaceutical
costs growth rate. We have implemented a number of techniques to contain the growth of pharmaceutical costs including,
without limitation, pre-authorization or certification for the use of certain high cost pharmaceuticals. We believe the rate
of growth in pharmaceutical costs will grow in 2004 because of increases in the cost of certain specialty pharmaceuticals
and more challenging comparisons to our performance in 2003.
TRICARE. Our Government Contracts reportable segment includes government-sponsored managed care plans
through the TRICARE programs and other government contracts. In August 2003, we were awarded a new five year
contract for the TRICARE North Region that supports nearly 2.8 million Military Health System eligible participants. The
new North Region contract covers Connecticut, Delaware, Illinois, Indiana, Kentucky, Maine, Maryland, Massachusetts,
Michigan, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Vermont,
Virginia, West Virginia, Wisconsin and the District of Columbia. In addition, the contract covers a small portion of
Tennessee, Missouri and Iowa. Health care delivery is expected to begin on the new contract on July 1, 2004 for the area
that was previously Regions 2 and 5 and September 1, 2004 for the area that was previously Region 1.
We incur administrative and health care expenses in connection with our administration of the TRICARE program in
the regions we manage on behalf of the Department of Defense. Health care expenses are directly related to the use of
civilian providers by TRICARE eligible beneficiaries and have risen in recent quarters as a direct result of increased
military activity. Increased military activity results in increased enrollment and the deployment of military medical
personnel overseas which reduces beneficiaries’ access to military treatment facilities. We expect that in 2004 we will
continue to experience elevated levels of costs due to reservist call-ups and higher utilization of civilian providers.
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