Health Net 2004 Annual Report Download - page 22

We face competitive pressure to contain premium prices.
In addition to the challenge of controlling health care costs, we face competitive pressure to contain premium prices. While
health plans compete on the basis of many factors, including service and the quality and depth of provider 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. 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 disparities between the premium increases of our health plans and those of our major competitors or by limitations on our
ability to increase or maintain our premium levels.
Over the course of 2004, we instituted premium increases at the high end of the range of premium increases instituted by our
competitors. We lost members as a result of these premium increases and could lose additional members in the future. Maintaining
premiums at the high end of the market also increases the risk that our health plans are affected by “adverse risk selection.” Adverse
risk selection occurs when members who utilize higher levels of health care services compared with the insured population as a whole
choose to remain with our health plans at the higher premium rates rather than risk moving to another plan. This could cause health
care costs to be higher than anticipated and therefore cause our financial results to fall short of expectations.
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. For example, throughout 2004, we had to continually increase reserves due to changes in
claim payment patterns in our California health plan. In the fourth quarter of 2004, we recorded a $252 million pre-tax earnings
charge. Of the $252 million recorded, $65 million related to adverse reserve development ($9 million of which related to 2003 and
prior). The prior period adverse reserve development was due in part to the changes in payment practices in our California health plan
and to inadequate reserves previously booked for claims costs during 2004. For additional information on the fourth quarter 2004
earnings charge, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 16
to our consolidated financial statements. 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
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